Disclosure considerations for risks and impacts of the Coronavirus are evolving at a fast pace.  On February 19, 2020, the SEC Chairman, CorpFin Director and Chief Accountant and the PCAOB Chairman issued a Statement addressing reporting considerations and potential reporting relief about this rapidly evolving situation.  (The Statement also addresses certain multinational auditing considerations.)  The Statement includes this suggestion:

“we urge issuers to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements.”

The Statement also specifically mentions subsequent event disclosure considerations.

Another resource that companies may find valuable is this memo from Nelson Mullins which addresses areas beyond financial reporting, including:

• the SEC’s forward-looking disclosure obligations and decision-making matrix when outcomes are uncertain but a known trend or uncertainty will be (or is “likely to cause” under the proposed SEC rules issued January 30, 2020) a material change

• selected disclosure considerations by industry

• environmental, social and governance (“ESG”) considerations

• the role Board members and executives have in SEC disclosure

• enhanced labor and employment law, data privacy and cybersecurity considerations

As always, your thoughts and comments are welcome!

As many of you may know, SEC Institute’s Associate Director Bob Laux, who is instrumental in making SECI’s Midyear and Annual Forums such great programs, actually wore two professional hats for many years.  In addition to his position at SECI, Bob was also the North American Lead of the International Integrated Reporting Counsel.  With this wealth of experience Bob helps us all understand more about integrated reporting and how it is more than just “ESG” disclosures, this proposed addition to S-K Item 101(c), in the SEC’s August 9, 2019 proposed rule to modernize certain parts of Regulation S-K, caught our attention:

A description of the registrant’s human capital resources, including in such description any human capital measures or objectives that management focuses on in managing the business (such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the attraction, development, and retention of personnel).

Here are some of Bob’s thoughts on this issue:

This proposed change is a perfect example of moving beyond the traditional reporting model to a more complete reporting model.  As described in The Conference Board Report, “The Emergence of Integrated Reporting”:

Over the last 30 years, intangible assets have moved from 20 percent to over 80 percent of the value of public companies, yet decision making within companies has failed to keep pace. Financial reporting has made even less progress in addressing these changes. As they take ESG impacts ever more seriously, US investors are urging management and the board to adopt a reporting method that accounts for both tangible and intangible assets. “Integrated reporting” is such a method: it provides a framework that highlights all the ways a company creates and will continue to create value.

 For instance, human capital – people’s competencies, capabilities, experience, and motivation to innovate – is often the most significant asset an organization has as business models become centered on people and technology.  The SEC rule proposal is consistent with the concept of integrated reporting and previous comments from SEC Chairman Jay Clayton, where he indicated:

Today, human capital and intellectual property often represent an essential resource and driver of performance for many companies.  This is a shift from human capital being viewed, at least from an income statement perspective, as a cost . . . I think investors would be better served by understanding the lens through which each company looks at their human capital.   Does management focus on the rate of turnover, the percentage of their workforce with advanced degrees or relevant experience, the ease or difficulty of filling open positions, or some other factors?

As always, your thoughts and comments are welcome!

In this post we discussed the SEC’s new Release about the use of metrics.  One of the points the SEC emphasized in this release was consistency.  If a company changes how a metric is computed or changes its presentation to discontinue use of a previously presented metric, it should make appropriate disclosure about the change and the reasons for the change.

This Investor FAQ Document from Square provides an example of such a disclosure.  While this example is about a non-GAAP measure rather than a pure metric, it is an example of making disclosures about changes in the presentation of information outside the financial statements.

You will see that this document starts with two fundamental questions:

What change is being made to Square’s reporting?

Why were you using the Adjusted Revenue measure?

While there is no formal standard about such disclosure, it is clearly important to tell investors about such changes in a full and forthright manner.

As always, your thoughts and comments are welcome.

On January 30, 2020 the SEC issued formal guidance in a Financial Release about the use of key performance indicators and metrics.  This new Release, number 33-10751 or FR 87, was issued at the same time as a proposed rule to amend the MD&A requirements and eliminate S-K Item 301 Selected Financial Data and the quarterly information required by S-K Item 302.

While the MD&A changes and elimination of S-K Items 301 and 302 are all proposed, the new guidance about the use of metrics is not a proposed rule and its requirements will be effective when it is published in the Federal Register.

(We will put up a post when the Release is published in the Federal Register.)

Its imminent effectiveness makes becoming familiar with the Release important when preparing earnings releases as it may well apply to key performance indicators and metrics in year-end earnings releases and will almost certainly apply to such measures used in first quarter earnings releases.

As a brief review the SEC addressed Key Performance Indicators in its 2003 MD&A release, (33-8350 – FR 72):

1. Focus on Key Indicators of Financial Condition and Operating Performance

As discussed, one of the principal objectives of MD&A is to give readers a view of the company through the eyes of management by providing both a short and long-term analysis of the business.   To do this, companies should “identify and address those key variables and other qualitative and quantitative factors which are peculiar to and necessary for an understanding and evaluation of the individual company.”

Financial measures generally are the starting point in ascertaining these key variables and other factors. However, financial measures often tell only part of how a company manages its business. Therefore, when preparing MD&A, companies should consider whether disclosure of all key variables and other factors that management uses to manage the business would be material to investors, and therefore required.   These key variables and other factors may be non-financial, and companies should consider whether that non-financial information should be disclosed.

Over the years the staff has asked companies to provide additional information about their use of metrics in the comment process.  You can find some examples in this post which provides deeper background about metrics, this post with example SEC comments on the use of metrics and this post about an enforcement case focused on metrics.

In this new Release the SEC builds on and formalizes what it did in FR 72 and its comments about metrics in filing reviews.  The major points the SEC focuses on in the new Release include:

1. Metrics should be used with care to assure they are not misleading.

The release states:

“When including metrics in their disclosure, companies should consider existing MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading.”

This language harkens back to Exchange Act Rule 12b-20:

12b-20   Additional information.

In addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading.

A perhaps extreme example of this situation would be presenting a metric that shows a business as improving and getting stronger when on a GAAP basis it is experiencing widening losses and potential liquidity issues.

2.  When presenting a metric companies should consider whether an existing set of requirements such as GAAP, IFRS or the SEC’s non-GAAP measure guidance in Regulation G or Regulation S-K Item 10(e) applies.

3.  When presenting a metric, companies should consider what additional information should be presented to “provide adequate context” for investors to understand the metric and the information it conveys. The Release indicates that the SEC would “generally expect” these disclosures:

“A clear definition of the metric and how it is calculated;

A statement indicating the reasons why the metric provides useful information to investors; and

A statement indicating how management uses the metric in managing or monitoring the performance of the business.”

The release also notes that if there are “estimates or assumptions underlying the metric or its calculation careful consideration should be given to disclosure of such items to assure the metric is not materially misleading”.

4.  The release emphasizes consistency in the preparation and presentation of metrics, an issue that the SEC has dealt with in the comment process. For example, when a company changes how a metric is computed it likely should explain why the change was made and what the impact of the change was. Additionally, if a new metric is presented or a previously presented metric is discontinued, this should likely be discussed and the metric for previous periods may need to be recomputed.

The Release states:

“If a company changes the method by which it calculates or presents the metric from one period to another or otherwise, the company should consider the need to disclose, to the extent material:

(1) the differences in the way the metric is calculated or presented compared to prior periods,

(2) the reasons for such changes,

(3) the effects of any such change on the amounts or

(4) such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company’s performance or prospects.

Depending on the significance of the change(s) in methodology and results, the company should consider whether it is necessary to recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context.”

5.  FR 87 also emphasizes that metrics should be considered in a company’s disclosure controls and procedures. Disclosure controls and procedures (DCP) are defined in Exchange Act Rule 13(a)-15:

(e) For purposes of this section, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Since DCP are applicable in reports “filed or submitted” and earnings releases are furnished to the SEC in an Item 2.02 Form 8-K it is important that metrics that provide material information be considered in the DCP process.  A likely starting point in this consideration is: are metrics included in your disclosure committee’s discussions?

Clearly the SEC will begin to focus on how companies use metrics and the adequacy of disclosures around metrics.  As an example of issues to consider, you could review this section at the beginning of Facebook’s most recent Form 10-K titled “Limitations of Key Metrics and Other Data” or the section about metrics at the beginning of Twitter’s 2018 Form 10-K.

In our next post we will review an example of the disclosures a company made when they decided to change their presentation of a metric like non-GAAP measure.

As always, your thoughts and comments are welcome.

ICFR is clearly a hot topic on the SEC and PCAOB agendas as the recent MetLife enforcement and other developments demonstrate.  And, ICFR over unusual transactions and new accounting standard implementation present significant challenges.  Reed Wilson, one of the workshop leaders of our Form 10-K In-Depth Workshop, who is also a member of the FEI Committee on Corporate Reporting (Yes, that is CCR! How about “Down on the Corner” as a theme song?), alerted us to some very useful preparer build ICFR aids from CCR at FEI.  The first deals with ICFR over the business combinations process:

A Guide to Designing and Operating an Effective System of Internal Control Over Business Combinations

CCR also published two Insight Guides dealing with ICFR considerations for the Lease Accounting Standardand CECL.

Thanks to Reed and FEI and, as always, your thoughts and comments are welcome!

One of the more subtle issues we discussed in our recent Sixth Annual Form 10-K Tune-up One Hour Briefing was a reminder to properly categorize (i.e., 12(b) versus 12(g) securities that the company has registered under the Exchange Act and to list all securities registered pursuant to either of those sections on the cover pages of Forms 10-K and 10-Q.  While this was not a big deal historically, the list of 12(b) securities now also requires the trading symbols to be included.

As an example shown below are the cover pages from P&G’s June 30, 2018 and 2019 Form 10-K’s.  You can see the difference in the 12(b) lists from 2018 to 2019.

As another thought, this is closely tied to the new requirement to have, as an exhibit to the Form 10-K a description of securities (as set forth in Item 202 of Regulation S-K) that are registered under section 12 (whether 12(b) or 12(g)).  You can read all the details in this blog post which will also has the detailed instructions from See S-K Item 601(b)(4)(vi) and Item 202.

In P&G’s case, they provided a separate exhibit for each class, which makes a lot of sense – some securities may go away (such as when debt securities are redeemed) and you can simply delete that exhibit in the future rather than having to amend an all-inclusive exhibit.

Which brings us to a final point – one that we noticed even with P&G – their exhibit 4.3.2, which purports to be a description of their common stock, also describes their preferred stock, none of which is outstanding nor are these classes registered under section 12.  The new exhibit requirement is NOT a requirement to provide a description of the company’s authorized capitalization – it is a requirement to provide certain information required by S-K Item 202 but only as to securities that are registered under section 12 of the Exchange Act.

Again, to see the difference compare these two P&G cover pages from 2018 and 2019:

Notice the difference in their cover page from their  June 30, 2019 10-K cover page after the Disclosure Modernization and Update rule:

As always, your thoughts and comments are welcome!

As we mentioned in our MD&A Hot Topics One-Hour Briefing on February 3^rd, the International Business Council of the World Economic Forum has been working to develop usable and practical ways of communicating ESG matters.  This report, prepared in collaboration with Deloitte, EY, KPMG and PwC and endorsed by many large public companies, is a first step in that process.

As always, your thoughts and comments are welcome!

On January 30, 2020 the SEC, as the next part of the JOB’s Act disclosure review, proposed changes to S-K Items 303 (MD&A), and also proposed to eliminate S-K Item 301 Selected Financial Data (the five year summary) and S-K Item 302 Supplementary Financial Data (the quarterly information for two years).

According to the SEC’s Release and Related Fact sheet the changes to MD&A would:

• “Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
• Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction to prompt registrants to discuss off-balance sheet arrangements in the broader context of MD&A;
• Eliminate Item 303(a)(5), Tabular disclosure of contractual obligations given the overlap with information required in the financial statements and to promote the principles-based nature of MD&A;
• Add a new disclosure requirement to Item 303, Critical accounting estimates, to clarify and codify existing Commission guidance in this area; and
• Revise the interim MD&A requirement in Item 303(b) to provide flexibility by allowing companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.”

Interestingly, along with the proposed rule the SEC issued a release that, for the first time, provides formal guidance about the use of metrics.  Again, according to the release:

“The guidance provides that, where companies disclose metrics, they should consider whether additional disclosures are necessary and gives examples of such disclosures. The guidance also reminds companies of the requirements in Exchange Act Rules 13a-15 and 15d-15 to maintain disclosure controls and procedures and that companies should consider these requirements when disclosing metrics.”

The Release about metrics will be effective upon publication in the Federal Register.

The proposed rule will have a 60 day comment period.

More about these changes in future posts, and we will also address them in our Fifth Annual MD&A Hot Topics One Hour Briefing on Monday February 3, 2020.

As always, your thoughts and comments are welcome!

Clearly ICFR is a major agenda item at the SEC and the PCAOB.  On December 18, 2019 the SEC announced that the Commission had “charged MetLife, Inc. with violating the books and records and internal accounting controls provisions of the federal securities laws relating to two errors in its accounting for reserves associated with its annuities businesses.”  MetLife will pay $10 million to settle the charges.

This case relates to the books and records and internal accounting controls provisions of the federal securities laws.  In essence it is an ICFR case, and it illustrates the importance of disclosing material weaknesses in ICFR and also makes the point that a material misstatement does not have to occur for a material weakness to exist.

In its December 31, 2017 financial statements in Form 10-K MetLife disclosed the following:

Revisions

As a result of the following adjustments, amounts previously reported have been immaterially restated. In addition, the Company has corrected other unrelated immaterial errors which were previously recorded in the periods the Company identified them.

Group Annuity Reserves

On December 15, 2017, the Company announced that it was undertaking a review of practices and procedures used to estimate its reserves related to certain Retirement and Income Solutions (“RIS”) group annuitants who have been unresponsive or missing over time. As a result of this process, the Company increased reserves by $510 million , before income tax, to reinstate reserves previously released, and to reflect accrued interest and other related liabilities. Of this increase, $372 million was considered an error and, recording this amount in the fourth quarter of 2017 financial statements would have had a material effect on the results of operations for 2017.

Assumed Variable Annuity Guarantee Reserves

An internal review of practices and procedures was completed in early 2018, focusing on the calculation of certain reserves associated with MetLife Holdings variable annuity guarantees assumed from a former operating joint venture in Japan. As a result, the Company reduced these reserves by $896 million , before income tax. Of this decrease, $682 million was considered an error and, recording this amount in the fourth quarter of 2017 financial statements would have had a material effect on the results of operations for 2017.

Interestingly, the materiality of the revisions is based on the “iron curtain” versus “roll-over” thought process in SAB 108, but the effect on each year reported was not deemed material.

With all of that as a starting point, in MetLife’s Form 10-K for the previous year, 2016, their ICFR report in Item 9A stated that ICFR was effective:

Management’s Annual Report on Internal Control Over Financial Reporting

 Management of MetLife, Inc. and subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. In fulfilling this responsibility, estimates and judgments by management are required to assess the expected benefits and related costs of control procedures. The objectives of internal control include providing management with reasonable, but not absolute, assurance that assets are safeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordance with management’s authorization and recorded properly to permit the preparation of consolidated financial statements in conformity with GAAP.

Management has documented and evaluated the effectiveness of the internal control of the Company at December 31, 2016 pertaining to financial reporting in accordance with the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 In the opinion of management, MetLife, Inc. maintained effective internal control over financial reporting at December 31, 2016 .

 Deloitte & Touche LLP, an independent registered public accounting firm, has audited the consolidated financial statements and consolidated financial statement schedules included in the Annual Report on Form 10-K for the year ended December 31, 2016 . The Report of the Independent Registered Public Accounting Firm on their audit of the consolidated financial statements and consolidated financial statement schedules is included on page 386.

MetLife’s 2017 Form 10-K Item 9A included this different report:

 Management’s Annual Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. In fulfilling this responsibility, estimates and judgments by management are required to assess the expected benefits and related costs of control procedures. The objectives of internal control include providing management with reasonable, but not absolute, assurance that assets are safeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordance with management’s authorization and recorded properly to permit the preparation of consolidated financial statements in conformity with GAAP.

Management evaluated the design and operating effectiveness of the Company’s internal control over financial reporting based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”). Solely because of the material weaknesses in internal control over financial reporting described below, in the opinion of management, MetLife, Inc. did not maintain effective internal control over financial reporting as of December 31, 2017.

 A material weakness (as defined in Rule 12b-2 under the Exchange Act) is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Identification of the Material Weaknesses in Internal Control over Financial Reporting

 The Company has identified the following deficiencies in the principles associated with both the control activities and information and communication components of the COSO framework:

 RIS Group Annuity Reserves:

 Ineffective design and operating effectiveness of the controls related to processes and procedures for identifying unresponsive and missing group annuity annuitants and pension beneficiaries (Control Activities); and

Ineffective design and operating effectiveness of the controls intended to ensure timely communication and escalation of the issue throughout the Company (Information & Communication).

 Assumed Variable Annuity Guarantee Reserves:

Ineffective design and operating effectiveness of the controls related to data validation and monitoring of reserves for variable annuity guarantees issued by a former operating joint venture in Japan and reinsured by the Company and included within MetLife Holdings (Control Activities).

 These deficiencies, if not effectively remediated, could result in unprevented and undetected misstatements of accounts or disclosures related to liabilities for certain RIS group annuity contracts and MetLife Holdings assumed variable annuity guarantee reserves. Such misstatements could result in a material misstatement of the annual or interim consolidated financial statements.

The Company’s independent registered public accounting firm, Deloitte & Touche LLP, has issued its report on its audit of the effectiveness of internal control over financial reporting, which is included on page 401.

There was no material misstatement in MetLife’s financial statements as a result of these ICFR material weaknesses.  Still, as the enforcement release brings out, the material weaknesses created books and records violations and resulted in the fine.

As always, your thoughts and comments are welcome!

On January 24, 2020 the SEC’s Division of Corporation Finance issued three C&DI’s dealing with questions surrounding the March 2019 Disclosure Modernization and Simplification rule change allowing the omission of the third year back in MD&A.  As a reminder the rule change added this instruction to S-K Item 303:

For registrants providing financial statements covering three years in a filing, discussion about the earliest of the three years may be omitted if such discussion was already included in the registrant’s prior filings on EDGAR that required disclosure in compliance with Item 303 of Regulation S-K, provided that registrants electing not to include a discussion of the earliest year must include a statement that identifies the location in the prior filing where the omitted discussion may be found.

The new C&DI’s address three issues:

Question 110.02

Question: A registrant providing financial statements covering three years in a filing relies on Instruction 1 to Item 303(a) to omit a discussion of the earliest of three years and includes the required statement that identifies the location of such discussion in a prior filing. Does the statement identifying the disclosure in a prior filing incorporate such disclosure by reference into the current filing?

Answer: No. A statement merely identifying the location in a prior filing where the omitted discussion can be found does not incorporate such disclosure into the filing unless the registrant expressly states that the information is incorporated by reference. See Securities Act Rule 411(e) and Exchange Act Rule 12b-23(e). [Jan. 24, 2020]

Question 110.03

Question: May a registrant rely on Instruction 1 to Item 303(a) to omit a discussion of the earliest of three years from its current MD&A if it believes a discussion of that year is necessary?

Answer: No. Item 303(a) requires that the registrant provide such information that it believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations. A registrant must assess its information about the earliest of three years and, if it is required by Item 303(a), include it in the current disclosure or expressly incorporate by reference its discussion from a previous filing. [Jan. 24, 2020]

Question 110.04

Question: A registrant has an effective registration statement that incorporates by reference its Form 10-K for the fiscal year ended December 31, 2018. In its Form 10-K for the fiscal year ended December 31, 2019, the registrant will omit the discussion of its results for the fiscal year ended December 31, 2017 pursuant to Instruction 1 to Item 303(a) and include a statement identifying the location of the discussion presented in its Form 10-K for the fiscal year ended December 31, 2018. The filing of the Form 10-K for the fiscal year ended December 31, 2019 will operate as the Section 10(a)(3) update to the registration statement. After the company files the Form 10-K for the fiscal year ended December 31, 2019, will the company’s discussion of its results for the fiscal year ended December 31, 2017 be incorporated by reference in the registration statement?

Answer: No. The filing of the Form 10-K for the fiscal year ended December 31, 2019 establishes a new effective date for the registration statement. As of the new effective date, the registration statement incorporates by reference only the Form 10-K for the fiscal year ended December 31, 2019, which does not contain the company’s discussion of results for the fiscal year ended December 31, 2017 unless, as indicated in Question 110.02, the information is expressly incorporated by reference. [Jan. 24, 2020]

As always your thoughts and comments are welcome!