On January 11, 2021, the SEC’s Disclosure Modernization Final Rule, “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” was published in the Federal Register.

The rule will be effective on February 10, 2021.  The rule provides for a mandatory compliance date 210 days after the publication date.  This mandatory compliance date is August 9, 2021.

This means that a company must apply the new rule for its fiscal year that ends after August 9, 2021.

The rule’s transition provisions provide for voluntary implementation earlier than a company’s mandatory compliance date.  This early implementation may be on an S-K item-by-item basis.  The Compliance Date section on page 104 of the Final Rule states that registrants:

“may provide disclosure consistent with the final amendments any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety. For example, upon effectiveness of the final amendments, a registrant may immediately cease providing disclosure pursuant to former Item 301, and may voluntarily provide disclosure pursuant to amended Item 303 before its mandatory compliance date. In this case, the registrant must provide disclosure pursuant to each provision of amended Item 303 in its entirety, and must begin providing such disclosure in any applicable filings going forward.”

We will dive into the details of each of the provisions in upcoming posts.

As always, your thoughts and comments are welcome!

As we work on reporting for year-end 2020 (and how many of us are happy we are finally there?), we are presenting a series of posts about SEC comments that focus on areas that may require additional attention in our reporting for year-end.  This comment is about the impact of the pandemic and the potential need to make known-trend disclosures:

On your first quarter earnings call, you indicate that you currently anticipate second
quarter revenue to be down as much as 50% to 60% with approximately 80% of your global business having been closed since April 1, 2020. Revise your future periodic filings to disclose known trends and uncertainties related to COVID-19. For example, disclose how you expect COVID-19 to impact your future operating results and near-and-long term financial condition and how that compares to the current period. See Item 303 of Regulation S-K, SEC Release No. 33-8350, and CF Disclosure Guidance Topic No. 9.

You can read the comment and the company’s response here.

As always, your thoughts and comments are welcome!

Principles-based disclosure guidance is a major theme in current SEC rulemaking.  Recent changes to Regulation S-K business, risk factor and MD&A disclosures rarely prescribe specific disclosures and frequently require materiality judgments.  For example, the business description disclosures in the new S-K Item 101 include this overall requirement:

When describing each segment, only information material to an understanding of the businesstaken as a whole is required. Disclosure may include, but should not be limited to, the information specified in paragraphs (c)(1)(i) through (v) of this section.

These kinds of judgments are never simple.  The old business description guidance had more prescriptive rules.  One such rule was a requirement to disclose the name of a customer who accounted for over 10% of consolidated revenues.  This was a more objective and simpler disclosure decision.  Now we must use judgment to decide if a customer relationship is material information to an investor rather than relying on this kind of “bright-line.”

The new human capital resources disclosure in S-K Item 101 demonstrates the complexity in principles-based disclosure requirements.  First, the provision above – “only information material to an understanding of the business taken as a whole is required” applies to this disclosure.   Second, it requires us to make some very subjective judgments:

(ii) A description of the registrant’s human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant 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 development, attraction and retention of personnel).

It would be much simpler if the rule provided a list of areas such as retention practices, training programs and compensation plans.  Instead, we must first determine what management focuses on in the realm of human capital resources and then determine what information is material and hence required to be disclosed.  This will be much more time consuming and challenging!

It is reasonable to ask why the SEC is moving from objective, rule-based, disclosures to a more principles-based regimen.  On November 18, 2020, CorpFin Division Director William Hinman addressed this issue in a speech at the eighteenth annual PLI Directors’ Institute on Corporate Governance titled “The Regulation of Corporation Finance – A Principles-Based Approach.”  His perspective about the importance of principles-based requirements is clear:

“However, I believe that our principles-based requirements, which articulate an objective and allow companies to satisfy the objective by providing disclosure appropriately tailored to their facts and circumstances, in most cases are the ones that provide investors with the most meaningful information.  These requirements can be highly effective in eliciting disclosure about complex and evolving areas like climate change, Brexit, cybersecurity and the LIBOR transition.”

Later in this speech he says:

“There are many different approaches that companies can take when preparing disclosure.  I encourage an approach that does not begin with the question “What must I disclose?”  Rather, for the good corporate citizen, the question is better framed as “What should I disclose?”  Companies should disclose the information that investors and the markets will find useful and important, regardless of whether there is some technical argument that compliance with specific disclosure requirements can be met with less illuminating disclosure.”

Yes, these principles-based requirements present more challenges than prescriptive, rules-based requirements.  But the message here is clear.  With this movement to a more principles-based disclosure regimen, we must carefully address these judgments and make them with investors in mind.

As always, your thoughts and comments are welcome.

In its first COVID-19 disclosure enforcement case, on December 4, 2020, the SEC announced a settled administrative proceeding against The Cheesecake Factory, Inc.

Underlying the case is a March 23, 2020 Item 7.01 Form 8-K.  In this Form 8-K, The Cheesecake Factory withdrew its financial guidance for 2020.  The accompanying five-paragraph press release included this incremental disclosure:

“All of the Company’s restaurants have transitioned to an off-premise operating model as required by state and local officials. The Cheesecake Factory restaurants have a long-standing business in the off-premise channel, with historical sales volumes approaching the size of many stand-alone restaurants, which is enabling the Company’s restaurants to operate sustainably at present under this model.”

Before the March 23 Form 8-K was furnished, The Cheesecake Factory initiated efforts to conserve and raise cash.  On March 18, 2020, as part of its efforts to reduce cash outflows, the company sent letters to its landlords informing them that it would not pay April 2020 restaurant rents.  In its capital raising efforts, again before the March 23 Form 8-K was filed, the company disclosed to potential private equity investors and lenders that it was losing $6 million in cash each week and estimated its cash and other sources of liquidity would last approximately 16 weeks.

The SEC’s Order found that neither of these facts was disclosed to the public on a timely basis.  Two days after the March 23, 2020 Form 8-K, the letters to landlords were reported in the press.  On March 25, 2020, two days after the newspaper articles, the company furnished a Form 8-K disclosing that it was not planning to pay April rent and was engaged in discussions with its landlords.  Later, on  April 20, 2020, the company announced a $200 million subscription agreement with a private investor for the sale of convertible preferred stock.

The message in this case is clear ­— be forthright and complete as you discuss the impact of COVID-19 on your business this year-end. To support this process, the enforcement Press Release includes a link to this April 8, 2020 Statement by Chairman Clayton and CorpFin Director Hinman about the importance of disclosure in this period of disruption and uncertainty.

As always, your thoughts and comments are welcome!

As we discussed in this post, the SEC has amended Regulation S-T to allow electronic signatures in many filings.  In this post, we highlighted that this rule is effective as of December 4, 2020.

To use electronic signatures, companies must take some fairly straightforward steps.  First, the rule requires an initial “authentication document” to be signed the “traditional” way (i.e., with an original signature) and retained by the company.

Thanks to SEC Institute workshop leader Gary Brown and Charles Vaughn, Partners at Nelson Mullins Riley & Scarborough, you can find an example of an initial “authentication document” at the end of this post.  They also suggest the following guidance for the second step:

The platform used for electronic signatures must:

• require the signatory to present a physical, logical, or digital credential that authenticates the signatory’s individual identity;
• reasonably provide for non-repudiation of the signature;
• provide that the signature be attached, affixed, or otherwise logically associated with the signature page or document being signed; and
• includes a timestamp to record the date and time of the signature.

DocuSign is an example of a platform that meets these requirements.

Thanks again to Gary and Charles, and your thoughts and comments are welcome. 

[NAME OF COMPANY] 

Initial Electronic Signature Authentication Document

for Documents Filed with

the United States Securities and Exchange Commission

The undersigned is either (a) a member of the board of directors of [NAME OF COMPANY], a [State] corporation (the “Company”), or (b) an officer of the Company, or both, who will or may be called upon to sign, either on behalf of the Company or individually, documents that will be filed with the United States Securities and Exchange Commission (the “SEC”).  The undersigned is signing this Initial Electronic Signature Authentication (this “Authentication”) pursuant to rules adopted by the SEC to permit documents filed with the SEC to be signed via DocuSign or another similar electronic platform.

Background

Rule 302(b)(2) of SEC Regulation S-T requires that before an officer or director (a “signatory”) initially uses an electronic signature to sign a signature page or other document to be filed with the SEC, the signatory must manually sign a document (an “authentication document”) attesting that the signatory agrees that the use of an electronic signature in any authentication document constitutes the legal equivalent of such individual’s manual signature for purposes of authenticating the signature to any filing for which it is provided.  An electronic filer like the Company must (a) retain this manually signed document for as long as the signatory may use an electronic signature to sign an authentication document and for a minimum period of seven years after the date of the most recent electronically signed authentication document; and (b) furnish a copy of it upon request to the SEC or its staff.

Attestation and Agreement

In light of the foregoing, I hereby attest, acknowledge and agree that the use of my electronic signature in any authentication document constitutes the legal equivalent of my manual signature for purposes of authenticating the signature to any SEC filing for which it is provided.  I acknowledge that the Company will (a) retain this Authentication for as long as I may use an electronic signature to sign an authentication document and for a minimum period of seven years after the date of the most recent electronically signed authentication document; and (b) furnish a copy of this Authentication upon request to the SEC or its staff.

* * * * * * *

As we discussed in this post, the SEC adopted a Final Rule on November 17, 2020, providing a process to use electronic signatures in many filings.  That Final Rule was published in the Federal Register on December 4, 2020, and is effective as of that date.

As always, your thoughts and comments are welcome.

One of the more complex issues companies deal with when performing goodwill impairment tests is what to do when a company’s market capitalization is less than its book value.  Does this mean an impairment automatically exists?  Is it an indicator of impairment?  How should this be dealt with in the impairment analysis?

Here is an SEC comment that raised this question for ArcelorMittal, a steel company:

We note the company’s net book value significantly exceeds its market capitalization. We also note this trend has persisted for a considerable period of time and the degree to which net book value exceeds market capitalization has substantially increased. Given that declines in market capitalization may indicate potential asset impairments, please explain if and how this factor has impacted your asset impairment assessments. Please more fully explain and address the following:

Explain how you determine your cash generating units for impairment testing of property, plant and equipment;

Explain how you determine and assess the reasonableness of the useful lives of property, plant and equipment;

Explain how you determine your groups of cash generating units for impairment testing of goodwill;

Since recoverable amounts appear to exceed market capitalization, explain how you determine the material assumptions underlying your impairment analyses and how you determine each material assumption is reasonable and supportable; and

Explain how you assess the reasonableness of your fair value estimates, including if and how you reconcile your fair value estimates to your market capitalization.

ArcelorMittal is a foreign private issuer and prepares its financial statements in accordance with IFRS as adopted by the IASB.  While the goodwill impairment test in IFRS is a bit different from the test under US GAAP, the company’s response is an interesting and thorough analysis of this issue.

The company’s response is too lengthy to include in this post so here is a link to the response.

Not to provide spoilers, but the next letter in the process is the SEC’s closing letter.

Thanks to Alyson Clabaugh of Intelligize for spotting this example, and as always, your thoughts and comments are welcome!

As we discussed in this post, on November 17, 2020, the SEC adopted a Final Rule — ­­­­­­­ “Electronic Signatures in Regulation S-T Rule 302.”

The Final Rule will not be effective until it is published in the Federal Register.  However, on November 20, 2020, CorpFin announced, “the staff will not recommend the Commission take enforcement action with respect to the requirements of Rule 302(b) in advance of such time provided that a signatory complies with all of the requirements of amended Rule 302(b).”

As always, your thoughts and comments are welcome!

On November 18, 2020, CorpFin updated several areas in the FRM for recent changes made by the SEC, FASB and PCAOB.  There are some areas where updates are still in process.

The current update addresses:

• New Smaller Reporting Company definition
• Accelerated and Large Accelerated Filer definitions
• Audit requirements for SPACs
• Various SEC disclosure simplification and modernization rules
• Various updates and changes related to FASB and PCAOB standards

Areas for future updates, including links to the related final rules, are:

Amendments to Financial Disclosures about Acquired and Disposed Businesses

Financial Disclosures about Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities

Qualifications of Accountants (Auditor Independence Requirements)

These new rules contain early transition provisions.  If you have questions when dealing with one of them, CorpFin recommends contacting the staff identified in each Final Rule.

As always, your thoughts and comments are welcome!

In response to a reader comment about our recent posts delving into the SEC’s August 2020 modernization of business, risk factor and legal proceedings disclosures, this post explores the implications of these changes for smaller reporting companies or SRCs.

A review of the SRC definition and a list of SRC disclosure accommodations is included at the end of this post.  SRCs can use this system in an “à la carte” fashion, picking and choosing which disclosure accommodations they will use.

The impact of the SEC’s August 2020 Final Rule on SRCs is essentially the same as non-SRCs, with the differences described below.

Description of  Business

Consistent with the changes for non-SRCs, the requirements for how many periods to present and hyperlinking were updated for SRCs.  Notably, the prescriptive and detailed business description requirements for SRCs in S-K Item 101(h) were not changed.  They are included at the end of this post.

Number of Periods to Present

The old version of S-K Item 101(h) contained this language:

A smaller reporting company, as defined by §229.10(f)(1), may satisfy its obligations under this Item by describing the development of its business during the last three years.

This is replaced by a more principles-based requirement:

In describing developments under paragraphs (h)(1) through (3), information should be provided for the period of time that is material to an understanding of the general development of the business.

One note in this regard – remember the instructions to Form 10-K Item 1 limit this requirement to the period from the beginning of the year of the report:

Item 1. Business. 

Furnish the information required by Item 101 of Regulation S-K (§ 229.101 of this chapter) except that the discussion of the development of the registrant’s business need only include developments since the beginning of the fiscal year for which this report is filed.

Hyperlinking

The new S-K Item 101(h) also has this language about hyperlinking, which is consistent with the changes made for non-SRCs:

Notwithstanding the provisions of § 230.411(b) or § 240.12b-23(a) of this chapter as applicable, a smaller reporting company may only forgo providing a full discussion of the general development of its business for a filing other than an initial registration statement if it provides an update to the general development of its business disclosing all of the material developments that have occurred since the most recent registration statement or report that includes a full discussion of the general development of its business. In addition, the smaller reporting company must incorporate by reference, and include one active hyperlink to one registration statement or report that includes, the full discussion of the general development of the registrant’s business

Risk Factors

The August 2020 changes to risk factor disclosure did not include any special provisions for SRCs.  As a result, SRCs are subject to the new requirement to provide a risk factor summary if their risk factor disclosures are over 15 pages long.  This requirement is now in S-K Item 105(b):

(b) Concisely explain how each risk affects the registrant or the securities being offered. If the discussion is longer than 15 pages, include in the forepart of the prospectus or annual report, as applicable, a series of concise, bulleted or numbered statements that is no more than two pages summarizing the principal factors that make an investment in the registrant or offering speculative or risky.

SRC’s do have a disclosure accommodation for risk factors that was not changed by the August 2020 Final Rule.  The Instructions to Form 10-K Item 1A provide that SRCs do not have to disclose risk factors:

Item 1A. Risk Factors.

Set forth, under the caption “Risk Factors,” where appropriate, the risk factors described in Item 105 of Regulation S-K (§ 229.105 of this chapter) applicable to the registrant. Provide any discussion of risk factors in plain English in accordance with Rule 421(d) of the Securities Act of 1933 (§230.421(d) of this chapter). Smaller reporting companies are not required to provide the information required by this item.

Legal Proceedings

There are no SRC legal proceedings disclosure accommodations.  All the disclosure changes described in this post apply to both SRCs and non-SRCs.

As always, your thoughts and comments are welcome!

Here, for ease of reference are:

• Definition of an SRC
• SRC disclosure accommodations
• S-K Item 101(h) description of business

Definition of an SRC

As a brief reminder, the definition of a small reporting company is in Regulation S-K Item 10(f):

(1) Definition of smaller reporting company. As used in this part, the term smaller reporting company means an issuer that is not an investment company, an asset-backed issuer (as defined in §229.1101), or a majority-owned subsidiary of a parent that is not a smaller reporting company and that:

(i) Had a public float of less than $250 million; or

(ii) Had annual revenues of less than $100 million and either:

(A) No public float; or

(B) A public float of less than $700 million.

This definition was adopted in this June 2018 Final Rule which increased the public float level from $75 million to $250 million and also added the provision that companies with less than $100 million in revenue and public float less than $700 million could use the SRC system.  This allowed tech and biotech companies that are in a “pre-revenue” stage to use the SRC reduced disclosure regimen.  In the final rule the SEC estimated that approximately 966 additional registrants would meet the new SRC definition.

SRC Disclosure Accommodations

You can find a list of the Regulation S-K disclosure accommodations for SRCs in S-K Item 10(f) and the financial statement requirements for SRCs in S-X Article 8.  SRC financial statements need only comply with US GAAP.  The additional requirements in Regulation S-X, with the exception of the auditor requirements in Article 2, do not apply to SRCs.

SRC Description of Business

The detailed requirements in S-K Item 101(h) for an SRC to address in the description of its business were not changed by the August 2020 Final Rule.  They include:

(1) Form and year of organization;

(2) Any bankruptcy, receivership or similar proceeding; and

(3) Any material reclassification, merger, consolidation, or purchase or sale of a significant amount of assets not in the ordinary course of business.

(4) Business of the smaller reporting company. Briefly describe the business and include, to the extent material to an understanding of the smaller reporting company:

(i) Principal products or services and their markets;

(ii) Distribution methods of the products or services;

(iii) Status of any publicly announced new product or service;

(iv) Competitive business conditions and the smaller reporting company’s competitive position in the industry and methods of competition;

(v) Sources and availability of raw materials and the names of principal suppliers;

(vi) Dependence on one or a few major customers;

(vii) Patents, trademarks, licenses, franchises, concessions, royalty agreements or labor contracts, including duration;

(viii) Need for any government approval of principal products or services. If government approval is necessary and the smaller reporting company has not yet received that approval, discuss the status of the approval within the government approval process;

(ix) Effect of existing or probable governmental regulations on the business;

(x) [Reserved]

(xi) Costs and effects of compliance with environmental laws (federal, state and local); and

(xii) Number of total employees and number of full-time employees.