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Key issues for upcoming Q3 10-Q filings

As public companies prepare their Q3 releases and filings, some of the key issues they should consider include:

  • MD&A – as we reported last quarter, the SEC Staff issued COVID-19 guidance in June calling for companies to disclose the impact of the pandemic through the eyes of management, including, to the extent material:
    • The effects of the pandemic on a company’s operations, liquidity and capital resources; the short- and long-term impact of any federal relief received under the CARES Act; and the company’s ability to continue as a going concern
    • Operational changes as a result of the pandemic – from converting to telework to modifying supply chain and customer contracts, and now converting to the return to the workplace and business reopenings
    • Trends, events or uncertainties (such as possible events of default, breach of covenants, etc.), unless a company can conclude either that it is not reasonably likely that the trend, uncertainty or other event will occur, or that a material effect on the company’s liquidity, capital resources or results of operations is not reasonably likely to occur
  • Non-GAAP Financial Measures – as we recently noted, it appears few companies are jumping on the EBITDAC bandwagon; however, the SEC staff has issued comments on such measures that include adjustments for COVID-19, as in Comment 6 here. Accordingly, companies should be prepared to explain the quantification of any such adjustments and their rationale, consistent with the guidance described in our earlier

SEC Staff Provides Roadmap for Extending Confidential Treatment Orders

The SEC staff amended CF Disclosure Guidance: Topic No. 7 on September 9, 2020 to address the options for companies with confidential treatment orders that are about to expire.  The guidance explains that companies have three choices:

  • Refile the unredacted exhibit. If the contract is still material and none of the redacted information still needs to be protected, the company should refile it in complete, unredacted form.
  • Extend the confidential period pursuant to Rules 406 or 24b-2. If the contract continues to be material, and the previously redacted information continues to be confidential, the company may request to extend the period of confidential treatment by filing an application under Rule 406 of the Securities Act of 1933 or Rule 24b-2 of the Securities Exchange Act of 1934.
    • Short-form application for orders about to expire and initially issued less than three years ago.  If the order is about to expire and was initially issued less than three years ago, companies may use the short-form application, which provides a streamlined process to file an application to extend the time for which confidential treatment has been granted. If the company reduces the extent of omitted information, it must file the revised redacted version of the exhibit on Edgar when submitting the application.

Short-form applications should be submitted to CTExtensions@sec.gov. That email address should not be used for any other confidential treatment request.

    • New application for orders about to

SEC Staff Announces Temporary Procedures for Supplemental Materials and Rule 83 Confidential Treatment Requests

In light of health and safety concerns related to the pandemic, the SEC staff recently announced the availability of a temporary secure file transfer process for the submission of supplemental materials pursuant to Rule 418 under the Securities Act of 1933 or Rule 12b-4 under the Securities Exchange Act of 1934 and information subject to Rule 83 confidential treatment requests (“CTRs”).

From time to time companies provide supplemental materials to the SEC staff, typically when responding to SEC comments.  Rule 418 provides broad authority to the SEC and its staff to request information concerning a company, its registration statement, the distribution of its securities and market or underwriter activities. Rule 12b-4 provides similar authority with respect to registration statements and periodic or other reports. Both rules require the SEC to return supplemental materials upon request, provided the request is made at the time they are furnished to the staff and return of the materials is consistent with the protection of investors and FOIA.  Rule 418 also requires that the materials not have been filed in electronic format.

SEC Rule 83 provides a procedure by which persons submitting information may include a CTR for portions of that information where no other confidential treatment process applies. Typically, this is utilized when companies provide responses to SEC staff comments.  Rule 83 generally requires the submission of the information covered by the CTR separately from that for which confidential treatment is not requested, appropriately marked as confidential, and accompanied by

Consider Updates to D&O Questionnaire as Pressure Mounts for Voluntary Racial, Ethnic and Gender Diversity Disclosures

As the pandemic and racial unrest continue in 2020, companies should consider whether to update their D&O questionnaires to gather information in response to the growing pressure for voluntary diversity disclosures from investors, proxy advisors, activists and others, as noted in our recent posts on August 3 and August 10.

Boards grappling with the possibility of voluntary diversity disclosures must consider how to accurately collect data.  In February 2019, the SEC issued Compliance and Disclosure Interpretation 133.13 requiring certain disclosures if a board or nominating committee considers self-identified diversity characteristics of an individual who has consented to the company’s disclosure of those characteristics.  Companies understandably were slow to address self-identification of diversity traits in D&O questionnaires, given the sensitivity of the topic.

But now, as pressures mount and some companies publicly pledge to add diverse directors to their boards within one year, the annual D&O questionnaire can be a useful way to document the issue and provide a basis for any voluntary disclosures a company may decide to make.  Given the sensitivity of the issue, companies could consider discussing the topic in advance of circulating the questionnaire in order to evaluate whether or how directors wish to proceed. To maintain collegiality, companies should make clear responses are optional, and take care to avoid any implication that particular directors were appointed because of their race, gender or other characteristics.  In lieu of a questionnaire, the board could consider addressing self-identification disclosures during a board meeting or in

Divided SEC amends Regulation S-K rules to modernize descriptions of business, legal proceedings and risk factors

On August 26, 2020, by a 3-2 party-line vote, the SEC adopted amendments to Regulation S-K that aim to modernize the descriptions of business and legal proceedings, and risk factor disclosure requirements. The amendments reflect a principles-based approach in which disclosure objectives are set and management is permitted to exercise judgment on how to satisfy those objectives — tailored to the particular registrant — to the extent such information is material to an understanding of the topic.

We have prepared a client alert describing the amendments in more detail.  The following is a brief summary.

Description of Business (Items 101(a) and (c)). The amendments provide a nonexclusive list of the types of information that a company may need to disclose, based on a principles-based approach. For example, a company would describe its dependence on key products and services that are material instead of focusing on products and services that meet the quantitative thresholds based on revenue currently prescribed in Item 101(c)(1)(i).

Among other things, the revised list of disclosure topics relating to the general development of a company’s business and accompanying business description:

  • Eliminates the look-back in Item 101(a) – generally five years, or three years for smaller reporting companies — to focus on material developments of a company’s business, regardless of a specific time frame.
  • Revises and expands the list of disclosure topics in Item 101(c) with a principles-based, non-exclusive list of topics.
  • Require, to the extent material, new disclosures regarding “human capital resources,” which includes any

ISS opens 2021 Annual Policy Survey, following call to voluntarily disclose ethnicity of directors, officers

Institutional Shareholder Services Inc. (ISS) opened its 2021 Annual Policy Survey on July 29, 2020, to seek input from institutional investors, public companies, directors and others to begin development of ISS’ annual benchmark policies and assess potential policy changes for 2021 and beyond.  The survey will close on August 21, 2020, at 5 p.m. ET.

This year’s survey includes questions related to recently released ISS policy guidance on issues related to the COVID-19 pandemic, including annual general meeting formats and stakeholder expectations regarding compensation and adjustments to incentives.  The survey also requests feedback on a global level related to climate change risk, sustainable development goals, auditors and audit committees, and racial and ethnic diversity on corporate boards. As in prior years, after analysis and consideration of the survey responses, among other inputs, ISS will open a public comment period in October for all interested market participants on the proposed changes to 2021 benchmark voting policies.

Earlier this month, ISS sent letters to multiple public companies asking them to voluntarily disclose “information on the self-identified race/ethnicity of each of the company’s directors and named executive officers (NEOs), to the extent that the company and the individual directors or NEOs are willing to provide this.”  The letter allows each director or officer to disclose up to three classifications from multiple categories, largely drawn from the OMB Standards for the Classification of Race and Ethnicity. Individuals may also provide supplemental information in free-text fields.

The letter states the request is driven by the

A Detailed Analysis of the SEC’s Amendments to Financial Statement Requirements for Business Acquisitions and Dispositions

As we previously posted, the SEC recently adopted a number of amendments to the financial disclosure requirements for business acquisitions and dispositions by U.S. public companies including to (i) revise the requirements for financial statements and pro forma financial information for acquired businesses, (ii) revise the tests used to determine significance of acquisitions and dispositions giving rise to required financials, and (iii) permit certain expense omissions in those financial statements.

We have now prepared a client alert providing a more detailed analysis of the amendments, including descriptions of a number of changes incorporated in the final rule that differ from the SEC’s initial rule proposal.

The SEC stated in its adopting release that the amendments are intended to reduce the complexity of financial disclosure requirements for business acquisitions and dispositions, facilitate more timely access to capital, and reduce the complexity and costs to registrants to prepare the required disclosure.  As we note in our client alert, the result is that, as a practical matter, there will likely be fewer “significance” determinations and thus fewer historical and pro forma financial statement disclosures about acquired businesses.  And although the amendments are intended to streamline and simplify various aspects of the rules and filing requirements, these provisions of Regulation S-X remain highly complex. Registrants are advised to take great care in analyzing them in connection with the consummation of corporate transactions.

SEC Issues More COVID-19 Disclosure Guidance as Quarter End Approaches

On June 23, 2019, both the Division of Corporation Finance and the Office of the Chief Accountant issued additional statements to public companies and their stakeholders about the importance of “high-quality” financial reporting and the need for focused analysis and disclosures in the context of the principles-based disclosure system.

The Division of Corporation Finance issued CF Disclosure Guidance Topic No. 9A, a supplement to Topic No. 9 issued near the close of the first quarter of this year (see our prior blog post on Topic No. 9 here).  The new guidance states that the Division is monitoring how companies are addressing COVID-19 related disclosures and encourages public companies to provide meaningful disclosures of the current and expected impact of COVID-19 through the eyes of management.  The key topics covered by the guidance are the effects of the pandemic on a company’s operations, liquidity and capital resources; the short and long-term impact of any federal relief received under the CARES Act; and the company’s ability to continue as a going concern.

The staff acknowledges that companies are making many operational changes as a result of the pandemic – from converting to telework to modifying supply chain and customer contracts, and now converting to the return to the workplace and business reopenings.  The guidance says that companies need to consider whether any or all of those changes “would be material to an investment or voting decision” and disclose accordingly.  The staff takes a similar tack with respect to the

Public Companies Beware of SEC’s Continuing Interest in Accounting and Disclosure Cases

As the end of the quarter approaches for most public companies, it is important to keep in mind that the SEC’s Enforcement Division has brought numerous cases alleging financial and disclosure fraud in the past year.  Many of the cases stem from efforts to meet analysts’ earnings expectations by recognizing revenue prematurely or underreporting expenses and reserves.  Some of the notable matters include:

  • a case against a technology company alleging that it accelerated sales originally scheduled for future quarters, thereby masking declining market conditions,
  • a case against a large insurance company alleging that it underreported reserves, and
  • a case against a publicly traded REIT, alleging that it improperly adjusted “same property net operating income,” a non-GAAP metric.

Allegations in some of the other cases involved:

  • recognizing revenue when there were undisclosed side agreements enabling distributors to return product, or when getting paid was conditioned on the distributor’s sale to an end user,
  • inflating the value of a portfolio of complex reverse mortgage bonds, and
  • failing to correct an error in accounting for FX losses.

The cases are usually accompanied by allegations of books and records violations and significant deficiencies in internal controls.  The SEC almost always imposes multi-million dollar penalties on the companies and brings charges against the individuals the SEC deems responsible for the misstatements, which usually includes CEOs, CFOs and Controllers.

Financial reporting involves judgment calls that can be difficult to make.  It is important that the company’s motivation is accuracy and transparency in

Delaware Court of Chancery Again Declines to Dismiss a Caremark Oversight Failure Claim

On April 27, 2020, the Delaware Court of Chancery for the third time in a year denied a motion to dismiss a Caremark claim. The case, Hughes v. Hu, involves a derivative claim against the audit committee and officers of a Delaware corporation, Kandi Technologies Group, Inc., a Nasdaq-traded company based in China that manufactures electric car parts. In denying the motion, Vice Chancellor Laster found that there was a substantial likelihood that the defendants breached their fiduciary duty of loyalty by failing to act in good faith to maintain an adequate board-level oversight.

Two recent Delaware court decisions raised concern that Caremark duties may have expanded: Marchand v. Barnhill (declining to dismiss a Caremark claim against the board of Blue Bell Creamery for failing to make a good-faith effort to implement a system of board-level compliance monitoring and reporting to oversee the food safety of its ice cream production) and In re Clovis Oncology, Inc. Derivative Litigation  (where the board “did nothing” when the company released unsubstantiated reports about cancer treatments in clinical trials).  However, it appears that the Caremark duties remain unchanged, with Delaware courts underscoring the requirement that directors implement board-level oversight of mission-critical areas in good faith to ensure that the systems are working effectively and heed warnings or “red flags” that are discovered. This view of the line of recent Caremark decisions is further reinforced by Hughes, where serious alleged failures in internal processes regarding related-party transactions resulted in the plaintiff’s claim surviving a motion to dismiss.

The Hughes decision chronicles a long history of problematic internal control and monitoring within

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