IT IS ANNUAL REPORT TIME—RECENT DEVELOPMENTS AND TRENDS FOR THE PREPARATION OF FORM 20-F 

It is now time for foreign private issuers (FPIs) to prepare their annual reports on Form 20-F. For companies with a calendar year-end, the Form 20-F must be filed with the U.S. Securities and Exchange Commission (the SEC) by April 30, 2021.

To help you with the preparation of this filing, consider the following recent developments, trends and topics that may be areas of focus of the SEC during the 2021 review process.

SEC Guidance on COVID-19 Disclosure

In March and June 2020, the Division of Corporate Finance of the SEC issued disclosure guidance Topic No. 9 and Topic No. 9A, respectively, in relation to disclosure that companies should consider in connection with COVID-19 and related market disruptions. The SEC encouraged “companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes of management and to proactively revise and update disclosures as facts and circumstances change.” In particular, the guidance emphasized the importance of providing clear disclosure related to the management of short- and long-term liquidity and funding risks in the current economic environment.

In an effort to help companies analyze their specific facts and circumstances and weigh their disclosure obligations, the guidance provided a detailed list of questions that companies should consider with respect to the effects of COVID-19 on their present and future operations. The list of questions covers topics relating to operational matters, liquidity position, new financing activities, availability of traditional funding sources, covenant compliance, disclosed metrics, other responsive measures, debt servicing obligations, customer relationships, supplier financing arrangements and disclosure of subsequent events, among others. The suggested topics are not meant to be exhaustive and companies are encouraged to consider whether other material trends or risks have emerged as a result of COVID-19, including risks or trends that may affect a company if its counterparties are affected by COVID-19. The Cheesecake Factory settlement for making materially false and misleading statements about the effect of the COVID-19 pandemic on its business, while financially insignificant, illustrates the SEC’s focus on registrant’s disclosures relating to the COVID-19 impacts on operations.

In addition, the SEC encouraged management to consider whether the conditions and events that their company has faced, taken as a whole, “raise substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements.” The SEC listed two specific questions to consider regarding the going concern disclosure and reinforced that, where substantial doubt exists regarding a company’s ability to continue as a going concern, management must provide appropriate disclosures in the company’s financial statements.

Relatedly, the SEC’s Office of the Chief Accountant (the OCA) also issued a statement on the importance of high-quality financial reporting in light of COVID-19. Among other matters, the OCA stressed that companies should ensure that significant judgments and estimates are reasonable and disclosed in a manner that is understandable and useful to investors.

Trends in SEC Comment Letters in 2020

Disclosures of Non-GAAP Financial Measures

As observed in recent years, the SEC continues to focus on the use of financial measures that do not conform either to U.S. GAAP or IFRS (collectively, “non-GAAP”) in its review of Form 20-F annual reports and other disclosures by FPIs.

SEC comment letters in 2020 again addressed compliance with the SEC’s rules and guidance regarding disclosure of non-GAAP financial measures, including:

• Use of Individually Tailored Accounting Principles. Adjustments that result in non-GAAP measures that present financial results to essentially give effect to superseded accounting principles have resulted in SEC comments to remove such adjustments. While the SEC has permitted using such tailored accounting non-GAAP measures when a new standard has been adopted (such as IFRS 15—Revenue from Contracts with Customers) without full retrospective application in order to make it easier for investors to compare current results with those for prior periods, the SEC believes these measures are otherwise inappropriate outside of the transition period because such continued individual tailoring for superseded accounting principles causes the measures to be misleading. Accordingly, there was an increase on the number of comments issued on individually tailored measures other than revenue, such as those (i) adjusting equity method accounting to show pro rata consolidation, (ii) removing the impact of purchase accounting (“fair value”) adjustments and (iii) adjusting for only a portion of the amortization associated with acquired intangible assets.
• Exclusion of normal, recurring cash operating expenses. During 2020, there was a rise in the number of comments challenging registrants that excluded recurring charges (e.g., costs to be a public company and frequent restructuring costs) from non-GAAP measures. Given the SEC’s guidance through its compliance and disclosure interpretations (C&DIs) and the emphasis placed during periodic reviews, the SEC’s position is that such exclusions could be considered misleading as they exclude normal, recurring cash operating expenses necessary to operate the registrant’s business.
• “Equal or Greater Prominence” and Disclosures on Purpose and Use. As in recent years, the SEC continued to emphasize that non-GAAP financial measures should not be presented with greater prominence than the corresponding GAAP or IFRS financial measure, as the case may be. In addition to the importance of balanced presentation, comment letters also continued to reiterate the need to include clear and detailed disclosure to explain the usefulness of such non-GAAP measures to investors and how management uses such measures.

Disclosure in Management’s Discussion and Analysis (Item 5 - Operating and Financial Review and Prospects)

The Management’s Discussion and Analysis (MD&A) section remains the leading source of SEC comments. Consistent with one of its principal goals—investor protection—comment letters during 2020 continued to hone in on the importance of enabling investors to see companies “through the eyes of management.” Outside the COVID-19 context, the majority of comments focused on (i) transparency in the discussion of performance metrics to ensure registrants disclose key metrics used by management and (ii) greater specificity, such as identifying the underlying drivers of material changes and detailing how performance metrics correlate with material changes affecting earnings or that are reasonably likely to have a material effect on future operating results. See “SEC Updates—Guidance and Amendments to Modernize and Simplify Disclosure Rules—KPIs and Other Metrics” below. With respect to the effects of COVID-19, comments concentrated on liquidity and availability of capital resources, as well as known trends or uncertainties related to COVID-19 that will have a material favorable or unfavorable impact on results from continuing operations. See “SEC Guidance on COVID-19 Disclosure” above.

Other prevalent comments stemming from MD&A disclosures were those requesting (i) expanded discussions on significant components of operating expenses, such as costs of sales, which asked registrants to not only describe changes in revenue and segment profit or loss, but also to directly and separately explain (including, quantifying) the changes in significant operating expenses that have affected revenue and/or segment results and (ii) registrants to provide a more robust analysis of critical accounting estimates than what is included in the significant accounting policies note to the financial statements.

Revenue Recognition

While most registrants have applied IFRS 15 since it became effective in 2018, the SEC staff continues to focus on how companies identify performance obligations, determine that they have satisfied performance obligations and disaggregate revenue in their disclosures. The SEC staff was especially interested in how registrants support their conclusions that certain promised goods and services are or are not separately identifiable.

Segment Reporting

In 2020, the SEC again directed many comments toward segment reporting rationale and how registrants apply the guidance on this topic in ASC 280/IFRS 8. The areas the SEC staff continues to focus on include (i) identification of operating segments, (ii) aggregation of operating segments into reportable segments and (iii) whether registrants provide appropriate entity-wide disclosures related to products and services, revenues attributable to individual foreign countries and revenues from major customers. In addition, the SEC continues to ask registrants to explain any inconsistencies between how the business is described in public information and how it is described in the segment footnotes. For example, the SEC staff has challenged registrants when they say the basis for identifying operating segments is something other than product or service lines (e.g., geography), but publicly disclosed information suggests that management uses financial information by product or service lines to make decisions and allocate resources.

SEC Updates

Guidance and Amendments to Modernize and Simplify Disclosure Rules

In 2020, the SEC issued new guidance and adopted amendments to its rules and forms, including Form 20-F, to modernize and simplify disclosure requirements. This guidance on key performance indicators (KPIs) and MD&A disclosure, and the related amendments, should be taken into consideration when preparing the 2020 Form 20-F.

KPIs and Other Metrics

In January 2020, the SEC issued guidance on KPIs and other metrics used in MD&A disclosure to promote disclosure of KPIs and other metrics as a way of facilitating the SEC’s goal of allowing investors to see a company “through the eyes of management.” Effective from February 25, 2020, the guidance is a reminder to companies that when including such metrics in their disclosure, they should consider existing MD&A requirements and the need to include any other material information as may be necessary in order to make the presentation of the metrics not misleading. As such, the guidance recommends that to accurately define and disclose any metrics, the disclosure should include:

• 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.

These disclosures required by the guidance are consistent with those the SEC staff has encouraged over the years in public statements and comment letters. However, the issuance of such specific Commission-level guidance will likely lead to additional staff focus on disclosures about KPIs and other metrics companies include in their operating results discussions.

Revised MD&A Rules

In January 2020, the SEC also issued guidance (Section 110) to clarify FPIs’ ability to omit discussion of the earliest of the three years in the MD&A included in their filings. When FPIs omit a discussion of the earliest of the three years in a filing, the required statement identifying the location of a discussion in a prior filing would not result in the prior discussion being incorporated by reference into the filing.

The guidance clarifies that if an FPI believes a discussion of its earliest of three years is necessary to understand its financial condition, changes in condition and results of operations, it may not omit the discussion pursuant to the new rules.

Amendments to Modernize and Enhance MD&A Disclosure

In November 2020, the SEC adopted amendments to simplify, modernize and enhance MD&A and other financial disclosure. The amendments will become effective on February 10, 2021 and compliance will be required upon the first fiscal year ending on or after August 9, 2021. Therefore, compliance with these amendments is not required for the 2020 Form 20-F for calendar year-end companies. Voluntary compliance is permitted at any time after the amendments become effective, provided that the registrant adopts the amended item in its entirety.

Some of the key changes include, among other things:

1. eliminating Item 3.A of the Form 20-F, which requires disclosure of selected financial data for the last five years;
2. revising Item 5 of the Form 20-F to specify that the discussion must include a quantitative and qualitative description of the reasons underlying material changes, including where material changes within a line item offset one another;
3. amending Item 5.A.2 of the Form 20-F to require only disclosure of hyperinflation, rather than current standard which requires disclosure of inflation (if material) and hyperinflation (if the currency in which the financial statements are presented is of a country that has experienced hyperinflation);
4. revising the liquidity and capital resources requirement in Item 5.B of the Form 20-F to specify that a registrant must broadly disclose material cash commitments, not just capital expenditures;
5. changing Item 5.D of the Form 20-F to require disclosure of “material trends” instead of “the most significant recent trends;”
6. replacing Item 5.E of the Form 20-F, which currently requires disclosure of material off-balance sheet arrangements in a separate section, with a principles-based instruction to include a discussion of material commitments in the liquidity and capital resources discussion;
7. eliminating the requirement for contractual obligations table in Item 5.F of the Form 20-F and replacing with disclosure of material cash requirements from known contractual and other obligations as part of liquidity and capital resources discussion; and
8. a new requirement for registrants to disclose critical accounting estimates, which codifies previous SEC guidance.

We anticipate registrants will adopt some of these amendments in connection with the 2020 annual reports on 20-F, particularly those mentioned in 1, 6 and 7 above.

Risk Factor Disclosure

In August 2020, the SEC adopted amendments to modernize certain disclosure requirements in Regulation S-K. Effective from November 9, 2020, these amendments seek to simplify compliance requirements and improve the readability of disclosure documents by discouraging the inclusion of information that is not material and eliminating repetition in the disclosure. The updates address the following Regulation S-K disclosures: Item 101 (description of business); Item 103 (legal proceedings); and Item 105 (risk factor disclosure). These changes are also generally consistent with the recent changes to the European Prospectus Regulation (Regulation (EU) 2017/1129 of the European Parliament and of the Council).

The final amendments to Items 101 and 103 affect only domestic companies and FPIs that have elected to file on domestic forms. In contrast, the amendments to Item 105 apply to the 2020 Form 20-F to the extent the 20-F disclosure is incorporated by reference into an FPI’s SEC registration statement. Amongst the wide array of amendments, the updates to the risk factor disclosure include the following changes:

• if the risk factor section exceeds 15 pages, registrants are required to provide a summary section of no more than two pages, consisting of a series of concise, bulleted or numbered statements that summarize the principal factors that make an investment in the company or offering speculative or risky;
• the standard of disclosure is changed from the previous standard of disclosing “most significant” risks to disclosing “material” risk factors; and
• risk factors are required to be organized under relevant headings (in addition to the sub-captions currently required), with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate heading.

While we have seen both domestic issuers and FPIs begin to incorporate these changes into their reports, there does not yet appear to be a consistent approach on how to present the required risk factor summary section. Based on our informal discussions with some of the SEC staff, we believe a simple bullet point list of certain risk factors will not be enough. Accordingly, we recommend that companies analyze material risk factors within each category and provide the heading and a brief one to two sentence summary of each applicable risk factors.

For a more complete review of these amendments, please refer to our related client publication.

Changes to The Form 20-F

As part of the various updates introduced over the course of the year, the cover page of Form 20-F has been updated and now includes a mark to be checked if the FPI has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act by the registered public accounting firm that prepared or issued its audit report. To clarify, this does not require the filing of a separate exhibit as the report is included as part of the auditor’s report the precedes the financial statements.

XBRL Changes

As reminder, in line with August 2019 C&DIs, which clarified the applicability of the new Inline eXtensible Business Reporting Language (XBRL) requirements, FPIs are required to comply with the Inline XBRL requirements based on their filer status and basis of accounting. As such, for FPIs that prepare their financial statements in accordance with IFRS, the new Inline XBRL requirements will apply for 20-Fs commencing with fiscal years ending on or after June 15, 2021.

Goodbye to Guide 3

In September 2020, the SEC finalized rules that will replace Industry Guide 3 (Guide 3), the industry guide for banking organizations. In addition to streamlining Guide 3-type disclosure since 1986, the rules eliminate a number of requirements formerly set out under Guide 3, and which under applicable accounting rules are now captured in the financial statements.

These new rules will apply starting for fiscal years ending on or after December 15, 2021. While voluntary compliance with the new rules will be accepted in advance of the mandatory compliance date (provided the rules are adopted in their entirety), we do not anticipate widespread early adoption given registrants will need ample time to coordinate these changes with their public accounting firm. Guide 3 will be rescinded effective January 1, 2023.

For a more complete review of the new rules, please refer to our client publication.

SEC Filing Fee

Commencing on October 1, 2020 through September 20, 2021, the SEC filing fee for registration statements will decrease to $109.10 per $1 million of securities registered.

Special thanks to Shearman & Sterling Law Clerk Harekrishna Ashar for his contribution to this client publication.