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January 10, 2022

It Is Annual Report Time—Recent Developments and Trends for the Preparation of Form 20-F

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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 May 2, 2022 (which is the first business day following April 30, 2022).

This memorandum provides an overview of recent developments, trends and topics that are relevant to FPIs preparing their 2021 Form 20-F.

Approaching the 2021 Form 20-F

Many of the rule changes that are relevant to the preparation of the 2021 Form 20-F were made during 2020 and have now become mandatory for the 2021 Form 20-F. In addition, during 2021, the SEC indicated its focus on certain disclosure topics and signposted various priorities for rulemaking in 2022. Therefore, in addition to addressing currently effective rule changes, issuers should also evaluate their existing disclosures (or lack thereof) in view of SEC guidance and public statements made during 2021 in relation to areas of disclosure focus. While it is not possible to anticipate the eventual shape of any forthcoming rule changes and additional requirements, by considering their disclosures on the themes discussed in this memorandum, issuers may be able to avoid SEC comments, improve overall disclosure and transition disclosures towards potential new requirements.

SEC Updates

Amendments to Modernize and Enhance MD&A Disclosures

In November 2020, the SEC adopted amendments to simplify, modernize and enhance disclosures in Management’s Discussion and Analysis of Financial Condition and Results of Operations (also referred to as Operating and Financial Review and Prospects) (MD&A) and other financial disclosures. The amendments became effective on February 10, 2021 and compliance is required beginning with the first fiscal year ended on or after August 9, 2021. Therefore, compliance with these amendments is now required for the 2021 Form 20-F for companies with a calendar year-end. Voluntary early compliance was permitted, although many issuers chose not to do that.

Some of the key changes include:

  • eliminating Item 3.A of the Form 20-F, which requires disclosure of selected financial data for the last five years;
  • 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;
  • amending Item 5.A.2 of the Form 20-F to require only disclosure of hyperinflation, rather than the 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);
  • 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;
  • changing Item 5.D of the Form 20-F to require disclosure of “material trends” instead of “the most significant recent trends”;
  • 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;
  • eliminating the requirement to include a contractual obligations table in Item 5.F of the Form 20-F, replacing it with disclosure of material cash requirements from known contractual and other obligations as part of the liquidity and capital resources discussion; and
  • a new requirement for registrants to disclose critical accounting estimates, which codifies previous SEC guidance. However, Item 303(b)(3) does not apply to companies that prepare their financial statements in accordance with IFRS. IFRS already requires financial statements to include disclosures regarding sources of estimation uncertainty and judgments made in the process of applying accounting policies that have the most significant effect on the amounts recognized in the financial statements.

Risk Factor Disclosures

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).

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 Form 20-F to the extent the Form 20-F disclosure is incorporated by reference into an FPI’s SEC registration statement.

Among the wide array of amendments, the updates to risk factor disclosures 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.

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 factor.

For a more complete review of these amendments, please refer to our related client publication, SEC Approves Final Amendments Modernizing Disclosure Requirements of Regulation S-K.

Inline XBRL

In line with the 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.

  • For FPIs that prepare their financial statements in accordance with IFRS, the new Inline XBRL requirements apply to Form 20-Fs commencing with fiscal years ending on or after June 15, 2021. Therefore, for companies with a calendar year-end, these requirements apply to the 2021 Form 20-F.
  • For FPIs that prepare their financial statements in accordance with U.S. GAAP, the new Inline XBRL requirements have applied to financial statements for fiscal years ending on or after June 15, 2019.

Inline XBRL requirements mean that XBRL data is embedded directly within the annual report rather than filed as a separate exhibit. Therefore, issuers should allow sufficient time for Inline XBRL data to be inserted by their EDGAR filing provider or software system.

Financial Disclosure Requirements for Guaranteed or Secured SEC-Registered Debt

On March 2, 2020, the SEC released its final amendments to the rules governing the supplemental financial information required for SEC-registered debt securities that have guarantees or that are collateralized by shares or other securities of subsidiaries or other affiliates. These amendments significantly reduce the amount of financial information required for those securities in addition to the parent company’s consolidated financial statements. The amendments became effective on January 4, 2021.

These rules require issuers of SEC-registered debt securities to include certain disclosures in Exchange Act reports (including Form 20-F within Item 8, Instruction 17). These disclosure obligations apply until an issuer or guarantor no longer has Exchange Act reporting obligations with respect to the relevant securities. Unless the relevant securities are listed on a U.S. stock exchange, if there are fewer than 300 holders of record of the relevant securities (which is often the case), then the Exchange Act reporting obligation is automatically suspended after the first annual report following the issuance of the relevant securities. This is a relaxation of the prior rules that required certain disclosures to be included until the relevant securities were no longer outstanding.

These rules also created a new Exhibit 17 requirement to Form 20-F, which requires identification of (i) each subsidiary that is a guarantor, issuer or co-issuer of each guaranteed security that the parent company issues or guarantees, and (ii) each affiliate whose security is pledged as collateral, as well as the identification of the security or securities pledged as collateral.

For a more complete review of the new rules, please refer to our related client publication, SEC Eliminates Consolidating Financial Information for SEC-Registered Debt Securities.

Disclosure Focus Areas

Environmental, Social and Governance (ESG) Disclosures

ESG issues are an increasingly important area of focus for issuers and investors. Issuers have begun to disclose more information on ESG, including the business impacts of climate change and their efforts aimed at advancing the ESG agenda and reducing carbon emissions. Increasing investor focus on ESG has led to asset managers offering more investment products that incorporate ESG themes, and issuers are increasingly issuing green bonds, sustainability-linked bonds and other types of sustainable bonds.

As such, possible areas for comments to be issued by the Staff of the SEC with respect to an issuer’s Form 20-F are likely to include:

  • comments seeking greater transparency, accuracy and reliability of ESG disclosures. In a speech on November 8, 2021, Gurbir Grewal, the Director of the SEC’s Division of Enforcement, emphasized that “If an issuer chooses to speak on climate or ESG—whether in an SEC filing or elsewhere—it must ensure that its statements are not materially false or misleading, or misleading because they omit material information”; and
  • comments arising from a comparison between public disclosures outside of the SEC reporting system versus disclosures made in SEC filings in order to assess whether there are material omissions from disclosures filed with the SEC. For example, many companies publish sustainability/corporate social responsibility reports on their websites and care should be taken in analyzing the degree to which material disclosures made in such publication should also be included in the Form 20-F annual report.

Climate Change Disclosures

During 2021, the SEC has consistently signaled that it is focusing on climate change disclosures made by issuers. In comments made in The Wall Street Journal’s CEO Council Summit on December 7, 2021, Chair Gary Gensler indicated that the SEC hopes to propose new climate change rules in early 2022. Therefore, while new disclosure rules will not apply to the 2021 Form 20-F, issuers should nonetheless take stock of their existing disclosures and consider potential modification in light of the SEC’s focus on this topic.

We set out below a chronology of certain key statements made by the SEC during 2021, together with relevant links to where further detail can be obtained. Prior to SEC rulemaking proposals being released, the statements referred to below are useful for issuers in shaping their thinking on these topics and considering whether to update disclosures in advance of any rulemaking.

  • In a public statement on February 24, 2021, then-Acting Chair Allison Herren Lee directed the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings. She asked the Staff of the SEC to consider how companies comply with previously issued SEC guidance and current disclosure requirements.
  • On March 4, 2021, the SEC announced the creation of the Climate and ESG Task Force in the Division of Enforcement. The initial focus of the Task Force is to identify any material gaps or misstatements in companies’ disclosure of climate risks under existing disclosure requirements. Therefore, the more proactive approach of the Division of Corporate Finance in raising comments on climate change disclosures could also lead to issuers receiving additional attention from the Task Force.
  • In prepared remarks on July 28, 2021, SEC Chair Gary Gensler set forth key considerations for the Staff of the SEC to address in the SEC’s forthcoming rulemaking proposal on mandatory climate risk disclosures. The Financial Stability Board created the Task Force on Climate-related Financial Disclosures (TCFD) to improve and increase reporting of climate-related financial information. In prepared remarks, SEC Chair Gary Gensler indicated in September 2021 that he had asked the Staff of the SEC to learn from the TCFD framework, among other things, in developing proposals for climate risk disclosure requirements. Therefore, TCFD recommendations are a useful resource for companies formulating their overall approach to climate change disclosure.
  • On September 14, 2021, SEC Chair Gary Gensler testified before the Senate Committee on Banking, Housing, and Urban Affairs that investors are demanding “consistent, comparable, and decision-useful disclosures around climate risk, human capital management and cybersecurity.”
  • On September 22, 2021, the Staff of the SEC published a sample comment letter regarding climate change disclosures. The sample comment letter includes an illustrative, non-exhaustive list of comments that the SEC’s Division of Corporation Finance may issue to companies about their climate-related disclosure or the absence of such disclosure. The sample comment letter contains nine points, mainly focused on risk factors and MD&A disclosures. Most of the topics addressed in the sample comment letter were previously covered in the interpretative guidance published by the SEC in February 2010. These disclosure matters can include:
    • the impact of pending or existing climate change–related legislation, regulations and international accords;
    • the indirect consequences of regulation or business trends (such as transition risks relating to low/net zero carbon emissions); and
    • the physical impacts of climate change.

Therefore, when preparing disclosure for the 2021 Form 20-F, issuers should review the topics raised in the sample comment letter and consider if, and how, their disclosure should be amended to reflect those areas of focus.

  • Climate-related disclosures encompass three levels of reporting for greenhouse gas emissions: Scope 1 (emissions from a company’s own operations, which is the narrowest reporting scope); Scope 2 (emissions from the company’s use of electricity, steam, heating or cooling); and Scope 3 (emissions that are the result of activities from assets not owned or controlled by the company, but that the company indirectly impacts in its value chain). In his December 7, 2021 remarks, Chair Gary Gensler said that the SEC was still considering whether to mandate all three levels of reporting for U.S. public companies, particularly those issuers that have set themselves “net-zero” emissions goals to eliminate greenhouse gas emissions altogether. Chair Gary Gensler noted that “If these companies are making such commitments, then we’re considering what disclosures they have to the public around those commitments.” Therefore, companies that disclose extensive sustainability-related commitments (such as net-zero) should consider their ability to disclose performance-related metrics to enable performance tracking.

Human Capital Management and Board Diversity Disclosures

An increasing focus on all elements of ESG, not just climate change, has led many companies to consider expanding their human capital management (HCM) disclosures. Expanded HCM disclosures are on the SEC’s rulemaking agenda and, in prepared remarks on June 23, 2021, SEC Chair Gary Gensler indicated that additional HCM metrics could include “workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety.” It is not known whether any such rules would also apply to FPIs.

In the amendments to Item 101 of Regulation S-K referred to above, the SEC also required domestic U.S. issuers (but not FPIs) to include new disclosures on human capital resources. These amendments require domestic companies to include in their annual reports “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).” This disclosure is required to the extent that it is material to an understanding of the issuer’s business taken as a whole, or if it is material to a particular segment, then that segment should be identified. Our Corporate Governance & Executive Compensation Survey found there was little uniformity in the information and related data that was reported on this topic in filings made by domestic companies during 2021.

Therefore, while these disclosure requirements are not applicable to FPIs, companies should nonetheless consider whether the inclusion of disclosure on these topics would be useful to investors and improve the company’s overall disclosures, particularly as investors become more accustomed to seeing these disclosures being made by domestic U.S. companies.

No additional rules will apply to forthcoming 2021 Form 20-F annual reports, but issuers may nonetheless consider expanding their HCM disclosures, and doing so may potentially include the establishment of the processes for collection and evaluation of key HCM metrics.

Cybersecurity Disclosures

The SEC continues its focus on cybersecurity disclosures against the backdrop of cyberattacks increasing in frequency and severity around the world. “Cybersecurity risk governance” is on the SEC’s near-term rulemaking agenda, and while a rulemaking proposal from the SEC might be forthcoming in the short term, it would be some time before a final rule on cybersecurity risk disclosures is issued. However, issuers should nonetheless take the opportunity to reassess their cybersecurity disclosures.

Cybersecurity disclosures were addressed in the SEC’s 2018 interpretative guidance, but this was not codified in SEC rules. While there is no existing issuer disclosure requirement explicitly referring to cybersecurity risks and cyber incidents, the SEC’s guidance makes clear that issuer may nonetheless be required to provide disclosure relating to cybersecurity risks and incidents pursuant to Regulation S-K and Regulation S-X, where cybersecurity may be material in order to discharge an issuer’s disclosure obligations relating to business and operations, risk factors, MD&A, internal controls over financial reporting, and disclosure controls and procedures. The SEC expects companies to provide disclosure that is tailored to their particular cybersecurity risks and incidents. The SEC emphasized avoiding generic boilerplate cybersecurity-related disclosure and the need to provide specific information that is useful to investors.

Cybersecurity is also on the SEC’s enforcement agenda. Beginning in June 2021, the SEC’s Division of Enforcement sent letters to certain SEC reporting issuers whom the SEC believed may have been impacted by the SolarWinds cyberattack in December 2020. The SEC offered amnesty to companies who voluntarily disclose to the SEC (i) how the company was impacted by the SolarWinds cyberattack and any other cyberattacks resulting in unauthorized accesses lasting longer than one day, and (ii) any remedial actions the company implemented in response, to the extent that those voluntary disclosures show that the company failed to make prior required disclosures or maintain adequate internal controls.

On August 16, 2021, the SEC announced the settlement of an enforcement action against a U.K.-based company dual listed on the New York Stock Exchange and the London Stock Exchange. The SEC alleged that the company had misled investors about a 2018 cyberattack because the company had failed to revise its risk factor disclosure in its quarterly earnings release and its Form 20-F annual report to reflect that it had experienced a material data breach. The SEC’s order instituting cease-and-desist proceedings stated that the company’s periodic disclosures remained unchanged and implied that no “major data privacy or confidentiality breach” had occurred when the company knew months earlier about the material data breach. The chief of the SEC enforcement division’s cyber unit said that “As public companies face the growing threat of cyber intrusions, they must provide accurate information to investors about material cyber incidents.”

This case demonstrates the SEC’s continued focus on disclosure relating to cybersecurity issues and illustrates that if a company has experienced a cybersecurity incident, then great care should be taken in analyzing the impacts on the company’s future disclosures—including the use of “could” or “may” in the face of incidents that have already materialized. The 2018 guidance listed various criteria for companies to consider when determining whether a cybersecurity incident constitutes a “material” event and companies should carefully evaluate their materiality criteria for disclosure of cybersecurity incidents. Companies should take care not to understate the nature and scope of cybersecurity incidents or overstate their cyber protections.

In a speech on October 29, 2021, SEC Commissioner Elad L. Roisman noted that, because issuers’ businesses vary, the cybersecurity-related risks they face also will vary, and therefore a principles-based rule would likely work best. In commenting on the enforcement actions referred to above, Commissioner Roisman noted that “The idea is not to blame the victim, but rather to address situations in which an entity did not fulfill its responsibilities under the law.”

COVID-19 Disclosures

In March and June 2020, the Division of Corporate Finance of the SEC issued disclosure guidance Topic No. 9 and Topic No. 9A in relation to disclosure that companies should consider in connection with COVID-19 and related market disruptions (as discussed in our client publicationSEC Issues New COVID-19 Disclosure Guidance). 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.

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.

COVID-19–related disclosures impact many areas of the Form 20-F, including the MD&A and the risk factors. Comments on quarterly reports on Form 10-Q for domestic reporting companies initially concentrated on the 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. However, as the COVID-19 pandemic has progressed, additional risks have emerged, such as supply chain disruptions, manufacturing shortages (such as semiconductors), increasing difficulty in workforce recruitment in certain markets and inflation-related risks.

Nasdaq Board Diversity Requirements

On August 6, 2021, the SEC approved the Nasdaq Stock Market’s proposal to amend its listing rules in order to advance greater board diversity through a combination of:

  • a “comply or explain” board diversity requirement to have a specified number of diverse directors; and
  • requirements to disclose additional board diversity statistics using a standardized matrix template.

In contrast to many other Nasdaq corporate governance rules, the new board diversity requirements also apply to FPIs.

For FPIs with a calendar year-end, the board diversity matrix disclosure requirements will apply to the Form 20-F filed for the 2022 year-end. FPIs listed on the Nasdaq Global Select Market, the Nasdaq Global Market or the Nasdaq Capital Market must have one diverse director (or explain why they do not) in their Form 20-F for the 2023 year-end, and such companies must have two diverse directors (or similarly “comply or explain”) in their Form 20-F for the 2025 year-end (except for companies listed on the Nasdaq Capital Market for whom the requirement applies from 2026 year-end).

For FPIs to satisfy the board diversity requirement, two board members can self-identify as female, or one director can self-identify as female and one director can self-identify as LGBTQ or as an “underrepresented individual.” In this context, an underrepresented individual means an individual who self-identifies as underrepresented based on national, racial, ethnic, indigenous, cultural, religious or linguistic identity in the country of the company’s principal executive offices.

Companies with five or fewer board members can meet the board diversity objective by having only one instead of two diverse directors. “Controlled companies” are not exempt from these rules.

Newly listed companies that were not previously subject to a substantially similar requirement on another stock exchange are required to comply with the board diversity matrix disclosure requirements within one year of their listing. Newly public companies must “comply or explain” with the director diversity requirements by the date that depends on the Nasdaq market on which the company lists. A company newly listed on the Nasdaq Global Select Market or the Global Market must “comply or explain” as to one diverse director within one year following its listing and as to two diverse directors within two years following its listing (but in each case no earlier than the general deadlines described above).

Therefore, while no additional disclosures will be required in the 2021 Form 20-F, given increasing focus on this topic from the investor community and from the SEC, issuers should nonetheless consider whether to address this topic more fully in their forthcoming annual reports.

Developments Applicable to Certain Categories of Issuers

Statistical Disclosures by Bank Holding Companies (Replacement of Guide 3)

In September 2020, the SEC finalized rules that replaced Industry Guide 3, the industry guide for banking organizations. In addition to streamlining the statistical disclosures required for banks, bank holding companies and savings and loan registrants, 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. The new rules are within the new Subpart 1400 of Regulation S-K.

These new rules apply starting for fiscal years ended on or after December 15, 2021, and are therefore applicable to the forthcoming 2021 Form 20-F for companies with a calendar year-end. Voluntary early compliance was permitted. Guide 3 will be rescinded effective January 1, 2023. The overlap between the mandatory implementation date for the new rules and the rescission date of existing Guide 3 (January 1, 2023) is to allow those registrants who had existing registration statements on file prior to the mandatory implementation date to continue to rely on the existing Guide 3 requirements.

For a more complete review of the new rules, please refer to our client publication, At Long Last—SEC Modernizes GUIDE 3 Disclosures for Banking Registrants.

Mining Disclosure Rules (Replacement of Guide 7)

In October 2018, the SEC adopted a new framework for reporting reserves and other disclosures by mining companies, which is codified in Subpart 1300 of Regulation S-K. The new rules are intended to harmonize the SEC’s mining property disclosure requirements with current industry and global regulatory practices and standards, reflecting an acknowledgement of the significant globalization that has occurred in the industry since Guide 7 was adopted. The new rules take effect beginning with a company’s first fiscal year beginning on or after January 1, 2021, and are therefore applicable to the forthcoming 2021 Form 20-F for companies with a calendar year-end.

For more information on the new mining disclosure rules, please refer to our related client publication, SEC Overhauls Disclosure Requirements for Mining Companies.

Companies Based in Mainland China and Hong Kong: Holding Foreign Companies Accountable Act

The Holding Foreign Companies Accountable Act of 2020 (HFCAA) limits access to the U.S. capital markets for public companies that are audited by registered public accounting firms that are not subject to inspection by the Public Company Accounting Oversight Board (PCAOB). The PCAOB is currently unable to make inspections of accounting firms in mainland China and Hong Kong.

The HFCAA amends the Sarbanes-Oxley Act of 2002 in a number of significant ways, including:

  • Identification of issuers: The SEC is required to identify SEC reporting companies whose financial statements are audited by an accounting firm located in a foreign jurisdiction that the PCAOB is unable to inspect due to a position taken by an authority in that foreign jurisdiction where the audits are performed. The SEC has indicated it will identify issuers pursuant to the HFCAA requirements after the filing of annual reports for the year ended December 31, 2021.
  • Delisting after three consecutive years of inability of PCAOB to inspect: The SEC is required to prohibit trading on any U.S. national securities exchange and in the over-the-account market if the PCAOB is unable to inspect an SEC reporting company’s auditor for three consecutive years. Therefore, the earliest an issuer could be delisted under these provisions would be after the filing of a registrant’s 2023 annual report, which would be filed in 2024.
  • Disclosure on governmental ownership and control: SEC-identified issuers will be required to submit documentation through EDGAR to establish, if true, that the issuer is not owned or controlled by a governmental entity in the jurisdiction of the relevant public accounting firm.
  • Additional annual report disclosure requirements: Issuers who file annual reports with financial statements audited by an auditor that did not permit PCAOB inspection will be required to include specified disclosures within the relevant Form 10-K or Form 20-F. These disclosure requirements apply to the annual report for each year in which the issuer was an SEC-identified issuer, so this would not apply until the 2022 Form 20-F filed in 2023 for companies with a calendar year-end. In Form 20-F, these amendments are included under Item 16I (Disclosure Regarding Foreign Jurisdictions that Prevent Inspections).

In addition to the requirements of the HFCAA, the SEC is also focused on additional disclosures for investor protection related to companies based in China, including risks relating to many China-based operating companies that are structured as variable interest entities as well as regulatory oversight risks relating to bringing and enforcing actions against China-based issuers. On December 20, 2021, the SEC’s Division of Corporation Finance published a sample comment letter to China-based issuers in which the Staff of the SEC addresses these additional disclosures. The sample comment letter includes an illustrative, non-exhaustive list of comments that the SEC’s Division of Corporation Finance may issue to companies seeking more prominent disclosure about the legal and operational risks associated with China-based companies.

Therefore, relevant issuers should review the sample comment letter in detail and consider including prominent disclosure of these matters and the risk related to HFCAA in their 2021 Form 20-F.

Trends in SEC Comment Letters in 2021

As required by the Sarbanes-Oxley Act of 2002 (SOX), the Staff of the SEC is required to undertake some level of review of a Form 20-F filing of a registrant at least once every three years, but the SEC will take a risk-based approach in issuing comments. There is a continuing trend of the Staff of the SEC issuing fewer comments, with comments often focusing on key focus areas. In 2021, the majority of comment letters contained only one or two comments.

Internal Control over Financial Reporting and Disclosure Controls and Procedures

The most frequently occurring comment on Form 20-F annual reports during 2021 related to mistakes in disclosures relating to internal control over financial reporting and disclosure controls and procedures when a company files its second annual report. SEC rules permit newly public companies to delay including management’s assessment of internal controls under Section 404(a) of SOX until the company’s second annual report. Many companies failed to update the Exhibit 12.1 and 12.2 certifications at such transition to include the wording prescribed by Instruction 12 to Item 19 of Form 20-F.

In addition, companies should be precise about the wording used when disclosing their assessment of internal control over financial reporting and disclosure controls and procedures. Examples that had failed to use the words “effective” or “ineffective” often resulted in comment letters being issued.

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 2021 again addressed compliance with the SEC’s rules and guidance regarding disclosure of non-GAAP financial measures, including:

  • Adjustments for COVID-19. The SEC issued various comments on non-GAAP measures that had been adjusted for effects of the COVID-19 pandemic. Comments mainly sought more information about the nature of the non-GAAP adjustments and the method used to calculate them, as well as whether adjustments are incremental to, and separable from, normal operations. Examples of adjustments that would typically not be appropriate would include estimated lost revenue and excess overhead costs such as temporarily idled facilities.
  • Titles of Non-GAAP Measures. The SEC issued various comment letters that emphasized the need to ascribe appropriate titles to non-GAAP measures. For example, if EBITDA modifies net income more than by just interest, taxes, depreciation and amortization, then this should often be labeled “Adjusted EBITDA.” If a non-GAAP measure is calculated other than as commonly understood in the market (such as calculating free cash flow other than as cash flow from operations minus capital expenditure), then the title ascribed to such measure may need to include “adjusted” or other appropriate label.
  • “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.

Issuers should continue to focus on the requirements of Item 10 of Regulation S-K and Regulation G with respect to the presentation of non-GAAP financial measures.

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

The MD&A section remains the leading source of SEC comments. Consistent with one of its principal goals—investor protection—comment letters during 2021 continued to focus on the importance of enabling investors to see companies “through the eyes of management.” The majority of comments on Form 20-F annual reports focused on (i) greater specificity in key disclosures, such as identifying the underlying drivers of material changes in financial results, and (ii) transparency and completeness of the discussion of key performance indicators (KPIs) (such as KPIs discussed in earnings calls, earnings releases or slide decks but not included in the Form 20-F).

A recurring theme for comments (including comments on the notes to the financial statements) was for companies to provide more specific and detailed disclosure on the factors driving increases in allowance for doubtful accounts, including more granular disclosure on how an issuer determined the appropriate allowance for doubtful accounts. Companies that have experienced significant changes in doubtful accounts, as a result of the COVID-19 pandemic or otherwise, should ensure that their disclosure is sufficiently detailed in order to provide a clear understanding of the changes or trends in credit quality that are driving a company’s allowance for doubtful accounts.

Given that FPIs do not file quarterly reports on Form 10-Q, unless a company has been through an SEC review process for an offering, the 2021 Form 20-F review season will be the first time their disclosures in relation to COVID-19 may be reviewed by the SEC. See “COVID-19 Disclosures” above.

Segment Reporting

As in previous years, the Staff of the SEC has continued to focus on segment reporting and numerous comment letters focus on how companies apply ASC 280/IFRS 8 segment reporting in their financial statements. Comment letters focused on how companies identified their operating segments and how companies aggregate operating segments into reportable segments. This was particularly evident when companies only have one reportable segment, where the SEC was seeking further information as to the basis upon which companies determined that they have one reportable segment. As part of this focus, the Staff of the SEC also continues to ask registrants to explain any inconsistencies between how the business is described in public information (including other parts of the Form 20-F) and how it is described in the segment footnotes to the financial statements.

Other Updates

Notifications of Delayed Filings on Form 12b-25

If a company is unable to file its Form 20-F annual report by the due date, it is able to file a Form 12b-25 (also referred to as “Form NT”) no later than one business day after the due date of the annual report. If a company timely files a Form NT, the company has an additional 15 days to file its Form 20-F annual report and still be deemed to have filed its annual report on a timely basis under its Exchange Act reporting obligations.

However, care should be taken when completing a Form NT because the form requires a company to state whether it anticipates any significant change in its results of operations for the prior year. If any such significant changes are anticipated, the company is required in the Form NT to explain such significant changes in narrative and quantitative form, or to explain why reasonable estimates cannot be provided.

On April 29, 2021, the SEC announced that it had settled charges against eight public companies for allegedly failing to disclose in Form NT filings that the companies anticipated restatements of, or corrections to, financial statements in either a Form 10-K or Form 10-Q. Each of the relevant companies subsequently announced restatements or corrections in financial statements within four to 14 days following the filing of their Form NT. Each company agreed to pay a penalty of either $25,000 or $50,000, depending on the number of alleged violations. In its announcement, the Staff of the SEC noted that it had used data analytics to identify potential disclosure violations.

Therefore, if a company does expect a significant change versus its prior year results of operations (including anticipated restatements or corrections), the company should not be silent about such changes and should not provide merely boilerplate or vague disclosure in a Form NT. As such, when a company anticipates the need to make a Form NT filing as a result of a late Form 20-F, it should work with its counsel and accountants sufficiently in advance of the due date in order to formulate appropriate narrative and quantitative disclosures that provide meaningful disclosure for investors.

SEC Proposes New Disclosure Rules for Share Repurchases

On December 15, 2021, the SEC proposed a new rule that would, among other things, require SEC reporting companies (including FPIs) to report any share repurchases on a new Form SR one business day after the issuer executes a share repurchase, as well as requiring significant additional disclosures regarding the structure of a company’s repurchase program and executed share repurchase transactions. The comment period for the proposed new rule is 45 days, beginning from the date the rule is first published in the Federal Register.

FPIs are currently required to disclose share repurchase information annually in Form 20-F, whereas the proposed new Form SR would impose a daily reporting obligation. In the SEC’s rulemaking proposal, the SEC sought comment on whether the SEC should exempt all FPIs from the requirement to file a Form SR or provide for different requirements. The SEC noted that some FPIs are required to provide daily detailed disclosure in their home jurisdictions and that some FPIs file those reports under Form 6-K. Therefore, companies should monitor the progress of these proposed rules and the requirements introduced by any final rulemaking, including interactions with any home jurisdiction rules and non-U.S. stock exchange disclosure requirements.

For more information on the proposed rules, please refer to our related client publication, SEC Proposes New Disclosure Rules For Share Repurchases.

SEC Filing Fees and Filing Fee Disclosures

As announced by the SEC on August 23, 2021, commencing on October 1, 2021 through September 30, 2022, the SEC filing fee for registration statements decreased to $92.70 per $1 million of securities registered.

In addition, the SEC is also amending most of its fee-bearing forms to require filers to present the information required for filing fee calculations in a separate exhibit structured in Inline XBRL. These amendments will generally be effective on January 31, 2022.

Authors and Contributors

Richard Alsop

Partner

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Roberta B. Cherman

Partner

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Marwa Elborai

Partner

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Masahisa Ikeda

Partner

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Trevor Ingram

Partner

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Maria Marulanda Larsen

Counsel

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Kyungwon (Won) Lee

Partner

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Jason Lehner

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Jonathan A. Lewis

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Grissel Mercado

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Toshiro M. Mochizuki

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Lona Nallengara

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Manuel A. Orillac

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Andrew Schleider

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Antonia E. Stolper

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Pawel J. Szaja

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