Introduction

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

Registrants should consider the following developments, trends and topics which may be the SEC's areas of focus during the 2021 review process.

SEC guidance on COVID-19 disclosure

In March 2020 and June 2020 the SEC Division of Corporate Finance issued guidance on Topic 9 and Topic 9A that concerned disclosures which companies should consider providing in connection with the COVID-19 pandemic 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.

The guidance particularly emphasised the importance of providing clear disclosures relating to the management of short and long-term liquidity and funding risks in the current economic environment.

To help companies analyse their specific facts and circumstances and weigh their disclosure obligations, the guidance provided a 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 covered topics such as:

  • 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.

The suggested topics are not exhaustive and companies should consider whether other material trends or risks have emerged as a result of COVID-19, including those 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 COVID-19 on its business, while financially insignificant, illustrates the SEC's focus on registrants' disclosures relating to the impacts of COVID-19 on their 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 emphasised 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.

The SEC Office of the Chief Accountant (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 judgements and estimates are reasonable and disclosed in a manner that is understandable and useful to investors.

Trends in 2020 SEC comment letters

Disclosures of financial measures that do not conform to generally accepted accounting measures

The SEC continued to focus on the use of financial measures that do not conform to either the US generally accepted accounting measures (GAAP) or the international financial reporting standards (IFRS) (collectively, non-GAAP measures) 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 the disclosure of non-GAAP measures.

Use of individually tailored accounting principles

Adjustments that resulted in non-GAAP measures which presented financial results to essentially give effect to superseded accounting principles led to SEC comments to remove such adjustments. The SEC permits the use of tailored accounting non-GAAP measures where a new standard is adopted without full retrospective application (eg, IFRS 15) to make it easier for investors to compare current results with those for prior periods. However, the SEC believes that these measures are inappropriate outside the transition period because continued individual tailoring for superseded accounting principles causes the measures to be misleading. Accordingly, there was an increase in the number of comments issued on individually tailored measures other than revenue, such as those that:

  • adjusted equity method accounting to show pro rata consolidation;
  • removed the effect of purchase accounting (fair value) adjustments; and
  • adjusted for only a portion of the amortisation associated with acquired intangible assets.

Exclusion of normal, recurring cash operating expenses

During 2020, there was a rise in the number of comments that challenged registrants which excluded recurring charges (eg, costs to be a public company and frequent restructuring costs) from non-GAAP measures. The SEC's position, as indicated in its compliance and disclosure interpretations and the emphasis placed during periodic reviews, is that these exclusions could be considered misleading as they exclude normal, recurring cash operating expenses that are necessary to operate a registrant's business.

Equal or greater prominence and disclosures on purpose and use

The SEC continued to emphasise that non-GAAP financial measures should not be presented with greater prominence than the corresponding GAAP or IFRS financial measure. 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 non-GAAP measures to investors and how management uses such measures.

Disclosure in management's discussion and analysis

The management's discussion and analysis section remained the leading source of SEC comments. Consistent with one of the SEC's principal goals – investor protection – comment letters during 2020 continued to emphasise the importance of enabling investors to see companies "through the eyes of management". Outside the context of COVID-19, most comments focused on the need for:

  • transparency in the discussion of performance metrics, to ensure that registrants disclose key metrics used by management; and
  • greater specificity, including:
    • identifying the underlying drivers of material changes; and
    • detailing how performance metrics correlate with material changes that affect earnings or that are reasonably likely to have a material effect on future operating results.

With respect to the effects of COVID-19, comments concentrated on liquidity and availability of capital resources, as well as known trends or uncertainties relating to COVID-19 that will have a material favourable or unfavourable impact on results from continuing operations (see "SEC guidance on COVID-19 disclosure" above).

Other prevalent comments relating to the management's discussion and analysis section were those that requested registrants to provide:

  • expanded discussions on significant components of operating expenses, such as sales costs – not only to describe changes in revenue and segment profit or loss, but also to directly and separately explain and quantify the changes in significant operating expenses that have affected revenue and segment results; and
  • more robust analysis of critical accounting estimates than that which 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 continued to focus on how companies:

  • identify performance obligations;
  • determine that they have satisfied performance obligations; and
  • disaggregate revenue in their disclosures.

The SEC was especially interested in how registrants support their conclusions that certain promised goods and services are or are not separately identifiable.

Segment reporting

The SEC again directed many comments towards segment reporting rationale and how registrants apply the guidance on this topic in accounting standards codification (ASC) 280 and IFRS 8. The SEC continued to focus on:

  • the identification of operating segments;
  • the aggregation of operating segments into reportable segments; and
  • whether registrants provide appropriate entity-wide disclosures relating to:
    • products and services;
    • revenues attributable to individual foreign countries; and
    • revenues from major customers.

In addition, the SEC continued to ask registrants to explain any inconsistencies between how their business was described in public information and how it was described in the segment footnotes. For example, the SEC has challenged registrants which say that the basis for identifying operating segments is something other than product or service lines (eg, geography), but publicly disclosed information suggests that management uses financial information by product or service lines to make decisions and allocate resources.