Management’s Discussion and Analysis (MD&A). MD&A rules require companies to “describe any known trends or uncertainties that have had or that are reasonably likely to have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.” In the current geopolitical and economic climate, many companies are increasing their disclosure related to supply chain issues, inflationary pressures, impact of foreign exchange rates, lengthening sales cycles, potential recession, effects of higher interest rates, and Russia’s invasion of Ukraine. Companies should disclose both current and potential future impacts of geopolitical and economic conditions on their business. This is particularly important given the U.S. Securities and Exchange Commission’s (SEC’s) focus on a principles-based approach to MD&A, as detailed in our previous client alert.
Risk Factors. Companies should keep the substance of their risk factors updated as current risks change and new risks emerge. The geopolitical and economic considerations that companies assess for purposes of MD&A disclosure, described above, may be key areas for companies to consider when refining risk factor disclosure. Companies should also consider risks specific to their business or industry. Many companies have pared down COVID-19 risk factor disclosure, but given the uncertainty surrounding the virus, companies should continue to assess any remaining risks and uncertainties of the pandemic on their business. Companies should also take care to ensure that risk factors are reviewed and updated, as needed, to reflect actual changes in circumstances or events that have occurred, including changing any hypothetical statements if necessary.
In addition, companies should confirm that the structure of their risk factor disclosure is compliant with the SEC’s rules. Risk factors should be categorized under subject matter headings. Although the SEC discourages generic risk factors, if they are included they should be disclosed under the heading “General Risk Factors.” If the risk factor disclosure is over 15 pages long, a risk factor summary (no longer than two pages) must be included in the annual report, which summarizes the principal risk factors.
Competitors. Companies should take a fresh look at their disclosures related to competitors. The Department of Justice (DOJ) has recently stepped up enforcement of Section 8 of the Clayton Act, which bars any individual or entity from serving as a director or officer of two competing companies, as detailed in our previous client alerts here, here, and here. In determining which companies compete with a particular company, the DOJ may reference a company’s stated “competitors” in its disclosures filed with the SEC. Consider providing a general description of the competitive landscape as opposed to listing specific companies as competitors, and if listing companies, only list actual competitors.
SEC Comment Letter Trends. Based on a review of SEC comment letters for the 12 months ended June 30, 2022, and consistent with last year, the top three areas of SEC focus were: non-GAAP financial measures; MD&A including, results of operations, critical accounting policies and estimates, and liquidity and capital resource matters; and segment reporting. Notably, climate-related disclosure was added to the top 10 most frequent comment areas during this period.1 In September 2021, SEC staff published a sample letter with climate-related disclosure comments that have been issued to certain companies regarding their climate-related disclosures. Many of these comments were based on the SEC’s 2010 climate change disclosure guidance. In addition to the sample comment letter on climate-related disclosures, in May 2022, SEC staff published a sample letter with comments relating to Russia’s invasion of Ukraine and related supply chain issues. See our previous client alert for more information. While the foregoing geopolitical issues were not included in the top 10 areas of comment, disclosures relating to those issues are currently key areas of review and comment by SEC staff. Notably, the volume of SEC comment letters increased 10 percent compared to the previous period. As such, companies should review these trends and sample comment letters together with related disclosures as drafting of the Form 10-K gets underway.
Emerging Growth Company Transition. Effective September 20, 2022, the SEC increased the annual gross revenue threshold at which companies transition out of Emerging Growth Company status from $1.07 billion to $1.235 billion. If a company’s status as an Emerging Growth Company will terminate as of the end of its current fiscal year, its annual meeting proxy statement will require several enhancements, including a full compensation discussion and analysis (CD&A) section. For additional details about the transition from Emerging Growth Company status, please see our previous client alert.
Human Capital Management. Human capital management (HCM) disclosure continued to expand in 2022 and remains an important area of focus for the SEC. We expect the SEC to release proposed rules on new HCM disclosure soon.2 Companies are discussing a broad range of topics in their HCM disclosure, including: employee engagement; pay equity; employee health and wellness; flexible work arrangements; and diversity, equity, and inclusion. Many companies also provided quantitative HCM disclosure, such as the percentage of female employees and amount of employee turnover and retention, or the impact of initiatives to improve gender or ethnic diversity in the workforce. Often, quantitative disclosure is based on EEO-1 data. While some HCM disclosure is required in Form 10-K, if material, many companies also included HCM-related information in their proxy statements, where the HCM disclosure can be paired with other ESG-related content. HCM disclosures, as with other ESG-related disclosures, should be consistent across all channels of company communication.
HCM disclosures also take on enhanced importance in light of the SEC’s release of Staff Legal Bulletin No. 14L (SLB 14L). SLB 14L rescinded several previous bulletins to, among other things, update SEC guidance on how the SEC views Rule 14a-8’s ordinary business exception.3 Under SLB 14L, the SEC focuses on whether the proposal “raises issues with a broad societal impact[,]” irrespective of whether it is significant for the company. By way of example, the SEC wrote, “proposals squarely raising human capital management issues with a broad societal impact would not be subject to exclusion solely because the proponent did not demonstrate that the human capital management issue was significant to the company.”
Non-GAAP Financial Measures. As noted above, non-GAAP financial measures continue to be a top area of focus for SEC comment letters. Companies that disclose non-GAAP financial measures in their Form 10-K should carefully review these disclosures to confirm that they are compliant with Regulation G and Item 10(e) of Regulation S-K and to ensure they are not making misleading adjustments or inconsistently presenting the non-GAAP financial measures without disclosing the reasons for such changes. In addition, on December 13, 2022, the SEC’s Division of Corporation Finance published new and updated Compliance and Disclosure Interpretations (CDIs) including Questions 100.01, 100.04 – 100.06, and 102.10(a), (b), and (c). The CDIs include information relating to non-GAAP adjustments, disclosures, and prominence, and include specific examples of disclosure that SEC staff would consider problematic. Companies should carefully review these new and updated CDIs as they prepare their year-end disclosures as some of them provide guidance on gray areas of non-GAAP disclosure.
Holding Foreign Companies Accountable Act. Under the rules implemented by the SEC pursuant to the Holding Foreign Companies Accountable Act, companies are required to include Item 9C, Disclosure Regarding Foreign Jurisdictions that Prevent Inspections, in their Form 10-K. While many companies will not have applicable disclosures under this item, companies should still include the item and caption in their Form 10-K and, if appropriate, indicate that the item is not applicable. In addition, in order for the SEC to identify companies that may be subject to the rules, i.e., companies that have filed an annual report containing an audit report issued by an audit firm that the PCAOB is unable to inspect or investigate completely because of a position taken by a foreign authority, all companies filing financial statements using Inline XBRL are required to tag their auditor’s name, location where the auditor’s report has been issued, and the audit firm’s or branch’s PCAOB ID Number in their Forms 10-K.
Section 302 and Section 906 Certifications (CEO/CFO Certifications). Companies should carefully review their Section 302 and Section 906 certifications included as exhibits to their Form 10-K. In particular, a newly public company filing its second annual report is no longer in the transition period established by the SEC before its CEO and CFO need to certify their assessment of the company’s internal control over financial reporting. These companies will need to (1) update their Section 302 certifications so that the principal executive officer and principal financial officer make all required certifications,4 and ensure that their Section 302 certifications are updated in subsequent Form 10-Q filings, and (2) update the language in Item 9A, Part II of the Form 10-Ks to include management’s report on internal control over financial reporting and, if applicable, a statement regarding the outside auditor’s attestation report.5
Reminder of Electronic Signature Rules. In late 2020, the SEC finally permitted companies and others to use electronic signatures for SEC filings, including the Form 10-K. Prior to using electronic signatures, each signatory must have manually signed an attestation agreeing that the use of an electronic signature constitutes the legal equivalent of such individual’s manual signature before companies. Companies should consider including attestations as part of their onboarding process for new directors and applicable officers, if they have not done so already. If a company has not received a manually executed attestation for any new directors or applicable officers, companies should have one signed in advance of seeking electronic signatures for their Form 10-K. Contact us for an appropriate form of attestation.
Exhibit Index. Companies should take a fresh look at the exhibit index of their Form 10-K. In addition to reviewing their Forms 10-Q and 8-K filed in the last year, companies should consider whether they need to make any updates related to the certificate of incorporation or bylaws, material contracts and amendments (including immaterial amendments to material contracts that were not previously filed with periodic or current reports), the description of the capital stock, or the list of subsidiaries. Any expired or terminated material contracts with no continuing obligations should be removed from the exhibit index. Further, companies should check that each exhibit is hyperlinked to the correct document. When reviewing the exhibit index, check to see whether any previous grant of confidential treatment is due to expire in 2023 so that appropriate extensions can be sought, if appropriate.
As a reminder, companies are required to identify the Interactive Data Files in the exhibit index of their Form 10-K. Include any Interactive Data File required under Rule 405 of Regulation S-T as Exhibit 101 and any Cover Page Interactive Data File required under Rule 406 of Regulation S-T as Exhibit 104 in the exhibit index. Note that the title description of Exhibit 101 must include the word “Inline” and the title description of Exhibit 104 should cross-reference to the Interactive Data Files submitted under Exhibit 101.
Electronic Filing of Glossy Annual Reports. In connection with annual stockholder meetings, companies are required to file and distribute to stockholders annual meeting proxy statements. In addition, companies are required to send annual reports to stockholders, which reports must precede or accompany the annual meeting proxy statements.6 While these annual reports are not required to be filed with the SEC, companies have been required to furnish copies of their glossy annual reports to the SEC by either mailing hard copies to the SEC or submitting the glossy annual report on EDGAR. In practice, companies typically relied on prior guidance from the SEC staff that permitted a company to satisfy this obligation by posting an electronic version of its annual report to its investor relations website. However, in June 2022, the SEC adopted amendments to Rule 101 of Regulation S-T, which become effective on January 11, 2023, that mandate the electronic submission of certain documents on EDGAR, including “glossy” annual reports. Accordingly, after January 11, 2023, companies must furnish their annual reports electronically on EDGAR in a PDF format no later than the date on which the report is first sent to shareholders. The submission will not be deemed “filed” unless the company explicitly incorporates the annual report by reference into an SEC filing. The PDF of the annual report cannot be reformatted or otherwise redesigned from the original format.
Effect of Form 10-K on Outstanding Registration Statements. The filing of the Form 10-K may require updates to outstanding registration statements. If the company has any outstanding registration statements on Form S-1, then it will need to file a post-effective amendment to the Form S-1 in order to incorporate the annual financial statements by reference. If the company has any outstanding registration statements on Form S-3, then it will need to ensure that it continues to meet the eligibility requirements for using the Form S-3 as of the time it files its Form 10-K. Specifically, if it previously filed a well-known seasoned issuer (WKSI) shelf registration statement, it will need to confirm that it is still a WKSI in order to use that registration statement; otherwise, it will need to re-file it (if the company is eligible) as a non-WKSI shelf. If it previously filed a non-WKSI shelf registration statement, it will need to confirm that it still meets the requirements to use that registration statement; otherwise, it will need to re-file it as a Form S-1.
Form S-8. Companies with equity plans that provide for automatic increases to the number of shares authorized for issuance thereunder, often referred to as evergreen increases, will need to file a Form S-8 to register those shares. Companies may want to consider filing the Form S-8 and its exhibits shortly after their Form 10-K to align the auditor procedures for both filings. As with all registration statements, companies must now include the filing fee table as a separate exhibit to the Form S-8 instead of on the cover page.
In addition, New York Stock Exchange (NYSE) listed companies are required to file a supplemental listing application (SLAP) prior to the issuance of additional shares of a listed security, including shares issued under the company’s equity plans.7 These additional securities may not be issued until the NYSE has authorized the SLAP. Accordingly, an NYSE-listed company should submit a SLAP electronically through Listing Manager as soon as that company’s board approves the Form S-8 filing for the evergreen increase. Nasdaq does not have a similar filing or notification requirement for evergreen increases to listed companies’ equity plans.
Considerations for D&O Questionnaires and Company Charters and Bylaws
D&O Questionnaires. With the DOJ’s renewed enforcement of Section 8 of the Clayton Act relating to interlocking directorates (discussed above under “Competitors”) and the U.S. Federal Trade Commission’s (FTC’s) recent policy statement appearing to reinterpret the FTC Act to include broad powers related to interlocking directorates, we recommend that companies review their existing Clayton Act-related questions in their director and officer (D&O) questionnaires and consider updates or additional questions that may elicit responses to address the expansive nature of the DOJ’s enforcement efforts. For more information, including how to address potential competitive board seats or board observer positions, including at venture or private equity firm portfolio companies, refer to our previous client alerts (here, here, and here).
In addition, to the extent that the D&O questionnaire is being used to gather information relating to possible disclosures under Section 13(r) of the Securities Exchange Act of 1934 relating to sanctionable activities, companies may want to consider clarifying that the disclosures reach beyond activities relating to Iran, for example, to certain entities and individuals in Russia who have been recently added to the list of blocked parties.
Finally, companies that are incorporated, or that are qualified to do business, in California generally have to file an annual statement of information with the California Secretary of State. In 2022, California added a new question to this form asking whether any director or officer has an outstanding final judgment for the violation of any wage order or provision of the California Labor Code. If the foregoing is not already covered by the legal proceedings questions in a company’s D&O questionnaire, then companies incorporated in or qualified to do business in California should consider adding this question to their D&O questionnaires.
Company Charters. Companies undertaking corporate governance reviews this year may consider updating their charters in light of certain changes to the General Corporation Law of the State of Delaware (DGCL). In August 2022, Delaware amended DGCL Section 102(b)(7) to allow Delaware corporations to adopt charter provisions that exculpate officers from direct claims by stockholders asserting breaches of the fiduciary duty of care, but not for derivative or similar claims brought by or in the right of the corporation. For more information on these amendments, refer to our previous client alert. Before adopting charter amendments to reflect the updates to Delaware law, companies should consider, among other things: a charter amendment will require both board and stockholder approval; the DGCL sets minimum stockholder approval thresholds for charter amendments; a company’s existing charter provisions may require an even higher level of stockholder approval than Delaware law; the scope of exculpation allowed for officers is limited relative to the exculpation allowed for directors; and the views of proxy advisory firms like Institutional Shareholder Services (ISS) and Glass Lewis and Co. (Glass Lewis).
While ISS and Glass Lewis appear to be generally supportive of specific charter amendment proposals addressing Section 102(b)(7) officer exculpation (recommending favorable votes in the first instances this fall where companies presented stand-alone proposals), their updated voting guidelines signal a more moderated approach, with both ISS and Glass Lewis indicating that they will review these proposals on a case-by-case basis, and Glass Lewis indicating that it would not be supportive of these proposals absent a compelling rationale for adoption provided by the board. For more information on ISS and Glass Lewis voting guidelines, see our previous client alert.
If you wish to pursue a charter amendment related to officer exculpation, keep in mind that it will require the filing of a preliminary proxy statement with the SEC. Adequate advance planning for such a filing will need to be reflected in annual meeting checklists and the corporate calendar.
Bylaws. With the recent amendments to the DGCL, as well as the SEC’s adoption of universal proxy rules late last year (see our previous client alert), now is a good time for a fresh look at a company’s bylaws. In particular, companies may want to consider updates to their advance notice bylaws to ensure adequate notice and information will be provided by stockholders in advance of proxy contests, and also to include provisions relating to the universal proxy rules set forth in Exchange Act Rule 14a-19. Among other things, companies should consider specifying that any notice relating to director nominees include a statement as to whether the stockholder intends to solicit the requisite percentage (67 percent) of the voting power of the company’s stock under Rule 14a-19; provide that if the stockholder fails to comply with the requirements of Rule 14a-19 such stockholder’s nominees will be ineligible for election at the annual meeting and any votes or proxies for those nominees will be disregarded; and require that the proponent stockholder provide reasonable evidence of satisfaction of the Rule 14a-19 requirements prior to the company’s annual meeting.
Companies may also want to consider amending their bylaws to add flexibility in giving notice for adjourned meetings, including an adjournment taken to address a technical failure or to convene a meeting using remote communication, and to eliminate the requirement to make the list of stockholders entitled to vote at a stockholder meeting available at such meeting. Amendments to bylaws generally only require board approval, but companies should consider the timing of any revisions to avoid disrupting procedures for upcoming annual meetings. Also, amendments to bylaws are reportable events pursuant to Item 5.03 of Form 8-K.
For more information on annual reporting requirements, governance matters, or any related matter, please contact any member of the firm's public company representation or corporate governance practices.
[1] For SEC comment letter trend data, refer to Ernst & Young’s SEC Reporting Update – Highlights of Trends in 2022 SEC Comment Letters, available for download here (last accessed December 14, 2022).
[2] See Item 101(c)(2)(ii) of Regulation S-K; see the SEC’s Spring 2022 Regulatory Agenda, which reflected anticipated action on human capital management proposed rules in October 2022.
[3] See Exchange Act Rule 14a-8(i)(7), which allows a company to exclude shareholder proposals from the company’s proxy statement that deal with matters relating to the company’s ordinary business operations.
[4] See Item 601(b)(31) of Regulation S-K.
[5] See Item 308(a) of Regulation S-K.
