It is now time for foreign private issuers 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, 2020.

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 in the 2020 review process.

Trends in SEC Comment Letters in 2019

Revenue Recognition

Given that IFRS 15—Revenue from Contracts with Customers became effective for annual reporting periods beginning on or after January 1, 2018, it is not surprising that the SEC staff focused on how companies apply the new standard in their 2018 annual reports. The comment letters have focused on areas of judgment with respect to revenue recognition, such as identifying performance obligations and determining the timing of satisfaction of performance obligations, estimating variable consideration, and determining the amortization period of capitalized contract costs. In many of the comment letters, the SEC staff has requested companies to explain and provide their analysis for certain judgments and estimates made in their application of IFRS 15 and to ensure that disclosures enable users to understand the nature, timing and uncertainty of revenue and cash flows arising from contracts with customers.

Disclosures of Non-GAAP Financial Measures

Consistent with the trend observed in recent years, the use of financial measures that do not conform either to U.S. GAAP or IFRS (collectively, non-GAAP) has remained on the SEC's radar in reviewing Form 20-F annual reports and other disclosures by foreign private issuers.

SEC comment letters in 2019 have addressed compliance with the SEC's rules regarding disclosure of non-GAAP financial measures, including:

  • Adjustment for Significant Financing Component under IFRS 15: Where adjustments appear to substitute individually tailored recognition and measurement methods for those of GAAP, the SEC has requested companies to remove these adjustments from the relevant non-GAAP measure or explain why they are necessary in light of its guidance on non-GAAP measures. This includes the reversal in non-GAAP measures (such as adjusted EBITDA) of the significant financing component calculated and reported outside revenue under IFRS 15.
  • Equal or Greater Prominence: Non-GAAP financial measures should not presented with greater prominence to the corresponding GAAP or IFRS financial measure, as the case may be. This means that presenting only non-GAAP financial measures in a list of key 2019 financial results without the comparable GAAP or IFRS financial measure could draw the SEC Staff's attention. In 2019, the SEC brought its first enforcement action against a company that had presented non-GAAP financial measures more prominently.

As a reminder, when presenting any non-GAAP financial measure, companies must also provide a reconciliation of such measure to the most directly comparable financial measure calculated and presented in accordance with IFRS or GAAP, as applicable.

Presentation of a non-GAAP financial measure must also include an explanation of why management believes the non-GAAP financial measure provides useful information to investors regarding the company's financial condition and results of operations, as well as any additional purposes for which management uses the non-GAAP measure. The SEC staff may request information provided to the company's board to support statements that non-GAAP financial measures are used to assess business or operating performance.

Operating and Financial Review and Prospects (OFR) (Item 5 of Form 20-F)

A number of comment letters in 2019 focused on segment reporting in the OFR and financial statements. As a reminder, the OFR section should include a discussion of financial condition and results of operations at a segment level. For companies that have changed how their segments are reported, the SEC staff may ask how the new reporting segments were determined and how the company complied with the applicable guidance in IFRS 8.

Dealings in Countries Designated as "State Sponsors of Terrorism" and Countries Subject to U.S. Sanctions

When a company discloses, in its Form 20-F or elsewhere, that it engages in transactions in or with countries designated by the U.S. Department of State as "state sponsors of terrorism," which currently include Iran, North Korea, Sudan and Syria, such companies will frequently receive comment letters from the SEC's Office of Global Security Risk requesting additional information on such activities. In 2019, the SEC reportedly increased the number of comment letters regarding companies' disclosures of business dealings in U.S.-sanctioned countries. These comment letters often request information regarding the nature and extent of any past, current and anticipated contacts with these countries, such as any services, products, information or technology provided to, and direct or indirect agreements, commercial arrangements or other contacts with, the governments of those countries or any entities that might be controlled by those governments.

The SEC staff frequently asks companies to provide information on whether operations in or with state sponsors of terrorism constitute a material risk in both quantitative and qualitative terms, by discussing revenues, assets and liabilities associated with such operations, as well as any potential adverse effect on the company's reputation.

As a reminder, under Section 13(r) of the Securities Exchange Act of 1934, companies are required to disclose in Form 20-F if they or any of their affiliates knowingly engaged in specified activities relating to Iran, terrorism or the proliferation of weapons of mass destruction. There is no materiality threshold for disclosure under Section 13(r), so all transactions, however de minimis, are required to be reported.

Sanctions Update

Expanding Reach of U.S. Economic Sanctions

In 2019, the continued expansion of U.S. economic sanctions, coupled with the Trump administration's "maximum pressure" policies, continues to have direct implications for non-U.S. issuers in the form of secondary sanctions risks. This is especially true with respect to dealings with countries like Venezuela and Iran. As 2019 has shown, we expect frequent changes to U.S. sanctions affecting both U.S. persons and non-U.S. persons. For example, in August 2019, the United States imposed blocking sanctions on the entire Government of Venezuela, along with any state-owned entities, and has demonstrated an intention to target non-U.S. companies, such as shipping lines and air carriers, who support the country's oil exports. The United States has also broadened restrictions on non-U.S. companies doing business with Iran. For example, in May, the United States terminated the "significant reduction exemption" waivers that had previously permitted foreign governments to purchase Iranian oil without risking U.S. sanctions penalties, and has begun targeting non-U.S. companies involved in Iran's oil exports, as well as new economic sectors such as Iran's metals industry.

United States Permits Lawsuits under Helms-Burton Act, Title III

In April 2019, the Trump administration announced that it would no longer block a provision in a 1996 U.S. law commonly known as the Helms-Burton Act, which had been waived by every presidential administration since that law's adoption. Title III of the Act creates a private right of action for U.S. citizens and companies whose property was appropriated by the Cuban government after 1959 to bring suit for monetary damages against persons "trafficking" in that property. The announcement was controversial, particularly in the EU and Canada. Experts predicted a wave of lawsuits against large, multinational corporations that have made use of properties in Cuba for decades. So far, a handful of such lawsuits have been filed in the United States against both U.S. and non-U.S. companies, but the possibility of such lawsuits has cast a shadow over new investments in Cuba.

Increased Potential for Divergence of U.K. and EU Sanctions Law

Under the U.K.'s Sanctions and Anti-Money Laundering Act 2018, the U.K. introduced greater revenue and fine generating powers. Furthermore, as part of its Brexit preparations, the U.K. continues to introduce domestic sanctions legislation. These laws empower U.K. ministers to establish and amend sanctions regimes, which previously could have been set at the EU-level. Although the EU and U.K. sanctions regimes remain closely aligned, Brexit allows the U.K. to adopt a more independent sanctions policy. We are yet to see how the U.K. exercises its greater independence, but companies should remain vigilant to divergence between the U.K. and EU sanctions regimes.

Fifth Money Laundering Directive (MLDV)

The EU's latest amendments to pan-European money laundering law should be transposed by member states into domestic law by January 10, 2020. The European Commission is currently empowered to publish a list of high-risk third countries—in accordance with these amendments, business relationships or transactions involving the identified high-risk third countries will need to be subject to prescribed enhanced due diligence and monitoring. Furthermore, additions to the existing list of high-risk jurisdictions have been subject to continued debate between EU institutions, and the European Commission is expected to continue seeking consensus on expanding this list throughout 2020.

SEC Updates

Amendments to Form 20-F to Modernize and Simplify Disclosure Rules

In 2019, the SEC adopted amendments to its rules and forms, including Form 20-F, to modernize and simplify disclosure requirements. The amendments are intended to streamline disclosures made by public companies to make them more effective and reduce compliance costs while continuing to provide material information to investors.

Key changes effected by the amendments include:

  • Revising the requirements for the "Operating and Financial Review and Prospects" section of annual reports (Item 5 of Form 20-F) to allow companies to exclude a discussion of the earliest of the three years, provided that a discussion of that year has been included in a prior report;
  • Clarifying that companies do not necessarily need to present the discussion in the OFR section in the format of a year-over-year comparison, but may use any other format that in their judgment enhances a reader's understanding of changes in its financial condition and results of operations;
  • Allowing companies to redact confidential information from most exhibits to their filings without submitting a request for confidential treatment, provided that the redacted information is not material and that public disclosure would likely cause competitive harm;
  • Permitting companies to omit entire schedules and similar attachments to any filed exhibits unless the schedules and attachments contain material information that is not otherwise disclosed in the exhibit itself or in the disclosure document; and
  • Incorporating technology to improve access to information by requiring data tagging for items on the cover page of certain filings and the use of hyperlinks for information that is incorporated by reference and available on EDGAR.

The provisions requiring XBRL (eXtensible Business Reporting Language) data tagging are subject to a three-year phase-in, depending on the filing status of the company.

On April 1, 2019, the SEC published guidance on complying with the new rules allowing issuers to redact non-material competitively sensitive information from material contracts filed as exhibits to SEC reports. In this guidance, the SEC notes that it intends to review for compliance with the new rules by requesting a paper copy of the unredacted exhibit and may ask companies to further substantiate redaction decisions.

Guidance on Good Disclosure of Brexit Risks and Other Complex, Uncertain and Evolving Risks

In March 2019, William Hinman, the Director of the SEC's Division of Corporation Finance, gave a speech in which he outlined best practices companies should consider when deciding what to disclose about complex and evolving risks, such as Brexit and sustainability.

Mr. Hinman emphasized that the SEC's disclosure rules generally favour a principles-based, rather than prescriptive, approach to topics that are complex, associated with uncertain risks and rapidly evolving. He reiterated that, when drafting any risk factor disclosure, companies should focus on the most significant things that make an investment in a company and its securities subject to uncertainties or risk. Concise and focused disclosure explaining how each risk specifically affects the company is most useful for investors. Companies should take care not to bury the reader in generic boilerplate or laundry lists of risks that could apply to any company.

Mr. Hinman provided the following framework that may be helpful to companies in making disclosure decisions about Brexit and other complex and uncertain risks:

[I]nvestors are better served by understanding the lens through which each company's management looks at its exposure. How does management assess and analyze Brexit-related risks and the potential impacts on the company and its operations? What is management doing to mitigate and manage these risks? What is the nature of the board's role in overseeing the management of these risks? Depending on the facts and circumstances of each company, the answers to these questions should provide material information to investors seeking to understand the risks attendant to Brexit for that company. One analytical tool to evaluate disclosure in this context is to consider how management discusses Brexit-related risks with its board of directors. Obviously not all discussions between management and the board are appropriate for disclosure in public filings, but there should not be material gaps between how the board is briefed and how shareholders are informed. For those of you involved in crafting disclosure documents, you can ask yourself a straightforward question: would these disclosures satisfy the curiosity of a thoughtful, deliberative board member considering the potential impact of Brexit on the company's business, operations and strategic plans?

Specifically, Mr. Hinman said companies should consider whether Brexit exposes companies to material risks in the following areas:

  • Regulatory risk;
  • Supply chain risk;
  • Loss of customers, decrease in sales or increase in costs, due to tariffs or other factors;
  • Currency devaluation, foreign currency exchange rate risk or other market risk;
  • Contractual risk; and
  • Effect on financial statement recognition, measurement or disclosure items, such as inventory write-downs, long-lived asset impairments, collectability of receivables, assumptions underlying fair value measurements, foreign currency matters, hedge accounting or income taxes.

LIBOR Transition Risk Factor

On July 12, 2019, the SEC's staff issued a statement regarding the anticipated transition away from LIBOR as a benchmark interest rate in 2021. The statement encourages market participants to begin the process of identifying existing contracts that extend past 2021 to determine any material risks posed by the expected transition away from LIBOR.

The statement emphasized that companies should consider their disclosure obligations relating to risks facing the company arising from the expected discontinuation of LIBOR. Specifically, the company's risk factors (Item 3.D of Form 20-F), operating and financial review and prospects (Item 5 of Form 20-F) and financial statements may require LIBOR-related disclosure.

In deciding which disclosures are relevant and appropriate, the staff provided the following guidance:

  • The evaluation and mitigation of risks related to the expected discontinuation of LIBOR may span several reporting periods. Companies should consider disclosing the status of efforts to date and the significant matters yet to be addressed.
  • When a company has identified a material exposure to LIBOR but does not yet know or cannot yet reasonably estimate the expected impact, it should consider disclosing that fact.
  • Disclosures that allow investors to see LIBOR-related issues through the eyes of management are likely to be the most useful for investors. This may entail sharing information used by management and the board in assessing and monitoring how transitioning from LIBOR to an alternative reference rate may affect the company. This could include qualitative disclosures and, when material, quantitative disclosures, such as the notional value of contracts referencing LIBOR and extending past 2021.

New SEC Mining Disclosure Rules: Companies May Voluntarily Comply Prior to 2021

In October 2018, the SEC adopted a new framework for reporting reserves and other disclosures by mining companies, which are codified in Subpart 1300 of Regulation S-K. The new rules take effect beginning with a company's first fiscal year beginning on January 1, 2021 or later. The SEC had previously stated that companies could elect to voluntarily comply with the new rules prior to the effective date, subject to the SEC completing the necessary tweaks to EDGAR to accommodate the new disclosures, and so long as the company complies with all of Subpart 1300's requirements.

On May 7, 2019, the SEC issued a statement clarifying that, even though the changes to the EDGAR system are still ongoing, companies may immediately elect to comply with the new mining disclosure requirements during the transition period. Any technical report summary required should be filed as an additional exhibit under Item 601(b)(99) of Regulation S-K or Exhibit No. 15 of Form 20-F. Any maps, diagrams or other graphic material included in the technical report summary must meet EDGAR's technical specification requirements.

SEC Filing Fee

For the period from October 1, 2019 to September 30, 2020, the SEC filing fee for registration statements is $129.80 per $1 million of securities registered.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.