As our clients and friends know, each year Mintz provides an analysis of the regulatory developments that impact public companies as they prepare for their fiscal year-end filings with the Securities and Exchange Commission (SEC) and their annual shareholder meetings. This memorandum discusses key considerations to keep in mind as you embark upon the year-end reporting process in 2023.
In 2022, while disruptions of the COVID-19 pandemic, such as new variants, office closures and travel restrictions, have continued to fade, many public companies continue to face other significant challenges. These include inflation, higher interest rates, a difficult capital-raising environment, challenges in hiring and retaining employees and adapting to a more permanent remote or hybrid work environment, supply chain disruptions, impacts from the conflict in Ukraine, the effects of climate change and ongoing cybersecurity challenges and risks, among others. Challenges such as these will need to be considered and addressed in companies' 2022 Annual Reports on Form 10-K. Public companies will also need to assess whether their filer status has changed since last year and whether they are or are not eligible to avail themselves of the accommodations for smaller reporting companies or emerging growth companies this year.
In preparing for their 2023 annual shareholder meetings, we expect public companies will be considering the skills and qualifications of their directors and addressing gaps where applicable through their director nominations or ongoing board education for existing directors. In addition, we expect boards of directors will continue to consider issues of board diversity, overboarding and director interlocks as part of the nominations process. Public companies should also consider early in their annual meeting preparations whether they will be pursuing a stock option repricing to help improve employee retention and whether they will seek to amend their charter documents to provide for the exculpation of officers for breaches of the fiduciary duty of care, which is now permitted following recent amendments to Delaware law.
In 2022, the SEC has been very active in its rulemaking efforts. At the beginning of this year, the SEC's rule mandating universal proxy cards in contested director elections took effect. In addition, the SEC recently issued its final rules on pay-versus-performance disclosure, which will need to be included in proxy statements for 2023 annual shareholder meetings. The SEC also recently issued its final rule requiring the national securities exchanges to adopt rules to require listed companies to adopt clawback policies meeting certain strict requirements, and we anticipate most public companies will need to adopt new clawback policies in 2023 to comply with these rules. The SEC is also anticipated to issue its final rule on climate disclosure soon, and public companies should be taking steps now to prepare to comply with the new requirements. Beyond the climate disclosure rule, we also expect continued pressure from investors, the SEC, proxy advisory firms and other stakeholders in connection with establishing rules and standardized disclosure for various environmental, social and governance (ESG) topics and metrics. In 2023, companies should continue to incorporate ESG concepts into their ongoing board conversations and their routine disclosure practices. Mintz is a leader in assisting companies and their boards in addressing the ESG movement, and the Mintz ESG Practice continues to work with clients on these important issues.
Other developments we discuss in this memorandum include proxy advisor voting guidelines, cybersecurity and recent litigation impacting corporate governance and disclosure.
Updating the MD&A and Risk Factors in 2023
As we come to the end of 2022, public companies continue to be tested in many ways. From the COVID-19 pandemic over the past few years to continuing global political, economic, social and environmental challenges, companies have had to adapt to changing business conditions and evolving risks. As we begin 2023, companies should take a fresh look at their disclosures, particularly their risk factors and Management's Discussion and Analysis of Financial Condition (MD&A) section of their Annual Report on Form 10-K. Among other things, public companies are required to describe in the MD&A 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, as well as any known trends or demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the company's liquidity increasing or decreasing in any material way and any known material trends, favorable or unfavorable, in the company's capital resources.1 Public companies are also required to include in the risk factor section of Form 10-K a discussion of the material factors that make an investment in the company speculative or risky.2 Importantly, risks that have begun to materialize should not be discussed in a hypothetical way. Instead, risk factors should describe how a risk has materialized and what the current risks are to the company.
In connection with closely reviewing and updating the MD&A and risk factor sections this year, below are a few key topics that companies should consider in particular this year to determine if and how they have affected or may affect the company's business:
Inflation and Market Conditions.
During the 12 months from October 2021 to October 2022, the U.S. Consumer Price Index rose approximately 7.7%, with energy prices increasing approximately 17.6%.3 As a result of inflation, many companies have experienced and continue to experience increased costs for the supply of product components and raw materials, and companies may or may not be able to offset these cost increases by increasing the prices of their own products. To the extent companies increase their product pricing, it may result in fewer products sold. All of these factors may have an impact on revenues and earnings.
Interest Rates and Capital Markets.
As interest rates have and may continue to rise, the cost of borrowing has increased for many companies. In addition, the current environment continues to present challenges to companies seeking to raise funds through the capital markets. This may result in companies choosing to adjust their business plans to pursue strategies that may be less capital-intensive in the near term, for example, by delaying ramping production and commercial infrastructure or entering into new product lines. Life science companies may decide to delay new clinical trials or refocus their development efforts on fewer product candidates or fewer indications in an effort to extend their cash runway during this challenging environment in the capital markets.
COVID-19 Pandemic.
As many of the impacts of the COVID-19 pandemic over the past year, such as quarantines, travel restrictions and office closures, continue to fade, COVID-related disclosures should be revised to reflect any continuing impacts and risks that may arise in the event of a resurgence of the pandemic, through a new variant or otherwise. We would expect, however, that many companies will begin or continue to scale back their COVIDrelated disclosure to focus on these continuing impacts and risks rather than the more acute impacts that companies experienced early in the pandemic.
Human Capital Resources and the Labor Market.
Many companies continue to face significant competition for talent as the labor market remains tight. As employees have become accustomed to working from home or to other increased flexibility in working conditions during the pandemic, many companies need to adapt to a more permanent hybrid or remote working environment to continue to retain their workers. Due to both the tight labor market and inflation, many companies are also facing increased labor costs.
Supply Chain Challenges.
Throughout the COVID-19 pandemic, many companies have experienced supply chain disruptions that have made it increasingly difficult to ensure a reliable and cost-effective supply of components and raw materials. In particular, companies dependent on single-supply sources and companies dependent on components in high demand with limited sources have faced increased risk. Dependence on supply sources in places with strict COVID-19 policies, such as China, has also led to increased risk for companies.
Ukraine Conflict.
In addition to the humanitarian crisis that has resulted from the conflict in Ukraine, the conflict has adversely affected global energy prices. In addition, many companies that have employees in Ukraine, sell products or services into Ukraine or are conducting other activities, such as clinical trials, in Ukraine have been and will likely continue to be impacted by the conflict.
Climate Change.
There continues to be a significant focus on the impact of business activities on climate change from regulators, proxy advisory firms, shareholders, employees and other constituents, regardless of whether the company operates in an industry that would be expected to have the greatest impact on climate change. Please refer to the section below entitled "Pending Climate Disclosure Requirements" for more information about the SEC's proposed climate disclosure rule and steps companies should consider taking now to prepare for the anticipated final rule.
Cybersecurity
Cybersecurity continues to present significant risks to many companies, as the consequences for cybersecurity events are significant and the risks continue to change as technology evolves. Please also refer to the section below entitled "Privacy Legislation, Data Protection and Cybersecurity Disclosure" for more information about recent developments in cybersecurity.
Filer Status Transitions in a Volatile Stock Market
In 2020 and 2021, many public companies (particularly life science companies) benefitted from booming valuations. These increased valuations often resulted in more burdensome disclosure obligations under the Securities Exchange Act of 1934, as amended (the Exchange Act). As discussed in our article, once the value of a company's public float exceeds $700 million, regardless of whether it is actually producing revenue, it becomes subject to the more rigorous Exchange Act requirements of a large accelerated filer, which include, among other things, an accelerated filing schedule, more fulsome compensation disclosures, additional financial statement requirements and a requirement that its auditors attest to its internal controls. These disclosure obligations and, in particular, the auditor attestation requirement, are expensive and time-consuming. Though a company's status for the next fiscal year is determined as of the last day of a company's second fiscal quarter, many companies often need more than six months to prepare for these obligations.
Now that valuations seem to have receded, many of these companies (particularly those without revenues) now again qualify for non-accelerated filer and smaller reporting company status and are thus eligible to report as a smaller reporting company as soon as the first Quarterly Report on Form 10-Q following the second quarter determination. So, many companies in this situation are questioning whether they should again take advantage of these scaled disclosures or maintain the more rigorous internal controls implemented in connection with the auditor attestation requirements.
In short, there is no uniform answer to these questions. While most companies will not obtain auditor attestation of their internal controls unless it is truly required due to expense, we are seeing many companies continuing to follow the internal controls put in place in preparation for attestation as a matter of good practice. For the scaled smaller reporting company disclosures, companies are considering a variety of facts and circumstances, including (i) their shareholder base and whether their particular shareholders or potential investors have expressed an interest in or become accustomed to the additional disclosure provided, (ii) consistency and how likely it is that the company will again have to comply with more fulsome disclosure rules following their next filer status determination date, and (iii) the relative costs for continued compliance.
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Footnotes
1. See Item 303 of Regulation S-K, 17 CFR § 229.303.
2. See Item 105 of Regulation S-K, 17 CFR § 229.105.
3. U.S. Bureau of Labor Statistics, TED: The Economics Daily: Consumer prices up 7.7 percent over year ended October 2022, November 17, 2022.
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.
