Five Lessons from Early Comment Letters on COVID-19

It’s still early, but we’re starting to learn more about how the SEC is policing disclosures around the pandemic. Like the disease itself, SEC comment letters take time to surface, and those we are seeing now are from the early days of the pandemic. We expect that as we sort through our comment letter database in the days and weeks to come, we will draw more fulsome conclusions about the SEC’s approach to disclosure in the COVID-19 era. But here are some early lessons:

Understand the continuum between risk factors’ reasonably likely known effects and MD&A’s known trends.

Early comment letters, such as the SEC’s comment letter to Scienjoy (fka Wealthbridge Acquisition Ltd.), ask issuers to discuss “reasonably likely known effects” of COVID-19 risks “as a result of all of Scienjoy’s employees being located in China.” This is consistent with the general principle (which came into play for Facebook), that a company should not cite risk factors as hypothetical when they have already occurred. Read in conjunction with letters to Fidelity Summer Street Trust and Desert Hawk Gold Corp., we see how closely the SEC is monitoring coronavirus-related risk factors.

But reviewers aren’t stopping there. A letter that began as a request to elaborate on a general health epidemic risk factor at E-Home Household Services morphed into a request for a MD&A discussion of “reasonably known effect of the Coronavirus pandemic on growth indicators for fiscal 2020.” SEC Regulation S-K states that companies’ MD&A must disclose negative (or positive) trends if two things are “reasonably likely”: (i) the occurrence of the trend, and (ii) a material impact on the business. That’s clear enough, as far as it goes. However, issuers still must decide if any significant trend or uncertainty that management is closely monitoring, has identified in risk factors, and/or discussed with the board should be evaluated for MD&A disclosure. Meten EdtechX walked through a similar MD&A analysis at the SEC’s request: they navigated from a hypothetical risk factor about the potential closing of learning centers to a four paragraph MD&A discussion.

Provide forward-looking insights about the impact of COVID-19.

It may not be credible, at this point, for companies in the United States to avoid talking about the impact of the pandemic on their businesses. Back in February, China-based HiTek Global, Inc. filed a registration statement, and within a week the SEC asked it to disclose COVD-19’s expected impact on its financials, if material. The company did so and added a risk factor. Companies following this (advised) course should protect their forward-looking statements by ensuring they are safe-harbored.

Provide a complete picture with your metrics.

In the MD&A on a registration statement, China Liberal Education Holdings offered some detail on the impact of COVID-19 on its revenue, but not enough context to matter to investors. The company said that its revenue for the year was “below expectations by approximately 32%” and revenue from a particular service line “below expectations by approximately 26%.” It sounds very informative—until you realize that investors didn’t know what the company’s expected revenues were. The SEC advised the company to restate the impact of COVID-19 based on its historical financial performance.

Clarify the impact of any facility closures or supply chain issues.

Industrial Technical Holdings Corporation met with skepticism when it filed a registration statement with no disclosures at all about COVID-19. That earned the company its first comment letter. In response, the company maintained that the pandemic had not made a material impact on its operations, despite the fact that a factory and multiple suppliers had been shut down. That earned it further side-eye from the SEC. In a second letter, the SEC asked Industrial to get specific and “clarify for how long your factory and suppliers were shut down . . . .”

Ensure that material information included in press releases also appears in SEC filings.

The SEC will be checking to make sure that’s the case. Just ask the biopharmaceutical company iBio. After it filed a registration statement, the SEC shot back with a question about why the filing didn’t mention the company’s collaboration with a Chinese partner to develop a COVID-19 vaccine, which it had previously announced in a press release. (iBio responded that it had included its joint development agreement in the original filing and disclosed four provisional patents coming out of the collaboration in an 8-K.)