With the prices of copper, iron ore, coal and other metals and minerals at or near multi-year lows  and forecasts of continuing price weakness, the upcoming 2015 Form 10-K and proxy season will force public companies to  carefully consider and disclose the impact of the slump in prices on their businesses. To avoid the  risk of receiving SEC staff comments, the need to amend SEC filings in the future, and the potential of derivative lawsuits arising out of material  misstatements or omissions relating to the affect that lower commodity prices may have on a company’s business, it is essential to proactively  review and revise any affected company’s disclosure. Here we cover the Form 10-K and proxy  disclosures that demand the highest level of scrutiny.

Management's Discussion and Analysis

For over a decade, the SEC has made it a priority to encourage companies to improve the quality of  Management's Discussion and Analysis (MD&A) to provide a clear narrative that is “necessary to an  understanding of [a company's] financial condition, changes in financial condition and results of  operations.”3 The SEC has repeatedly emphasized that MD&A should not restate information provided in financial statements, but rather should “[d]escribe any known trends or  uncertainties that have had or that the registrant reasonably expects will have a material  favorable or unfavorable impact on net sales or revenue or income from continuing operations.”4    In addition to providing information specifically required to be contained within MD&A, the SEC expects that management will provide an analysis of that information and its significance for the  company. Thus, a company impacted by lower commodity prices should carefully consider the potential  impacts that may be significant to the company:

  • Are any of its major customers or counterparties likely to experience a degradation in  credit that could affect the company?
  • Have hedging techniques used by the company left it vulnerable to significant or prolonged  drops in commodity prices?
  • Have falling prices made it uneconomic to mine resources previously classified as reserves?
  • What are companies’ break-even costs and how will their exploration and development  activities be impacted by current pricing levels and price uncertainty?

The SEC staff has also examined companies’ public statements and presentations on trends or events  and has compared those statements to companies’ MD&A disclosure for consistency. To the extent  events or trends are disclosed publicly but not developed as part of MD&A, companies should expect to receive SEC comments.

MD&A is also required to include a discussion of liquidity and capital resources that provides  detail regarding sources and uses of cash and material changes in particular items underlying the  major captions reported in a company’s financial statements. The SEC believes this information is  critical to an assessment of a company's prospects for the future and even the likelihood of its  survival. In particular, the SEC staff has recently stressed the need for expanded disclosure of  material terms of debt agreements. If there is, or is projected to be, a failure to meet a  financial covenant, such as the result of a write-down, registrants will be expected to describe  the financial covenant, the company’s covenants measurements for the most recent reporting period,  sensitivities of those measurements, anticipated future covenant performance, and the potential  impact of a covenant failure on the availability of credit. Companies should also be prepared to  include a detailed discussion about difficulties the company has experienced or may face in  accessing the credit or capital markets due to recent declines in commodity prices.

For companies subject to Industry Guide 7, the SEC staff’s position that companies use the  historical three-year average price for reserve estimates will delay the full impact of the price  declines on reserves for many companies5. For companies subject to Canada's National Instrument  43-101 and most other international standards, the price declines will have a more immediate impact as management’s future price estimates generally form the basis of resource and reserve  determinations. MD&A should address any changes in reserves and the underlying impact of the drop in commodity prices.

Write-Downs and Impairments

Many companies will be required to take significant write-downs as long-term price forecasts  decline. Companies may also face impairment of goodwill from acquisitions completed while prices  were higher. The SEC accounting staff will be paying close attention to write-downs and impairments  given the current price environment, and companies should take extra care in documenting their  determinations with an eye towards subsequent SEC scrutiny. Perceived errors in write-downs and  impairments have been a frequent cause of restatements in past downturns.

Risk Factors

The SEC views the risk factor section of Form 10-K, which is required under Item 1A of Form 10-K,  as the opportunity for a company to “identify and disclose known trends, events, demands,  commitments and uncertainties that are reasonably likely to cause reported financial information  not to be necessarily indicative of future operating performance or future financial condition.”6    In order to meet these expectations, a company should carefully review existing risk factors to  make sure the statements correctly reflect management’s current assessments about risks the company faces that  could have a material adverse impact on its business, financial condition and results of  operations. Companies should also spend adequate energy considering and crafting new risk factors  that appropriately consider the affect that current pricing and the potential for a prolonged  environment of lower commodities prices would have on the company’s future business, reserve  carrying values, financial condition and results of operations.

Executive Compensation and Say on Pay

Favorable industry trends in recent years led to growth in executive compensation levels for many  mining and metals companies. Declining stock prices that have resulted from lower commodity prices  may force some companies to review and reconsider whether current compensation programs will  continue to adequately incent and reward executives. At the same time, in light of lower commodity  prices and deteriorating total stockholder return (a favorite metric of proxy advisors), companies  should expect to face headwinds on say-on-pay votes as stockholders and proxy advisory firms view  executive compensation packages for mining executives more critically, especially for companies  facing a say-on-pay advisory vote this year. Companies whose equity-based incentive programs call  for grants to be made at fixed values (for example, grant date values as a multiple of base  salary), should consider whether continuing this practice under current conditions might cause  stockholders and proxy advisory firms to view such grants as excessive given the increased number  of shares granted if stock prices rebound. Companies that decide instead to augment or substitute  equity compensation grants with cash incentives or other cash-based retention programs due to these  or other concerns should explain these changes as part of their Compensation Discussion & Analysis.  Companies adjusting their incentive compensation programs in light of these or other concerns  should also closely monitor compliance with Section 162(m) of the Internal Revenue Code in order to  make sure that their performance based compensation remains tax deductible.