SEC provides additional guidance regarding COVID-19 disclosures

On June 23, 2020, the Staff of the Division of Corporation Finance of the US Securities and Exchange Commission (SEC) provided additional guidance regarding considerations it believes public companies should take into account when evaluating potential disclosures with respect to business and market disruptions resulting from the coronavirus disease 2019 (COVID-19) pandemic. 

As we previously summarized, on March 25, 2020, the Staff issued Disclosure Guidance Topic No. 9 regarding disclosure and other securities law considerations with respect to the COVID-19 pandemic.  The Staff’s new guidance, Disclosure Guidance Topic No. 9A, supplements its previous guidance, with a particular focus on disclosures related to companies’ operations, liquidity and capital resources.

Staff observations

Changes to business operations

In its most recent guidance, the Staff encourages companies to consider their obligations to disclose the nature and potential impact of any operational adjustments implemented in response to the pandemic that may have an effect that would be material to an investment or voting decision. Examples cited by the Staff of operational adjustments that may give rise to disclosure include transitions to remote working, supply chain and distribution adjustments and suspending or modifying certain operations to comply with health and safety guidelines to protect employees, contractors and customers, including in connection with a transition back to the workplace. 

The Staff also notes that, while SEC rules do not require any particular set of metrics or line item adjustments for operational changes, the Staff expects that companies will make disclosures consistent with existing principles-based disclosure and that any disclosures will “reflect how management and the Board of Directors are assessing operational issues.”

Financing activities

The Staff also notes in its guidance that it expects companies to provide “robust and transparent” disclosures with respect to actions taken to address short- and long-term liquidity and funding risks, particularly when financing activities may present new risks or uncertainties to the business.  Financing activities that may give rise to disclosure include not just traditional equity or debt financing through public or private capital markets, but also more operational measures, such as implementing supplier finance programs or negotiating new or modified customer payment terms.

Annual and quarterly reports

In addition to its guidance on substantive disclosure topics, the Staff also suggested that it expects companies to provide more robust COVID-19-related disclosures in their annual and quarterly reports on Forms 10-K and 10-Q, in addition to earnings releases.  In particular, the Staff noted that, while it has observed companies’ providing disclosures in earnings releases, it encourages companies to evaluate whether comparable information should be included in the management’s discussion and analysis (MD&A) section of their Exchange Act reports.  Other areas of disclosures may include a company’s business section, risk factors, financial statements, disclosure controls and procedures and internal control over financial reporting.

Disclosure considerations

In addition to its general observations regarding disclosure, the Staff also provided considerations that it believes companies should consider when preparing their disclosure documents.  These considerations supplement those contained in the previous guidance.

The questions included in the updated guidance are:

• What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace? How are the changes impacting or reasonably likely to impact your financial condition and short- and long-term liquidity?
•  How is your overall liquidity position and outlook evolving? To the extent COVID-19 is adversely impacting your revenues, consider whether such impacts are material to your sources and uses of funds, as well as the materiality of any assumptions you make about the magnitude and duration of COVID-19’s impact on your revenues. Are any decreases in cash flow from operations having a material impact on your liquidity position and outlook?
• Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs? Are your disclosures regarding these actions and any unused liquidity sources providing investors with a complete discussion of your financial condition and liquidity?
• Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods? Have you provided additional collateral, guarantees or equity to obtain funding? Have there been material changes in your cost of capital? How has a change, or a potential change, to your credit rating impacted your ability to access funding? Do your financing arrangements contain terms that limit your ability to obtain additional funding? If so, is the uncertainty of additional funding reasonably likely to result in your liquidity decreasing in a way that would result in you being unable to maintain current operations?
• Are you at material risk of not meeting covenants in your credit and other agreements?
• If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity? Are there estimates or assumptions underlying such metrics the disclosure of which is necessary for the metric not to be misleading?
• Have you reduced your capital expenditures and, if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them? What factors will you consider in deciding to extend or curtail these measures? What is the short- and long-term impact of these reductions on your ability to generate revenues and meet existing and future financial obligations?
• Are you able to timely service your debt and other obligations? Have you taken advantage of available payment deferrals, forbearance periods or other concessions? What are those concessions and how long will they last? Do you foresee any liquidity challenges once those accommodations end?
• Have you altered terms with your customers, such as extended payment terms or refund periods and, if so, how have those actions materially affected your financial condition or liquidity? Did you provide concessions or modify terms of arrangements as a landlord or lender that will have a material impact? Have you modified other contractual arrangements in response to COVID-19 in such a way that the revised terms may materially impact your financial condition, liquidity, and capital resources?
• Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring or vendor financing, to manage your cash flow? Have these arrangements had a material impact on your balance sheet, statement of cash flows, or short- and long-term liquidity and, if so, how? What are the material terms of the arrangements? Did you or any of your subsidiaries provide guarantees related to these programs? Do you face a material risk if a party to the arrangement terminates it? What amounts payable at the end of the period relate to these arrangements, and what portion of these amounts has an intermediary already settled for you?
• Have you assessed the impact material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on your liquidity and capital resources and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?

These questions, together with those provided in the Staff’s original guidance, are not exhaustive and should be considered in light of each company’s specific facts and circumstances.  The Staff also reminded companies to refer to its recent guidance on performance metrics disclosure, which may be found here.

Additional disclosure guidance

The Staff also addressed disclosure considerations for companies that received financial assistance under the CARES Act and companies that may be facing going-concern issues.  In particular, the Staff reminded companies impacted by the pandemic of their obligations under financial accounting rules to consider whether conditions and events, taken as a whole, raise substantial doubt about the company’s ability to meet its obligations as they become due within one year after the issuance of the financial statements.  Where there is substantial doubt about a company’s ability to continue as a going concern, the Staff notes that the company should provide not only financial statement disclosures required under applicable accounting rules, but also substantive discussion in MD&A regarding the nature of the conditions and events that give rise to the determination and management’s plans to address the challenges.

Conclusion

While the Staff’s supplemental guidance is non-binding, it serves as an additional reminder of the focus within the SEC on COVID-19-related disclosures and investor protection.  As companies begin preparations their quarter-end activities and draft related disclosures, we are available to answer any questions with respect to public company disclosure obligations or other matters related to the COVID-19 pandemic or otherwise.

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This information does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only. No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.