As companies close their books on the second quarter and prepare their second quarter disclosures, it is important to assess the continuing impact of COVID-19 on businesses, employees and financial results and provide appropriate disclosures. This alert provides information in two parts:
In its latest COVID-19 related disclosure guidance, the SEC’s Division of Corporation Finance issued Topic No. 9A1 (“Topic 9A”) to provide guidance on operations, liquidity and capital resources disclosures that companies should consider in light of disruptions related to COVID-19. Importantly, Topic 9A notes that the SEC continues to monitor how companies are disclosing the effects and risks of COVID-19 on their business, financial condition and result of operations. Moreover, Topic 9A reiterates a recent theme in SEC guidance that encourages companies to consider disclosure they would provide in their earnings releases for inclusion in their MD&A.2
The crux of Topic 9A focuses companies on their operational adjustments and financing activities in response to the effects of COVID-19. In particular, Topic 9A notes that it is important that companies consider the following for their disclosure:
- Liquidity. With respect to liquidity, the SEC notes that it is “important that companies provide robust and transparent disclosures about how they are dealing with short- and long-term liquidity and funding risks in the current economic environment, particularly to the extent efforts present new risks or uncertainties to their businesses.” This can include activities such as utilizing credit facilities, accessing public and private markets, implementing supplier finance programs, and negotiating new or modified customer payment terms.
- Operational Adjustments. Companies should also consider disclosing, to the extent material, information concerning employees’ transition to remote working arrangements; the suspension or modification of certain operations to comply with health and safety guidelines to protect employees; and supply chain and distribution adjustments. For these types of measures, the SEC cautions companies that they should “carefully consider their obligations to disclose this information to investors.”
Questions to Consider from Topic 9A
Topic 9A encourages companies to contemplate a broad range of questions on these subjects as they prepare their disclosures, including the following:
- Management/Board Focus: What are the material operational challenges that management and the board of directors are monitoring and evaluating?
- Health and Safety: 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?
- Impact on Revenues: 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?
- Debt Covenants: Are you at material risk of not meeting covenants in your credit and other agreements or not being able to timely service debt and other obligations?
- Capital Expenditures: Have you reduced your capital expenditures, and if so, how?
- Payment Terms: 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?
- Subsequent Events: 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?
Ability to Continue as a Going Concern
Topic 9A and a statement issued from the SEC’s Chief Accountant3 further emphasize the importance of this quarter’s going concern evaluation for many companies. Under FASB accounting standards, management must consider, for each reporting period, whether there is 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.4
Where there is substantial doubt about a company’s ability to continue as a going concern, management should provide the appropriate respective disclosures in the financial statements and consider the following questions regarding the MD&A disclosure:
- Are there conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern? For example, have you defaulted on outstanding obligations? Have you faced labor challenges or a work stoppage?
- What are your plans to address these challenges? Have you implemented any portion of those plans?
Government Assistance – The CARES Act
Topic 9A also advises companies receiving financial assistance under the CARES Act to “consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity, and capital resources” and related disclosures, including required disclosures under US GAAP relating to “the accounting principles followed and the methods of applying those principles if they materially affect financial condition, cash flows, or results of operations and related disclosures.”
- Tell Your Story: Companies should aim in their 10-Qs, earnings releases and earnings calls to provide a coherent, cohesive narrative on how they have adapted to the COVID-19 pandemic and its impacts. Investors are particularly eager for disclosure about a company’s adaptability and longer-term operational resiliency in light of COVID-19, including disclosure on what CEOs and boards have learned as a result of the pandemic and how they will apply these lessons to their future planning.5 Fulsome disclosure regarding COVID-19 risks and impacts on your company, as well as the company’s response, helps build integrity with your investors and can be helpful in protecting against liability relating to the company’s disclosures.
- Update Investors: While many companies may be hesitant to provide detailed information, given the high level of uncertainty resulting from the pandemic, it is important to disclose material trends and uncertainties as required by SEC rules and to provide updates to investors and the market on previously made disclosures and predictions. At the SEC roundtable, it was noted that less than 10% of the S&P 500 had given earnings guidance for the second quarter, and although companies can be forthcoming in admitting to a lack of clarity, they should also aim to provide accurate insight to investors, who are hungry for information given the lack of earnings guidance and paucity of information many companies provided in Q1 disclosures.
- Provide as much forward-looking information as possible, while ensuring such information is only made in good faith and on a reasonable basis: The focus of investors is on forward-looking information related to COVID-19. Specifically, they want disclosure surrounding: (i) liquidity, including more standardization and specificity, such as a discussion regarding items such as cash burn and inventory, as well as days cash on hand; (ii) other forward-looking financial and operational information; and (iii) a range of scenarios and possible outcomes, including the underlying assumptions and the implications if those assumptions turn out not to be true. Given that it may be years before the pandemic and its impact are fully resolved, companies should do their best to explain not only how they are managing their current environment, but also provide predictions for what the company might look like in the future. Forward-looking information based on assumptions and expectations regarding future events should always be made in good faith, have a reasonable basis for the assumptions made, and provide updated safe harbor legends to ensure the company is availing itself of the protections of the Private Securities Litigation Reform Act of 1995.
A review of recent SEC comment letters6 on COVID-19 related disclosures reveals several important lessons that companies should consider when drafting their disclosure. Specifically:
- Ensure risk factor disclosure is appropriately robust and specific: The SEC has repeatedly commented on risk factor disclosures that only touch on general economic or societal impacts of COVID-19 and do not go far enough in describing company-specific COVID-19-related risks. A company should make sure that its risk factors accurately and fully describe the risks it faces, including risks that have already had an impact on the company. For example, one SEC comment asked a company to expand its risk factor discussion, which merely discussed a general decrease in consumer spending momentum, to describe “the reasonably likely known effects of the coronavirus on [its] business” and, to address, to the extent material, “the expected impact on [its] results of operation and financial condition for fiscal 2020.”7
- Don’t put disclosure in risk factors if it belongs in MD&A: Companies should carefully consider whether any significant trend or uncertainty that management is closely monitoring, has identified in risk factors, and/or discussed with the board is appropriate for MD&A disclosure.
- For example, one SEC comment letter that initially requested that a company elaborate on a general health epidemic risk factor ultimately resulted in a request from the SEC that the company provide an MD&A discussion of the “reasonably known effect of the Coronavirus pandemic on growth indicators for fiscal 2020.”8
- Similarly, a second SEC comment letter noted that a company’s risk factor disclosure highlighting the material adverse effect of COVID-19 on its business operations was not addressed in its MD&A discussion of the recent growth of its business. The company was asked to expand its MD&A discussion to address the “reasonably known effect of the Coronavirus pandemic on…growth indicators for fiscal 2020” including, for example, how it expected the pandemic to impact its future operating results and near-and-long-term financial condition “in light of changing trends and the overall economic outlook.”9
- Material information included in press releases should also appear in SEC filings: Comment letters reveal that the SEC has been checking to make sure that disclosure made in press releases, on websites, and elsewhere, matches what is disclosed in SEC filings, so companies should ensure that all public disclosure is internally consistent and accurate.
- For example, the SEC commented on a company’s registration statement for failing to mention the company’s collaboration with an international partner, which it had previously announced in a press release, requesting that the company “disclose the material terms of the collaboration agreement referenced in…the press release and file it as an exhibit to [its] filing, or explain why it is not material to an investment decision.”10
- You can’t ignore COVID-19: Given the far reaching impact COVID-19 has had on the economy, supply chain, workforce and operations, companies that fail to provide sufficient disclosure and updates related to the existing, anticipated or potential impact of COVID-19 are at risk for comments from the SEC. Companies should fully assess that appropriate disclosures related to COVID-19 are made, considering required disclosure in the risk factors, financial statements and MD&A.
- For example, one company that filed a registration statement without any disclosure on COVID-19 or related business or market disruptions was asked to provide its analysis supporting the conclusion that this was the appropriate approach. The company initially argued that it had not been impacted, despite factory and supplier shutdowns, but upon pushback from the SEC, it then added COVID-related disclosure, including a risk factor.11
- A second SEC comment on this topic emphasized the need to update previously provided disclosures. The SEC recently commented on a company’s registration statement, noting that “significant market events related to COVID-19 have occurred since [it] was filed” and asking the company to consider whether its disclosures, including its risk disclosure, should be revised based on how these events are affecting the company’s investments. In response, the company added COVID-related disclosure to the summary, risk factors, forward-looking statements and business sections.12
1 Available here. Corp Fin’s March 25, 2020 guidance, CF Disclosure Guidance Topic No. 9, “Coronavirus (COVID-19)” is available here. For more information, see our prior alert, “SEC Emphasizes Importance of Robust Forward-Looking Disclosure for Q1 to Address COVID-19.”
2 See, for example, guidance issued by the SEC on January 30, 2020, available here, which encourages companies to consider any key performance indicators that it includes in earnings releases for inclusion in the company’s MD&A.
3 See “Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19” (June 22, 2020).
4 See FASB’s Accounting Standards 205-40-50 (Presentation of Financial Statements – Going Concern – Disclosure), available here.
5 For example, see discussion at SEC virtual roundtable discussion moderated by SEC Chairman Jay Clayton, which included Corp Fin Director William Hinman (the “SEC roundtable”). Participants on the panel included Gary Cohn, Former Director of the National Economic Council; Glenn Hutchins, Chair of North Island; Tracy Maitland, President and CIO of Advent Capital; and Barbara Novick, Vice Chair and Co-Founder of BlackRock.
6 Survey of the 94 comment letters posted between January 1, 2020 and June 30, 2020.
7 SEC comment letter dated February 24, 2020.
8 SEC comment letter dated March 26, 2020.
9 SEC comment letter dated March 2, 2020.
10 SEC comment letter dated March 10, 2020.
11 SEC comment letters dated March 30, 2020 and March 31, 2020.
12 SEC comment letter dated May 22, 2020.
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