Sample Comment Letter
On May 3, 2022, the Division of Corporation Finance ("Corp Fin") of the Securities and Exchange Commission ("SEC") posted a sample comment letter emphasizing companies' potential disclosure obligations related to direct or indirect impacts that Russia's actions in Ukraine and the international response have or may have on their business.1
The sample letter provides significant guidance on areas of potential impact that companies should consider when drafting their disclosures, and makes clear that additional disclosures may be required even by companies that have no operations in Russia, Ukraine or Belarus.
Specifically, Corp Fin notes that, to the extent material, companies should be providing detailed disclosure regarding:
- direct or indirect exposure to Russia, Belarus, or Ukraine (the "affected countries") through their operations, employee base, investments in the affected countries, securities traded in Russia, sanctions against Russian or Belarusian individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting Russia or Belarus,
- direct or indirect reliance on goods or services sourced in Russia or Ukraine or, in some cases, in countries supportive of Russia,
- actual or potential disruptions in the company's supply chain, or
- business relationships, connections to, or assets in, the affected countries.
Corp Fin also notes that companies' financial statements may need to reflect and disclose certain matters, including, but not limited to, changes to customer contracts or the ability to collect amounts under contracts, changes in exchange rates, changes in inventory valuation, as well as asset impairments or exit and disposal costs.
The comment letter provides sample comments that may be issued, including requests for additional disclosures relating to:
- the direct or indirect impact of Russia's actions in Ukraine on companies that have business or operations in the affected countries – or an explanation of why there is no material impact,
- the extent and nature of the board's role in providing risk oversight related to the situation in Ukraine and its impacts,
- new or heightened risks of potential cyberattacks by state actors or others and any mitigating actions taken,
- Management's Discussion and Analysis of Financial Condition and Results of Operations matters, including:
- known trends and uncertainties "arising from, related to, or caused by the global disruption from" Russia's actions,
- enhanced critical accounting estimate disclosures for certain items such as asset impairments, inventory valuations, bad debt allowances, deferred tax asset valuation allowances and revenue recognition,
- impacts of import or export bans on products and commodities used or sold by the company,
- whether and how supply chain disruptions have materially impacted the business, including efforts to mitigate the impact and, where possible, a quantification of the impact, and
- any changes in internal control over financial reporting as a result of the situation in Ukraine and/or supply chain disruptions.
The comment letter also includes a sample comment asking about the impact of the situation in Ukraine on the design of a company's disclosure controls and procedures, as well as its impact on the conclusion that they were effective as of the end of the reporting period.
Finally, sample comments included in the letter provide reminders for compliance with Regulation G if a company has or intends to make adjustments to its financial measures as a result of the events in Ukraine and/or supply chain issues. Specifically, the letter includes comments regarding (1) adjustments for estimated losses of revenues, which may involve the use of an individually tailored revenue recognition and measurement method that may not be in compliance with Rule 100(b) of Regulation G,2 and (2) exclusions of certain expenses incurred, which could be misleading under SEC guidance in the case of expenses that are normal, recurring, cash operating expenses that are necessary to operate a company's business.3
The SEC notes that the sample comments do not constitute an exhaustive list of the issues that companies should consider, and companies should be monitoring the direct and indirect impact of the events on their businesses ahead of upcoming disclosures.
White & Case S&P 500 Disclosure Survey
This is a rapidly evolving area, and many companies are already disclosing the impact or potential impact of the situation in Ukraine on their business. White & Case surveyed the S&P 500 and found that 45% of these companies disclosed risks related to Russia's actions in Ukraine in their Form 10-Ks and 10-Qs filed between January 31, 2022 and May 4, 2022.
Topics covered in these disclosures included, among others, the following:
- Supply chains and trade
- Russian business operations
- Ukraine business operations
- Reputational risk
Some notable trends that arose in the analysis of these 224 disclosures included the following:
- 132 disclosures (59% of the filings) provided disclosure of how existing risks would be heightened as a result of the situation;
- 111 disclosures (50% of the filings) disclosed considerations related to supply chain issues;
- 94 disclosures (42% of the filings) disclosed considerations related to sanctions;
- 73 disclosures (33% of the filings) disclosed considerations related to inflation;
- 72 disclosures (32% of the filings) provided disclosure on existing Russian business operations;
- 43 disclosures (19% of the filings) provided disclosure on existing Ukrainian business operations; and
- 11 disclosures (5% of the filings) discussed reputational risks of continuing business operations in Russia.
While the significant majority of the S&P 500 did not include such disclosure in their Form 10-Ks, with the passage of time and the increasing severity of the situation, many more have now added such disclosure in their first quarter 10-Qs. Outside of those surveyed companies that had or have significant operations in Russia, these disclosures generally covered a broad range of potential risks in the future (e.g. supply chain and inflation concerns).
In light of the SEC sample comment letter, companies should be focused on their risk factor disclosure and clarify the extent to which there are any material impacts, direct or indirect, of the situation in Ukraine on their businesses. As a practical matter, companies should first identify and assess whether there are any material impacts and focus on developing disclosure that is company-specific and meaningful, rather than general or vague. Moreover, as with all risk factor disclosure, companies should clarify which disclosure addresses purely hypothetical risks and whether any risks have already occurred and are no longer hypothetical.4
We would like to thank associates Nico Kroeker, Rana Ozer and Audrey Bae for their work on this alert.
Below please find the quoted text of the comments in the letter posted by the SEC on its website:
We have reviewed your filing and have the following comments. Please revise or update your disclosure in response to our comments.
1. [You refer to your business in [Russia/Belarus/Ukraine]] OR [We note that a material portion of your operations or those of companies with which you do business is conducted through facilities located in [Russia/Belarus/Ukraine]]. Please describe the direct or indirect impact of Russia's invasion of Ukraine on your business. In addition, please also consider any impact:
- resulting from sanctions, limitations on obtaining relevant government approvals, currency exchange limitations, or export or capital controls, including the impact of any risks that may impede your ability to sell assets located in Russia, Belarus, or Ukraine, including due to sanctions affecting potential purchasers;
- resulting from the reaction of your investors, employees, customers, and/or other stakeholders to any action or inaction arising from or relating to the invasion, including the payment of taxes to the Russian Federation; and
- that may result if Russia or another government nationalizes your assets or operations in Russia, Belarus, or Ukraine.
If the impact is not material, please explain why.
2. Please describe the extent and nature of the role of the board of directors in overseeing risks related to Russia's invasion of Ukraine. This could include, but is not limited to, risks related to cybersecurity, sanctions, employees based in affected regions, and supply chain/suppliers/service providers in affected regions as well as risks connected with ongoing or halted operations or investments in affected regions.
Risks Related to Cybersecurity
3. To the extent material, disclose any new or heightened risk of potential cyberattacks by state actors or others since Russia's invasion of Ukraine and whether you have taken actions to mitigate such potential risks.
Management's Discussion and Analysis of Financial Condition and Results of Operations
4. Please disclose any known trends or uncertainties that have had or are reasonably likely to have a material impact on your cash flows, liquidity, capital resources, cash requirements, financial position, or results of operations arising from, related to, or caused by the global disruption from, Russia's invasion of Ukraine. Trends or uncertainties may include impairments of financial assets or long-lived assets; declines in the value of inventory, investments, or recoverability of deferred tax assets; the collectability of consideration related to contracts with customers; and modification of contracts with customers.
5. Please enhance your critical accounting estimate disclosures related to [impairment of assets, valuation of inventory, allowance for bad debt, deferred tax asset valuation allowance, or revenue recognition], as applicable, with both qualitative and quantitative information, to the extent the information is material and reasonably available, that addresses the following:
- Why the critical accounting estimate is subject to uncertainty, including any new uncertainties related to the estimate, such as the asset, customer, or supplier is located in or reliant upon business(es) or operations in [Russia/Belarus/Ukraine];
- The method used to develop the estimate and the significant assumptions underlying its calculation, such as discounted cash flow and the discount rate assumption;
- The degree to which the estimate and the underlying significant assumptions have changed over the current period or since the last assessment, including due to effects of changing prices, changes in exchange rates, changes in estimated cash flows due to loss of operations, etc.; and
- The sensitivity of the reported amount to the method and assumptions underlying its calculation. For example, if the cash flow estimates used were based on assumptions about the invasion or sanctions and those assumptions could significantly impact the estimate, then that should be disclosed along with how sensitive the estimate is to changes in those assumptions.
6. Disclose any material impact of import or export bans resulting from Russia's invasion of Ukraine on any products or commodities, including energy from Russia, used in your business, or sold by you. Disclose the current and anticipated impact on your business, taking into account the availability of materials, cost of needed materials, costs and risks associated with transportation in your business, and the impact on margins and on your customers.
7. Please disclose whether and how your business segments, products, lines of service, projects, or operations are materially impacted by supply chain disruptions, especially in light of Russia’s invasion of Ukraine. For example, discuss whether you have or expect to:
- suspend the production, purchase, sale, or maintenance of certain items;
- experience higher costs due to constrained capacity or increased commodity prices or challenges sourcing materials [(e.g., nickel, palladium, neon, cobalt, iron, platinum or other raw material sourced from Russia, Belarus, or Ukraine)];
- experience surges or declines in consumer demand for which you are unable to adequately adjust your supply;
- be unable to supply products at competitive prices or at all due to export restrictions, sanctions, or the ongoing invasion; or
- be exposed to supply chain risk in light of Russia's invasion of Ukraine and/or related geopolitical tension or have [sought][made or announced plans] to "de-globalize" your supply chain.
Explain whether and how you have undertaken efforts to mitigate the impact and where possible quantify the impact to your business.
8. We note your adjustment to add an estimate of lost revenue due to [Russia's invasion of Ukraine and/or supply chain disruptions]. Recognizing revenue that was not earned during the period presented results in the use of an individually tailored revenue recognition and measurement method which may not be in accordance with Rule 100(b) of Regulation G. Please remove these adjustments. Refer to Question 100.04 of the Division’s C&DI for Non-GAAP Financial Measures.
9. We note your adjustment for certain expenses [such as compensation expense or bad debt expense] incurred related to your operations in Russia, Belarus, and/or Ukraine that appear to be normal and recurring to your business. Please tell us the nature of these expenses. Explain how you have considered Question 100.01 of the Division's C&DI for Non-GAAP Financial Measures and why you believe that the expenses excluded from your non-GAAP measures do not represent normal, recurring operating expenses.
Disclosure Controls and Procedures
10. Based on your disclosures, it appears that you may have had changes in or issues that arose impacting the effectiveness of your disclosure controls and procedures due to Russia's invasion of Ukraine [and/or supply chain disruptions]. Please tell us the impact of Russia's invasion of Ukraine on your design of disclosure controls and procedures and its impact on your conclusion of their effectiveness as of the end of the reporting period.
Internal Control Over Financial Reporting
11. Based on your disclosures, it appears that you may have had changes to your internal controls as a result of Russia's invasion of Ukraine [and/or supply chain disruptions]. Please disclose any changes in your internal control over financial reporting identified in connection with your evaluation that occurred during the last fiscal quarter (or your fourth fiscal quarter in the case of an annual report) that has materially affected or is reasonably likely to materially affect your internal controls over financial reporting. See Item 308(c) of Regulation S-K."
1 The sample letter posting is available here. See Appendix A for the complete text of the sample letter.
2 Also see Question 100.04 of the SEC Non-GAAP Financial Measure C&DIs available here.
3 Also see Question 100.01 of the SEC Non-GAAP Financial Measure C&DIs available here.
4 In the past, the SEC has alleged that statements in a company's risk factors were materially misleading because a company stated that an event only "may" or "could" occur, but the event was no longer hypothetical at the time of the disclosure. See discussion in our prior client alert, "SEC Emphasizes Importance of Robust Forward-Looking Disclosure for Q1 to Address COVID-19."
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