On June 23, 2020, the U.S. Securities and Exchange Commission (SEC) Division of Corporation Finance (the Division) supplemented its guidance from March 25, 2020 to provide additional views on disclosures regarding operations, liquidity and capital resources in light of business and market disruptions from COVID-19. The new guidance draws on the Division’s monitoring and review of public company disclosures about the effects and risks of COVID-19 over the past few months. It also includes specific guidance on disclosures relating to government assistance and the ability to continue as a going concern. Concurrent with the new Division guidance, the SEC’s Chief Accountant, Sagar Teotia, issued a statement reiterating the continued importance of high-quality financial reporting for investors in view of COVID-19 that addressed a number of disclosure-related issues.
Supplemental Division Guidance Relating to COVID-19 Disclosures
New CF Disclosure Guidance: Topic No. 9A supplements CF Disclosure Guidance: Topic No. 9 (discussed in a previous Sidley Update) and addresses a number of considerations for operations, liquidity and capital resources disclosures, including disclosures relating to government assistance and the ability to operate as a going concern. Public companies should continue to consider whether to update, supplement or add disclosure regarding COVID-19-related risks and effects in management’s discussion and analysis (MD&A), the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting and the financial statements.
Operations, Liquidity and Capital Resources
- Acknowledging that companies have undertaken significant operational adjustments (e.g., with respect to telework, supply chain realignment and health and safety guidelines) and capital-raising and other financing activities (e.g., through credit facilities, public and private capital markets, supplier finance programs and revised customer payment terms) in light of COVID-19, the Division highlighted that its principles-based disclosure regime requires disclosure that reflects how management and the Board of Directors are assessing operational issues. The Division observed that companies typically include these types of disclosures in earnings releases but urged companies to consider whether any of the information, if material, should also be included in MD&A. The Division provided a list of questions that companies should consider as they evaluate their disclosure obligations with respect to the effects of COVID-19 on their present and future operations, including the following:
- Operational Matters: 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?
- Liquidity Position: 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?
- New Financing Activities: 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?
- Traditional Funding Sources: 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?
- Covenant Compliance: Are you at material risk of not meeting covenants in your credit and other agreements?
- Disclosed Metrics: 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?1 Are there estimates or assumptions underlying such metrics the disclosure of which is necessary for the metric not to be misleading?
- Other Responsive Measures: 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?
- Debt Service 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?
- Customers: 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?
- Suppliers: 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?2 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?
- 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?
- The list provided by the Division is not exhaustive, and companies should continue to consider whether other material trends or risks have emerged, including risks or trends that may affect a company if its counterparties (e.g., borrowers, lenders, significant suppliers or customers, and participants in its distribution chain) are affected by COVID-19.
- As always, the Division encouraged disclosure that is tailored to provide material information and enable investors to evaluate the current and expected impact of COVID-19 through the eyes of management. The Division also emphasized the need to proactively revise and update disclosures as facts and circumstances change.
Government Assistance – The Coronavirus Aid, Relief, and Economic Security Act (CARES Act)
- The Division emphasized that companies receiving federal assistance under the CARES Act (or equivalent program in the case of foreign private issuers) should consider the short- and long-term impacts of that assistance on their financial condition, results of operations, liquidity and capital resources. They should evaluate the related disclosures and critical accounting estimates and assumptions, and provide required U.S. GAAP disclosures relating to any CARES Act assistance received, including 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.3
- The Division provided a list of questions to consider regarding CARES Act-related disclosure set forth below:
- Material Terms of Assistance: How does a loan impact your financial condition, liquidity and capital resources? What are the material terms and conditions of any assistance you received, and do you anticipate being able to comply with them? Do those terms and conditions limit your ability to seek other sources of financing or affect your cost of capital? Do you reasonably expect restrictions, such as maintaining certain employment levels, to have a material impact on your revenues or income from continuing operations or to cause a material change in the relationship between costs and revenues? Once any such restrictions lapse, do you expect to change your operations in a material way?
- Tax Relief: Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?
- Accounting Issues: Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate? What accounting estimates were made, such as the probability a loan will be forgiven, and what uncertainties are involved in applying the related accounting guidance
- In addition to the considerations highlighted by the Division, companies that borrowed and subsequently repaid a loan under the CARES Act should ensure that their liquidity and capital resources disclosures do not conflict with management’s rationale for pursuing and repaying the loan.
A Company’s Ability to Continue as a Going Concern
- The Division reminded companies that management should continue to evaluate whether, in light of all conditions and events known and reasonably knowable as of the date the financial statements are issued, taken as a whole and without taking into consideration potential mitigating effects of management’s plans that have not been fully implemented, there is a substantial doubt about a company’s ability to continue as a going concern (i.e., to meet its obligations as they become due within one year after issuance of the financial statements).
- Where substantial doubt exists regarding a company’s ability to continue as a going concern, the Division reinforced that management must provide appropriate disclosures in the financial statements and provided a list of questions to consider regarding going concern disclosure in MD&A set forth below:
- Substantial Doubt: 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?
- Management Plans: What are your plans to address these challenges? Have you implemented any portion of those plans?
Finally, the Division emphasized that disclosures relating to disclosure controls and procedures and internal control over financial reporting may also be implicated by COVID-19. The Division referred to the SEC’s Chief Accountant statement, discussed below, for additional accounting and audit-related matters companies should consider.
Statement from the SEC’s Chief Accountant Regarding High-Quality Financial Reporting
In tandem with the new Division guidance, the SEC’s Office of the Chief Accountant (OCA) also issued a statement on the importance of high-quality financial reporting in light of COVID-19 as a supplement to a previous statement issued on April 3, 2020. Among other matters, the OCA stressed a number of disclosure-related considerations relating to audit and accounting issues, including the following.
- Companies should ensure that significant judgments and estimates are reasonable and disclosed in a manner that is understandable and useful to investors, and that the resulting financial reporting reflects and is consistent with the company’s specific facts and circumstances, particularly with respect to significant judgments and estimates made in light of COVID-19.
- Companies should disclose any changes that materially affect, or are reasonably likely to materially affect, a company’s internal control over financial reporting in the report for the fiscal quarter in which the change occurred (or fiscal year in the case of a foreign private issuer), bearing in mind changes made to how controls operate or can be tested or the risk of the control operating effectively in a telework environment. The OCA also noted that changes to the business and additional uncertainties in the present environment may result in additional risk of material misstatement to the financial statements and that new or enhanced controls may need to be implemented to mitigate such risks.
- Where substantial doubt about a company’s ability to continue as a going concern exists, companies should provide appropriate disclosure, including in financial statement footnotes and possibly the MD&A, regarding whether management’s plans alleviate such substantial doubt, including (a) the principal conditions giving rise to the substantial doubt, (b) management’s evaluation of the significance of those conditions relative to the company’s ability to meet its obligations, (c) if applicable, management’s plans that alleviated the substantial doubt and (d) additional disclosure in the event management’s plans do not alleviate the substantial doubt.
As many public companies begin to prepare for their next reporting cycle, they should heed the disclosure considerations recently emphasized by the Division and the OCA throughout the process. Public companies should also be aware of this upcoming roundtable event on COVID-19 related disclosure considerations:
Chairman Jay Clayton will moderate a roundtable entitled “Q2 Reporting: A Discussion of COVID-19 Related Disclosure Considerations,” which will be webcast live on SEC.gov at 4:00 PM ET. Roundtable participants will include Gary Cohn, Former Director of the National Economic Council; Glenn Hutchins, Co-Founder of Silver Lake Partners; Tracy Maitland, President of Advent Capital Management; and Barbara Novick, Vice Chairman of BlackRock.
1 The Division refers to the Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 33-10751 (Jan. 30, 2020). This guidance was discussed in a previous Sidley Update.
2 The Division noted that these programs can vary significantly in their terms and structures and that they often involve an intermediary like a financial institution. The Division emphasized that companies should determine the appropriate balance sheet and cash flow classifications of obligations relating to the programs, which also may impact how the programs are discussed in MD&A.
3 For example, the Division noted that the SEC staff would not object if a company accounted for a loan under the Paycheck Protection Program in Section 1102 of the CARES Act as either debt pursuant to ASC 470 or as a government grant by analogy to IAS 20, provided that the relevant conditions are met.
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