Further COVID-19 Disclosure Guidance from the SECJune 25, 2020
Public companies and any other companies contemplating raising capital from investors should review and implement as appropriate guidance from the Securities Exchange Commission on disclosing the effects of the COVID-19 pandemic on their businesses. The most recent SEC COVID‑19 guidance presents a useful set of questions for companies to consider as they prepare disclosures for shareholders or prospective investors with respect to operations and financial condition for the first six months of 2020.
Since the onset of the COVID-19 pandemic, public companies and other companies seeking to raise capital have faced a challenging communications obligation in addition to operating in an uncertain economic climate: the obligation to provide their investors with meaningful, legally compliant disclosures about the effects of the COVID‑19 pandemic on their businesses. Appropriate disclosures will give investors the opportunity to evaluate management’s views on the current and expected impact of COVID-19 on the company’s operations and financial condition.
During the early stages of the COVID-19 pandemic, staff of the SEC Division of Corporation Finance provided guidance regarding disclosures and other securities law obligations that companies should consider with respect to COVID-19 and related business and market disruptions. On June 23, 2020, as most public reporting companies neared the end of a fiscal quarter for a second time during the COVID-19 pandemic, SEC staff supplemented their prior guidance with the new Disclosure Guidance: Topic 9A, Coronavirus (COVID-19) — Disclosure Considerations Regarding Operations, Liquidity, and Capital Resources, providing additional direction regarding operational, liquidity, and capital resources disclosures companies should consider with respect to business and market disruptions related to COVID-19. Also on June 23, 2020, the SEC Office of the Chief Accountant issued its Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID-19.
In this latest guidance, the SEC continues to encourage companies to provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the views of management and to proactively revise and update disclosures as facts and circumstances change. These disclosures should enable an investor to understand how management and the Board of Directors are analyzing the current and expected impact of COVID-19 on the company’s operations and financial condition, including liquidity and capital resources.
Disclosure Considerations - Operations, Liquidity and Capital Resources
The SEC noted the operational adjustments and financing and other transactions undertaken by companies in response to the effects of COVID-19, such as supply chain and distribution adjustments, suspending or modifying operations to comply with health and safety guidelines, financing activities such as obtaining and utilizing credit facilities, accessing public and private capital markets, implementing supplier finance programs and negotiating new or modified customer payment terms. The SEC stated it is important that companies provide “robust and transparent” disclosure about how they are addressing 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. The SEC also encouraged companies making these disclosures to evaluate whether any of the information, in light of its potential materiality, should be included in MD&A discussions in addition to discussions in earnings releases.
Disclosure considerations arising out of the impact of the COVID-19 pandemic and companies’ responses might include:
- the material operational challenges that companies are monitoring, the extent to which companies have altered operations and the effect of such changes on their financial condition and short- and long-term liquidity;
- how the company’s liquidity position and outlook are evolving and, if COVID-19 is adversely impacting revenues, whether such impacts are material to sources and uses of funds, as well as the materiality of assumptions about the magnitude and duration of COVID-19’s impact on revenues;
- whether disclosures regarding accessed revolving lines of credit or raised capital provide investors with a complete discussion of financial condition and liquidity;
- whether COVID-19 related impacts affected the company’s ability to access traditional funding sources on the same or reasonably similar terms as available in recent periods and any material changes in cost of capital or the terms or availability of additional funding;
- any material risk of not meeting credit covenants;
- whether the use of financial metrics, such as cash burn rate or daily cash use, are accompanied by clear definitions of the metric and explanations of how management uses them;
- the extent of any reductions in capital expenditures, share repurchase programs or dividend payments, as well as in other potential cost-cutting measures such as business dispositions and reductions in human resource expenditures;
- whether the company is able to service its debt and/or has taken advantage of available payment deferrals, forbearance periods or other concessions (and the extent and nature of those concessions);
- the extent of any changed terms (e.g., extended payment terms or other concessions) with customers and the impact of those actions on financial condition, liquidity and capital resources;
- the terms and effect of any supplier finance or supply chain financing programs to manage cash flow; and
- the impact of material events occurring after the end of a reporting period, but before the financial statements were issued, on liquidity and capital resources and whether disclosure of subsequent events in the financial statements and in the MD&A is required.
Coronavirus Aid, Relief, and Economic Security Act (CARES Act) Matters
The SEC stated that companies that received CARES Act financial assistance (such as loans under the Small Business Administration’s Paycheck Protection Program) should consider the short- and long-term impact of that assistance on their financial condition, results of operations, liquidity and capital resources, as well as the related disclosures and critical accounting estimates and assumptions. Issues that the SEC believes companies should consider include:
- the effect of a CARES Act loan on the company’s financial condition, liquidity, and capital resources and the material terms and conditions of that assistance (including an assessment of the company’s ability to comply with the terms of any assistance and the effect of such compliance, such as maintaining employment levels) on revenues or income from continuing operations and whether there may be a material change in operations after the restrictions lapse;
- the extent of any CARES Act or other tax relief and its impact on short- and long-term liquidity; and
- the financial accounting impact of CARES Act assistance and whether new material accounting estimates or judgments should be disclosed or materially changed.
Finally, the SEC addressed issues arising for companies seriously affected by the effects of COVID-19 with substantial doubt about their ability to meet obligations as they become due within one year after the issuance of the financial statements (that is, their ability to continue as a going concern). Under those circumstances, the company should provide appropriate disclosures in its financial statements and consider disclosure of events that give rise to the substantial doubt about the company’s ability to continue as a going concern (e.g., loan defaults) and the company’s plans to address these changes.
In its Statement on the Continued Importance of High-Quality Financial Reporting for Investors in Light of COVID‑19, the SEC Office of the Chief Accountant ("OCA") addressed a range of matters including, for purposes of this Alert, the importance of high-quality financial reporting and the vital role of audit committees.
Accounting Estimates and Judgments. The OCA noted that many companies have been required to make significant judgments and estimates to address a variety of accounting and financial reporting matters during the COVID-19 pandemic, and stated that it would not object to well-reasoned judgments that entities have made. It cautioned that companies should ensure that significant judgments and estimates are disclosed in an understandable and useful manner and with financial reporting that reflects and is consistent with the company’s specific facts and circumstances.
Disclosure Controls and Procedures and Internal Control over Financial Reporting. The OCA stated that it understands companies have adapted, or are adapting, their financial reporting processes as they respond to the changing environment (such as telework) and that the changes may include consideration on how controls operate or can be tested. The OCA reminded companies that if any change materially affects, or is reasonably likely to materially affect, an entity’s internal control over financial reporting, the change must be disclosed in quarterly filings in the fiscal quarter in which it occurred.
Going Concern. The OCA reminded companies that management should consider in each reporting period whether relevant 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. In instances where substantial doubt about an entity’s ability to continue as a going concern exists, management should consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors. The OCA also noted that auditors also have a responsibility to evaluate the ability to continue as a going concern based on their knowledge of relevant conditions that exist or occurred prior to the date of the auditor’s report.
Audit Committee. The OCA stressed that in times of rapid change and increased uncertainty, the need for the oversight role that audit committees play is critical, stating “the most effective audit committees are engaged, executing their responsibilities with diligence, and this engagement significantly enhances the financial reporting output.”
If you have any questions concerning the SEC’s latest COVID-19 guidance or the implications and disruptions of COVID-19 on your business, please contact any of the authors above or another member of the Lewis Rice COVID-19 Task Force.