Disclosures Related To COVID-19
Posted by Securities Attorney Laura Anthony | April 17, 2020 Tags:

The SEC has been reiterating the need for robust disclosures related to the impact of COVID-19 on publicly reporting companies.  In the last few weeks I have written about some of the guidance issued by the SEC including Disclosure Guidance Topic No. 9.  Since that time the SEC has continued to issue guidance in the form of public statements.  This blog will summarize the SEC guidance and statements on disclosures up to date, and include a sample risk factor for inclusion in SEC reports.

Public Statement by Chair Jay Clayton and Director of the Division of Corporation Finance, William Hinman

On April 8, 2020, SEC Chairman Jay Clayton and William Hinman, the Director of the Division of Corporation Finance, issued a joint public statement on the importance of disclosure during the COVID-19 crisis.

Before I get into summarizing the statement, my personal thought is that although there are many reasons why disclosure is important, including the basic premise that the securities laws are founded on that very concept, it is especially important now to support investor confidence, activity in our markets and capital raising efforts.  If investors are kept informed of the impact of COVID-19 on companies, see that these companies are continuing on and meeting their requirements and that the markets haven’t just fallen into Neverland, they will continue to invest through the trading of securities, and direct investments through PIPE transactions.  Without adequate information, not only will investors not likely invest directly in companies, but a company may be prohibited from accepting funds even if they want to if there is a concern of trading on material non-public information.

In my view the best way to protect the capital markets is to encourage confidence and investments.  I’ve seen a noticeable uptick in liquidity in the small-cap space.  My belief is that many people who are staying at home, are not just watching Netflix, but rather are actively trading the markets, making both short-term and long-term plays, following the markets very closely, reviewing companies for undervalued opportunities and spending more time researching than ever before.  My advice to all my clients, and readers, is to make sure that information is being disseminated as quickly as available and as often as possible.

Further on the broader economic level, transparency and information will bolster confidence on a B2B level such as between suppliers, manufacturers and retailers, allow for the extension of credit and support the general continued flow of business operations.

Reporting Earnings and Financial Results

Both Topic No. 9 and the Public Statement encourage companies to proactively address financial reporting matters earlier than usual.  Many companies will rely on the available 45-day extension and will be grappling with the accounting complexities of the COVID-19 impact including short-term dramatic changes in expenses and revenues.  The SEC suggests engaging needed experts and beginning an analysis of the potential impacts as quickly as possible to be prepared to meet filing deadlines, even with the extensions.

Many companies, although not obligated, choose to issue earnings releases and conduct investor and analyst calls (for more on earnings releases, see HERE.  In their Public Statement, Chair Clayton and Director Hinman urged companies to provide as much information as practicable regarding their current and future financial and operating status.  Disclosures should include any information on the impact of COVID-19 as it stands today, how the company is responding to COVID-19 including how it is protecting the health and well-being of its workers and customers, and how operations and financial condition may change in the future as a result of the virus.  The SEC advises against boilerplate information, but rather companies should make a concerted effort to provide meaningful information on key operational and financial considerations and challenges.

The SEC notes that historical information is relatively less significant at this time, making forward-looking information all the more important.  Investors and analysts are extremely interested to know where companies stand today and, importantly, how they have adjusted, and expect to adjust in the future, their operational and financial affairs to most effectively work through the COVID-19 health crisis. Detailed discussions of current liquidity positions and expected financial resource needs is particularly helpful to investors and markets.  Where material, a company should disclose any CARES Act or similar federal or state assistance that has been applied for and/or received, including the nature, amount and effects of such assistance.

With that said, to the extent that a company had previously issued 2020 guidance which remains in place, it is important to address the degree to which the company believes it can continue to meet those previous projections and any changes to that prior guidance.  Obviously, all companies should be reviewing prior guidance to determine if it should be withdrawn.

Forward-looking information will be protected under either Sections 27A and 21E of the Private Securities Litigation Reform Act of 1995 (PSLRA) or the common law bespeaks caution doctrine as long as proper disclaimers are included (for more information, see HERE.

In addition to other considerations, the SEC reminds companies of their obligations under Item 10 of Regulation S-K and Regulation G related to the presentation of non-GAAP financial measures.   The SEC permits companies to present non-GAAP financial measures in their public disclosures subject to compliance with Regulation G and Item 10(e) of Regulation S-K. Regulation G and Item 10(e) require reconciliation to comparable GAAP numbers, the reasons for presenting the non-GAAP numbers, and govern the presentation format itself including requiring equal or greater prominence to the GAAP financial information.  For more on Item 10 and Regulation G, see HERE.

Topic No. 9 specifically acknowledges that there may be instances where a GAAP financial measure is not available at the time of the earnings release because the measure may be impacted by a COVID-19 related adjustment that may require additional information and analysis to complete.  In these situations, the SEC would not object to companies reconciling a non-GAAP financial measure to preliminary GAAP results that either include provisional amount(s) based on a reasonable estimate, or a range of reasonably estimable GAAP results.  For example, if a company intends to disclose EBITDA on an earnings call, it could reconcile that measure to either its GAAP earnings, a reasonable estimate of its GAAP earnings that includes a provisional amount, or its reasonable estimate of a range of GAAP earnings.  In filings where GAAP financial statements are required, such as on Form 10-K or 10-Q, companies should reconcile to GAAP results and not include provisional amounts or a range of estimated results.

The SEC also cautions companies against using the Topic No. 9 guidance and current SEC flexibility to present non-GAAP financial measures or metrics for the sole purpose of presenting a more favorable view of the company.

General Disclosure Guidance – Topic No. 9

The SEC Division of Corporation Finance has issued Disclosure Guidance Topic No. 9 regarding the SEC’s current views on disclosures and the obligations that companies should consider with respect to COVID-19.  The overarching messaging is that a company must consider its COVID-19 impact in its disclosure documents and make necessary material disclosures using a principles-based strategy.

Certainly the actual impact and risks are difficult to ascertain and may be unknown or dependent on third parties, but the SEC encourages material disclosure on what management expects the virus’ future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties.  Examples of areas of reports that may be impacted and thus require disclosure include  management’s discussion and analysis, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting, and the financial statements.

Topic No. 9 suggests that management consider the following non-exclusive list in considering COVID-19 related disclosures:

  • How has COVID-19 impacted the financial condition and results of operations? How do you expect COVID-19 to impact your future operating results and near-and-long-term financial condition?  Do you expect that COVID-19 will impact future operations differently than how it affected the current period?
  • How has COVID-19 impacted your capital and financial resources, including your overall liquidity position and outlook? Consider if the cost of or access to capital and funding sources has changed and whether it is likely to change or continue to change.  Have sources and uses of cash been materially impacted?  Has the ability to continue to meet ongoing credit agreements changed or is it materially likely it will change? Disclosure should also be made as to the course of action a company has taken or proposes to take in light of the material impact on its financial resources.
  • How do you expect COVID-19 to affect assets on your balance sheet and your ability to timely account for those assets?  For example, will there be significant changes in judgments in determining the fair-value of assets measured in accordance with U.S GAAP or IFRS?
  • Do you anticipate any material impairments (e.g., with respect to goodwill, intangible assets, long-lived assets, right of use assets, investment securities), increases in allowances for credit losses, restructuring charges, other expenses, or changes in accounting judgments that have had or are reasonably likely to have a material impact on your financial statements?
  • Have COVID-19-related circumstances such as remote work arrangements adversely affected your ability to maintain operations, including financial reporting systems, internal control over financial reporting and disclosure controls and procedures?  If so, what changes in your controls have occurred during the current period that materially affect or are reasonably likely to materially affect your internal control over financial reporting?  What challenges do you anticipate in your ability to maintain these systems and controls?
  • Have you experienced challenges in implementing your business continuity plans or do you foresee requiring material expenditures to do so?
  • Do you expect COVID-19 to materially affect the demand for your products or services?
  • Do you anticipate a material adverse impact of COVID-19 on your supply chain or the methods used to distribute your products or services?
  • Will your operations be materially impacted by any constraints or other impacts on your human capital resources and productivity?
  • Are travel restrictions and border closures expected to have a material impact on your ability to operate and achieve your business goals?

Sample Risk Factor

Although COVID-19 risk factors have taken many forms, it is important to try and be specific as to a particular business impact.  An outline of a risk factor that can be amended to address particular business situations is:

Public health epidemics or outbreaks, such as COVID-19, could materially and adversely impact our business.

In December 2019, a novel strain of coronavirus (COVID-19) emerged in Wuhan, Hubei Province, China. While initially the outbreak was largely concentrated in China and caused significant disruptions to its economy, it has now spread to several other countries and infections have been reported globally.

Because COVID-19 infections have been reported throughout the United States, certain federal, state and local governmental authorities have issued stay-at-home orders, proclamations and/or directives aimed at minimizing the spread of COVID-19. Additional, more restrictive proclamations and/or directives may be issued in the future. As a result, all of our [describe business locations] have been closed effective April 1, 2020.  [Describe risk of loss of franchise fees, rents, consumer/customer payments].

The ultimate impact of the COVID-19 pandemic on the Company’s operations is unknown and will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the COVID-19 outbreak, new information which may emerge concerning the severity of the COVID-19 pandemic, and any additional preventative and protective actions that governments, or the Company, may direct, which may result in an extended period of continued business disruption, reduced customer traffic and reduced operations. Any resulting financial impact cannot be reasonably estimated at this time but is anticipated to have a material adverse impact on our business, financial condition and results of operations.

The measures taken to date will impact the Company’s business for the fiscal fourth quarter and potentially beyond. Management expects that all of its business segments, across all of its geographies, will be impacted to some degree, but the significance of the impact of the COVID-19 outbreak on the Company’s business and the duration for which it may have an impact cannot be determined at this time.

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