On June 23, 2020, the SEC Office of the Chief Accountant (OCA) and the Division of Corporation Finance of the SEC issued further guidance to assist companies in addressing their financial statement reporting and disclosure obligations with respect to the impacts of COVID-19. This most recent guidance was issued as many companies are preparing their second periodic reports impacted by COVID-19 and continuing uncertainties.
Relatedly, the SEC announced a June 30 roundtable: "Q2 Reporting: A Discussion of COVID-19 Related Disclosure Considerations,” moderated by SEC Chair Jay Clayton. Roundtable participants will include former National Economic Council Director Gary Cohn, Silver Lake Partners co-founder Glenn Hutchins, Advent Capital Management President Tracy Maitland, and BlackRock Vice Chair Barbara Novick. The roundtable will be webcast live on the SEC's website.
SEC Office of the Chief Accountant Statement
On June 23, the OCA issued a further statement on financial reporting in light of the impacts of COVID-19. The statement follows a previous statement made by the OCA on April 3, 2020. Both statements emphasize the importance of high-quality financial information in light of the unprecedented uncertainty due to COVID-19.
The June 23 statement generally covers familiar ground (for example, understandable and useful disclosure of significant estimates and judgments, the importance of disclosure controls and procedures and internal control over financial reporting, and the importance of the role of the audit committee). It reminds issuers that significant judgments and estimates should be disclosed in a manner that is understandable and useful to investors, and the resulting financial reporting should reflect a company’s specific facts and circumstances. In discussing the importance of robust internal accounting controls, the June 23 statement notes that companies have adapted their financial reporting processes in responding to the telework environment and that changes to the business and additional uncertainties may result in additional risks of material misstatements, necessitating new or enhanced controls to mitigate such risks. Further, the June 23 statement recognizes that many companies may have adapted how their controls operate or are tested in a telework environment. Any changes that materially affect or are reasonably likely to affect a company’s internal controls over financial reporting are required to be disclosed in the Form 10-Q or 10-K, as applicable.
OCA also reminded companies that management should consider whether there is doubt as to a company’s ability to continue as a going concern. Management should consider 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 such instances, management should consider whether its plans alleviate such substantial doubt, and make appropriate disclosures to inform investors.
SEC Division of Corporation Finance Disclosure Guidance
On June 23, the Division of Corporation Finance issued disclosure guidance (CF Disclosure Guidance; Topic No. 9A) regarding operations, liquidity and capital resources disclosures companies should consider related to the impact of COVID-19. This guidance supplements guidance with respect to the impact of COVID-19 that the Division had issued on March 25, 2020 (CF Disclosure Guidance Topic No. 9) regarding additional disclosure considerations. The additional guidance focuses on operational adjustments implemented by companies in response to COVID-19, including transition to telework, supply chain and distribution adjustments, and suspending or modifying certain operations to comply with health and safety guidelines to protect employees, contractors and customers, as well as changes in financing activities taken in response to COVID-19.
The Division continues to emphasize that companies should provide disclosures that allow investors to evaluate the current and expected impact of COVID-19 through the eyes 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. Among other things, the guidance notes the following:
- Operational adjustments made by companies (such as telework, supply chain and distribution adjustments, suspending or modifying operations to comply with health and safety guidelines) may be material to an investment decision, and companies need to consider their disclosure obligations; and
- Financing activities undertaken in response to COVID-19 (such as utilizing credit facilities, implementing supplier finance programs, negotiating new or modified customer payment terms) should be disclosed, including in the MD&A.
In considering their disclosure obligations, the Division advises that companies should consider the following questions, among others, when evaluating disclosures:
- What are the material operational challenges that management and the Board of Directors are monitoring and evaluating, and how and to what extent has the company altered operations?
- How are changes to operations impacting the company’s financial condition?
- How are the company’s overall liquidity position and outlook evolving and, to the extent COVID-19 is adversely impacting revenues, are such impacts material to sources and uses of funds?
- Has the company accessed revolving lines of credit or raised capital in the public or private markets to address its liquidity needs, and are disclosures relating to these actions providing a complete discussion?
- Has COVID-19 affected the company’s ability to access its traditional funding sources on the same or reasonably similar terms as were available to the company in recent periods, and if so, what are the material changes?
- Is the company at material risk of not meeting covenants in its credit and other agreements?
- Has the company reduced its capital expenditures as a result of COVID-19, and if so, how?
- Has the company reduced or suspended its share repurchase programs or dividend payments?
- Has the company ceased any material business operations or disposed of a material asset or line of business?
- Has the company materially reduced or increased its human capital resource expenditures?
- Is the company able to timely service its debt and other obligations, and has it taken advantage of payment deferrals, forbearance periods or other concessions?
- Has the company altered terms with its customers, and if so, how have those actions materially affected the company’s financial condition or liquidity?
- Is the company relying on supplier finance programs, structured trade payables, reverse factoring or vendor financing to manage cash flow? If so, have these arrangements had a material impact on the company’s balance sheet, statement of cash flows, or short- and long-term liquidity?
- Has the company assessed the impact of material events occurring after the preparation of its financial statements and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?
The guidance also addresses disclosure implications arising from the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which provides for various forms of financial assistance and tax relief for certain companies. The Division advises that companies receiving such federal assistance 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. Questions that companies should consider include:
- How does a loan impact the company’s financial condition, liquidity and capital resources?
- What are the material terms and conditions of any assistance the company has received, and does the company anticipate being able to comply with them?
- Do the terms and conditions of federal assistance limit the company’s ability to seek other sources of financing or affect the cost of capital?
- Does the company reasonably expect restrictions imposed by accepting federal assistance to have a material impact? Once any such restrictions lapse, does the company expect to change its operations in a material way?
- Is the company taking advantage of any tax relief, and if so, how does that relief impact the company’s short- and long-term liquidity? Does the company expect a material tax refund for prior periods?
- Does the federal 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?
Finally, the Division advised that management should consider the company’s ability to continue as a going concern. Where there is substantial doubt about a company’s ability to continue as a going concern or the substantial doubt is alleviated by management’s plans, management should provide the appropriate disclosures in the financial statements and consider the following questions regarding the MD&A disclosure:
- Are there specific conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern?
- What are the company’s plans to address these challenges? Has the company implemented any portion of those plans?
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Anyone having questions about this client alert should contact members of our Securities Practice Group, Carmen M. Fonda at cmfonda@Venable.com, William N. Haddad at wnhaddad@Venable.com, Michael A. Leber at mleber@Venable.com, Jeffrey N. Ostrager at jnostrager@Venable.com, Eric R. Smith at ersmith@Venable.com, Gabriel M. Steele at gmsteele@Venable.com, Thomas D. Washburne, Jr. at twashburne@Venable.com, or Darius Alam at dralam@Venable.com.