’ve written several times about the need for Covid-19 disclosures including public statements by Chair Clayton and William Hinman, the Director of the Division of Corporation Finance and the SEC Division of Corporation Finance Disclosure Guidance Topic No. 9 regarding the SEC’s current views on disclosures that companies should consider with respect to COVID-19. For my summary blog on the topic, see HERE.
As I’ve previously mentioned, my personal thought is that although there are many reasons why disclosure is important, 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. 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.
Not surprisingly, the topic of Covid-19 disclosure was front and center at the SEC’s Investor Advisory Committee (“IAC”) meeting on May 4, 2020 (held virtually, of course) with investors providing positive feedback on the SEC’s guidance to date, but also suggesting additional information that they would like to be informed about by public companies.
IAC meeting participants indicated that the SEC’s prior recommendations related to disclosures on business continuity, the receipt of federal aid and general financial impacts as laid out in Topic No. 9 have been very useful. A refresher on Topic No. 9 is included at the end of this blog.
Several participants at the IAC meeting encouraged the SEC to require more disclosure related to human capital and in particular, how human capital impacts a company’s ability to resume safe and sustainable operations. Human capital is typically considered an environmental, social and governance (ESG) related disclosure. The IAC has been a strong proponent of ESG disclosures, including related to human capital, so this is not surprising. See, for example, HERE.. Also, On May 14, 2020 the IAC published a recommendation to the SEC to require ESG disclosures.
Although the SEC has to date declined to require ESG related disclosures, its most recent published proposed amendments to the business description disclosure required by Regulation S-K includes suggested disclosure on human capital. The proposed amendments would include any human capital measures or objectives that management focuses on in managing the business, and the attraction, development and retention of personnel (such as in a gig economy). See HERE . For more on ESG in general, see HERE and for a summary of SEC Chair Jay Clayton’s views on ESG related disclosure, see HERE.
Getting back to human capital disclosures, as mentioned the IAC’s emphasis was on safe and sustainable workplaces. Drilling down to particular disclosures, investors are interested in: (i) workplace safety hazards and related risks; (ii) systems and controls to reduce hazards including air quality, employee barriers, cleaning supplies and training; (iii) the capacity for testing, contract tracing, and isolation of potentially infected employees including those that are asymptomatic but may have come into contact with an infected person; (iv) controls and accommodations to promote a safe work environment including cleaning supplies and hand washing stations; (v) human resource policies including paid sick leave and adjusted work schedules; (vi) the availability of personal protective equipment; (vii) workforce stability and turnover; and (viii) employee relations including supporting an environment where workers feel safe and plans for dealing with unrest.
Drill Down On Financial Impact
Although the SEC made several recommendations to management to consider in fashioning Covid-19 related disclosures, the IAC meeting participants think companies should really drill down further. For example, how will the impact of Covid-19, financial and otherwise, impact a company’s position vis-a-vis its competition, both domestically and internationally. The changing international hot zones and opening and closing of different countries at different times all impact a company’s operations. Investors would like to see disclosures related to revenues, as well as supply chains, including manufacturing and logistical issues.
Investors would like to see more current real-time disclosure. The SEC has indicated that it will not second-guess best-effort forward-looking statements during these difficult times. However, IAC members would like to see more real-time data, especially since expectations are so difficult to determine in a global crisis. Personally, I think too much real-time data would be confusing and cause unnecessary volatility for the markets. Of course if there is a material real-time negative impact on liquidity, operations, management or earnings (defaults on material obligations; the closing of a manufacturing facility; the shutdown of an export or import border; the infection of a senior executive) or a positive impact (the re-opening of a manufacturing facility; extensions or work-outs with creditors; recovery of sick executive; new funding sources, etc.) these should be reported whether specifically required by Form 8-K or not. For a review of Form 8-K requirements, see HERE.
Investors also want to be sure they are given a heads-up about actual or potential bankruptcy and the real impact of going concern statements. Participants of the meeting noted that during the 2008 recession, some companies filed bankruptcy without any forewarning or even auditor going concern opinions. Although not discussed at the IAC meeting, the fact is, the world has already seen several large bankruptcies as a result of Covid-19. It begs the question that if a company’s financial foundation is fragile enough to be knocked over in 3 months (or less), investors should know. Hertz filed for bankruptcy May 22, directly citing the coronavirus as a cause. Even as the company was beginning layoffs, it paid out a reported $16.2 million in executive bonuses. Certainly management and auditors had to know that the company’s financial position was precipitous, but the marketplace did not.
Participants at the IAC meeting indicated they will want to know how a company’s internal controls over financial reporting held up during the Covid-19 crisis and if deficiencies were discovered, how they are being rectified. In addition, in-person auditor meetings and site reviews have been replaced with Zoom and other electronic communications. IAC members wonder what impact that has over internal controls and even noted that they have not seen an increase in any disclosure related to this dramatic system change.
Refresher On – 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?
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.
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, and 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.