Disclosure Amid COVID-19: Notable SEC Public Statement Focuses on Underlying Public Policy

A recent US Securities and Exchange Commission statement stressed the importance of disclosure and highlighted its role in the national effort to foster a meaningful, responsible increase in economic activity. In light of the coronavirus (COVID-19) pandemic and its effect on national and global economies, public companies should take a careful look at the impact of these circumstances on their disclosure obligations under federal securities laws.

Company disclosure is an essential tool for efficient markets and enables the US Securities and Exchange Commission (SEC) to advance its mission to maintain market integrity, facilitate capital formation, and protect investors. In a constantly evolving environment, the substance of such disclosures and the manner in which companies can satisfy their disclosure obligations and preserve the health and safety of workers and customers—and even further national and local crisis mitigation efforts—require ongoing, dynamic consideration.

This LawFlash addresses various disclosure-specific issues to be considered against the backdrop of COVID-19, and is one of a series focused on COVID-19’s impact on corporate governance, including the duties and actions of boards and committees.

For more discussion on corporate governance, mergers and acquisitions, securities, and myriad other issues companies and individuals face during the crisis, visit our Coronavirus COVID-19 resource page.

QUARTERLY REPORTS

With the first quarter of the calendar year now behind us, many companies are in the midst of preparing for their quarter-end disclosures. Historically, quarter-end filings and reports, including earnings reports and Forms 10-Q, have utilized primarily historical quantitative data (i.e., balance sheets, income statements, cash flow statements) as key predictors of future performance. However, COVID-19 may mandate a change in approach.

Impact of COVID-19

In an April 8 Public Statement (Public Statement), SEC Chairman Jay Clayton and Division of Corporation Finance (DCF) Director William Hinman focused not only on typical themes in discussing the value of robust disclosure, but also went beyond this perspective by speaking to the manner in which public company disclosure can play a part in the overall national effort to foster a meaningful, responsible increase in economic activity.

The Public Statement suggests that quarter-end disclosures should integrate the ways in which the company has been impacted by COVID-19 and the company’s related responses. More specifically, the Public Statement recommends that disclosures address the following:

• Where the company stands today from an operational and financial standpoint
• How the company’s COVID-19 response, including its efforts to protect the health and well-being of its workforce and customers, is progressing
• How the company’s operations and financial conditions may change as overall efforts to fight COVID-19 progress
• The “nature, amounts and effects” of any financial assistance being received by the company, whether the company is receiving any assistance under the Coronavirus Aid, Relief, and Economic Security (CARES) Act or other COVID-19-related federal and state programs, and if so, whether such assistance has materially affected or is reasonably likely to have a future material effect on the company

Based on the themes expressed in the Public Statement, combined with the discussion contained in Disclosure Guidance Topic No. 9 (DGT 9) issued by the DCF on March 25, we would stress the need for companies to review any COVID-19-specific effects and considerations as they may relate to (1) management discussion and analysis (MD&A), including known trends and uncertainties; (2) liquidity and capital resources; and (3) subsequent events, as well as risk factors and forward-looking statements.

Forward-Looking Statements

Importantly, although companies are often “cautioned to limit their forward-looking disclosures” because such predictions may not materialize, the SEC is actively encouraging companies to utilize the safe harbors for forward-looking statements during the COVID-19 pandemic, noting as to forward-looking information:

• The information will benefit investors.
• Market digestion of the information will benefit the company.
• The broad dissemination and exchange of company-specific plans for addressing the effects of COVID-19 under various scenarios will substantially contribute to our nation’s collective effort to fight and recover from COVID-19.

The Public Statement also encourages robust-yet-tailored (i.e., not boilerplate) disclosures. The SEC advocates that companies and their advisers “make all reasonable efforts to convey meaningful information—information that provides investors a level of insight that allows them to see the key operational and financial considerations and challenges the company faces through the eyes of management.” In furtherance of this goal, the SEC suggests companies disclose “broad frameworks of some of the strategies that have been suggested, how following those strategies may affect their operations and whether that analysis would be of material interest to investors.”

To provide reassurance to companies concerned about the broad provision of forward-looking information, the Public Statement indicates that the SEC “would not expect to second guess good faith attempts to provide investors and other market participants appropriately framed forward-looking information.”

Risk Factors

Risk factor updates and additions may address the following topics and the related impact of COVID-19:

• The company’s business, customers, and suppliers
• The ability to make and receive payments
• Business relationships affected by restrictions on travel and otherwise
• Liquidity
• Compliance with financial and operating covenants
• Key management personnel
• The impact of the invocation of the Defense Production Act
• Issues affecting employees and operations, including any requirement by federal or state governments to close operations to the extent not considered “essential”

It is important to draft risk factors to address the current state of material risks faced by a company. If an identified risk has occurred, it should no longer be phrased in a hypothetical manner.

MD&A

Consider the impact of COVID-19 on historical results as well as—and perhaps more importantly—known trends and uncertainties.

• Current Impact on Financial Condition and Results of Operations. Under DGT 9, companies should consider if COVID-19 has had a material effect on the demand for their products or services and whether operations are materially impacted by any constraints or other impacts on human capital resources and productivity. Companies should also examine whether travel restrictions and border closures are expected to have a material impact on the ability to operate and achieve business goals, such as supply chains or distribution.

• Known Trends and Uncertainties. In DGT 9, the SEC staff directed companies to consider their financial condition and results of operations, including expectations regarding the impact on future operating results and financial condition, both near-term and long-term, in light of the overall economic outlook and changing trends, and whether COVID-19 will impact future operations differently than the current period. Some matters to consider include the following:

• How are remote work arrangements impacting the business?
• Have conditions adversely affected the ability to maintain operations, including financial reporting systems, internal control over financial reporting, and disclosure controls and procedures? What challenges are anticipated in the ability to maintain these systems and controls?
• Has the company discovered a hole in its business continuity plan?

For example, for a company that did not have remote signing capabilities or the authority to remotely sign documents when this pandemic started, its disclosures may address whether this situation has impacted the company, and whether and how it has been remediated.

A company should also consider addressing whether it anticipates any material impairments (e.g., 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.

• Liquidity and Capital Resources. In DGT 9, the SEC staff asked companies to consider COVID-19’s impact on liquidity and capital resources, including any effect on customers and timing of payments, the sufficiency of credit facilities (including compliance with lender covenants such as liquidity ratios), any impairment charges, and any need to increase drawdowns of credit facilities.

• Subsequent Events. As noted above, the impacts of COVID-19 are constantly evolving, and companies should look beyond the end of their quarters when drafting disclosures and include disclosure of relevant subsequent events. In fact, DGT 9 specially urged companies to “proactively revise and update disclosures as facts and circumstances change.”

UPDATES TO EXISTING TRANSACTIONAL DISCLOSURE

Companies with pending or proposed transactions that are or become the subject of filings with the SEC may consider updating existing disclosures, or crafting new disclosures, to the extent the COVID-19 pandemic may have an impact on the transaction.

For example, a company may want to address whether the COVID-19 pandemic presents a risk to a capital raise or acquisition financing, or whether any representations, warranties, or covenants are no longer true in light of COVID-19.

Companies may also want to consider updates to their risk factors in their transactional disclosures.

FORM 8-K CONSIDERATIONS

Although COVID-19 by itself does not trigger a disclosure under the SEC current reporting obligations on Form 8-K, there are instances in which a company’s response to the effects of COVID-19 may trigger a current disclosure obligation.

Examples of when disclosure may be triggered include if a company decreases the salaries of any of its named executive officers (NEOs), enters into a material loan agreement or draws down on a credit facility due to the need for additional liquidity in response to COVID-19.

As we discussed in our March 25 LawFlash, the SEC has granted public companies a 45-day extension of the deadline to file certain disclosure reports that would otherwise have been due between March 1-July 1, 2020.

While the SEC has provided relief in the timing of certain disclosure obligations for public companies as a result of COVID-19, there are some items that require a company to respond quickly and file an 8-K. Because reliance on the relief order itself requires filing an 8-K, there would be very few circumstances in which it would make sense to rely on the relief order for an 8-K obligation.

POTENTIAL PITFALLS

Despite the SEC’s clear imperatives in the Public Statement, issuers should nevertheless be mindful of potential pitfalls in certain elements of forward-looking disclosure. For example, quarterly and annual guidance are frequent topics of forward-looking disclosure. During the current COVID-19 response, companies should evaluate whether to retain, withdraw, or revise guidance. As part of this evaluation, a company must balance whether it is in a position to produce reliable guidance at any particular moment given market conditions and continued COVID-19-related uncertainty.

Companies must also consider the implications of disclosing revisions to previously issued guidance on their future public disclosure obligations. Despite the assurances in the Public Statement about not second guessing good faith attempts, a company may still face challenges from plaintiffs’ firms. Such firms could later argue that a company has assumed a duty to provide further revisions as a result of changing circumstances relating to COVID-19 or otherwise. As such, a company should modify its disclaimers to explicitly disclaim any future updates if it chooses to issue revised guidance.

CORONAVIRUS COVID-19 TASK FORCE

For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.

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