On September 17, 2010, the Securities and Exchange Commission (SEC) issued Release Nos. 33-9144; 34-62934 (the Interpretive Release)1, providing interpretive guidance on the presentation of the following aspects of liquidity and capital resources disclosures in management’s discussion and analysis of financial condition and results of operations (MD&A):
This guidance sets forth the SEC’s position under its rules as they currently exist and becomes effective immediately upon publication in the Federal Register. It supplements the SEC’s prior MD&A interpretative guidance, which remains in effect.2
At the same time that it issued the Interpretive Release, the SEC proposed a separately captioned subsection of the MD&A to provide a comprehensive explanation of short-term borrowings.3 We will circulate a separate Legal Update discussing that proposal at a later date.
Item 303(a) of Regulation S-K requires disclosures of known trends, demands, commitments, events or uncertainties that will, or are reasonably likely to, result in the registrant’s liquidity increasing or decreasing in any material way. The Interpretive Release identifies “difficulties accessing the debt markets, reliance on commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the valuation of collateral, and counterparty risk” as examples of important trends or uncertainties impacting liquidity, which could require disclosure in the MD&A.
Additional narrative disclosure could be required in the MD&A if financial statements do not adequately convey financing arrangements during the period covered by the MD&A, or the impact of financing arrangements on liquidity. As an example, the Interpretive Release explains that “if borrowings during the reporting period are materially different than the period-end amounts recorded in the financial statements, disclosure about the intra-period variations is required under current rules to facilitate investor understanding of the registrant’s liquidity position.”
The Interpretive Release notes that although there are no specific references in existing MD&A disclosure requirements for off-balance sheet arrangements or contractual obligations to repurchase transactions that are accounted for as sales, or to any other transfers of financial assets that are accounted for as sales, these arrangements are nevertheless subject to MD&A disclosure requirements. The relevant inquiry is “whether the transaction is reasonably likely to result in the use of a material amount of cash or other liquid assets.” These transactions may need to be disclosed in the discussion of liquidity and capital resources, especially if the information is not contained in the registrant’s off-balance sheet discussion or contractual obligations table. The Interpretive Release leaves it up to the registrant to determine what section of the MD&A is most appropriate for such disclosure.
The Interpretive Release also states that cash management and risk management policies that are relevant to an assessment of financial condition may need to be described in the MD&A to provide context for identified exposures. For example, banks “should consider discussing their policies and practices in meeting applicable banking agency guidance on funding and liquidity risk management, or any policies and practices that differ from applicable agency guidance.” If cash and other investments provide a material source of liquidity for a company, it “should consider providing information about the nature and composition of that portfolio, including a description of the assets held and any related market risk, settlement risk or other risk exposure,” including “limits or restrictions and their effect on the company’s ability to use or to access those assets to fund its business operations.”
The Interpretive Release reminds registrants disclosing capital or leverage ratios for which there is no method of calculation prescribed by regulation, or for which a modified methodology is being used, that they need to determine whether any such ratio is a financial measure. If the ratio is a financial measure, the company must determine if it is a non-GAAP (Generally Accepted Accounting Principles) financial measure. If the ratio is either not a financial measure or is a non-GAAP financial measure, the registrant must apply the SEC’s existing rules and guidance. If a ratio is being presented in connection with debt instruments, guarantees and related covenants, the registrant must follow the SEC’s past guidance on that topic.
The Interpretive Release specifies that when a ratio or measure is included in a filing, the MD&A must contain a clear explanation of the calculation methodology. Unusual, infrequent, non-recurring or adjusted inputs would have to be described. If the financial measure differs from industry practice, it may be necessary for the registrant to discuss the differences so that the presentation would not be misleading. The registrant should clearly state why such financial measure is useful to understanding its financial condition.
Contractual Obligations Table
The contractual obligations table can be presented in a way that reflects categories of obligations that are meaningful in light of a company’s capital structure and business. Changes in presentation should be highlighted.
The SEC has not issued general guidance regarding treatment of specific items such as interest payments, repurchase agreements, tax liabilities, synthetic leases, obligations that arise under off-balance sheet arrangements or questions arising the context of purchase obligations. Rather, the SEC leaves it up to each registrant to assess how best to present the contractual obligation information that is relevant to its business. The Interpretive Release recommends footnotes to provide information necessary for an understanding of the timing and amount of specified contractual obligations, as well as additional narrative disclosure to promote understanding of the data contained in the contractual obligations table.
Because the Interpretive Release provides guidance on rules that are already in effect, it is applicable to upcoming Form 10-Q and Form 10-K reports, as well as to registration statements that contain MD&A disclosure. Companies therefore need to immediately consider how the guidance in the Interpretive Release applies to their MD&A disclosures.
If you have any questions about the Interpretive Release, please contact the author of this Legal Update, Laura D. Richman, at +1 312 701 7304, or any other member of our Corporate & Securities practice.
Learn more about our Corporate & Securities practice.
1. Available at http://www.sec.gov/rules/interp/2010/33-9144.pdf.
2. For example, see “Commission Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Release No. 33-8056 (Jan. 22, 2002), available at http://www.sec.gov/rules/other/33-8056.htm; “Disclosure in Management’s Discussion and Analysis About Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments,” Release No. 33-8144 (Nov. 4, 2002), available at http://www.sec.gov/rules/proposed/33-8144.htm; “Disclosure in Management’s Discussion and Analysis About Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments,” Release No. 33-8182 (Jan. 28, 2003), available at http://www.sec.gov/rules/final/33-8182.htm; and “Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Release No. 33-8350 (Dec. 19, 2003), available at http://www.sec.gov/rules/interp/33-8350.htm.
3. See Release Nos. 33-9143; 34-62932, available at http://www.sec.gov/rules/proposed/2010/33-9143.pdf.
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