As the quarter comes to an end and companies prepare to file earnings releases and financial results, the Securities and Exchange Commission (SEC) has released a series of statements making it clear that it expects to see thoughtful and up-to-date disclosure on the ongoing impact of the COVID-19 crisis. On June 23, 2020, the Division of Corporation Finance (the Division) released guidance regarding the Division’s views on operations, liquidity and capital resource disclosures in light of the continued disruptions caused by COVID-19 (the June Guidance). On that same day, the Office of the Chief Accountant (OCA), released a statement on the importance of high-quality financial reporting during COVID-19 (the OCA Guidance). Finally, on June 25, 2020, SEC Chairman Jay Clayton testified before the US House Committee on Financial Services, where he detailed the recent COVID-19 guidance and emphasized the importance of educating and informing investors during this time. Companies should carefully review the various forms of SEC guidance to ensure they are providing as much information as practicable regarding their future operational and financial planning.
Guidance from the Division of Corporation Finance
The June Guidance supplements guidance released by the Division on March 25, 2020 (the “March Guidance,” and together with the June Guidance, the “Division Guidance”), which outlined disclosure considerations at the onset of the COVID-19 pandemic. The Division Guidance is intended to aid companies in drafting disclosure that enables investors to understand how management and the Board of Directors are analyzing the impact of COVID-19 on a company’s operations and financial conditions. While the March Guidance discussed general topics and issues that a company should evaluate at the onset of COVID-19, the June Guidance focuses specifically on considerations regarding the ongoing impact of COVID-19 on operations, liquidity and capital resources.
- Operations, liquidity and capital resources
With regard to operations, the Division notes that companies are undertaking a number of operational adjustments in response to COVID-19, such as transitioning to telework, and suspending or modifying certain operations to comply with health and safety guidelines. To the extent these adjustments may affect a company’s regular investment processes, such adjustments should be disclosed to investors, even when not explicitly required by a form line item. Additionally, as companies look to various funding sources to address short- and long-term liquidity, including sources with novel terms and structures, the Division encourages companies to evaluate whether the potential materiality of such arrangement warrants additional disclosure in the Management’s Discussion and Analysis section.
For those companies relying on the loans and tax relief provided by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), the Division emphasizes the need to evaluate the short- and long-term effects of the CARES Act relief, including the material terms of any assistance, and the effect of those terms the ability to obtain other forms of financing or the maintenance of revenue levels.
Finally, the Division directs management to “consider whether 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.” This includes situations where there is substantial doubt and where such substantial doubt is alleviated by management’s plans.
Guidance from the Office of the Chief Accountant
The OCA Guidance was issued to assist companies as they prepare their second quarter financials, and emphasizes important lessons for companies to keep in mind as they respond to the COVID-19 pandemic. In particular, OCA reiterates the importance of relevant and faithfully represented financial information to educate and aid investors during this period. OCA stresses the importance that a strong financial reporting system plays in the functioning of the markets and the collective effort to mitigate the impact of the COVID-19 pandemic.
- Reasonable judgments and estimates
In the OCA Guidance, OCA acknowledges that many companies are being forced to make significant judgments and estimates to address various accounting and financial reporting matters. OCA notes that it has a historical policy of not objecting to well-reasoned judgments that entities make and highlights that it will maintain this policy moving forward.
- Importance of disclosure controls and procedures and internal control over financial reporting
As companies are adjusting to the changes and volatility brought on by the COVID-19 pandemic, OCA cautions companies that there is a heightened risk of violations of disclosure controls and internal controls over financial reporting, including additional risks regarding material disclosure misstatements. OCA urges companies to continually assess the need for new or enhanced controls.
- Vital role of the audit committee
Finally, OCA reminds all companies of the important role the audit committee plays in the financial reporting system and emphasized that this role is even more crucial during these times of rapid change and increased uncertainty. OCA encourages both the audit committee and management to be engaged, diligent and communicative through an ongoing two-way dialogue.
Application to business development companies and registered closed-end funds
Business development companies (BDCs) and registered closed-end funds should review the SEC’s statements and consider how such guidance may shape any forthcoming disclosure. BDCs in particular should also review the application of the guidance to their portfolio companies and how such application may impact the BDC’s disclosure.
For more information, and for a list of specific questions to consider, please review the March Guidance, available at https://www.sec.gov/corpfin/coronavirus-covid-19, and the June Guidance, available at https://www.sec.gov/corpfin/covid-19-disclosure-considerations. OCA’s statement is available at https://www.sec.gov/news/public-statement/teotia-financial-reporting-covid-19-2020-06-23. Chairman Clayton’s prepared testimony may be accessed at https://www.sec.gov/news/testimony/clayton-2020-06-25.
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