SEC Shapes New Disclosure Requirements

At an open meeting in September, the SEC voted to propose rules that would require a public company to provide certain enhanced disclosures about its short-term borrowings in its filings with the SEC. The SEC also voted to approve the issuance of an interpretive release to provide guidance regarding the SEC’s current disclosure requirements in the MD&A relating to liquidity and capital resources. The objective of these initiatives is to address so-called “balance sheet window-dressing” by requiring disclosure about a public company’s leverage and liquidity throughout the course of the relevant reporting period rather than only at period-end.

A. Short-Term Borrowings

Currently, SEC rules require companies to disclose short-term borrowings at the end of a period. There is no specific requirement to disclose information about the amount of short-term borrowings outstanding throughout the reporting period. According to the SEC, investors have expressed concerns that certain public companies mask their liquidity positions by reducing short-term borrowings shortly before reporting dates. To address this concern, the SEC has proposed amendments to its requirements for disclosure relating to short-term borrowings. These proposed rules will require a registrant to provide enhanced disclosure regarding the use and impact of short-term borrowing arrangements throughout the relevant reporting period for the following categories of short-term borrowings: federal funds purchased and securities sold under agreements to repurchase, commercial paper, borrowings from banks, borrowings from factors or other financial institutions, and other short-term borrowings reflected on the registrant’s balance sheet. In particular, registrants would be required under an amended Item 303 of Regulation S-K to provide disclosure of the following information for each of these categories of short-term borrowings:

• the amount of short-term borrowings [1] outstanding at the end of the period and the weighted average interest rate on those borrowings,
• the average amount outstanding during the period and the weighted average interest rate on those borrowings, and
• the maximum amount outstanding during the period.

All registrants would be required to present information for each category of short-term borrowings, even where the relevant category represents only a small portion of the company’s stockholders’ equity at the end of the period. Registrants would be required to disaggregate the amounts shown for each category by currency, interest rate or other meaningful criteria, to the extent that presentation of separate amounts is necessary to promote understanding or to prevent aggregate amounts from being misleading.

Registrants would also be required to include a narrative discussion and analysis in the MD&A to provide context for the tabular data. The new MD&A disclosure requirement is intended to provide investors with a discussion of the drivers of variations in the level of short-term borrowings outstanding during the period and at period-end.

For purposes of calculating and reporting maximum and average amounts of short-term borrowings outstanding during the reporting period, “financial companies” [2] would be required to provide averages calculated on a daily average basis, comparable to the calculations currently required for bank holding companies under Securities Act Industry Guide 3, and to disclose the maximum amount outstanding on any day in the period. Non-financial companies would be required to calculate averages using an average period not to exceed a month and to disclose the maximum month-end amount during the period.

The SEC has also proposed that substantially similar requirements be applicable to foreign private issuers in the “Operating and Financial Review and Prospects” item in Form 20-F and that smaller reporting companies be granted certain exclusions from the most rigorous and costly features of the new requirements. Finally, the SEC has proposed conforming amendments to Items 2.03 and 2.04 of Form 8- K relating to short-term debt obligations.

The SEC will be taking comment on the proposed rules as soon as they are published. The new rules would require that public companies have systems in place to record and report average balances of short-term borrowings. To the extent that a public company does not have systems in place to report balances of short-term borrowings other than at the end of a quarter, consideration should be given to augmenting existing systems to be able to comply with the proposed rules.

B. Liquidity and Capital Resources

The SEC is also concerned that disclosures about on- and off-balance sheet arrangements do not permit investors to fully understand the liquidity position of certain public companies. To address this concern, the SEC will publish interpretive guidance on existing MD&A requirements relating to liquidity and capital resources. This guidance will take effect immediately upon publication in the Federal Register.

In particular, the SEC will require that companies that engage in complex and diverse finance activities clearly communicate material liquidity risks and provide reasons for using particular types of financing techniques. The guidance will remind registrants of long-standing MD&A principles that require the identification of known trends and uncertainties related to critical liquidity matters that could warrant disclosure. The guidance will also emphasize that leverage ratios and other financial measures be calculated such that they do not obscure the company’s leverage profile or reported results. There will also be new guidance as to the existing requirements applicable to repurchase agreements, accounted-for sales, and other similar arrangements in order to make clear that the use of financing structures in a manner that masks the registrant’s reported financial condition is not permitted.

Finally, the guidance will address divergent practices that have arisen in the presentation of tabular disclosure of contractual obligations regarding future payments. The guidance will emphasize the inherent flexibility in the requirements and will discuss the use of footnotes and narrative disclosure as a supplement to the tabular disclosure where company-specific disclosure questions arise.

Endnotes

[1] Under the proposed rules, short-term borrowings would include amounts payable for short-term obligations reflected on the entity’s balance sheet. The proposed rules do not cover “off-balance sheet” arrangements, which would continue to be assessed under the SEC’s existing disclosure rules for “off-balance sheet” arrangements.
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[2] “Financial companies” would be those registrants that are engaged to a significant extent in the business of lending, deposit-taking, insurance underwriting or providing investment advice, are brokers or dealers as defined in Section 3 of the Exchange Act, or are one of certain other types of enumerated businesses, including business development companies or mortgage REITs. Companies that offer both financial and non-financial services would be permitted to present shortterm borrowings information for their financial and non-financial businesses separately. The SEC will seek comment on the scope of the definition of “financial company” under these new provisions.
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