On September 17, 2010, the Securities and Exchange Commission (the “SEC”) proposed amendments to enhance MD&A disclosure that public companies provide about short-term borrowing.1 In a companion release, the SEC also issued interpretive guidance intended to improve the discussion of liquidity and capital resources in MD&A, particularly with respect to short-term borrowings.2 The proposed amendments and interpretive guidance emphasize the SEC’s increased focus on liquidity and capital resources disclosure and are intended to enhance investors’ understanding of the liquidity and funding risks facing public companies.

The proposed amendments are subject to a 60-day comment period. If adopted, the new short-term borrowings disclosure requirements would likely be phased in over a three-year period. The interpretive guidance is effective immediately upon publication in the Federal Register. Public companies should consider both the interpretative guidance and the proposals as they prepare their upcoming quarterly and annual reports.

Proposed Amendments Regarding Short-Term Borrowings Disclosure

Citing evidence that many failures in the recent financial crisis arose due to liquidity constraints, the SEC proposals are intended to address concerns that some companies engage in balance sheet “window dressing” by reducing their debt shortly before the end of a reporting period in order to present a better liquidity picture to investors. Because a company’s short-term borrowings may vary greatly during a given reporting period, the SEC is concerned that period-end disclosures may not always accurately reflect the company’s ongoing liquidity and investment risks. SEC rules currently require companies, other than bank holding companies, to disclose their short-term borrowings as of the end of a reporting period, but information on the amount of intra-period borrowing is not required unless the intra-period amounts are materially different from the amounts at the end of a reporting period.

The proposed rules would require quantitative disclosures of companies’ short-term borrowings3 similar to those already provided by bank holding companies under Guide 3, Statistical Disclosure by Bank Holding Companies (“Guide 3”). Specifically, non-financial companies4 would be required to disclose, for each specified category of short-term borrowings: (i) the amount of short-term borrowings outstanding at the end of the reporting period and the weighted interest rate thereon, (ii) the average amount of short-term borrowings during the reporting period (calculated with an averaging period not to exceed one month) and the weighted average interest rate thereon and (iii) the maximum month-end amount of short-term borrowings during the reporting period. Financial companies would be required to provide similar information, but would instead be required to present average outstanding short-term borrowing amounts computed on a daily average basis and report the maximum day-end amount of short-term borrowings during the period. Companies with both financial and non-financial operations would be permitted to provide separate short-term borrowings disclosure for their financial and non-financial business operations. In addition to the tabular disclosure, all public companies would be required to provide a narrative analysis of their short-term borrowings, which would include a discussion of: (i) the types of short-term borrowings used and their business purpose, (ii) the importance of the borrowings to the company’s liquidity, capital resources, market-risk support, credit-risk support or other benefits, (iii) the reasons for any material differences between the maximum or average intraperiod borrowings and the period-end borrowings and (iv) the reasons for the maximum outstanding amounts in each reported period.

Under the proposed amendments, the new short-term borrowings disclosure would be required in quarterly and annual reports and registration statements. For companies that are not bank holding companies or otherwise subject to Guide 3, the requirement for comparative annual short-term borrowings data disclosed in the annual report would be phased in over three years. Companies currently subject to Guide 3 would be required to comply with the new quantitative disclosure requirements at the time the rules are adopted. Additionally, smaller reporting companies would be required to provide short-term borrowings disclosure (both qualitative and quantitative) for two years rather than three in the annual report and would not be required to disclose quarterly information regarding short-term borrowings, unless material changes to shortterm borrowings had occurred since the end of the preceding fiscal year.

Interpretive Guidance Regarding Liquidity and Capital Resources Disclosure

In the companion interpretive release, the SEC broadly reiterated its previous guidance on liquidity and capital resources disclosure in MD&A. Specifically, the SEC noted that as financing activities have become more diverse and complex, it is increasingly important that the discussion and analysis of liquidity and capital resources provided by public companies meet the objectives of MD&A disclosure.

Liquidity Disclosures. In the context of liquidity, the SEC reemphasized the need for companies to provide MD&A disclosure of known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, a material change in the company’s liquidity. The release notes that some important trends and uncertainties relating to liquidity that companies should consider including in their MD&A are (i) difficulties accessing the debt markets, (ii) reliance on commercial paper or other short-term financing arrangements, (iii) maturity mismatches between borrowing sources and the assets funded by those sources, (iv) changes in terms requested by counterparties, (v) changes in the valuation of collateral and (vi) counterparty risk. In evaluating whether disclosure in MD&A may be required in connection with repurchase agreements, companies should consider whether the transaction is reasonably likely to result in the use of a material amount of cash or other liquid assets. The release also suggests that to provide context for the exposures identified in MD&A, companies should consider describing cash management and risk management policies that are relevant to an assessment of the company’s financial condition. Further, a company that maintains or has access to a portfolio of cash or other investments should consider providing information about the nature and composition of that portfolio, including a description of assets held and any related market risk, settlement risk or other exposure risk.

Leverage Ratio Disclosure. The release emphasizes that capital or leverage ratios in MD&A must comply with SEC rules and guidance governing the inclusion of non-GAAP financial measures if applicable. Additionally, any such ratios should be accompanied by a clear explanation of the calculation methodology, which should articulate the treatment of any inputs that are unusual, infrequent or non-recurring, or that are otherwise adjusted so that the ratio is calculated differently from directly comparable measures. The release further notes that companies should include disclosure clearly stating why the measure is useful to understanding the company’s financial position and, if the financial measure presented differs from other measures commonly used in the company’s industry, the company should consider whether a discussion of those differences or a presentation of those measures would be necessary to make the disclosures not misleading.

Contractual Obligations Table. In the release, the SEC notes that the contractual obligations tabular disclosure in MD&A should be prepared with the goal of presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. Because this is a flexible requirement, companies are encouraged to develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of the company’s capital structure and business. To that end, the SEC suggests that footnotes should be used to provide information necessary for an understanding of the timing and amount of the specified contractual obligations or, where necessary to promote understanding of the tabular data, companies should consider additional narrative discussion outside of the table.

Conclusion; Contact Information

The SEC’s proposed rules and interpretive guidance are consistent with its increased focus on liquidity and capital resources disclosure in light of the recent financial crisis. Companies should carefully consider both the interpretive guidance and proposed amendments as they prepare their upcoming quarterly and annual reports.