The SEC recently issued interpretive guidance to companies to improve the discussion of their liquidity and capital resources in Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) included in registration statements filed under the Securities Act of 1933, as amended (Securities Act), and periodic reports filed under the Securities Exchange Act of 1934, as amended (Exchange Act).1 Additionally, the SEC recently issued proposed rules that would require new disclosures about companies' short-term borrowings in MD&A.2

Interpretive Guidance on Liquidity and Capital Resource Disclosures in MD&A

The SEC's interpretive release provides interpretive guidance to companies for use in preparing the liquidity and capital resources disclosures presented in their MD&A.

Liquidity Disclosure

The interpretive release reminds companies that Item 303(a)(1) of Regulation S-K requires that they “identify and separately describe internal and external sources of liquidity and briefly discuss any material unused sources of liquidity” in their MD&A. As companies have undertaken more varied and complex financing activities in recent years, the interpretive release highlights the following additional important trends and uncertainties relating to liquidity that companies should consider disclosing in their MD&A:

  • Difficulties accessing debt markets
  • Reliance on commercial paper and other short-term financing arrangements
  • Maturity mismatches between borrowing sources and assets funded by those sources
  • Changes in borrowing terms requested by counterparties
  • Changes in the valuation of collateral securing borrowing arrangements
  • Counterparty risk

The interpretive release directs companies to consider providing additional narrative disclosure about their financing arrangements if their financial statements do not sufficiently inform investors about such financing arrangements because of the impact of any known trend, demand, commitment, event, or uncertainty on those financing arrangements. Further, the interpretive release reminds companies that they must disclose any known commitments, events, or uncertainties that will result in, or are reasonably likely to result in, any material increase or decrease in their liquidity. The SEC points out that companies must closely review particular types of transactions, including repurchase transactions, securities lending transactions, or other transactions involving the transfer of assets, where those transactions are accompanied by an obligation to repurchase assets and they have been accounted for as sales. A company will be required to provide disclosure about such a transaction in its MD&A if that transaction will likely result in the use of a material amount of that company's cash or other liquid assets. Finally, the interpretive release directs companies to consider describing their cash management and risk management policies that are relevant for assessing their financial condition.

Capital or Leverage Ratio Disclosures

The SEC's interpretive guidance also reminds companies that include capital or leverage ratio disclosures in their filings that they must report these ratios in compliance with existing SEC rules. In particular, if a company discloses a capital or leverage ratio that is a non-GAAP financial measure, that company must ensure that the non-GAAP financial measure is presented in compliance with SEC rules, including reconciling the financial measure with its most direct GAAP equivalent. Moreover, the guidance reminds companies that any ratio or measure included in their filings must be accompanied by a clear explanation of the calculation methodology used to determine that ratio or measure. Finally, any company that discloses a ratio or measure in its filings should consider discussing the reasons it believes it is useful to include that ratio or measure in its filings as well as how it is useful to understanding that company's financial condition.

Contractual Obligations Table Disclosures

The SEC's interpretive guidance also reminds companies that the contractual obligations tabular disclosures included in their filings with the SEC should be prepared with the goal of providing investors with a meaningful understanding of the cash requirements arising from contractual payment obligations. Companies should develop a presentation method that provides clarity and appropriately reflects meaningful categories of obligations in light of their capital structure and business. Further, companies should consider providing qualitative information or narrative disclosure to supplement their contractual obligations disclosures where necessary to promote greater understanding of the data presented. In general, the SEC reminds companies that they must provide the contractual obligations disclosures in a manner that improves transparency and gives investors greater context in assessing their short- and long-term liquidity and capital resource needs.

Proposed Rules on Disclosure of Short-Term Borrowings

The SEC's proposing release on short-term borrowings would require companies to provide additional detailed disclosures about their short-term financing arrangements. Current SEC rules generally require that companies disclose their use of short-term borrowing arrangements and exposure to related risks and uncertainties. However, companies are not specifically required to disclose detailed information about their intra-reporting period use of short-term borrowings. Moreover, the SEC's proposing release notes that due to their short-term nature, a company's use of short-term financing arrangements can fluctuate materially during a reporting period, which means that presentation of period-end amounts of short-term borrowings alone may not be indicative of the company's funding needs or activities during the period.

If adopted by the SEC, the proposed rules would require a company to include a new, separately captioned subsection of MD&A that provides comprehensive information about its short-term borrowings during a reporting period. The company would be required to disclose both qualitative and quantitative information about its short-term borrowings during a given reporting period. This information would be provided in tabular form accompanied by a narrative discussion of the company's short-term borrowing arrangements.

Definition of Short-Term Borrowings

Under the proposed rules, “short-term borrowings” would include amounts payable by a company for short-term obligations that are:

  • Federal funds purchased and securities sold under agreements to repurchase
  • Commercial paper
  • Borrowings from banks
  • Borrowings from factors and other financial institutions
  • Any other short-term borrowings reflected on a company's balance sheet

The proposed rules would require a company to present information for each category relevant to the types of short-term financing activities that the company conducts, even if a particular category is not required to be reported as a separate line item on the company's balance sheet under Regulation S-X.

Tabular Disclosure of Quantitative Information About Short-Term Borrowings

Under the proposed rules, companies would have to present the following quantitative information about their intra-period short-term borrowing arrangements in tabular form:

  • The amount of each specific category of short-term borrowings at the end of the reporting period and the weighted average interest rate on those borrowings
  • The average amount in each specified category of short-term borrowings for the period and the weighted average interest rate on those borrowings
  • If the company is a “financial company,” the maximum daily amount of each specified category of short-term borrowings during the reporting period, determined based on the largest amount of each specified category outstanding as of the end of any day in the reporting period
  • If the company is not a “financial company,” the maximum month-end amount of each specified category of short-term borrowings during the reporting period, determined based on the largest amount of each specified category outstanding as of the end of the last day of any month in the reporting period

The short-term borrowings disclosure rules would apply to all reporting companies. However, the disclosure requirements would be more detailed for companies that qualify as “financial companies.” Under the proposed rules, companies that during a reporting period are engaged to a “significant extent” in the business of lending, deposit-taking, insurance underwriting, or providing investment advice, or that are broker-dealers as defined in the Exchange Act, would qualify as “financial companies.” The SEC has not proposed a specific threshold for determining whether a company's engagement in these financial businesses qualifies as “significant.”

The SEC has proposed allowing companies with both financial and non-financial businesses to report the short-term borrowings of their financial business separately from their non-financial businesses. For example, a manufacturing company that has a subsidiary that provides purchase financing to its customers could disclose the short-term borrowings of its financing subsidiary under the “financial companies” rules while reporting the short-term borrowings of its non-financial businesses under the non-financial company disclosure rules.

Financial companies would have to compile and report data on their short-term borrowings on a daily basis when calculating their average amounts outstanding (determined based on the amount outstanding at the end of each day, averaged over the reporting period). In contrast, non-financial companies would not have to report on a daily basis the average amounts of short-term borrowings outstanding. Nevertheless, the averaging period used by non-financial companies to determine their average amounts outstanding could not exceed a month.

Finally, as noted above, in reporting the maximum amounts of short-term borrowings during a given reporting period, financial companies would have to report the maximum daily amount of each category of short-term borrowings being disclosed. In contrast, non-financial companies would only be required to report the maximum month-end amount of each category of short-term borrowings being disclosed.

Narrative Disclosure of Qualitative Information About Short-Term Borrowings

In addition to providing qualitative disclosure in tabular form, companies would be required to include a narrative discussion and analysis of qualitative information about their short-term borrowings. This narrative discussion is intended to highlight a company's short-term financing activities and to provide greater context to the company's disclosure of its liquidity and capital resources in its MD&A. As proposed, this narrative discussion of qualitative information about a company's short-term borrowings would address such topics as:

  • A general description of short-term borrowing arrangements included in each reported category (including any key metrics or other factors that could reduce or impair the company's ability to borrow under such arrangements and whether there are any collateral posting arrangements) as well as the business purpose of such borrowings
  • The importance to the company of its short-term borrowing arrangements relative to its liquidity, capital resources, market-risk support, credit risk support, or other benefits
  • Reasons for any material differences between the company's average amounts of short-term borrowings for the reporting period versus the company's period-end amounts
  • Reasons for the maximum amount of each category of short-term borrowings for the reporting period, including potential non-recurring transactions or events, use of proceeds, or other information that provides investors with context for the maximum amount

While the narrative discussion is intended to complement existing liquidity and capital resources disclosures in MD&A, it is not intended to be duplicative of those disclosures. As a result, companies would need to consider their related liquidity and capital resources disclosures in preparing the short-term borrowings discussion. In making these disclosures, companies would need to provide investors with a comprehensive discussion that addresses their short-term liquidity profiles as well as potential future short- and long-term trends in their liquidity and funding risks.

Reporting Periods

Under the proposed rules, for annual reports, companies would provide the disclosures about their short-term borrowings for the three most recent fiscal years as well as for the fourth fiscal quarter. In the case of registration statements filed under the Securities Act that include audited full-year financial statements, companies would provide these short-term borrowings disclosures for the three most recent full fiscal years. Companies also would have to provide interim information on short-term borrowings for any subsequent interim periods that are included in the registration statement.

For quarterly reports, companies would provide these short-term borrowings disclosures for the relevant fiscal quarter. However, companies would not be required to present comparative data for the corresponding quarter of the prior fiscal year.

Nevertheless, companies would be required to provide information on short-term borrowings in quarterly reports with the same level of detail as disclosed in their annual reports. Additionally, a company would be required to identify material changes from previously reported disclosures so that investors would be informed of consequential changes in the company's short-term borrowings. These more detailed disclosure requirements in quarterly reports are intended to promote transparency about intra-period borrowing activities. Importantly, the more detailed disclosure requirements in quarterly reports contrast with current MD&A rules that only require companies to disclose material changes in their short-term borrowings. As a result, if the proposed rules are adopted, companies would be required to provide much more detailed information about their short-term borrowings during each fiscal quarter than they are currently required to disclose in the MD&A included in their quarterly reports.

Treatment of Foreign Private Issuers

The proposed rules would apply to foreign private issuers other than Canadian multijurisdictional disclosure system (MJDS) filers in a manner substantially similar to U.S. reporting companies. However, foreign private issuers would be able to base their reported categories of short-term borrowings on the categories of short-term borrowing arrangements that they classify in accordance with the comprehensive set of accounting principles that they use to prepare their primary financial statements (e.g., their home country GAAP-equivalent or International Financial Reporting Standards), so long as the disclosures would provide a level of detail that mirrors the required disclosure levels for U.S. reporting companies. Additionally, foreign private issuers would only be required to provide annual updates to their short-term borrowings disclosures because they do not file quarterly reports with the SEC. Nevertheless, if a foreign private issuer files a registration statement under the Securities Act that includes interim period financial statements, then that foreign private issuer would have to provide an update of its short-term borrowings disclosures with respect to those interim periods included in the registration statement.

Treatment of Smaller Reporting Companies

Smaller reporting companies, which are eligible to provide scaled disclosure in accordance with Regulation S-K, also would be subject to the short-term borrowings disclosure rules. However, smaller reporting companies generally would only be required to provide short-term borrowings disclosures on an annual basis. They would not have to provide quarterly updates of their short-term borrowings unless material changes in their short-term borrowing arrangements occurred during the interim period being reported. Further, smaller reporting companies would not be required to include these short-term borrowings disclosures for the fourth fiscal quarter in their annual reports. Finally, where smaller reporting companies only provide information on net sales and revenues and income from continuing operations for two years (rather than three years), then only two years of short-term borrowings information would be required to be included in the MD&A presented in their annual reports.

Phase-In Period

The SEC has proposed a three-year transition period for companies to implement the short-term borrowings disclosure rules. During the first year of the transition period, a company would only be required to include short-term borrowings information in its annual report for its most recent fiscal year, along with fourth fiscal quarter information from the most recent fiscal year for companies other than smaller reporting companies, and would be able to omit information for the prior two fiscal years. Then, during the second year of the transition period, the company would be required to include short-term borrowings information in its annual report for its two most recent fiscal years, along with fourth fiscal quarter information from the most recent fiscal year for any company other than a smaller reporting company, while omitting information for the preceding third fiscal year. Finally, during and after the third year of the transition period, the company would be required to include short-term borrowings information in its annual report for each of its three most recent fiscal years.

In the case of registration statements filed under the Securities Act, during the first year of the transition period, a company would similarly only be required to include short-term borrowings information for its most recently completed fiscal year, along with interim information on short-term borrowings for any subsequent interim periods that are included in its registration statements. During the second year of the transition period, the company would be required to include short-term borrowings information for its two most recent fiscal years in its registration statements, along with any required subsequent interim period information. Finally, during and after the third year of the transition period, the company would be required to include short-term borrowings information for each of its three most recent fiscal years in its registration statements, along with any required subsequent interim period information.

This transition period would not apply to bank holding companies because they already provide short-term borrowings information for their three most recent fiscal years.

What Do the Interpretive Guidance and Proposed Rules Mean for Companies?

As the fiscal year end is approaching for many reporting companies, these companies will soon begin preparing their annual reports. In light of the SEC's interpretive guidance on the liquidity and capital resource disclosures in MD&A, companies should revisit how they present information discussing their liquidity and capital resources when preparing their annual reports and subsequent filings with the SEC. In particular, companies should attempt to provide a clearer, more detailed picture of their liquidity, capital resources, and financial performance profile when making these disclosures in the MD&A.

If the short-term borrowings disclosure rules are adopted as currently proposed by the SEC, companies will have to more closely monitor their short-term financing obligations. In effect, they will have to track their borrowings under these short-term financing arrangements on a daily basis. Companies also may have to reconsider the types of short-term financing arrangements they enter into because they will be required to provide more detailed and comprehensive disclosure on their various short-term financing arrangements.