As a companion release to the proposed amendments to Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") released by the Securities and Exchange Commission ("SEC") on September 17, 2010, and in light of increasingly complex financing arrangements undertaken by registrants, the SEC has issued interpretive guidance summarizing and emphasizing existing SEC rules and guidance regarding liquidity and capital resources disclosures in MD&A. The SEC’s new interpretive guidance became effective as of September 28, 2010. Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management's Discussion and Analysis Release Nos. 33–9144; 34–62934 (September 17, 2010).
The interpretive release emphasizes that existing rules require an issuer to identify and separately describe internal and external sources of liquidity and briefly discuss any material unused sources of liquidity (Regulation S-K, Item 303(a)(1)). Item 303(a)(1) calls for disclosure of “known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, the registrant’s liquidity increasing or decreasing in any material way.” Thus, “the scope of the discussion should […] address liquidity in the broadest sense, encompassing internal as well as external sources, current conditions as well as future commitments and known trends, changes in circumstances and uncertainties.” Commission Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations Release No. 33-8056 (January 22, 2002).
In its release, the SEC highlights certain items registrants should discuss in MD&A:
- difficulties in 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.
Disclosure of Intra-Period Variations. To facilitate investor understanding of a registrant's liquidity position, the registrant may be required to add narrative disclosure to its MD&A if the financial statements do not adequately convey the registrant's financing arrangements during the relevant period, or the impact of such arrangements on liquidity, because of a known trend, demand, commitment, event or uncertainty. For example, if borrowings during a reporting period are materially different than the period-end amounts recorded in the financial statements, existing rules require disclosure of these intra-period variations.
Repurchase Agreements that are Accounted for as Sales. In this context, a repurchase transaction, securities lending transaction or any other transaction involving the transfer of financial assets with an obligation to repurchase financial assets, that has been accounted for as a sale, may require disclosure in MD&A under existing SEC rules if a registrant determines that such transaction is reasonably likely to result in the use of a material amount of cash or other liquid assets. Unless information regarding these transactions is included in the disclosure of off-balance sheet arrangements or the contractual obligations table, disclosure may be required in the discussion of liquidity and capital resources.
Liquidity Management Policies. In the interpretive release, the SEC states that companies should consider the following additional disclosure in MD&A with respect to liquidity:
- a description of cash and risk management policies relevant to an assessment of a company’s financial condition;
- banks, in particular, should consider disclosing the policies and practices used to satisfy, or any policies and practices that vary from, applicable banking agency guidance on funding and liquidity risk management; and
- companies with a material source of liquidity consisting of a portfolio of cash and other investments (or access to such a portfolio) should consider disclosing the nature and composition of the portfolio, including the assets held and any related market risk, settlement risk or other risk exposure (e.g., the nature of any limits or restrictions and their effect on the ability to use or access the assets).
It is the SEC’s view that if prior disclosure does not adequately foreshadow subsequent events or if new information that impacts known trends or uncertainties becomes apparent, additional disclosure should be considered and may be required. Further, an item that is not material for annual disclosure may be material in the context of quarterly results. See Release No. 33-8350 (December 19, 2003) and Release No. 33-6835 (May 18, 1989).
Leverage Ratio Disclosures
Any capital or leverage ratio disclosed in a registrant’s filing should be accompanied by:
- a clear explanation of the calculation methodology, stating any inputs that are unusual, infrequent or non-recurring, or that are adjusted so that the ratio is calculated differently from directly comparable measures;
- a discussion of any differences in the financial measure presented from commonly used industry measures; and
- reasons for including a particular financial measure and a clear explanation of why the measure is useful to the understanding of the registrant’s financial condition.
The SEC’s interpretive release reminds registrants to first determine whether the ratio is a financial measure or not (such as industry metrics or value metrics). If the ratio is a financial measure and falls within the scope of the SEC’s requirements for non-GAAP financial measures, the rules and guidance set forth in Release 33-8176 (January 22, 2003) must be followed.
Contractual Obligations Table Disclosure
In the interpretive release, the SEC’s staff notes that divergent disclosure practices have developed in response to the requirements of Regulation S-K Item 303(a)(5). While reiterating the flexible nature of the contractual obligations disclosure requirements, the interpretive release encourages registrants to develop a clear and understandable presentation method that appropriately reflects the contractual obligation categories that are meaningful in light of the registrant’s capital structure and business in its contractual obligations table. In addition, the release noted that registrants should highlight any changes in the presentation of the table to enable investors to make comparisons between periods.
The interpretive release noted that since the adoption of the contractual obligations disclosure requirements, registrants have questioned SEC staff about how to treat various items, including interest payments, repurchase agreements, tax liabilities, synthetic leases, purchase obligations and obligations arising under off-balance sheet arrangements. The release indicated that any uncertainties about what to include or how to allocate amounts over the requisite periods in the table should be resolved consistent with the table’s purpose – i.e., to provide aggregated information about contractual obligations and contingent liabilities and commitments in one location to illustrate a registrant’s short-term and long-term liquidity and capital resources needs as well as to enable investors to evaluate the relative role of off-balance sheet arrangements. See also Disclosure in Management’s Discussion and Analysis About Off Balance Sheet Arrangements and Aggregate Contractual Obligations, Release No. 33-8182 (January 28, 2003).
The interpretive release reiterated that in accordance with the instructions to Item 303(a)(5)(i), footnotes or additional narrative disclosure should be used to promote an understanding of the timing and amounts of specified contractual obligations or the tabular data. For example, the release indicated that registrants should consider separating amounts in the table between those included in the balance sheet and those arising from off-balance sheet arrangements, particularly where such information ties to the financial statements and MD&A discussion.
The interpretive guidance is currently effective and is applicable to liquidity and capital resources disclosures contained in registrants’ upcoming Annual and Quarterly Reports, including Quarterly Reports for registrants with quarters ending September 30, 2010. Accordingly, registrants should carefully review the interpretive release as well as re-familiarize themselves with existing MD&A disclosure requirements and prior SEC guidance in order to determine whether their existing liquidity and capital resources disclosures should be revised or updated in light of the interpretive release, considering whether their existing disclosures fully convey their true liquidity position during all periods in a clear and meaningful way.