On September 17, 2010, the Securities and Exchange Commission ("SEC") unanimously voted to publish for comment proposed rules that would require registrants to increase disclosure of short-term borrowing arrangements in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A"). The SEC also unanimously voted to issue an interpretive release reiterating its long-standing guidance regarding liquidity and capital resources disclosure requirements in MD&A.

The proposing release may be found here. Public comment on the proposing release must be submitted to the SEC within 60 days of publication of the proposing release in the Federal Register.

The interpretive release may be found here and will be effective upon publication in the Federal Register.

I. Proposed Rules

The proposed rules are intended to address concerns that, because a registrant's short-term borrowings may vary widely during a given reporting period, period-end disclosures may not accurately reflect a registrant's ongoing liquidity and investment risks. During the open meeting announcing the proposed rules, the SEC staff acknowledged that fluctuating levels of short-term borrowing throughout a period may occur and that such borrowings are not in and of themselves inappropriate. Rather, the staff explained that they seek only greater transparency for investors. The proposed disclosure requirements are intended to provide investors with a better understanding of whether short-term borrowings reported at the end of a reporting period are consistent with amounts reported during the reporting period.

SEC rules currently require registrants, other than bank holding companies, to report their short-term borrowings at the end of a reporting period, but information on the amount of intra-period borrowings may not be required. Pursuant to Industry Guide 3, Statistical Disclosure by Bank Holding Companies ("Guide 3"), bank holding companies are currently required to report annually the average and maximum amounts of their short-term borrowings throughout the year. The proposed rules would codify the current Guide 3 reporting obligations of bank holding companies and, with certain changes, apply them to all companies that provide MD&A disclosure by incorporating these reporting obligations into Item 303 of Regulation S-K.

The proposed amendments to MD&A would be applicable to quarterly and annual reports, proxy or information statements that include financial statements, and registration statements under the Securities Act of 1933 and the Securities Exchange Act of 1934 (the "Exchange Act"). In annual reports, information for the three most recent fiscal years and the fourth quarter would be required. Disclosure in quarterly reports would be for the relevant reporting period only; comparative data would not be required.

A. Quantitative and Qualitative Disclosure

The proposed rules would require that registrants provide tabular quantitative disclosure and qualitative narrative disclosure regarding short-term borrowings in a separately captioned subsection in MD&A.

Quantitative Disclosure

Under the proposed rules, registrants generally would be required to disclose, by category of the short-term borrowings in the financial statements, the following information:

  • The average amount of short-term borrowings outstanding for the reporting period (calculated with an averaging period not to exceed one month) and the weighted average interest rate on those borrowings;
  • The amount of short-term borrowings outstanding at the end of a reporting period and the weighted average interest rate on those borrowings; and
  • The maximum month-end amount of short-term borrowings outstanding during the reporting period.

Registrants that would be considered "financial companies" under the proposed rules, as discussed below, would be required to disclose the following additional information:

  • The average amount of short-term borrowings outstanding for the reporting period (computed on a daily average basis) and the weighted average interest rate on those borrowings;
  • The amount of short-term borrowings outstanding at the end of a reporting period and the weighted average interest rate on those borrowings; and
  • The maximum daily amount of short-term borrowings outstanding during the reporting period.

Qualitative Disclosure

In addition to the proposed quantitative disclosure discussed above, the proposed rules also would require in the new separate subsection of MD&A a narrative discussion and analysis of a registrant's short-term borrowing arrangements. This narrative disclosure would include the following topics:

  • A general description of the short-term borrowing arrangements included in each category of short-term borrowing arrangements and the business purpose of those arrangements;
  • The importance to the registrant of its short-term borrowing arrangements to liquidity, capital resources, market-risk support, credit-risk support or other benefits;
  • The reasons for any material differences between average short-term borrowings for the reporting period and period-end short-term borrowings; and
  • The reasons for the maximum amount of short-term borrowings for the reporting period, including any non-recurring transactions or events, use of proceeds or other information that provides context for the maximum amount.

B. Definitions of "Short-Term Borrowing" and "Financial Company"

The proposed rules define "short-term borrowings" as the amounts payable for short-term obligations that are (1) federal funds purchased and securities sold under agreements to repurchase, (2) commercial paper, (3) borrowings from banks, (4) borrowing from factors or other financial institutions, and (5) any other short-term borrowings reflected on a registrant's balance sheet. This definition is derived from Regulation S-X and Guide 3.

The proposed rules would introduce a new activities-based definition of "financial company". The definition is potentially broad and would capture a registrant that, during the relevant reporting period, is engaged to a significant extent in the businesses of lending, deposit taking, insurance underwriting or providing investment advice, or is a broker or dealer as defined in Section 3 of the Exchange Act. Any registrant that is, or is the holding company of, any of the following would be considered a financial company for these purposes, though the list is not exhaustive: a bank, a savings association, an insurance company, a broker, a dealer, a business development company, an investment adviser, a futures commission merchant, a commodity trading advisor, a commodity pool operator or a mortgage real estate investment trust. The SEC has distinguished between financial and non-financial companies under the assumption that the costs for non-financial companies of obtaining the additional information required of financial companies would outweigh the benefit to investors.

A registrant that has both financial and non-financial business operations would be allowed to disclose short-term borrowings separately for its financial and non-financial business operations.

C. Phase-In Period

The SEC has proposed that, for registrants that are not bank holding companies or otherwise currently subject to Guide 3, the requirement for comparative annual data disclosed in the annual report would be phased in over three years so that, in year 1, only information for the preceding fiscal year would be required; in year 2, information for the two preceding fiscal years would be required; and in year 3, information for the three preceding fiscal years would be required. Registrants currently subject to Guide 3 would be required to comply at the time the rules are adopted.

D. Foreign Private Issuers and Smaller Reporting Companies

Foreign private issuers would be subject to substantially similar disclosure requirements, except that no quarterly information would be required. These companies would be allowed to categorize short-term borrowings according to the set of accounting principles used in preparing their financial statements.

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. Smaller reporting companies would also not be required to disclose quarterly information regarding short-term borrowings, unless material changes to short-term borrowings had occurred since the end of the preceding fiscal year.

II. Interpretive Release

In the interpretive release, the SEC broadly reiterates its previous guidance on liquidity and capital resources in MD&A. The interpretive release highlights that, as a registrant's financing activities become more complex, the discussion and analysis of liquidity and capital resources in MD&A should reflect the registrant's complexities, in accordance with long-standing MD&A principles that apply to this disclosure (see the previous guidance, here, here and here). In addition, the interpretive release encourages registrants to review past SEC guidance when drafting MD&A disclosure regarding capital resources and liquidity, in particular noting: (1) the disclosure of cash requirements, cash management, sources and uses of cash; and (2) disclosure of debt instruments, guarantees and related covenants.

The interpretive release also identified several trends and uncertainties that should be considered when drafting disclosure of liquidity in MD&A, including:

  • difficulty accessing 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 value of collateral, and
  • counterparty risk.

The interpretive release also asks registrants to consider adding disclosure to MD&A if the registrant's financial statements do not adequately convey the registrant's financing arrangements during a period or reflect the impact of financing arrangements on liquidity. The interpretive release reminds registrants that any ratios or measures included in MD&A should be presented and accompanied with a clear explanation of how such amounts are calculated.

With respect to the contractual obligations table, the release reiterates the SEC's previous guidance that, while the requirements of the tabular contractual obligations table are flexible, registrants should use footnote and narrative disclosure as necessary to help ensure that disclosure is not misleading and so that investors will be able to understand what is and is not being disclosed in this table.

III. What Companies Should Do Now

Proposing Release. The SEC presented a large number of general and specific questions for comment in the proposing release. We encourage registrants to consider commenting on these issues, including:

  • Is the proposed definition of "short-term borrowings" sufficiently clear? For example, should the definition be linked to "short-term obligations" as defined in U.S. GAAP?
  • Is the activities-based definition of "financial company" appropriate? Is it too broad? Should registrants that fall within the definition of "financial company" but that are not bank holding companies be subject to the expanded disclosure obligations? What are the costs involved in gathering and reporting this information on a daily basis for registrants that do not currently close their books each day?

Interpretive Release. Registrants should begin to review current MD&A disclosure now and assess whether the interpretive release will require changes to their liquidity and capital resources disclosure.