In a release dated September 17, 2010 (the “Release”),1 the SEC issued guidance on the disclosure of a company’s liquidity and capital resources in the MD&A section of its SEC filings.2 The Release begins by reminding companies of the basic rules regarding the disclosure of liquidity set forth in Item 303 of Regulation S-K, noting that Item 303(a)(1) of Regulation S-K requires them to “identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquidity.”3 The Release affirms that, “[i]n the context of liquidity, Item 303(a)(1) of Regulation S-K requires 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.”4
The Release makes the following key points that could affect disclosure of particular liquidity issues:
- Important uncertainties regarding liquidity could include past or anticipated difficulties in accessing the debt markets, reliance on commercial paper or other short-term borrowings, changes in the terms requested by counterparties to liquidity arrangements, changes in the valuation of collateral, and the risk that counterparties will be unable to perform their obligations.
- Companies should be careful to include disclosure regarding possible liquidity issues that arise in the middle of a financial reporting period if their financial statements might otherwise not make such issues apparent. For example, “if borrowings during the reporting period are materially different than the period-end amounts recorded in the financial statements, disclosure about the intra-period variations is required.”5
- Repurchase agreements and other short-term financings that may not be fully disclosed on period-end balance sheets require special scrutiny, and perhaps additional disclosure if the “transaction is reasonably likely to result in the use of a material amount of cash or other liquid assets.”6
- Material cash and risk management policies also should be described. For example, if a company relies on portfolios of securities to meet liquidity needs, it should describe the assets of the portfolio and any related risks.
- Leverage ratios in credit agreements should be clearly explained and disclosure should focus on aspects of the ratio that may vary from industry norms or that represent “inputs that are unusual, infrequent or non-recurring.”7
- Tabular disclosure of contractual obligations should be supplemented with footnotes and narrative discussion, as appropriate, to provide information necessary for an understanding of the timing and amount of specified contractual obligations.
The guidance contained in the Release is effective immediately. Companies should consider how this guidance applies to the MD&A disclosure in their upcoming Form 10-Q and Form 10-K reports.