Small Business Securities Bulletin: SEC Guidance on Liquidity and Funding Risks
October 2010 (No. II)
A periodic bulletin keeping small businesses informed about current developments in securities law and related matters
Last month the Securities and Exchange Commission (SEC) issued an interpretive release, available at www.sec.gov/rules/interp/2010/33-9144fr.pdf, aimed at improving liquidity and capital resources disclosure in the Management’s Discussion and Analysis (MD&A) section of reports and registration statements to facilitate investor understanding of the liquidity and funding risks facing SEC reporting companies. As guidance on existing rules, the release is effective immediately.
The release reminds reporting companies that under existing requirements they must separately identify and describe “internal and external sources of liquidity, and briefly discuss any material unused sources of liquidity.” In this regard, the release cites to the SEC’s 2003 interpretive guidance [PDF] and 2002 interpretive guidance [PDF]. The release identifies additional important trends and uncertainties relating to liquidity, in addition to those outlined in the 2002 guidance, for which disclosure might be required, including “difficulties 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.” The release also states that, with respect to liquidity and capital resources, a discussion in the company’s MD&A “to enable an understanding of the amounts depicted in the financial statements” may be required if its financial statements do not adequately convey financing arrangements during the period, or the impact of those arrangements on liquidity, because of a known trend, demand, commitment or uncertainty. For example, disclosure of intra-period variations may be required when borrowings during the period were materially different than period-end amounts. The release also states that companies should consider describing cash management and risk management policies relevant to an assessment of financial condition, specifically referencing banks’ policies and practices to meet applicable banking agency guidance on funding and liquidity risk management and policies and practices that might differ from applicable agency guidance.
The release also reminds companies that capital or leverage ratios or other measures disclosed in MD&A should be accompanied by a clear explanation of how the ratio was calculated and disclosure as to why the ratio or measure is useful to an understanding of the company’s financial condition. With respect to any ratio for which there are no regulatory requirements prescribing how the ratio is calculated, companies need to consider whether additional disclosure for non-financial measures pursuant to the 2003 interpretive guidance or required disclosures for non-GAAP financial measures is required.
The release also states that with respect to the required table of contractual obligations, companies should highlight any changes from the prior table and consider additional narrative disclosure where necessary for an understanding of the information in the table.
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