Disclosure issues in a COVID-19 context

August 2020  |  FEATURE  |  RISK MANAGEMENT

Financier Worldwide Magazine

August 2020 Issue

Public companies of all sizes have had significant challenges to overcome since the outbreak of COVID-19, including the pressing issue of how to handle reporting disclosures to the market. The reality is that many companies have been negatively impacted by the pandemic and it may take a long time to assess the magnitude of the damage and repair it. Already, many public companies have withdrawn or amended published earnings guidance as a result of the crisis.

The financial and reputational consequences of failing to adequately disclose information can be significant. Every company required to do so must give ample thought to what information it should disclose and when.

As part of quarterly or annual disclosure, public companies need to address trends and risks that could reasonably affect their financial statements, operations and business in general. However, the advent of COVID-19 has presented novel, unpredictable risks that are not easily distilled.

Recent regulatory guidance

Various regulators, in response to the crisis, have permitted issuers to delay publication of annual and quarterly financial reports.

In the US, the Securities and Exchange Commission (SEC)’s Division of Corporation Finance released disclosure guidance in March in the wake of the COVID-19 crisis. It encouraged registrants to assess the continued effects of COVID-19 on their operations when considering appropriate public disclosures regarding related risks, including how the company and management are responding to them. The SEC suggested this should be done a way that is specific to the company’s situation, to allow investors to evaluate the current and expected impact of COVID-19 on the company’s operations.

According to the guidance, the most important aspects companies must consider include: (i) the impact of COVID-19 on the company’s financial condition and results of operations; (ii) the expected near- and long-term impact of COVID-19 on the company’s future operating results; (iii) the impact of COVID-19 on the company’s capital and financial resources, including overall liquidity position and outlook, and the company’s ability to remain in compliance with the covenants of its credit agreements; and (iv) the effect of COVID-19 on the company’s financial statements, such as balance sheet assets, material impairments and allowances for credit losses.

Across the EU, certain issuers need to meet their ongoing disclosure obligations under the Market Abuse Regulation (MAR), both in the context of their ordinary course reporting to the market and in their offering documentation.

In the UK, the Financial Conduct Authority (FCA) expects issuers and other market participants to continue to meet their disclosure obligations under the MAR, and the Financial Conduct Authority (FCA)’s Disclosure and Transparency Rules in a timely fashion. However, in recognition that such disclosure obligations may become increasingly difficult to satisfy, the FCA has acknowledged that there may be slight delays to reporting disclosures in the short term as new operational processes are put into place.

On 27 March, the European Securities and Markets Authority (ESMA) published a statement reminding European issuers to continue complying with their ongoing disclosure obligations despite the ongoing COVID-19 pandemic. The statement made particular reference to the obligation under the MAR to disclose ‘inside information’ – precise information which would be likely to have a significant effect, either positive or negative, on the price of one or more of the issuer’s financial instruments – to the market as soon as possible. In the current context, sudden unexpected events, such as supply chain failures, government intervention, travel restrictions or even the absence of key personnel for health reasons, may give rise to inside information and, consequently, a disclosure obligation.

Following the ESMA statement, a number of national regulators, including the French Autorité des marches financiers (AMF), the Belgian Financial Services and Markets Authority and the Italian Market Authority, published statements in relation to listed issuers’ ongoing disclosure obligations.

Avoiding disclosure deficiencies

Many considerations play into corporate disclosures. Now, perhaps more than ever, public companies need to adequately evaluate their current business prospects, reporting deadlines and disclosure obligations. Serious financial implications may await companies that fail to get it right.

“Issuers could face regulatory action or litigation if they were not sufficiently forthcoming about the impact of the COVID-19 virus on their operations, their financial ties to infected regions such as China or Italy, or if they characterise the virus as a hypothetical risk, while, in reality, the virus has affected the issuer’s operations,” says Oleg Stratiev, an associate at Fasken Martineau DuMoulin LLP.

“Issuers should not limit themselves to pandemic disclosure only but should evaluate the impact of COVID-19 on their business in general,” he adds. “Disruption to a supply chain, for instance, impacts the end consumer and the issuer’s ability to fulfil its orders. A global economic slowdown and high market volatility could make it more difficult to obtain financing. Unstable trading conditions and shortages of cash flows could increase the risk that an issuer breaches its financial covenants.”

Companies need to evaluate and disclose the primary risks they face during the pandemic, including any economic ramifications of lockdown measures, for example. This will likely affect the management discussion and analysis (MD&A) portion of the companies’ annual reports or quarterly filings, in which details of the company’s performance are discussed. Companies will also want to consider appropriate disclosure around any earnings guidance.

Timing is also critical. A company may choose to make disclosures related to the impact of COVID-19 prior to its next earnings release or periodic report. Early disclosure may be favourable to investor relations and credibility.

According to the SEC’s March statement: “When companies disclose material information related to the impacts of COVID-19, they are reminded to take the necessary steps to avoid selective disclosures by disseminating such information broadly to the public. Depending on a company’s particular circumstances, it should consider whether it may need to revisit, refresh, or update previous disclosure to the extent that the information becomes materially inaccurate.” This cautionary note applies to financial results, business impacts, guidance and other relevant issues.

The SEC recognises that, in many cases, actual financial and operational results will differ substantially from reasonable estimates given by issuers right now. Because of the prevalent ongoing global economic and business uncertainty, the SEC has indicated that it will not second-guess an issuer’s good-faith attempts to provide investors and other market participants with appropriately framed, forward-looking information.

In Canada, issuers that have provided earnings guidance or other material financial outlook or future-oriented financial information (FOFI) will also need to consider related disclosure requirements. “This includes the requirement to discuss in their next MD&A events and circumstances that occurred that are reasonably likely to cause financial results to differ materially from such guidance, outlook or FOFI and state the expected differences,” explains Mr Stratiev.

“When updating or providing new guidance, outlook or FOFI, issuers must use assumptions that are reasonable in the circumstances, which might prove to be difficult in such a fluid situation,” he continues. “If an issuer instead decides to withdraw previously disclosed guidance, outlook or FOFI, it will be required to disclose the decision in its MD&A and discuss the events and circumstances that led to that decision, including a discussion of the underlying assumptions that are no longer valid.”

The lingering cloud of COVID-19

The advent of COVID-19 is a novel risk, which has resulted in logistical, health and financial issues many companies have never seen before. “The challenge is thus to provide investors with accurate information about the future while information about the virus is changing on a daily basis,” says Mr Stratiev.

Given the importance of making accurate disclosures, companies should ensure that proper training, coordination and approval of all communications is observed. Choice of language may also become increasingly important. “In the future, regulators may require a more fact-specific disclosure, asking issuers to avoid ‘boilerplate’ language,” points out Mr Stratiev. “Especially, for the short term, regulators will be interested in key risks and uncertainties that are likely to affect the issuer’s future performance and cash position.”

Providing accurate information to investors requires the oversight of directors & officers (D&Os). Such oversight involves frequent, transparent communication with shareholders and investors. Given the travel restrictions and social distancing measures implemented in most jurisdictions, the majority of this communication will now be conducted digitally.

“D&Os must carefully assess their operations and determine, to the extent possible, the impact of COVID-19 both within the context of the industry they operate in, as well as within the context of their particular business,” notes Mr Stratiev. “They must consult their advisers to ensure that the information provided to the public is as true as possible given current circumstances.

“However, companies must note that exemplary disclosure does not mean disclosure beyond what is legally required. Issuers should avoid creating false expectations for investors by prematurely identifying certain events as being more significant to the company than may actually be the case,” he adds.

COVID-19 has been one of the most disruptive and potentially transformative events in a generation. For companies, it is imperative that they handle related disclosures professionally and accurately. There could be serious consequences if disclosures made now are later found to be misleading or inadequate. Several national regulators and the ESMA have acknowledged that issuers will likely face challenges in connection with the timely publication of their periodic reports for the foreseeable future.

In the coming months, shareholders may revisit early disclosures and allege failures by the company and its directors to adequately disclose or update disclosures as the pandemic evolved. In the UK, for example, such claims could be based on common law or statute. A statutory claim could be made under section 90A Financial Services and Markets Act 2000 (FSMA) in respect of misstatements or omissions in an issuer’s periodic financial disclosures or in information published to the market by means of a recognised information service.

Companies also need to bear in mind reputational issues which could affect a company’s financial performance. If a company is deemed to have exploited its customers’ fears for profit, for example, it may lead to a loss of confidence in the brand, stock drops and shareholder claims down the line.

The COVID-19 pandemic presents evolving, nuanced risks. Companies are scrambling to cope with its effects on their business and attempting to institute new policies and processes to comply with changing regulatory standards. Amid the chaos, companies need to pay sufficient attention to ensuring their disclosures are as defensibly precise and transparent as possible.

© Financier Worldwide

BY

Richard Summerfield