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| Adele Hogan |
While the human impact is significant and not to be minimized, this article discusses some of the factors to consider to determine if and when securities law disclosure obligations related to COVID-19 are triggered.
The response to COVID-19 has begun to impact many industries, and has included countries closing their borders, enhanced health screenings, health care service preparation and delivery, quarantines, cancellations, disruptions to supply chains and customer activity, as well as the general concern and uncertainty.
Factors to consider include:
- The SEC's forward-looking disclosure obligations and decision-making matrix when outcomes are uncertain, but a known trend or uncertainty will be (or is likely to cause under the proposed SEC rules issued Jan. 30) a material change, selected disclosure considerations by industry;
- Environmental, social and governance issues;
- The role board members and executives have in SEC disclosure; and
- Enhanced labor and employment law, data privacy and cybersecurity.
SEC Disclosure Obligations When Outcomes are Uncertain
Continuing its modernization and simplification of Regulation S-K as mandated by the Jumpstart Our Business Startups Act and Fixing America's Surface Transportation Act, the SEC on Jan. 30 proposed amendments to certain financial disclosure requirements of Regulation S-K — particularly management's discussion and analysis, or MD&A, of the financial condition and results of operations.
The proposed amendments are intended to eliminate overlapping or unnecessary disclosure requirements, to revise requirements in light of advancements in technology — such as the availability of past financial statements and disclosure documents on the SEC's Electronic Data Gathering, Analysis, and Retrieval system, or EDGAR — and to further promote the principles-based nature of MD&A disclosure.
In addition to the numerous personal implications of the COVID-19 outbreak, companies should keep in mind this principles-based approach when considering the disclosure obligations that may be implicated.
There are many uncertainties around COVID-19's likely financial impact on gross earnings, net earnings and other business matters. The ESG factors are also hard to quantify at this time.
Nevertheless, if the forward-looking disclosure of COVID-19 relates to what the SEC considers a known trend or uncertainty, then the following chart outlines the decision-making process related to SEC disclosure obligations.
In the forward-looking disclosures decision tree below, officers of a company must decide whether the known trend is likely to come to fruition.
Three Outcomes
As the chart above indicates, where boards and executives are uncertain of the outcome, and the outcome could be material, then disclosures must be made. That is particularly difficult at the early stage of a health situation such as COVID-19.
The impact of COVID-19 may have repercussions on a number of disclosure areas, including liquidity and capital resources, sources and uses of funds, gross and net revenues in the short, medium and long term, and other economic and noneconomic, personal and ESG considerations.
Enhanced or additional risk factor disclosure related to COVID-19 pursuant to Regulation S-K Item 105 may be needed if it is or becomes one of the most significant factors that make an investment in the company or any offering speculative or risky.
Since SEC disclosure is increasingly principles-based, even if there is not a rule specifically dealing with a situation that a company may find itself in related to COVID-19, the principles of full and fair disclosure apply. Companies should be mindful that their planning for uncertainties that may arise as a result of COVID-19 and their response to events as they unfold may be material to an investment decision and should plan their disclosure accordingly.
Consider other situations where disclosure of material nonpublic information may be necessary, such as if senior management or boards become impaired and are unable to serve or whether a material adverse change in prospects has occurred or is reasonably likely to occur.
Business interruption insurance policies may be triggered. "Act of God" provisions may be applicable. Contract disputes may occur over COVID-19 related matters. Professionals should review and update insider trading policies, blackout periods and trading activity monitoring in light of new information related to COVID-19.
Mergers and acquisitions activity may increase due to temporary dips in targets' stock prices, while other deals may be temporarily stalled while the impact from COVID-19 is assessed.
Filings and other deadlines may be inadvertently missed and there may be gaps in government services in various parts of the world at various times.
We are anticipating that disputes and litigation related to COVID-19 and its aftermath may increase, and companies should consider many factors, not just more immediate concerns, when evaluating whether COVID-19 related disclosure is required under the securities laws.
It is noteworthy that in the SEC's Jan. 30 proposal to update MD&A in Item 303(a)(3)(ii), companies would be required to disclose known events that are reasonably likely to cause — as opposed to will cause — a material change in the relationship between costs and revenues.
Interestingly, the proposed amendments would for the first time provide guidance about the use of metrics. Metrics may be important related to COVID-19 and its likely trajectory and impact. According to the SEC release regarding the proposed amendments:
The guidance provides that, where companies disclose metrics, they should consider whether additional disclosures are necessary and gives examples of such disclosures. The guidance also reminds companies of the requirements in Exchange Act Rules 13a-15 and 15d-15 to maintain disclosure controls and procedures and that companies should consider these requirements when disclosing metrics.
It is inevitable that some companies will have to grapple with how to handle complex SEC disclosure obligations related to COVID-19, even if the impact is temporary or short term.
Selected Disclosure Considerations by Industry
Specific factors to consider related to SEC disclosures for the impacts of COVID-19 may vary by industry. Impacted industries may include, without limitation:
- Education, research and religious institutions (child care, preschool, elementary, secondary, colleges, universities, research institutes, think tanks, public libraries, religious institutions and related services);
- Financial services (banks, insurance, investment banks);
- Food and beverage (food supply, farmers, restaurants, agriculture and livestock);
- Government (courts, military, legislative bodies, governmental authorities, U.S. Department of Homeland Security, local councils and administrative bodies, social services, prisons, etc.);
- Health care (pharmaceutical companies, hospitals, nursing homes, urgent care, medical devices, etc.);
- Investment management and funds (private equity, venture capital, alternative assets);
- Leisure (casinos, cruise lines, hotels, sports clubs, country clubs, ski resorts, theaters, publications, zoos, amusement parks, museums, health clubs, spas, social media and the press);
- Manufacturing;
- Real estate (shared office service companies, open floor plan design companies, commercial and residential buildings, homes, cooperatives and condominiums, etc.);
- Retail;
- Service providers (consultants, lawyers, accountants, advisers, human resources, payroll, security, architects, etc.);
- Transportation (air, auto, bus, rail, shipping); and
- Technology, media and telecommunications.
ESG Considerations
ESG considerations are always important. They have a heightened relevance at a time when COVID-19 and its ramifications are unknown. Some considerations include:
Environmental
What chemicals and drugs will plants, animals and humans be subjected to? What lingering impact will they have on the environment and nature?
Social
What steps should be taken to protect populations and prevent unnecessary discrimination? How will various levels of employees be treated in a fair manner? What are the considerations of employees, shareholders, customers, suppliers and other stakeholders? How should their needs be prioritized?
Governance
What policies, procedures and controls are in place to ensure good governance? Are the governance standards appropriate and rigorous enough to withstand unusual stresses? What are the contingency plans and quality assurance protocols?
Role of Boards of Directors and Senior Management
If the COVID-19 situation continues to escalate, it is and will be a time for each person to show leadership and fortitude in small and sometimes large ways. Directors, trustees and management, as well as those in equivalent positions, can work to better inform themselves and exercise good judgement and gravitas.
Enhanced Labor and Employment Law
In some jurisdictions, including New York state and New York City, an employee who contracts the flu or a serious virus may be considered disabled and entitled to additional protections under relevant employment law. In those jurisdictions, the employer may be obligated to engage in the interactive process to accommodate the employee by providing additional leave or other accommodations beyond any statutory sick leave entitlement or company policy.
Other Considerations
Data Privacy
The employer could have certain confidentiality obligations under the Health Insurance Portability and Accountability Act related to the protection of personal health information of the ill employee. Collecting, storing, sharing and selling personal data, for example, may also implicate the California Consumer Privacy Act that came into effect on Jan. 1, the European Union's General Data Protection Regulation, or other data privacy regulations.
Cybersecurity
Cybersecurity policies and procedures may need to be updated to accommodate increased offsite working by employees and increased internet traffic by customers, suppliers and other stakeholders. Enhanced guidance on use of public Wi-Fi, covering computer screens so information is not publicly displayed, and use of office equipment off premises may be appropriate.
Heightened vigilance to prevent phishing and other cybersecurity breach attempts, scams, fraud, money laundering, theft and other criminal activity is warranted during this period.
Security
Companies should make sure physical security related to access to offices, servers, documents, data and other assets are secured with reduced staff and off premises usage.
Social Media
Policies related to appropriate social media usage should be revisited as appropriate, including heightened sensitivity training where necessary related to COVID-19 and its impact on people.
Reductions in Force
To the extent the impact of COVID-19 disrupts the economic plans of companies, a company may face more serious financial pressure to consider furloughs and reductions in force. These considerations should be made with careful understanding of various wage and hour implications, as well as mass layoff laws, including any advance notification requirements. Furthermore, anti-discrimination laws should be followed.
Some of these considerations related to COVID-19 outlined above may trigger disclosure updates under the securities laws.
Wait and See
The COVID-19 situation may be a relatively contained situation or it may become more serious. When it is too early to tell, but the impact will be material — or is reasonably likely to be material — if the uncertain event occurs, then securities law disclosure obligations may be triggered.
At this point, it may be difficult to ascertain what disclosure is appropriate, but many companies have already added disclosure about COVID-19 and its likely impact on their business to their earnings releases and other disclosure documents.
Checking other similarly situated companies' disclosure as well as periodic advice from regulators may provide additional guidance.
Adele Hogan is a partner at Nelson Mullins Riley & Scarborough LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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