On September 17, 2010, the Securities and Exchange Commission (the “SEC”) unanimously voted to propose expansive new disclosure requirements with respect to shortterm borrowing arrangements in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (the “MD&A”) section of quarterly and annual reports.
In a companion release, the SEC issued interpretive guidance regarding MD&A liquidity and capital resources disclosure requirements. For a detailed description of the interpretive release, please see our October 2010 Securities Law Update: New SEC Guidance on MD&A Liquidity and Capital Resource Disclosures.
The proposed rules address concerns that a company’s period-end disclosures do not accurately reflect ongoing liquidity and investment risks when borrowing varies extensively during a given reporting period. They are designed to help investors understand a company’s actual funding needs and financing activities, and evaluate liquidity risks. The rules would combat a practice known as balance sheet “window dressing”, whereby some companies intentionally pay down short-term debts just before the end of a reporting period so that such debt, which may nonetheless be important to a company’s operations, does not appear on the balance sheet.
Under the current reporting rules, companies, other than bank holding companies, are only required to disclose short-term borrowing at the end of the period; there is no specific requirement to disclose intra-period shortterm borrowing information. Bank holding companies, however, are currently required to annually report the average and maximum amounts of their short-term borrowings throughout the year in accordance with the disclosure guidance set out in Industry Guide 3, Statistical Disclosure by Bank Holding Companies (“Guide 3”). 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.
The proposed rules would be applicable to disclosures in (1) annual and quarterly reports, (2) proxy or information statements that include financial statements, (3) registration statements under the Securities Exchange Act of 1934, and (4) registration statements under the Securities Act of 1933. For annual reports, disclosure would be required for the three most recent fiscal years and for the fourth quarter. For quarterly reports, information would be presented for the relevant quarter, without a requirement for comparative data.
QUANTITATIVE DISCLOSURES
The proposed rules would require a company’s MD&A disclosure to include the following quantitative information for each type of short-term borrowing used:
- The amount outstanding at the end of the reporting period and the weighted average interest rate on those borrowings;
- The average amount outstanding during the period and the average interest rate on those borrowings; and
- The maximum amount outstanding during the reporting period.
Companies would be permitted to calculate averages using an averaging period not to exceed one month and to disclose the maximum month-end amount during that period. However, companies categorized as “financial companies”, as discussed below, would be required to provide averages calculated on a daily average basis and to disclose the maximum amount outstanding on any day in the period.
QUALITATIVE DISCLOSURES
In order to provide a context for the quantitative data, the proposed rules would require a narrative discussion of short-term borrowing arrangements that would include the following information:
- A general description of the short-term borrowing arrangements included in each category and the business purpose of those arrangements;
- The importance to the company of its short-term borrowing arrangements to liquidity, capital resources, market-risk support, credit-risk support, or other benefits;
- The reasons for the maximum reported level of short-term borrowings for the reporting period; and
- The reasons for any material differences between average short-term borrowings and period-end short-term borrowings.
SHORT-TERM BORROWING
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 agreement to repurchase, (2) commercial paper, (3) borrowings from banks, (4) borrowings from factors or other financial institutions, or (5) any other short-term borrowings reflected on the company’s balance sheet.
FINANCIAL COMPANIES
For the purposes of the proposed rules, a “financial company” includes, without limitation, a bank, a bank holding company, a savings association, an insurance company, a broker, a dealer, a business development company, an investment advisor, a futures commission merchant, a commodity trading advisor, a commodity pool operator, or a mortgage real estate investment trust. The definition is purposefully flexible and broad. It is intended to capture companies that, during a given reporting period, are engaged to a significant extent in the business of lending, deposit taking, insurance underwriting, providing investment advice, or are brokers or dealers of any of the above enumerated types of entities.
A company that is engaged in both financial and non-financial businesses would be permitted to present the short-term borrowings information for its financial and non-financial businesses separately, following the rules applicable to each.
TRANSITION PERIOD
For companies other than bank holding companies and those already subject to Guide 3 requirements, the proposed rules would be phased-in over three years such that in year one, only information from the preceding fiscal year would be required; in year two, information for the two preceding years would be required; and in year three, information for the three preceding years would be required. Companies currently subject to Guide 3 would be required to comply at the time the rules are adopted.
FOREIGN PRIVATE ISSUERS
Under the proposed rules, foreign private issuers would be subject to largely the same short-term borrowing disclosure requirements as domestic companies. 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
The proposed short-term borrowing disclosure requirements would apply to smaller reporting companies, except that (1) quarterly disclosures would only be required if there had been a material change during the interim period and (2) information for the fourth fiscal quarter would not be required in annual reports. Further, for those companies only required to provide two years of financial information on net sales and revenues and income on continuing operations under the current scaled MD&A disclosure requirements, only two years of short-term borrowing information would be required.
PRACTICAL CONSIDERATIONS
The SEC is accepting public comment on the proposed rules until November 27, 2010. To the extent that a company believes these amendments impose overly burdensome record-keeping and reporting obligations, a company should consider preparing a comment letter or joining an industry group comment letter in order to have input on the scope and form of the final disclosure requirements. The proposed rules and instructions for submitting comments are available for review at http://www.sec.gov/rules/proposed/2010/33- 9143.pdf.
Further, in anticipation of these amendments becoming enforceable following final approval, companies that do not have systems in place to report intra-quarter balances of short-term borrowings should give thought to augmenting existing programs to comply with the proposed rules.