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SEC Provides Interpretive Guidance for Enhanced Liquidity and Capital Resources Disclosure

Author(s): Kate Coolican, James Lurie, Matthew Sadofsky

Oct 7, 2010

On September 17, 2010, the U.S. Securities and Exchange Commission (SEC) provided new interpretive guidance intended to improve the discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A). See SEC Release No. 33-9144 at  In a companion release, the SEC also proposed amendments to its rules designed to improve the qualitative and quantitative disclosure in annual and quarterly reports regarding the short-term borrowing of registrants. See SEC Release No. 33-9143 The Osler Update on the SEC’s proposed amendments to MD&A can be found here.

The new guidance is effective immediately and, accordingly, should be considered by a U.S. domestic registrant when preparing MD&A disclosure for its upcoming Form 10-Q. Foreign private issues should also consider the new guidance in the preparation of their MD&A liquidity and capital resource disclosures.

Liquidity Disclosure

The guidance cautions that as financing activities become more diverse and complex it is increasingly important that the discussion and analysis of liquidity and capital resources meets the objective of MD&A disclosure. Specifically, Item 303(a)(1) of Regulation S-K requires registrants to disclose known trends or any known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in any material increase or decrease in the registrant’s liquidity. The guidance highlights the following trends that registrants should consider addressing:

  • difficulties accessing 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.

Intra-period Variations

The SEC indicated that if financial statements do not adequately convey the registrant’s financing arrangements, or the impact of those arrangements on liquidity, additional narrative disclosure may be required to enable an understanding of the amounts indicated in the financial statements for the applicable reporting period.  For example, the SEC notes that if borrowings during a reporting period are materially different than the period-end amounts recorded in the financial statements, disclosure about the intra-period variations may be required to facilitate investor understanding of the registrant’s liquidity position.

Repurchase Agreements

The SEC noted that “there may be confusion about how to address certain repurchase agreements that are accounted for as sales, as well as other types of short-term financings that are not otherwise captured in period-end balance sheets.” Disclosure of a repurchase transaction, securities lending transaction, or any other transaction involving the transfer of financial assets with an obligation to repurchase, is required to be disclosed in MD&A if it will result in (or is reasonably likely to result in) a material increase or decrease of the registrant’s liquidity or is reasonably likely to result in the use of a material amount of cash or other liquid assets. Such disclosure is required even in the absence of specific references in existing disclosure requirements for off-balance sheet arrangements, or any transfers of financial assets that are accounted for as sales.

Cash Management and Risk Management Policies

The guidance suggests that registrants consider describing their cash management and risk management policies to the extent they are relevant to an assessment of their liquidity and financial condition. Banks and other financial institutions should consider discussing their policies and practices in meeting applicable regulatory agency guidance on funding and liquidity risk management, or any policies and practices that differ from applicable agency guidance. In addition, a company that maintains or has access to a portfolio of cash and other investments that is a material source of liquidity should consider providing information about the nature and composition of that portfolio, including a description of the assets held and any related market risk, settlement risk or other risk exposure.

Leverage and Other Ratio Disclosures

The guidance reminds registrants that where leverage or capital ratios are included in MD&A, registrants must follow the SEC’s rules governing the use of non-GAAP financial measures. Where a measure or ratio is not a financial ratio (such as industry or value metrics), the guidance reminds registrants to consider the SEC guidance in 2003.  See SEC Release No. 8350 (Dec. 19, 2003) at In addition, any ratio or measure included in a filing should be accompanied by a clear explanation of the calculation methodology. The explanation must outline the treatment of any inputs that are unusual, infrequent or non-recurring, or that are otherwise adjusted so that the ratio is calculated differently from comparable measures. Registrants must also include disclosure explaining why the measure is useful to understanding its financial condition.

Under U.S. GAAP, only bank holding companies are currently required to disclose certain capital and leverage ratios in the financial statements that are included in SEC filings. The SEC believes investors may benefit from disclosure about the capitalization and leverage profile of companies other than bank holding companies, particularly for those who rely heavily on external financing to fund their business.  Therefore, in the companion short-term borrowings release, the SEC  is seeking comment on whether to extend a leverage ratio disclosure requirement to companies that are not bank holding companies and how such a requirement would take into account the differences among metrics and industries while still providing comparability.

Contractual Obligations Table Disclosures

The guidance reinforces that the tabular disclosure of contractual obligations should be prepared with the goal to presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. The SEC emphasizes that the purpose of the table is to provide aggregated information about contractual obligations and contingent liabilities, and commitments in a single location to improve transparency of an issuer’s short-term and long-term liquidity and capital resources needs, and to provide context for investors to assess the relative role of off-balance sheet arrangements. Registrants are reminded to prepare disclosure consistent with that objective and to include footnotes and additional narrative discussion where necessary. The flexibility of the disclosure requirement allows registrants to provide company-specific information in a way that is suitable to a registrant’s business and the guidance encourages registrants to develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of its capital structure and business.



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