Matt Kelly:
Hello everyone and welcome to another episode of Coping through COVID. I'm your host, Matt Kelly, editor of Radical Compliance. Thank you all for listening today. This is a limited podcast series sponsored by NAVEX Global, where we talk about corporate compliance and risk management challenges posed or amplified by the COVID-19 crisis. In each episode we take a deep dive into some specific issue, whether that's executive communication, cybersecurity, regulatory compliance, or supply chain risk. We look at it all and we talk with a thought leader in that field, so compliance and risk professionals can better understand the challenges we all face and how we should navigate our way through them.
In this episode, we're going to talk about the Securities and Exchange Commission and what the SEC expects from publicly traded companies as those firms try to file financial statements and give investors a clear sense of the risks the company is facing that are related to COVID-19. To talk with us about that, I'm joined by Steve Quinlivan. He is a partner at the Stinson Law Firm, where Steve works on corporate legal issues such as regulatory compliance, M&A deals, corporate finance. He's also one of the lead writers at the Dodd-Frank.com blog, which is always worth following if you're looking for analysis of regulatory issues. So Steve, welcome. Thank you for joining us today.
Steve Quinlivan:
Thank you very much. I'm happy to be here today, Matt.
Matt Kelly:
The first question, the SEC has turned out numerous statements and pieces of guidance lately, and the fundamental challenge that the SEC wants companies to address here is what exactly? Is it concerns about so much subjective judgment floating around on these critical financial disclosures? What's going on?
Steve Quinlivan:
There's a lot coming out of the SEC these days. It's hard to keep track of. Despite all the noise, the SEC hasn't adapted any new disclosure requirements as they believe their existing rules are adequate for investor protection. Basically their goal is the same. The SEC wants you to tell investors where you are at and where you're going. It's never been harder to prepare SEC disclosure documents than it is now. And many of our listeners are working on their Form 10-Q for the first quarter. Although the SEC has an adapted new rules, they've issued interpretive guidance and considering the impact of COVID-19 under the existing rules. It's kind of a multiple, but it's referred to as CF Disclosure Guidance: Topic No. 9. It's available on the SEC website. The SEC certainly recognizes that it's difficult to assess or predict the precision and the broad effects of COVID-19 on industries or individual companies. They recognize the actual impact will on many factors beyond the company's control and knowledge.
Nonetheless, the SEC wants you to discuss the effects of COVID-19 has had on your company, what management expects its future impact will be, how management is responding to the evolving events and how it's planning for COVID-19 related uncertainties. This could touch almost every part of your SEC report being MD&A, the business section, which isn't applicable to a 10-Q, risk factors leading legal proceedings, disclosure controls and procedures, internal control or financial reporting, and of course the financial statements. Completing the financial statements can be one of the most difficult areas for SEC filers, significant judgement's required in a number of areas including fair value and impairment considerations, leases, revenue recognition, income taxes, going concern and subsequent events. Subjective judgments are involved in all of that. The SEC officials have indicated that they have consistently not objected to well-reasoned judgments, and they will continue that practice in the future so that registers don't need to worry about being second guessed if they do their homework.
Matt Kelly:
My question then is how much does anybody, frankly, even including the SEC, do they know what the correct answer is for good disclosure? For example, I know a company's supposed to disclose material risks to investors, but I'm sort of at a loss at what constitutes thoughtful, useful disclosure here about pandemic risks when we have got no idea when this is going to end or the full economic uncertainty. So how do you devise a something and say, "Okay, this is the right answer. This is in our comfort zone." How does that work?
Steve Quinlivan:
Well, I don't think anybody knows what the correct answers are. You need to do your best to make reasonable judgments and unfortunately there is no one-size-fits-all answer because every company and every industry is different. As I said before, it's never been harder to prepare SEC disclosure documents than it is now. Jay Clayton, the Chair of the SEC and Bill Hinman who runs the Division of Corporation Finance, which reviews disclosure documents for issuers, recently released a statement on what they think investors are looking for. According to them, your disclosure should reflect investor interest in where the company stands today operationally and financially. What the company's response to COVID-19 has been to date, how you're protecting the health and safety of workers and the customers and how that's progressing. And how all of that can change as we all continue to fight COVID-19.
Public companies and their earnings releases and analyst calls to provide as much information as is practicable regarding your current operating status and your future operating plans under various COVID-19 related scenarios because nobody knows exactly what path it is we're going to head down. They've emphasized that detailed discussions of current liquidity and financial resources would be particularly helpful to investors in the markets. I mean, they know what they're asking is not easy and then it's always going to be based on a mix of assumptions, including things that are beyond the company's control. Everybody knows we're an uncharted territory. Even if we knew when the State shutdowns would end, there's no experience for bringing an economy of our size back online. Are your customers going to come back? Is your supply chain going to be reliable? Will the employees come back to work? Are they going to be rolling shutdowns in the future if we experience resurgences of COVID-19?
So what we suggest is when giving the detail requested by the two SEC officials to make sure you disclose what your material assumptions are and perhaps you want to discuss a range of scenarios depending on how long that might last and how a recovery might work. The securities lives do provide for protection for forward-looking statements and we encourage companies to take advantage of those protections by, as you've seen in SEC reports, making sure your forward-looking statement disclaimers are up to snuff and you're disclosing the risks related to your forward-looking statements.
Matt Kelly:
I'm also curious how companies will actually try and pull together this information because certainly in normal times you've had your tried and true processes to gather the necessary information and disclosures for security filings, but how much are those processes... Are they going to go out the window or are they otherwise insufficient for what we have to do in COVID-19? Are we going to see... I don't know. You're going to have to ask different questions or look for different information. You're going to have to talk to different people in the enterprise to try and pull together the right report. Do you have any thoughts about what are the mechanics of pulling all of this together in this particular crisis?
Steve Quinlivan:
Well, I don't think I would throw out any carefully thought out processes that the companies have devised and employed to date. What I might worry about is everybody working from home, which has a lot of inefficiencies and distractions and being swamped with trying to keep the company afloat and not carefully focusing on the upcoming 10-Q.
In historical times, a lot of companies haven't focused on liquidity and financial resources since for a lot of issuers those scenarios were pretty much given. Maybe those disclosure processes should be reexamined. For additional processes, I mean I think I would look to see what the SEC is asking for based upon the stuff we've talked about. Where does the company stand operationally and financially? What you've done to respond to COVID-19 to date and how that might change in the future? Probably a lot of this is covered by existing processes, but I would encourage careful thought about what else needs to be done and who else might need to be brought into the loop. And I think the best advice I can give is to start early and make sure everyone is attuned to the need for proper disclosure.
Matt Kelly:
What are the deadlines to get the 10-Q or the 10-K filed now? Because you and I are talking on April 14. So first quarter 2020 just ended about two weeks ago. Has the SEC then granting any extra time to do any filings or anything like that?
Steve Quinlivan:
The current disclosure deadlines have not been pushed back. As you probably know and our readers know, it depends upon your status as a non-accelerated filer or an accelerated filer or a large accelerated filer. They recognize that for whatever reason, companies may be challenged to meet those deadlines and they have, as part of their numerous pronouncements you mentioned earlier, provided sort of a self executing extension that you can take advantage of if you can't file on time. The extension to evaluate yourself of is a little bit tricky and you want to make sure you hit all the rungs. And basically before the deadline you have to make certain announcements and filings saying that you can't meet the deadline and why, and you get a short period of additional time to comply.
Matt Kelly:
Okay, so this is not a free recess period for filers. You're going to have to try, but if you can't, they're open to the idea of extensions, but you have to earn it so to speak.
Steve Quinlivan:
You have to earn it. We always recommend filing on time, especially for closely followed companies.
Matt Kelly:
Who or what type of firm do you think will be most challenged to meet these disclosure requirements these days? Either by industry or by size or I don't know what, but what are your thoughts?
Steve Quinlivan:
That's a hard question to answer. But picking off the low hanging fruit, I would say companies with a history of significant deficiencies or material weaknesses in internal controls because their processes haven't been adequate in the past. Those that are financially challenged and might not have the resources to dedicate to it. Sort of as a parallel side, if you've laid off your disclosure personnel, you don't have the people to do the work, or if you've assigned your disclosure personnel additional work, they might be challenged to make those sorts of judgments. And as a catchall, those with decentralized or disparate operations or significant international operations simply because there's more points of contact to gather information and perhaps different areas of the company being affected differently.
Matt Kelly:
Last question, I have seen speculation out there that in the fullness of time we are going to see more SEC enforcement related to this time period because some number of unscrupulous people out there, clearly nobody listening to this podcast. But somebody somewhere, they are going to try insider trading or cooking the books or some other sort of securities fraud during such a tumultuous and confusing time. What do you think of that theory? What's the misconduct risk today that would bring more enforcement risk tomorrow? Is this a valid scenario you think?
Steve Quinlivan:
Well, it's certainly valid. If you look back to 2008, we had some Ponzi schemes that came to light almost immediately when the music stopped such as Bernie Madoff. That hasn't happened here at least so far, although the current economic shock is perhaps quicker and more significant and deeper. Insider trading is a real concern. Just because things are so fluid, there's going to be a lot of undisclosed and material information out there about companies and financial position and earnings. We recommend that companies reemphasize their insider trading policies, perhaps engage in additional training where appropriate, increase blackout periods where necessary and limited distribution of those who need to know.
I imagine there could be some temptation to cover up deficiencies in liquidity or financial position, so customers, suppliers and investors don't flee either now or when the economy is reopened. There could be temptation to cook the books to improve results and impress markets and investors. Think about whether anyone has an incentive to do that in your companies because of compensation or whatever. The best defense to that type of behavior is to make sure everyone's fully engaged in the financial reporting and disclosure process.
Another driver or fraud might be where unrealistic expectations are communicated from the top, or senior management doesn't recognize the challenge of those in the ground, and someone might use earnings management schemes to keep senior management happy. We'll certainly see our share of garden-variety securities frauds. Companies will claim to have the inside edge of some sort of cure vaccine or whatever. There'll be the micro-cap pump-and-dump schemes, but hopefully that will be at a minimum.
Matt Kelly:
All right. Well, Steve, you've covered a lot of ground for us. That's all the time we have today, but really appreciate your time. Thank you very much.
Steve Quinlivan:
Okay. Well, I really appreciated the opportunity and thank you for asking.
Matt Kelly:
Again everybody, that was Steve Quinlivan. He is a partner in the corporate law practice at the Stinson Law Firm and he joined us today to talk about securities regulation issues that are likely to arise from COVID-19. If you have an idea for what you'd like this podcast to explore, please do let us know. You can drop me an email at mkelly@radicalcompliance.com and we would love to hear your thoughts. That's all for this episode of Coping through COVID. I'm Matt Kelly, editor of Radical Compliance. Thank you all for listening. Thank you to NAVEX Global for sponsoring this series and I hope you'll join us again next time.