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On September 17, 2010, the Securities and Exchange Commission (SEC) unanimously voted to publish proposed rules requiring registrants to disclose short-term borrowing arrangements in registration statements and periodic reports. Additionally, the SEC unanimously voted to issue interpretive guidance regarding the existing liquidity and capital resources disclosure requirements in the Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). Public comment on the proposing release must be received within 60 days of the publication, while the interpretive guidance is effective immediately, and should be considered by companies in preparing third quarter periodic reports on Form 10-Q. Both releases provide further indication that the SEC is focused on liquidity and capital resource disclosure in an effort to prevent "window dressing," reducing debt before period ends in order to improve financial statements.

I.  Interpretive Release on MD&A Liquidity and Capital Resource Disclosure

The interpretive guidance reiterates the SEC's previous guidance related to liquidity and capital resources, while providing further indication that the SEC staff will continue to focus on a registrant's MD&A disclosure. In addition to encouraging registrants to review past guidance on liquidity and capital resources disclosure, the SEC identified the following trends and uncertainties for disclosure:

  • Difficulty 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 value of collateral.
  • Counterparty risk.

The guidance urges companies to consider all intraperiod borrowing and certain repurchase transactions to be certain that MD&A and financial statements adequately address liquidity and capital resource disclosure requirements. Any financing arrangements that may impact liquidity should be disclosed, including a potential discussion of cash and risk management policies. Similarly, the release provides a reminder that ratios or measures included in MD&A should be accompanied by a clear explanation of the calculation. Finally, the interpretive release reiterates the SEC's position regarding the use of footnotes and narrative information as necessary to improve transparency of a registrant's contractual obligations table, particularly in light of the objective of improving transparency with respect to short-term borrowing and liquidity.

II.  Proposed Rules for Disclosure of Short-Term Borrowing

The proposed rules are designed to address concerns that a registrant's period-end disclosures do not accurately address liquidity concerns due to the volatility and variety of short-term borrowing during any given period. The proposed disclosure requirements are designed to give investors a better indication of the correlation between short-term borrowings reported at the end of a reporting period and the amounts reported during the period. The proposed amendments would require both quantitative and qualitative disclosures of a registrant's "short-term borrowings," which is defined to include: commercial paper, borrowings from banks, borrowings from factors or other institutions, federal funds purchased and securities sold under agreements to repurchase, and any other short-term borrowings reflected on the balance sheets of registrant.

A. Quantitative Disclosures

Tabular disclosures to be made by registrants for each category of short-term borrowings in the financial statements would generally mirror those set forth in Guide 3 for Bank Holding Companies and would include:

  • The amount of short-term borrowings outstanding at period end and the weighted average interest rate thereon.
  • The average amount of short-term borrowings outstanding during the period and the weighted average interest rate thereon.
  • The maximum month-end short-term borrowings outstanding during the period.

If the registrant is a financial company, then the new disclosures would also include:

  • The average amounts of short-term borrowings outstanding during the period computed on a daily average basis and the weighted average interest rate thereon.
  • The maximum daily amount of short-term borrowings outstanding during the period.

Financial company is defined in the proposal as a registrant that is engaged to a "significant extent" in the business of lending, deposit taking, insurance underwriting or providing investment advice, or is a broker or dealer as defined in Section 3 of the Securities Exchange Act of 1934. There is no quantitative test for the inclusion of financial companies, but the SEC has included in its list, without limitation: banks, savings associations, insurance companies, brokers, dealers, business development companies, investment advisors, futures commission merchants, commodity trading advisors, commodity pool operators and real estate investment trusts.

The SEC's list in the proposed rule is not exhaustive; however, the SEC has distinguished financial companies from non-financial companies based upon the assumption that non-financial companies' cost in obtaining the additional information required of financial companies under the proposed rule would outweigh any potential benefit to investors. Companies that have financial and non-financial sectors or businesses would be able to provide separate disclosures for each, respectively.

B.  Qualitative Disclosures

Under the proposed rule changes, registrants would also be required to provide a narrative analysis of short-term borrowing arrangements in the registrant's MD&A section, including a discussion of:

  • The forms or types of short-term borrowing arrangements used.
  • The business purposes and importance of the short-term borrowings.
  • Material difference between the maximum or average borrowings during the period and the same at the end of the period.
  • The importance of short-term borrowing arrangements to liquidity, capital resources, and market- and credit-risk support.

The phase in period for the proposed rule changes requiring additional quantitative and qualitative disclosures of market risk will occur depending on whether or not the company is subject to Guide 3. For bank holding companies or companies otherwise subject to Guide 3, the disclosure requirements are effective immediately. For other companies, the comparative annual data is to be phased in over three years. In the initial transition year, companies would disclose short-term borrowings of the most recent fiscal year, omitting the two preceding fiscal years. In the second transition year, companies would disclose short-term borrowings of the two most recent fiscal years, omitting the third preceding fiscal year. In the third year and thereafter, the disclosure would include short-term borrowings for the preceding three fiscal years. Foreign Private Issuers would be permitted to categorize short-term borrowings based upon the accounting principles used by the Foreign Private Issuer registrant in preparing its financial statements. Similarly, Smaller reporting companies would only be required to disclose quarterly short-term borrowing information where material changes have occurred since the end of the preceding fiscal year.

The proposed rules and interpretive guidance of September 17, 2010, are in line with the SEC's recent focus on liquidity and capital resources disclosures of registrants. The interpretive guidance refers to previous guidance in several instances, so registrants should pay attention to previous guidance issued by the SEC. For questions or more information, contact one of the members of the firm's Securities/SEC Practice Group including:

Lewis U. Davis, Jr. — 412 562 8953;
Jeremiah G. Garvey — 412 562 8811;
Jennifer R. Minter — 412 562 8444;
Brian S. North — 215 665 3828;
Brian S. Novosel — 412 562 5266;