SEC advises on how to disclose complex, uncertain and evolving risks, including Brexit – let investors see with management’s eyes

At a recent conference in London, Bill Hinman, Director of the SEC’s Division of Corporation Finance, spoke about crafting reliable and robust company disclosure, the philosophical underpinning of the U.S. securities regulatory regime, against a backdrop of uncertain and rapidly evolving risks—including Brexit.

Hinman reminded that U.S. securities disclosure requirements are largely principles-based, meaning they articulate an objective and then expect management to exercise judgment in satisfying that objective through disclosure, for example in risk factors and the operating and financial review. Principles-based also means the requirements are flexible, enabling disclosure that keeps pace with emerging issues.

Chief among the principles is materiality: disclose X if there is a substantial likelihood that a reasonable investor would consider X important in deciding how to vote or make an investment decision.

Enter Brexit: Hinman was clear that Brexit may be material to any company with extensive international operations. And if material, a company should provide thoughtful and appropriately detailed disclosure of the impact to its business and operations, rather than generic disclosure akin to the company throwing its hands up in light of the uncertainty (i.e., Brexit is a risk, the outcome is uncertain and it could impact us). To counteract the uncertainty, companies should consider what they have done as a business to prepare for Brexit.

To inform the disclosure of the nature and extent of the risks posed, Hinman encouraged companies to offer to investors the lens through which management looks at its exposure to Brexit-related risks: how does management assess and analyse the risks and impacts?, what is management doing to mitigate the risks?, and how does management discuss Brexit risks with the Board?  He commented that there should not be material gaps between how the Board is briefed and how shareholders are informed (while noting that not all discussions between management and the Board are appropriate for disclosure).

The ultimate goal is to provide tailored insight into how management views the risks posed to the business and operations and what actions they are taking to address these risks.

Hinman also shared six disclosure topics that companies may consider to inform their Brexit disclosure, though cautioned that this list was by no means exhaustive:

1. Regulatory risk: Is the business exposed to new regulatory risk given the uncertainty as to which set of laws and regulations will apply and whether transition agreements will be in place? This may be the case more significantly for some industries (e.g., financial services) than others.

2. Supply chain risk: Are there significant supply chain risks due to the potential disruption to the UK’s access to free trade agreements, and any resulting changes in tariffs on exports or imports? Supply chain risk could be from a monetary or time-delay perspective.

3. Customer/revenue loss risk: Does the company face a material risk of losing customers, a decrease in sales or an increase in costs? This is critical so investors understand whether current financial information is indicative of future results, and could require quantitative disclosure of estimates or ranges of foreseen changes.

4. Currency/other market risk: Does the company have exposure to currency devaluation, foreign currency exchange rate risk or other market risk? This may require disclosure of a company’s approach to managing these risks, such as increased hedging activities.

5. Contractual risk: What is the company’s exposure to contractual risk, and what review has the company undertaken of contracts with counterparties in the UK or EU? This is of particular importance for any material contracts.

6. Financial statement implications: Do Brexit-related issues affect financial statement recognition, measurement or disclosure items, such as inventory write-downs, impairments, collectability of receivables, assumptions underlying fair value, foreign currency, hedge accounting or taxes? This could reflect how audit committees are considering reporting implications.