March 16, 2020
The outbreak and continuing spread of the novel coronavirus (“COVID-19”) and the related disruption to the worldwide economy are affecting public companies across all industries. While noting that the ultimate effects may be difficult to quantify at this time, regulators, including the U.S. Securities and Exchange Commission (“SEC”), are asking for robust disclosure of the potential impacts of COVID-19 in public company filings. Similarly, COVID-19 is changing the contours of capital raising activities in the public and private markets. Issuers should consider including specific disclosure in their offering documents as to the potential effects of COVID-19 on their supply chain, operations, financial performance and liquidity and should expect an increased focus on the impact of COVID-19 in due diligence inquiries. Adverse impacts resulting from market declines and business disruptions may also result in increased securities litigation in future quarters.
To provide enhanced disclosure and manage related securities litigation risks, company management, working with its board of directors, should consider the following actions:
In addition, companies that traditionally hold in-person annual shareholder meetings at this time should consider holding virtual or hybrid meetings or delaying the meetings to a later date.
Due to ongoing uncertainty related to the COVID-19 outbreak, as well as logistical problems caused by quarantines and travel restrictions, on March 4, 2020, the SEC provided conditional relief to public companies unable to timely file their SEC reports. The SEC has granted an additional 45 days to file reports required under the Securities Exchange Act of 1934, as amended (“Exchange Act”) which are due between March 1 and April 30, 2020, subject to certain conditions, including filing a current report by the later of March 16 or the report’s original filing deadline that states why the report could not be timely filed and an estimated date that the filing is expected to be made. Companies relying on this relief will be considered current and timely with respect to Form S-3 and Form S-8 eligibility. The SEC has stated that it intends to monitor the current situation and may, if necessary, extend the time period during which this relief applies, with any additional conditions the SEC deems appropriate and/or issue other relief.
The SEC has encouraged companies to contact the Staff if they need additional assistance meeting filing obligations in certain situations, for instance where an executive whose signature is needed is located in a quarantined area.
In addition to granting the above relief, the SEC reminded companies “to provide investors with insight regarding their assessment of, and plans for addressing, material risks to their business and operations resulting from the coronavirus to the fullest extent practicable to keep investors and markets informed of material developments.” In its SEC filings, a company should consider making appropriate disclosures and updating previous disclosures, if necessary, to address the COVID-19 outbreak, including, but not limited to, the effect or potential effect of the outbreak on earnings, revenues, operations, supply chains and pending or planned transactions. Companies are also advised to consider disclosing risk management plans in place or in progress as they relate both internally and externally with respect to third parties with whom the company does business.
Reporting companies should evaluate whether there has been an event triggered by the impact of COVID-19 that requires the filing of a Form 8-K or a material change that requires prompt disclosure pursuant to the rules of an exchange. Companies should otherwise be prepared to provide disclosure of the impact of COVID-19 on operations and financials in the next periodic report. Note that companies providing forward-looking information, such as known trends or uncertainties regarding COVID-19, may avail themselves of the safe harbor in Exchange Act Section 21E. Set forth below are areas where these disclosure considerations come into play for U.S. companies as well as, in some cases for foreign private issuers and non-listed companies that file periodic reports with the SEC.
Risk factors. As the situation evolves, issuers should carefully consider risk factor disclosure in their SEC reports, which may need to be enhanced to ensure all material risks are addressed, and continue to evaluate the risks in subsequent Form 10-Qs. Risks related to the COVID-19 outbreak may need to address macro or micro-economic implications such as the economy in general and/or how the company and its industry may be specifically impacted.
MD&A. Regulation S-K of the Securities Act of 1933, as amended (“Securities Act”), provides that Management’s Disclosure and Analysis of Financial Condition and Results of Operations (“MD&A”) should include a discussion of known trends and uncertainties that have had, or that the company reasonably expects will have, a material impact on its financial condition and results of operations. Accordingly, MD&A disclosure may need to address how the spread of COVID-19 could materially impact the company going forward, including applicable discussions regarding expected results of operations, revenues, debt payment issues, capital expenditures and liquidity and capital resources. In light of potential downgrades, companies should examine, if applicable, the interplay between lien covenants in investment grade debt and secured debt capacity to ensure that investors understand the company’s true liquidity outlook.
Earnings guidance. Due to the uncertainty of the COVID-19 outbreak’s duration and effects, 2020 earnings guidance for many companies has been difficult for management and audit committees to assess. As the outbreak evolves, companies that have issued guidance should consider whether or not it should be revised or withdrawn. To the extent effects of the outbreak are quantifiable, they should be included in the guidance. Where important factors are not yet quantifiable, guidance should address this fact and note that, if applicable, the outbreak’s effect on the company’s business and results of operations could be significant. To date, companies have responded in various ways. Because guidance is not required under the federal securities laws, some have opted to provide no guidance. Others have opted to provide guidance that includes forecasted effects of COVID-19 for the first quarter only. Some companies have rescinded previous 2020 guidance. While there is no obligation to update prior forward-looking statements under the federal securities laws, where guidance has been previously issued that has materially changed, companies should consider updating or withdrawing.
Selective disclosure considerations. In response to the outbreak, the SEC has advised that when a company becomes “aware of a risk related to the coronavirus that would be material to its investors, it should refrain from engaging in securities transactions with the public” and should “take steps to prevent directors and officers (and other corporate insiders who are aware of these matters) from initiating such transactions until investors have been appropriately informed about the risk.” When a company discloses material information about the impact of COVID-19 on the company’s business, it should disseminate the information broadly and avoid selective disclosure in accordance with Regulation FD’s prohibition against selective disclosure of material non-public information. Where a company has made previous disclosures, it should monitor and assess whether to update any such disclosure that has become materially inaccurate.
Financial statements. Company management and boards of directors should consider potential accounting implications resulting from the COVID-19 outbreak and whether there is a need to disclose these implications in the next periodic report or Form 8-K. The SEC staff has urged issuers to work with auditors and audit committees to “ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances.” The SEC has emphasized the need to consider potential disclosure of subsequent events in the notes to the financial statements in accordance with the guidance in ASC 855. Management, the board and the audit committee should also discuss any impact of COVID-19 on disclosure controls and procedures as well as any concerns relating to quality and timing of audits.
As companies evaluate appropriate disclosures regarding the effects of COVID-19 on their businesses, they should be aware that they may be subject to claims that failures to provide such disclosures were materially misleading or that prior risk disclosures were inadequate in informing investors regarding the risks associated with a pandemic and the resulting disruption to the their operations. For example, investors may attempt to assert liability on the theory that the company should have more fully disclosed potential risks of a global outbreak or disruption event, particularly if the company had significant operations in foreign countries most impacted by COVID-19. Investors may also claim that projections and other forward-looking statements are actionable because they were not accompanied by meaningful cautionary language regarding risks of global pandemics on a company’s particular business.
We expect that plaintiff securities litigation firms will file so-called “event driven” cases based on losses experienced by investors with respect to companies whose business models have proven particularly susceptible to COVID-19 risks. The outcomes of those cases will depend on the individual circumstances of the companies, their preexisting disclosures and whether courts are willing to accept, particularly in the context of a crisis and broad stock market decline, that companies failed to disclose known or even predictable risks of a fast-moving global pandemic. At a minimum, adopting enhanced disclosures now should help significantly in avoiding and defending cases filed by subsequent investors.
As a result of the COVID-19 outbreak, some companies have decided to hold virtual or hybrid in-person/virtual shareholder meetings. Others are restricting access to in-person meetings by persons from certain areas. Companies that wish to hold a virtual or hybrid annual or special meeting should first check their organizational documents and state law to ensure virtual meetings are permitted and/or whether any bylaw amendments or board resolutions will be necessary. Under Delaware law, for example, the board has to explicitly authorize the corporation to hold virtual meetings.
Companies will also need to update proxy materials to provide for a virtual meeting if they have already been mailed and filed with the SEC. Because redistributing proxy materials can be expensive, on March 13, 2020, the SEC Staff issued guidance providing that companies seeking to change the date, location or form of annual meeting from in-person to virtual are not required to redistribute proxy materials under SEC rules. Instead, a press release filed as additional definitive supplemental materials for most companies should be sufficient provided the notice requirements are met. If the notice requirements cannot be met, meetings may need to be postponed or adjourned to a later date. Note that if the meeting is postponed, the company may be required to provide a new notice. In addition, the window for shareholder proposals may reopen. If a company decides to hold a virtual or semi-virtual meeting, platform providers such as Broadridge or Computershare should be contacted as soon as possible to work out logistics. The Staff guidance also encourages companies to allow activist investors alternative means, such as by telephone, to present their proposals at the annual meetings in light of the difficulties activist investors face as a result of COVID-19.
The effect of the COVID-19 pandemic on the capital markets has been severe. Debt issuers that suddenly find themselves facing deteriorating financial conditions will need to take into account their ability to meet covenant tests and make scheduled payments. In some cases, issuers may need to consider restructuring debt in a debt exchange, up-tiering transaction and/or consent solicitation as well as reaching out to lenders for temporary covenant or payment relief.
Purchase, underwriting and placement agent agreements for new issuances include standard provisions that allow underwriters or initial purchasers to unilaterally terminate offerings upon unforeseen events such as epidemics and pandemics. These termination rights are typically only applicable for a short period of time, between pricing and closing, and are rarely invoked due to the late point in the transaction when they become effective and the advanced state of the offering. For greater certainty going forward in the wake of COVID-19, these provisions may nonetheless merit scrutiny to ensure protection for issuers and certainty for underwriters and initial purchasers. Both sides of a transaction may benefit by the establishment of explicit COVID-19 baselines for these provisions that would clearly distinguish between differing conditions at the time of pricing and closing in relation to any termination right.
In addition, initial purchasers, underwriters and placement agents are expanding due diligence queries and disclosure requirements relating to the effects of COVID-19 on the issuer’s operations and financial statements. Note that the disclosure considerations outlined above for periodic reports also apply to offering documents used in capital markets transactions. Travel restrictions and quarantines brought on by COVID-19 have also spurred a move to net roadshows and investor conference calls as opposed to in-person roadshows and investor conferences. Similarly, the ability of parties wishing to conduct physical due diligence has been limited.
COVID-19 presents serious, rapidly-evolving challenges for U.S. public companies. As part of their fiduciary duties, boards of directors are responsible for keeping abreast of and addressing the company’s key risks. Through a robust process, management should identify and analyze these risks and apprise board members on an on-going basis of the company’s comprehensive response plans. Management and the board should work together, along with the company’s auditors and legal counsel, to monitor current developments, ensure material information is adequately and accurately disclosed, and establish internal protocols and contingency plans.