“As you know all too well, there is tremendous uncertainty associated with Brexit … In addition, there is a lack of clarity on what the actual effects of Brexit will be on companies, their investors and on global financial markets. Despite this uncertainty, the reality for many companies is that Brexit is already here.” – William Hinman, Director, Division of Corporation Finance, U.S. Securities and Exchange Commission

At a conference in London held in March 2019, Director Hinman gave a speech addressing how the U.S. securities disclosure requirements apply to Brexit as an issue that is “complex, associated with uncertain risks and rapidly evolving.”¹ In his speech, Director Hinman emphasized that the principles-based approach of the U.S. disclosure regime requires companies to reject generic, one-size-fits-all Brexit-related disclosure in favor of carefully-crafted disclosure tailored to a company’s specific circumstances.

Principles-based disclosure

Director Hinman explained, “Principles-based disclosure requirements articulate an objective and look to management to exercise judgment in satisfying that objective by providing appropriate disclosure when necessary.”² To satisfy principles-based disclosure requirements, when disclosing information, companies must consider whether such information is “material,” that is, whether a reasonable investor would consider such information important in deciding how to make an investment decision.³

Management’s discussion and analysis (MD&A) and risk factor disclosure are two areas that Director Hinman identified as critical for companies disclosing complex risk. In risk factor disclosure, a company should focus on the most significant factors that make an investment in such company subject to risk and uncertainty. Disclosure of risk factors should be concise, focused and to-the-point, avoiding “generic boilerplate” and “laundry lists of risks”.⁴ A well-written MD&A should give an investor insight into how “management is positioning the company in the face of uncertainties”.⁵

Brexit-related disclosure

A key takeaway from Director Hinman’s speech is that the SEC is looking for tailored Brexit disclosure, which means disclosure that explains to investors the specific impact of Brexit on a company’s business and operations. Generic disclosure, in which a company merely states that “Brexit presents a risk, that the outcome is uncertain and that it could materially and adversely impact the business and its operations” is, in Director Hinman’s view, insufficient to provide meaningful guidance to investors.⁶ The focus on tailored disclosure means that Brexit-related disclosure will – and should – differ across industries and among companies.

Director Hinman suggested the following straightforward question to guide companies drafting Brexit-related disclosure: “Would these disclosures satisfy the curiosity of a thoughtful, deliberative board member considering the potential impact of Brexit on the company’s business, operations and strategic plans?” He emphasized that, while not all discussions between management and the board are appropriate for public disclosure, “there should not be material gaps between how the board is briefed and how shareholders are informed.”⁷

Director Hinman also provided a non-exhaustive set of questions to guide companies when drafting Brexit-related disclosures:

1. Regulatory risk. What specific regulatory risks does the company face due to the uncertainty of what laws will apply or what (if any) transition arrangements will be in place following Brexit? What regulatory risks are applicable in light of a company’s industry, sector and the location of its operations, supply chains and customer base? Companies should be prepared to demonstrate that they have analyzed regulatory risks specific to them. For example, a biopharmaceutical company with UK operations may face risks related to the regulation of its products or clinical trials, while a financial services company may face risks relating to the loss of passporting arrangements. Companies should also explain what (if any) actions they have taken to mitigate regulatory risk, such as the relocation of UK subsidiaries.
2. Trade and supply chain risk. Is the company at risk due to changes in trade arrangements between the UK and other states and resulting changes in import and export tariffs? Companies should actively consider the potential effects of supply chain disruption due to delays in customs administration, in particular if they rely on just-in-time supply chain arrangements.
3. Loss of customers and decrease of sales, profits or revenues. Does the company face increased costs, decreased revenues or profits or loss of customers due to Brexit-related changes? Is demand for a company’s products sensitive to changes in exchange rates or tariffs? Companies should consider these questions and tailor their disclosure with the aim of helping investors understand whether their previously reported financial information is indicative of future results. If management anticipates material changes in costs, forecasted sales or working capital, it may be appropriate to include quantitative estimates, as well as qualitative disclosures.
4. Currency devaluation and exchange rate risk. What (if any) exposure does the company have to currency devaluation or foreign currency exchange rate risk? Companies should use qualitative and quantitative disclosure to explain their approach to the management of potential currency devaluation and exchange rate risk, such as increasing their hedging activities.
5. Contractual risk. Do the company’s material contracts expose it to contractual risk and, if so, how is the company mitigating such risk? Companies should undertake a review of their material contracts with counterparties in the EU or UK to determine their exposure to contractual risk and take appropriate action to address such risk. Companies should disclose contractual risk related to all material contracts
6. Reporting implications. Do Brexit-related risks affect financial statement recognition, measurement or disclosure items, assumptions underlying fair value measurements, foreign currency matters, hedge accounting or income taxes? Board and audit committees should be actively considering the reporting implications of Brexit-related risks and how to accurately reflect these in company disclosures

The key takeaway from Director Hinman’s speech is that companies can satisfy the SEC’s principles-based approach to Brexit-related disclosure by rejecting generic language in favor of carefully-tailored disclosures focused on the material business, operational and strategic risks identified by management and any actions taken to mitigate such risks.

Footnotes

1) Director Hinman also discussed disclosure related to sustainability. The full transcript of Director Hinman’s speech is available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519.

2) Director William Hinman, Address at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019) (transcript available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519).

3) TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976).

4) Director William Hinman, Address at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019) (transcript available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519).

5) Director William Hinman, Address at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019) (transcript available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519).

6) Director William Hinman, Address at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019) (transcript available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519).

7) Director William Hinman, Address at the 18th Annual Institute on Securities Regulation in Europe (Mar. 15, 2019) (transcript available at https://www.sec.gov/news/speech/hinman-applying-principles-based-approach-disclosure-031519)