Even as the Brexit process unwinds in an ever more confounding pile of confusion, companies must continue to plan, operate, and report to their shareholders. U.S. securities regulators have already issued calls for reporting companies to provide greater details about the plans of management in the face of the risks and uncertainties surrounding the Brexit process. On March 15, 2019, William Hinman, the Director of the SEC’s Division of Corporate Finance, speaking at a securities regulation conference in London, offered a more detailed overview of the kind of disclosures he believes companies should be providing their shareholders about Brexit. Among other things, Hinman provided a useful checklist of questions companies should be asking themselves and about which companies should also be advising their investors. The text of Hinman’s March 15, 2019 speech can be found here.
In a referendum vote on June 23, 2016, a majority of U.K. voters voted in favor of the country’s withdrawal from the European Union. Article 50 of the Lisbon Treaty specifies the process for withdrawing from the EU. When a party invokes Article 50 to withdraw from the union, the party and the EU have two years to agree to the terms of the split. U.K. Prime Minister Theresa May triggered this process on March 29, 2017, meaning that the U.K. is (at least as of today) scheduled to leave the EU at 11 p.m. on Friday, March 29, 2019.
After invoking Article 50, Mrs. May’s government undertook negotiations with EU representatives over the terms of the U.K.’s withdrawal from the EU. In December 2018, the negotiating parties reached an agreement for the terms of the U.K.’s withdrawal. This withdrawal agreement has been presented to the U.K. House of Commons for a vote on two occasions, for the first time in January and more recently this past Tuesday, and each time the agreement has been voted down. On March 14, 2019, with the March 29 withdrawal date looming, the House of Commons voted for Mrs. May to ask the EU for an extension of the deadline, presumably until June. Brexit remains deeply divisive within Parliament, and a great deal of uncertainty remains.
As the Brexit process has been unfolding in recent months, U.S. securities regulators have issued calls for U.S.-listed companies to keeping their shareholders informed of their management’s assessment of Brexit and the possible impact it could have on company operations. For example, as discussed here, in November 2018, SEC Chair Jay Clayton issued a call for companies to share their views about Brexit with the investment community.
In his March 15, 2019 speech to the 18th Annual Institute on Securities Regulation in Europe, in London, SEC Finance Division Director Hinman provided a more detailed outline for the kinds of disclosures companies should be considering with respect to Brexit.
Hinman opened his remarks by noting that the SEC has “a keen interest in the quality of disclosure that is being provided by the many issuers for which Brexit may have a material impact.” He also noted that for months the SEC has been stressing the “the need for more robust public company disclosure about how companies are considering Brexit and its possible impact on their business and operations.” Hinman emphasized that these concerns are not limited just to U.K.- or even EU-based companies, and that in fact the vast majority of reporting companies these days have extensive international operations and business relationships that potentially could be affected by the Brexit process.
In order to provide some guidance for companies trying to address these issues in their public disclosures, Hinman laid out what he described as a “principles-based” approach to the Brexit disclosure issues. The point of this approach is that investors “are better served by understanding the lens through which each company’s management looks at its exposure.” Subject to materiality requirements, a company’s Brexit disclosure “should provide tailored insight into how management views the risks posed to the business and operations and what actions they are taking to address the issue.”
With these objectives in mind, Hinman then provided a short checklist of six items for companies to consider in assessing and crafting their Brexit-related disclosure. As the Cooley law firm noted in a March 15, 2019 post on its PubCo blog (here), Hinman’s checklist “offers a very useful cheat sheet of good questions to consider in crafting appropriately tailored disclosure.”
The items Hinman identifies are as follows – please note that his discussion of each of these items is more detailed than summarized here, but his discussion of these items is worth considering in full, rather than just in summary form as set out here. The six items Hinman identified are:
- Is the business exposed to new regulatory risk given the uncertainty of which set of laws and regulations will apply and whether transition agreements will be in place?
- Are there significant supply chain risks due to the potential disruption to the U.K.’s access to free trade agreements with other nations and any resulting changes in tariffs to exports or imports?
- Does the company face a material risk of losing customers, a decrease in sales or revenues or an increase in costs due to tariffs or other factors? Is the demand for the company’s product especially sensitive to exchange rates or changes in tariffs?
- Does the company have exposure to currency devaluation, foreign currency exchange rate risk or other market risk?
- What is the company’s exposure to contractual risk in the face of Brexit? Has the company undertaken a review of its existing contracts with counterparties in the U.K. or the EU to determine whether renegotiation or termination is necessary in light of contractual obligations?
- Do Brexit-related issues affect financial statement recognition, measurement or disclosure items, such as inventory write-downs, impairments, collectability of receivables, assumptions underlying valuations, foreign currency matters, hedge accounting, or income taxes?
The one thing this list highlights is how fraught with peril the Brexit process is, with all of that peril magnified by the continuing uncertainty. Of course, it remains to be seen how the Brexit process will finally unfold and how it ultimately will affect companies business operations and results. It may well be that some of the worst possibilities will never materialize.
However, if there is any Brexit-related disturbance in the months ahead, particularly if Brexit-related events cause supply chain disruption, financial transaction dislocation, or currency exchange or tariff charge commotion, companies’ operating results could be affected, which in turn could trigger adverse investor reactions.
If Brexit-related events cause operational or financial reporting issues, the affected companies’ prior Brexit-related disclosures undoubtedly will be closely scrutinized. All of this creates a context within which opportunistic plaintiffs’ lawyers might seek to assert hindsight allegations that the companies failed to warn investors about possible problems that might emerge. Given these possibilities, Hinman’s disclosure checklist may be all that much more important for companies trying to reduce the chance of future Brexit-related disclosure claims.
In the current circumstances, there may be limited opportunities for companies to reduce the uncertainties surrounding Brexit. However, in light of the items Hinman identified in his speech, there may at least be ways for companies to try to reduce the possibilities of later Brexit-related disclosure claims.
Sustainability Disclosure Issues: In his discussion of principles-based disclosure, Hinman also addressed the topic of company disclosure regarding sustainability issues. Hinman emphasized that to date the SEC has refrained from mandating a prescriptive model for sustainability disclosures, instead allowing the marketplace to evolve disclosure standards. The SEC, Hinman emphasized, is wary of imposing bright-line disclosure requirements that might increase costs without providing relevant and material information to investors and others.
Hinman emphasized that under the principles-based disclosure requirements, the objective is to allow investors to see the company “through the eyes of management,” and along those lines, Hinman suggests that for companies considering their disclosure of sustainability related issues, the company should consider evaluating its disclosure relative to the disclosure that management provides the board.
With respect to climate change-related disclosures specifically, Hinman referred to the SEC’s 2010 Guidance Regarding Disclosure Related to Climate Change, which discussed climate change-related disclosure issues in light of the agency’s existing disclosure requirements. Hinman emphasized that the agency’s approach to climate change disclosure is consistent with its requirements concerning cybersecurity-related issues. Hinman emphasized that companies vulnerable to severe weather or climate-change events “should consider disclosing the material risks of, or consequences from, these events.” Hinman also emphasized that disclosure requirements include the board’s risk oversight, and that company disclosure should discuss the nature of the board’s role in overseeing the management of climate-related risks.