The SEC is watching — Part 2: Brexit disclosures

Part 1 of this series focused on cybersecurity disclosures. In this installment, we look at Brexit disclosures, and in Part 3, we’ll turn our focus to LIBOR phaseout disclosures.

Brexit disclosure review is another one of the SEC’s key priorities in 2019, especially in light of the uncertainty surrounding yet another delay of the United Kingdom’s (U.K.) withdrawal from the European Union (EU) until October 31, 2019. This uncertainty centers around the legal, political, and economic implications of whether still another delay will follow to allow for more negotiations or whether the proposed deal will be overturned or modified and around what the actual effects of Brexit will be on companies, investors, and the financial markets.

Companies are finding that they must prepare for different outcomes, mitigating the risk of whatever outcome they may face, and investors should be in the know about the nature and extent of those risks and about the steps that companies are taking to prepare for them. To that end, SEC Staff, through their guidance and comment letters, attempt to steer registrants away from boilerplate and other commonplace disclosures that might apply to any company and towards disclosures tailored to their business and operations.

Brexit disclosure, disclosure, disclosure

The SEC and its Staff have been consistent in their message regarding the need for companies to disclose material risks associated with Brexit along with anticipated effects on business. In fact, SEC Division of Corporation Finance (Corp Fin) Chief Accountant Kyle Moffatt echoed that sentiment at the Current Financial Reporting Issues Conference in New York in November 2018, as did SEC Chairman Jay Clayton in December 2018 in a speech covering, among other topics, challenges posed by Brexit. Corp Fin Director William Hinman also followed suit in a speech that he delivered to the 18th Annual Institute on Securities Regulation in Europe in March 2019 (available on Thomson Reuters Checkpoint), in which he acknowledged that Brexit disclosures will certainly vary across companies and industries, but emphasized that “merely stating that Brexit presents a risk, that the outcome is uncertain and that it could materially and adversely impact the business and its operations” won’t cut it.

Mr. Hinman went on to mention some of the questions that SEC Staff will likely have in mind when evaluating Brexit disclosures in your Securities Exchange Act periodic reports, including:

• Whether your business is 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, noting, for example, that biopharmaceutical companies with substantial U.K. operations face risks concerning how their products and clinical trials will be regulated and that airlines face risks that potential restrictions on flying rights or changes in administration of antitrust laws may negatively impact their joint ventures;
• The existence of significant supply chain risks for your business due to the potential disruption to the U.K.’s access to free trade agreements with other nations;
• Whether you’re materially at risk of losing customers, a decrease in sales or revenues or an increase in costs due to tariffs or other factors;
• Your exposure to currency devaluation, foreign currency exchange rate risk or other market risk;
• Whether you’ve undertaken a review of existing contracts with counterparties in the U.K. or the EU to determine whether renegotiation or termination is necessary in light of material contractual obligations; and
• Whether Brexit-related issues affect financial statement recognition, measurement or disclosure items, such as inventory write-downs and hedge accounting.

Brexit disclosures under scrutiny

To help you understand what the SEC expects when it comes to the level of Brexit disclosure, below are three such disclosures that were the subject of SEC comments.  Each case highlights the company’s original disclosure, the SEC’s comments and the company’s response, and in each one, SEC Staff didn’t raise any issue with the company’s response.  This will hopefully help to drive home the importance of these disclosures being detailed enough to enable investors to evaluate material risks posed by Brexit.

1) Pear Tree Funds (Post-Effective Amendment to Registration Statement on Form N-1A filed May 31, 2019)

• Original disclosure: The “Additional Information About Investment Objectives, Strategies and Risks” section covering pages 26 through 40.

• SEC oral comments provided on July 11, 2019: “With respect to each of Foreign Value Fund and Foreign Value Small Cap Fund, the schedule of investments as of March 31, 2019, which comprises part of the Registrant’s certified shareholder report on Form N-CSR as filed with the Commission on June 5, 2019, shows that as of March 31, 2019, Foreign Value Fund invested in U.K. securities representing approximately 16.3 percent of its net assets, and Foreign Value Small Cap Fund invested in U.K. securities representing approximately 17.8 of its net assets. Please add risk disclosure to the Prospectus for those two funds that is specific to U.K. securities (e.g., the potential impact of Brexit) or explain why such additional disclosure is not appropriate.”

• Company response filed July 26, 2019: “The Registrant believes that adding disclosure to the Prospectus for each of Foreign Value Fund and Foreign Value Small Cap Fund that is specific to U.K. risks would be inappropriate. The Registrant notes that neither fund has a stated principal investment strategy of investing a significant percentage of its assets in U.K. securities. In addition, the percentages of securities invested by each fund in specific established markets, such as Japan and Germany, has varied significantly over time. Finally, the Registrant does not believe that, as a general matter, U.K. securities pose specific risks to either fund or that there has been significant adversity in the U.K. market from June 2016 – the time of the Brexit referendum – to the present to warrant specific risk disclosure relating to Brexit. In fact, the FTSE 100 has increased approximately 22 percent over that period.”

2) Unisys Corporation (Form 10-K filed March 4, 2019)

• Original disclosure (Risk Factors, page 10): The company has significant pension obligations and required cash contributions and may be required to make additional significant cash contributions to its defined benefit pension plans. The company has significant unfunded obligations under its U.S. and non-U.S. defined benefit pension plans. In 2018, the company made cash contributions of $129.7 million to its worldwide defined benefit pension plans. Based on current legislation, global regulations, recent interest rates and expected returns, in 2019 the company estimates that it will make cash contributions to its worldwide defined benefit pension plans of approximately $105.6 million, which are comprised of approximately $67.2 million for the company’s U.S. qualified defined benefit pension plans and approximately $38.4 million primarily for non-U.S. defined benefit pension plans. Although estimates for future cash contributions are likely to change based on a number of factors including market conditions and changes in discount rates, the company currently anticipates that its required cash contributions will increase in 2020 and for the next several years.
• SEC comments filed April 8, 2019: “Considering your operations in the United Kingdom (“U.K.”) as well as the U.K. pension plan, please tell us what consideration was given to including risk factor disclosure for Brexit.”
• Company response filed April 18, 2019: “The Company did give consideration to including risk factor disclosure for Brexit. While we believe the risk factors outlined in the Company’s Form 10-K generally address the uncertainties and risks associated with possible events such as Brexit, including, global economic, trade and regulatory uncertainty, we intend to add the following risk factor to our next quarterly report on Form 10-Q: The impact of Brexit could adversely affect the company’s operations in the United Kingdom as well as the funded status of the company’s U.K. pension plans. The impact of the decision by the United Kingdom to withdraw from the European Union, commonly referred to as “Brexit”, and the resulting effect on the political and economic future of the U.K. and the European Union is uncertain. Depending on the outcome, the company may decide to alter its European operations to respond to the new business, legal, regulatory, tax and trade environments that may result, which may adversely affect the company’s financial results. In addition, uncertainty regarding Brexit could cause a slowdown in economic activity in the U.K., the European Union or globally. As a result of these possible effects, among others, Brexit could adversely impact the company’s operations in the U.K., cause increased volatility in the measurement of the pension assets or benefit obligations in the company’s U.K. pension plans, as well as adversely affect the funded status of the company’s U.K. pension plans.”

3) Forethought Variable Insurance Trust (Post-Effective Amendment to Registration Statement on Form N-1A filed February 12, 2019)

• Original Disclosure: Portfolio summaries and “Principal Investment Risks” section covering pages 1-66 and 69-81, respectively.
• SEC oral comments provided on March 25, 2019: “Please confirm whether any of the Portfolios invest in securities from the European Union (“EU Securities”). If so, please include disclosure regarding the risks associated with Brexit in the applicable Portfolio’s Item 4 Principal Investment Risks section and in the Item 9 Principal Investment Risks section.”
• Company response filed April 18, 2019: “Registrant confirms that certain of the Portfolios that invest in foreign securities may invest in EU Securities. Registrant further confirms that Global Atlantic BlackRock Selects’ and Global Atlantic Franklin’s overall exposure to EU Securities may be significant. Accordingly, Registrant has revised Foreign Investment Risk in the Item 4 Principal Investment Risk section for Global Atlantic BlackRock Selects and Global Atlantic Franklin to add the following language: Ongoing concerns regarding the economies of certain countries in Europe, as well as the possibility that one or more countries could leave the European Union (the “EU”), create risks for investing in the European markets. These risks may be heightened due to the June 2016 referendum in which the United Kingdom (“UK”) voted to exit the EU (commonly known as “Brexit”). Although the full impact of Brexit is not yet known, the impact on the UK, EU and global markets could include increased volatility and illiquidity, potentially lower economic growth and decreased asset valuations, as well as significant economic, legal and political uncertainty as the UK navigates its exit from the EU.” The company also revised the “Foreign Investment Risk” subsection in Item 9’s “Principal Investment Risks” section to add similar language.

Takeaway

Registrants, you should reflect on the above and other SEC comments and company responses (available on Thomson Reuters Checkpoint) as you prepare your Brexit disclosures. And stay tuned for the next and final installment covering LIBOR phaseout disclosures.