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Russia-Ukraine Disclosures And Supply Chain Issues

Supply chain issues continue to plague just about every industry and the continuing attack by Russia against the Ukraine, gives little hope of a respite in the near future.  The recent easing of congestion at the handful of U.S. ports big enough to accommodate container ships is likely more a result of inflation and a summer slowdown than effective logistical management.  Amid the ongoing difficulties, the SEC has published a sample letter to companies regarding disclosures pertaining to Russia’s invasion of the Ukraine and related supply chain issues.

SEC Sample Comment Letter

The SEC is of the view that companies should provide detailed disclosure, to the extent material or if required by a prescriptive rule, regarding: (i) direct or indirect exposure to Russia, Belarus, or Ukraine through their operations, employee base, investments in Russia, Belarus, or Ukraine, securities traded in Russia, sanctions against Russian or Belarusian individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting Russia or Belarus; (ii) direct or indirect reliance on goods or services sourced in Russia or Ukraine or, in some cases, in countries supportive of Russia; (iii) actual or potential disruptions in the company’s supply chain; or (iv) business relationships, connections to, or assets in, Russia, Belarus, or Ukraine.

In addition, a company may need to include financial statement disclosures where appropriate.  Examples of potential financial statement items include: (i) impairment of assets; (ii) changes in inventory valuation; (iii) deferred tax asset valuation allowances; (iv) disposal or exiting of business expenses or write-offs; (v) de-consolidation; (vi) changes in exchange rates; (vii) amendment to significant contracts; or (viii) changes in the ability to collect contract considerations or receivable.  Furthermore, since Russia’s invasion of Ukraine, many companies have experienced heightened cybersecurity risks, increased or ongoing supply chain challenges, and volatility related to the trading prices of commodities regardless of whether they have operations in Russia, Belarus, or Ukraine that warrant disclosure.

Adding to the complexity of considerations, companies should consider how these matters affect management’s evaluation of disclosure controls and procedures, management’s assessment of the effectiveness of internal control over financial reporting, and the role of the board of directors in risk oversight of any action or inaction related to Russia’s invasion of Ukraine, including consideration of whether to continue or to halt operations or investments in Russia and/or Belarus. The SEC expects affirmative disclosures related to the impact on both disclosure controls and procedures and internal controls over financial reporting.  In addition, a company should describe the role of the board of directors in overseeing risks related to cybersecurity, sanctions, employees based in affected regions, and supply chain/suppliers/service providers in affected regions as well as risks connected with ongoing or halted operations or investments in affected regions.

In addition to describing the board’s role in cybersecurity risk management, a company should disclose any new or heightened risk of potential cyberattacks by state actors or others which could be related to Russia’s invasion.

Generally, the sample comment letter requests additional information on any impact: (i) resulting from sanctions, limitations on obtaining relevant government approvals, currency exchange limitations, or export or capital controls, including the impact of any risks that may impede your ability to sell assets located in Russia, Belarus, or Ukraine, including due to sanctions affecting potential purchasers; (ii) resulting from the reaction of your investors, employees, customers, and/or other stakeholders to any action or inaction arising from or relating to the invasion, including the payment of taxes to the Russian Federation; and (iii) that may result if Russia or another government nationalizes your assets or operations in Russia, Belarus, or Ukraine.

Management’s discussion and analysis of financial condition and results of operations will require significant consideration for any company that is directly or indirectly impacted by the Russian-Ukraine world events.  The SEC sample comment letter requests disclosure of any known trends or uncertainties that have had or are reasonably likely to have a material impact on your cash flows, liquidity, capital resources, cash requirements, financial position, or results of operations arising from, related to, or caused by the global disruption from, Russia’s invasion of Ukraine. Trends or uncertainties may include impairments of financial assets or long-lived assets; declines in the value of inventory, investments, or recoverability of deferred tax assets; the collectability of consideration related to contracts with customers; and modification of contracts with customers.

In addition, enhanced critical accounting estimate disclosures related to impairment of assets, valuation of inventory, allowance for bad debt, deferred tax asset valuation allowance, or revenue recognition is being requested including both qualitative and quantitative information.  Accounting disclosures should address:

  • Why the critical accounting estimate is subject to uncertainty, including any new uncertainties related to the estimate, such as the asset, customer, or supplier is located in or reliant upon business(es) or operations in [Russia/Belarus/Ukraine];
  • The method used to develop the estimate and the significant assumptions underlying its calculation, such as discounted cash flow and the discount rate assumption;
  • The degree to which the estimate and the underlying significant assumptions have changed over the current period or since the last assessment, including due to effects of changing prices, changes in exchange rates, changes in estimated cash flows due to loss of operations, etc.; and
  • The sensitivity of the reported amount to the method and assumptions underlying its calculation. For example, if the cash flow estimates used were based on assumptions about the invasion or sanctions and those assumptions could significantly impact the estimate, then that should be disclosed along with how sensitive the estimate is to changes in those assumptions.

Also, in MD&A the SEC would like to see enhanced disclosure on the material impacts of import or export bans resulting from Russia’s invasion of Ukraine on any products or commodities, including energy from Russia, used in the business, or sold by the business.  Disclosure should include the anticipated impact on the business, taking into account the availability of materials, cost of needed materials, costs and risks associated with transportation in the business, and the impact on margins and on customers.

Concluding the MD&A related comments, the SEC seeks additional information on business segments, products, lines of service, projects, or operations that are materially impacted by supply chain disruptions, especially in light of Russia’s invasion of Ukraine.  For example, companies should consider disclosure on: (i) the suspension of production, purchase, sale or maintenance of items; (ii) higher costs due to constrained capacity, increased commodity prices or challenges in sourcing materials; (iii) surges or declines in consumer demand for which the company cannot adequately adjust supply; (iv) inability to supply products at competitive prices or at all due to export restrictions, sanctions or the ongoing invasion; or (v) exposure to supply chain risk or plans to de-globalize the company’s supply chain.  A company should also discuss efforts to mitigate the impacts of these issues to its business.

Many companies have included non-GAAP information in their filings to adjust for estimated lost revenue, expenses and other financial impacts resulting from the Russian invasion of Ukraine.  The SEC reminds companies of their obligation to comply with Regulation G and the various C&DI issued on the use of Non-GAAP measures.  For more information on Regulation G and SEC C&DI, see HERE.

Supply Chain Thoughts

The SEC comment letter doesn’t provide a lot of advice on how management should be thinking through supply chain issues – this got me thinking about how to advice clients on this complex issue.  Although it seems axiomatic, the first thing high level management and the board of directors needs to do is understand their particular supply chain structure (they will need to do the same for climate-related disclosures).  That is not as easy as it sounds.  In today’s globalized world, companies may have supply chains that not only span the globe, but that also includes value added steps along a multi-tiered chain of suppliers feeding suppliers.

For companies with multiple locations, the supply chain can be even trickier especially where local management makes certain supply chain decisions, or even a centralized management breaks up sourcing based on geographical areas.

Moreover, part of understanding the supply chain structure is understanding the logistical issues.  It is relatively easy to know how a direct supplier moves and delivers product to a company user, but what about how your supplier is receiving their supply – and importantly, what is their supply (are they an OEM receiving parts and pieces from several different sources?).  I say “relatively easy” because many companies are not overly familiar with their own direct logistic process.  The largest importers (Walmart, Target, etc.) are able to maintain a workforce in China and other manufacturing locations to oversee the packaging and loading of materials on a container ship headed to the U.S.  But what about a small Nasdaq life science company utilizing a variety of items sourced from China, Taiwan, Italy and Korea for its research?

A board should then follow up with poking holes at the structure and finding the pain points and vulnerabilities.  That follows with plan B – backup sourcing or contingencies for designing or proceeding around delayed supplies.  Historically, manufacturing and sourcing moved to China and other countries because the cost was significantly lower.  I think that will change.  Between the increased costs associated with decarbonization and ESG reporting and the lack of political reliability, buying and sourcing locally will now be the competitive alternative.

The Author

Laura Anthony, Esq.
Founding Partner
Anthony L.G., PLLC
A Corporate Law Firm

Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service.  The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

Ms. Anthony is a member of various professional organizations including the Crowdfunding Professional Association (CfPA), Palm Beach County Bar Association, the Florida Bar Association, the American Bar Association and the ABA committees on Federal Securities Regulations and Private Equity and Venture Capital. She is a supporter of several community charities including siting on the board of directors of the American Red Cross for Palm Beach and Martin Counties, and providing financial support to the Susan Komen Foundation, Opportunity, Inc., New Hope Charities, the Society of the Four Arts, the Norton Museum of Art, Palm Beach County Zoo Society, the Kravis Center for the Performing Arts and several others. She is also a financial and hands-on supporter of Palm Beach Day Academy, one of Palm Beach’s oldest and most respected educational institutions. She currently resides in Palm Beach with her husband and daughter.

Ms. Anthony is an honors graduate from Florida State University College of Law and has been practicing law since 1993.

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