July 28, 2022
July 28, 2022
Over the past two years, public companies in the United States have faced an unpredictable risk environment. Two geopolitical crises—the COVID-19 pandemic and the Russian invasion of Ukraine—strained international supply chains and destabilized financial markets. It is tempting to view these events as temporary departures from the stable climate for international commerce of the past 75 years. There are reasonable grounds for that position. After all, COVID-19 was the first global pandemic since 1918, and the conflict in Ukraine marks the first large-scale conventional conflict in Europe since World War II. Geopolitical instability, however, may be the new normal. Companies must therefore consider how the resulting risks from such events impact them, and for public companies, whether and how to disclose such information to shareholders.
As these events have unfolded, the US Securities and Exchange Commission (SEC) has provided guidance in various forms as to what it expects in terms of disclosure by building on already existing requirements in the SEC’s Regulation S-K. Specifically, the SEC issued nonbinding guidance on COVID-19–related disclosures and later issued a sample letter focused on the conflict in Ukraine. Turning first to the 2020 pandemic guidance, the SEC staff identified a detailed list of COVID-19–related factors for issuers to examine in drafting future disclosures, including the following:
On May 3, 2022, the SEC issued the sample letter, and directly addressed the nexus between the Russia-Ukraine conflict and Regulation S-K. The sample letter informed issuers that the Ukraine conflict may trigger disclosure obligations for any “direct or indirect impact[s]” on operations, liquidity, supply chain, or assets, and advised issuers to specifically examine risks related to cybersecurity, supply chain integrity, and commodity price volatility. The SEC also advised companies to carefully review their sanctions compliance function. In addition, the sample letter paid particular attention to the role of the board of directors, emphasizing that companies should disclose the role of the board in “overseeing risks related to” the conflict. And, perhaps most significantly, the SEC placed increased focus on supply chain risk: the sample letter indicated that in future regulatory investigations, issuers could anticipate questions about whether supply chain risks flowing from Ukraine were adequately disclosed, and whether issuers undertook or considered efforts to “deglobalize” their supply chains.
Collectively the pandemic guidance and the sample letter provide issuers with the best available template for complying with SEC rules and regulations in the event that other potential disruption creates geopolitical instability. In particular, and just by way of example, issuers should consider the potential downstream risks of geopolitical tension between the People’s Republic of China (mainland China) and the Republic of China (Taiwan). In recent years, tensions between China and Taiwan—always high—have escalated, with the military and civilian leadership of both countries openly contemplating the outbreak of hostilities, and China acknowledging its intent to develop the military capabilities necessary to mount a full-scale invasion.
For issuers that depend on global supply chains, the potential impacts of a conflict between Taiwan and China are highly relevant, and, in light of the SEC’s pandemic guidance and sample letter, may require disclosure to investors. For example, even if the United States were to remain neutral, domestic issuers would still likely lose access to Taiwan and to all ports in China because both China and Taiwan have submarine and anti-ship missile capabilities sufficient to reach any commercial vessels that transit the area. The loss of access to Taiwan would, in turn, effectively eliminate the ability of domestic companies to manufacture products that rely on semiconductors, while the inability to access Chinese ports and exporters would create massive disruption for retailers, manufacturers, and other industries that rely on China for finished goods and raw materials.
To that point, several issuers already identify and disclose the risk of a conflict in the Taiwan Strait to their shareholders. Best Buy, for example, disclosed in its most recent 10-K filed on Mar. 18, 2022, that “further deterioration between Taiwan and China” could disrupt the manufacture of “hardware components in the region.” Similarly, Gravity Co. filed a Form 20-F on Apr. 28, 2022, that noted “a significant percentage of… revenue” came from customers in Taiwan, and therefore “an increase in tensions between Taiwan and China and the possibility of instability and uncertainty” could affect customer demand and the business in general. And Micron Technology, in its Mar. 30, 2022, Form 10-Q, disclosed “political and economic instability, including the effects of disputes between China and Taiwan” as a risk to international sales and operations.
Of course, we hope that all of the issues discussed above—the COVID-19 pandemic, Russia’s invasion of Ukraine, and the increasing tension in the relationship between China and Taiwan—come to an end. We also hope that the world is not entering into a period of more frequent and severe events causing geopolitical instability. Nonetheless, as issuers deal with a global environment that generates greater risks, companies that apply the SEC’s pandemic guidance and sample letter to their finances, supply chains, and operations during a crisis are more likely to issue disclosures that satisfy shareholders, avoid private civil litigation or reduce the likelihood that such litigation is successful, and withstand potential SEC scrutiny.
Richard Zelichov is a partner and Trevor T. Garmey is an associate at Katten Muchin Rosenman.