SEC Urges Inflation Risk Disclosures as Price Increases Persist

It’s on the minds of everyone from central bankers to shoppers paying bigger grocery bills. Inflation now needs to be top of mind for companies as they draw up their financial statements, US regulators are telling them.

The Securities and Exchange Commission is reminding companies as diverse as childcare provider Bright Horizons Family Solutions Inc., chip maker Nvidia Corp., tobacco company Philip Morris International Inc., and others that they need to spell out to investors and analysts how inflation affects their bottom lines. The SEC wrote to companies, telling them to reveal in future filings how inflationary pressures impact areas like operations, cash flows, liquidity, and pricing.

Companies are rusty on disclosing details about inflation, largely because there hasn’t been much of it for decades. In 1980, during a period of rapid inflation, the SEC mandated that companies discuss inflation in their financial statements, but it scaled back the requirement six years later to an instruction to discuss it only if the effect of inflation was “material.”

In 2020, the SEC went further. In a wide-ranging cleanup of SEC regulations, the agency removed references to inflation and price changes. Instead, companies would only have to disclose these issues if they were part of a known trend or uncertainty that has had a material favorable or unfavorable impact on net sales, or revenue, or income from continuing operations.

“Companies weren’t addressing inflation because it wasn’t anything impacting them,” said Tim Kviz, national managing partner at BDO USA LLP. “And sure enough, no sooner does the SEC remove the requirement, and then inflation rears its ugly head for first time in 40 years.”

Talking Inflation

Inflation soared to 9% in June 2022, with prices of cars, gas, and groceries jumping. The inflation rate steadily eased through most of 2023, but reversed course in July. Prices rose 3.2% in July, up from the 3% reported in June, according to Bureau of Labor Statistics data.

The word is on the lips of company executives: They said “inflation” more than a thousand times in earnings calls for S&P 500 companies over the past 30 days, according to Bloomberg earnings call transcripts. During the same period in 2020, “inflation” popped up just over one hundred times, transcripts show.

Which leads to the SEC’s next point of interest: If companies deem inflation important enough to flag in an earnings call or an investor presentation, they had better mention it in their financial statement risk factors or in the management’s discussion and analysis section of their filings, BDO’s Kviz said.

“Are they absorbing the costs? Are they passing them through in the form of price changes? How is this affecting the longer-term trends? If they’re addressing it in the calls but not in the filings, that’s an area that’s likely to trigger a comment,” Kviz said. “It just so happens right now that inflation is the topic du jour.”

The agency’s Division of Corporation Finance reviews company filings at least once every three years, but reviews some companies more frequently. Reviewers zoom in on issues like disclosure transparency, misleading financial metrics, or adherence to accounting rules, and send letters asking questions. The SEC publicly releases the correspondence 20 business days after a review concludes.

In Search of Specifics

Companies don’t have to write dissertations in their financial statements about inflation, said Cheryl Linthicum, accounting professor at the University of Texas at San Antonio’s school of business. They should be as specific as they can, though.

“You say inflation matters; tell us exactly what it matters for,” said Linthicum, who served two stints at the SEC as an academic fellow. “Is it the price of all your products? Is it a cost of a key commodity? If so, which commodity? What’s the percentage increase? How much do you think that will impact your bottom line, or how much has it impacted your bottom line?”

Philip Morris, in its latest 10-Q published in July after receiving the SEC letter, included three new paragraphs in the Management’s Discussion & Analysis section to describe how increasing costs of certain materials and higher energy and transportation costs would likely add $500 million in extra expenses for the year. The company said it expected to offset those expenses through pricing and negotiating with suppliers, holding tobacco leaf inventory longer, and using hedging strategies.

After its SEC letter, Bright Horizons supplemented its existing disclosures about tuition and wages with information about the impacts of tuition increases and paying higher wages to workers, according to its 10-Q published Aug. 8.

Nividia told the SEC said it would identify the principal factors contributing to the inflationary pressures and spell out any actions to mitigate inflationary pressures. The company has not yet filed its third-quarter 10-Q.

The impact will vary from company to company. While plenty of companies have felt the pinch of higher prices, some may be insulated because of locked-price contracts for fuel or other key supplies. In those cases, companies should disclose what they expect to happen when the contracts expire, Linthicum said.

Companies also have to be transparent about the ripple effect of inflation: increases in prices they charge their customers. Those price increases could be a temporary boost to earnings if corresponding costs don’t rise as swiftly—and the SEC will be paying attention.

“There’s just a zinger waiting for some companies there,” Linthicum said.