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MD&A’s Makeover, Part I: Proposed Amendments to Financial Disclosure Requirements in Regulation S-K

The Securities and Exchange Commission (SEC) has proposed amendments to simplify and enhance certain financial disclosure requirements in Regulation S‑K. The proposed amendments, released January 30, 2020, would eliminate Items 301 (Selected Financial Data), 302 (Supplementary Financial Information) and 303(a)(5) (Tabular Disclosure of Contractual Obligations in MD&A) of Regulation S‑K, and revise a number of disclosure obligations under Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations).

The proposed amendments are part of an ongoing re-evaluation of the current disclosure regime per the SEC’s recommendation in the Report on Review of Disclosure Requirements in Regulation S‑K, which was mandated by Section 108 of the JOBS Act, adopted in 2012. Their aim is to eliminate certain duplicative disclosures and modernize and enhance Management’s Discussion and Analysis (MD&A) disclosures for the benefit of investors while reducing the compliance burden on companies. We discuss the key features of the proposed amendments in greater detail below.

In addition, the SEC simultaneously issued interpretive guidance regarding the disclosure of key performance indicators (KPIs) and metrics in MD&A. This guidance is discussed in Part II of this two-part “MD&A’s Makeover” alert.

Proposed Amendments to Financial Disclosure Requirements in Regulation S‑K

The proposed amendments include the key changes identified below, among others (including corresponding amendments applicable to foreign private issuers and smaller reporting companies). We have also identified the SEC’s primary rationale for the proposed changes.

Proposed Deletions

Regulation S‑K

Item 301, Selected Financial Data

Item 302, Supplementary Financial Data

Item 303(a)(5), MD&A – Contractual Obligations

Items 301, 302 and 305(a) would be eliminated and companies would no longer be required to provide:

  • Five years of selected financial data (301)
  • Two years of selected quarterly financial data (302)
  • Information regarding oil and gas-producing activities (302)
  • A contractual obligations table (303)(a)(5)

Rationale: Reduce duplicative disclosure and encourage companies to take a more principles-based approach in presenting the relevant information. Information regarding prior periods remains available to investors, as previous filings remain available on EDGAR and the information is tagged using XBRL format. Information covered by the contractual obligations table is expected to be covered by the financials and the expanded capital resources disclosure.

Proposed Additions and Amendments

Regulation S‑K

Item 303 (General), Management’s Discussion & Analysis of Financial Condition and Results of Operations

A new paragraph 303(a) would be created to clarify the objective of MD&A and streamline the instructions. Specifically, the rule would incorporate the substance of Instructions 1, 2 and 3 to emphasize the objective of MD&A at the outset and codify guidance from the SEC's 2003 MD&A Interpretive Release (the 2003 Guidance) stating that a company should provide a narrative explanation of the company’s financial statements that allows investors to see it “through the eyes of management.” Additionally, the rule would include product lines as an example of a subdivision of a company’s business (along with geographic areas) that should be discussed when the company believes necessary to understand its business.

The current Item 303(a) would be moved to Item 303(b) and would clarify that MD&A requires a narrative discussion of the “underlying reasons” for material changes from period-to-period rather than just the “cause” for material changes.

Lastly, the SEC has proposed several amendments to further streamline the text of Item 303, including clarification in 303(a) that companies may combine their discussions of liquidity and capital resources when the topics are interrelated as well as the elimination of Instructions 13 and 14.

Rationale: Remind companies that the general purpose of MD&A is to provide both a historical and prospective analysis of the company’s financial condition and results of operations, with particular emphasis on prospects for the future. Principles-based approach is employed to elicit disclosure about complex and rapidly evolving areas without the need to continuously amend the text of the rule. The addition of product lines is intended to provide additional clarity on the types of subdivisions that may require separate disclosure.

Regulation S‑K

Item 303(a)(2), MD&A – Capital Resources

Item 303(a)(2) would be expanded to require disclosure of known material cash requirements, including commitments for capital expenditures.

Rationale: Consistent with the 2003 Guidance and intended to modernize requirements in light of the types of expenditures and cash commitments other than capital investments in property, plant and equipment that may be increasingly important, especially for companies for which human capital or intellectual property are key resources.

Regulation S‑K

Item 303(a)(3)(ii), MD&A – Results of Operations – Known Trends and Uncertainties

Item 303(a)(3)(ii), which requires disclosure of known trends and uncertainties, would be revised to require disclosure of known events that are reasonably likely to cause (as opposed to will cause) a material change in the relationship between costs and revenues, such as known or reasonably likely future increases in costs of labor or materials or price increases or inventory adjustments.

Rationale: Conform language to other Item 303 disclosure requirements for known trends and align Item 303(a)(3)(ii) with prior guidance on forward-looking disclosure.

Regulation S‑K

Item 303(a)(3)(iii), MD&A – Results of Operations – Net Sales and Revenues

Item 303(a)(3)(iii) would be revised to require disclosure of material changes (as opposed to material increases) in net sales or revenue.

Rationale: Codify prior guidance.

Regulation S‑K

Item 303(a)(3)(iv), MD&A – Results of Operations – Inflation and Price Changes

Item 303(a)(3)(iv), as well as Instructions 8 and 9 to Item 303(a), would be eliminated and companies would no longer be required to discuss the impact of inflation and price changes on their net sales, revenues and income for the three most recent fiscal years.

Rationale: Lessen undue attention to inflation and changing prices.

Regulation S‑K

Item 303(a)(4), MD&A – Off-Balance Sheet Arrangements

Item 303(a)(4) would be replaced with a new instruction to 303(b) that would require companies to discuss commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons that have, or are reasonably likely to have, a material current or future effect on the company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements or capital resources.

Rationale: Avoid boilerplate or disjointed disclosure.

Regulation S‑K

New Item 303(b)(4), MD&A – Critical Accounting Estimates (Proposed New Rule)

Item 303(a) (which would become Item 303(b)) would be amended to include a subsection (4) requiring disclosure of critical accounting estimates in MD&A. A critical accounting estimate would be defined as an estimate made in accordance with generally accepted accounting principles that involves a significant level of estimation uncertainty and has had or is reasonably likely to have a material impact on the company’s financial condition or results of operations. For each critical accounting estimate, the proposed rule would require companies to disclose, to the extent material, why the estimate is subject to uncertainty, how much each estimate has changed during the reporting period, the sensitivity of the reported amounts to the material methods, assumptions and estimates underlying the estimate’s calculation.

Rationale: Clarify the disclosures required to address any critical accounting estimates, reduce boilerplate or duplicative disclosures, and provide investors with material information regarding critical accounting estimates. Disclosure intended to provide greater insight on the uncertainties involved in creating and applying an accounting policy and how significant accounting policies of companies faced with similar circumstances may differ.

Regulation S‑K

Item 303(b) and New Item 303(c), MD&A – Interim Periods

Item 303(b) (to be renumbered 303(c)) would be revised to allow companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as currently required) or the immediately preceding quarter. If a company elects to compare its results to the immediately preceding quarter, the rule would require it to provide summary financial information that is the subject of the discussion for that quarter or identify the prior EDGAR filing that presents such information so investors have ready access to the relevant prior quarter financial information. Furthermore, if a company changes the comparison from its approach in the prior quarter, the company would be required to explain the reason for the change and present both comparisons in the filing where the change is announced.

The SEC is also proposing additional amendments to simplify the current 303(b)(proposed Item 303(c)), including the elimination of the language that states that companies need not provide a discussion of the impact of inflation and changing prices.

Rationale: Grant companies additional flexibility to provide an analysis that they believe is most relevant to an understanding of the frequency and amplitude of past business cycles while also ensuring that investors have appropriate information to assess the comparisons being presented.

Regulation S‑K

Item 303(c), MD&A – Safe Harbor for Forward-Looking Information

Current Item 303(c), which confirms the application of the statutory safe harbors to Off-Balance Sheet Arrangements and the Tabular Disclosure of Contractual Obligations, would be eliminated.

Rationale: Conforming change in light of the elimination of 304(a)(4) and 304(a)(5). This will not alter the availability of the regulatory safe harbors in Securities Act Rule 175 and Exchange Act Rule 3b-6.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.

TRENDING LEGAL ANALYSIS


About this Author

Elizabeth A. Diffley, Corporate, Securities Attorney, Drinker Biddle, Law Firm
Partner

Elizabeth A. Diffley is an accomplished and pragmatic advisor to public and private clients on corporate and securities matters, including corporate governance, capital raising transactions, public company reporting and compliance, and mergers and acquisitions, as well as general corporate matters. Knowledgeable across a broad range of industries, Beth has particular experience advising insurance and other financial services companies on a variety of securities, mergers and acquisitions, governance and general corporate matters.

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Caroline Henry Associate Corporate Group Mergers & Acquisitions
Associate

Caroline Henry* represents public and private clients in a variety of corporate and securities matters. Her experience includes public company reporting and compliance, mergers and acquisitions, public and private capital raising transactions, and governance and general business counseling.

*Admitted in Illinois only. New York bar admission pending.

212-248-3151
Marc Leaf, Corporate lawyer, Drinker Biddle
Partner

Marc A. Leaf is Regional Partner in Charge of the New York office of Drinker Biddle, and a trusted counselor and adviser to senior government officials, corporate leaders, and independent directors. An experienced and practical dealmaker with a proven record of success, Marc helps issuers and investors in technology, media, telecom and other industries achieve their goals in capital raising transactions, business combinations, and joint ventures.

Prior to joining Drinker Biddle, Marc served on the Executive Staff of the U.S....

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