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SEC Proposes Revisions to Management’s Discussion and Analysis of Financial Condition and Results of Operations Disclosure Requirements

On January 30, 2020, the Securities and Exchange Commission (“SEC”) proposed a series of new amendments to the Regulation S-K requirements. The proposed amendments seek to modernize, simplify, and enhance certain financial disclosure requirements primarily by reducing duplicative disclosure and focusing issuers’ efforts on material information. The proposal would eliminate Items 301 and 302, which deal with selected financial data and supplementary financial data, respectively. The SEC’s primary focus is on Item 303. This item addresses disclosure requirements in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of issuers’ periodic reports (i.e., Forms 10-K and 10-Q) and registration statements.

The MD&A section is designed to do exactly what the name implies. It requires that public companies discuss their historical financial results, as well as “known trends…events or uncertainties that are reasonably likely” to have a material impact on liquidity, capital, sales, revenues or income. These disclosures are intended to provide shareholders and investors with the transparency they need to better understand a company’s financial statements. Among other things, the proposed amendments to Item 303 would:

  • Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
  • Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction to prompt registrants to discuss off-balance sheet arrangements in the broader context of MD&A;
  • Eliminate Item 303(a)(5), Tabular disclosure of contractual obligations, given the overlap with information required in the financial statements and to promote the principles-based nature of MD&A;
  • Add a new disclosure requirement to Item 303, Critical accounting estimates, to clarify and codify existing SEC guidance in this area; and
  • Revise the interim MD&A requirement in Item 303(b) to provide flexibility by allowing companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.

Although modifying and improving the MD&A section is part of the SEC’s current disclosure modernization initiative, it is by no means a new one. In 2003, the SEC released comprehensive guidance for drafting the MD&A section. Then, in 2008, the SEC came out with a detailed list of additional guidance, which has since been updated in 2009, 2010, 2012, 2013, 2014 and 2020 (through a separate January 30, 2020 interpretative release on disclosure of key performance metrics). The SEC is continuously attempting to achieve a balance between providing issuer transparency for investors, while simultaneously simplifying the task of drafting the MD&A for issuers. But when guidance is not heeded, the SEC may force disclosure. For example, in the 2008 guidance update, the SEC recommended that issuers include their critical accounting estimates (i.e., tax positions, goodwill impairment, and assessment of the fair value of shares related to share-based compensation) in several sections. However, the SEC has now proposed to add “critical accounting estimates” as a new disclosure requirement in MD&A. This disclosure is intended to supplement, not duplicate, the description of significant accounting policies or other disclosures in the notes to financial statements. This current proposal implies that issuers have not been following earlier guidelines, so the SEC is seeking to turn its recommendation into a new requirement.

The proposed amendments have not yet been published in the Federal Register. Comments should be received on or before the date that is 60 days after such publication.

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