Client Alert

U.S. SEC Adopts Changes to Streamline and Modernize Financial and MD&A Disclosures

25 Nov 2020

On November 19, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments intended to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K.[1] The SEC has eliminated the requirements to provide selected financial data and supplementary financial data, and amended the Management’s Discussion and Analysis (MD&A) requirement to revise or eliminate certain disclosure obligations. These rule changes are the latest development in the SEC’s disclosure effectiveness efforts.

Background

The SEC proposed amendments to the selected financial data, supplementary financial data and MD&A requirements on January 30, 2020 as part of its ongoing evaluation of disclosure requirements that was recommended in the Staff’s Report on Review of Disclosure Requirements in Regulation S-K (Regulation S-K Study), which was mandated by Section 108 of the Jumpstart Our Business Startups Act.[2] Based on the recommendation set forth in the Regulation S-K Study, the Staff of the Division of Corporation Finance (the “Staff”) initiated an evaluation of the information that companies are required to disclose, how that information is presented, where the information is disclosed, and how to better leverage technology as part of these efforts. In developing the latest proposed amendments to the financial data and MD&A requirements, the SEC considered input from comment letters, the Staff’s experience from reviewing filings, and changes in the regulatory and business landscape since the adoption of Regulation S-K. The SEC received comments that were generally supportive of the proposals, with some suggesting changes to the SEC’s approach.

Selected Financial Data

Current Item 301 of Regulation S-K requires certain public companies to furnish selected financial data in comparative tabular form for each of the company’s last five fiscal years and any additional fiscal years necessary to keep the information from being misleading. Instruction 1 to Item 301 states that the purpose of the item is to supply, in a convenient and readable format, selected financial data that highlights certain significant trends in the company’s financial condition and results of operations, while Instruction 2 to Item 301 lists specific items that must be included, subject to appropriate variation to conform to the nature of the company’s business, and provides that companies may include additional items they believe would enhance an understanding of, and highlight, other trends in their financial condition or results of operations.

The SEC adopted amendments to eliminate Item 301 of Regulation S-K as proposed.  The SEC notes in the adopting release that “[n]otwithstanding the amendments to eliminate Item 301, we encourage registrants to consider whether trend information for periods earlier than those presented in the financial statements may be necessary as part of MD&A’s objective to ‘provide material information relevant to an assessment of the financial condition and results of operations.’”  The SEC also encourage companies “to consider whether a tabular presentation of relevant financial or other information, as part of an introductory section or overview, including to demonstrate material trends, may help a reader’s understanding of MD&A.”

Supplementary Financial Data

Item 302(a)(1) of Regulation S-K requires certain public companies to disclose selected quarterly financial data of specified operating results, and Item 302(a)(2) of Regulation S-K requires disclosure of variances in those results from amounts previously reported in a Form 10-Q.

The SEC adopted amendments retaining Item 302(a) of Regulation S-K and streamlining its requirements to require disclosure only when there are one or more retrospective changes that pertain to the statements of comprehensive income for any of the quarters within the two most recent fiscal years and any subsequent interim period for which financial statements are included or required to be included by Article 3 of Regulation S-X and that, individually or in the, aggregate, are material. The SEC notes in the adopting release that Item 302(a) as amended will require companies “to provide an explanation of the reasons for such material changes and to disclose, for each affected quarterly period and the fourth quarter in the affected year, summarized financial information related to the statements of comprehensive income (as specified in Rule 1-02(bb)(ii) of Regulation S-X) and earnings per share reflecting such changes.” For this purpose, “the affected quarters may include, depending on the facts and circumstances, a single quarter in which the material retrospective change applies, or it may flow through to subsequent quarters during the relevant look-back period (i.e., the quarters within the two most recent fiscal years and any subsequent interim period for which financial statements are included or required to be included by Article 3 of Regulation S-X).” The SEC also amended Rule 1-02(bb) to clarify that the disclosure of summary financial information may vary, as appropriate, to conform to the nature of the company’s business. The SEC adopted these amendments acknowledging “that timely disclosure of the effects of material retrospective changes may be important to investors, and lack of such disclosure could impact the ability to derive fourth quarter information when there have been such changes.”

Current Item 302(b) of Regulation S-K requires companies engaged in oil and gas producing activities, other than smaller reporting companies, to disclose information about those activities, and the same disclosure is also required U.S. GAAP; however, unlike the U.S. GAAP requirement, Item 302(b) incrementally requires that the disclosure be provided for each period presented. In 2018, the SEC referred Item 302(b) to the Financial Accounting Standards Board (the “FASB”) for potential incorporation into U.S. GAAP because of the overlap. On May 6, 2019, the FASB issued proposed Accounting Standards Update, Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosure Update and Simplification, which would amend U.S. GAAP to require the incremental disclosure called for by Item 302(b) and disclosure of oil and gas producing activities for each period presented. The FASB has not finalized its proposed amendments to U.S. GAAP, so the SEC did not eliminate Item 302(b) at this time.

MD&A Disclosure Requirements

Item 303 of Regulation S-K requires disclosure of information relevant to assessing a company’s financial condition, changes in financial condition, and results of operations. The SEC adopted a number of amendments to Item 303 of Regulation S-K that are intended to modernize, simplify, and enhance the MD&A disclosures for investors, while reducing compliance burdens for companies.

The first paragraph of current Item 303(a) of Regulation S-K specifies that companies must discuss their financial condition, changes in financial condition, and results of operations for full fiscal years. The paragraph goes on to set forth the items that must be included in this discussion, including liquidity, capital resources, results of operations, off-balance sheet arrangements, contractual obligations, and any other information a company believes would be necessary to understand its financial condition, changes in financial condition, and results of operations. The paragraph also instructs that discussions of capital resources and liquidity may be combined when the topics are interrelated. Further, the paragraph states that a company must provide a discussion of business segments and/or of subdivisions when, in the company’s judgment, such a discussion would be appropriate for understanding the company’s business. This discussion must focus on each relevant, reportable segment and/or other subdivision of the business and on the entire company. There are also 14 instructions to current Item 303(a) of Regulation S-K.

The SEC adopted a new Item 303(a) largely as proposed to succinctly state the purposes of MD&A by incorporating a portion of the substance of Instruction 1, as well as much of the substance of Instructions 2 and 3, into the item. As amended, Item 303(a) articulates the objectives of MD&A, which is for companies to provide disclosure regarding:

  • material information relevant to an assessment of the financial condition and results of operations of the company, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources;
  • the material financial and statistical data that the company believes will enhance a reader’s understanding of the company’s financial condition, cash flows and other changes in financial condition, and results of operations; and
  • material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition, including descriptions and amounts of matters that: (i) have had a material impact on future operations; and (ii) are reasonably likely, based on management’s assessment, to have material impact on future operations.

The SEC also codified the guidance that a company should provide a narrative explanation of its financial statements that enables investors to see a company “through the eyes of management,” specifying that “[a] discussion and analysis that meets these requirements is expected to allow investors to view the registrant from management’s perspective.”

The SEC adopted amendments re-captioning current Item 303(a) as Item 303(b), which  applies to all MD&A disclosures, while retaining the current language that outlines what is to be covered in the discussion of a company’s financial condition, changes in financial condition, and results of operations. In addition, the SEC amended this item to add product lines as an example of other subdivisions of a company’s business that should be discussed where, in the company’s judgment, such a discussion would be necessary to an understanding of the company’s business.

The SEC adopted amendments to move to Item 303(b) that portion of current Instruction 4 to Item 303(a) that requires a description of the causes of material changes from year-to-year in line items of the financial statements to the extent necessary to an understanding of the company’s business as a whole. The SEC amended that language to clarify that MD&A requires a narrative discussion of the “underlying reasons” for material changes from period-to-period in one or more line items in quantitative and qualitative terms, rather than only the “cause” for material changes. The SEC also amended the language to clarify that companies should discuss material changes within a line item, even when such material changes offset each other.

The SEC adopted other amendments to further streamline Item 303: 

  • Instruction 8 to current Item 303(b) indicates that the term “statement of comprehensive income” is defined by Rule 1-02 of Regulation S-X, and the SEC moved this language to Instruction 11 to Item 303(b) to clarify that the instruction applies to both full fiscal year and interim period MD&A disclosure; and
  • the SEC eliminated current Instructions 13 and 14 to Item 303(a), which reference certain industry guides, noting that companies would still need to consider the industry guides when preparing their disclosures, to the extent applicable.

Current Item 303(a)(2) of Regulation S-K requires a company to discuss its material commitments for capital expenditures as of the end of the latest fiscal period, and to indicate the general purpose of such commitments and the anticipated sources of funds needed to fulfill such commitments. A company also must discuss any known material trends, favorable or unfavorable, in its capital resources, and indicate any expected material changes in the mix and relative cost of such resources. The discussion must consider changes between equity, debt, and any off-balance sheet financing arrangements.

The SEC amended Item 303(a)(2) as proposed. As amended, the item will specify, consistent with the SEC’s prior guidance, that a company should broadly disclose material cash commitments, including, but not limited, to capital expenditures. The amendment requires a company to describe its material cash requirements, including commitments for capital expenditures, as of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements, and the general purpose of such requirements. The SEC indicates that this change is intended to modernize Item 303(a)(2) by specifically requiring disclosure of material cash requirements in addition to capital expenditures, and to complement the deletion of the contractual obligations table, discussed below.

Results of Operations – Known Trends or Uncertainties

Current Item 303(a)(3)(ii) of Regulation S-K requires a company to describe any known trends or uncertainties that have had or that the company reasonably expects will have a material impact (favorable or unfavorable) on net sales or revenues or income from continuing operations. If the company knows of events that will cause a material change in the relationship between costs and revenues, that change in the relationship must be disclosed under this disclosure requirement.

The SEC amended Item 303(a)(3)(ii) to provide that when a company knows of 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, price increases or inventory adjustments, the reasonably likely change must be disclosed. This amendment conforms the language to other Item 303 disclosure requirements for known trends and aligns the disclosure requirement with the SEC’s guidance on forward-looking disclosure. The SEC clarified in the adopting release that, as part of MD&A’s objectives, “whether a matter is ‘reasonably likely’ to have a material impact on future operations is based on ‘management’s assessment.’”

In the adopting release, the SEC clarifies and explains how companies should analyze and disclose information regarding known trends, demands, commitments, or uncertainties, reiterating the SEC’s “longstanding emphasis that analysis in this area should be based on objective reasonableness.” The SEC notes that, with respect to the evaluation of whether a known trend or uncertainty is reasonably likely, “the development of MD&A disclosure should begin with management’s identification and evaluation of what information…is important to providing investors and others an accurate understanding of the company’s current and prospective financial position and operating results.”  Further, when considering whether disclosure of a known event or uncertainty is required, the analysis is based on materiality and what would be considered important by a reasonable investor in making a voting or investment decision. The SEC indicates that “reasonably likely” threshold “does not require disclosure of any event that is known but for which fruition may be remote, nor does it set a bright-line percentage threshold by which disclosure is triggered.” Instead, the SEC indicates that this threshold “requires a thoughtful analysis that applies an objective assessment of the likelihood that an event will occur balanced with a materiality analysis regarding the need for disclosure regarding such event.”

The SEC indicates that, when applying the “reasonably likely” threshold, companies should consider whether a known trend, demand, commitment, event, or uncertainty is likely to come to fruition. If such known trend, demand, commitment, event or uncertainty would reasonably be likely to have a material effect on the company’s future results or financial condition, disclosure is required. The SEC notes that known trends, demands, commitments, events, or uncertainties that are not remote, or where management cannot make an assessment as to the likelihood that they will come to fruition, and that would be reasonably likely to have a material effect on the company’s future results or financial condition, were they to come to fruition, should be disclosed if a reasonable investor would consider omission of the information as significantly altering the mix of information made available in the company’s disclosures. The SEC notes that “[t]his analysis should be made objectively and with a view to providing investors with a clearer understanding of the potential material consequences of such known forward-looking events or uncertainties.”  The SEC indicates that the analysis does not call for disclosure of immaterial or remote future events, therefore “it should not result in voluminous disclosures or unnecessarily speculative information.”

Results of Operations – Net Sales and Revenues

Current Item 303(a)(3)(iii) of Regulation S-K specifies that, to the extent financial statements disclose material increases in net sales or revenues, a company must provide a narrative discussion of the extent to which such increases are attributable to increases in prices, or to increases in the volume or amount of goods or services being sold, or to the introduction of new products or services. The SEC amended this item to codify guidance that the results of operations discussion should describe not only increases but also decreases in net sales or revenues and to clarify the requirement by tying the required disclosure to “material changes” in net sales or revenues, rather than solely to “material increases” in those line items.

Results of Operations – Inflation and Price Changes

Current Item 303(a)(3)(iv) of Regulation S-K generally requires companies, for the three most recent fiscal years, or for those fiscal years in which the company has been engaged in business, whichever period is shortest, to discuss the impact of inflation and price changes on their net sales, revenue, and income from continuing operations. Current Instruction 8 to Item 303(a) clarifies that a company must provide a discussion of the effects of inflation and other changes in prices only to the extent it is material. Instruction 8 further states that the discussion may be made in whatever manner appears appropriate under the circumstances and that no specific numerical financial data is required, except as required by Rule 3-20(c) of Regulation S-X, which applies to foreign private issuers. Current Instruction 9 to Item 303(a) states that companies that elect to disclose supplementary information on the effects of changing prices may combine such disclosures with the Item 303(a) discussion and analysis or provide it separately with an appropriate cross-reference.

The SEC eliminated Item 303(a)(3)(iv) and Instructions 8 and 9 to Item 303(a), as proposed. The SEC notes in the adopting release that companies “will be required to discuss the impact of inflation or changing prices if they are part of a known trend or uncertainty that had, or is reasonably likely to have a material impact on net sales, revenue, or income from continuing operations.” Further, Item 303 as amended requires that, where the financial statements reveal material changes from period-to-period in one or more line items, “registrants must describe the underlying reasons for these material changes in quantitative and qualitative terms, which may also implicate a discussion of inflation and changing prices.”

Off-Balance Sheet Arrangements

Current Item 303(a)(4) of Regulation S-K requires, in a separately captioned section, a discussion of a company’s off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on a company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. For the purpose of this item, an “off-balance sheet arrangement” is defined as certain guarantees, retained or contingent interests in assets transferred to an unconsolidated entity, obligations under certain derivative instruments, and variable interests in any unconsolidated entity.

The SEC adopted amendments that replace current Item 303(a)(4) with a new instruction to Item 303(b) that requires 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 a company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements, or capital resources. The SEC notes in the adopting release that this more principles-based approach is appropriate, particularly in light of the updates that have been made to U.S. GAAP, which have resulted in overlap between U.S. GAAP requirements and current Item 303(a)(4).

Tabular Disclosure of Contractual Obligations

Current Item 303(a)(5) of Regulation S-K requires that companies (other than smaller reporting companies) must disclose in tabular format their known contractual obligations. This item requires a company to disclose contracts by type of obligations, the overall payments due, and by prescribed time periods.

The SEC eliminated Item 303(a)(5) as proposed. In response to commenters, the SEC amended Item 303(b) to specifically require disclosure of material cash requirements from known contractual and other obligations as part of a liquidity and capital resources discussion. The amendments to Item 303(b) “are intended to clarify the requirements while continuing to emphasize a principles-based approach focused on material short- and long-term liquidity and capital resources needs, while also specifying that material cash requirements from known contractual and other obligations should be considered as part of these disclosures.” Specifically, these amendments:

  • create a new Item 303(b)(1) to provide the overarching requirements for liquidity and capital resources disclosures in order to clarify these requirements;
  • incorporate in Item 303(b)(1) portions of current Instruction 5 to Item 303(a), which defines “liquidity” as the ability to generate adequate amounts of cash to meet the needs for cash, clarifying its applicability to the liquidity and capital resources requirements more generally;
  • codify prior SEC guidance that specifies that short-term liquidity and capital resources covers cash needs up to 12 months into the future while long-term liquidity and capital resources covers items beyond 12 months;
  • require the discussion on both a short-term and long-term basis;
  • require the discussion to analyze material cash requirements from known contractual and other obligations and such disclosures to specify the type of obligation and the relevant time period for the related cash requirements;
  • include a new instruction that states that the discussion of material cash requirements from known contractual obligations may include, for example, lease obligations, purchase obligations, or other liabilities reflected on the registrant’s balance sheet; and
  • include a new instruction that states, consistent with prior SEC guidance, the analysis for all of Item 303(b) should be in a format that facilitates easy understanding and does not duplicate disclosure already provided in the filing.
Critical Accounting Estimates

The SEC amended Item 303(a) of Regulation S-K to explicitly require disclosure of critical accounting estimates, consistent with prior SEC guidance on the topic. In response to concerns raised by commenters, the SEC clarified that:

  • the application of the material and reasonably available qualifier applies to all parts of the disclosure, not just to quantitative information;
  • the discussion on how much each estimate has changed may also be met through a discussion of changes in the assumptions during the period; and
  • the disclosure of changes in the estimate/assumption will cover a “relevant period,” rather than a “reporting period.”

Critical accounting estimates are defined in the rule as “those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant.”

The item requires companies to provide qualitative and quantitative information necessary to understand the estimation uncertainty and the impact the critical accounting estimate has had or is reasonably likely to have on financial condition or results of operations to the extent the information is material and reasonably available. The rule indicates that this information should include why each critical accounting estimate is subject to uncertainty and, to the extent the information is material and reasonably available, how much each estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.

Interim MD&A Requirement

Current Item 303(b) of Regulation S-K requires companies to provide MD&A disclosure for interim periods that enables market participants to assess material changes in financial condition and results of operations between specified periods. Item 303(b)(1) of Regulation S-K requires companies to discuss any material change in financial condition from the end of the preceding fiscal year to the date of the most recent interim balance sheet. Item 303(b)(2) of Regulation S-K requires companies to discuss any material changes in their results of operations for the most recent fiscal year-to-date period presented in their income statement, along with a similar discussion of the corresponding year to-date period of the preceding fiscal year. If a company is required or elects to provide an income statement for the most recent fiscal quarter, the discussion must also cover material changes with respect to that fiscal quarter and the corresponding fiscal quarter in the preceding fiscal year. Item 303(b)(2) also states that companies subject to Rule 3-03(b) of Regulation S-X providing statements of comprehensive income for the 12-month period ended as of the date of the most recent interim balance sheet must discuss material changes of that 12-month period as compared to the preceding fiscal year rather than the preceding period.

The SEC adopted amendments to Item 303(b) (renumbered as Item 303(c)) as proposed. The item as amended permits 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. If a company elects to discuss changes from the immediately preceding sequential quarter, the company must provide summary financial information that is the subject of the discussion for that quarter or identify the prior filing on EDGAR that presents the information. If a company changes the comparison from the prior interim period comparison, 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 also adopted amendments to simplify the item that:

  • eliminate the text that states that companies need not provide a discussion of the impact of inflation and changing prices; and
  • amend Item 303(b)(2) (adopted as Item 303(c)(2)) to break the requirements into two subsections: (i) Item 303(c)(2)(i) continues to require companies to discuss any material changes in their results of operations between the most recent year-to date interim period(s) and the corresponding period(s) of the preceding fiscal year for which statements of comprehensive income are provided; and (ii) Item 303(c)(ii) requires companies to compare their most recently completed quarter to either of the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.

The SEC also eliminated the language of the item that requires companies subject to Rule 3-03(b) of Regulation S-X that elect to provide a statement of comprehensive income for the 12 month period ended as of the date of the most recent interim balance sheet to discuss material changes in that 12-month period with respect to the preceding fiscal year, rather than the corresponding preceding period. The SEC also deleted Instructions 2, 3, 5, 6, 7, and 8 to current paragraph (b).

Safe Harbor for Forward-Looking Statements

Current Item 303(c) of Regulation S-K states that the safe harbors provided in Section 27A of the Securities Act and 21E of the Securities Exchange Act apply to all forward-looking information provided in response to Item 303(a)(4) (off-balance sheet arrangements) and Item 303(a)(5) (contractual obligations), provided such disclosure is made by certain enumerated persons. Current Item 303(c) confirms application of the statutory safe harbors to Item 303(a)(4) and Item 303(a)(5), and states that all of the required disclosures under these two items are deemed to be “forward-looking statements” as that term is defined in the statutory safe harbors, except for historical facts. Current Item 303(c) further states that the “meaningful cautionary statements” element of the statutory safe harbors is satisfied if a registrant satisfies all of the Item 303(a)(4) requirements.

As proposed, the SEC eliminated Item 303(c). The SEC notes that the amendments do not alter the availability or scope of the statutory and regulatory safe harbors.

Smaller Reporting Companies

Current Item 303(d) of Regulation S-K states that a smaller reporting company may provide Item 303(a)(3)(iv) information for the most recent two fiscal years if it provides financial information on net sales and revenues and income from continuing operations for only two years. Item 303(d) also states that a smaller reporting company is not required to provide the contractual obligations table specified in Item 303(a)(5). The SEC eliminated Item 303(d), given the elimination of Items 303(a)(3)(iv) and (a)(5).

Foreign Private Issuers

The SEC adopted corresponding amendments that would apply to foreign private issuers providing disclosure required by Form 20-F or Form 40-F. The SEC also adopted amendments to current Instruction 11 to Item 303 of Regulation S-K, which specifically applies to foreign private issuers that choose to file on domestic forms.

Conforming Amendments

The SEC adopted conforming amendments to numerous rules and forms to reflect the proposed amendments.

Next Steps

The final rules are effective 30 days after publication in the Federal Register, which is referred to as the “effective date.” Companies will be required to apply the amended rules for their first fiscal year ending on or after 210 days after publication in the Federal Register, which is referred to as the “mandatory compliance date.” Companies will be required to apply the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. Although companies will not be required to apply the amended rules until their mandatory compliance date, they may provide disclosure consistent with the final amendments any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety. The SEC notes that, for example, upon effectiveness of the final amendments, “a registrant may immediately cease providing disclosure pursuant to former Item 301, and may voluntarily provide disclosure pursuant to amended Item 303 before its mandatory compliance date. In this case, the registrant must provide disclosure pursuant to each provision of amended Item 303 in its entirety, and must begin providing such disclosure in any applicable filings going forward.”


[1] Release No. 33-10890, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information (Nov. 19, 2020), available at: https://www.sec.gov/rules/final/2020/33-10890.pdf.

[2] Release No. 33-10750, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information (Jan. 30, 2020), available at: https://www.sec.gov/rules/proposed/2020/33-10750.pdf; Report on Review of Disclosure Requirements in Regulation S-K (Dec. 2013), available at https://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.

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