SEC Adopts Amendments To Management Discussion And Analysis

It has been a very busy year for SEC rule making, guidance, executive actions and all matters capital markets.  Continuing its ongoing disclosure effectiveness initiative on November 19, 2020, the SEC adopted amendments to the disclosures in Item 303 of Regulation S-K – Management’s Discussion & Analysis of Financial Conditions and Operations (MD&A).  The proposed rule had been released on January 30, 2020 (see HERE).  Like all recent disclosure effectiveness rule amendments and proposals, the rule changes are meant to modernize and take a more principles-based approach to disclosure requirements.  In addition, the rule changes are intended to reduce repetition and disclosure of information that is not material.

The new rules eliminate Item 301 – Selected Financial Data – and amend Items 302(a) – Supplementary Financial Information and Item 303 – MD&A.  In particular, the final rules revise Item 302(a) to replace the current tabular disclosure with a principles-based approach and revise MD&A to: (i) to state the principal objectives of the disclosure; (ii) update liquidity and capital resource disclosures to require disclosure of material cash requirements including commitments for capital expenditures as of the latest fiscal period, the anticipated source of funds needed to satisfy cash requirements and the general purpose of such requirements; (iii) update the results of operations disclosure to require disclosure of known events that are reasonably likely to cause a material change in the relationship between costs and revenues; (iv) update the results of operations disclosure to require a discussion of the reasons underlying material changes in net sales or revenues; (v) replace the specific requirement to disclose off-balance-sheet arrangements with a directive to disclose the arrangements in the broader context of the MD&A discussion; (vi) eliminate the need for a tabular disclosure of contractual obligations as the information is already in the financial statements; and (vii) add a requirement to discuss critical accounting estimates and (viii) add the flexibility to choose whether to compare the same quarter from the prior year, or the immediately preceding quarter.

The new rules also apply to foreign private issuers (FPIs). Finally, the amendments will make numerous cross-reference clean-up amendments including to various registration statement forms under the Securities Act and periodic reports and proxy statements under the Exchange Act.

Below the discussion of the rule changes is a chart of each of the amendments and its principal objective.  The amendments take effect thirty days after publication in the federal register.

Detail on Final Rules

Elimination of Item 301 – Selected Financial Data

Item 301 generally requires a company to provide selected financial data in a comparative tabular form for the last five years.  Smaller reporting companies (SRCs) are not required to provide this information, and emerging growth companies (EGCs) that are not also SRCs are not required to provide information for any period prior to the earliest audited financial statements in the company’s initial registration statement.

When Item 301 was developed, prior financial information was not available on EDGAR and financial statements were not tagged with XBRL.  Also, the purpose behind Item 301 is to illustrate trends but Item 303 requires a discussion of material trends.  Accordingly, Item 301 is not useful and the SEC has eliminated it.

Amendment to Item 302 – Supplementary Financial Information

Item 302 requires selected disclosures of quarterly results and variances in operating results including the effects of any discontinued operations and unusual or infrequently occurring items.  SRCs and FPIs are not required to provide the information (note that FPIs are not required to report quarterly results or file quarterly reports at all).  Also, Item 302 only applies to companies that are registered under the Exchange Act and accordingly does not apply to voluntary or Section 15(d) reporting companies (for more on voluntary and Section 15(d) reporting, see HERE).

The SEC had originally proposed eliminating this item altogether like Item 301.  However, the SEC recognized that while most quarterly financial information could be found in prior filings, certain fourth quarter information was only captured in Item 302.  Accordingly, the final rule release did not eliminate Item 302 but amended it such that it now only requires disclosure when there are one or more material changes for any of the quarters in the last two fiscal years for which financial statements are provided.  Duplicative disclosures are not required.

Elimination of Item 303(a)(5) – Contractual Obligations Table

Under Item 303(a)(5) companies, other than SRCs, must disclose known contractual obligations in tabular format.  There is no materiality threshold for the disclosure.  The SEC has eliminated the table consistent with its objective of promoting a principals based MD&A disclosure and to streamline disclosures and reduce redundancy.  Likewise, current Items 303(c) and (d) have been eliminated as these items have been picked up in amended 303(b).

Item 303 – Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)

Currently MD&A is broken down into 5 parts.  Item 303(a) requires full-year disclosures on liquidity, capital resources, results of operations, off-balance-sheet arrangements, and contractual obligations.  Item 303(b) covers interim periods and requires a disclosure of any material changes to the Item 303(a) information.  Item 303(c) acknowledges the application of a statutory safe harbor for forward-looking information provided in off-balance-sheet arrangements and contractual obligations disclosures.  Item 303(d) provides scaled-back disclosure accommodations for SRCs.  The amended rule substantially changes this structure.

The new Item 303 (i) adds a new Item 303(a) to state the principal objectives of MD&A including as to full fiscal years and interim periods and to provide instructions to guide the rest of the rule; (ii) eliminates unnecessary cross-references, clarifies and removes outdated and duplicative language; (iii) updates capital resource disclosures to require disclosure of material cash requirements including commitments for capital expenditures as of the latest fiscal period, the anticipated source of funds needed to satisfy cash requirements and the general purpose of such requirements; (iv) updates the results of operations disclosure to require disclosure of known events that are reasonably likely to cause a material change in the relationship between costs and revenues; (v) updates the results of operations disclosure to require a discussion of the reasons underlying material changes in net sales or revenues; (vi) eliminates the requirement to discuss the impact of inflation; (vii) replaces the specific requirement to disclose off-balance-sheet arrangements with a directive to disclose the arrangements in the broader context of the MD&A discussion, (viii) adds a requirement to discuss critical accounting estimates,  and (ix) adds the flexibility to choose whether to compare the same quarter from the prior year, or the immediately preceding quarter.

The new Item 303(a) instruction paragraph has been revised to set forth the principal objectives of MD&A. The instructions codify guidance that requires a narrative explanation of financial statements to allow a reader to see a company “through the eyes of management.”  The SEC stresses that MD&A should provide an analysis that encompasses short-term results as well as future prospects.  The SEC does not want companies to merely recite the amounts of changes from year to year that are readily calculated from the financial statements, but rather to provide greater analysis as to the reasons for changes.

Also, the instructions emphasize providing disclosure on:

(i) 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 outside sources;

(ii) The material financial and statistical data that the company believes will enhance a reader’s understanding of its financial condition, changes in financial condition and results of operations; and

(iii) Material events and uncertainties known to management that would 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 (a) would have a material impact on future operations and have not had an impact in the past and (b) have had a material impact on reported operations and are not expected to have an impact on future operations.

Chart on Rule Changes

The following chart, copied from the SEC’s rule release, summarized the new rules.

Further Background on SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative.  The following is a recap of such initiative and proposed and actual changes.  I have scaled down this recap from prior versions to focus on the most material items.

On November 19, 2020, as discussed in this blog, the SEC adopted amendments to Management’s Discussion & Analysis of Financial Conditions and Operations (MD&A) required by Item 303 of Regulation S-K.  In addition, to eliminate duplicative disclosures, the SEC also eliminated Item 301 – Selected Financial Data and revised Item 302 – Supplementary Financial Information.  For my blog on the rules January 30, 2020 proposal, see HERE.

On August 26, 2020, the SEC adopted final amendments to Item 101 – description of business, Item 103 – legal proceedings, and Item 105 – Risk Factors of Regulation S-K.  See HERE.

In May 2020, the SEC adopted amendments to the financial statements and other disclosure requirements related to the acquisitions and dispositions of businesses.   See my blog HERE on the proposed amendments.  My blog on the final amendments will be published after this blog.

In March 2020, the SEC adopted amendments to the definitions of an “accelerated filer” and “large accelerated filer” to enlarge the number of smaller reporting companies that can be exempt from those definitions and therefore not required to comply with SOX Rule 404(b) requiring auditor attestation of management’s assessment on internal controls.  See HERE.

On March 20, 2019, the SEC adopted amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The amendments: (i) revise forms to update, streamline and improve disclosures including eliminating risk-factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks. See HERE.  Some of the amendments had initially been discussed in an August 2016 request for comment – see HERE, and the proposed rule changes were published in October 2017 – see HERE illustrating how lengthy rule change processes can be.

In December 2018, the SEC approved final rules to require companies to disclose practices or policies regarding the ability of employees or directors to engage in certain hedging transactions, in proxy and information statements for the election of directors. To review my blog on the final rules, see HERE and on the proposed rules, see HERE.

In the fourth quarter of 2018, the SEC finalized amendments to the disclosure requirements for mining companies under the Securities Act and the Securities Exchange. The proposed rule amendments were originally published in June 2016.  In addition to providing better information to investors about a company’s mining properties, the amendments are intended to more closely align the SEC rules with current industry and global regulatory practices and standards as set out in by the Committee for Reserves International Reporting Standards (CRIRSCO). In addition, the amendments rescinded Industry Guide 7 and consolidated the disclosure requirements for registrants with material mining operations in a new subpart of Regulation S-K. See HERE.

On June 28, 2018, the SEC adopted amendments to the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K.  See HERE and later issued updated C&DI on the new rules – see HERE. The initial proposed amendments were published on June 27, 2016 (see HERE).

On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC.  The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list.  In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format.  The new rule went into effect on September 1, 2017 for most companies and on September 1, 2018 for smaller reporting companies and non-accelerated filers.  See my blog HERE on the Item 601 rule changes and HERE related to SEC guidance on same.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments).  See my blog on the proposed rule change HERE.  Final amendments were approved on August 17, 2018 – see HERE

The July 2016 proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016.  See my two-part blog on the S-K Concept Release HERE and HERE.

In September 2015, the SEC issued a request for public comment related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates.  See my blog HERE.  In March 2020, the SEC adopted final rules to simplify the disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, and for affiliates whose securities collateralize a company’s securities.  See my blog HERE.

In early December 2015, the FAST Act was passed into law.  The FAST Act required the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K.  See my blog HERE.