Your Company’s MD&A Discussion: How the SEC is Helping You Focus on What Matters

Dec 21, 2020

By Steve Soter

 

After 30 years of leaving its public company disclosure rules untouched, the Securities and Exchange Commission (SEC) finalized significant changes to Regulation S-K twice within (almost) just as many months. Are you playing the lead in “Total Recall,” anticipating a fantasy world for reporting professionals?

 

Well, that’s doubtful. But filers are now operating in a marketplace where, based on its second batch of final rules, the SEC makes clear it values modernized and enhanced management discussion and analysis (MD&A) and streamlined S-K financial disclosures. Investor insights into management's priorities are valued. “Outdated, duplicative or repetitive disclosures,” to quote one supportive comment letter, are out.

 

How would the late November S-K rule changes (on the heels of a recent modernization of business, legal proceeding, and risk disclosures) accomplish that goal? Through the first SEC purpose statement for MD&A, shedding mandates for a five-year table of financial data and eight quarters’ worth of quarterly statements, creating new road maps for how you report liquidity sources and known trends or uncertainties, and offering flexibility for how you report interim periods, among other streamlining efforts.

 

As always, time will tell how much more efficiently and effectively your team reports MD&A and creates financial disclosures. But my first take is that the revised S-K rules offer filers a lot of practical benefits. Let’s look at each of the principles-based changes.

 

First, the Meatiest Changes

  • What should MD&A accomplish, anyway? – Until now, SEC rules did not include a succinct objective for your company’s MD&A. But new Item 303(a) codifies the SEC’s interpretive guidance and says MD&A must tell investors 1) how management views the company and 2) which matters management thinks are reasonably likely to affect future operations.

Clear mission statements are always beneficial, but it’s particularly useful to focus your team on showing management’s current priorities to investors. Kudos to the SEC staff for plugging this gap.

  • What financial data must we report? – Before, some filers were required to report specific  data in a comparative table covering each of the last five (and sometimes more) fiscal years. By eliminating Item 301, the SEC has ensured that going forward, you have no obligation to provide selected data. But you are encouraged to consider presenting trends in M&A that pre-date your financial statements.

This change should eliminate costly, time-consuming decisions such as whether to recast earlier years under new accounting standards. Admittedly, filers enjoy some peace of mind working under a hard-and-fast rule vs. making judgment calls on which financial data to show investors. However, that comfort is trumped by the convenience and flexibility you can leverage in reporting under the new rule.

  • How do we report liquidity and capital expenditures? – New Item 303(b)(1) gives overarching guidance on disclosing liquidity outlays and discussing committed capital expenditures. The new rule codifies prior SEC interpretive guidance that short-term liquidity sources cover known contracts of up to 12 months, and long-term liquidity means cash needs beyond a year. Also, filers are reminded to disclose material cash requirements (covering both capital and other expenditures) at the end of the latest fiscal period, their general purpose, and your anticipated source of funds to meet them.

Your team may find it exasperating to pull data for a new table of contractual obligations. On the other hand, in stressful economic times like these, it could be very useful to have your company’s disclosures of cash commitments aggregated in one location.

  • How do we discuss interim periods? – Under amended Item 303(c), filers now have flexibility to report results of operations for the most recently completed fiscal quarter compared to either the same quarter of the prior year or to the immediately preceding quarter.

Some filers would have been very happy if the SEC also gave the option to stop reporting YTD numbers with prior YTD, but let’s not look too deeply into this gift horse’s mouth.

  • Which trends or uncertainties must be reported? – Filers now are directed to disclose any known events that are “reasonably likely to cause” a material change in the cost-revenue relationship, such as “known or reasonably likely” future cost increases. Before amended Item 303(b)(2)(ii), the rules stipulated “will cause” and “known,” respectively.

The bottom line is you must disclose a known trend or uncertainty if 1) it is reasonably likely to occur and 2) it would have a material impact on your company. Not every company likes two-step processes, and “reasonably likely” is a concept that probably needs more SEC guidance. But this change gets a lot closer to current reporting practices. Just remember to follow the two steps without fail.

  • Should MD&A cover CAEs? – New Item 303(b)(3) codifies previous SEC interpretive guidance to require disclosure of critical accounting estimates (CAEs) or assumptions in MD&A and defines a CAE. Filers will have to discuss 1) why each CAE is uncertain, 2) how much each CAE or assumption changed in a period, and 3) how sensitive reported amounts are to the methods and assumptions used to calculate a CAE.

This change actually could have backfired a bit had the SEC not responded to filers’ concerns and modified the level of sensitivity analysis required in CAE calculations. The SEC here has cleared up ambiguity that made it harder for filers to disclose CAEs. Your team should keep an eye out for any potential relationship between CAEs and critical audit matters (CAMs) disclosed in the audit opinion.

 

Let’s Not Overlook These Other Changes

 

There also is much to like in these other revised approaches from the SEC:

Item

Impact On Your Company and Reporting Team

Amended Item 302(a)

Certain filers no longer are mandated to disclose select financial data for each quarter in the last two fiscal years, along with variances from prior Form 10-Qs and effects of any discontinued operations. But if you are reporting a material, retrospective change for any quarter during the last two fiscal years, then you must explain that change using appropriate financials for the affected periods.

Amended Item 303(b)(2)(iii)

Filers must discuss factors that led to material “changes” from period to period in sales or volume; previously, the standard was material “increases.” Also, you will need to discuss underlying reasons for material changes affecting line items in the consolidated financial statements in both quantitative and qualitative terms.

Item 303(a) Instructions

Filers no longer are required to discuss the impact of inflation or price changes unless they are part of a known trend that is reasonably likely to affect revenues or income.

Item 303(b) Instructions

Filers no longer are required to discuss off-balance sheet (OBS) arrangements in a separately captioned section. Instead, they can be disclosed with liquidity and capital resources.

Amended Item 303(b)(1)

Filers no longer are required to report aggregate contractual obligations in a table format. They still must be disclosed as material cash requirements.

 

As your team prepares to operate under the latest modernized S-K rules, you should read professional commentary and regularly check the SEC Professionals Group website for helpful guidance.

 

What do you think of the new release? Make sure you are logged in as a member of SEC Professionals Group and then join the discussion at the bottom of this blog.

 

 


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