SEC Continues to Modernize the Disclosure Regime

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On November 19, the U.S. Securities and Exchange Commission (SEC) continued its ongoing efforts to streamline and enhance its disclosure regime by adopting amendments to Items 301, 302, and 303 of Regulation S-K. These amendments, like others adopted since the SEC began this modernization initiative, are intended to facilitate principles-based and company-specific disclosures. Moreover, they are intended to discourage repetition and eliminate immaterial information, which should lower cost and complexity for companies while enhancing readability for investors.

Item 301: Selected Financial Data

Once the new rules become effective, companies will no longer be required to provide five fiscal years (and any additional years to prevent misleading disclosures) of selected financial data. Although the five-year selected financial data table is widely considered to be needlessly repetitive, costly, and complex, some commenters expressed concern that trend disclosures would be negatively impacted by its elimination. Because management’s discussion and analysis (MD&A) disclosure rules and related guidance have required, and will continue to require, disclosure of material historical and future trends in areas such as liquidity, capital resources, and revenues, companies should continue to look back at five (or more) years of data to make sure all material trends are captured, disclosed, and discussed. Companies should also consider whether to continue to present certain financial disclosures in a tabular format to the extent appropriate and helpful to demonstrate material trends.

Item 302(a): Supplemental Financial Information

Although the SEC initially proposed eliminating Item 302(a) altogether, the final rule instead significantly streamlines its disclosure requirements. Under revised Item 302(a), companies no longer are required to provide quarterly tabular disclosure. Instead, amended subsection (a) requires disclosure only where retrospective changes pertaining to statements of comprehensive income for any quarter within the two most recent fiscal years, and any subsequent interim period, are material individually or in the aggregate. Companies should explain the material changes that have occurred and provide earnings per share and summarized financial information reflecting the changes for each affected quarter and the fourth quarter of an affected year.

Item 303: MD&A

MD&A Objectives

The revised rules add a new subsection (a) to Item 303 that sets forth the overarching objectives of MD&A by calling for the following disclosures:

  • “Material information relevant to an assessment of the financial condition and results of operations of the registrant, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources.”
  • “Material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be indicative of future operating results or of future financial condition. This includes descriptions and amounts of matters that have had a material impact on reported operations as well as matters that are reasonably likely based on management’s assessment to have a material impact on future operations.”
  • “The material financial and statistical data that the registrant believes will enhance a reader’s understanding of the registrant’s financial condition, cash flows and other changes in financial condition, and results of operations.”

New subsection (a) incorporates certain of the current instructions to Item 303 and SEC guidance regarding MD&A disclosures in order to provide greater clarity to companies preparing a discussion and analysis of financial information. The final rule notes that companies should “regularly revisit” these items when preparing MD&A disclosures and focus on future prospects and materiality and trend disclosures. Overall, MD&A should provide a thoughtful discussion of short-term results with future prospects.

Amended Item 303(b)

Current subsection (a) has been re-designated as subsection (b) and amended to discourage companies from merely reciting numerical year-over-year changes that can easily be calculated from the financial statements while seeking to elicit greater analysis. The changes include:

  • Moving and clarifying language from current Instruction 4 to Item 303(b) of Regulation S-K to state that the underlying reasons of material changes in financial statement line items should be discussed in quantitative and qualitative terms (including that offsetting line item material changes should still be discussed).
  • Including “product lines” as an example of an item to discuss if material to an understanding of a company’s business.
  • Broadening capital resource disclosures beyond capital expenditures to a discussion of a company’s material cash requirements, which includes capital expenditure commitments (as of latest completed fiscal period) and the expected source of funds for and general purpose of these requirements. The final rule eliminates the contractual obligations table currently required by Item 303(a)(5) of Regulation S-K due in part to overlap with the broader capital resource disclosures.
  • Amending the standard for disclosing a known event from “will” cause to “reasonably likely” to cause a material change between costs and revenues.
  • Requiring filers to provide a narrative discussion of material “changes” in net revenues or sales reflected in the financial statements as opposed to the current requirement for material “increases.”
  • Eliminating the requirement to discuss inflation and price change impacts so MD&A instead focuses on information that is material to a company’s facts and circumstances.
  • Replacing the line item requirement to discuss off-balance sheet arrangements with a principles-based instruction to discuss commitments or obligations resulting from arrangements with unconsolidated persons or entities that are reasonably likely to have or have a material current or future effect on the company’s financial information. This disclosure is required even if there is no obligation on the company’s balance sheet arising from the arrangement.

Critical Accounting Estimates

Disclosures regarding critical accounting estimates are not required specifically by current Item 303 but were instead, until this recent set of amendments, part of SEC guidance that companies should consider whether accounting judgments and estimates could materially affect financial information when preparing MD&A disclosures. The final rule now adds Item 303(b)(3) to clarify disclosure requirements in this area and remove duplicative disclosures from significant accounting policies in the financial statements.

The final rule defines critical accounting estimates 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 registrant’s financial condition or results of operations.” Companies must disclose, to the extent material and for each critical accounting estimate, why it is subject to uncertainty, the change in estimate during the relevant period, and sensitivity to the estimates underlying the calculation. Qualitative and quantitative disclosures should be provided when that information is reasonably available and will be material to investors.

Interim Period Disclosures

The amendments allow for new flexibility when comparing interim periods. In renumbered Item 303(c), companies are allowed to compare their most recently completed quarter to the corresponding prior year quarter (as required under the current rule) or the previously completed quarter. A company whose business is not seasonal may find the additional flexibility offered by this change to provide a more meaningful analysis that is better matched to its business cycles. Summary financial information or identification of the prior filing on EDGAR must be provided for ready access to the information discussed, if the company compares to the previously completed quarter. If a company changes the comparison in a future Form 10-Q filing, the company must provide both comparisons in that filing and explain the reason for the change in comparison.

Effective Date

The final rules will be effective 30 days after they are published in the Federal Register. Application of the amended rules will be required for a company’s first fiscal year that ends at least 210 days after publication in the Federal Register. However, companies can voluntarily begin to apply the amended rules after the effective date, but the disclosure must be responsive to an amended item in its entirety and they must continue to do so going forward.

Looking Ahead

The SEC’s efforts to modernize the disclosure regime are likely to continue, as evidenced by amendments to the securities offering framework and sales to workers proposed on November 24. One aspect to keep an eye on in the weeks and months ahead is how much of these continued efforts will focus on environmental, social, and governance (ESG) and sustainability disclosures. In a joint statement on this final rule, Commissioners Allison Herren Lee and Caroline A. Crenshaw highlighted the failure of these amendments to address climate risk while noting that other modernization disclosure amendments similarly did not deal with this and long-term sustainability aspects. Additionally, footnote 9 in the final rule contained a discussion of some of the commenters’ input on ESG and sustainability disclosures.

But perhaps most directly providing insight on the future path of the SEC’s disclosure modernization initiatives, Commissioners Lee and Crenshaw’s joint statement on the final rule included the following: “[w]e have an opportunity going forward to address climate, human capital, and other ESG risks, in a comprehensive fashion with new rulemaking specific to these topics. … [t]here’s no time to waste in setting to ourselves to this task, and we look forward to rolling up our sleeves to establish requirements for standard, comparable, and reliable climate, human capital, and other ESG disclosures.”

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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