On January 30, 2020, the U.S. Securities and Exchange Commission (SEC) announced that it was providing guidance on key performance indicators (KPIs) and metrics in Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). In addition, on the same day, the SEC also announced that it voted to propose amendments to certain financial disclosure requirements in Regulation S-K, including MD&A.
SEC Guidance on KPIs and Metrics
Item 303(a) of Regulation S-K requires discussion of a company's financial condition, changes in financial condition, and results of operations, including information specified in the five subtopics specified therein and "such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations." In 2003 guidance, the SEC encouraged the use of KPIs and non-financial business and operational data in MD&A to provide investors with a better view of the "key variables and other qualitative and quantitative factors which are peculiar to and necessary for an understanding and evaluation of the individual company."1 For many years, KPIs and metrics have been a frequent area of SEC comment, but there has been little recent guidance from the SEC.
The SEC's 2020 guidance relates specifically to the disclosure of KPIs and metrics in MD&A, and includes information relating to 1) the disclosure of KPIs and metrics in MD&A, generally, 2) disclosures that companies should consider when changing the methodology by which they calculate their KPIs and metrics from one period to another, and 3) the requirement to maintain effective disclosure controls and procedures when disclosing company-derived information.
Disclosure of KPIs and Metrics. For companies that include KPIs or metrics in their MD&A disclosures, the guidance states that these companies "should consider existing MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading." In undertaking this analysis, the guidance states that companies should consider the following:
- "the extent to which an existing regulatory framework applies, such as Generally Accepted Accounting Standards (GAAP) or, for 'non-GAAP measures,' Regulation G or Item 10 of Regulation S-K;"
- "what additional information may be necessary to provide adequate context for an investor to understand the metric presented;" and
- "whether there are estimates or assumptions underlying the metric or its calculation, and whether disclosure of such items is necessary for the metric not to be materially misleading."
The information that the SEC generally expects to accompany KPIs or metrics depends on the facts and circumstances but is similar to the SEC's guidance on statements that should accompany non-GAAP financial measures. In particular, the SEC suggested including the following: 1) a clear definition of the metric and how it is calculated; 2) a statement of the reasons why the metric provides useful information to investors; and 3) a statement of how management uses the metric in managing or monitoring the performance of the business. The guidance also provides a non-exhaustive list of examples of the metrics to which the guidance applies, including, among others, operating margin, same store sales, total customers/subscribers, average revenue per user, and others.2
Changes to Methodology Used to Calculate KPIs or Metrics. As companies and markets grow and change, KPIs and metrics may need to change as well. The guidance provides a list of disclosures for companies to consider when changing the methodology by which one or more of their metrics are calculated from one period to another, which is, again, similar to the SEC's statements regarding changes in non-GAAP financial measures. These disclosures include the following, to the extent material: "(1) the differences in the way the metric is calculated or presented compared to prior periods, (2) the reasons for such changes, (3) the effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported, and (4) such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company's performance or prospects." In addition, if the changes in methodology are significant, then companies "should consider whether it is necessary to recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context."
Disclosure Controls and Procedures. Lastly, the guidance reminds companies of "the requirement to maintain effective disclosure controls and procedures" and the importance of maintaining these controls "when disclosing material key performance indicators or metrics that are derived from the company's own information." If such information is material to an investment decision, then companies "should consider whether it has effective controls and procedures in place to process information related to the disclosure of such items to ensure consistency as well as accuracy."
What to Do Now?
The guidance reflects the views of the SEC and how the SEC interprets federal securities laws and regulations. Thus, as companies prepare their Form 10-Ks, and other filings requiring MD&A disclosure:
- They should take a fresh look at 1) their disclosure controls and procedures relating to the calculation and disclosure of their KPIs or metrics and 2) any KPIs, metrics, and related disclosures that they include in their MD&A, to ensure that these disclosures include, at a minimum and based on facts and circumstances, a clear definition of the metric, reasons why the metric is useful to investors, and how management uses the metric in managing or monitoring the operation business.
- They should review this guidance if they decide to change the methodology by which they calculate their key metrics. This latest guidance provides a useful roadmap for disclosures that companies should consider when changing the methodology used to calculate their metrics from one period to another.
While the SEC's guidance applies specifically to MD&A, companies may wish to consider how this advice applies to other disclosures involving KPIs and metrics, including earnings press releases furnished with the SEC on Form 8-K.
Proposed Amendments to MD&A, Selected Financial Data, and Supplementary Financial Information
In addition to the guidance discussed above, the SEC is proposing amendments to Items 301, 302, and 303 of Regulation S-K. These latest proposed amendments to Regulation S-K are part of the SEC's ongoing efforts to modernize and simplify its disclosure requirements, and "are intended to eliminate duplicative disclosures and modernize and enhance MD&A disclosures for the benefit of investors, while simplifying compliance efforts for registrants."3
Given the number of proposed amendments, the SEC provided a useful chart summarizing all of the proposed amendments, as well as a separate chart summarizing the proposed amendments and related structural changes to Item 303 of Regulation S-K. Abridged versions of these charts have been included as an Annex to this Client Alert for reference. The following is a narrative summary of some of the key highlights of the proposed amendments:4
Item 301, Selected Financial Data
- Current rule. Item 301 requires companies to furnish selected financial data for at least the last five fiscal years, with limited exceptions or accommodations for smaller reporting companies and emerging growth companies.
- Proposed Amendment. Citing the accessibility of information on EDGAR, XBRL tagging requirements, and existing disclosure requirements under Item 303 (e.g., material trends), the proposed amendments delete Item 301 entirely.
Item 302, Supplementary Financial Information
- Current Item 302(a), Selected quarterly financial data. Item 302(a) generally requires companies, with limited exceptions for smaller reporting companies and foreign private issuers, to 1) provide selected quarterly financial data for each full quarter within the two most recent fiscal years, 2) reconcile and describe the reasons for any quarterly information that varies from the amounts previously reported on the applicable Form 10-Q, and 3) describe the effect of any discontinued operations and unusual or infrequently occurring items recognized in each of the full quarters presented and the aggregate effect and nature of year-end or other adjustments which are material to the results of that quarter. In addition, Item 302(a)4) requires that if the financial statements to which the supplementary financial information relates have been reported on by an accountant, then that accountant must follow appropriate professional standards and procedures regarding that supplementary financial information.
- Proposed Amendment. Citing the prescriptive and duplicative nature of these disclosures and the accessibility of information on EDGAR, the proposed amendments delete Item 302(a) entirely. The SEC concedes that this would eliminate separate presentations of fourth quarter information but states that "where fourth quarter results are material or there is a material retrospective change, existing requirements would still elicit this disclosure."
- Current Item 302(b), Information about oil and gas producing activities. Item 302(b) requires companies engaged in oil and gas producing activities, with limited exceptions for smaller reporting companies, to disclose information about those activities for each period presented.
- Proposed Amendment. In May 2019, the Financial Accounting Standards Board (FASB) proposed amendments to U.S. GAAP that would require the same disclosure required by Item 302(b). Thus, subject to FASB finalizing those amendments, the proposed amendments delete Item 302(b) in its entirety.
Item 303, Management's Discussion and Analysis of Financial Condition and Results of Operations
- Current Item 303(a). Item 303(a) generally requires, for full fiscal years, disclosures relating to a company's financial condition, changes in financial condition, and results of operations, and includes five specified topics: liquidity; capital resources; results of operations; off-balance sheet arrangements; and the contractual obligations table.
- Proposed Amendment - New Item 303(a), Objective. The proposed amendments create a new Item 303(a) that would state the purposes and objective of MD&A. The new language would 1) be drawn from, among other things, current Instructions 1, 2, and 3 to Item 303(a), 2) include a statement that the MD&A must include a narrative explanation of the company's financial statements "that allows investors to view the [company] from management's perspective," and 3) promote a principles-based approach to MD&A.
- Proposed Amendment - Item 303(a), MD&A. The proposed amendments recaption existing Item 303(a) as Item 303(b) and, among other things, 1) add language to clarify that MD&A should include a description, in both quantitative and qualitative terms, of the underlying reasons for any material changes from period-to-period in one or more line items of the financial statements and 2) add "product lines" as an additional example of other subdivisions of a company's business that should be discussed if necessary to an understanding of the business.
- Proposed Amendment - Item 303(a)(2), Capital resources. The proposed amendments 1) recaption existing Item 303(a)(2) as Item 303(b)(2) and 2) broaden the disclosure requirements beyond a discussion of capital resources, to require a description of material cash requirements and the anticipated source of funds needed to satisfy such cash requirements.
- Proposed Amendment - Item 303(a)(3), Results of operations. The proposed amendments recaption existing Item 303(a)(3) as Item 303(b)(3). For purposes of Item 302(a)(3)(ii), the proposed amendments revise the second sentence of Item 303(a)(3)(ii) to require disclosure by a company if it knows of events that "are reasonably likely to" (not just events that "will") cause a material change in the relationship between costs and revenues. For purposes of Item 302(a)(3)(iii), the proposed amendments codify prior SEC guidance by adding a requirement for companies to include a narrative discussion of material changes (rather than just material increases) in net sales or revenues, to clarify that this discussion also applies to material decreases. Finally, for purposes of Item 302(a)(3)(iv), the proposed amendments delete this section and its related instructions in their entirety but states that companies "would still be expected to discuss the impact of inflation or changing prices if they are part of a known trend or uncertainty that has had, or the [company] reasonably expects to have, a material favorable or unfavorable impact on net sales, or revenue, or income from continuing operations."
- Proposed Amendment - Item 303(a)(4), Off-balance sheet arrangements. In an effort to promote principles-based MD&A disclosures and reduce the redundancy in disclosures that may result from overlapping U.S. GAAP disclosure requirements, the proposed amendments replace this section in its entirety with a new Instruction 8 to Item 303(b) that would require 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 that this amendment is not intended to broaden the disclosure requirements and that new Instruction 8 would include the same examples as are provided in existing Item 303(a)(4)(ii): however, this discussion, where required, would no longer be in a separately-captioned section. In parallel with the foregoing amendment, the SEC would also amend Items 2.03 and 2.04 of Form 8-K to add the definition of "off-balance sheet arrangements" that is in existing Item 303(a)(4)(ii) rather than a cross-reference to this Item since this definition would no longer be included in Item 303.
- Proposed Amendment - Item 303(a)(5), Tabular disclosure of contractual obligations. In an effort to promote principles-based MD&A disclosures and reduce the redundancy in disclosures that may result from overlapping U.S. GAAP disclosure requirements, the proposed amendments delete this requirement in its entirety.
- Proposed Amendment - New Item 303(b)(4), Critical accounting estimates. Although not explicitly required by existing Item 303, past SEC guidance has addressed the importance of these disclosures in MD&A.5 The proposed amendments add new Item 303(b)(4) explicitly requiring disclosure of critical accounting estimates in MD&A. In the proposal, the SEC states that its "intent is to eliminate disclosure that duplicates the financial statement discussion of significant accounting policies and, instead, promote enhanced analysis of measurement uncertainties." To that end, the proposed amendments define a critical accounting estimate as "an estimate made in accordance with generally accepted accounting principles that involves a significant level of estimation uncertainty and has had or is reasonably likely to have a material impact on the [company]'s financial condition or results of operations."
In the proposal, the SEC noted the potential for overlap with the disclosure in the auditor's report of critical accounting matters but stated that "a critical accounting estimate may not be a critical audit matter because it may not involve especially challenging, subjective, or complex auditor judgment, but it would still require analysis in MD&A." In addition, the SEC noted the different objectives of the two disclosures, stating that "critical audit matters provide insight into matters that are especially challenging, subjective, and complex to audit from the perspective of the auditor" whereas "critical accounting estimates disclosure should provide management's insights into estimation uncertainties that have had or reasonably likely to have a material impact on reported financial statements."
- Current Item 302(b). Item 302(b) generally requires, for interim periods, similar disclosures required under Item 303(a) other than discussion of the impact of inflation, changing prices on operations, or the contractual obligations table.
- Proposed Amendment. The proposed amendments recaption Item 302(b) as Item 302(c) and permit 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 chooses to discuss the immediately preceding quarter, then it must provide summary financial information for that quarter or identify the prior EDGAR filing where such information is discussed. In addition, if a company chooses to discuss the immediately preceding quarter in a Form 10-Q, and then chooses to discuss the corresponding quarter of the prior year in a subsequent Form 10-Q, then it would be required to explain its reasons for the change and to present both comparisons in that subsequent Form 10-Q. The proposed amendments also 1) delete the reference to "the impact of inflation and changing prices" consistent with the similar deletion in Item 303(a) (recaptioned as Item 303(b) in the proposed amendments) and 2) deletes most of the Instructions to current Item 303(b).
- Current Item 302(c). Item 302(c) acknowledges that the statutory safe harbors for forward-looking information apply to the disclosures relating to off-balance sheet arrangements and the contractual obligations table.
- Proposed Amendment. Given that the proposed amendments delete current Item 303(a)(4), Off-balance sheet arrangements, and Item 303(a)(5), Tabular disclosure of contractual obligations, the proposed amendments also delete current Item 302(c). However, the SEC notes in the proposal that off-balance sheet arrangement disclosures made in response to the new Instruction 8 to Item 303(b) "would continue to be covered by existing safe harbors" and notes that the "proposed amendments are  not intended to alter the application of the statutory safe harbor provisions of the Private Securities Litigation Reform Act."
- Current Item 302(d). Item 302(d) provides certain accommodations to smaller reporting companies from the disclosure requirements of Item 303(a).
- Proposed Amendment. Given that the proposed amendments delete the two sections referenced in Item 302(d), for which accommodations are provided to smaller reporting companies, the proposed amendments delete this section in its entirety. Notwithstanding the foregoing, smaller reporting companies would continue to be able to rely on Instruction 1 to Item 303(a) (recaptioned as Item 303(b) in the proposed amendments), which provides that a smaller reporting company's MD&A shall cover the two-year period required in Article 8 of Regulation S-X.
What to Do Now?
The SEC is accepting public comments on the proposed amendments within 60 days of their publication in the Federal Register, which can be submitted here.
Summary of All Proposed Amendments
Summary of Proposed Amendments and Structural Changes to Item 303
 Opinion of Advocate General Saugmandsgaard Oe in Data Protection Commissioner v Facebook Ireland Limited, Maximillian Schrems (Case C‑311/18), December 19, 2019.
 See paragraph 343 of the opinion.
 See paragraph 158 of the opinion.
 See paragraph 193 of the opinion.