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Home Compliance

Prepare Now to Comply with SEC’s Updated MD&A and Related Financial Disclosure Requirements

The new rules go into effect later this year. Get a jump on the updates to avoid a last-minute crunch.

by Kaitlyn McGowan
March 3, 2021
in Compliance, Featured
The facade of the SEC in Washington, D.C.

The SEC’s updated MD&A rules will bring about key changes in financial disclosures, streamlining existing disclosure requirements.

In adopting final amendments to Regulation S-K on November 19, 2020, the Securities and Exchange Commission (SEC) took additional steps to streamline disclosure requirements relating to Management’s Discussion and Analysis (MD&A) and other financial disclosures required in public company periodic reports and registration statements filed with the SEC. This article provides a summary of these amended rules and elaborates on some of these requirements.

The final rules include the following key changes:

  • Disclosure of selected financial data is no longer required.
  • Quarterly supplementary financial data must be disclosed only when there are one or more material retrospective changes.
  • Registrants now have flexibility to choose to compare the current quarter with the immediately preceding quarter instead of the prior-year quarter in MD&A in quarterly reports.
  • Disclosure of critical accounting estimates in MD&A is now required (a position that clarifies and codifies previous SEC guidance).
  • Registrants are no longer required to provide the contractual obligations table in MD&A, but disclosure in MD&A of the company’s material cash requirements is mandatory.
  • Registrants no longer need to disclose off–balance sheet arrangements under a separately captioned section. Such obligations should be discussed in the broader context of MD&A.

Smaller reporting companies are not affected by the elimination of the requirement to disclose selected financial data or the streamlining of supplementary financial data requirements since they were not required to provide such disclosure prior to the amendments. However, such companies will be required to disclose material cash requirements as part of the liquidity and capital resources discussion in MD&A, even though they were not required to include the table of contractual obligations prior to the amendments. The SEC also adopted corresponding amendments that apply to foreign private issuers, with the same goals of modernizing and clarifying MD&A disclosure requirements.

SEC’s Updated MD&A Requirements: Effective Date

The effective date of the rules was February 10, 2021. However, registrants are not required to comply with the amended rules until their first fiscal year ending on or after August 9, 2021. Registrants may voluntarily comply with the amended rules early, so long as the disclosures are responsive to an amended item in its entirety. Registrants will be required to apply the amended rules in a registration statement that, on its initial filing date, must contain financial statements for a period on or after the mandatory compliance date.

Disclosure of Selected Financial Data Has Been Eliminated

Prior to the amendments, registrants were required to disclose selected financial data in comparative tabular form for up to the past five fiscal years, as well as — where applicable — for interim periods. This requirement has been eliminated under the new amendments since prior-period financial information is now readily available electronically.

Registrants, however, are not off the hook entirely. In the SEC’s updated MD&A rules, it reiterated that in preparing the presentation of selected financial data, registrants should consider whether:

  • Trend information for periods prior to the periods presented in the financial statements should be disclosed and discussed in MD&A, particularly since disclosure of material trends is already required in MD&A; and
  • A tabular presentation of relevant financial or other information would enhance a reader’s understanding of MD&A.

Streamlined Disclosure of Supplementary Financial Information

Prior to the amendments, under Item 302(a) of Regulation S-K, registrants were required to disclose selected quarterly financial data for the following:

  • Certain operating results;
  • Variances in such results from amounts reported in a previous Form 10-Q; and
  • The effect of any discontinued operations and unusual or infrequent items.

Although it had previously proposed eliminating Item 302(a) in its entirety, the SEC ultimately chose instead to streamline this disclosure requirement in the final rules. Under the amended rules, Item 302(a) requires disclosure of quarterly financial data only when there have been one or more material retrospective changes pertaining to the statements of income for any quarters within the past two fiscal years and for any subsequent interim period for which financial statements are required. Retrospective changes that may trigger disclosure include the following:

  • Correction of an error; and
  • Disposition of a business accounted for as discontinued operations.

General Principles and Disclosure Standards

The SEC’s updated MD&A requirements reassess and clarify the objectives of the reporting, with an emphasis on:

  • Providing “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.”
  • Focusing on “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.”
  • Discussion and analysis of “the financial statements and other 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.”

The SEC also has made it clear that it believes the “reasonably likely” threshold remains an appropriate standard for prospective matters and forward-looking information required under the MD&A rules. Based on opinions received during the comment period, the SEC noted in its final rules:

[W]hen applying the “reasonably likely” threshold, registrants 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 registrant’s future results or financial condition, disclosure is required.

The SEC added:

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 registrant’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 registrant’s disclosures.

Additional, Specific Guidance

The SEC’s perspective is that the following changes captured in the final rules will help investors gain a view of the company from management’s perspective.

Reporting Reasons Underlying Material Changes

Under the SEC’s updated MD&A requirements, the commission requires registrants to describe the underlying reasons for material changes in qualitative and quantitative terms, including “[w]here the financial statements reflect material changes from period-to-period in one or more line items” and “where material changes within a line item offset one another [ . . . ].”

Although this requirement reflects prior SEC guidance, the SEC believed it necessary to emphasize this requirement in order to enhance analysis in MD&A. The SEC encourages companies to acknowledge the fact that “isolating reasons for specific material changes, and quantifying such isolated reasons, can sometimes be challenging because they can be highly interrelated.” It also asks companies “explain such interrelated circumstances to the extent possible.”

Additional Examples of Segment or Subdivision Information

Under the SEC’s updated MD&A rules, companies must discuss information about reportable segments “and/or other subdivisions” of the company where such discussion enhances understanding of its business. In addition to the previous “geographic areas” example of such a subdivision, the SEC added “product lines” as another. To avoid misunderstanding, the SEC noted that the additional example is not intended to require product line disclosure unless it is necessary to an understanding of the company’s business.

Liquidity and Capital Resources Analyses

Under the amended rules, liquidity and capital resources disclosures must analyze the registrant’s ability to generate and obtain adequate amounts of cash to meet the company’s cash requirements. The registrant is also required to identify short- and long-term plans for cash and (as required prior to the amendments) describe known trends and uncertainties that will result in, or that are reasonably likely to result in, a material increase or decrease in its liquidity.

Under the amended MD&A rules, registrants must broadly disclose “material cash requirements.” Such disclosure should include, but is not limited to, commitments for capital expenditures. The rule specifies that the discussion “must consider changes among equity, debt and any off-balance sheet financing arrangements.”

“Reasonably Likely” Standard Also Applies to Results of Operations

The amended rules clarify that the “reasonably likely” standard applies to certain disclosures regarding known trends in results of operations and that “material changes” in net sales or revenue, rather than only “material increases,” should be disclosed. The SEC’s updated MD&A rules no longer specify the requirement to discuss the impact of inflation and changing prices. Such information, however, must be disclosed if it is material or is part of a known trend or uncertainty that had or is reasonably likely to have a material impact.

Off–Balance Sheet Arrangements and Contractual Obligations “Relocated”

Prior to the amendments, off–balance sheet arrangement disclosures were to be included in a separately captioned item, and known contractual obligations were to be presented in a specified tabular format. The amended rules eliminate these requirements and instead direct registrants to integrate such information and disclosures throughout MD&A in the case of off–balance sheet arrangements, and specifically in their liquidity and capital resources disclosures, in the case of known contractual obligations.

Avoidance of Unnecessary Repetition in Critical Accounting Estimates

As part of the SEC’s goal to streamline the reporting process and avoid unnecessary repetition of the significant accounting policy footnotes, the amended rules explicitly require disclosure of critical accounting estimates but also define “critical accounting estimates” with a focus on estimation uncertainties. The SEC explains:

Critical accounting estimates are 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.

Under the SEC’s updated MD&A rules, registrants must provide reasonably available qualitative and quantitative information that is material and necessary in order to understand the estimation uncertainty and the impact that the critical accounting estimate has had or is likely to have on financial condition or results of operations. To the extent material and reasonably available, this information should include:

  • How much each estimate and/or assumption has changed over a relevant period.
  • The sensitivity of the reported amount to the methods, assumptions, and estimates underlying its calculation.

Options for Comparison of Quarterly Results

Registrants have the ability, under the amended rules, to compare their most recently completed quarter with either the corresponding quarter of the prior year or the immediately preceding quarter. This does not alter the requirement that registrants must discuss material changes in results of operations with respect to the most recent fiscal year-to-date period and the corresponding year-to-date period of the preceding fiscal year.

Conclusion

The SEC’s updated MD&A rules and those and involving related financial disclosures underscore the commission’s continued efforts to streamline and modernize the reporting process. Although the mandatory compliance date is the better part of a year away, it would behoove registrants to begin efforts to prepare for compliance with the amended rules.


Tags: Financial ReportingSEC
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Kaitlyn McGowan

Kaitlyn McGowan

Kaitlyn Daniel McGowan is an associate in in Jones Walker LLP‘s Corporate Practice Group. While in law school, Kaitlyn externed for Judge John W. deGravelles of the US District Court for the Middle District of Louisiana and served as a research assistant. She also served as a production editor for the LSU Journal of Energy Law and Resources.  

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