By Soyoung Ho
The SEC on January 30, 2020, issued a proposal that is largely intended to streamline some of the disclosure requirements in management’s discussion and analysis (MD&A) of financial condition and results of operation as part of a broader effort to overhaul the disclosure regime of Regulation S-K for publicly traded companies.
Reg S-K under the Securities Act of 1933 lays out the reporting requirements in SEC regulatory filings. The capital market regulator proposes to amend Item 303 of Reg S-K, which requires companies to write an MD&A.
The proposal would also eliminate Item 301, thus companies would no longer be required to provide five years of selected financial data. The SEC also wants to get rid of Item 302, which requires companies to provide two years of selected quarterly financial data. Among other things, the SEC said the information can be readily accessed in previous filings and elsewhere through Electronic Data Gathering, Analysis, and Retrieval (EDGAR) System.
“The proposed amendments are intended to modernize, simplify, and enhance the financial disclosure requirements by reducing duplicative disclosure and focusing on material information in order to improve these disclosures for investors and simplify compliance efforts for registrants,” the SEC said.
The proposal is in Release No. 33-10750, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information. Comments are due 60 days after publication in the Federal Register, which normally occurs a few weeks after a rulemaking document is posted on the SEC’s website.
At the same time, the market regulator issued a separate commission-level interpretive guidance on disclosure of key performance indicators and metrics in MD&A. (See SEC Issues Guidance on Disclosure of Key Performance Indicators in the February 3, 2020, edition of Accounting & Compliance Alert.)
“The proposal and the guidance we are releasing today, which reflect the staff’s wealth of experience, would improve the quality and accessibility of registrants’ presentation of financial results and performance metrics,” SEC Chairman Jay Clayton said in a statement. “The improved disclosures would allow investors to make better capital allocation decisions, while reducing compliance burdens and costs without in any way adversely affecting investor protection.”
In particular, Release No. 33-10750 would add new Item 303(a), Objective, to state the principal objectives of MD&A: companies should provide material information that is relevant in assessing the financial condition and results of operations, including an evaluation of the amounts and certainty of cash flows, among other information.
The proposal would replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction that would prompt companies to discuss the arrangements in the broader context of MD&A.
The SEC is also proposing to eliminate Item 303(a)(5), Tabular disclosure of contractual obligations, because the information is found in the financial statements and “to promote the principles-based nature of MD&A”
Not all proposed requirements were about simplification. The securities market regulator wants to make it explicit that companies must disclose critical accounting estimates. Currently, it is not required, and the SEC only said that companies should consider disclosing the estimates.
Overall, the SEC’s effort on Reg S-K reflects Chairman Clayton’s view that disclosures should be rooted in standards of materiality. He believes one-size-fits-all regulation and prescriptive rules do not work well because companies have different facts and circumstances, and company managers know their business operations best.
Thus, Release No. 33-10750 says, “We are also proposing to codify into the forepart of Item 5 Commission guidance that states that a registrant should provide a narrative explanation of its financial statements that enables investors to see a registrant ‘through the eyes of management.’”
The SEC issued the proposal without holding a public meeting, and Commissioner Allison Herren Lee voted against it because there is no planned requirement for a standardized disclosure on climate change risk.
The last time the commission addressed it was in 2010 when it published Release No. 33-9106, Commission Guidance Regarding Disclosure Related to Climate Change, asking companies to disclose material information related to climate change. The guidance says companies should inform investors about the risks they face from climate change, including lawsuits, business problems, regulatory supervision, or international treaties. The significant effects of climate change, such as severe weather, rising sea levels, loss of farmland, and the declining availability and quality of water, have the potential to affect a company’s operations and financial results and should be disclosed.
“Much has changed in the last decade with respect to what we know about climate change and the financial risks it creates for global markets,” Lee said in a statement.
The looming economic threat has become more apparent, voluntary reporting standards have proliferated, and major legislation has been introduced. But most importantly for the SEC, investors have been clamoring for better corporate disclosures about climate change in the past several years and that they need consistent and comparable disclosures, she said.
“It is also clear that the broad, principles-based ‘materiality’ standard has not produced sufficient disclosure to ensure that investors are getting the information they need—that is, disclosures that are consistent, reliable, and comparable,” she said. “What’s more, the agency’s routine disclosure review process could be used to improve disclosure under the materiality standard, but in recent years there’s been minimal comment on climate disclosure.”
She believes without a mandatory standardized framework, not all companies will feel compelled to divulge information that may be unflattering, and it will be difficult for investors to properly compare companies.
This article originally appeared in the February 3, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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