SEC Proposes to Modernize MD&A and Financial Disclosures in Regulation S-K

Practical Law Legal Update w-023-8527 (Approx. 6 pages)

SEC Proposes to Modernize MD&A and Financial Disclosures in Regulation S-K

by Practical Law Corporate and Securities

Eliminating Items 301 and 302

The SEC is proposing to eliminate Item 301 (selected financial data) due to duplication of information already included in the financial statements, overlap with trend disclosures already required in Item 303 (MD&A), and the high cost of compliance. Similarly, the SEC is proposing to eliminate Item 302(a) (supplementary financial information) because the information is either already readily available in or easily calculable from previous filings.

Additionally, the SEC proposed eliminating Item 302(b), which applies to registrants engaged in oil and gas producing activities, subject to the FASB finalizing proposed amendments to US GAAP that would require the same disclosure.

Amendments to Item 303 (MD&A)

Item 303 (MD&A) of Regulation S-K requires companies to disclose information that allows investors to assess its financial condition and results of operations. The SEC is proposing significant amendments to Item 303, including:

Restructuring Item 303(a). The SEC is proposing to streamline and clarify the purposes of MD&A by:
- adding a new Item 303(a) to succinctly state the principal objectives of MD&A; and
- codifying SEC guidance that registrants should provide a narrative explanation of their financial statements that enables investors to see a registrant "through the eyes of management" into the description of MD&A objectives.
Recaptioning current Item 303(a) as Item 303(b). Current Item 303(a) will still apply to all MD&A disclosures, but it will be moved to Item 303(b). Additionally, the SEC is proposing to:
- amend current Item 303(a)(2) to specifically require a discussion of material cash requirements, including commitments for capital expenditures, as of the latest fiscal period, the anticipated source of funds needed to satisfy the cash requirements, and the general purpose of the cash requirements;
- amend current Item 303(a)(3)(ii) to clarify that a registrant must disclose "reasonably likely" material changes in the relationship between costs and revenues;
- amend current Item 303(a)(3)(iii) and Instruction 4 to Item 303(a) to require a narrative discussion of the "underlying reasons" for material changes from year-to-year in one or more-line items;
- eliminate current Item 303(a)(3)(iv) and its related instructions requiring a discussion of the impact of inflation and price changes because under revised Item 303 companies would still be expected to discuss this information if inflation or price changes are part of a known trend or uncertainty that has had or that the companies reasonably expect to have a material impact;
- replace Item 303(a)(4) (off-balance sheet arrangements) with a principles-based instruction to encourage companies to provide a discussion of off-balance sheet arrangements in the broader context of MD&A disclosures;
- eliminate current Item 303(a)(5) (contractual obligations) due to overlap with GAAP requirements and inclusion in a discussion of material cash requirements in proposed changes to current Item 303(a)(2);
- add a new Item 303(b)(4) to explicitly require disclosure of critical accounting estimates, which is defined in the proposed rule as an estimate made in accordance with GAAP that involves a significant level of estimation uncertainty and has had or is reasonably likely to have a material impact on the registrant's financial condition or results of operations;
- eliminate Instructions 13 and 14 to current Item 303(a);
- add product lines as an example of other subdivisions of a registrant's business that should be discussed when necessary, as determined by the registrant;
- move the text of current Item 303(a) stating registrants may combine to their discussions of liquidity and capital resources when the topics are interrelated to an instruction in proposed Item 303(b);
- move language in Instruction 8 to current Item 303(b) indicating the term "statement of comprehensive income" is defined by Rule 1-02 of Regulation S-X to Instruction 11 of proposed Item 303(b) to clarify it applies to both full fiscal year and interim period MD&A disclosures; and
- amend current Instruction 11 to Item 303(a) to incorporate the requirement for foreign private issuers (FPIs) to discuss hyperinflation in a hyperinflationary economy from Form 20-F (see below).
Recaptioning current Item 303(b) as Item 303(c). Current Item 303(b) governing interim MD&A disclosures is proposed to be recaptioned as Item 303(c), as well as amended to permit registrants to compare their most recently completed quarter to either a corresponding quarter of the prior year (current requirement) or to the immediately preceding quarter. In addition, under the proposal, if a company changes its quarterly comparison, in the filing where it announces the change, it would have to explain the reason for the change and present both comparisons.
Eliminating current Item 303(c). Current Item 303(c) states that the statutory safe harbors provided in Section 27A of the Securities Act and Section 21E of the Exchange Act apply to all forward-looking information provided in response to Items 303(a)(4) and 303(a)(5). Since the proposed rule eliminates those items, the SEC is also proposing to eliminate Item 303(c). However, forward-looking information included in response to the proposed instruction for off-balance sheet arrangement disclosures and disclosures regarding contractual obligations would continue to be covered by the statutory safe harbors.
Eliminating current Item 303(d). Consistent with the proposed amendments to Item 303(a)(3)(iv) and (a)(5), the proposed rule would eliminate Item 303(d) relating to disclosure obligations of smaller reporting companies.

Foreign Private Issuers

In addition to the proposed amendments to Regulation S-K, the SEC is proposing corresponding amendments that would apply to FPIs providing disclosures required by Form 20-F or Form 40-F (as well as forms calling for information in Forms 20-F), including:

Deleting Item 3.A and the related instructions from Form 20-F.
Conforming the requirements for Item 5 of Form 20-F to those of the proposed Item 303 of Regulation S-K referenced above, except that FPIs must still provide a discussion of hyperinflation in a hyperinflationary economy.
Eliminating the contractual obligations disclosure requirement from Form 40-F.
Only requiring the disclosure of off-balance sheet arrangements to the extent not already provided under the MD&A required by Canadian law on Form 40-F.
Eliminating Form 40-F's general instruction acknowledging the application of the statutory safe harbor for contractual obligation and off-balance sheet disclosure requirements.

Other Conforming Amendments

The SEC is also proposing conforming amendments consistent with the above amendments, including changes to:

Item 914 of Regulation S-K.
Regulation AB.
Summary prospectus in Form S-1 and Form F-1.
Form S-4, Form F-4, and Schedule 14A, where used in conjunction with a business combination.
Form S-20.

The comment period for the proposed rule will be open for 60 days after publication in the Federal Register.

For information on preparation of MD&A disclosures, see Practice Note, Preparation of Management's Discussion and Analysis of Financial Condition and Results of Operations.

SEC Proposes to Modernize MD&A and Financial Disclosures in Regulation S-K | Practical Law