Simplifying MD&A and KPI disclosure requirements

In January, the Securities and Exchange Commission (SEC) issued a proposal that would streamline the disclosure requirements in management’s discussion and analysis (MD&A) of financial condition and results of operations. The proposal is part of a broader effort to overhaul the disclosure regime for public companies. On the same day that the proposal was issued, the SEC published interpretive guidance on disclosing key performance indicators (KPIs).

Proposed changes to MD&A

Public companies are required to write MD&As under Reg. S-K Item 303 of the Securities Act of 1933. This requirement would be amended by a recent SEC proposal, Release No. 33-10750, Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information.

Specifically, the proposal would:

  • Add a statement about the objectives of MD&A — companies should provide material information that’s relevant in assessing the financial condition and results of operations, including an evaluation of the amounts and certainty of cash flows,
  • Provide principles-based instructions for off-balance sheet arrangements, and
  • Eliminate the tabular disclosure contractual obligations.

The proposal would also eliminate Item 301, which requires companies to provide five years of selected financial data, and Item 302, which requires companies to provide two years of selected quarterly financial data. Stakeholders interested in obtaining this information can access it through previous filings and elsewhere through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.

Not all proposed requirements were about simplification, however. The SEC also wants companies to disclose critical accounting estimates.

Overall, the proposed changes reflect SEC Chairman Jay Clayton’s view that disclosures should be rooted in standards of materiality. He believes one-size-fits-all regulation and prescriptive rules don’t work well because companies have different facts and circumstances, and company management knows their business operations best. “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,” Clayton said.

Comments on the proposal are due 60 days after publication in the Federal Register. This normally occurs a few weeks after a rulemaking document is posted on the SEC’s website.

Interpretive guidance on KPIs

At the same time, the SEC issued a separate commission-level interpretive guidance on disclosure of KPIs in MD&A. Release No. 33-10751, Commission Guidance on Management’s Discussion and Analysis of Financial Condition and Results of Operations, says MD&A should:

  • Provide clear definitions of KPIs and how they’re calculated,
  • Include a statement about the reasons why KPIs are relevant to investors,
  • Explain how management uses KPIs to manage or monitor business performance, and
  • Evaluate whether there are estimates or assumptions underlying KPIs or their calculations and whether disclosure of such items is necessary to not be misleading.

The guidance also states that, if a company changes the method by which it calculates or presents the metric from one period to another, management should consider disclosing the differences in the way the metric is calculated, the reasons for such changes, the effects of the changes and other differences in methodology that would be reasonably relevant in understanding the company’s performance or prospects in the future.

In addition, the guidance reminds companies to maintain effective disclosure controls. It says, “Effective controls and procedures are important when disclosing material [KPIs] or metrics that are derived from the company’s own information. When [KPIs] and metrics are material to an investment or voting decision, the company 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.”

In recent years, companies have increasingly used non-GAAP metrics, which are disclosed outside of the financial statements. Many companies have been using metrics that are misleading or difficult to understand, and the SEC has sought to crack down on some of the more egregious practices. In December 2019, Clayton urged companies to refrain from changing non-GAAP metric calculations from quarter to quarter.

Minimize costs, maximize value

The SEC’s recent proposal, together with its interpretive guidance on KPIs, aims to improve the quality and accessibility of companies’ presentation of financial results. “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,” said Clayton in a recent statement.

For more information on how to craft a clear and concise MD&A that meets the latest SEC requirements, contact your CPA.

Sidebar: What about climate change disclosures?

The Securities and Exchange Commission (SEC) recently proposed changes to the disclosure requirements in management’s discussion and analysis (MD&A) of financial condition and results of operations. (See main article.) But SEC Commissioner Allison Herren Lee voted against issuing the proposal, because it doesn’t mandate a standardized disclosure on climate change risk.

Lee argued that, without a mandatory standardized framework, some companies won’t voluntarily disclose potentially unflattering information, making it difficult for investors to properly compare companies. She says that investors have been clamoring for better corporate disclosures about climate change in the past several years and that they need consistent and comparable disclosures.

The last time the SEC addressed the issue of climate change was in 2010, when it published Release No. 33-9106, Commission Guidance Regarding Disclosure Related to Climate Change. That guidance says that companies should inform investors about the risks they face from climate change, including:

  • Lawsuits,
  • Business problems,
  • Regulatory supervision, and
  • 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. “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.”

In a public statement accompanying the recent MD&A proposal, SEC Chairman Jay Clayton said that the landscape around climate change disclosures will continue to be complex, uncertain and multinational. Capital allocation decisions based on climate-related factors are substantially forward-looking and likely involve estimates and assumptions that are complex and uncertain. But the SEC’s current disclosure regime is largely based on currently verifiable and largely historic company-specific information.

Though climate change disclosures aren’t part of the current MD&A proposal, Clayton said he was interested in learning more about how companies use climate-related models and metrics in their operations and planning, including price, risk and capital allocation decisions. Lee said she was pleased to see Clayton’s views on climate-related disclosures. “I am hopeful we can work together on this issue going forward,” she said.