Yesterday, the SEC announced that it has adopted, without an open meeting, final amendments designed to simplify and modernize MD&A and other financial disclosure requirements of Reg S-K. With SEC Chair Jay Clayton and Corp Fin Director William Hinman both having announced their intent to leave the SEC by year end, the adoption may well be part of a term-end crunch. As summed up in the press release, the amendments are “intended to enhance the focus of financial disclosures on material information for the benefit of investors, while simplifying compliance efforts for registrants.” The amendments are also designed to “improve disclosure by enhancing its readability, discouraging repetition and eliminating information that is not material.” Once again, like other recent rulemakings, these amendments tilt toward a more principles-based, company-specific approach, describing the objectives of MD&A with the goal of highlighting the importance of materiality and trend disclosures to a more thoughtful, less rote MD&A and allowing investors a better view of the company from management’s perspective. In some cases, the amendments eliminate prescriptive requirements in favor of more general disclosures that are integrated into the primary discussions. And some of the proposed changes are fairly dramatic—such as eliminating selected financial data and the Table of Contractual Obligations. Whether the changes result in more nuanced, analytical disclosure remains to be seen. The amendments will become effective 30 days after publication in the Federal Register.
The amendments were initially proposed on January 30 (see this PubCo post), as part of the SEC’s Disclosure Effectiveness Initiative and follow on the 2013 S-K Study, the Report on Review of Disclosure Requirements in Regulation S-K, required by Section 108 of the JOBS Act, and the 341-page 2016 concept release, which sought comment on modernizing certain business and financial disclosure requirements in Reg S-K (see this PubCo post). The amendments take into account the comment letters received in response to the proposal, as well as the staff’s experience with Reg S-K as part of Corp Fin’s disclosure review program and changes in the regulatory and business landscape since the adoption of Reg S-K.
This post hits the highlights based on the press release. I plan to publish an update to this post with more detail about the final rules at a later time, so stay tuned.
Commissioners Allison Lee and Caroline Crenshaw dissented. In their joint statement, Lee and Crenshaw are appreciative that some of the changes to Item 303 of Reg S-K—such as the statement of the objective of MD&A to provide a thoughtful narrative discussion and the new requirement to provide disclosure regarding critical accounting estimates—“should enhance the quality of MD&A disclosures,” but take issue with two “significant aspects” of the final amendments.
First, they object to the elimination of the Table of Contractual Obligations, which they believe “provides investors with critical insight into supply chain and risk management.” While the proponents of the changes maintain that the Table is duplicative of information available elsewhere, the two commissioners contend that purchase obligations, required in the Table, are not always required by GAAP and not typically otherwise disclosed. Yet, they observe, “purchase obligation disclosures [provide] information about the amount and timing of payments due in future periods, providing insight into corporate supply chain risk management, financial hedging, and anticipated increases in product demand,” disclosures that were especially useful during the pandemic, for example, to assess the exposure of the cruise line industry. In addition, they note, even the SEC’s Investor Advisory Committee questioned the policy choice to eliminate the Table.
Second, as with the SEC’s recent effort to modernize the Reg S-K requirements for business, legal proceedings and risk factor disclosures (see this PubCo post) on which Lee and Crenshaw similarly dissented, this rulemaking also fails to address climate risk, despite a huge proportion of public comments calling for the SEC to do so. In addition, they note, “investors in other contexts are echoing that call for improved climate disclosure, recognizing the systemic risks that climate change poses to global financial stability.” In the view of Lee and Crenshaw, the SEC’s recent modernization rulemakings would have provided “the opportunity to issue standardized disclosure requirements that would facilitate efficient comparisons of how companies manage these risks and assets. The Commission, instead, chose to rely heavily on principles-based disclosure requirements.” While the commissioners do not disagree that information about management of material climate risk should be elicited under principles-based disclosure and, although some companies do provide disclosure on these topics, the “majority of U.S. based large companies have failed to acknowledge the financial risks of climate change in their filings.” In addition, the information that is provided is “non-standardized, inconsistent, and incomparable disclosures,” which does not “allow market participants to accurately price and compare the risks and opportunities associated with these risks.” (See this PubCo post.) Indeed, they cite a major study finding that “many institutional investors rank ‘climate risk-disclosures’ as being just as important as financial statements when predicting investment performance.”
Lee and Crenshaw also note other changes of concern, including the elimination of the requirement to disclose selected financial data and specific disclosures related to off-balance sheet arrangements and amendments to selected quarterly financial data.
Nevertheless, they see a “silver lining.” (Could that possibly be a new administration?) In their view, the opportunity remains to address climate, human capital and other ESG risks, with a new comprehensive rulemaking in the future. They advocate that the SEC establish “an internal task force and ESG Advisory Committee that is dedicated to building upon the recommendations of leading organizations, such as the Task Force on Climate-Related Financial Disclosures, and defining a clear plan to address sustainable investing.”
Amendments to Management’s Discussion and Analysis, Selected Financial Data and Supplementary Financial Information
According to the press release, the final amendments, which include the following changes to Items 301, 302 and 303 of Reg S-K, should
“sharpen the focus on material information by:
- Eliminating Item 301 (Selected Financial Data); and
- Modernizing, simplifying and streamlining Item 302(a) (Supplementary Financial Information) and Item 303 (MD&A). Specifically, these amendments:
- Revise Item 302(a) to replace the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes;
- Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
- Amend current Item 303(a)(1) and (2) (amended Item 303(b)(1)) to modernize, enhance and clarify disclosure requirements for liquidity and capital resources;
- Amend current Item 303(a)(3) (amended Item 303(b)(2)) to clarify, modernize and streamline disclosure requirements for results of operations;
- Add a new Item 303(b)(3), Critical accounting estimates, to clarify and codify Commission guidance on critical accounting estimates;
- Replace current Item 303(a)(4), Off-balance sheet arrangements, with an instruction to discuss such obligations in the broader context of MD&A;
- Eliminate current Item 303(a)(5), Tabular disclosure of contractual obligations, in light of the amended disclosure requirements for liquidity and capital resources and certain overlap with information required in the financial statements; and
- Amend current Item 303(b), Interim periods (amended Item 303(c)) to modernize, clarify and streamline the item and allow for flexibility in the comparison of interim periods to help registrants provide a more tailored and meaningful analysis relevant to their business cycles.”
The SEC also adopted parallel amendments to the financial disclosure requirements applicable to foreign private issuers, including to Forms 20-F and 40-F, as well as other conforming amendments.
As noted above, the amendments will become effective 30 days after publication in the Federal Register. Compliance will be required for “the first fiscal year ending on or after the date that is 210 days after publication in the Federal Register (the ‘mandatory compliance date’). Registrants will be required to apply the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. ” Early compliance is permitted after the effective date, so long as the disclosure provided is responsive to an amended item in its entirety.