The SEC provided guidance on disclosure of financial metrics in MD&A. At the same time, the SEC proposed rules to amend other disclosure obligations of public companies.
Financial Metrics in MD&A
The guidance on financial metrics in MD&A is effective when published in the Federal Register which usually occurs shortly after announcement. Given that many companies are in the process of preparing their Form 10-Ks, the guidance will need to be considered rapidly.
The SEC noted some companies disclose non-financial and financial metrics when describing the performance or the status of their business. Those metrics can vary significantly from company to company and industry to industry, depending on various facts and circumstances. For example, some of these metrics relate to external or macro-economic matters, some are company or industry specific, and some are a combination of external and internal information. Some companies voluntarily disclose specialized, company-specific sales metrics, such as same store sales or revenue per subscriber. Some companies also voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.
According to the SEC, a company should consider what additional information may be necessary to provide adequate context for an investor to understand any metric presented. The SEC said it would generally expect, based on the facts and circumstances, the following disclosures to accompany any metric presented:
- A clear definition of the metric and how it is calculated;
- A statement indicating the reasons why the metric provides useful information to investors; and
- A statement indicating how management uses the metric in managing or monitoring the performance of the business.
The SEC advised public companies they should also consider whether there are estimates or assumptions underlying the metric or its calculation, and whether disclosure of such items is necessary for the metric not to be materially misleading.
According to the SEC, if a company changes the method by which it calculates or presents the metric from one period to another or otherwise, the company should consider the need to disclose, to the extent material:
- the differences in the way the metric is calculated or presented compared to prior periods,
- the reasons for such changes,
- the effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported, and
- such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company’s performance or prospects.
Depending on the significance of the change(s) in methodology and results, the SEC stated public companies should consider whether it is necessary to recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context.
The SEC also noted effective controls and procedures are important when disclosing material key performance indicators or metrics that are derived from the company’s own information. When key performance indicators 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.
Proposed Rule Changes
The SEC also proposed amendments it believes are designed to modernize, simplify, and enhance certain financial disclosure requirements in Regulation S-K. The proposed amendments are far reaching and among other things would eliminate Item 301 (selected financial data) and Item 302 (supplementary financial data), and amend Item 303 (management’s discussion and analysis).
Among other things, the proposed amendments to Item 303, the MD&A rule, would:
- Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
- Replace Item 303(a)(4), Off-balance sheet arrangements, with a principles-based instruction to prompt registrants to discuss off-balance sheet arrangements in the broader context of MD&A;
- Eliminate Item 303(a)(5), Tabular disclosure of contractual obligations given the overlap with information required in the financial statements and to promote the principles-based nature of MD&A;
- Add a new disclosure requirement to Item 303, Critical accounting estimates, to clarify and codify existing Commission guidance in this area; and
- Revise the interim MD&A requirement in Item 303(b) to provide flexibility by allowing companies to compare their most recently completed quarter to either the corresponding quarter of the prior year (as is currently required) or to the immediately preceding quarter.