The U.S. Securities and Exchange Commission has issued guidance on the use of financial metrics and has proposed significant amendments pertaining to Regulation S-K's financial disclosure provisions. In addition, SEC Chairman Jay Clayton issued an accompanying statement that addresses potential impacts that the coronavirus and climate change may have on disclosure requirements.
Guidance on the Use of Financial Metrics
On January 30, 2020, the SEC issued guidance on disclosure pertaining to key performance indicators and metrics (Metrics) in a company's Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A). The commission emphasized that the Metrics should be accompanied by:
- 1. A clear definition of the Metric and how it is calculated,
- 2. A statement indicating the reasons why the Metric provides useful information to the investors, and
- 3. A statement indicating how management uses the Metric in managing or monitoring the performance of the business.
Companies should also consider whether underlying estimates or assumptions should be disclosed in the event that Metrics would be materially misleading without such disclosure.
Secondly, if the manner of calculating the Metric changes, companies should carefully consider the need to disclose the following:
- 1. The differences in the way the Metric is calculated or presented compared to prior periods,
- 2. The reasons for such changes,
- 3. The effects of any such change on the amounts or other information being disclosed, and on amounts or other information previously reported, and
- 4. 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.
Also, depending on the significance of the change(s) in methodology and results, 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.
Most technology and life sciences companies are already incorporating this latest guidance within their disclosures and, therefore, the new guidance will likely not result in significant changes. However, companies should review their disclosure policies pertaining to key performance indicators and metrics in light of this new guidance to ensure that existing disclosures reflect the new guidance.
Proposed Amendments to Regulation S-K's Financial Disclosure Provisions
The SEC also issued proposed amendments to the financial disclosure provisions of Regulation S-K. The changes continue the SEC's efforts to eliminate duplicative disclosures and modernize and enhance MD&A disclosures, while simplifying compliance efforts. The proposed amendments would eliminate Item 301 (Selected Financial Data) and Item 302 (Supplementary Financial Data) and amend Item 303 (MD&A) to, primarily:
- 1. Add a new Item 303(a) "Objective," to state the principal objectives of the MD&A;
- 2. 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;
- 3. 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;
- 4. Add a new disclosure requirement to Item 303 "Critical accounting estimates," to clarify and codify existing SEC guidance in this area; and
- 5. 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.
Statements from the Chairman of the SEC
SEC Chairman Jay Clayton issued an accompanying statement to the SEC's releases, in which he noted that, as of January 30, 2020, the staff of the SEC was monitoring the impact of the coronavirus as it may relate to disclosure requirements. He indicated that, if necessary or appropriate, the staff would provide guidance and other assistance regarding such disclosures. Until then, companies with a significant amount of manufacturing or other ties to China should monitor the situation and consider including a risk factor, if appropriate. We have seen companies with operations in China include risk factor disclosures referencing the coronavirus and its potential ramifications.
Chairman Clayton also reiterated the SEC's commitment to environmental and climate-related disclosure efforts generally. Although the SEC has not provided any official guidance on this front, given the ever-increasing scrutiny in this space, companies should ensure that adequate disclosures regarding the environment and climate change are included in their filings.
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