On January 30, 2020, the Securities and Exchange Commission (the SEC) issued proposed amendments to simplify the requirements of Regulation S-K and an interpretative release relating to Management’s Discussion and Analysis (“MD&A”).

Proposed Amendments to Regulation S-K

The SEC announced (available here) that it had voted to propose amendments to modernize, simplify and enhance certain financial disclosure requirements under Regulation S-K, in order to focus on a principles-based disclosure framework. This is consistent with the goal of other recent amendments and proposals (discussed here, here and here).

The proposed amendments (available here) are intended to:

• eliminate duplicative disclosure requirements;

• modernize and enhance MD&A disclosures for the benefit of investors; and

• simplify compliance efforts for companies.

The proposed amendments intend to:

• eliminate the requirement for:

• selected financial data under Item 301;

• supplementary financial data under Item 302(a);

• certain disclosure regarding oil and gas producing activities for each period presented under Item 302(b);

• disclosure of the impact of inflation and changing prices under Item 303(a)(3)(iv); and

• the tabular disclosure of contractual obligations under Item 303(a)(5) that overlaps with information required in the financial statements;

• amend the requirements for MD&A under Item 303, mainly to:

• add a new Item 303(a) to state the principal objectives of MD&A and to streamline such item;

• enhance the requirements under Item 303(a)(2), which is currently limited to capital expenditures, to add a discussion of material cash requirements;

• clarify the registrant should include a discussion of reasonably likely changes in the relationship between costs and revenues under Item 303(a)(3)(ii), and include a discussion of the reasons underlying material changes from period-to-period in one or more line items under Item 303(a)(3)(iii);

• replace the required disclosure on off-balance sheet arrangements under Item 303(a)(4) with principles-based instructions about the importance of discussing off-balance sheet arrangements in a broader context;

• add a new requirement about critical accounting estimates, codifying existing SEC guidance in this subject; and

• revise the interim requirements to provide flexibility to companies to compare the most recent quarter to either the corresponding quarter in the previous year or to the immediately preceding quarter.

The latest proposed rules are subject to a 60-day public comment period following publication in the Federal Register. Comments may be submitted via: (1) e-mail to rule-comments@sec.gov; (2) the SEC Internet comment form (https://www.sec.gov/rules/proposed.shtml); or (3) paper comments to Vanessa A. Countryman, Secretary, Securities and Exchange Commission, 100 F Street NE Washington, DC 20549-1090. All submissions should refer to File Number S7-01-20. This file number should be included in the subject line if email is used.

Guidance on Key Performance Indicators and Metrics in MD&A

The SEC also issued an Interpretative Release (available here) providing guidance on key performance indicators and metrics discussed in MD&A. Item 303(a) of Regulation S-K requires disclosure of information not specifically referenced in the item that the registrant believes is necessary to an understanding of its financial condition, changes in financial condition and results of operations. The item also requires discussion and analysis of other statistical data that in the registrant’s judgment enhances a reader’s understanding of MD&A. When proposing the current MD&A framework, the Commission noted that “[f]or each business, there is a limited set of critical variables which presents the pulse of the business.” The SEC previously has emphasized that, when preparing MD&A, “companies should consider whether disclosure of all key variables and other factors that management uses to manage the business would be material to investors, and therefore required.”

The SEC’s current guidance is a reminder of these requirements. Registrants must disclose key variables and other qualitative and quantitative factors that management uses to manage the business and that would be peculiar and necessary for investors to understand and evaluate the registrant’s performance, including non-financial and financial metrics.

Examples of such metrics, as applicable to particular registrants, include, but are not limited to: operating margin; same store sales; sales per square foot; total customers/subscribers; average revenue per user; daily/monthly active users/usage; active customers; net customer additions; total impressions; number of memberships; traffic growth; comparable customer transactions increase; voluntary and/or involuntary employee turnover rate; percentage breakdown of workforce (e.g., active workforce covered under collective bargaining agreements); total energy consumed; and data security measures (e.g., number of data breaches or number of account holders affected by data breaches).

The guidance reminds companies that, when including metrics in their disclosure, they should consider existing MD&A requirements and the need to include such further material information, if any, as may be necessary in order to make the presentation of the metric, in light of the circumstances under which it is presented, not misleading. The disclosure of such additional metrics, based on the facts and circumstances, should be accompanied by the following disclosures:

• a clear definition of the metric and how it is calculated;

• a statement indicating the reasons why the metric provides useful information to investors;

• a statement indicating how management uses the metric in managing or monitoring the performance of the business; and

• whether the disclosure of any estimates or assumptions underlying such metric or its calculations are necessary to be disclosed for the metric not to be materially misleading.

The disclosure of additional metrics should also comply with any applicable existing regulatory framework. For instance, in making disclosures of any non-GAAP measures, the guidance includes a reminder that the registrant must be mindful of the requirement to comply with Regulation G and Item 10 of Regulation S-K.

In addition, if a company changes the method by which it calculates or presents the metric from oneperiod to another or otherwise, the company should consider the need to disclose, to the extent material, the differences between periods, the reasons for the changes and the effect of the changes. Changes may necessitate recasting the prior period’s presentation to ensure the comparison is not misleading.

Companies will also need to maintain appropriate disclosure controls and procedures with respect to these supplemental measures and the related disclosure.

Lack of Climate Change and ESG-Related Disclosure Requirements

Interestingly, SEC Chairman Jay Clayton and two Commissioners issued public statements regarding the absence of requirements relating to environmental and climate-related matters in the proposed amendments to Regulation S-K.

Commissioner Allison Herren Lee emphasized in her public statement (available here) that the SEC missed the opportunity to use this modernizationproposal to address the concerns related to climate change, noting that “investors have increased their demands on companies and regulators for consistent, reliable, and comparable disclosures” and, in particular, that “investors are overwhelmingly telling [the SEC], through comment letters and petitions for rulemaking, that they need consistent, reliable, and comparable disclosures of the risks and opportunities related to sustainability measures, particularly climate risk.”

In addressing this subject in his public statement (available here), Chairman Jay Clayton emphasized the SEC’s commitment to this topic for over a decade, citing the SEC’s 2010 Guidance Regarding Disclosure Related to Climate Change (available here) and the abundant feedback received from comments letters (available here) on climate-related disclosure in response to the SEC’s April 2016 concept release on Business and Financial Disclosure required by Regulation S-K. However, Chairman Clayton believes such commitment should remain “disclosure-based and rooted in materiality, including providing investors with insight regarding the issuer’s assessment of, and plans for addressing, material risks to its business and operations.”

Commissioner Hester M. Peirce also noted in her public statement (available here) the SEC’s ongoing focus in simplifying and updating disclosure requirements in order to “reduce costs ultimately borne by shareholders while preserving important investor protections.” Commissioner Peirce stressed her concern in expanding the SEC’s “disclosure framework to require [environmental, social, and governance (“ESG”)] and sustainability disclosures regardless of materiality,” and concern about the potential slippery slope of materiality.

In corroborating her concern about expanding mandatory disclosure requirements, Commissioner Peirce cited that only six Form 10-Ks filed in 2019 used a sustainability metric highlighted in the SEC’s guidance (total energy consumed), while another metric mentioned in the SEC Guidance (operating margin) showed up in approximately 499 Form 10-Ks.

However, Commissioner Lee seemed to disagree with Chairman Clayton and Commissioner Peirce, stating that “[i]t 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.”

Commissioner Lee also criticized the proposed amendments to eliminate what Commissioner Lee refers as “significant disclosure items, while laudably enhancing others,” favoring a principles-based approach as opposed to balancing such approach with a more directly comparable and uniform disclosure requirement. Commissioner Lee stressed her concern with the increased flexibility and discretion given to companies by the SEC’s policy choice to the detriment of comparability of simplified and uniform standards.

For now, the SEC has maintained its ongoing principles-based approach, relying on materiality and management’s discretion to disclose key performance indicators and metrics.

We would like to thank Rodrigo Surcan in our New York office for his assistance in preparing this article.

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