January 31, 2020

S-K Financial Disclosure: SEC Proposes Big Changes!

Yesterday, the SEC voted to propose significant changes to the financial disclosure provisions of Regulation S-K.  The changes are intended to eliminate duplicative disclosures & modernize and enhance MD&A disclosures while simplifying compliance efforts. Here’s the 196-page proposing release. This excerpt from the SEC’s press release summarizes the proposed rule changes:

The proposed amendments would eliminate Item 301 (selected financial data) and Item 302 (supplementary financial data), and amend Item 303 (management’s discussion and analysis). 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.

Among other things, the proposed amendments to Item 303 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.

Yesterday’s vote was another divisive one. Commissioner Allison Herren Lee issued a dissenting statement criticizing the proposal for ignoring “the elephant in the room” – climate change disclosure. She observed that in all of the SEC’s efforts to modernize Reg S-K in recent years, it has not once mentioned climate change or its relevance to these disclosures.

SEC Chair Jay Clayton issued his own lengthy statement in which he addressed, among other things, the SEC’s ongoing efforts to get its arms around climate change & environmental disclosure issues. Meanwhile, the ever-quotable Commissioner Hester Peirce weighed-in with a statement in support of the proposal, in which she warned that due in part to the efforts of “an elite crowd pledging loudly to spend virtuously other people’s money, the concept of materiality is at risk of degradation” through its expansion to ESG & sustainability disclosures.

But Wait! There’s More! SEC Issues Guidance on MD&A Metrics

As if a revamp of S-K’s financial disclosures wasn’t enough, the SEC also issued this 7-page interpretive release providing guidance on disclosure of key performance metrics in MD&A. The guidance says that when companies disclose such metrics, they should also consider whether additional disclosures are necessary and gives examples of such disclosures. The guidance also cites the requirements in Exchange Act Rules 13a-15 and 15d-15 to maintain disclosure controls and procedures and advises companies to consider these requirements when disclosing metrics.

Risk Factors: Wuhan Coronavirus Outbreak

Jay Clayton also addressed the disclosure implications of the coronavirus outbreak in his statement on the S-K financial disclosure rule proposals. He noted the significant uncertainty surrounding the outbreak’s implications for businesses, but also observed that “how issuers plan for that uncertainty and how they choose to respond to events as they unfold can nevertheless be material to an investment decision.”

Speaking of that, Levi-Strauss filed its Form 10-K yesterday and it includes the first 10-K risk factor disclosure addressing the outbreak (see p. 19). Here’s an excerpt:

Disasters occurring at our or our vendors’ facilities also could impact our reputation and our consumers’ perception of our brands. Moreover, these types of events could negatively impact consumer spending in the impacted regions or depending upon the severity, globally, which could adversely impact our operating results. For example, in December 2019, a strain of coronavirus was reported to have surfaced in Wuhan, China, resulting in store closures and a decrease in consumer traffic in China. At this point, the extent to which the coronavirus may impact our results is uncertain.

John Jenkins