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The New MD&A Rule: Part Two – Objective

George Wilson, SEC Institute Director

This article is Part II in a series about MD&A Modernization. See Part I here.

The SEC’s Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information Final Rule was published in the Federal Register on January 11, 2021 and is effective for filings on or after February 10, 2021.

The rule’s transition provisions provide a mandatory transition date but also allow voluntary early compliance. The mandatory transition date is each company’s first fiscal year that ends after August 9, 2021, which is 210 days after the effective date. Companies may voluntarily apply the new rule, on an S-K item-by-item basis, in any filing made on or after the effective date of February 10, 2021.

This means a company that files a Form 10-K on or after February 10, 2021 has the option to early implement this new MD&A (S-K Item 303) guidance. If a company has not implemented the rule early, as we suggested in the earlier post, this is a good project to put on our to-do list for the summer. Additionally, implementation of the new rule allows companies to look for other opportunities to improve their MD&A disclosure.

This article explores the first of the changes to the MD&A requirements, the addition of an objective to S-K Item 303.

A clear writing objective is crucial to effective business writing such as MD&A. Before this new rule, the most recent statement of the MD&A objective was in FR 72, the 2003 MD&A release which states:

The purpose of MD&A is not complicated. It is to provide readers information “necessary to an understanding of [a company’s] financial condition, changes in financial condition and results of operations.” The MD&A requirements are intended to satisfy three principal objectives:

  • to provide a narrative explanation of a company’s financial statements that enables investors to see the company through the eyes of management;

  • to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and

  • to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

This articulation of MD&A’s objective is over 17 years old, but it has never been part of the core guidance for MD&A in S-K Item 303. In the new rule, the SEC included a writing objective as part of S-K Item 303 and modernized the language:

229.303 (Item 303) Management’s discussion and analysis of financial condition and results of operations.

(a) Objective. The objective of the discussion and analysis is to provide material information relevant to an assessment of the financial condition and results of operations of the registrant including an evaluation of the amounts and certainty of cash flows from operations and from outside sources. The discussion and analysis must focus specifically on material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be necessarily indicative of future operating results or of future financial condition. This includes descriptions and amounts of matters that have had a material impact on reported operations, as well as matters that are reasonably likely based on management’s assessment to have a material impact on future operations. The discussion and analysis must be of the financial statements and other statistical data that the registrant believes will enhance a reader’s understanding of the registrant’s financial condition, cash flows and other changes in financial condition and results of operations. A discussion and analysis that meets these requirements is expected to better allow investors to view the registrant from management’s perspective.

In the Final Rule, the SEC included these statements about the new objective:

By emphasizing the purpose of MD&A at the outset of Item 303, the proposal was intended to provide clarity and focus to registrants as they consider what information to discuss and analyze. The proposal was also intended to facilitate a thoughtful discussion and analysis, and encourage management to disclose factors specific to the registrant’s business, which management is in the best position to know, and underscore materiality as the overarching principle of MD&A.

Registrants should regularly revisit these objectives in Item 303(a) as they prepare their MD&A and consider ways to enhance the quality of the analysis provided. These objectives provide the overarching requirements of MD&A and apply throughout amended Item 303. As such, they emphasize a registrant’s future prospects and highlight the importance of materiality and trend disclosures to a thoughtful MD&A.

The Final Rule also focused on the principles-based requirements for MD&A:

[W]e continue to believe that MD&A’s materiality-focused and principles-based approach facilitates disclosure of complex and often rapidly evolving areas, without the need to continuously amend the text of the rule to update or impose additional prescriptive requirements. These amendments are intended to further emphasize these goals.

This objective will help companies improve MD&A. Based on this new objective, here are three key issues to remember in drafting and reviewing MD&A:

  • 1.

    Don’t write from a theoretical or academic perspective. Write about what management regards as important and regularly reviews in the financial statements.

  • 2.

    Focus on the future as much as the past. Any known issues that indicate historical financial performance is not predictive of future financial performance must be considered for disclosure. (As a reminder of this disclosure requirement check out this enforcement action, which involved a $5,000,000 fine when a company failed to disclose an issue that meant that revenues were likely to decline in future periods.)

  • 3.

    MD&A must focus on the financial statements but cannot stop there. It should include “other statistical data that the registrant believes will enhance a reader’s understanding of the registrant’s financial condition, cash flows and other changes in financial condition and results of operations.” (This is very consistent with the SEC’s new metrics release which you can read about in this post and hear more about in PLI’s March 6, 2020 One-Hour Briefing.)

The updated objective of MD&A and these three framing concepts help us understand what we must communicate to investors and are the foundation for effective MD&A disclosure.

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