SEC Proposes Disclosure Reforms

The Securities and Exchange Commission has proposed new rules meant to simplify corporate financial disclosure, and also fired off a piece of guidance about how companies should approach non-financial metrics they might want to include in securities filings. 

The proposed rules weren’t exactly a surprise; the SEC has long talked about wanting to streamline the boatloads of information that companies must disclose under Regulation S-K. But the SEC did not hold any open meeting to discuss the proposals or hold a formal vote. The text of the amendments just appeared online Thursday afternoon with a short press release summary.

Anyway, about the proposals themselves. The proposed amendments would eliminate Item 301 (selected financial data) and Item 302 (supplementary financial data); and amend Item 303 (Management Discussion and Analysis) in several ways. 

For those MD&A changes in Item 303, the highlights are:

• 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 for firms 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.

You can read the full proposal on the SEC website, which is as usual is a dense monstrosity that runs 196 pages. The important point for compliance executives to remember right now is that these are proposed amendments, open for public comment. We don’t know when any final amendments will come up for a vote, or how that final version will differ from the proposals released today.

Ethics and compliance professionals — this probably won’t affect you all that much; keep up with that FCPA training and third-party due diligence. Corporate secretaries and other legal types who worry about SEC filings — this ultimately could affect you a lot, since you may need to revisit your company’s disclosure controls as required disclosures change. 

Even if the SEC moves to a more principles-based theory of disclosure (which is what SEC chairman Jay Clayton would like), you’ll still need to understand how judgments your executives make will or won’t fit those principles. 

Guidance on Non-Financial Disclosure 

The SEC also published seven pages of guidance about non-financial metrics that companies might include in securities filings, and the preparation that should go into disclosing those. 

Those metrics can be almost anything: same-store sales, revenue per subscriber, average yield per customer, revenue per available seat mile, or who knows what else. They are not part of Generally Accepted Accounting Principles, and many have no standard framework for calculating and disclosing the metric at all. 

The SEC stressed that when companies do use such metrics, they must include enough context so that investors won’t be confused or misled about the true message. As the SEC phrased it:  

We remind 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.

Some of non-financial metrics actually are financial in nature, but they diverge from GAAP. In that case, SEC rules require the company to explain why it’s including a non-GAAP metric, and to reconcile the number back to the closest GAAP metric that exists — reconciling adjusted net income to net income, for example. With a thoughtful explanation of why net income doesn’t capture the company’s truest tale of performance. 

For even more esoteric non-financial metrics, the SEC said it expects to see the following: 

• 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 company should also consider what any estimates or assumptions lie underneath the metric, and whether you need to disclose those items too so the metric won’t be misleading. 

The guidance also stresses that if you change how a non-financial metric is calculated from one period to the next — that change should be explained clearly, including how it affects the numbers you’ve been reporting. Stealth changes to the calculation of non-GAAP metrics is a big no-no. 

Why all this fuss about non-financial metrics? Because we’re entering peak 10-K reporting season, and these days just about every company under the sun includes at least some non-financial metrics. 

That’s fine; those metrics can help to paint nuanced pictures of performance that investors should see. But they can also be misused to cover up poor performance, which is what the SEC does not want.