While developments with respect to the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section in SEC disclosure documents have garnered less attention in the legal press in recent years than certain other areas in the SEC disclosure arena, preparing and crafting MD&A disclosures remains a major area of focus for SEC disclosure lawyers.
The MD&A is the section of a periodic report or registration statement in which management provides its analysis of the registrant’s financial condition and results of operations, thereby providing critical insight into the views of management regarding the key drivers and trends impacting a public company’s financial performance.
Disclosure lawyers should note these key tips and observations when preparing or reviewing MD&A:
- Layered Disclosure. Drafting layered disclosure, whereby the MD&A is ordered with the more important themes or highlights set forth at the beginning of the disclosure, with additional detail to follow, has been advocated by the SEC Staff (including in its 2003 MD&A interpretative release) and will enhance the readability of the MD&A. Such layered disclosure will be facilitated by the inclusion of an executive summary at the beginning of the MD&A, an approach which is followed by some, but not all, registrants.
- Other Readability Techniques. The usage of headings, bullet points, and a plain English drafting approach may also improve the readability of the MD&A. The readability of the MD&A may also be enhanced by cross-referencing (rather than repeating) discussions elsewhere in the periodic report or (in the case of Form 10-Q MD&A disclosure) disclosures in the Form 10-K to the extent these disclosures do not require updating.
- Item 303 Requirement to Disclose Material Trends. A core disclosure component of Item 303 of Regulation S-K (which sets forth the SEC disclosure requirements applicable to MD&A) is the requirement to provide an analysis of known material trends, uncertainties and other events impacting a registrant’s results of operations, liquidity or capital resources. Practice varies widely among registrants regarding the extent to which the disclosure of forward-looking statements is included in the MD&A. While there may be reticence among some registrants to include overly expansive forward-looking disclosure (for example, based on concerns about liability exposure if such forward-looking information is not ultimately accurate), countervailing considerations include the fact that such disclosure may result in more useful disclosure as well as the fact that the failure to disclose known trends can give rise to exposure from Rule 10b-5 allegations from private parties as well as SEC civil actions.
- Impact of Trends Disclosure on Future Periodic Reports. When considering how and whether to disclose material trends in the MD&A, registrants should be mindful of the fact that the inclusion of such trends disclosure in the MD&A may in certain circumstances create the need to update (and continue) such disclosure in the MD&A in the next periodic report of the registrant (rather than simply deleting such disclosure in the next succeeding periodic report).
- Location of Trends Disclosure. In considering whether to disclose a trend in the financial statements footnote or the MD&A, disclosure counsel should be mindful of the fact that the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act (PSLRA) (which applies to forward-looking statements accompanied by meaningful cautionary language) are applicable to disclosures in the MD&A but do not apply to financial statement footnote disclosures.
- Interaction between MD&A Disclosure and Risk Factors Disclosure. In drafting MD&A disclosure, disclosure counsel should consider whether any disclosure included in the MD&A also gives rise to a need (when drafting Form 10-K MD&A disclosure) to make corresponding revisions to risk factors disclosure in the Form 10-K or (when drafting Form 10-Q MD&A disclosure) potentially merits any risk factor updates for inclusion in the Form 10-Q.
- Quantification of Factors Impacting Performance. When providing a narrative description of factors impacting the results of operations for a registrant in the MD&A, disclosure counsel should give consideration not only as to whether particular drivers of results materially impacted performance, but also whether it is helpful or necessary to quantify the impact of such trends during the applicable period in order to provide a clearer picture of performance.
- Non-GAAP Financial Measures. Many registrants will include less extensive disclosures of non-GAAP financial measures in periodic reports than in earnings release disclosures, which may be based on the view that it is unnecessary to include the same level of non-GAAP financial disclosure in periodic reports given the lesser analyst and investor focus on periodic reports in comparison to earnings release materials. To the extent non-GAAP financial disclosures are included in the MD&A of periodic reports, disclosure counsel should closely review SEC rules and Staff guidance regarding non-GAAP financial disclosures to ensure compliance with legal requirements (including with respect to the requirement to provide equal or greater prominence to GAAP financial information).
- Review Earnings Release Disclosure Package for Consistency. Disclosure counsel should review the earnings release, earnings call transcript and (to the extent applicable) earnings deck investor presentation for consistency with the periodic report. In this regard, the SEC Staff will review not only earnings releases, but also earnings call transcripts, and any material inconsistencies between these disclosures and periodic report disclosures can be a topic of SEC comment. In addition, the question and answer portion of the earnings call may yield helpful insight into the most important issues and trends impacting a registrant from the perspective of analysts.
- Post-Period Events. Disclosure counsel should be mindful of the potential need (given that the MD&A speaks as of the date of filing) to disclose events arising following the end of a quarter, even if such events do not impact results of operations for the quarter or need to be disclosed in the financial statement footnotes included in the periodic report (except in a subsequent event footnote).
- Review Peer Company Disclosure. There may be benefit in periodically reviewing the MD&A disclosure of peer companies of the registrant, as well as SEC comment letters received by such peer companies in order to assess areas of focus of the SEC Staff which may also be of relevance to the registrant.
- Critical Accounting Policies and Estimates. Taking into account past Staff pronouncements on this issue, most registrants will disclose (either in the periodic report or in some cases through cross-referencing to the Form 10-K) critical accounting policies and estimates. Registrants will commonly address three to five critical accounting policies (which will be a subset of the accounting policies otherwise discussed in the financial statement footnotes) in the MD&A, and when doing so should provide an analysis as to why the impact of these critical accounting policies could be material.
If you have questions, please feel free to contact Kevin Douglas directly or, if applicable, contact your primary Bass, Berry & Sims corporate & securities relationship attorney.