SEC Posts New Interpretive Release on MD&A Disclosure

First reported: February 19, 2004

The Securities and Exchange Commission ("SEC") has posted a new interpretive release on Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") disclosure which can be read in its entirety on the SEC's website at http://www.sec.gov/rules/interp/33-8350.htm . On a global level, there are no surprises here; however, the release contains a fair amount of detailed guidance and several useful illustrations that should be helpful in improving companies' analyses. The release will be effective when published in the Federal Register. The Division of Corporation Finance will continue to review MD&A and keep the Commission apprised of whether disclosure has improved or whether additional action is required.

The release reiterates that the purpose of MD&A is to provide 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:

1) to provide a narrative explanation of a company's financial statements that enables investors to see the company through the eyes of management;

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

3) 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.

Picking up on a theme from the SEC's 1989 MD&A release, the SEC reiterates that MD&A should be a discussion and analysis of a company's business "as seen through the eyes of those who manage that business." The SEC's additional guidance is in the following areas:

• the overall presentation of MD&A, focusing on the following points:
• within the universe of material information, companies should present their disclosure so that the most important information is most prominent;
• companies should avoid unnecessary duplicative disclosure that can tend to overwhelm readers and act as an obstacle to identifying and understanding material matters; and
• companies should consider starting their MD&As with a section that provides an executive-level overview that provides context for the remainder of the discussion;
• the focus and content of MD&A (including materiality, analysis, key performance measures and known material trends and uncertainties), focusing on the following points:
• companies should focus on material information and eliminate immaterial information that does not promote understanding of companies' financial condition, liquidity and capital resources, changes in financial condition and results of operations (both in the context of profit and loss and cash flows);
• companies should identify and discuss key performance indicators, including non-financial performance indicators, that their management uses to manage the business and that would be material to investors;
• companies must identify and disclose known trends, events, demands, commitments and uncertainties that are reasonably likely to have a material effect on financial condition or operating performance; and
• companies should disclose not only information responsive to specific requirements but, to satisfy the objectives of MD&A, also analyze and explain management's view of the implications and significance of that information;
• disclosure regarding liquidity and capital resources, focusing on disclosure of cash requirements and sources of cash:
• companies should consider enhanced analysis and explanation of the sources and uses of cash and material changes in particular items underlying the major captions reported in their financial statements, rather than recitation of the items in the cash flow statements;
• companies using the "indirect method" (discussed below) in preparing their cash flow statements should pay particular attention to disclosure and analysis of matters that are not readily apparent from their cash flow statements; and
• companies also should consider whether their MD&A should include enhanced disclosure regarding debt instruments, guarantees and related covenants; and
• disclosure regarding critical accounting estimates, particularly where the subjective nature of judgments is material to understanding the uncertainty of certain amounts, including enhanced discussion that:
• supplements, but does not duplicate, the description of accounting policies in the notes to the financial statements; and
• provides greater insight into the quality and variability of information regarding financial condition and operating performance.

(Source: © 2005 The State Bar of California)

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