Comments on MD&A remain a focus area
The key objectives of MD&A are to provide a narrative explanation of the financial statements that enables investors to see the company through the eyes of management, to offer context to the financial statements, and to provide information that allows investors to assess the likelihood that past performance is indicative of future performance. We have found the majority of SEC staff comments in this area are not aimed at meeting specific technical requirements, but rather at enhancing the quality of disclosures to meet these objectives.
The SEC staff comments reinforce the well-established MD&A objectives that disclosures should be
- transparent in providing relevant information,
- tailored to the company’s facts and circumstances,
- consistent with the financial statements and other public communications, and
- comprehensive in addressing the many business risks that exist in today’s economic environment.
Results of operations and liquidity and capital resources have garnered the most attention.
Segment related comments increase
Although the SEC staff has raised questions in prior years regarding how registrants identify and aggregate their operating segments, the volume of comment letters issued around segments has increased by 34% from 2015 to 2016.
The objective of segment disclosures is to provide investors with a view of the business through the eyes of management. As business operations evolve, the way management makes operating decisions and assesses performance are likely to evolve as well, resulting in the need to reassess how operating segments are identified.
The SEC staff often requests detail of how the annual budgeting process works, what registrants’ organizational charts look like, how compensation is determined for segment managers and what financial information is regularly presented to and reviewed by the CODM.
It is also not unusual for the staff to request additional data regarding the financial metrics of registrants’ operating segments in order to assess the appropriateness of aggregation based on economic similarity.
Comments related to non-GAAP measures are expected to be prevalent in 2017
Although our analysis shows a decline in the number of non-GAAP related comments from 2015 to 2016, as a result of the release of the CD&I in May and recent statements made by the SEC staff, we expect the number of non-GAAP related comments to increase from 2016 to 2017.
Our study of financial reporting trends indicated that 91 percent of companies disclosed non-GAAP measures in their earnings releases, while 48 percent of those companies also disclosed non-GAAP measures in their Form 10-K filings.
An analysis of non-GAAP measures by subsector revealed that software & internet companies have a higher propensity to report non-GAAP measures in their Form 10-K filings with 70 percent, compared to 47 percent of computers & networking companies and just 27 percent of semiconductor companies.
State sponsors of terrorism disclosures become an area of increased focus
There number of SEC staff comments issued regarding registrants’ business conducted with state sponsors of terrorism (Syria, Cuba, Iran, and Sudan) has increased by 46% from 2015 to 2016.
The SEC staff continues to ask registrants to disclose quantitative and qualitative information about interactions with these countries that a reasonable investor would regard as important in making an investment decision.
These include the nature and extent of contact (directly or indirectly), including the amount of revenues derived and assets associated with each country (without any materiality threshold), and a description of equipment and technology that the company has provided to these countries. These comment letters are often issued based on the review of public information outside of the registrant’s own filings, such as relevant news articles or registrant websites.