Current macroeconomic and geopolitical uncertainty may make it difficult for companies to know how to tackle their Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") disclosure. In this article, the White & Case team discusses recent MD&A disclosure challenges faced by companies in the current market and provides guidance and key practical takeaways that companies should consider.
The conflict in Ukraine and resulting sanctions, geopolitical uncertainty, energy costs and multi-decade high inflation rates are just some of the factors contributing to the dimmed financial markets prospects of a post COVID-19 economic recovery.1 Without a doubt, these macroeconomic trends have and will continue to have serious implications on the performance, operations and conditions of many companies. According to Kevin Vaughn, senior associate chief accountant at the US Securities and Exchange Commission ("SEC"), the SEC has been attentive "to the various factors affecting issuers as a result of the shifting economic and geopolitical conditions" such as the conflict in Ukraine, supply chain issues, inflation and rising interest rates.2
The SEC’s MD&A disclosure requirements make it clear that management must disclose trends, which likely have a material adverse effect on a company’s financial results. As such, management will have to pay closer attention to a company’s public statements in light of the current economic volatility, with MD&A disclosure set to receive particular focus. This presents its own challenges considering that prospectuses and ongoing reporting are often investor-facing and, understandably, management may be incentivised to emphasise positive results or outlooks rather than analyse trends relating to an economic downturn. In addition, the recent move of the SEC towards a broader principles-based approach, an increased focus on disclosure through management’s eyes and the forward-looking nature of the MD&A itself, adds additional complexities.
In such market conditions, where disclosure topics may be complex, and associated with uncertain risks that are rapidly evolving, companies may find it more challenging to navigate disclosure requirements without practical guidance. This alert reviews the key recent developments in the MD&A section in the midst of the market conditions and offers some practice points.
Forward-looking analysis and principles-based approach
The MD&A is a standout among the SEC disclosure requirements as it calls for both disclosure of historical data alongside trends that currently, and in the future may, affect businesses. This requires the company to conduct more detailed forward-looking analysis of market trends and their interactions with such company’s expected performance.
Section 303(b)(2)(ii) of Regulation S-K3 requires that the MD&A disclosure identify any "known trends or uncertainties that have had or that are reasonably likely to have a material favourable or unfavourable impact on net sales or revenues or income from continuing operations." The SEC has indicated that the MD&A disclosure requirement turns on (1) the likeliness of a known trend or uncertainty to occur and (2) if so, whether such trend or uncertainty is likely to have a material effect on a company’s financial condition or its results. Also, the SEC continues to stress that the purpose of the MD&A is to convey management’s discussion and analysis — driving home the notion that investors should be able to see through management’s eyes. A well written MD&A, thus, enables investors "to understand how management is positioning a company in the face of uncertainties."4 The requirement to conduct such forward-looking analysis so that investors are able to see through management’s eyes, in terms of disclosure, makes the MD&A even more susceptible to after-the-fact scrutiny.
In addition, in recent years, the SEC has emphasised that the disclosure requirements are moving towards a largely principles-based approach. The SEC’s transition from a prescriptive to a principles-based approach is aimed to encourage management to exercise judgement in assessing what disclosure to provide, which in turn, will result in disclosure that is tailored to the company’s specific facts and circumstances.
As part of this transition to a principles-based approach, the SEC adopted several amendments to Regulation S-K, including changes to required MD&A disclosure on 19 November 2020.5 These amendments, which incorporate the SEC’s move towards modernisation, provided management with a higher degree of flexibility and discretion by removing several prescriptive rules in favour of a broader principles-based approach to MD&A disclosure. Key amendments included (i) the addition of new item 303(a), which explicitly refers to the "through management eyes standard," (ii) an instruction emphasising the need to discuss off-balance-sheet obligations in the broader context of MD&A disclosure when such obligations have or are likely to have a material effect on the company’s performance and (iii) eliminating the requirement for quarter-on-quarter comparison to be against the same quarter of the previous year in support of a flexible approach which allows either prior year or prior quarter comparison.
MD&A disclosure in perspective: Economic and Geopolitical Uncertainty
Although the SEC is leaving behind its exhaustive list of disclosure items in lieu of a principles-based approach, which provides both issuers and the SEC with more space to manoeuvre in turbulent economic climates, it continues to issue guidance on significant macroeconomic trends, which is, in some respects, reminiscent of its older formulaic approach. Management should carefully consider this guidance in preparing MD&A disclosures, given the particular challenges posed to issuers by the current economic volatility and geopolitical uncertainty. For example, disclosures on a business’ geographic and sanctions exposure could play a much larger role than is accorded to them in peaceful periods.
SEC’s stance on geographic exposure – beyond accounting
The SEC has historically sought enforcement action against companies that failed to disclose the material impact of exposure to particular markets or jurisdictions in their reports. In the seminal MD&A enforcement action by the SEC, Caterpillar,6 the SEC alleged that management knew of the materiality of sales from the company’s Brazilian and South American subsidiaries to its bottom line, and failed to adequately disclose an anticipated decline in such sales to investors in its reports. While the SEC recognised that under GAAP rules at the time, the company was not required to show its Brazilian subsidiary as a foreign operation, it should have addressed its "disproportionate impact" as part of the MD&A discussion. Simply put, the defendant’s "failure to include required information about [its Brazilian subsidiary] in the MD&A left investors with an incomplete picture of [the defendant’s] financial condition and results of operations and denied them the opportunity to see the company ‘through the eyes of management.’"7 The SEC made it clear that companies need to think beyond accounting or other formal rules and focus on full disclosure and transparency.
SEC’s stance on conflicts, supply chain issues and sanctions – direct or indirect/actual or potential effect
On 3 May 2022, the SEC published guidance on disclosure pertaining to the conflict in Ukraine and related supply chain issues.8 The guidance instructs companies to provide detailed disclosure of (i) direct or indirect exposure to Russia, Belarus or Ukraine, (ii) direct or indirect reliance on goods or services sourced in any of the above jurisdictions, (iii) actual or potential disruptions to the supply chain and (iv) any business relationships, connections or assets in any of the above jurisdictions. While not specifically referring to MD&A disclosure, the SEC points out that "Companies also should consider how these matters affect management’s evaluation of disclosure," making it clear that companies need to think beyond the direct sanctions-related implications of the conflict in Ukraine in their disclosure.
This guidance reflects that the MD&A section would be equally scrutinised by the SEC not only in instances of exposure to markets which are directly materially affected by conflicts or sanctions but also in instances of markets indirectly materially affected, such as markets closely linked to the affected areas or economically dependent markets.
SEC’s stance on inflation rates – companies’ discretion
Perhaps most notably in the current climate, the SEC in its amendments in 2021, removed item 303(a)(3)(iv), which required discussion of the impacts of price changes and inflation, indicating that the previous rules accorded undue attention to the topic of inflation. The SEC nevertheless indicated that issuers "will still be required to discuss these matters if they are part of a known trend or uncertainty that has had, or the registrant reasonably expects to have, a material favorable or unfavorable impact on net sales, or revenue, or income from continuing operations,"9 leaving a healthy amount of discretion in the hands of companies and plenty of room for interpretation that is ripe for scrutinising after-the-fact.
It is worth mentioning that this rule amendment was enacted following a period of nearly 15 years of low inflation rates and relative global economic stability. Not since the summer of 2008 have inflation rates in the US registered a 5% (or higher) increase year-on-year, and not since the Gulf war has such an inflationary peak been sustained for longer than a couple of months.10 2022 would therefore be the first year where price increases and global inflation form part of a noteworthy trend, with some global markets, including Sudan and Sri Lanka experiencing hyperinflation.11 While the SEC has not issued updated guidance on inflation rates, it is probable that MD&A disclosure on inflation will be subject to careful review by the SEC in accordance with the amended rules that promote its principles-based approach.
SEC’s stance on ESG – principles-based materiality
The principles-based approach to disclosure is also exemplified by certain of the SEC’s recently proposed rules with respect to climate change disclosure.12
The proposed rules aim for companies’ ESG disclosure to match those currently envisioned by the SEC for the MD&A section. The SEC noted that rules pertaining to ESG and climate disclosure "will serve a similar function to the MD&A," and that "the materiality determination that a registrant would be required to make regarding climate-related risks under the proposed rules is similar to what is required when preparing the MD&A section." If implemented in current form, the proposed ESG rules would require management to pay closer attention to the company’s internal controls, audit and oversight functions in order to generate adequate disclosure in a similar vein to the MD&A.
The proposed ESG disclosure rules are also likely to affect the MD&A section. In particular, rules requiring discussion of effects of climate change on business and strategy will result in increased scrutiny of disclosure quality from both the MD&A and ESG perspective. Indeed, the proposed ESG rules point out that disclosure, of either climate-related risks or opportunities should address "the actual or potential… impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains, as a whole."13
As demonstrated by the above, the SEC may utilise its principles-based approach and "management’s eyes" standard to allow itself increased flexibility in reviewing and scrutinising a wide range of disclosure. Going forward, companies should be mindful in making determinations of materiality in disclosure and carefully consider what information available to management could potentially be relevant to investors.
The principles-based approach in practice – lessons from NVIDIA
The SEC’s course of action in the case study of NVIDIA illustrates its willingness to apply its principles-based approach towards MD&A disclosure in novel contexts or sets of circumstances that may impact a company’s financial results or conditions.
Recently in NVIDIA,14 the SEC sought enforcement action against the gaming company alleging its management knew of the materiality of crypto-mining sales on its overall performance but failed to report this to investors, as it did not have the tools to quantify the effect during the 2018 fiscal year. The SEC, through a close review of subsequent disclosure in the MD&A section from the company’s 2018 Form 10-K report, picked up on the lack of earlier disclosure and sought action based on negligence. NVIDIA was found to have violated Section 17(a)(2) and (3) of the Securities Act of 1933 and the disclosure provisions of the Securities Exchange Act of 1934.15
In its findings, the SEC focused on the company’s failure "to disclose that crypto-mining was a significant factor in the material year-over-year growth in [its] gaming revenue," which resulted in "[omissions of] significant information relating to NVIDIA’s GPU segment revenue and its component GPUs for gaming, and any related risks."16 These omissions, in conjunction with NVIDIA’s later disclosure of the impact of crypto-mining on its sales "gave the misimpression… during the relevant period that the year-over-year growth in the company’s gaming revenue was not meaningfully impacted by crypto-mining."17 The SEC stressed that, given the volatile nature of crypto-mining and uncertainty with regards to its long term prospects, the company should have further emphasised its impact on its sales and whether it would be indicative of future performance.
The SEC also found that NVIDIA failed to maintain adequate disclosure controls and procedures. In NVIDIA the SEC pointed out that "even though NVIDIA had information indicating that crypto-mining was a significant factor… [it] failed to maintain disclosure controls or procedures designed to ensure that information required to be disclosed in NVIDIA’s results of operations was reported as required by the MD&A provisions of Regulation S-K."18
In light of the turbulent circumstances of our global economy, managers should not omit any material information, especially factors that are novel and/or susceptible to fluctuation, which may be of relevance to investors. The NVIDIA enforcement action also demonstrates the intrinsic link between effective internal control mechanisms and adequate disclosure. Management’s eyes should be directed at assessing the adequacy of the company’s internal reporting and control mechanisms, and prudent management should seek to reinforce and amplify those in response to a changing economic landscape when required. Without such mechanisms, disclosure in due diligence processes, offering documents and shareholder reports will likely fall short of the SEC’s requirements, and could potentially trigger not only enforcement action but also litigation.
Conclusion: Current macroeconomic trends require careful attention
The SEC’s transition from specified disclosure items to a broader principles-based approach to the MD&A section should merit the attention of every company, particularly in the current economic and geopolitical times. While the SEC’s principled standard of review may result in uncertainty, the lack of a clear disclosure checklist, and consequently greater discretion, can be utilised by companies to make pre-emptive disclosures that go beyond discussion of the financial statements.
Companies should ensure that effective controls and procedures are in place to record all known trends or uncertainties that are available to management and make determinations of disclosure with the standard of "through management’s eyes" in mind. Management then should err on the side of caution, utilising all the information it has available to it at the time of drafting. It should make determinations of materiality arising from trends that are relevant to both current and potential future impacts on the business, direct or indirect, even if not clearly demonstrable by the financial statements or difficult to quantify in financial terms.
The MD&A section of a prospectus or as part of this ongoing reporting should be drafted carefully and in consultation with outside counsel. For any further advice and guidance in this area, please reach out to your White & Case contact or to one of the Capital Markets attorneys listed on this alert.
1 Although the COVID-19 induced volatility of 2020-2021 and its economic repercussions continue to reverberate today, it will not be the main focus of this client alert. For more information, see Coronavirus Resource Center | White & Case LLP (whitecase.com)
2 As reported by CFO Dive, Vaughn was one of the speakers during the Financial Accounting Standards Board’s (FASB) advisory council meeting held 20 September 2022. See SEC presses for economic risk disclosures | CFO Dive.
3 The regulation under the US Securities Act of 1933 which establishes the reporting requirements on public companies when making various SEC filings, and which provides guidance to issuers conducting Rule 144A offerings.
4 As quoted by William Hinman (SEC Director, Division of Corporation Finance) at the 18th Annual Institute on Securities Regulation in London, England on 15 March 2019. See SEC.gov | Applying a Principles-Based Approach to Disclosing Complex, Uncertain and Evolving Risks
5 For more information on the SEC amendments to the MD&A and other Financial Disclosures, see Press Release published by the SEC on 19 November 2020: SEC.gov | SEC Adopts Amendments to Modernize and Enhance Management’s Discussion and Analysis and other Financial Disclosures
6 In re Caterpillar Inc., Exchange Act Rel. No. 30532, 51 SEC Docket (CCH) 147 (March 31, 1992)
7 Id, 
8 The guidance represents the views of the staff of the Division of Corporation Finance at the SEC, published 3 May 2022. See SEC.gov | Sample Letter to Companies Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues 
9 See page 8 of the Final rule: Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information (sec.gov) effective from February 10, 2021.
10 For more information on past inflationary episodes, see Historical Parallels to Today’s Inflationary Episode - CEA - The White House, published on 6 July 2021
11 For a list of countries worst hit by inflation today, see The global inflation nightmare: Ten worst-hit nations (firstpost.com), published on 4 October 2022
12 See footnote 9
13 As stated on pp. 21349 and 21465 of the SEC proposed rule on the Enhancement and Standardization of Climate-Related Disclosures for Investors, published on April 11, 2022. See https://www.regulations.gov/document/SEC-2022-0494-0001
14 In re NVIDIA Corporation Securities Litigation, No. C 08-04260 RS (N.D. Cal. 12 Oct. 2011)
15 For more information on the charges against NVIDIA Corporation, see the press release published by the SEC on 6 May 2022, SEC.gov | SEC Charges NVIDIA Corporation with Inadequate Disclosures about Impact of Cryptomining
16 See footnote 14
Diala Kakish (White & Case, Legal Assistant, London) contributed to the development of this publication.
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