Question & Answer: The SEC historically has only required companies to disclose information that is “material to a reasonable investor.”…..

Materiality of an item

FASB Accounting Standards Codification (ASC) 105-10-05-6 states that “the provisions of the Codification need not be applied to immaterial items.” However, neither the FASB nor the SEC provides specific guidance clarifying how to consider the materiality of individual disclosure requirements. As a result, companies often provide every specified GAAP disclosure that relates to each area (e.g., stock compensation expense) that they determine is material to their financial statements. We believe that companies should consider how individual disclosures affect the total mix of information available. That is, companies don’t need to include all specified disclosures if they conclude that an individual disclosure is immaterial. We believe this view is consistent with the Supreme Court’s definition of materiality.

Materiality considerations as part of SEC review process

Companies tend to retain disclosures that were material in a previous period but may no longer be material. This phenomenon is especially true when the disclosure was added in response to an SEC staff comment. The SEC staff has said publicly that companies should remove disclosures made in response to earlier SEC staff comment letters if those matters are no longer material. The SEC staff also has said that just because it raises questions, companies should not assume that they need to add more disclosures to their filings, particularly immaterial information. The SEC staff often issues comments seeking clarification rather than additional disclosure. In some cases, registrants should respond by revising their disclosure to make it more effective rather than adding new disclosures. The SEC staff is assessing whether its comment letter practices have contributed to the disclosure of immaterial information and will consider whether any changes to its filling review and comment practices are necessary.

The SEC has said that companies can improve the relevancy of disclosures and reduce clutter by presenting information in a logical, easy-to-read manner. In 2003, the SEC issued FR-72, Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations, which provides interpretive guidance concerning the preparation, format and content of management’s discussion and analysis (MD&A). FR-72 states that MD&A should provide an explanation of the company’s financial statements that enables investors to see the company through the eyes of management. In addition, FR-72 says the primary purpose of MD&A is for management to communicate with investors in a straightforward manner. It states that companies should: • Focus on material information, eliminate immaterial information and avoid unnecessary duplicative disclosure • Use a “layered” approach to present their disclosure so that the most important material information is most prominent • Present MD&A in a clear and understandable way by using tables and headings to help readers follow the flow of pertinent information • Provide not only required disclosure but also an analysis that explains management’s view of the implications and significance of that information We encourage companies to revisit these principles when enhancing the effectiveness of their MD&A disclosures. We also believe companies should consider whether similar principles can be applied to the presentation of financial statement notes or other disclosures outside their financial statements. For example, these principles may guide how a company presents and discusses both financial and nonfinancial information, including operational and strategic goals, key performance indicators, and corporate and social responsibility information considered material to its investors. In the following sections, we discuss these concepts and best practices based on our review of filings by companies that have already applied them.

Use of layering

Layering refers to emphasizing the most important information and providing additional details elsewhere. Layering can be accomplished in several ways. FR-72 encourages companies to use an executive-level overview to provide context for their MD&A. The summary should present the important factors in evaluating the company’s financial condition and operating performance without merely repeating the detailed discussion and analysis that follows. The SEC staff expects an informative executive-level overview to provide insight into material opportunities, challenges and risks on which the company’s executives are most focused for both the short and long term, as well as the actions they are taking to address them. In our view, companies can apply this concept to other disclosures. They can use summaries, activity rollforwards or hyperlinks that emphasize or allow navigation to the most important information, provide additional context and details, or minimize redundancies. See below for recommendations and illustrations of how layering can be used to make MD&A and footnote disclosures more effective. Longer term, we expect technology to play an important role in disclosure reform. For several years, the SEC has contemplated using technology to structure disclosure and make it easier for investors to find material information.

Use of graphs, charts and tables

Information often can be presented more clearly and concisely in graphs, charts and tables than in text. In recent standards and rule releases, the FASB and SEC have encouraged and, in some cases, required tabular presentations of disclosure. For example, the rules related to executive compensation disclosures require tabular disclosures along with narrative discussion that supplements the tables.Furthermore, FR-72 encourages the use of tables to compare and explain changes in results between different periods.

Use of cross-references

Regulators often point to duplicative disclosures as a factor contributing to information overload and investor confusion. When a company provides substantially similar disclosure in different areas of a filing, the document is longer than it needs to be and users aren’t likely to understand why disclosure is repeated. Disclosures about significant accounting policies, loss and legal contingencies, and business descriptions are often repeated in different places in the disclosure documents (e.g., risk factors, MD&A, footnote disclosure). Cross-referencing is an effective way to reduce repetition and direct the reader to a section that contains additional relevant information on a topic. There are valid concerns that cross-referencing from the financial statement notes to MD&A may result in confusion with respect to audit responsibility. Conversely, there are valid concerns that referencing from MD&A to the notes results in the loss of safe-harbor protections for forward-looking disclosures. Despite these concerns, we believe there are several areas where companies can use properly worded cross-references (e.g., from MD&A to the notes) to enhance their disclosure. In addition, if information is complementary but not required content and could provide additional context, insight or detail, a company may point to such information outside the disclosure document (e.g., on the company’s website) without making the information part of the SEC filing. A company also may consider, as appropriate, incorporating by reference disclosure from previous filings, thereby avoiding repetition.

Eliminating immaterial disclosures

We have seen companies effectively reduce the size of their filings by removing immaterial disclosures that have accumulated over time. For example, disclosures that were included for business conditions or events that are no longer material to understanding the company’s operating results or financial condition may linger in filings for several periods. As part of their financial reporting processes, companies should identify immaterial disclosures that can be omitted or substantially reduced. In conjunction with that, they should document their rationale. Contemporaneous documentation of the rationale for omitting immaterial disclosure items can be valuable if those omissions are later challenged by regulators or litigants. In many cases, because the FASB does not list all specified disclosures in a single place, companies use disclosure checklists that accumulate all individual SEC and FASB disclosure requirements to evaluate which disclosures are applicable and material. Companies should also use these checklists to document the relevant quantitative and qualitative factors they evaluated when deciding to exclude disclosures they deemed not material.

In this section, we explore how companies are making their disclosures more meaningful. The illustrations below reflect effective practices that we have seen in company filings. However, because every company’s facts and circumstances are different, companies must tailor the structure and content of disclosure based on their needs.

Financial statement footnotes

Several companies have focused on making certain lengthy footnote disclosures more meaningful while still providing the required information.Most commonly, we have seen companies change how disclosures about pensions and other postretirement benefits, stock-based compensation, loss contingencies, derivatives and hedging, and fair value measurements are presented such that required information is conveyed in a meaningful manner.

Disclosure of significant accounting policies

The significant accounting policies note should identify and describe the material accounting principles followed by the company, the methods of applying those principles and the important judgments made in applying them. In particular, ASC 235 requires disclosure of material accounting principles and methods that involve any of the following: • A selection from existing acceptable alternatives • Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry • Unusual or innovative applications of US GAAP We often see companies go well beyond this requirement and describe policies for every line item. For example, a company may disclose its accounting policy for prepaid expenses even when it has made no material judgments or policy elections in the periods presented. Companies should consider removing disclosures of accounting policies that are not currently applicable or material to the financial statements or that require little to no discretion to apply. Furthermore, companies frequently cite the requirements in the FASB Codification when they describe their policies. In our view, disclosure should not repeat what a standard says about policy requirements if the standard does not permit alternative methods. Instead, companies should describe policy elections they have made and the related judgments and estimates required to apply the authoritative literature to their transactions, if relevant.