Management must include, as part of Form 10-K filings, a section entitled “Management Discussion and Analysis of Financial Condition and the Results of Operations” (commonly referred to as Management Discussion & Analysis [MD&A]). The governing regulation is Section 229.303 of Regulation S-K and is referred to as Item 303. As stated in Item 303, the objective of the MD&A is “to provide to investors and other users information relevant to an assessment of the financial condition and results of operations of the registrant as determined by evaluating the amounts and certainty of cash flows from operations and from outside sources.” The MD&A should permit shareholders and users to see and understand the specific decisions made through the eyes of management. The Securities and Exchange Commission (SEC) has stated:

The Commission has long recognized the need for a narrative explanation of the financial statements, because a numerical presentation and brief accompanying footnotes alone may be insufficient for an investor to judge the quality of earnings and the likelihood that past performance is indicative of future performance. MD&A is intended to give the investor an opportunity to look at the company through the eyes of management by providing both a short- and long-term analysis of the business of the company. The Item asks management to discuss the dynamics of the business and to analyze the financials. [Securities Act Release No. 6711, April 24, 1987, 52 Federal Register (FR) 13715]

The SEC has especially emphasized the need for prospective disclosures:

The MD&A requirements are intended to provide, in one section of a filing, material historical and prospective textual disclosure enabling investors and other users to assess the financial condition and results of operations of the registrant, with particular emphasis on the registrant's prospects for the future. [Release Nos. 33-6835; 34-26831, May 18, 1989]

This is notably similar to the statement given by the Financial Accounting Standards Board (FASB) on the purpose of financial reporting in general:

Financial reporting should include explanations and interpretations to help users understand financial information provided. For example, the usefulness of financial information as an aid to investors, creditors, and others in forming expectations about a business enterprise may be enhanced by management's explanations of the information. Management knows more about the enterprise and its affairs than investors, creditors, or other “outsiders” and can often increase the usefulness of financial information by identifying certain transactions, other events, and circumstances that affect the enterprise and explaining their financial impact on it. [par. 54, FASB Concepts Statement, Objectives of Financial Reporting by Business Enterprises]

Additionally, the Financial Analysts Federation has endorsed the MD&A:

We have supported the efforts of the SEC to make these disclosures meaningful. The MD&A, when properly prepared, can be extremely valuable in helping users understand the results of operations and, by extension, the factors which will affect future operating results. [Letter dated September 30, 1986, from Anthony Cope, Chairman, SEC Liaison Committee of the Financial Analysts Federation, to Jonathan Katz, Secretary, SEC]

In sum, both the SEC and the investment community strongly support the MD&A requirement. Furthermore, in light of SEC enforcement actions, particular care should be exercised in drafting the MD&A.

(b) Brief History

The requirement for a management discussion section originated in 1968 when the SEC adopted the Guides for Preparation and Filing of Registration Statements (Securities Act Release No. 33-4936). These guides required a summary of earnings, which was to address unusual conditions affecting net income. In 1974, this summary was mandated for filings under the Securities Exchange Act and was broadened to include a discussion of underlying trends in profitability. Although specific topics to be discussed were not specified, recommendations were made. The SEC wanted to keep the requirements flexible, allowing management to discuss those items peculiar to its business, in order to prevent a “boilerplate” presentation. However, corporations generally fulfilled the requirement by providing percentage changes of financial statement line items (which investors could calculate themselves) without providing substantive reasons for the changes.

In 1977, the SEC's Advisory Committee on Corporate Disclosure reiterated that corporate management, in fact, be given broad latitude in their discussions but that better direction be provided. To elicit more meaningful prospective analyses, the SEC granted protection under safe harbor rules in 1979.¹ Then in 1980, the MD&A requirement was substantially expanded and rewritten. Although “soft” information was to be provided, the overriding belief was that the potential relevance surpassed problems of verifiability. The 1980 requirements changed the MD&A from a summary of earnings only to an analysis of liquidity, capital resources, and results of operations.

In May 1989, the SEC issued an Interpretive Release, Management's Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures, which provided guidance, particularly on prospective or “forward-looking” disclosures.² This is significant in that the examples included in the release can serve as standards against which the SEC can measure the adequacy of registrant disclosures. The entire 1989 release is known as FR 36. (See www.sec.gov/rules/interp/33-6835.htm.)

With respect to currently known trends, the 1989 release points out that management must assess whether the trend, demand, commitment, event, or uncertainty is likely to happen. If a matter is not likely, no disclosure is required. However, management must be able to make a determination that a matter is not likely. If management cannot make such a determination, it must evaluate the consequences based on the assumption that the event will happen and then disclose the effects if the consequences are material. The release distinguishes currently known trends from anticipated trends.

Examples of known trends affecting future operations include reductions in the registrant's product prices, erosion in market share, changes in insurance coverage, likely nonrenewal of a material contract, discontinuation of a growth trend, and implementation of recently enacted legislation. With respect to future liquidity, the release indicates that the SEC expects registrants to discuss both short- and long-term liquidity, and to use the framework of the statement of cash flows as a basis of discussion (i.e., future operating, investing, and financing cash flows).³

To underscore the SEC's insistence on enhanced prospective disclosures, the SEC issued this warning in footnote 28 in its May 1989 Interpretative Release:

Where a material change in a registrant's financial condition (such as a material increase or decrease in cash flows) or results of operations appears in a reporting period and the likelihood of such change was not discussed in prior reports, the Commission staff as part of its review of the current filing will inquire as to the circumstances existing at the time of the earlier filings to determine whether the registrant failed to discuss a known trend, demand, commitment, event or uncertainty as required by Item 303. [Release Nos. 33-6835; 34-26831, May 18, 1989]

Prior to the passage of the Sarbanes-Oxley Act of 2002 (SOX), the SEC issued additional guidance for MD&A. After the passage of SOX, two of the three releases were formally codified and incorporated into Regulation S-K through SEC rule making.

In 2001, the SEC issued Cautionary Advice Regarding the Use of “Pro Forma” Financial Information in Earnings Releases (also referred to as FR 59). In response to Section 401(b) of SOX and to codify guidance in FR 59, the SEC amended Regulation S-K with the issuance of the final rule, Conditions for Use of Non-GAAP Financial Measures, on January 22, 2003 (also referred to as FR 65).

The SEC also issued, in 2001, Cautionary Advice Regarding Disclosure About Critical Accounting Policies (referred to as FR 60). On May 10, 2002, the SEC proposed a rule entitled Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies. This proposal remains outstanding.

During 2001, the SEC also issued a statement entitled Commission Statement About Management's Discussion and Analysis of Financial Condition and Results of Operations (referred to as FR 61). This release primarily addressed liquidity and capital resources disclosures. In response to section 401(a) of SOX and to codify FR 61, the SEC amended Regulation S-K with the issuance of a final rule entitled Disclosure in Management's Discussion and Analysis About Off-Balance-Sheet Arrangements and Aggregate Contractual Obligations (also referred to as FR 67).

After the passage of SOX , the SEC continued issue MD&A guidance. During 2003, the SEC issued interpretative guidance entitled Commission Guidance Regarding Management's Discussion and Analysis of Financial Condition and Results of Operations (referred to as FR 72).

The SEC has continued to focus on MD&A disclosures on liquidity and capital resources. During 2010, the SEC issued an interpretative guidance entitled Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management's Discussion and Analysis (referred to as FR 83).

Exhibit 6.1 provides the full text of Section 229.303 (Item 303), “Management's Discussion and Analysis of Financial Condition and Results of Operations,” of Regulation S-K. Exhibit 6.2 lists, in chronological order, the major SEC releases related to the MD&A.

Exhibit 6.1 Item 303 of Regulation S-K

TITLE 17—COMMODITY AND SECURITIES EXCHANGES

CHAPTER II—SECURITIES AND EXCHANGE COMMISSION

PART 229 STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES ACT

Subpart 229.300 Financial Information

Section 229.303 (Item 303) Management's discussion and analysis of financial condition and results of operations.

a. Full fiscal years. Discuss registrant's financial condition, changes in financial condition and results of operations. The discussion shall provide information as specified in paragraphs (a)(1) through (5) of this Item and also shall provide such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition, and results of operations. Discussions of liquidity and capital resources may be combined whenever the two topics are interrelated. Where in the registrant's judgment a discussion of segment information or of other subdivisions of the registrant's business would be appropriate to an understanding of such business, the discussion shall focus on each relevant, reportable segment or other subdivision of the business, and on the registrant as a whole.

1. Liquidity. Identify any known trends or any known demands, commitments, events, or uncertainties that will result in or that are reasonably likely to result in the registrant's liquidity increasing or decreasing in any material way. If a material deficiency is identified, indicate the course of action that the registrant has taken or proposes to take to remedy the deficiency. Also identify and separately describe internal and external sources of liquidity, and briefly discuss any material unused sources of liquid assets.

2. Capital resources.

i. Describe the registrant's material commitments for capital expenditures as of the end of the latest fiscal period, and indicate the general purpose of such commitments and the anticipated source of funds needed to fulfill such commitments.

ii. Describe any known material trends, favorable or unfavorable, in the registrant's capital resources. Indicate any expected material changes in the mix and relative cost of such resources. The discussion shall consider changes between equity, debt, and any off-balance-sheet financing arrangements.

3. Results of operations.

i. Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant's judgment, should be described in order to understand the registrant's results of operations.

ii. Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.

iii. To the extent that the financial statements disclose material increases in net sales or revenues, provide a narrative discussion of the extent to which such increases are attributable to increases in prices or to increases in the volume or amount of goods or services being sold or to the introduction of new products or services.

iv. For the three most recent fiscal years of the registrant, or for those fiscal years in which the registrant has been engaged in business, whichever period is shortest, discuss the impact of inflation and changing prices on the registrant's net sales and revenues and on income from continuing operations.

4. Off-balance-sheet arrangements.

i. In a separately-captioned section, discuss the registrant's off-balance-sheet arrangements that have or are reasonably likely to have a current or future effect on the registrant's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors. The disclosure shall include the items specified in paragraphs (a)(4)(i)(A), (B), (C), and (D) of this Item to the extent necessary to an understanding of such arrangements and effect and shall also include such other information that the registrant believes is necessary for such an understanding.

A. The nature and business purpose to the registrant of such off-balance-sheet arrangements;

B. The importance to the registrant of such off-balance-sheet arrangements in respect of its liquidity, capital resources, market risk support, credit risk support, or other benefits;

C. The amounts of revenues, expenses, and cash flows of the registrant arising from such arrangements; the nature and amounts of any interests retained, securities issued, and other indebtedness incurred by the registrant in connection with such arrangements; and the nature and amounts of any other obligations or liabilities (including contingent obligations or liabilities) of the registrant arising from such arrangements that are or are reasonably likely to become material and the triggering events or circumstances that could cause them to arise; and

D. Any known event, demand, commitment, trend, or uncertainty that will result in or is reasonably likely to result in the termination, or material reduction in availability to the registrant, of its off-balance-sheet arrangements that provide material benefits to it, and the course of action that the registrant has taken or proposes to take in response to any such circumstances.

ii. As used in this paragraph (a)(4), the term off-balance-sheet arrangement means any transaction, agreement, or other contractual arrangement to which an entity unconsolidated with the registrant is a party, under which the registrant has:

A. Any obligation under a guarantee contract that has any of the characteristics identified in paragraph 3 of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (November 2002) (“FIN 45”), as may be modified or supplemented, and that is not excluded from the initial recognition and measurement provisions of FIN 45 pursuant to paragraphs 6 or 7 of that Interpretation;

B. A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to such entity for such assets;

C. Any obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument, except that it is both indexed to the registrant's own stock and classified in stockholders' equity in the registrant's statement of financial position, and therefore excluded from the scope of FASB Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities (June 1998), pursuant to paragraph 11(a) of that Statement, as may be modified or supplemented; or

D. Any obligation, including a contingent obligation, arising out of a variable interest (as referenced in FASB Interpretation No. 46, Consolidation of Variable Interest Entities [January 2003], as may be modified or supplemented) in an unconsolidated entity that is held by, and material to, the registrant, where such entity provides financing, liquidity, market risk, or credit risk support to, or engages in leasing, hedging, or research and development services with, the registrant.

5. Tabular disclosure of contractual obligations.

i. In a tabular format, provide the information specified in this paragraph (a)(5) as of the latest fiscal year end balance sheet date with respect to the registrant's known contractual obligations specified in the table that follows this paragraph (a)(5)(i). The registrant shall provide amounts, aggregated by type of contractual obligation. The registrant may disaggregate the specified categories of contractual obligations using other categories suitable to its business, but the presentation must include all of the obligations of the registrant that fall within the specified categories. A presentation covering at least the periods specified shall be included. The tabular presentation may be accompanied by footnotes to describe provisions that create, increase, or accelerate obligations, or other pertinent data to the extent necessary for an understanding of the timing and amount of the registrant's specified contractual obligations.

ii. Definitions:. The following definitions apply to this paragraph (a)(5):

A. Long-Term Debt Obligation means a payment obligation under long-term borrowings referenced in FASB SFAS No. 47 Disclosure of Long-Term Obligations (March 1981), as may be modified or supplemented.

B. Capital Lease Obligation means a payment obligation under a lease classified as a capital lease pursuant to FASB SFAS No. 13 Accounting for Leases (November 1976), as may be modified or supplemented.

C. Operating Lease Obligation means a payment obligation under a lease classified as an operating lease and disclosed pursuant to FASB SFAS No. 13 Accounting for Leases (November 1976), as may be modified or supplemented.

D. Purchase Obligation means an agreement to purchase goods or services that is enforceable and legally binding on the registrant that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum, or variable price provisions; and the approximate timing of the transaction.

Instructions to Paragraph 303(a):

1. The registrant's discussion and analysis shall be of the financial statements and other statistical data that the registrant believes will enhance a reader's understanding of its financial condition, changes in financial condition and results of operations. Generally, the discussion shall cover the three-year period covered by the financial statements and shall use year-to-year comparisons or any other formats that in the registrant's judgment enhance a reader's understanding. However, where trend information is relevant, reference to the five year selected financial data appearing pursuant to Item 301 of Regulation S-K may be necessary. A smaller reporting company's discussion shall cover the two-year period required in Article 8 of Regulation S-X and shall use year-to-year comparisons or any other formats that in the registrant's judgment enhance a reader's understanding.

2. The purpose of the discussion and analysis shall be to provide to investors and other users information relevant to an assessment of the financial condition and results of operations of the registrant as determined by evaluating the amounts and certainty of cash flows from operations and from outside sources.

3. The discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition. This would include descriptions and amounts of (A) matters that would have an impact on future operations and have not had an impact in the past, and (B) matters that have had an impact on reported operations and are not expected to have an impact upon future operations.

4. Where the consolidated financial statements reveal material changes from year to year in one or more line items, the causes for the changes shall be described to the extent necessary to an understanding of the registrant's businesses as a whole; provided, however, that if the causes for a change in one line item also relate to other line items, no repetition is required and a line-by-line analysis of the financial statements as a whole is not required or generally appropriate. Registrants need not recite the amounts of changes from year to year which are readily computable from the financial statements. The discussion shall not merely repeat numerical data contained in the consolidated financial statements.

5. The term liquidity as used in this Item refers to the ability of an enterprise to generate adequate amounts of cash to meet the enterprise's needs for cash. Except where it is otherwise clear from the discussion, the registrant shall indicate those balance sheet conditions or income or cash flow items which the registrant believes may be indicators of its liquidity condition. Liquidity generally shall be discussed on both a long-term and short-term basis. The issue of liquidity shall be discussed in the context of the registrant's own business or businesses. For example a discussion of working capital may be appropriate for certain manufacturing, industrial, or related operations but might be inappropriate for a bank or public utility.

6. Where financial statements presented or incorporated by reference in the registration statement are required by Rule 4-08(e)(3) of Regulation S-X to include disclosure of restrictions on the ability of both consolidated and unconsolidated subsidiaries to transfer funds to the registrant in the form of cash dividends, loans, or advances, the discussion of liquidity shall include a discussion of the nature and extent of such restrictions and the impact such restrictions have had and are expected to have on the ability of the parent company to meet its cash obligations.

7. Any forward-looking information supplied is expressly covered by the safe harbor rule for projections. See Rule 175 under the Securities Act, Rule 3b-6 under the Exchange Act and Securities Act Release No. 6084 (June 25, 1979).

8. Registrants are only required to discuss the effects of inflation and other changes in prices when considered material. This discussion may be made in whatever manner appears appropriate under the circumstances. All that is required is a brief textual presentation of management's views. No specific numerical financial data need be presented except as Rule 3-20(c) of Regulation S-X otherwise requires. However, registrants may elect to voluntarily disclose supplemental information on the effects of changing prices as provided for in SFAS No. 89, Financial Reporting and Changing Prices, or through other supplemental disclosures. The Commission encourages experimentation with these disclosures in order to provide the most meaningful presentation of the impact of price changes on the registrant's financial statements.

9. Registrants that elect to disclose supplementary information on the effects of changing prices as specified by SFAS No. 89, Financial Reporting and Changing Prices, may combine such explanations with the discussion and analysis required pursuant to this Item or may supply such information separately with appropriate cross reference.

10. All references to the registrant in the discussion and in this Item shall mean the registrant and its subsidiaries consolidated.

11. Foreign private registrants also shall discuss briefly any pertinent governmental economic, fiscal, monetary, or political policies or factors that have materially affected or could materially affect, directly or indirectly, their operations or investments by U.S. nationals.

12. If the registrant is a foreign private issuer, the discussion shall focus on the primary financial statements presented in the registration statement or report. There shall be a reference to the reconciliation to United States generally accepted accounting principles, and a discussion of any aspects of the difference between foreign and United States generally accepted accounting principles, not discussed in the reconciliation, that the registrant believes is necessary for an understanding of the financial statements as a whole.

13. The attention of bank holding companies is directed to the information called for in Guide 3 (Sec. 229.801(c) and Sec. 229.802(c)).

14. The attention of property-casualty insurance companies is directed to the information called for in Guide 6 (Sec. 229.801(f)).

Instructions to Paragraph 303(a)(4):

1. No obligation to make disclosure under paragraph (a)(4) of this Item shall arise in respect of an off-balance-sheet arrangement until a definitive agreement that is unconditionally binding or subject only to customary closing conditions exists or, if there is no such agreement, when settlement of the transaction occurs.

2. Registrants should aggregate off-balance-sheet arrangements in groups or categories that provide material information in an efficient and understandable manner and should avoid repetition and disclosure of immaterial information. Effects that are common or similar with respect to a number of off-balance-sheet arrangements must be analyzed in the aggregate to the extent the aggregation increases understanding. Distinctions in arrangements and their effects must be discussed to the extent the information is material, but the discussion should avoid repetition and disclosure of immaterial information.

3. For purposes of paragraph (a)(4) of this Item only, contingent liabilities arising out of litigation, arbitration, or regulatory actions are not considered to be off-balance-sheet arrangements.

4. Generally, the disclosure required by paragraph (a)(4) shall cover the most recent fiscal year. However, the discussion should address changes from the previous year where such discussion is necessary to an understanding of the disclosure.

5. In satisfying the requirements of paragraph (a)(4) of this Item, the discussion of off-balance-sheet arrangements need not repeat information provided in the footnotes to the financial statements, provided that such discussion clearly cross-references to specific information in the relevant footnotes and integrates the substance of the footnotes into such discussion in a manner designed to inform readers of the significance of the information that is not included within the body of such discussion.

b. Interim periods. If interim period financial statements are included or are required to be included by Article 3 of Regulation S-X, a management's discussion and analysis of the financial condition and results of operations shall be provided so as to enable the reader to assess material changes in financial condition and results of operations between the periods specified in paragraphs (b) (1) and (2) of this Item. The discussion and analysis shall include a discussion of material changes in those items specifically listed in paragraph (a) of this Item, except that the impact of inflation and changing prices on operations for interim periods need not be addressed.

1. Material changes in financial condition. Discuss any material changes in financial condition from the end of the preceding fiscal year to the date of the most recent interim balance sheet provided. If the interim financial statements include an interim balance sheet as of the corresponding interim date of the preceding fiscal year, any material changes in financial condition from that date to the date of the most recent interim balance sheet provided also shall be discussed. If discussions of changes from both the end and the corresponding interim date of the preceding fiscal year are required, the discussions may be combined at the discretion of the registrant.

2. Material changes in results of operations. Discuss any material changes in the registrant's results of operations with respect to the most recent fiscal year-to-date period for which an income statement is provided and the corresponding year-to-date period of the preceding fiscal year. If the registrant is required to or has elected to provide an income statement for the most recent fiscal quarter, such discussion also shall cover material changes with respect to that fiscal quarter and the corresponding fiscal quarter in the preceding fiscal year. In addition, if the registrant has elected to provide an income statement for the twelve-month period ended as of the date of the most recent interim balance sheet provided, the discussion also shall cover material changes with respect to that twelve-month period and the twelve-month period ended as of the corresponding interim balance sheet date of the preceding fiscal year. Notwithstanding the above, if for purposes of a registration statement a registrant subject to paragraph (b) of Rule 3-03 of Regulation S-X provides a statement of income for the twelve-month period ended as of the date of the most recent interim balance sheet provided in lieu of the interim income statements otherwise required, the discussion of material changes in that twelve-month period will be in respect to the preceding fiscal year rather than the corresponding preceding period.

Instructions to Paragraph (b) of Item 303:

1. If interim financial statements are presented together with financial statements for full fiscal years, the discussion of the interim financial information shall be prepared pursuant to this paragraph (b) and the discussion of the full fiscal year's information shall be prepared pursuant to paragraph (a) of this Item. Such discussions may be combined.

2. In preparing the discussion and analysis required by this paragraph (b), the registrant may presume that users of the interim financial information have read or have access to the discussion and analysis required by paragraph (a) for the preceding fiscal year.

3. The discussion and analysis required by this paragraph (b) is required to focus only on material changes. Where the interim financial statements reveal material changes from period to period in one or more significant line items, the causes for the changes shall be described if they have not already been disclosed: Provided, however, that if the causes for a change in one line item also relate to other line items, no repetition is required. Registrants need not recite the amounts of changes from period to period which are readily computable from the financial statements. The discussion shall not merely repeat numerical data contained in the financial statements. The information provided shall include that which is available to the registrant without undue effort or expense and which does not clearly appear in the registrant's condensed interim financial statements.

4. The registrant's discussion of material changes in results of operations shall identify any significant elements of the registrant's income or loss from continuing operations which do not arise from or are not necessarily representative of the registrant's ongoing business.

5. The registrant shall discuss any seasonal aspects of its business which have had a material effect upon its financial condition or results of operation.

6. Any forward-looking information supplied is expressly covered by the safe harbor rule for projections. See Rule 175 under the Securities Act, Rule 3b-6 under the Exchange Act and Securities Act Release No. 6084 (June 25, 1979).

7. The registrant is not required to include the table required by paragraph (a)(5) of this Item for interim periods. Instead, the registrant should disclose material changes outside the ordinary course of the registrant's business in the specified contractual obligations during the interim period.

c. Safe harbor.

1. The safe harbor provided in section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934 (“statutory safe harbors”) shall apply to forward-looking information provided pursuant to paragraphs (a)(4) and (5) of this Item, provided that the disclosure is made by: an issuer; a person acting on behalf of the issuer; an outside reviewer retained by the issuer making a statement on behalf of the issuer; or an underwriter, with respect to information provided by the issuer or information derived from information provided by the issuer.

2. For purposes of paragraph (c) of this Item only:

i. All information required by paragraphs (a)(4) and (5) of this Item is deemed to be a forward looking statement as that term is defined in the statutory safe harbors, except for historical facts.

ii. With respect to paragraph (a)(4) of this Item, the meaningful cautionary statements element of the statutory safe harbors will be satisfied if a registrant satisfies all requirements of that same paragraph (a)(4) of this Item.

d. Smaller reporting companies. A smaller reporting company, as defined by Sec. 229.10(f)(1), may provide the information required in paragraph (a)(3)(iv) of this Item for the last two most recent fiscal years of the registrant if it provides financial information on net sales and revenues and on income from continuing operations for only two years. A smaller reporting company is not required to provide the information required by paragraph (a)(5) of this Item.

47 FR 11401, Mar. 16, 1982, as amended at 47 FR 29839, July 9, 1982; 47 FR 54768, Dec. 6, 1982; 52 FR 30919, Aug. 18, 1987; 68 FR 5982, 5999, Feb. 5, 2003; 73 FR 958, Jan. 4, 2008.

Exhibit 6.2 MD&A-Related SEC Releases

The following are SEC releases pertinent to MD&A regulation in chronological order.

Securities Act Release No. 4936 (December 9, 1968) (33 FR 18617), Guides for Preparation and Filing of Registration Statements under the Securities Act of 1933. This was the first requirement for a narrative discussion of the results of operations, which was incorporated in registration statements.
Securities Act Release No. 5520 (September 3, 1974) (39 FR 31894), Commission's Guidelines for Registration and Reporting. This required a narrative discussion about the results of operations to accompany all periodic financial statements.
Securities Act Release No. 5992 (November 7, 1978) (43 FR 53251), Guide for Reports or Memoranda Concerning Registrants. This release set forth a “safe harbor” for forward-looking information. As a result, the government or private plaintiffs are prevented from alleging fraud in suits where forward-looking projections fail to materialize, as long as they have a reasonable basis and are disclosed in good faith.
Securities Act Release No. 6231 (September 2, 1980) (45 FR 63630), Amendments to Annual Report Form, Related Forms, Rules, Regulations, and Guides; Integration of Securities' Acts Disclosure System. This release expanded the required discussion to include liquidity, capital resources, as well as the results of operations. It also required discussion of certain prospective information. It remains in force.
Securities Act Release No. 6349 (September 28, 1981), 23 SEC Docket 962 [not published in the Federal Register]. This release reported deficiencies in complying with the 1980 requirement and gave examples of disclosures to assist companies in drafting the MD&A.
Securities Act Release No. 6711 (April 24, 1987) (52 FR 13715), (April 17, 1987), Concept Release on Management's Discussion and Analysis of Financial Condition and Results of Operations. This release was referred to as the Concept Release. Its main purpose was to seek comment from various parties to proposed changes in the MD&A requirements made by the accounting profession.
Securities Act Release Nos. 33-6835; 34-26831; IC-16961; FR-36; (May 18, 1989) (54 FR 22427), Management's Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures; Certain Investment Company Disclosures. This release gave more examples of MD&A disclosures, particularly those pertaining to prospective information.
Securities Act Release Nos. 33-8039, 34-45124, FR-59 (December 4, 2001) (Federal Register: December 10, 2001, Volume 66, Number 237), Cautionary Advice Regarding the Use of “Pro Forma” Financial Information in Earnings Releases. This release provides cautionary advice regarding the use of “pro forma” financial information in earnings releases.
Securities Act Releases Nos. 33-8040, 34-45149, FR-60 (December 12, 2001) (Federal Register, December 17, 2001, Volume 66, Number 242), Cautionary Advice Regarding Disclosure About Critical Accounting Policies. This release provides cautionary advice regarding disclosure about critical accounting policies.
Securities Act Release Nos. 33-8056; 34-45321; FR-61 (January 22, 2002) (Federal Register, January 25, 2002, Volume 67, Number 17), Commission Statement About Management's Discussion and Analysis of Financial Condition and Results of Operations. This release sets forth certain views of the Securities and Exchange Commission regarding disclosure in MD&A concerning liquidity and capital resources including off-balance-sheet arrangements; certain trading activities that include non-exchange-traded contracts accounted for at fair value; and effects of transactions with related and certain other parties.
Securities Act Release Nos. 33-8098; 34-45907 (Federal Register, May 20, 2002, Volume 67, Number 97). Proposed rule, Disclosure in Management's Discussion and Analysis About the Application of Critical Accounting Policies. The SEC proposed disclosure requirements that would enhance investors' understanding of the application of companies' critical accounting policies. The proposals would encompass disclosure in two areas: accounting estimates a company makes in applying its accounting policies and the initial adoption by a company of an accounting policy that has a material impact on its financial presentation. This proposal remains outstanding at date of this publication.
Release No. 33-8176; 34-47226; FR-65 (Federal Register, January 30, 2003, Volume 68, Number 20), Conditions for Use of Non-GAAP Financial Measures. This final rule addresses public companies' disclosure or release of certain financial information that is calculated and presented on the basis of methodologies other than in accordance with generally accepted accounting principles (GAAP). The SEC also adopted a new disclosure regulation, Regulation G, which requires public companies that disclose or release such non-GAAP financial measures to include, in that disclosure or release, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure. The SEC also adopted amendments to Item 10 of Regulation S-K to provide additional guidance to those registrants that include non-GAAP financial measures in SEC filings.
Securities Act Release Nos. 33-8182, 34-47264, FR-67 (Federal Register, February 5, 2003, Volume 68, Number 24), Disclosure in Management's Discussion and Analysis about Off-Balance-Sheet Arrangements and Aggregate Contractual Obligations. This final rule requires a registrant to provide an explanation of its off-balance-sheet arrangements in a separately captioned subsection of the MD&A section of a registrant's disclosure documents. The amendments also require registrants (other than small business issuers) to provide an overview of certain known contractual obligations in a tabular format. Securities Act Release Nos. 33-8350, 34-48960, FR-72 (Federal Register, December 29, 2003, Volume 68, Number 248), Commission Guidance Regarding Management's Discussion and Analysis of Financial Condition and Results of Operations. This interpretation is intended to elicit more meaningful disclosure in MD&A in a number of areas, including the overall presentation and focus of MD&A, with general emphasis on the discussion and analysis of known trends, demands, commitments, events, and uncertainties, and specific guidance on disclosures about liquidity, capital resources, and critical accounting estimates.
Securities Act Release Nos. 33-8876, 34-56994, 39-2451 (Federal Register: January 4, 2008, Volume 73, Number 3), Smaller Reporting Company Regulatory Relief and Simplification. This final rule amends the disclosure and reporting requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934 to expand the number of companies that qualify for its scaled disclosure requirements for smaller reporting companies. Companies that have less than $75 million in public equity float will qualify for the scaled disclosure requirements under the amendments. Companies without a calculable public equity float will qualify if their revenues were below $50 million in the previous year. To streamline and simplify regulation, the amendments move the scaled disclosure requirements from Regulation S-B into Regulation S-K.
Securities Act Release Nos. 33-9144, 34-62934, FR-83 (Federal Register, September 28, 2010, Volume 75, Number 187), Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management's Discussion and Analysis. This guidance that is intended to improve discussion of liquidity and capital resources in MD&A of financial condition and results of operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant.

(c) General Guidance on MD&A

Companies are required, in the MD&A, to provide investors and other users with material information that is necessary to understand the company's financial condition and operating performance as well as its prospects for the future. On December 19, 2003, the SEC issued interpretative guidance entitled Commission Guidance Regarding Management's Discussion and Analysis of Financial Condition and Results of Operations (referred to as FR 72). This guidance is intended to elicit more meaningful disclosure in MD&A in a number of areas, including the overall presentation and focus of MD&A, with general emphasis on the discussion and analysis of known trends, demands, commitments, and events and uncertainties, and with specific guidance on disclosures about liquidity, capital resources, and critical accounting estimates. It provides guidance to assist companies in preparing MD&A disclosure that is easier to follow and understand and contains information that more completely satisfies the SEC's previously enunciated principal objectives of MD&A. The release captures the objective of the MD&A in this way:

The purpose of MD&A is not complicated. It is to provide readers 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:

To provide a narrative explanation of a company's financial statements that enables investors to see the company through the eyes of management;
To enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
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

MD&A should be a discussion and analysis of a company's business as seen through the eyes of those who manage that business. Management has a unique perspective on its business that only it can present. As such, MD&A should not be a recitation of financial statements in narrative form or an otherwise uninformative series of technical responses to MD&A requirements, neither of which provides this important management perspective. Through this release we encourage each company and its management to take a fresh look at MD&A with a view to enhancing its quality. We also encourage early top-level involvement by a company's management in identifying the key disclosure themes and items that should be included in a company's MD&A.

Based on our experience with many companies' current disclosures in MD&A, we believe there are a number of general ways for companies to enhance their MD&A consistent with its purpose. The recent review experiences of the staff of the Division of Corporation Finance, including its Fortune 500 review, have led us to conclude that additional guidance would be especially useful in the following areas:

The overall presentation of MD&A;
The focus and content of MD&A (including materiality, analysis, key performance measures and known material trends and uncertainties);
Disclosure regarding liquidity and capital resources; and
Disclosure regarding critical accounting estimates.

Therefore, in this release, we emphasize the following points regarding overall presentation:

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
Many companies would benefit from starting their MD&A with a section that provides an executive-level overview that provides context for the remainder of the discussion.

We also emphasize the following points regarding focus and content:

In deciding on the content of MD&A, 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 provide not only disclosure of information responsive to MD&A's requirements, but also an analysis that is responsive to those requirements that explains management's view of the implications and significance of that information and that satisfies the objectives of MD&A.

For the full text of FR 72, see www.sec.gov/rules/interp/33-8350.htm.

As discussed in FR 72, the SEC provides several recommendations to assist registrants in improving their MD&A disclosures. The SEC believes that the presentation of the MD&A of too many companies may have become unnecessarily lengthy, difficult to understand, and confusing. It asserts that many companies can improve their MD&A by focusing on the most important information disclosed to investors. Disclosure should emphasize material information that is required or promotes understanding and deemphasize immaterial information that is not required and does not promote understanding. Companies should prepare MD&A with a strong focus on the most important information, provided in a manner intended to address the objectives of MD&A. The SEC recommends, in FR 72, consideration of these points:

Companies should consider whether a tabular presentation of relevant financial or other information may help a reader's understanding of MD&A.
Companies should consider whether the headings they use assist readers in following the flow of, or otherwise assist in understanding, MD&A, and whether additional headings would be helpful in this regard.
Many companies' MD&A could benefit from adding an introductory section or overview that would facilitate a reader's understanding.
While all required information must of course be disclosed, companies should consider using a “layered” approach. Such an approach would present information in a manner that emphasizes, within the universe of material information that is disclosed, the information and analysis that is most important.

(d) Recent Developments

(i) Smaller Reporting Companies

The SEC has adopted amendments to its disclosure and reporting requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934 to expand the number of companies that qualify for its scaled disclosure requirements for smaller reporting companies. On December 19, 2007, the SEC issued a final rule, Smaller Reporting Company Regulatory Relief and Simplification (Releases Nos. 33-8876; 34-56994; 39-2451; File No. S7-15-07).

Companies that have less than $75 million in public equity float qualify for the scaled disclosure requirements under the amendments. Companies without a calculable public equity float will qualify if their revenues were below $50 million in the previous year. To streamline and simplify regulation, the amendments move the scaled disclosure requirements from Regulation S-B into Regulation S-K.

Specific to the MD&A requirements, the final rule allows smaller reporting companies to provide only two years of analysis if the company is presenting only two years of financial statements, instead of the three years of analysis required of larger companies that are required to provide three years of financial statements; also, smaller reporting companies are exempt from providing tabular disclosure of contractual obligations.

The final rule is available at: www.sec.gov/rules/final/2007/33-8876.pdf.

The SEC also issued additional guidance for smaller public companies:

Smaller Reporting Company Compliance and Disclosure Interpretations, available at: www.sec.gov/info/smallbus/src-cdinterps.htm
Small Entity Compliance Guide, available at: www.sec.gov/info/smallbus/secg/s3f3-secg.htm

(ii) MD&A Disclosures on Fair Value and Liquidity and Capital Resources

In December 2008, the staff of the SEC participated in the American Institute of Certified Public Accountants' (AICPA) National Conference on Current SEC and Public Company Accounting Oversight Board (PCAOB) Developments. During this conference, the SEC staff made several presentations including two that identified best practices for fair value MD&A disclosures and considerations for preparing the liquidity and capital resources section of the MD&A. The slides are available at: http://sec.gov/news/speech/2008/spch120908wc-slides.pdf/.

Fair Value Disclosures.

The SEC's top ten best practices for fair value MD&A disclosures, as noted on slides 34 to 60, include these areas:

1. When to provide a sensitivity analysis

2. Alternative valuation technique disclosures

3. Details of other-than-temporary impairment charges on available-for-sale securities

4. Broker/pricing services

5. Collateral underlying mortgage-backed securities, collateralized debt obligations, collateralized loan obligations, and so on.

6. Quantitative disclosure of effects of the company's own credit risk and counterparty credit risk

7. Consideration of illiquidity in valuations

8. Key drivers of value for each significant Level 3 asset/liability grouping

9. Inputs that became unobservable when transfers to Level 3 occur

10. Transfers in or out of Level 3

These best practices were developed from two “Dear CFO” letters sent to 30 public companies in March 2008 and September 2008 by the SEC and posted to its Web site, given the much broader applicability of the guidance. The goal of these “Dear CFO” letters was to provide suggestions to improve transparency surrounding fair value measurements.

Subsequent to the issuance of the “Dear CFO” letters and the SEC staff speech, the FASB amended U.S. generally accepted accounting principles (GAAP) to improve financial statement disclosures about fair value. The primary changes for fair value disclosures were issued in 2010 and 2011 with the issuances of two Accounting Standards Updates (ASUs): ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures About Fair Value Measurements; and ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.

Liquidity and Capital Resources Disclosures.

The SEC's top ten considerations for companies when preparing the liquidity and capital resources section of the MD&A were developed by the SEC staff not only to provide investors with a clear picture of the company's current financial condition but also to provide investors with the opportunity to evaluate the company's future prospects.

The SEC's top ten best practices for liquidity and capital resources MD&A disclosures, as noted on slides 76 to 87, include:

1. Introductory Discussion: Provide greater analysis of the sources and uses of cash.

2. Operating Activities: Discuss changes in cash received from customers and other sources, and cash paid to suppliers and employees, and so on.

3. Operating Activities: Discuss any known trends and uncertainties that are reasonably expected to have material effects on the separate sources and uses of cash.

4. Investing Activities: Evaluate capital expenditures on a discretionary and nondiscretionary basis and discuss any anticipated funding sources.

5. Financing Activities: Discuss the sufficiency of the unused availability (or the estimated utilization), the anticipated circumstances requiring its use, any uncertainty surrounding the ability to access funds when needed, and any implications from not being able to access the funds.

6. Credit Ratings: Discuss the factors that may materially influence credit ratings, the potential implications of known or reasonably likely changes in credit ratings or credit rating outlook, and management's expectations.

7. Financial Covenants: Discuss any uncertainty or trends surrounding future compliance with financial covenants, and the material implications of a breach. Consider also providing company specific calculations when the actual ratios under the agreement are provided in a filing. Refer to FR 72 for disclosure suggestions when breach of covenant is reasonably likely.

8. Financial Covenants: Discuss the capacity for additional borrowing under the most restrictive covenant, whether there is otherwise an ability to raise these funds, and whether this amount is sufficient or insufficient for current and long-term needs.

9. Current Market Conditions: Discuss any uncertainties and reasonably likely implications related to:

a. Committed and uncommitted loan facilities from banks and other lending institutions

b. The commercial paper market

c. Cash and securities held at banks and other financial institutions

d. Illiquid investments

e. Future pension funding

f. Share repurchase programs and dividend payments

10. General: Prepare a user-friendly “Liquidity and Capital Resource” section that:

a. Can be read as a stand-alone document

b. Prominently displays the most critical information

c. Can be meaningful without supplemental investor calculations

d. Excludes superfluous information

e. Avoids boilerplate language

f. Includes management insight

The SEC also issued, on September 17, 2010, an interpretative release entitled Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management's Discussion and Analysis (referred to as FR 83). The release was effective September 28, 2010, and was issued to improve discussion of liquidity and capital resources in MD&A in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. The three primary areas addressed in the release are liquidity disclosure, leverage ratio disclosures, and contractual obligation table disclosures.

The release is available at: www.sec.gov/rules/interp/2010/33-9144.pdf.

6.2 Current Guidance

(a) Overall Requirements

For large-accelerated and accelerated filers, the MD&A must cover the three most recent fiscal years and the two interyear comparisons. For smaller reporting companies,⁴ the MD&A must cover the two most recent fiscal years.

Registrants need not discuss the earliest year in comparison to the preceding year unless the discussion is necessary for an understanding of a trend of the registrant's financial position or results of operations. The general requirements, as summarized from Item 303, are summarized next.

Discuss the registrant's financial condition, changes in financial condition and results of operations.
With respect to all of the categories just listed, registrants are required to identify any currently known trends, demands, commitments, events, or uncertainties that are reasonably expected to have material affects on the registrant's liquidity, capital resources, and results of operations, or that would cause reported financial information not to be necessarily indicative of future operating results or financial condition.
Provide such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition and results of operations.
These issues must also be discussed by business segments to the extent necessary, in the registrant's judgment, for an understanding of the business as a whole.
Address both positive and negative aspects of a company's financial condition and results of operations.
Where the consolidated financial statements reveal material changes from year to year in one or more line items, describe the causes for the changes to the extent necessary to an understanding of the registrant's businesses as a whole.

The required disclosures are ultimately conditional on passing both a “materiality” and a “cost” threshold. Immaterial effects or events need not be (but may be) disclosed.⁵ As stated in Item 303: “The information provided pursuant to this Item need only include that which is available to the registrant without undue effort or expense and which does not clearly appear in the registrant's financial statements.”

The full requirements are contained in Exhibit 6.1. Regulation S-K requires disclosure in these areas:

a. Liquidity

b. Capital resources

c. Results of operations

d. Off-balance-sheet arrangements

e. Tabular disclosure of contractual obligations⁶

(b) Critical Accounting Estimates

On December 12, 2001, the SEC issued an interpretative release entitled Cautionary Advice Regarding Disclosure About Critical Accounting Policies (referred to as FR 60). The SEC's rules governing MD&A have long required disclosure about trends, events, or uncertainties known to management that would materially affect reported financial information; the SEC observed, in FR 60, that disclosure responsive to these requirements could be enhanced. For example, environmental and operational trends, events, and uncertainties typically are identified in MD&A, but the implications of those uncertainties for the methods, assumptions, and estimates used for recurring and pervasive accounting measurements are not always addressed. Communication between investors and public companies could be improved if management explained in MD&A the interplay of specific uncertainties with accounting measurements in the financial statements.

The SEC encourages public companies to include in their MD&A full explanations, in plain English, of their critical accounting policies, the judgments and uncertainties affecting the application of those policies, and the likelihood that materially different amounts would be reported under different conditions or using different assumptions. The objective of this disclosure is consistent with the objective of MD&A.

The SEC pointed out that investors may lose confidence in a company's management and financial statements if sudden changes in its financial condition and results occur but were not preceded by disclosures about the susceptibility of reported amounts to change, including rapid change. In FR 60,⁷ the SEC alerted public companies to the importance of employing a disclosure regimen in these ways:

1. Each company's management and auditor should bring particular focus to the evaluation of the critical accounting policies used in the financial statements. As part of the normal audit process, auditors must obtain an understanding of management's judgments in selecting and applying accounting principles and methods. Special attention to the most critical accounting policies will enhance the effectiveness of this process. Management should be able to defend the quality and reasonableness of the most critical policies, and auditors should satisfy themselves thoroughly regarding their selection, application, and disclosure.

2. Management should ensure that disclosure in MD&A is balanced and fully responsive. To enhance investor understanding of the financial statements, companies are encouraged to explain in MD&A the effects of the critical accounting policies applied, the judgments made in their application, and the likelihood of materially different reported results if different assumptions or conditions were to prevail.

3. Prior to finalizing and filing annual reports, audit committees should review the selection, application, and disclosure of critical accounting policies. Consistent with auditing standards, audit committees should be apprised of the evaluative criteria used by management in their selection of the accounting principles and methods. Proactive discussions between the audit committee and the company's senior management and auditor about critical accounting policies are appropriate.

4. If companies, management, audit committees, or auditors are uncertain about the application of specific GAAP principles, they should consult with our accounting staff. We encourage all those whose responsibility it is to report fairly and accurately on a company's financial condition and results to seek out our staff's assistance. We are committed to providing that assistance in a timely fashion; our goal is to address problems before they happen.

On May 10, 2002, the SEC proposed a rule entitled Disclosure in Management's Discussion and Analysis About the Application of Critical Accounting Policies. The proposal encompassed disclosure in two areas:

1. Accounting estimates a company makes in applying its accounting policies. Under the first part of the proposals, a company would have to identify the accounting estimates reflected in its financial statements that required it to make assumptions about matters that were highly uncertain at the time of estimation. Disclosure about those estimates would then be required if different estimates that the company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the presentation of the company's financial condition, changes in financial condition, or results of operations. A company's disclosure about these critical accounting estimates would include a discussion of:

The methodology and assumptions underlying them
The effect the accounting estimates have on the company's financial presentation
The effect of changes in the estimates

2. The initial adoption by a company of an accounting policy that has a material impact on its financial presentation. Under the second part of the proposals, a company that has initially adopted an accounting policy with a material impact would have to disclose information that includes:

What gave rise to the initial adoption
The impact of the adoption
The accounting principle adopted and method of applying it
The choices it had among accounting principles

Companies would place all of the new disclosure in the MD&A section of their annual reports, registration statements, and proxy and information statements. In addition, in the MD&A section of their quarterly reports, U.S. companies would have to update the information regarding their critical accounting estimates to disclose material changes.

This proposal remains outstanding.

Many estimates and assumptions involved in the application of GAAP have a material impact on reported financial condition and operating performance and on the comparability of such reported information over different reporting periods. As previously discussed, the SEC's December 2001 Release, FR 60, reminded companies that, under the existing MD&A disclosure requirements, a company should address material implications of uncertainties associated with the methods, assumptions, and estimates underlying the company's critical accounting measurements. In its follow-up statement, FR 72, the SEC states that:

When preparing disclosure under the current requirements, companies should consider whether they have made accounting estimates or assumptions where: The nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and
The impact of the estimates and assumptions on financial condition or operating performance is material.

If so, companies should provide disclosure about those critical accounting estimates or assumptions in their MD&A.

(c) Non-GAAP Measures

On December 4, 2001, the SEC issued a release entitled Cautionary Advice Regarding the Use of “Pro Forma” Financial Information in Earnings Releases (referred to as FR 59). The SEC issued this release to registrants that present their earnings and results of operations on the basis of methodologies other than GAAP. This is often referred to as pro forma financial information. The SEC states that pro forma financial information can serve useful purposes for public companies that wish to focus investors' attention on critical components of financial results to provide a meaningful comparison to results for the same period of prior years or to emphasize the results of core operations. However, the SEC observed that to a large extent, this has been the intended function of disclosures in a company's MD&A section of its reports.

In response to Section 401(b) of SOX and to codify guidance in FR 59, the SEC amended Regulation S-K. The SEC subsequently adopted new rules and amendments to address public companies' disclosure or release of certain financial information that is calculated and presented on the basis of methodologies other than in accordance with GAAP. The final rule, Conditions for Use of Non-GAAP Financial Measures, was issued on January 22, 2003. The disclosure regulation, Regulation G, requires public companies that disclose or release such non-GAAP financial measures to include, in that disclosure or release, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to the most directly comparable GAAP financial measure. The final rule also adopted amendments to provide additional guidance to those registrants that include non-GAAP financial measures in SEC filings.

Here is a recap of the requirements:

Regulation G

Application. This regulation applies whenever a registrant required to file reports under Section 13(a) or 15(d) of the Exchange Act (other than a registered investment company), or a person acting on the registrant's behalf, discloses or releases publicly any material information that includes a non-GAAP financial measure. Typically, this information is furnished under Item 2.02 of Form 8-K.
Requirements. The registrant must present the most directly comparable GAAP measure and a reconciliation of the differences between the non-GAAP measure disclosed or released with the most directly comparable GAAP measure. With regard to forward-looking information, a quantitative reconciliation is required only to the extent available without unreasonable efforts. If all of the information necessary is not available without unreasonable efforts, the registrant must identify the information that is unavailable and disclose probable significance.

Item 10(e) of Regulation S-K

Application. This regulation applies to a registrant's filings with the SEC (e.g., 10-K, 10-Q, 20-F, S-1, F-1).
Requirements. The registrant must present:
- With equal or greater prominence, the most directly comparable GAAP measure
- A reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measures
- A statement disclosing why management believes the presentation of the non-GAAP measure provides useful information to investors regarding the registrant's financial condition and results of operations
- To the extent material, a statement disclosing the additional purposes, if any, for which management uses the non-GAAP measure

Subsequent to the enactment of these rules and regulations and the release of the SEC staff interpretative guidance, the SEC staff noted questions and inconsistencies in a recent study of registrant filings. As a result, in January 2010, the SEC's Division of Corporate Finance issued new Compliance and Disclosure Interpretations (C&DIs) on the use of non-GAAP financial measures. The C&DIs replace the interpretative guidance in the SEC staff's “Frequently Asked Questions Regarding the Use of Non-GAAP Measures” (FAQs), which was issued in June 2003, but the rules on non-GAAP financial measures (Regulation G and Item 10(e) of Regulation S-K) were not amended.

The issuance of the C&DIs was a result of the SEC staff's review of its June 2003 interpretations in an effort to eliminate any actual or perceived restrictions in the FAQs on the disclosure of non-GAAP information that were not consistent with the actual rules. In addition, they were issued to ensure that non-GAAP guidance is being read in a manner that provides clarity and flexibility to companies with respect to reporting information in their filings that they believe provides the most meaningful indicators of how they are doing and is consistent with other communications (e.g., through communications such as earnings calls and press releases).

(d) Effect of Newly Issued But Not Yet Effective Accounting Standards

Public companies must discuss the effect of newly issued, but not yet effective, accounting standards. SEC Staff Accounting Bulletin (SAB) Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant When Adopted in a Future Period (SAB No. 74) requires disclosure of the expected impacts on financial information to be reported in the future and is required in the financial statements if the change to the new accounting standard will be accounted for in future periods by restatement of the current financials. Additionally, disclosure in the financials is to be considered when the change will be accounted for prospectively or as a change in accounting principle.

6.3 Related Accounting Literature

(a) Risks and Uncertainties

The financial statements disclosures under GAAP have similar objectives as the MD&A disclosures. In 1994, the AICPA's Accounting Standards Executive Committee (AcSEC) issued Statement of Position (SOP) 94-6, Disclosure of Certain Significant Risks and Uncertainties. This SOP, subsequently codified in FASB's Accounting Standards Codification (ASC) 275, Risks and Uncertainties, requires an entity to disclose, in the notes to the financial statements, forward-looking information about certain significant estimates and concentrations. This is a GAAP requirement rather than a MD&A requirement and is applicable to both public and private entities. As discussed in ASC 275-10-05-2:

The central feature of this Subtopic's disclosure requirements is selectivity: specified criteria serve to screen the host of risks and uncertainties that affect every entity so that required disclosures are limited to matters significant to a particular entity.

The disclosures focus primarily on risks and uncertainties that could significantly affect the amounts reported in the financial statements in the near term or the near-term functioning of the reporting entity. The risks and uncertainties this Subtopic addresses can stem from any of the following:

a. The nature of the entity's operations

b. The use of estimates in the preparation of the entity's financial statements

c. Significant concentrations in certain aspects of the entity's operations.

Namely, an entity must disclose:

1. Nature of operations

2. Use of estimates in the preparation of financial statements

3. Certain significant estimates

4. Current vulnerability due to certain concentrations

The first two disclosures are always required. Disclosures about risks (related to concentrations) and uncertainties (concerning estimates) are required if specified criteria are met. The statement became effective for fiscal years ending after December 15, 1995. A summary of the required disclosures is presented next. For a complete understanding, readers should refer to the full text of ASC 275. (see: https://asc.fasb.org/subtopic&trid=2134480—a subscription service)

(b) Nature of Operations

The financial statements should include a description of the major products or services the entity sells or provides and its principal markets, including the locations of those markets. If the entity operates in more than one business, the disclosure should also indicate the relative importance of its operations in each business and the basis for the determination—for example, assets, revenues, or earnings. Disclosures about the nature of operations do not need to be quantified. The relative importance could be conveyed by use of terms such as “predominately,” “about equally,” or “major.”

(c) Use of Estimates in the Preparation of Financial Statements

Financial statements should include an explanation that the preparation of financial statements in conformity with GAAP requires the use of management's estimates.

(d) Certain Significant Estimates

Uncertainties concerning estimates that affect financial statement amounts (such as a valuation allowance for deferred tax assets or the carrying amount of inventory or a long-term contract) if it is at least reasonably possible the estimates will change in the near term and the effect of the change could be material to the financial statements must be disclosed.

As stated in ASC 275-10-50-8:

Disclosure regarding an estimate shall be made when known information available before the financial statements are issued or are available to be issued indicates that both of the following criteria are met:

a. It is at least reasonably possible that the estimate of the effect on the financial statements of a condition, situation, or set of circumstances that existed at the date of the financial statements will change in the near term due to one or more future confirming events. (The term reasonably possible as used in this Subtopic is consistent with its use in Subtopic 450-20 to mean that the chance of a future transaction or event occurring is more than remote but less than likely.)

b. The effect of the change would be material to the financial statements.

(e) Current Vulnerability Due to Certain Concentrations

Financial statements should include risks related to concentrations in volume of business, sources of supply, revenue, or market or geographic area if it is at least reasonably possible that the concentrations could have a severe impact on operations within the near term. As stated in ASC 275-10-50-16:

Vulnerability from concentrations arises because an entity is exposed to risk of loss greater than it would have had it mitigated its risk through diversification. Such risks of loss manifest themselves differently, depending on the nature of the concentration, and vary in significance. Financial statements shall disclose the concentrations described in paragraph 275-10-50-18 if, based on information known to management before the financial statements are issued or are available to be issued (as discussed in Section 855-10-25), all of the following criteria are met:

a. The concentration exists at the date of the financial statements.

b. The concentration makes the entity vulnerable to the risk of a near-term severe impact.

c. It is at least reasonably possible that the events that could cause the severe impact will occur in the near term.

Concentrations, including known group concentrations, are required to be disclosed if they meet the criteria of paragraph 275-10-50-16. Group concentrations exist if a number of counterparties or items that have similar economic characteristics collectively expose the reporting entity to a particular kind of risk. Some concentrations may fall into more than one of these categories:

Volume of business with a particular customer, supplier, lender, grantor, or contributor
Revenue from particular products, services, or fundraising events
Source of supply of materials, labor, services, or licenses or other rights
Market or geographic area in which operations are conducted

6.4 External Auditor Involvement

The external auditor is required follow Statement of Auditing Standards (SAS) No. 8, Other Information in Documents Containing Audited Financial Statements, when other information, such as the MD&A, is presented with the audited financial statements and the independent auditor's report. SAS 8⁸ was issued by the AICPA in December 1975 and in the codification, the reference is AU Section 550, Other Information in Documents Containing Audited Financial Statements. As excerpted from par. 4 of SAS 8, the auditor has the responsibility to read the other information, such as the MD&A:

Other information in a document may be relevant to an audit performed by an independent auditor or to the continuing propriety of his report. The auditor's responsibility with respect to information in a document does not extend beyond the financial information identified in his report, and the auditor has no obligation to perform any procedures to corroborate other information contained in a document. However, he should read the other information and consider whether such information, or the manner of its presentation, is materially inconsistent with information, or the manner of its presentation, appearing in the financial statements.

For a complete understanding, readers should refer to the full text of the standard. The full text of SAS 8 is available on the PCAOB Web site at: http://pcaobus.org/Standards/Auditing/Pages/AU550.aspx

Management may wish to engage the external auditor to perform additional procedures related to the MD&A. To accommodate such an engagement, the AICPA issued, in 2001, Statement on Standards for Attestation Engagements No. 10, Attestation Standards: Revision and Recodification, which is relevant to the external auditor's association with MD&A. In the codification, the reference is attestation standards (AT) Section 701, Management's Discussion and Analysis. This statement provides performance and reporting guidance and applies to engagements where management has opted to engage the external auditor to examine and to review the MD&A included in audited financial statements or in other documents. The full text of AT Section 701 can be accessed on the PCAOB's Web site at: http://pcaobus.org/Standards/Attestation/Pages/AT701.aspx.

¹ The safe harbor rule protects issuers from liability for forward-looking information, if such information has a reasonable basis and is disclosed in good faith. Otherwise, fraud actions under Rule 10b-5 may be brought against the firm.

² Although the 1989 release emphasizes prospective analysis, the historical analysis of the 1980 release is also required. The 1989 release interprets, but does not supersede, the 1980 release. Therefore, by continuing to require a discussion of historical changes as well as prospective events, the SEC underscores its belief that a better understanding of the causes of past performance is necessary for investors to assess the likelihood that the past is indicative of the future.

³ As a matter of interest, the 1989 release mentions one known, future, material event that need not be disclosed. Merger negotiations do not have to be discussed in the MD&A unless the registrant has otherwise disclosed them. The SEC acknowledges that the risk of disclosure may jeopardize the transaction. There are other disclosure items that are required under different SEC releases and that may be disclosed in the MD&A. For instance, the SEC's Financial Reporting Release No. 6 (1982) mentions the MD&A as an appropriate place to discuss the degree of exposure to exchange rate risks, the functional currencies used to measure significant foreign operations, and the nature of the translation component of equity. Also, in its Staff Accounting Bulletin (SAB) No. 74 (1987), the SEC states that the MD&A may be used to discuss the impact (if known or reasonably estimable) of a future adoption of a recently issued accounting standard.

⁴ The SEC defines a “smaller reporting company” as one with public float of less than $75 million. Public float is computed at the end of the second quarter, using one year's information. If there is no public float, then a revenue test is used. The revenue test for a “smaller reporting company” is whether the company has revenue of under $50 million.

⁵ The SEC discussed materiality in SAB No. 99, Materiality, August 12, 1999. Further, the SEC relies on the decisions rendered by the Supreme Court in two separate cases. In TSC Industries Inc. v. Northway (1980), the Court stated that “an omitted fact is material if there is a substantial likelihood that reasonable shareholders would consider it important.” The Court further explained: “To fulfill the materiality requirement, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” In Basic, Inc. v. Levinson (1988), the Court addressed materiality as it relates to possible future events: “Materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.” Finally, and most important, for both past events and possible future events, the Court stated: “Materiality depends on the facts and is to be determined on a case by case basis.” Therefore, materiality is a relative concept.

⁶ Smaller public companies (as defined) are not required to provide tabular disclosure of contractual obligations.

⁷ www.sec.gov/rules/other/33-8040.htm

⁸ In April 2003, the PCAOB adopted certain preexisting standards as its interim standards. Pursuant to Rule 3200T, Interim Auditing Standards consist of generally accepted auditing standards, as described in the AICPA's Auditing Standards Board's Statement of Auditing Standards No. 95, in existence on April 16, 2003, to the extent not superseded or amended by the Board.

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Table of Contents for Chapter 6: Management Discussion and Analysis

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6.1 Overview

(a) Introduction