From heavy equipment to cybersecurity – 30 years of applying management reports – Securities


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The announcement last week that NVIDIA Corporation had settled charges of improper disclosure in two of its Form 10-Q reports was something of a milestone and a reminder that one of the biggest and most frequent topics in enforcement proceedings initiated by the Securities and Exchange Commission (“SEC”) over the past decades has been inadequate disclosure of facts, trends and uncertainties known to management in the MD&A and analysis of the situation financial and operating results (“MD&A”). The first enforcement action after the landmark interpretive release of the SEC MD&A in 1989 was In re Caterpillar, Inc., SEC Release No. 34-30532 (Mar. 31, 1992), which the SEC announced just over 30 years ago. While there’s a big difference between heavy equipment that can weigh over 70,000 pounds empty and graphics processors that can have over 50 billion transistors today, it turns out that the principles that apply to MD&A disclosure are the same.

The principle of disclosure that the Division of Enforcement has repeatedly articulated over the past three decades is not complex: Section 303 of Regulation SK requires companies to disclose in the MD&A what management currently knowsabout facts, trends and uncertainties that have had, or are reasonably likely to have, a material impact on the company’s business and financial performance. These cases do not involve complex legal theories or factual connections, such as sometimes present in insider trading or market fraud cases. Most subsequent MD cases caterpillar are simple in fact and in law. Additionally, the facts necessary for the Enforcement Division to support its claims are usually readily available in company emails, memoranda, and other documents.

The frequency with which the SEC initiates — and wins — enforcement actions such as caterpillar and
Nvidia should be a continuous reminder of the importance of the basic principles of information to be provided in the management report. To state some of the most important principles:

  • The Company’s disclosure controls and procedures should be designed to identify facts, trends or uncertainties that have caused, or are reasonably likely to cause in the future, material changes or differences between periods financial reporting.

  • This information should be forwarded to the financial and commercial management of the company, as well as to the board of directors and in particular to the audit committee, for discussion and evaluation, not only for the purposes of internal commercial and financial planning, but as part of the company’s public disclosure processes. .

  • Management should regularly review the design and operation of the company’s disclosure controls and procedures and ensure that the company updates them as necessary to enable the company to comply with applicable disclosure requirements.

  • Management should remember that disclosure of the Form 10-Q MD&A is no less important than full-year disclosure in the company’s Form 10-K reports.

  • Although less important in caterpillar and
    Nvidia implementing measures, other MD&A implementing measures have made it clear that disclosure in the MD&A of facts, trends and uncertainties that have affected or may affect the business and performance in the future company’s financial statements should be accurate as of the date the report is filed, not the end of the fiscal year covered by the report.

Companies may fail to make the disclosure that was required in Caterpillar, Nvidia and many other similar performance measures because the fact, trend, or uncertainty may not yet have found its way to the bottom line of the income statement. As such, it is critical to note that SEC rules require the MD&A to disclose not only financial results, but also what management currently knows about facts, trends and uncertainties that have affected its financial performance or are reasonably likely to affect future financial performance. Execution measures like Caterpillar, Nvidiaand the many similar actions the Division of Enforcement has taken over the past 30 years are often based on a few very simple questions:

  • What does management know at this time – at the time the company files the report on Form 10-Q or Form 10-K, and not just at the end of the relevant fiscal year – about the facts, trends or the uncertainties that have recently affected the company’s products, markets, sales and net income, or are they reasonably likely to do so in the near future?

  • Has this information been clearly presented, with appropriate caveats or disclaimers, in the MD&A?

caterpillar and Nvidia clearly illustrate these principles. In caterpillar, the SEC alleged that the company’s management knew that sales in recent quarters reflected large and historically atypical increases in sales in South America. Moreover, during the periods covered by the enforcement actions, management knew that these increased sales were likely to decline. The company did not disclose these facts in the MD&A sections of its Form 10-Q and Form 10-K reports during the relevant periods.

Nvidia is based on a similar factual scenario. Sales of Nvidia’s graphics processing units (“GPUs”) were historically driven by computer games. During the relevant periods, NVIDIA’s revenue increased significantly due to demand for its GPU products for use in cryptocurrency mining. Although Nvidia’s systems did not allow the company to precisely quantify this impact, management was aware of this new market demand and sought to capitalize on it. However, NVIDIA did not disclose the impact of crypto mining sales in its Form 10-Q reports for the second and third quarters of its 2018 fiscal year; NVIDIA first disclosed the impact of these sales in its Form 10-K report for its fiscal year 2018.

In both of these cases, the SEC simply linked subsequent disclosure of events that affected the company’s business and financial performance to earlier reports that did not disclose known facts and trends. So the question a company should continually ask is: does its MD&A accurately reflect what management knows about what is currently shaping the company’s business and financial performance?

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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