SEC Adopts Rule Amendments to Modernize Disclosures of Business, Legal Proceedings, and Risk Factors Under Regulation S-K
By a 3-2 vote, the U.S. Securities and Exchange Commission (SEC) has adopted amendments designed to modernize the disclosure requirements involving description of business (Item 101), legal proceedings (Item 103), and risk factors (Item 105) under Regulation S-K. According to the SEC, the amendments are intended to reflect changes in the capital markets, simplify disclosure requirements, and make disclosure documents more readable.
- The five-year disclosure timeframe (three-year for smaller reporting companies) was eliminated from business description.
- After the initial filing containing a full discussion of a business’ developments, registrants can provide a general update, provided they hyperlink to the prior discussion.
- A description of human capital resources is added as a disclosure topic.
- The regulatory compliance disclosure requirement is refocused to include all material government regulations—not just environmental laws— and can be cross-referenced to other disclosures.
- The threshold for disclosure of environmental proceedings in which the government is a party was raised from $100,000 to $300,000. Under certain conditions, registrants can choose a different threshold.
- When the risk factor section exceeds 15 pages, the registrant must provide a summary of no more than two pages. Risk factors must be organized under headings, as well as sub-captions.
THE BOTTOM LINE
Many of the final amendments reflect the SEC's oft-stated commitment to a principles-based, registrant-specific approach to disclosure. The amendments are the first significant changes to these disclosures in 30 years. They become effective 30 days after publication in the Federal Register. Please consult counsel for guidance on how to adapt disclosures in periodic filings and registration statements to conform with the new requirements.
The Securities and Exchange Commission (SEC)—by a 3-2 vote on August 26—adopted amendments to modernize the disclosure requirements relating to description of business (Item 101), legal proceedings (Item 103), and risk factors (Item 105) under Regulation S-K. According to the SEC, the amendments were made to “reflect the many changes in our capital markets and the domestic and global economy in recent decades,” simplify the substantive disclosure requirements, and to make disclosure documents more readable. The amendments are the first significant changes to these disclosures in 30 years and were prompted by the comprehensive evaluation of the SEC’s disclosure requirements in Regulation S-K required by the JOBS Act. They become effective 30 days after publication in the Federal Register.
Summary of the Final Amendments
Many of the final amendments reflect the SEC's oft-stated commitment to a principles-based, registrant-specific approach to disclosure. The modernization of Items 101, 103, and 105 is intended to improve disclosures by reflecting a registrant’s particular circumstances and to streamline the compliance efforts of registrants. The amendments also are intended to improve the readability of disclosure documents, as well as discourage repetition and immaterial disclosure.
The chart here compares the final amendments to the existing rules.
Amendments to Item 101(a) and (h) General Development of Business
Elimination of the Five-Year and the Three-Year Disclosure Timeframes
The final rule amends Item 101(a) to eliminate the five-year disclosure timeframe and applies a materiality standard to all of a registrant’s disclosure of the general development of its business. In addition, the final rule adds a corresponding amendment to Item 101(h) to eliminate the three-year disclosure timeframe applicable to smaller reporting companies. The intent is that the amendment to Item 101(a) will focus registrants on information material to an understanding of the development of their business, irrespective of a specific timeframe. Similarly, the amendment to Item 101(h) eliminates the provision that requires smaller reporting companies to describe the development of their business during the last three years and directs smaller reporting companies, in describing the development of their businesses, to provide information for the period of time that is material to an understanding of the general development of the business.
Updated Disclosure in Subsequent Filings
For filings after the initial registration statement, a registrant now may provide an update of the general development of its business. The update must disclose all of the material developments, if any, that have occurred since the most recent filing containing a full discussion of the general development of its business. If a registrant chooses this approach, it must incorporate by reference the most recent full discussion of the general development of the registrant’s business using one active hyperlink. Moreover, under the final rule, registrants are permitted only to incorporate the full discussion of the general development of their business from a single previously filed document. If a registrant does not choose this approach, it must provide a complete discussion of its business development, including any material updates, in each filing.
Disclosure about Business Strategy
The final rule replaces the list of prescribed disclosure topics relating to business strategy with a non-exclusive list of the types of information that a registrant may need to disclose. The final rule also clarifies that disclosure of a topic would be required only to the extent that such information is material to an understanding of the general development of a registrant’s business. A registrant is no longer required to disclose the year it was organized and its form of organization, or to disclose any material changes in the mode of conducting its business in its list of disclosure topics. Nevertheless, such disclosure continues to be required if material to an understanding of the general development of the registrant’s business.
In addition, when it is material to an understanding of the general development of the business, registrants are now required to disclose material changes to a registrant’s previously disclosed business strategy. However, the SEC did not adopt a definition of the term “business strategy” or add a requirement to disclose a registrant’s business strategy annually.
Amendments to Item 101(c) – Narrative Description of Business
The final rule amends Item 101(c) to be more clearly principles-based by replacing the current list of specific items with a non-exclusive list of disclosure topic examples, identified below.
Revenue-generating activities, products and/or services, and any dependence on revenue-generating activities, key products, services, product families, or customers, including governmental customers
The final rule retains the requirement to disclose revenue-generating activities, products, and/or services, and any dependence on key products, services, product families, or customers, including governmental customers, to the extent this information is material to an understanding of the registrant’s business.
Status of development efforts for new or enhanced products, trends in market demand, and competitive conditions
The final rule retains the requirement to disclose information regarding development efforts for new or enhanced products, trends in market demand, and competitive conditions, to the extent this information is material to an understanding of the registrant’s business.
Resources material to a registrant’s business
Prior to the final amendments, two of the 12 disclosure requirements in Item 101(c) related to registrants’ resources: Item 101(c)(1)(iii) required disclosure of the sources and availability of raw materials, and Item 101(c)(1)(iv) required disclosure of the importance to the segment and the duration and effect of all patents, trademarks, licenses, franchises, and concessions held, each to the extent material to an understanding of the registrant’s business taken as a whole. These requirements are amended to refocus registrants’ disclosure on all resources material to their business. Specifically, these disclosure topics are combined into one principles-based, non-exclusive set of examples of information that should be disclosed, to extent material to an understanding of a registrant’s business as a whole.
A description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government
The final rule retains the requirement that registrants, to the extent material to an understanding of the registrant’s business taken as a whole, disclose any material portion of a business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.
The extent to which the business is or may be seasonal
The final rule retains the requirement that registrants, to the extent material to an understanding of the registrant’s business taken as a whole, disclose the extent to which the business of the segment is--or may be--seasonal. The SEC retained this item in the final rule out of concern about the potential loss of information in the fourth quarter about the extent to which the business of a registrant or its segments is or may be seasonal because U.S. GAAP may not require this disclosure.
Compliance with material government regulations, including environmental regulations
Item 101(c)(1)(xii) requires disclosure of the material effects of compliance with environmental laws on the capital expenditures, earnings, and competitive position of the registrant and its subsidiaries, as well as any material estimated capital expenditures for the remainder of the fiscal year, the succeeding fiscal year, and such future periods that the registrant deems material. Although there is no separate line item requiring disclosure of government regulations that may be material to a registrant’s business, it is common practice for many registrants to include disclosure about such information in response to Item 101(c)(1)(xii). In recognition of this common practice, and because the SEC believed the inclusion this disclosure would provide important information to investors, the final rule includes the material effects of compliance with material government regulations, not just environmental laws, as a listed disclosure topic in Item 101(c).
Human capital disclosure
Item 101(c)(1)(xiii) requires disclosure of the number of persons employed by the registrant. The final rules amend Item 101(c) to replace the requirement to disclose the number of people employed by the registrant with a requirement to provide a description of the registrant’s human capital resources, including any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business taken as a whole. In addition, the final rules include non-exclusive examples of human capital measures and objectives that may be material, depending on the nature of the registrant’s business and workforce, such as measures or objectives that address the attraction, development, and retention of personnel. A registrant is still required to disclose the number of people employed by the registrant, but only to the extent material to an understanding of the registrant’s business.
Amendments to Item 103 – Legal Proceedings
Hyperlinks and Cross-references
To avoid duplicative disclosure, the final rule requires that registrants expressly state that the legal proceedings disclosure may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document, such as in management’s discussion & analysis (MD&A), risk factors, or notes to the financial statements.
Disclosure Threshold for Environmental Proceedings in which the Government is a Party
Instruction 5.C. to Item 103 specifically requires registrants to disclose any proceeding under environmental laws to which a governmental authority is a party, unless the registrant reasonably believes it will not result in sanctions of $100,000 or more. Such proceedings which are similar in nature may be grouped and described generally. The final rules reorganize Item 103 to eliminate the current instructions and incorporate their contents into the text of Item 103.
In addition, the final rules adopt a modified disclosure threshold that increases the existing threshold, but also affords a registrant some flexibility. The final rule provides a range within which the registrant can select a different threshold that it determines will result in disclosure of material environmental proceedings. Accordingly, under the final rule, disclosure will be required for any proceeding that involves potential monetary sanctions of $300,000 or more or, at the election of the registrant, an amount that the registrant determines will result in the disclosure of a proceeding that is material to its business or financial condition. However, irrespective of any alternative threshold adopted by the registrant, disclosure will be required in all cases for any proceeding when the potential monetary sanctions exceed the lesser of $1 million or one percent of the current assets of the registrant and its subsidiaries on a consolidated basis. Furthermore, if a registrant chooses to use a threshold other than the $300,000 threshold, it must disclose this threshold (including any change thereto) in each annual and quarterly report.
Amendments to Item 105 – Risk Factors
In amending Item 105, the SEC’s goal was to address the lengthy and generic nature of the risk factor disclosure presented by many registrants. According to the SEC, registrants often disclose risk factors that are similar to those used by others in their industry without tailoring the disclosure to their circumstances and particular risk profile. To address these concerns, the SEC has made the following amendments to the Item 105 risk factor disclosure requirement:
Summary risk factor disclosure required if the risk factor section exceeds 15 pages
If a registrant’s risk factor disclosure exceeds 15 pages, the final rule now requires, at the beginning of the document, a series of concise, bulleted, or numbered statements, no more than two pages in length, summarizing the principal factors that make an investment in the registrant or offering speculative or risky. The SEC’s hope is to create an incentive for registrants to reduce the length of their risk factor discussion to avoid triggering the summary requirement.
Replace the requirement to disclose the “most significant” factors with the “material” factors
The final rule require the disclosure of the “material” risks rather than the “most significant” risks. The SEC intends for the final amendments to result in risk factor disclosure that is more tailored to the particular facts and circumstances of each registrant, which should reduce the disclosure of generic risk factors and potentially shorten the length of the risk factor discussion, to the benefit of both investors and registrants
Require registrants to organize risk factors under relevant headings
The final rule requires registrants to organize their risk factor disclosure under relevant headings, in addition to the sub-captions currently required. The final rule also require registrants to present risks that could apply to any registrant or any offering at the end of the risk factor section under a separate caption entitled “General Risk Factors.” The final rule, except as the “General Risk Factors” caption, does not provide specific risk factor headings that registrants should use and does not require registrants to prioritize the order in which they discuss their risk factors.
The SEC adopted the amendments with two dissenting votes. The two dissenting commissioners did not believe that a principles-based disclosure is suitable for the new human capital disclosure rule and would have preferred a more prescriptive approach. Commissioner Allison Herren Lee stated in her dissenting statement that she would have preferred a final rule that “had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics, such as part-time vs. full-time workers, workforce expenses, turnover, and diversity.” Commissioner Caroline A. Crenshaw’s dissenting statement suggests the SEC form an external ESG Advisory Committee that would guide the SEC’s response to ESG trends and address her perceived failure of the rule amendments to adequately address climate change risk and human capital.
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