SEC Proposes to Modernize, Improve, and Simplify Disclosure Framework Under Regulation S-K
On August 8, 2019, the Securities and Exchange Commission (the SEC) voted to propose rule amendments to modernize the description of business, legal proceedings, and risk factor disclosures that public companies are required to make pursuant to Regulation S-K. The SEC stated in its press release that “[t]he proposed amendments are intended to update the rules to improve disclosures for investors and to simplify compliance efforts for registrants.” The SEC also noted that this proposal reflects the dramatic changes in the world economy and markets since the adoption of the current rules for business disclosures by public companies. The 116-page proposing release is subject to a 60-day public comment period following its publication in the Federal Register.
Regulation S-K, adopted in 1977 and expanded in 1982, is a prescribed regulation under the Securities Act of 1933 that sets forth reporting requirements for various SEC filings used by public companies. Regulation S-K initially applies when companies use Form S-1 to register their securities with the SEC and continues to apply when public companies meet their ongoing reporting requirements by filing Forms 10-K, Forms 10-Q, Forms 8-K, etc. The required disclosures relating to the registrant’s business, legal proceedings, and risk factors have not undergone significant revisions in over 30 years. As a component of SEC’s Disclosure Effectiveness Initiative, the staff is proposing amendments to update the rules to account for developments since their adoption or last amendment, to improve these disclosures for investors, and to simplify compliance efforts for public companies.
The Proposed Amendments
Some important takeaways from the proposed amendments:
- General Development of Business (Item 101(a))
In light of the feedback received by the SEC recommending eliminating, streamlining or limiting the requirements of Item 101(a), the SEC is proposing the following amendments to Item 101(a):
Eliminate Prescribed Timeframe
Item 101(a) of Regulation S-K currently requires a description of the general development of the business of the registrant during the past five years, or such shorter period as the registrant may have been engaged in business. The SEC is proposing to revise this Item 101(a) to eliminate the five-year disclosure timeframe and require registrants to focus on the information material to an understanding of the general development of their business. Further, the SEC is also proposing to revise Item 101(h) to eliminate the provision that currently requires smaller reporting companies to describe the development of their business during the last three years.
- Require Only Updated Disclosure in Subsequent Filings
Currently, registrants are required to provide disclosure regarding the general development of the business in their registration statements and annual reports. The SEC is proposing to retain the requirement for registrants to describe the general development of the business in initial registration statements on one hand, and on the other hand is proposing to require an update of this disclosure, with a focus on material developments, if any, in the reporting period, in subsequent filings. To simplify the disclosures and to give a reader access to a full discussion, the proposed amendments would require that a registrant incorporate by reference, and include an active hyperlink, to the most recently filed disclosure.
- Include Material Changes to Business Strategy as A Potential Disclosure Topic
The proposed amendments would require Item 101(a)(1) to be more principles-based, which is an approach that articulates a disclosure concept rather than a specific line-item requirement and provides registrants with the flexibility to determine the disclosure that is material to an investment decision.
The proposed amendments would provide a non-exclusive list of the types of information that a registrant may need to disclose. Further, the proposed amendments would require disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant’s business. Moreover, the proposed amendments would include, as a listed disclosure topic, material changes to a registrant’s previously disclosed business strategy to the extent it is material to an understanding of the registrant’s business. However, if a registrant has not previously disclosed its business strategy, the SEC is not proposing to make the disclosure of that strategy mandatory in SEC filings.
- Eliminate Prescribed Timeframe
Narrative Description of Business (Item 101(c))
Item 101(c) of Regulation S-K requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries. The current Item 101(c) specifies 12 enumerated items that must be disclosed with respect to the registrant’s business in general.1
Similar to Item 101(a)(1), the SEC is proposing to shift Item 101(c) to an updated and more principles-based disclosure framework by requiring to include in Item 101(c) a non-exclusive list of disclosure topics. The proposed amendments would not explicitly reference some of the disclosure requirements currently contained in Item 101(c) and would no longer list the following topics: working capital practices, disclosure about new segments, and dollar amount of backlog orders believed to be firm. Nevertheless, under the proposed principles-based approach, registrants still would have to provide disclosure about these topics, as well as any other topics regarding the registrants’ business, if they are material to an understanding of their business.
The proposed non-exclusive disclosure topics under Item 101(c) include: (1) revenue-generating activities, products and/or services, and any dependence on key products, services, product families, or customers, including governmental customers; (2) status of development efforts for new or enhanced products, trends in market demand, and competitive conditions; (3) resources material to a registrant’s business, including raw materials, and the duration and effect of all patents, trademarks, licenses, franchises, and concessions held; (4) 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; (5) the extent to which the business is or may be seasonal; (6) compliance with material government regulations, including environmental regulations; and (7) human capital disclosure.
Disclosure topics 1-5 are similar or identical to the disclosure topics included in the current Item 101(c). For topic 6, the proposed amendments would expand the disclosure requirement to the material effects of compliance with material government regulations, not just environmental laws, as currently required by Item 101(c)(1)(xii). For topic 7, recognizing that intangible assets represent an essential resource for many companies and human capital may represent an important resource and driver of performance for certain companies, the SEC is proposing to replace the current requirement to disclose the number of employees with a requirement to disclose the registrant’s human capital resources. Such disclosures may include a description of 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.
- Legal Proceedings (Item 103)
Item 103 of Regulation S-K currently requires disclosure of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject. Unlike Item 101 and Item 105, the SEC is proposing to retain the prescriptive approach and is proposing the following two amendments to Item 103:
- Expressly allowing registrants to use hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document to avoid repetitive disclosure; and
- Raising the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation.
- Risk Factors (Item 105)
Item 105 of Regulation S-K currently requires disclosure of the most significant risk factors and specifies that the discussion of the risk factors should be concise and organized logically. The SEC is proposing to refine the principals-based approach and is proposing the following three amendments to Item 105:
- Requiring summary risk factor disclosure if the risk factor section exceeds 15 pages;
- Replacing the requirement to disclose the “most significant” risk factors with the “material” risk factors. “Material” is defined in Rule 405 of the 1933 Act as “when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security”; and
- Requiring registrants to organize risk factors under relevant headings. In addition, if a registrant chooses to disclose a risk that could apply to other companies or securities offerings and the disclosure does not provide an explanation of why the identified risk is specifically relevant to an investor in its securities, the proposed amendments would require the registrant to disclose such risk factors at the end of the risk factor section under the caption “General Risk Factors.”
The more than 50 securities attorneys in Ballard Spahr's Securities and Capital Markets Group represent public and private companies, underwriters, selling stockholders, and officers and directors, as well as private equity funds, venture capital firms, and institutional investors in compliance matters, capital-raising activities, and other transactions.
(1) principal products produced and services rendered; new products or segments;
(3) sources and availability of raw materials;
(4) intellectual property;
(5) seasonality of the business;
(6) working capital practices;
(7) dependence on certain customers;
(8) dollar amount of backlog orders believed to be firm;
(9) business subject to renegotiation or termination of government contracts;
(10) competitive conditions;
(11) the material effects of compliance with environmental laws; and
(12) number of employees. Item 101(c) of Regulation S-K.
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