United States: SEC Proposes Amendments To Modernize Business, Legal Proceedings And Risk Factor Disclosures Under Regulation S-K

On Aug. 8, 2019, the U.S. Securities and Exchange Commission (SEC) proposed amendments to modernize the description of business (Item 101), legal proceedings (Item 103) and risk factor disclosures (Item 105) that companies are required to make under Regulation S-K, available here. The proposed amendments are intended to improve these items for investors and to simplify compliance for companies by, among other things, discouraging the disclosure of immaterial information.

The SEC is soliciting public comment on the proposed amendments until Oct. 22, 2019.

Background to the Proposed Amendments

The SEC adopted Regulation S-K in 1977 to promote uniform and integrated disclosure for registration statements filed under the Securities Act of 1933 (the Securities Act) and the Securities Exchange Act of 1934 (the Exchange Act) and other filings under the Exchange Act, including periodic reports on Form 10-K and Form 10-Q and current reports on Form 8-K. In 1982, the SEC expanded Regulation S-K to be the principal disclosure regime for non-financial statement requirements. The disclosure requirements under Regulation S-K employ a mix of “prescriptive” requirements, which use bright-line, quantitative thresholds to determine when disclosure is required, and thus do not rely on a company’s judgment to make that determination, and “principles-based” requirements, which provide a company with the flexibility to determine whether certain information regarding its business and financial condition is material and requires disclosure.

Pursuant to the Jumpstart Our Business Startups, or JOBS, Act, the SEC staff prepared a report on Regulation S-K disclosure requirements in 2013 and recommended that the SEC conduct a comprehensive evaluation thereof. This evaluation, known as the Disclosure Effectiveness Initiative, assessed the information companies must disclose, how this information is presented, where this information is disclosed and related matters. In 2016, the SEC issued a comprehensive concept release discussing, and requesting public comment on, the business and financial disclosure requirements in Regulation S-K. The proposed amendments stem from these initiatives and would revise Items 101(a) and 101(c) and Item 105 of Regulation S-K to emphasize a more principles-based approach to disclosure, while the proposed amendment to Item 103 would continue the existing prescriptive approach to disclosure. A summary of these proposed amendments is provided below.

Summary of Proposed Amendments

Item 101(a) of Regulation S-K: General Development of Business

Item 101(a) currently requires a description of the general development of a company’s business during the past five years, or such shorter period as the company may have been engaged in its business. The proposed amendments to Item 101(a) are intended to provide a company with the flexibility to tailor its disclosures to its unique circumstances and thus provide more informative disclosures to investors. In particular, the proposed amendments to Item 101(a) would:

• Eliminate the five-year disclosure time frame and instead require disclosure of information material to an understanding of the general development of the company’s business.
• Permit a company, after the filing of its initial registration statement under the Securities Act or the Exchange Act, to provide only an update to the general development of the company’s business, focusing on material developments, if any, during the reporting period; and require the company to provide a hyperlink to, and incorporate by reference, the company’s most recently filed disclosure that, together with the update, would provide a full discussion of the general development of the company’s business.
• Provide a nonexclusive list of topics that a company may need to disclose if such information would be material to an understanding of the general development of the company’s business. The list would include three topics currently covered by Item 101(a)(1) — disclosure of material bankruptcy proceedings, disclosure of the effects of any material merger or consolidation of the company, and disclosure of the acquisition or disposition of any material amount of assets — and a new topic, namely disclosure of transactions and events that affect or may affect the company’s operations, including material changes to its previously disclosed business strategy, but only if such disclosure is material to the understanding of the company’s business.

Item 101(c) of Regulation S-K: Narrative Description of Business

Item 101(c) currently requires a company to provide a narrative description of the business conducted and intended to be conducted by the company and its subsidiaries and provides 12 specific topics that must be discussed by the company, to the extent they are material to an understanding of its business. These 12 topics do not generally apply to all companies; however, some companies have interpreted Item 101(c) to require disclosure of each such topic, regardless of applicability and materiality, resulting in immaterial disclosures. To enable disclosure more appropriately tailored to a company’s specific circumstances, the proposed amendments to Item 101(c) would adopt a more principles-based framework that encourages companies to exercise judgment in determining what disclosures to provide. In particular, the proposed amendments to Item 101(c) would:

• Provide a nonexclusive list of seven disclosure topics, which are derived from both a subset of the disclosure topics currently included in Item 101(c) (e.g., revenue-generating activities, products and/or services, and dependence on key products, services, products families or customers) and new disclosure topics, and clarify that disclosure of such topics would only be required if the information is material to an understanding of the general development of the company’s business.
• Include the material effects of compliance with material foreign and domestic governmental regulations, not only environmental regulations, as a disclosure topic.
• Replace the current requirement to disclose the number of a company’s employees with a new requirement to describe the company’s human capital resources, including any human capital measures or objectives that management focuses on in managing the company’s business, to the extent such information is material to an understanding of the company’s business.

Item 103 of Regulation S-K: Legal Proceedings

Item 103 currently requires a company to disclose material pending legal proceedings, other than ordinary routine litigation incidental to the company’s business, to which the company or any of its subsidiaries is a party, and to disclose the name of the court or agency in which the proceedings are pending, the date the proceedings were instituted, the principal parties involved in the proceeding and a description of the facts underlying the proceeding. The proposed amendments to Item 103 would:

• Expressly state that some or all of the required information about material legal proceedings may be provided by the use of hyperlinks or cross-references to legal proceedings disclosures located elsewhere in the company’s filing (e.g., notes to the financial statements and MD&A) in order to avoid repetitive disclosure.
• Increase the threshold for disclosure of environmental proceedings to which the government is a party from $100,000 to $300,000 to adjust for inflation.

Item 105 of Regulation S-K: Risk Factors

Item 105 currently requires a company to provide a concise and logically organized disclosure of the most significant factors that make an investment in the company or offering speculative or risky. Item 105 further requires a company to explain how each risk affects the company or the securities being offered and discourages disclosure of risks that may apply generically to any company. Notwithstanding these requirements, the SEC noted that risk factor disclosures have increased in recent years and cited “generic, boilerplate risks” that could apply to any company or offering as a contributing factor to this increase. The proposed amendments to Item 105 are intended to address these issues by:

• Requiring summary risk factor disclosure if the risk factor section exceeds 15 pages, which summary would appear at the front of the filing under an appropriately captioned heading and consist of a series of short, concise, bulleted or numbered statements summarizing the principal risk factors that make an investment in the company or the offering risky or speculative.
• Replacing the requirement to disclose the “most significant” risk factors with “material” risk factors in order to focus a company’s disclosure on those risk factors to which investors would attach importance in making investment decisions.
• Requiring risk factors to be organized under relevant headings and requiring a company that discloses “generic, boilerplate” risk factors that could generally apply to other companies or securities to disclose such risk factors at the end of the risk factor section under the caption “General Risk Factors.”

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