SEC Proposes Changes to Modernize Certain Disclosures Under Regulation S-K

On August 8, 2019, the Securities and Exchange Commission proposed amendments to modernize Regulation S-K’s description of business, legal proceedings and risk factor disclosure requirements in documents registrants file with the SEC, including periodic reports and registration statements. The proposed amendments are “intended to improve the readability of disclosure documents, as well as discourage repetition and disclosure of information that is not material.” Some of the more notable changes include: making the description of business disclosure requirements more principles-based, permitting a hyperlink to cross-reference disclosure for legal proceedings included elsewhere, and requiring a summary of risk factors if the risk factors section exceeds 15 pages. The SEC’s proposing release is available here.

The proposed amendments follow the SEC’s request for public comment in 2016 on certain business and financial disclosure requirements (described in our previous client alert, available here). Specifically, the proposed amendments focus on the following four disclosures under Regulation S-K:

Description of Business (Item 101 of Regulation S-K)

Item 101 of Regulation S-K requires a registrant to describe the general development of its business under Item 101(a) and to provide a narrative description of its business under Item 101(c). These items are currently prescriptive in nature and the SEC aims to make them more principles-based. While the SEC’s proposal notes that disclosure under Item 101(c) is currently required only if the enumerated items are material to the business, many registrants interpret Item 101(c) as requiring disclosure of each enumerated item, regardless of materiality. Per the SEC, switching to a more principles-based disclosure framework will encourage registrants to exercise judgment in evaluating what disclosure to provide, resulting in disclosures more appropriately tailored to a registrant’s specific facts and circumstances.

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

• Timeframe for Description of General Development of Business. The SEC proposes to eliminate the currently prescribed five-year timeframe (three years for smaller reporting companies) for providing the disclosure regarding the general development of a registrant’s business. In addition, registrants are instructed to focus on information material to an understanding of the development of their businesses, irrespective of a specific timeframe.
• Subsequent SEC Filings. Disclosure of the general development of a registrant’s business is currently required in registration statements and annual reports. The proposed amendments preserve the disclosure requirement in initial registration statements under the Securities Act and Exchange Act. However, for subsequent filings, only an update of this disclosure is required, with a focus on material developments, if any, in the reporting period, including if the registrant’s disclosed business strategy has changed. For subsequent filings, registrants are also directed to incorporate by reference, and include an active hyperlink to, the most recently filed SEC disclosure that, together with the update, would present a full discussion of the general development of the registrant’s business. Significantly, a registrant will be permitted to include only one hyperlink to limit the burden on investors caused by the discussion being located in multiple documents. Notwithstanding this proposed amendment, a registrant will be permitted to provide a complete discussion of its business development, including material updates, in which case a hyperlink will not be required.
• Non-Exclusive List of Required Disclosure Items, Including Material Changes to Business Strategy. The SEC also proposes to amend Item 101(a)(1) to create a more principles-based framework for a registrant’s business development disclosure by providing a non-exclusive list of the types of information that a registrant may need to disclose and by only requiring disclosure of a topic to the extent such information is material to an understanding of the general development of a registrant’s business. The SEC proposes the following non-exclusive disclosure topics under Item 101(a)(1):
  • any material bankruptcy, receivership, or any similar proceeding;
  • the nature and effects of any material reclassification, merger or consolidation of the registrant or any of its significant subsidiaries;
  • the acquisition or disposition of any material amount of assets otherwise than in ordinary course of business; and
  • any transaction and event that affects or may affect the company’s operations, including any material changes to a registrant’s previously disclosed business strategy.
  The first three topics are currently required and the fourth topic is new. With respect to the fourth topic, the SEC does not currently require, and does not propose to require, that the registrant disclose its business strategy. However, to the extent a registrant has previously disclosed its business strategy, any material changes to such previously disclosed business strategy must be disclosed.

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

• Revenue-generating activities, products and/or services, and any dependence on key products, services, product families, or customers, including government customers;
• Status of development efforts for new or enhanced products, trends in market demand and competitive conditions;
• Resources (e.g., raw materials and intellectual property) material to a registrant’s business;
• 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 extent to which the business is or may be seasonal¹;
• Compliance with material government regulations, including environmental regulations²; and
• Human capital resources disclosure (e.g., measures or objectives that address the attraction, development and retention of personnel).

With the exception of the human capital resources disclosure topic, the topics listed above generally represent a subset of the specific items enumerated in current Item 101(c) or, in the case of compliance with material government regulations, are consistent with common disclosure practices.

The human capital resources disclosure topic is intended to replace the current requirement to disclose a registrant’s number of employees and is an effort to modernize the SEC’s disclosure requirements following feedback from the SEC’s 2016 concept release, as well as comments in response to a 2017 human capital rulemaking petition. In an effort to avoid prescribing fixed, specific line item disclosures, the proposed amendment requires disclosure of the registrant’s human capital resources, including any human capital measures and 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. The proposed amendment provides a non-exhaustive list of examples of human capital measures and objectives that may be material, depending on the nature of a registrant’s business and workforce, such as those addressing the attraction, development and retention of personnel.

Consistent with the current rule, most of the disclosure topics will require disclosure that focuses on the registrant’s dominant segment or each reportable segment, but only to the extent that the specific topic is material to an understanding of the registrant’s business taken as a whole. For the last two topics listed above—compliance with material government regulations and human capital resources—the proposed amendments require the disclosure to focus on the registrant’s business taken as a whole, although a registrant will still be required to identify any segment for which the information elicited by these last two topics is material.

The proposed revisions to Item 101(c) do not explicitly require disclosure with respect to working capital practices, new segments, and dollar amounts of backlog orders believed to be firm, each of which is currently required by the rule. However, under the SEC’s proposed principles-based approach, disclosure regarding these topics, and any other topics regarding the registrant’s business, will still need to be provided if material to an understanding of the registrant’s business.

Legal Proceedings (Item 103 of Regulation S-K)

Item 103 of Regulation S-K currently requires under Part II, Item 1 of Form 10-Q and Part I, Item 3 of Form 10-K disclosure of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, which the registrant or any of its subsidiaries is a party to or of which any of their property is subject.

To reduce duplicative disclosures appearing in the notes to a registrant’s financial statements and other parts of its filings (i.e., risk factors and MD&A), the SEC proposes to revise Item 103 to expressly state that some or all of the required information may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document.

The SEC also proposes to revise Instruction 5.C of Item 103 to increase the disclosure threshold for environmental proceedings in which the government is a party from $100,000 to $300,000 to adjust for inflation.

Risk Factors (Item 105 of Regulation S-K)

Item 105 of Regulation S-K requires a discussion of the most significant factors that make an investment in the registrant or offering speculative or risky. To avoid the lengthy and generic nature of the risk factor disclosure presented by many registrants, the SEC is proposing three amendments to Item 105:

• Summary Risk Factor Disclosure. Summary risk factor disclosure will only be required if the risk factor section exceeds 15 pages. The SEC proposes that the summary risk factor disclosure appear in the forepart of the prospectus or annual report, as applicable, under an appropriately captioned heading. The summary should consist of a series of short, concise, bulleted or numbered statements summarizing the principal factors that make an investment in the registrant or offering speculative or risky.
• Require Only Material Risk Factors. The requirement to discuss the “most significant” risks will be replaced by a requirement to discuss “material” risks. In its proposing release, the SEC cites Securities Act Rule 405, which provides that the term “material,” 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 a security.
• Organize Risk Factors Under Relevant Headings. Registrants will organize their risk factor disclosure 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 a registrant’s investors, the SEC will require the registrant to disclose such risk factors at the end of the risk factor section under the caption “General Risk Factors.”

The SEC has requested public comment on many aspects of the proposed amendments; public comments are due 60 days following publication in the Federal Register.

¹ The SEC preserved this disclosure requirement when it previously removed the requirement in Item 303 to discuss seasonal aspects that have a material adverse effect on a registrant’s financial condition or results of operations in MD&A as part of the disclosure amendments it adopted in August 2018.

² The proposed rules expand disclosure from only material environmental regulations to all material government regulations. This disclosure topic should focus on the material effects that compliance with material government regulations may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries.