On August 26, the Securities and Exchange Commission adopted amendments to modernize the required disclosures under Regulation S-K regarding a company’s business description (Item 101), legal proceedings (Item 103) and risk factors (Item 105) (the Amendments). In a press release, the SEC staff noted that the Amendments are in line with the SEC’s long-standing commitment to a principles-based, registrant-specific approach to disclosure that, although prescriptive in some respects, focuses on materiality and is designed to provide an understanding of each registrant’s business, financial condition and prospects. The staff also noted that the Amendments are intended to result in disclosure that will be presented in a manner that is more readable because of the reduction of immaterial and/or repetitive disclosure and will also be more in line with the way that a registrant’s management and board of directors manage and assess the registrant’s performance. The Amendments reflect the adoption of rule amendments the SEC originally proposed in August 2019 (the Proposals), which were previously discussed in the August 16, 2019 edition of Corporate & Financial Weekly Digest, with certain modifications. The key changes made by the Amendments:
Item 101(a) of Regulation S-K (General Development of the Business):
- implement a principles-based approach, replacing the previously prescribed five-year look-back period (or three years for smaller reporting companies) for describing the development of the registrant’s business with a disclosure requirement focused on materiality to an understanding of the general development of the registrant’s business (which may cover a longer or shorter period);
- replace the existing prescriptive list of disclosure topics with a non-exclusive list of the types of information that a registrant may need to disclose, requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant’s business. The non-exclusive list of disclosure topics, which was modified from the list in the Proposals, includes the following (the final three of which were covered in Item 101(a)(1) prior to the adoption of the Amendments):
- material changes to a previously disclosed business strategy (which business strategy-related disclosure is not required by the current disclosure rules and will not be required upon the Amendments becoming effective, and, if a registrant has not previously disclosed a business strategy, such change in business strategy disclosure would not be mandatory);
- the nature and effects of any material bankruptcy, receivership or similar proceeding;
- the nature and effects of any material reclassification, merger or consolidation of the registrant or any of its significant subsidiaries; and
- the acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business; and
- permit (but not require) a registrant, in filings made after an initial registration statement, to provide only an update of the general development of the business that focuses on any material developments in the reporting period, along with a single active hyperlink to the registrant’s most recent filing that, together with the update, would contain the full discussion of the general development of the business. Note that the Amendments limit registrants to one hyperlink for this purpose, meaning that that registrants cannot hyperlink to parts of multiple filings in order to provide the required disclosure.
Item 101(c) of Regulation S-K (Narrative Description of Business), which requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries:
- modify the prescriptive list of disclosure topics that were already included in Item 101(c) to clarify the principles-based nature of the disclosure requirements and thereby eliminate the ambiguity prior to the Amendments that led some registrants to include disclosure concerning all of the topics listed in Item 101(c) regardless of their materiality to the registrant. Following effectiveness of the Amendments, the non-exclusive list of disclosure topics, many of which are modifications of topics from the prior prescriptive list, includes, to the extent such information is material to an understanding of the business taken as a whole:
- 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 status of development efforts for new or enhanced products, trends in market demand and competitive conditions;
- the resources material to a registrant’s business, such as (1) sources and availability of raw materials; and (2) the duration and effect of all patents, trademarks, licenses, franchises and concessions held;
- 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; and
- the extent to which the business is or may be seasonal;
- require a description of the registrant’s human capital resources (which term is not defined and the description of which may (but is not required to) include the number of persons employed (the disclosure of which was required prior to the Amendments) and a description of any human capital measures or objectives the registrant focuses on in managing the business (e.g., measures or objectives that address the development, attraction and retention of personnel)), if such disclosure would be material to an understanding of the registrant’s business;
- expand the requirement that registrants disclose the material effects of compliance with environmental laws to cover the material effects of complying with material government regulations, not just environmental laws; and
- eliminate the requirement that registrants include disclosure concerning working capital (which the staff of the SEC expects would be discussed in a registrant’s MD&A, to the extent material), new segments and the dollar amount of backlog orders believed to be firm, unless such disclosure would be material to an understanding of the business and is not otherwise disclosed.
Item 103 of Regulation S-K (Legal Proceedings), which required a registrant to disclose (a) any material legal proceedings, other than routine litigation incidental to the business it or its subsidiaries operate; and (b) any proceeding under environmental laws to which a governmental entity is a party unless a registrant believes it will not result in sanctions of $100,000 or more:
- expressly provide that the required disclosure may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document (such as in the footnotes to the financial statements), in an effort to avoid duplicative disclosure; and
- revise the current $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation, and provide a registrant the flexibility to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings so long as the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant and its subsidiaries on a consolidated basis. If a registrant elects to use a threshold other than $300,000, it must disclose the threshold it uses (including any change thereto) in each annual and quarterly report.
Item 105 of Regulation S-K (Risk Factors), which requires a registrant to disclose factors that make an investment in the registrant or an offering speculative or risky for a potential investor:
- require summary risk factor disclosure, in the form of bulleted or numbered statements, in the forepart of the document if the risk factor section exceeds 15 pages, which the SEC estimates will affect approximately 40 percent of filers based upon existing current disclosure;
- revise the disclosure standard from requiring the “most significant” factors to the “material” factors to focus registrants on disclosing the risks to which reasonable investors would attach importance in making an investment or voting decision with respect to the registrant’s securities; and
- consistent with a practice that many registrants already follow, require risk factors to be organized under relevant headings, with any risk factors that may generally apply to other companies or an investment in securities, without explanation of why the identified risk is specifically relevant to the particular registrant, to be disclosed at the end of the risk factor section under the caption “General Risk Factors.”
The Amendments will become effective 30 days after publication in the Federal Register.