SEC proposes amendments to disclosure requirements under Regulation S-K



August 20, 2019

Securities Law Alert

Author(s): Kelly D. Babson, Bohao Zhou

The SEC proposed amendments to Regulation S-K to modernize reporting companies’ disclosures describing their business, legal proceedings, and risk factors under Regulation S-K — the latest in a series of amendments under the SEC’s Disclosure Effectiveness Initiative intended to improve disclosures for investors and simplify compliance for public companies. This alert discusses what companies need to know.

Earlier this month, the Securities and Exchange Commission (“SEC”) proposed amendments to Regulation S-K to modernize reporting companies’ disclosures describing their business, legal proceedings, and risk factors. The proposed amendments are another in a series of amendments under the SEC’s Disclosure Effectiveness Initiative, and are intended to improve disclosures for investors and simplify compliance for public companies.

The proposed amendments to Regulation S-K Items 101(a) (description of the general development of the business), 101(c) (narrative description of the business), and 105 (risk factors) emphasize a principles-based approach by articulating a disclosure concept rather than a specific line-item requirement. Company management would be required to evaluate the significance of information in the context of the company’s overall business and financial circumstances and to determine whether disclosure is necessary. In contrast, the proposed amendments to Item 103 (legal proceedings) continue to follow a prescriptive approach of employing bright-line, quantitative thresholds to specify when disclosure is required, because that requirement depends less on specific characteristics of individual companies.

SEC Chairman Jay Clayton noted that the amendments to Items 101, 103 and 105 are proposed in light of the fact that “the world economy and our markets have changed dramatically in the more than 30 years since the adoption of our rules for business disclosures by public companies.” The proposal will be subject to a 60-day public comment period after its publication in the Federal Register.

The following chart summarizes the proposed amendments and the corresponding current requirements, with significant changes highlighted in bold. The full text of the proposal is available here.

Summary of Proposed Amendments

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

Current Rule Proposed Amendment

Requires a description of the general development of the business of the company during the past five years, or such shorter period as the company may have been engaged in business.

In describing the general development of the business, Item 101(a)(1) requires disclosure of:

  1. The year in which the company was organized and its form of organization;
  2. The nature and results of any bankruptcy, receivership, or similar proceedings with respect to the company or any of its significant subsidiaries;
  3. The nature and results of any other material reclassification, merger, or consolidation of the company or any of its significant subsidiaries;
  4. The acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business; and
  5. Any material changes in the mode of conducting the business.

Eliminates the five-year disclosure timeframe[1] and requires companies to focus on the information material to an understanding of the development of their business, irrespective of a specific timeframe.

Permits only an update that focuses on material developments in the reporting period, along with a hyperlink to connect the updated disclosure with the previous disclosure, which together would result in a full discussion of the company’s general business development.

Disclosure may include, but should not be limited to, these topics:

  1. Transactions and events that affect or may affect the company’s operations, including material changes to a previously disclosed business strategy;
  2. Bankruptcy, receivership, or any similar proceeding;
  3. The nature and effects of any material reclassification, merger, or consolidation of the company or any of its significant subsidiaries; and
  4. The acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business.

Item 101(c): Narrative Description of Business

Current Rule Proposed Amendment

To the extent material to an understanding of the company’s business taken as a whole, the description must include:

  1. Principal products produced and services rendered;
  2. 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 orders in backlog 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.

Provides a non-exclusive list of items that should be considered and described, to the extent material to the company’s business, including:

  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 the company’s business;
  4. Material portion of the business that may be subject to renegotiation of profits or termination of contracts at the election of the government;
  5. Seasonality of the business;
  6. Compliance with material government regulations, including but not limited to environmental regulations; and
  7. Human capital disclosure, 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 company’s business, such as measures or objectives that address the attraction, development, and retention of personnel.

Item 103: Legal Proceedings

Current Rule Proposed Amendment

Requires disclosure of any material pending legal proceedings (other than ordinary routine litigation incidental to the business) to which the company or any of its subsidiaries is a party or of which any of their property is the subject. Disclosure shall include the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, and a description of the factual basis alleged to underlie the proceeding and the relief sought. Similar information is to be included for such proceedings known to be contemplated by governmental authorities.

Disclosure of any proceeding under environmental laws to which a governmental authority is a party must be included unless the company reasonably believes it will not result in sanctions of $100,000 or more.

Current disclosure requirements are retained. However, the proposed amendments allow companies to use hyperlinks or cross-references to legal proceedings disclosure elsewhere in the filing (such as in MD&A, risk factors, or the notes to the financial statements).

The amendments also update the disclosure threshold for environmental proceedings in which the government is a party to $300,000, to account for inflation (the current $100,000 threshold was set in 1982).

Item 105: Risk Factors

Current Rule Proposed Amendment

Requires disclosure of the most significant factors that make an investment in the company or offering speculative or risky, and specifies that the discussion should be concise and organized logically.

  1. Requires summary risk factor disclosure if the risk factor section exceeds 15 pages;
  2. Replaces the requirement to disclose the “most significant” factors with the “material” factors; and
  3. Requires companies to organize risk factors under relevant headings.
  1. Similarly, the SEC is also proposing to eliminate the provision that currently requires smaller reporting companies to describe the development of their business during the last three years. However, the requirement that if a smaller reporting company has not been in business for three years, it must provide the same information for its predecessors, if any, would be retained.
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