SEC Adopts Amendments to Modernize Reg S-K Disclosure Requirements

Troutman Pepper

On August 26, the SEC modernized the disclosure requirements in Items 101 (Description of Business), 103 (Legal Proceedings), and 105 (Risk Factors) of Regulation S-K, reflecting the first significant revisions to these disclosure items in over 30 years. 

The new principles-based rules will:

  • provide additional flexibility for an issuer to craft its business description to its particular circumstances;
  • reduce, and in certain instances, eliminate disclosures that are not material to an investor’s understanding of such issuer’s business or legal proceedings; and
  • provide for more organized and tailored risk-factor disclosure, including a summary section if risk factor disclosures exceed 15 pages.

The amended rules add a requirement for disclosure of human capital resources, including any human capital measures or objectives an issuer focuses on in managing its business, to the extent material.

Items 101, 103 and 105 of Regulation S-K are used in many Securities and Exchange Act filings, including registration statements such as Form S-1 and annual and quarterly reports on Forms 10-K and 10-Q. The new rules will be effective 30 days after publication in the Federal Register.

The SEC adopted these amendments in part to improve the readability of disclosure documents by discouraging repetition and disclosure of immaterial information, and to simplify compliance efforts for issuers. The SEC believes the new rules will permit an issuer to provide better disclosures more tailored to its business, benefiting its investors and reducing compliance burdens.

The final amendments, among other things, amend the following items in Regulation S-K:

Regulation S-K Item Summary of Current Requirements Summary of
Amendments

Items 101(a))
(General Development of Business)

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

  • Requires principles-based disclosure of information material to an understanding of the general development of the business
  • Replaces the previously prescribed five-year timeframe with a materiality framework, which may include the following topics:
    • material changes to a previously disclosed business strategy (an issuer that currently provides disclosure of its business strategy will be expected to discuss material changes or updates to the strategy);
    • material bankruptcy or similar proceedings;
    • material reclassification, merger or consolidation; and
    • material acquisitions or dispositions outside of the ordinary course
  • In filings made after an issuer’s initial registration statement, allows an issuer to provide only an update of the general development of its business focused on material developments that have occurred since its most recent registration statement or report that includes a full discussion, which must be incorporated by reference and, when read together with the update, would contain the full discussion
    • This approach requires the issuer to incorporate by reference the earlier disclosure into the updated filing by including one active hyperlink to one previous filing that contains the full discussion of the general development of the business and prohibits the use of multiple hyperlinks to prior filings.
    • We expect many issuers to continue to include a complete discussion of the development of their businesses

Item 101(c)
(Narrative Description of Business)

Requires a narrative description of the business done and intended to be done by the issuer and its subsidiaries, focusing upon the issuer’s dominant segment or each reportable segment about which financial information is presented in its financial statements. To the extent material to an understanding of the issuer’s business taken as a whole, the description of each such segment must include disclosure of several specific matters.

  • Replaces the current list of specific disclosure items with a non-exclusive list of topics drawn in part from topics currently contained in Item 101(c), including the following:
    • revenue generating activities, products or services and dependence on any of these activities, products or services or customers;
    • status of product development efforts, trends in market demand and competitive conditions;
    • resources material to the issuer’s business (raw materials, IP);
    • business that may be subject to renegotiation of profits or contracts at the election of the government; and
    • the extent to which the business may be seasonal
  • Includes, as a disclosure topic, a description of the issuer’s human capital resources to the extent such disclosures would be material
  • Refocuses the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws
  • Deletes the explicit references in current Item 101(c) to:
    • disclosure about new segments;
    • the dollar amount of backlog orders; and
    • working capital practices (noting that working capital is to be discussed in the MD&A if material)

Item 101(h)
(Smaller Reporting Companies

 
  • Eliminates the three-year timeframe with respect to smaller reporting companies.
  • In filings made after a smaller reporting company’s initial registration statement, allows a smaller reporting company to provide only an update of the general development of its business focused on material developments that have occurred since its most recent registration statement or report that includes a full discussion of the general development of its business, which must be incorporated by reference and, when read together with the update, would contain the full discussion
    • consistent with the changes to Item 101(a), this approach requires the smaller reporting company to incorporate by reference the earlier disclosure into the updated filing by including one active hyperlink to one previous filing that contains the full discussion of the general development of the business and prohibits the use of multiple hyperlinks to prior filings
    • As with larger issuers, we expect many smaller reporting companies to continue to include a complete discussion of the development of their businesses

Item 103
(Legal Proceedings)

Requires disclosure of any material pending legal proceedings including the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Similar information is to be included for any such proceedings known to be contemplated by governmental authorities.

Contains a threshold for disclosure based on a specified dollar amount ($100,000) for proceedings related to Federal, State, or local environmental protection laws.

  • Permits the required information to be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document (such as MD&A, risk factors or the notes to the financials) to avoid duplicative disclosure
  • Increases the disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions from $100,000 to $300,000, but also affords an issuer some flexibility by allowing the issuer, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or 1 percent of the current assets of the issuer

Item 105
(Risk Factors)

Requires disclosure of the most significant factors that make an investment in the issuer or offering speculative or risky and specifies that the discussion should be concise, organized logically, and furnished in plain English. The Item also states that issuers should set forth each risk factor under a subcaption that adequately describes the risk. Additionally, Item 105 directs issuers to explain how each risk affects the issuer or the securities being offered and discourages disclosure of risks that could apply to any issuer.

  • Requires summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages
    • the summary list should be satisfied by using the bullet summaries often included in the forward-looking statements section
    • the SEC notes that the requirement to provide a risk factor summary may create an incentive for an issuer to reduce the length of its risk factor discussion to avoid triggering the summary requirement, to the extent that such an incentive outweighs perceived litigation risks
  • Refines the principles-based approach of Item 105 by requiring disclosure of “material” risk factors that make an investment in the issuer speculative or risky (rather than the “most significant” risks)
    • the SEC believes changing the standard from “most significant” to “material” risks will focus issuers on disclosing the risks to which reasonable investors would attach importance in making investment or voting decisions
  • Requires risk factors to be organized under relevant headings in addition to the subcaptions currently required (but not specifying the headings that should be used), with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under the separate caption “General Risk Factors”
    • the SEC believes that inclusion of risk factors under the “General Risk Factors” caption should not, by itself, affect the availability of the Private Securities Litigation Reform Act safe harbor
    • the SEC believes, however, this new rule may encourage issuers to better tailor their risk factor disclosures to emphasize the specific relationship of the risk to such issuer or the offering, and therefore avoid the need to include the risk under the general risk heading.

 Smaller Reporting Companies

Item 101(h) sets forth alternative disclosure standards for smaller reporting companies that allow an issuer to, among other things, provide a less detailed description of its business than is required under Item 101(a). The amendment to Item 101(h) eliminates the provision that requires smaller reporting companies to describe the development of their businesses during the last three years, and directs smaller reporting companies, in describing the development of their businesses, to provide information for the period of time that is material. 

Consistent with new Item 101(a), the amendment to Item 101(h) also permits a smaller reporting company, after its initial registration statement, to provide only an update of the general development of the full discussion with an incorporation by reference to the most recent full discussion. In so doing, a smaller reporting company is permitted to incorporate the full discussion from only a single previously filed registration statement or report by including an appropriate hyperlink.

Unlike the substantial revisions to disclosure set forth in revised Items 101(a) and (c), the new rules do not otherwise change the prescriptive disclosure requirements currently set forth in Item 101(h).

Human Capital Disclosure

Item 101(c) of Regulation S-K now requires, to the extent such disclosure is material, a description of an issuer’s human capital resources, including any human capital measures or objectives that the issuer focuses on in managing its business. Further, the Item also requires an issuer to disclose, to the extent material, the number of persons employed by the issuer. The SEC noted that to the extent that a measure, for example, of an issuer’s part-time employees, full-time employees, independent contractors and contingent workers, and employee turnover, in all or a portion of the issuer’s business, is material, the issuer must disclose this information.

Because the SEC determined to adopt a principles-based approach, the new rule does not define “human capital.” The SEC believes “this term may evolve over time and may be defined by different companies in ways that are industry specific.” The final rule identifies various human capital measures and objectives that address the attraction, development, and retention of personnel as non-exclusive examples of subjects that may be material, depending on the nature of the issuer’s business and workforce. The SEC indicated that each issuer’s disclosure must be tailored to its unique business, workforce, and facts and circumstances. 

Further, while the new rule does not require an issuer to use a disclosure standard or framework to provide human capital disclosure, the SEC believes a principles-based approach affords an issuer the flexibility to provide disclosure in accordance with some or all of the components of any current or future standard or framework that facilitates human capital resource disclosure. In his public statement made in conjunction with the adoption of the amendments, SEC Chairman Clayton stated that he does “expect to see meaningful qualitative and quantitative disclosure, including, as appropriate, disclosure of metrics that companies actually use in managing their affairs” and that “[a]s is the case with non-GAAP financial measures, [he] would also expect companies to maintain metric definitions constant from period to period or to disclose prominently any changes to the metrics used or the definitions of those metrics.”

The new rule passed by on a 3-2 vote. The two dissenting commissioners disapproved of adopting “a generic and vague” principles-based disclosure requirement with respect to human capital and would have required specific disclosures. The dissenters also criticized the new rule for being “silent on two critical subjects: diversity and climate risk disclosures.” One dissenting commissioner argued for additional study of environmental, social and governance (ESG) disclosures and metrics. We expect ESG matters to remain a key focus of the SEC, particularly if the White House changes hands in the election.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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