On August 26, 2020, the Securities and Exchange Commission (“SEC”) adopted amendments to Items 101, 103 and 105 of Regulation S-K. Though the SEC has made changes to certain parts of Regulation S-K over the past few years,1 these amendments will be the first changes to these specific rules since the regulation was created more than thirty years ago.
The amendments make the rules more principles-based and are intended to simplify compliance for registrants by requiring the disclosure of “material” information instead of specifically defined information. In summary, the amendments:
- Make Item 101(a) – General Development of Business largely principles-based by requiring disclosure of information material to an understanding of the general development of the business and replacing the previously prescribed five-year timeframe with a materiality framework. Under the amended rule, companies are also permitted to focus on material developments that update previously provided disclosure, rather than repeating the prior discussion.
- Clarify the principles-based approach under Item 101(c) – Narrative Description of Business to include a non-exclusive list of disclosure topic examples drawn in part from topics contained in the pre-amendment version of Item 101(c). Importantly, the SEC’s amendments also add as a disclosure topic a description of the company’s human capital resources to the extent such disclosure is material to an understanding of the company’s business and expand the requirement to disclose the material effects of regulatory compliance to cover all material government regulations, not just environmental laws and regulations.
- Revise Item 103 – Legal Proceedings to specifically permit information to be provided by hyperlink or cross-reference and increase the dollar threshold for certain governmental environmental proceedings from $100,000 to $300,000, while affording companies with the flexibility to select a different, reasonable threshold that does not exceed the lesser of $1 million or one percent of the current assets of the company.
- Revise Item 105 – Risk Factors to specifically permit companies to focus on “material” risk factors, require a summary of risk factor disclosure of no more than two pages if the company’s risk factor disclosure exceeds 15 pages and require companies to organize risk factor disclosure using appropriate headings and with general risk factors disclosed at the end.
The amendments adopted by the SEC on August 26, 2020, are very similar to the proposed amendments originally issued by the SEC in August 2019. However, there were some strong critiques to those proposals at the time not addressed by the adopted amendments. Many comments raised issue with the lack of rules regarding Environmental, Social and Governance (“ESG”) matters. Some individuals suggested that diversity of an organization’s workforce be required to be disclosed,2 while others also noted the lack of disclosure on climate change.3
These critiques were also raised by Commissioner Allison Herren Lee in her public statement issued on August 26, 2020. Commissioner Lee, who dissented in the vote to adopt the amendments, noted concern that the amendments to Item 101(c), which require disclosure regarding the company’s human capital resources to the extent material, “leaned too heavily on principles-based disclosures, both with respect to human capital and more broadly” and that the amendments failed all together to include climate risk. She also stated that ESG investing is “no longer just a matter of personal choice” and “[a] broad swath of investors find ESG risks to be as or more important in their decision-making process than financial statements, surpassing traditional metrics such as return on equity and earnings volatility.” In contrast, Chairman Jay Clayton and Commissioner Hester M. Peirce focused on the perceived positive effects of the principles-based approach in the amendments. Chairman Clayton, in his public statement, noted that the rules “are designed to elicit disclosure tailored to each company’s particular industry and business model, while being flexible enough to continue to allow for fulsome disclosure as businesses evolve in the future.” Commissioner Peirce also suggested that because of the principles-based requirement, companies may be more likely to share more meaningful disclosure about their workforces in contrast to if the requirement were more prescriptive. Reactions by companies and investors are likely to be similarly mixed.
The amendments will be effective thirty days after publication in the Federal Register. For calendar-year companies, this means that these amendments likely will be in effect and, therefore, must be considered by calendar-year companies as early as the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2020.
What This Means for Public Companies
- Companies that repeat all of their risk factors in their Forms 10-Q should consider beginning the process of review and reorganization now. Given the current market volatility and uncertainty, this may afford companies with an opportunity to begin a much-needed broader discussion regarding how risks are identified, analyzed and overseen internally.
- Companies should also begin reviewing their description of business and consider whether any aspect of the company’s human capital resources is material to an understanding of the company’s business.
- Lastly, while the largely principles-based approach adopted by the SEC will create more flexibility and control for companies in making disclosures pursuant to these rules, the approach also means that companies will need to carefully consider what information is “material” when making these disclosures. Also, the principles-based nature of these disclosures means that they are likely to vary significantly from industry to industry, and even between companies in the same industry, and companies will want to monitor the approaches taken by their peer companies to determine whether they are addressing investors’ expectations.
1 Both the Fixing America’s Surface Transportation Act (“FAST Act”) (Pub. L. No. 114-94, 129 Stat. 1312 (Dec. 4, 2015)) (requiring, among other things, that the SEC conduct a study, issue a report and issue a proposed rule on the modernization and simplification of Regulation S-K), and the Jumpstart Our Business Startups Act (“JOBS Act”) (Pub. L. No. 112-106, Sec. 108, 126 Stat. 306 (Apr. 5, 2012)) included requirements that the SEC conduct a review on the modernization and simplification of Regulation S-K. Section 108 of the JOBS Act required the Commission to conduct a review of Regulation S-K to determine how such requirements can be updated to modernize and simplify the registration process for emerging growth companies. Pursuant to Section 108 of the JOBS Act, the SEC staff prepared the Report on Review of Disclosure Requirements in Regulation S-K (“S-K Study”), which recommended that the SEC conduct a comprehensive evaluation of its disclosure requirements. The SEC staff also issued a Concept Release in 2016, requesting public comment on whether the business and financial disclosure requirements in Regulation S-K provide information that allows investors to make informed investment and voting decisions, or whether any of the rules had become outdated or unnecessary. As a result, the SEC has made amendments to modernize Regulation S-K, including amendments in March 2019 to, “among other things, increase flexibility in the discussion of historical periods in Management’s Discussion and Analysis, allow companies to redact confidential information from most exhibits without filing a confidential treatment request, and incorporate technology to improve access to information on the cover page of certain filings,” and proposed amendments in January 2020 to, among other things, modernize Items 301, 302(a), 302(b), and 303(a)(5), related to selected financial data, supplementary information and the Management’s Discussion and Analysis.
2 Letter from Louis E. Matthews, Jr. to SEC Rules Comments, SEC (Oct. 7, 2019), https://www.sec.gov/comments/s7-11-19/s71119-6261126-193027.htm; Letter from Judy Schultz to SEC Rules Comments, SEC (Oct. 11, 2019), https://www.sec.gov/comments/s7-11-19/s71119-193335.htm (“Schultz Letter”).
3 Schultz Letter; Letter from Dan B. to SEC Rules Comments, SEC (Oct. 11, 2019), https://www.sec.gov/comments/s7-11-19/s71119-193388.htm.