SEC Amends Rules for Disclosures Regarding Business, Legal Proceedings and Risk Factors
The SEC has adopted amendments to modernize certain disclosure requirements set forth in Regulation S-K. Specifically, the SEC updated the items governing a company’s description of its business, legal proceedings and risk factors. These amendments are the first substantial changes to these Regulation S-K items in 30 years and represent a continued attempt by the SEC to update and streamline disclosures.
Chairman Jay Clayton said that the new rules were rooted in materiality and would allow investors to make more informed investment decisions. As described further below, the amendments move the rules closer to a "principles-based" model rather than prescriptive one-size-fits-all specific line items.
Item 101: Description of Business
The amendments focus on a principles-based, materiality threshold in order to modify the scope of Item 101 to adapt to modern businesses. Under the amendments, companies will be required to disclose information material to an understanding of the general development of the business. In describing developments, only information material to an understanding of the general development of the business will be required, with no specific look back time frame set forth in the rules. As an alternative to repeating the full discussion once such discussion has been filed, companies may provide only an update of the general development of the business, focused on material developments that have occurred since the most recent full discussion, such as in a company’s annual report or registration statement. For companies choosing this streamlined updating approached, they must incorporate by reference the previously filed full discussion and may only incorporate by reference from a single prior filing, rather than multiple documents.
The amendments also clarify the requirement to provide a narrative description of the business pursuant to Item 101(c) and expand the existing principles-based approach, without the current specific rules regarding segments and other matters. The rule now provides a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c) with the goal to elicit information material to a general understanding of the development of the business. One notable addition to what companies must consider for disclosure is a new requirement to discuss their human capital resources, including any human capital measures or objectives used to manage the business, to the extent material to understanding the business (in addition to the currently-required number of employees). This requirement reflects the SEC’s perception of the growing importance of human capital to companies and their market value in the modern economy where plant, property and equipment are less critical than in the past. What gets disclosed under this new requirement will depend on the nature of the company’s business and workforce, including measures or objectives that address the development, attraction and retention of personnel. However, beyond this, "human capital resources" is not defined and it is left to each company to determine what is material enough under this topic to warrant disclosure. The amendments also expand the scope of regulatory compliance disclosure, requiring companies to address all government regulations materially effecting the business and not just environmental laws.
Item 103: Legal Proceedings
The amendments streamline a company’s obligation to disclose legal proceedings. To reduce duplicative disclosure, companies will be permitted to provide a cross-reference or hyperlink to legal proceedings disclosure located elsewhere in the document (such as in financial statement notes, risk factors or MD&A). The amendments also increase the materiality threshold for environmental proceedings to $300,000 and allow companies to select a different threshold, subject to conditions. The alternative threshold must be reasonably designed to result in the disclosure of material environmental proceedings and not exceed the lesser of $1 million or one percent of the company’s current assets.
Item 105: Risk Factors
In an effort to streamline risk factor disclosure, the amendments refine Item 105’s principles-based approach by requiring only material, rather than all "significant," risk factors to be disclosed. Additionally, the amendments modify organization and length requirements to assist investors ability to comprehend this disclosure. If a company’s risk factor section exceeds 15 pages (keeping in mind the SEC’s existing minimum 10 point font requirement!), the company will be required to include a summary risk factor disclosure of no more than two pages. Risk factors will now need to be ordered under relevant headings (as many companies already do voluntarily), and any risk factors applicable to an investment in securities generally, and not the company’s business, must now appear at the end of the section under a separate caption.
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The amendments will become effective in mid-October 2020, impacting registration statements and periodic reports after that time. If you would like further information regarding the above referenced amendments or their impact on your company’s disclosures, please contact the lawyer at Sullivan & Worcester LLP with whom you regularly consult, or any of the lawyers listed above.