On August 26, 2020, the Securities and Exchange Commission ("SEC") adopted amendments (the "Adopting Release") to modernize the description of business (Item 101), legal proceedings (Item 103) and risk factors (Item 105) disclosure requirements that public companies are required to make pursuant to Regulation S-K. The final amendments are in significantly the same form as proposed in August 2019 (the "Proposing Release"), and are intended to streamline disclosure requirements and promote flexibility and principles-based, company-specific disclosure in lieu of a more prescriptive disclosure regime. The amendments are summarized below and will become effective 30 days following publication in the Federal Register. Although the amendments have not yet been published in the Federal Register, based on historic practice, we expect the amendments will be in effect prior to the end of October.
The SEC began its evaluation to modernize its disclosure requirements with the SEC Staff's preparation of its Report on Review of Disclosures Requirements in Regulation S-K in 2013. The Staff invited public comment on how to improve public company disclosures as part of the Staff's Disclosure Effectiveness Initiative, and in a Concept Release issued in 2016, the Staff revisited the business and financial disclosure requirements of Regulation S-K and sought public comment on whether the disclosure requirements continued to elicit important information for investors and how the disclosure requirements could be revised to enhance such information. Overall, the amendments reflect modest changes from the current requirements. Two dissenting Commissioners—Lee and Crenshaw—noted that the Adopting Release did not address two important topics: diversity and climate change.
The amendments include the following key changes:
- Provides a largely principles-based requirement to disclose the development of the company's business. Amends Item 101(a) to eliminate the requirement to disclose developments over a five-year period, and filings may provide only an update of material developments if the registration statement or report incorporates by reference, with an active hyperlink to, the full discussion included in a prior registration statement or report.
- For the narrative description of the company's business, amended Item 101(c) modifies the list of disclosure topic examples that require disclosure if material. Adds as a disclosure topic human capital resources and human capital measures and objectives that the company uses in managing its business. Adds as a disclosure topic all material government regulations (currently, Item 101(c) only references environmental laws).
- Item 103, as amended, expressly permits companies to include a hyperlink or cross-reference to legal proceedings disclosure included elsewhere in the filing, such as in the notes to the financial statements. For environmental proceedings in which a governmental authority is a party and which involve potential monetary sanctions, the disclosure threshold is increased from $100,000 to $300,000, with an alternative disclosure threshold equal to the lesser of $1 million or one percent of the company's current assets.
- Item 105, as amended, requires that risk factors be organized under relevant headings in addition to the sub-captions currently required. Where the risk factors disclosure exceeds 15 pages, the company must include a summary of no more than two pages. Generic risk factors are discouraged, but if included, must be disclosed at the end of the risk factors section under a separate caption.
Amendments to Description of Business
Item 101(a) and Item 101(h) – General Development of Business
Item 101(a) has been amended to apply a materiality standard for disclosure of the general development of a company's business and to eliminate the currently prescribed five-year time frame over which a company is required to provide such disclosure. For smaller reporting companies, Item 101(h) has been amended to eliminate the currently prescribed three-year time frame for such disclosure and to instead require information for the period of time that is material. The amendments permit a company to omit the full discussion from filings subsequent to a company's initial registration statement and to provide only a description of material developments since the last full discussion. If omitting the full discussion of the general development of the business from subsequent reports, a company must incorporate that prior discussion by reference and provide a hyperlink to the registration statement or report that includes the full discussion. These changes should not affect current disclosure practices for most companies, as Form 10-K only requires disclosure of developments in the business since the beginning of the covered fiscal year, and registration statements on Form S-3 largely incorporate by reference to a company's reports under the Securities Exchange Act.
Item 101(a) was also amended to provide a non-exclusive list of disclosure topic examples relating to the development of the company's business versus the current prescribed list of disclosure topics. As amended, companies are no longer expected to disclose a company's year of and its form of organization. In addition, the amended item would require disclosure, if material, of any material changes to a previously-disclosed business strategy versus the current requirement to disclose any material changes in the mode of conducting the business.
Item 101(c) – Description of Business
Item 101(c) currently requires a narrative description of the business done and intended to be done by a company and its subsidiaries and contains 12 specific items that must be discussed if material to an understanding of the company's business. Where material, each such item shall be disclosed for each of the company's reportable segments.
As part of the SEC's principles-based revisions to Item 101, the SEC amended Item 101(c) to replace the current list of prescribed disclosure items with a non-exclusive list of disclosure topic examples. In addition, as part of its overall disclosure modernization, the disclosure rule was amended to remove items that result in duplicative disclosure or are less likely to be material. Accordingly, amended Item 101(c) removes currently prescribed disclosures of a company's practices relating to working capital and disclosures of new segments and backlog orders (although such items would continue to be required to be disclosed if material, as the amended list of disclosure topics is non-exclusive). Amended Item 101(c) also removes certain prescribed disclosures requiring quantification of any class of similar products or services that accounted for more than 10 percent of consolidated revenues (15 percent if revenues did not exceed $50 million) and identification of certain significant customers.
The amended rule provides the following non-exclusive list of disclosure topic examples for describing a company's business:
- Revenue-generating activities, products and/or services, and dependence on revenue-generating activities, key products, services, product families or customers, including governmental customers;
- Status of development efforts for new or enhanced products, trends in market demand and competitive conditions;
- Resources material to a registrant's business, such as: (A) sources and availability of raw materials; and (B) the duration and effect of all patents, trademarks, licenses, franchises, and concessions held;
- A description of 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.
In the adopting release, the SEC notes that the second disclosure topic example elicits more granular disclosure than the current requirement.
In addition, amended Item 101(c) now requires disclosure, to the extent material, of:
- The material effects that compliance with governmental regulations, including environmental regulations, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries, including the estimated capital expenditures for environmental control facilities for the current fiscal year and any other material subsequent period; and
- A description of the registrant's human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant's business and workforce, measures or objectives that address the development, attraction and retention of personnel).
Although many companies disclose the impact of non-environmental regulations on their business, amended Item 101(c) explicitly expands the disclosure requirement to include both environmental regulations and other regulations.
The amendment to Item 101(c) to require disclosure, where material, of human capital resources and management is expected to result in new disclosures. Over the past several years, companies have enhanced their proxy statement disclosures relating to human capital management, and we expect that the amended disclosure item will accelerate the trend towards more granular disclosure for this important area. In the Proposing Release, the SEC requested comment on whether the amended rule should include other non-exclusive examples of human capital measures, such as the number of full-time, part-time, seasonal and temporary workers. In the Adopting Release, the SEC emphasizes that the examples in Item 101(c) of "measures or objectives that address the development, attraction and retention of personnel" are examples of potentially relevant subjects, and are not mandated and further noted that the SEC did not include more prescriptive requirements due to the evolving nature of human capital measures and objectives, as well as variation based on factors such as a company's industry, the jurisdictions where a company operates and the general strategic posture of a company. Nevertheless, the SEC states in the Adopting Release that, under the principles-based approach, if a measure such as a company's part-time employees, full-time employees, independent contractors and contingent workers, or employee turnover, in all or a portion of a company's business, is material to an understanding of a company's business, disclosure of such information would be required. Commissioner Crenshaw, when explaining her dissent, specifically noted the Adopting Release's lack of specific, prescriptive rules governing human capital disclosure.
Amendments to Legal Proceedings (Item 103)
Item 103 currently requires disclosure of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which a company or any of its subsidiaries is a party or of which any of their property is the subject. Disclosure also is required of material proceedings known to be contemplated by governmental authorities. Subject to certain exceptions, disclosure is not required for negligence or other claims that ordinarily result from a company's business unless such proceedings depart from the normal kind of such actions, or for proceedings that involve primarily a claim for damages if the amount involved, exclusive of interest and costs, does not exceed 10 percent of a company's current assets. The disclosures required by Item 103 may overlap with the disclosure required by U.S. GAAP, resulting in duplicative disclosure (although the dollar threshold in Item 103 typically would not require disclosure of proceedings in many cases where disclosure would be required under U.S. GAAP). The amendments revise Item 103 to permit the requisite disclosures to be provided by hyperlink or cross reference to legal proceedings disclosure located elsewhere in the filing, such as in the notes to the financial statements.
Item 103 also currently requires a company to disclose any proceeding under environmental laws (or multiple proceedings which present the same issues) to which a governmental authority is a party unless the company reasonably believes that it will not result in sanctions of $100,000 or more. This lower disclosure threshold previously was adopted by the SEC based on its view that disclosure of fines by governmental authorities may be of greater importance in assessing a company's environmental compliance, as governmental fines may be more indicative of possible illegality or conduct contrary to public policy. In addition, environmental proceedings are required to be disclosed if material to the company's business or financial condition (without regard to the exceptions for routine or ordinarily occurring proceedings or the 10 percent of current assets threshold). The amendments revise Item 103 to increase the monetary threshold to $300,000 but allow a company to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings so long as the company-specific threshold does not exceed the lesser of $1 million or one percent of the current assets of the company. Any such company-specific threshold must be disclosed by the company in each Form 10-K and Form 10-Q filing. The amendments do not change any requirements related to climate change disclosure, which resulted in Commissioner Lee stating in her dissent to the Adopting Release that the SEC's "continued failure to even engage in the [climate change] discussion about this momentous risk to the financial system" puts the United States at risk of "falling behind international efforts and [puts] US companies at a competitive disadvantage globally."
Amendments to Risk Factors (Item 105)
Item 105 currently requires concise and logically organized disclosure in plain English of the most significant factors that make an investment in a company or an offering risky or speculative. Item 105 also currently provides that generic risk factors (i.e., risks that could apply generically to any company or offering) should not be presented. Consistent with the principles-based disclosure approach, amended Item 105 requires disclosure of "material" factors versus the current requirement to disclose the "most significant" factors. In addition, the current risk factors disclosure requirement provides that the risk factors be set forth under sub-captions that adequately describe the risk. In order to improve the readability of the risk factor disclosures, amended Item 105 requires that the risk factors discussion be presented both with relevant headings (i.e., groupings of related risk factors under descriptive headings) and with each risk factor set forth under a sub-caption that adequately describes the risk.
To address the concern that companies typically include generic risk factors that have contributed to the increased length of risk factor disclosure, amended Item 105 requires a summary risk factor disclosure if the risk factor section exceeds 15 pages. The risk factor summary must be in the form of a series of concise, bulleted or numbered statements summarizing the risk factors and may not be longer than two pages. Because the risk factor summary is not required to contain all of the risk factors identified in the full risk factors discussion, companies may prioritize certain risks and omit others. The SEC notes in the Adopting Release that the requirement to provide a risk factor summary may create an incentive for companies to reduce the length of their risk factors discussion to avoid triggering the summary requirement. The SEC Staff estimates that the 15-page threshold would affect approximately 40 percent of filing companies.
Finally, amended Item 105 discourages the disclosure of generic risks and provides that, if generic risk factors are presented, the company must disclose such generic risk factors at the end of the risk factors section under the caption "Generic Risk Factors." Notably, the SEC states in the Adopting Release that disclosure of risk factors under a "Generic Risk Factors" caption may be avoided if a company properly tailors its risk factors disclosure to emphasize the specific relationship of the risks to the company or the offering.