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Client Brief | SEC Proposes Rule Revisions to Modernize and Simplify Disclosure Requirements

August 16, 2019 | On August 8, 2019, the US Securities and Exchange Commission (SEC) proposed amendments to certain provisions of Regulation S-K to streamline and simplify disclosures related to business, legal proceedings, and risk factors.

The proposed amendments, which represent the first significant updates to these disclosures in over 35 years, are intended to improve the readability for investors, eliminate repetitive and immaterial information and simplify compliance for reporting companies. The amendments are part of the ongoing Disclosure Effectiveness Initiative led by the SEC’s Division of Corporation Finance to review and improve disclosure requirements for the benefit of both investors and companies.

Details on the most pertinent proposed amendments are as follows:

Business Disclosures. The proposed amendments discard the current one-size-fits-all line-item disclosure requirements in favor of a concept- and principles-based disclosure. Under the new model, company management has the authority to evaluate the significance of information within the context of the company’s overall business and financial circumstances to determine whether disclosure is necessary.

Amendments to Item 101(a): General Development of Business. Under the proposed amendments to Item 101(a), only disclosure of information that is “material to an understanding of the general development of the business” would be required. The proposed rule details four non-exclusive topics that should be considered in this discussion: bankruptcy; material reclassifications, mergers or consolidations; material acquisitions and dispositions; and “[t]ransactions and events that affect or may affect the company’s operations, including material changes to a previously disclosed business strategy.”

The first three topics are carryovers from current Item 101(a). Interestingly, although material changes to a disclosed strategy would be reportable under the current Item, the SEC did not propose making strategy disclosure mandatory out of concern that such a requirement could harm a company’s competitive position. The SEC did, however, request comments on whether disclosure of strategy should be mandatory.

In addition to the four topics, the SEC expressly states in the proposing release that “[t]o the extent that other matters beyond those listed in the amended item are material to an understanding of the general development of a registrant’s business, the registrant would be required to disclose those matters as well.” The Staff also proposed eliminating the current five-year development of business disclosure, opting instead for disclosure of what is material to investors without regard to a specific time frame.

Amendments to Item 101(c) – Narrative Description of Business. The proposed amendments to Item 101(c) are also principles-based and contain a non-exclusive list of topics for companies to consider. In addition to the disclosure items currently contained in Item 101(c) is one new topic: human capital resources. This includes disclosure of any human capital measures or objectives on which management focuses in operating the business, such as measures or objectives that address the needs of human resources. Human capital has been a hot topic lately and we are not surprised to see it addressed in the proposed amendments.

The proposed amendments retain the distinction between segment reporting and reporting on the business as a whole and, in general, indicate that governmental regulation and human capital resources should be reported in the context of the business as a whole.

Legal Proceedings. The proposed amendments to Item 103 enable filers to disclose legal proceedings via hyperlink or cross-reference the disclosure elsewhere in the document. This is helpful because such disclosure is often also included in MD&A, risk factors or notes to financial statements and would eliminate repetition. Additionally, under the revision, the threshold for disclosure of environmental proceedings to which a governmental entity is a party would increase from $100,000 to $300,000.

Risk Factors. The proposed amendments to Item 105 attempt to address a longstanding complaint from commentators and practitioners alike: risk factor disclosure has become too extensive and generic. The amendments fall into three categories:

Summary of Risk Factors. First, a summary of risk factors would be required if risk factor disclosure exceeds 15 pages in length. The summary would have to contain short, succinct bullet points or numbered statements in the front of the document highlighting the principal factors that make an investment in the company or offering speculative or risky.

Materials Risks Label. Second, the disclosure standard would change from “most significant risks” to “material” risks with the goal of creating shorter, more customized and user-friendly disclosures. This would have measurable benefits for both investors and registrants.

Relevant Headings. Third, the proposed amendments would require companies to organize risk factors disclosure under relevant headings. Further, as a means to minimize generic risk factors found in a significant portion of filings, disclosure of risks that could apply to other companies or offerings without explanation as to why the identified risk is specific to the company or the offering would be placed at the end under the heading “General Risk Factors.”

Smaller Reporting Companies. The SEC also proposed amending Item 101(h), which would eliminate the requirement that smaller reporting companies describe the development of their business over the past three years. The proposed rule also provides that, except for IPO disclosure, a smaller reporting company may provide updates to the general description of the business in accordance with Item 102(a)(2) instead of requiring a full discussion.

The SEC is now accepting comments, with final action likely to follow the comment period by several months. For that reason, it is unclear whether the rules will be adopted in time for the 2020 annual report and proxy season. Nonetheless, companies should be aware of the proposed changes and also consider whether, if implemented, the new rules would require changes to a company’s disclosure controls.

For more information, contact Geoff Morgan or Jessica Fairchild.

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