In her statement at the SEC open meeting to vote on issuing the “Disclosure Update and Simplification Proposing Release,” SEC Commissioner Kara Stein protested that “this proposal may be framed in such a hyper-technical way that it fails to provide a bona fide opportunity for a wide variety of commenters to truly access and understand what is being proposed and what we are seeking comment on.” She may have a point. The SEC’s most recent 318-page proposal to amend SEC rules to eliminate redundant, overlapping, outdated or superseded provisions is too “technical” — that’s a euphemism — to discuss at any length, but below are some examples of the types of modifications the SEC is proposing to make. As discussed in this PubCo post, the proposal represents an interim step in the SEC’s disclosure effectiveness project, as well as an effort to implement one of the mandates of the FAST Act. Here is the “demonstration version,” basically a blacklined copy of the rule changes.
Redundant or Duplicative Requirements
The SEC has identified a number of requirements that require substantially the same disclosures as U.S. GAAP, IFRS or other SEC disclosure requirements and is proposing to eliminate the redundant SEC disclosure requirements. Most of these redundancies relate to Reg S-X, but a couple involve S-K Item 601 exhibits. For example, the release proposes to eliminate Item 601(b)(11), which requires a statement showing the calculation of per-share earnings (unless the computation can be determined from information already in the report). According to the SEC, that requirement is duplicative of information required under GAAP, Reg S-X and IFRS.
The SEC has also identified SEC disclosure requirements that overlap with GAAP, IFRS or other SEC disclosure requirements, that is, they relate to those requirements, but are not exactly the same. In some cases, the SEC disclosure requirement would be deleted and, in other cases, integrated. In some cases, the result is a request for comment or referral to FASB.
The SEC identifies two broad themes here. The first, “disclosure location considerations,” raises the issue that, if streamlining of disclosure results in relocation, the disclosures could be more or less prominent or could be relocated in the financial statements, subjecting this information to audit or review, internal control over financial reporting, and XBRL requirements, as well as making unavailable the safe harbor under the Private Securities Litigation Reform Act of 1995. Relocating disclosures outside the financial statements would have the opposite effect. The second theme, “bright line disclosure threshold considerations,” relates to disclosure requirements that are similar, except that one includes a bright line disclosure threshold, while the other set of requirements does not. For these topics, the elimination of the bright line threshold would potentially change the disclosure provided to investors.
Among the overlapping deletions proposed are:
- Elimination of the requirement in Reg S-X to disclose, in interim financial statements, material events subsequent to the end of the most recent fiscal year in light of similar disclosures that result from compliance with a combination of GAAP and Item 303(b) of Reg S-K. Notably, this change would result in moving the disclosure outside of the financial statements.
- Elimination of the requirement in Item 101(b) of Reg S-K to disclose segment financial information, restatement of prior periods when reportable segments change, and discussion of interim segment performance that may not be indicative of current or future operations. GAAP and Item 303(b) of Reg S-K require similar disclosures, and Item 101(b) explicitly permits issuers to cross-reference to the notes to the financial statements and the description of business to avoid duplication. Removing the disclosure (or cross-reference) from the business section may give rise to prominence considerations. The same duplication exists with regard to the GAAP and Reg S-K disclosure requirement of financial information by geographic area. In that case, Item 101(d)(2) explicitly permits issuers to cross-reference between the notes to the financial statements and the description of business to avoid duplicative disclosures about geographic areas. Here again, the SEC is proposing to delete Item 101(d)(1) and Item 101(d)(2).
- Elimination of the Reg S-K Item 101(d)(3) requirements of disclosure of any risks associated with an issuer’s foreign operations and any segment’s dependence on foreign operations, in light of the similar, although slightly less expansive, requirements of Item 503(c) of Reg S-K to disclose significant risk factors. Similarly, Item 303(a) of Reg S-K requires disclosure of trends and uncertainties by segment (if appropriate to an understanding of the issuer as a whole), which would include disclosure of a segment’s dependence on foreign operations. These changes give rise to prominence considerations.
- Elimination of Instruction 5 to Item 303(b) and Item 101(c)(1)(v), which require disclosures regarding seasonality and which convey information similar to the disclosures required under GAAP and other parts of Reg S-K, in combination. Although there are some differences, the SEC believes that Item 303(b), together with GAAP, would result in disclosures that are reasonably similar to Item 101(c)(1)(v) about the effects of seasonality on an issuer’s financial statements at the segment level, if material and appropriate to an understanding of the business. Because GAAP requires seasonality disclosures in the financial statements, as opposed to MD&A and business, there may be prominence considerations as well as PSLRA concerns, which could deter issuers from voluntarily providing forward-looking information.
- Elimination of Items 101(c)(1)(xi) and 101(h)(4)(x) of Reg S-K, which require disclosures, if material, of the amount spent on research and development activities for all years presented. While some of the terms used for the same disclosure under GAAP are different, the SEC believes GAAP results in “reasonably similar” or even more expansive disclosures. The relocation could result in prominence considerations as well reluctance to provide forward-looking information because of the absence of the PSLRA safe harbor.
- Deletion of the requirements in Item 201(c)(1) of Reg S-K to disclose the frequency and amount of cash dividends declared for the two most recent fiscal years and any subsequent interim period, as well as the reference to dividends in Instruction 2 to Item 201. Rule 3-04 of Reg S-X already requires annual disclosure of the amount of dividends per share and in the aggregate for each class of shares, and the SEC’s proposed amendment would extend those requirements to apply to interim periods. The SEC observes that the frequency of dividends would also be evident from this disclosure. Moving the disclosure to the financial statements raises prominence considerations, as well as loss of the PSLRA safe harbor.
- Elimination of Reg S-K Item 201(d) and references to it, providing for tabular disclosure regarding existing equity compensation plans approved and not approved by shareholders. This information is currently required in Part III of Form 10-K, Item 11 of Form S-1, Item 9 of Form 10, and Item 10 of Schedule 14A. However, ASC 718-10-50-1 to 4 (formerly, SFAS No. 123R, Share-Based Payment), mandates disclosures that overlap with Item 201(d). Although Item 201(d) also requires additional disclosures regarding certain options, warrants, or rights assumed in connection with a merger and any formula for calculating the number of securities available for issuance under the plan, the SEC believes that the GAAP requirement “to provide disclosures to enable investors to understand the nature and terms of equity compensation arrangements and the potential effects of those arrangements on shareholders would results in reasonably similar disclosures.” The SEC also believes that drawing the distinction between approved and non-approved plans is no longer useful to investors because the major exchanges now require, with limited exceptions, shareholder-approved plans. Once again, relocating the disclosure to the financial statement notes raises PSLRA and prominence issues, particularly as the disclosure would no longer appear alongside information on equity compensation plans subject to shareholder action.
SoapBox: The SEC notes that “[t]hese proposed amendments would not affect the disclosures related to new plans or modifications of existing plans subject to shareholder action.” That’s unfortunate. As discussed in this PubCo post, even Corp Fin director Keith Higgins has questioned whether the New Plan Benefits Table might not be past its prime: “this table was part of our rules well before the current compensation tables that appear in the proxy statement. Are there revisions to this table we should be considering to capture the information that is important to investors, but also reduce duplicative disclosure?” And with regard to information related to modifications of existing plans, Higgins observes that this “set of rules addresses requirements when a pension or retirement plan is being submitted for shareholder approval. I am quite confident I never encountered such a situation in the 30 years I practiced law, although surely at one time these plans must have been submitted to shareholders. Is this requirement outdated? In addition, if the shareholder action relates to a plan under which options, warrants, or rights are granted, or to a specific grant of these rights, Item 10 lists several additional requirements. Much of this detailed, line-item information is likely included in the company’s description of the material features of a plan or in the New Plan Benefits table, although there are some requirements that might not otherwise be included. For example, there is a requirement to state the federal income tax consequences of the issuance and exercise of options both to the recipient and to the company. This requirement is limited only to options — and does not include restricted stock, cash-only rights or other types of awards. If investors consider this information important in deciding how to vote on a plan, wouldn’t it make sense to expand this requirement beyond options to include all forms of equity compensation? But is the tax effect of equity compensation arrangements important information for investors?” So, in light of those views, which are, to be sure, shared by many, why are these two confusing, outdated and redundant requirements not covered in this release?
- Deletion of Item 503(d) and Item 601(b)(12), with conforming revisions, relating to disclosure, in connection with debt securities, of the ratio of earnings to fixed charges and the related exhibit showing that computation. The SEC observes that this “ratio measures the issuer’s ability to service fixed financing expenses – specifically, interest expense, including management’s approximation of the portion of rent expense that represents interest expense, and preference dividend requirements – from earnings.” Now, however, there are a “variety of analytical tools available to investors that may accomplish a similar objective as the ratio of earnings to fixed charges.” In addition, debt investors often negotiate covenants requiring issuers to provide more relevant financial information.
In some cases involving overlapping requirements, the SEC is proposing to integrate the overlapping requirements. For example, there are a number of requirements to discuss restrictions on the payment of dividends, including in S-X as well as in Reg S-K Item 201(c)(1), which require disclosure of restrictions that currently or are likely to materially limit the issuer’s ability to pay dividends on its common equity. The SEC is proposing to streamline these disclosure requirements into a single requirement in Reg S-X for the disclosure of material restrictions on dividends and to eliminate the requirements in Item 201(c)(1). Similarly, two items in Reg S-K require disclosure of information indicating that the financial data may not be indicative of current or future operations. However, the requirement in Item 101(d)(4) refers explicitly to geographic performance, while Item 303 is more general. The SEC is proposing to delete 101(d)(4) and to add in Item 303 an explicit reference to “geographic areas.”
In the case of some overlapping requirements, the SEC is soliciting comment to determine whether to retain, modify, eliminate or refer them to FASB for potential incorporation into GAAP:
- Both GAAP and Reg S-K require disclosure regarding revenue from products and services; however, the S-K mandate has a 10% threshold, while GAAP requires disclosure for each product or service, or group of similar products and services, unless impracticable. Depending on the changes to these requirements, the modifications could result in PSLRA and other financial statement disclosure issues as well as bright line issues.
- Both GAAP and Reg S-K require disclosures about major customers, although Reg S-K is more expansive: Reg S-K requires disclosure if loss of one or a few customers would have a material adverse effect on a segment, while GAAP requires certain disclosures for each customer that accounts for 10% or more of total revenue. In addition, Reg S-K requires disclosure of the name of any customer that represents 10% percent or more of revenues and whose loss would have a material adverse effect, while GAAP does not.These differences again give rise to bright line and financial statement issues, including loss of the PSLRA safe harbor.
- GAAP requires disclosure of loss contingencies, while Reg S-K Item 103 requires disclosure of certain legal proceedings. The overlap leads most companies to either repeat the disclosures or cross-reference to them. Incorporation of Item 103 requirements into GAAP would result in more instances of disclosure of the possible range of loss, more disclosure that is subject to audit or review, internal control and XBRL requirements, more disclosure of prescribed facts (such as the court or agency, the date instituted, the principal parties involved, the alleged factual basis to the proceeding and the relief sought) and a more general materiality threshold in connection with environmental legal proceedings (instead of the 10% and $100,000 thresholds in Reg S-K). It would also give rise to PSLRA and other financial statement issues.
The SEC is also proposing to update or modify obsolete requirements, such as stale transition dates and requirements to identify the Public Reference Room and disclose its physical address and phone number. More significantly, the proposal would update the market price disclosures in Item 201(a)(1) of Reg S-K. Instead of information such as the high and low sales prices and sales price as of the latest practicable date, which are readily available for free on numerous websites on a daily basis, the proposal would amend Item 201(a)(1) as follows:
- ” Issuers with one or more classes of common equity would be required to disclose the principal U.S. market(s) where each class is traded and the trading symbol(s) used by the market(s) for each class of common equity. Foreign issuers also would be required to identify the principal established foreign public trading market, if any, and the trading symbol(s), for each class of their common equity.
- Issuers with common equity that is not traded on an exchange must indicate, as applicable, that any over-the-counter quotations in such trading systems reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
- Issuers with no class of common equity traded in an established public trading market would be required to state such fact and disclose the range of high and low bid information, if applicable, for each quarter over the last two fiscal years and any subsequent interim period. Also, such issuers would be required to disclose the source and explain the nature of such quotations.”
These proposed amendments would update disclosure requirements to reflect recent legislation and more recently updated SEC or GAAP disclosure requirements, such as changing references to GAAS that should be references to the standards of the PCAOB or to “applicable professional standards,” eliminating references to pooling-of-interests accounting treatment and “extraordinary items,” and resolving inconsistencies between GAAP and Reg S-X (e.g., the date as of which pro forma financial information should assume that a business combination occurred).