On April 13, 2016, the Securities and Exchange Commission (the “SEC”) published a concept release (the “Release”) seeking comment on “modernizing certain business and financial disclosure requirements in Regulation S-K.” Regulation S-K contains the itemized disclosure requirements that are applicable across a variety of SEC filings, including periodic reports and proxy statements filed under the Securities and Exchange Act of 1934 and registration statements filed under the Securities Act of 1933. The Release is part of a Division of Corporation Finance initiative to review public company disclosure requirements for potential improvements that would benefit both registrants and investors (the “Disclosure Effectiveness Initiative”). The Disclosure Effectiveness Initiative itself resulted from recommendations made in the staff’s Report on Review of Disclosure Requirements in Regulation S-K, published in 2013 (the “S-K Study”). The S-K Study was mandated by Section 108 of the Jumpstart Our Business Startups Act (the “JOBS Act”).
In connection with the S-K Study and embarking on the Disclosure Effectiveness Initiative, the SEC received comments on various topics related to Regulation S-K. Those comments are discussed in the Release, and the SEC seeks additional comment on those and other topics. There are a total of 340 requests for comment in the Release, not including sub-requests.
The Release appears to be both a continuation of the Disclosure Effectiveness Initiative and part of the SEC’s efforts to satisfy the requirements of Section 72003 of the Fixing America’s Surface Transportation Act of 2015 (the “FAST Act”). Section 72003 requires the SEC to undertake a study to determine ways to modernize and simplify Regulation S-K, to emphasize a company-by-company disclosure approach, and to evaluate alternative methods of information delivery and presentation.
The FAST Act, in Section 72002, also requires the SEC to, within 180 days of enactment, take action to revise Regulation S-K to scale or eliminate requirements to reduce the burden for emerging growth companies (“EGCs”), accelerated filers, smaller reporting companies and other smaller issuers, while still providing all material information, and to eliminate provisions of Regulation S-K that are repetitive, outdated or otherwise unnecessary. The Release notes that the staff is developing recommendations for specific proposals to address this requirement, but the Release itself does not satisfy the Section 72002 mandate and does not provide insight into these proposals or seek specific comment on the process.
The Release is wide-ranging, covering a variety of topics both narrow and broad. It begins by summarizing the history of Regulation S-K and various previous initiatives, legislation, and market and technological changes that have affected its development, and then discussing the nature of, and different approaches to, public company disclosure requirements. The majority of the Release addresses particular Regulation S-K business and financial item requirements and other specific disclosure topics, before finishing by returning to more general considerations related to scaled disclosure frameworks and the format, structure and method of delivery of information provided by public companies to investors.
Because of the breadth of the Release, this Alert does not attempt to summarize all aspects of it. Rather, it is designed to highlight certain of the topics addressed as well as some key issues and considerations. The Release can be found here.
History of Regulation S-K and Prior Initiatives and Legislation
The Release discusses the origins of Regulation S-K in the 1960s, its adoption in the late 1970s and additions in the early 1980s. Various earlier initiatives aimed at improving or modifying the disclosure framework are discussed. Those include, in addition to the recent S-K Study, the Task Force on Disclosure Simplification (1995), the Advisory Committee on the Capital Formation and Regulatory Processes (1995), the Plain English rules (1998) and the Advisory Committee on Improvement to Financial Reporting (2007). Legislation that resulted in additions or changes to Regulation S-K and other disclosure requirements is also discussed, most notably the Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and the JOBS Act, as well as other statutory mandates resulting in a variety of nonfinancial disclosure requirements, including those related to environmental matters, mine safety and dealings with Iran.
Nature and Purposes of Disclosure
Before diving into the specific disclosure requirements, the SEC provides a high-level discussion of some fundamental considerations with respect to the nature and purposes of public company disclosures that frame the issues appearing throughout the Release and in the comment requests. The concept of materiality is discussed, as are principles-based, prescriptive and objectives-oriented approaches to disclosure requirements. The target audiences for public company disclosures are also examined, along with issues associated with how the disclosure framework should address varying types and sophistication levels of investors who may have very different needs or desires as to the type, volume and format of disclosure. Finally, the Release discusses the question of how costs and compliance burdens should be assessed and evaluated.
Specific Regulation S-K Items and Disclosure Topics
The majority of the Release discusses specific Regulation S-K item requirements and other disclosure topics by summarizing current disclosure requirements and comments received in response to the S-K Study and Disclosure Effectiveness Initiative, briefly discussing some related considerations and approaches, and listing specific requests for comment.
The Release does not include discussion of the executive compensation and corporate governance requirements of the 400 series items of Regulation S-K or the offering-specific requirements of the 500 series items of Regulation S-K.
Some of the key disclosure requirements and topics addressed are:
- Business and Property Disclosures – Item 101(c) of Regulation S-K requires a narrative description of the registrant’s business and includes a list of specified topics to be addressed to the extent material. The Release focuses primarily on how the applicability and significance of certain of those specified topics, including technology and intellectual property, government contracts, and environmental and other regulatory matters, may differ among registrants in different industries, may have become less relevant over time and may need to be expanded or made less specific to cover a broader range of investor interests. Questions posed include whether other line item requirements should be added, whether the business discussion should address strategy and how to balance disclosures against the risk of competitive harm. The property disclosures required by Item 102 are also discussed briefly, with a focus on how disclosures differ in type and significance by industry and whether these disclosures could be revised to elicit more insight into operational structure and risks.
- Management’s Discussion and Analysis (“MD&A”) and other Financial Disclosures – The Release reviews the selected financial data requirements of Item 301 and the quarterly financial information requirements in Item 302, with a focus on whether these disclosures remain useful, as much of this information is reported elsewhere in filings or in other readily accessible public information. For example, questions addressed include whether five years of selected historical financial data is appropriate and whether the requirement for two years of quarterly information is necessary.
The Release includes a lengthy discussion of the current MD&A requirements, including references to interpretive guidance that the SEC has published over the years. This discussion of past guidance provides a useful overview of SEC positions on various aspects of MD&A, but generally does not break new ground. While the SEC seeks comment on almost all aspects of MD&A, the Release devotes particular attention to the quality of period-to-period comparisons (and usefulness of prior period comparisons), short-term borrowing disclosures, off-balance-sheet arrangements, contractual obligations and critical accounting estimates. In discussing these topics, the Release addresses how the existing requirements may overlap and interact with disclosures required in financial statements and the related notes and how to avoid a mere recitation of changes in amounts from year to year.
- Risk Disclosures – Risk-related disclosures are discussed in the context of the risk factors required by Item 503(c) and the market risk disclosures required by Item 305. With respect to risk factors, the discussion and comment requests generally focus on ways to improve utility by focusing on the most significant, material risks and how they affect the particular registrant, as opposed to generic boilerplate disclosure. This is a theme the staff has pushed extensively, primarily through the comment process, with little real impact on disclosures. The Release cites a study finding that today’s risk factors sections include an average of 22 risk factors spanning eight pages. The discussion of quantitative and qualitative market risk disclosure focuses on differing practices among registrants and how redundancies now exist with derivative disclosure in financial statement notes as a result of GAAP requirements imposed after Item 305 was initially adopted. There is also discussion of whether alternative approaches, such as a “management approach” focusing on the actual information and methods employed by the issuer to monitor and manage risk, should be considered. Finally, the SEC examines the potential benefits of a general requirement to discuss risk management strategy and process, noting that registrants generally do not discuss mitigation efforts in risk factors because the staff has historically discouraged that type of disclosure.
- Securities and Securities Transactions – The discussion in this section focuses on several specific Regulation S-K line item requirements, including:
- the requirement to disclose the number of holders of a class of registered securities (Item 201(b)(1)), and whether this is still useful in light of the way securities are now held;
- the description of capital stock (Item 202), and whether it should be included in periodic reports (as opposed to just registration statements as currently required);
- recent sales of unregistered securities (Item 701), and the utility of this disclosure in light of similar, but not identical, Form 8-K and financial statement requirements; and
- issuer purchases of equity securities (Item 703), and whether more frequent disclosure (such as on Form 8-K) or additional detail regarding the source of funding for, or impact on performance measures such as earnings per share of, such repurchases should be provided.
- Exhibits – The Release examines some of the current exhibit requirements of Item 601. The majority of this discussion is focused on the “material contract” requirements in Item 601(b)(10) and whether the categories of contracts required to be filed and the quantitative and qualitative thresholds in the requirements are appropriate. There is also specific discussion of several discrete items within Item 601, including whether the ability to omit immaterial schedules and attachments from a filed exhibit should be extended. Currently, registrants can omit these schedules and attachments from acquisition and similar agreements filed under Item 601(b)(2), but cannot omit these schedules and attachments from other types of material agreements, including loan agreements, filed under Item 601(b)(10).
- Other Matters – The Release also seeks comment on the continued utility of Industry Guides and whether additional disclosure requirements related to public policy and sustainability matters are appropriate.
Scaled Disclosure and Frequency of Interim Reporting
The Release summarizes and examines existing scaled disclosure frameworks for smaller reporting companies and EGCs and the eligibility requirements for those categories of registrants. As noted above, the FAST Act requires the SEC to revise Regulation S-K to “further scale or eliminate requirements in order to reduce the burden,” not just on EGCs and smaller reporting companies but also on accelerated filers and other smaller issuers “while still providing all material information to investors.” The Release notes that the staff is currently evaluating smaller reporting company qualification standards pursuant to the FAST Act mandate and expects to make recommendations to the SEC.
The Release raises the possibility of requiring semiannual, rather than quarterly, reporting for at least some categories of registrants, discusses arguments that have been made for and against this approach, and seeks comment on the topic.
Presentation and Delivery of Information
The Release concludes by addressing presentation and delivery requirements, including discussions on cross-references, incorporation by reference, the use of hyperlinks, and company websites and other specific formatting and presentation requirements. The utility and burdens of “structured data” requirements (e.g., XBRL financial statement requirements and the block-text tagging featured in recent Dodd-Frank Act executive compensation rule proposals) are also examined. The requests for comment in these areas focus on balancing concerns regarding readability, accessibility and redundancy with the need to maintain a comprehensive and reliable record of information that is made part of a filing. The Release also considers how the various liability standards under the securities law apply to different sources and locations for information.
Next Steps and Takeaways
Comments on the Release are due by July 21, 2016. As noted above, the SEC staff is also readying proposals to comply with the mandates of Section 72002 of the FAST Act. If the SEC complies with the 180-day deadline of the FAST Act, these proposals should be forthcoming in the near term.
The Release covers a lot of ground, and it appears clear that the Disclosure Effectiveness Initiative will be a challenging undertaking. While it would be difficult to argue with the goal outlined in the FAST Act to “modernize and simplify [the Regulation S-K] requirements in a manner that reduces the costs and burdens on issuers while still providing all material information,” that is easier said than done. The SEC must wrestle with significant questions related to the meaning of materiality, the nature and purpose of public company disclosure requirements, and how to balance the interests of different constituencies, including registrants of different sizes operating in different industries and investors with different levels of sophistication and goals. The discussion in the Release of prior disclosure initiatives demonstrates that the SEC has been considering these issues for a long time.
In addition, the discussion of various legislative mandates and market and technological changes makes clear that the Disclosure Effectiveness Initiative will not proceed in a vacuum. Recent experience indicates that legislative directives and outside events can significantly affect the direction and focus of SEC efforts. The Disclosure Effectiveness Initiative itself illustrates this point. It stemmed initially from a JOBS Act mandate but must separately address particular FAST Act requirements because of impending statutory deadlines, and it leaves for another day consideration of the executive compensation and corporate governance disclosure requirements still being developed in response to Dodd-Frank Act provisions.
Notwithstanding these challenges to a significant restructuring of the public company disclosure framework, the discussion of specific Regulation S-K item requirements in the Release identifies many opportunities for improvement in the short term should the SEC choose to take an incremental approach. While the Release is relatively balanced in identifying issues and discussing comments received to date without telegraphing a particular direction, the focus on some of the more granular Regulation S-K items could indicate where the SEC may be looking to streamline certain items, eliminate some disclosure requirements that may be redundant or unnecessary because of changes in the availability of information, and clarify certain areas of common confusion or difficulty.