The Situation: In an effort to update the rules to improve disclosures for investors and to simplify compliance efforts for registrants, the U.S. Securities and Exchange Commission ("SEC") amended certain disclosure requirements under Regulation S-K relating to business, legal proceedings, and risk factor disclosures.
The Result: The amended Regulation S-K rules reflect a shift toward a more principles-based disclosure framework and expand certain disclosure requirements relating to, among other things, human capital resources and government regulations.
Looking Forward: Registrants will need to closely review their current disclosures and will likely need to substantially modify their disclosures in future SEC reports and registration statements.
In August 2019, the SEC proposed amendments to modernize the description of business (Item 101), legal proceedings (Item 103), and risk factor disclosures (Item 105) that Exchange Act filers and registrants are required to make pursuant to Regulation S-K. On August 26, 2020, the SEC adopted the amendments in a 3–2 vote, substantially in the form that was proposed. The SEC noted that the final amendments mark the first significant revision to public company business disclosure rules in more than 30 years.
As Jones Day noted in our previous Commentary, "SEC Proposes to Modernize Certain Disclosures Under Regulation S-K,"the proposed amendments sought to improve the readability of disclosure documents, as well as discourage repetition and disclosure of information that is not material. While the final amendments do make a concerted effort to reduce duplication in a handful of narrow rules, the ultimate streamlining effect is not overwhelming. In fact, certain areas of the amendments require an expansion of disclosure—for example, Item 101(c) previously required a registrant to discuss only the material effects of compliance with applicable environmental regulations.
Now, registrants will be required to discuss the material effects of compliance with all applicable governmental regulations. While it was fairly commonplace for registrants to discuss material governmental regulations historically, it puts the onus on registrants to more carefully consider this topic, including, for example, whether and how to disclose the political effects, which could potentially expand disclosure in a meaningful way.
Registrants will also need to craft disclosure relating to human capital resources, including "human capital measures or objectives that the registrant focuses on in managing the business," to the extent material to a registrant's business. This significantly expands the historical requirement to simply disclose employee headcounts. The final rules do not provide prescriptive guidance as to the exact disclosure that will be expected, other than guidance to disclose "measures or objectives that address the development, attraction and retention of personnel" to the extent material, as well as employee headcounts.
The level of granularity to include will be a judgment call that may cause significant internal debate for a registrant. For example, registrants will need to consider whether to include detail of diversity and inclusion efforts and statistics, keeping in mind that investors will be empowered to track and criticize progress in such areas more closely. Interestingly, the SEC acknowledged in the commentary of the final amendments that the "incremental compliance costs [of these new rules] may not be trivial."
It is worth noting that despite a seeming overhaul of the human capital disclosure requirements, the two dissenting Commissioners, Caroline Crenshaw and Allison Herren Lee, expressed that they do not believe the amendments go far enough in terms of expanding environmental, social, and governance ("ESG") prescriptive requirements, since, for example, climate risk and other ESG metrics are not specifically addressed. Registrants can expect proponents of increased ESG disclosure to continue to push for more disclosure, regardless of the new amendments.
In sum, while a goal of the amendments was to simplify compliance efforts under Regulation S-K, registrants are likely to find themselves deliberating how best to update their disclosures.
The Final Amendments—Highlights
Among other changes, the amendments adopt the following technical modifications to Regulation S-K:
General Development of Business (Item 101(a)):
- Allows registrants to provide only an update relating to the general development of business, if accompanied by an active hyperlink to the most recent filing. Only one hyperlink may be used.
- Suggests a nonexclusive list of potentially material disclosure items, including, for example, any material changes to previously disclosed business strategy.
Note: Providing a new discussion of business strategy is not required if a registrant has not previously disclosed it. Many registrants, however, include a strategy discussion in their initial registration statement. If such a registrant has not subsequently discussed strategy in its filings, registrants may feel compelled to refresh their discussion of business strategy.
Narrative Description of Business (Item 101(c)):
- Requires disclosure, to the extent material to an understanding of a registrant's business, of an updated nonexclusive list of seven topics that includes:
- Status of development efforts for new or enhanced products.
- Portions of a business that may be subject to renegotiation of profits or termination of contracts at the election of the government.
- Effect of compliance with government regulations, including environmental regulations.
- Human capital resources, including measures or objectives that address the attraction, development, and retention of personnel.
Legal Proceedings (Item 103):
- Expressly permits some or all of the required information by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in a filing.
- Increases the disclosure threshold for environmental proceedings in which the government is a party from $100,000 to $300,000. A registrant may alternatively set its own threshold as long as it does not exceed the lesser of $1 million or 1% of the registrant's current assets. If a registrant chooses an alternative threshold, it must be disclosed.
Risk Factors (Item 105):
- Requires a summary risk factor disclosure section if the risk factor section exceeds 15 pages. The summary may be only two pages long. The SEC estimates that this will impact approximately 40% of current filers.
- Revises the standard for disclosure from the "most significant" risks to "material" risks.
- Require registrants to organize their risk factors under relevant headings, in addition to the subcaptions that are already required.
- If generic risk factors that are applicable generally to any company or a securities offering are included, the registrant is required to disclose such risk factors at the end of the section under a separate caption "General Risk Factors."
The full release detailing the final amendments can be found on the SEC's website, which includes a summary comparison of existing item requirements versus the final amendments. Click here to view a summary comparison table.
The amendments will be effective 30 days after publication in the Federal Register.
Two Key Takeaways
- The amendments, in most instances, reflect a shift toward a more principles-based disclosure framework, encouraging registrants to exercise judgment when deciding what disclosures to provide. Registrants will need to think critically about their disclosure strategy, especially in light of the COVID-19 pandemic and investor focus on racial inequities and inequalities in the United States.
- Registrants should plan ahead to allow for additional time to review their risk factor sections, given they will require a comprehensive review and reorganization of the section.