The SEC issued a proposing release on October 11, 2017 to amend a wide variety of disclosure rules, primarily under Regulation S-K, in an effort to modernize and in some cases simplify disclosure requirements for public companies, investment advisers and investment companies. The proposal is intended to implement the Congressional mandate under the Fixing America’s Surface Transportation (FAST) Act. The proposing release can be found here.
The proposing release reflects recommendations from the SEC staff’s FAST Act Report, as well as proposed changes arising from the Commission’s broader disclosure review reflected in its 2016 Concept Release seeking comments on how the disclosure system could be improved.
In an effort to update and streamline the Regulation S-K disclosure framework, the Commission proposed changes to the disclosure requirements of --
- Description of property (Item 102)
- MD&A (Item 303)
- Descriptions of directors and executive officers (Item 401)
- Disclosure of Section 16 late or missing filings (Item 405)
- Outside front cover of the prospectus (Item 501(b))
- Risk factors (Item 503(c))
- Plan of distribution (Item 508)
- Material contracts (Item 601(b)(10)); and
- Incorporation by reference rules
In addition, the release contains proposed changes to information required on the cover pages of prospectuses and Exchange Act Forms 10-K, 10-Q and 8-K and a new requirement that information on the cover pages be tagged in Inline XBRL format.
This client alert identifies most of the proposed changes in summary fashion. The SEC is soliciting comments over the next 60 days, but given the extensive work preceding this proposal and the nature of most of the recommendations, we expect the SEC to move forward quickly to finalize these changes.
Description of Property (Item 102). Item 102 requires disclosure of “principal” plants, mines and other “materially important” physical properties. Consistent with the FAST Act Report and the recommendation of several commenters on the 2016 Concept Release, the SEC is now proposing to amend Item 102 to emphasize materiality. The SEC is proposing to clarify that the disclosure should focus on physical properties that are material to the registrant and may be provided on a collective basis, if appropriate. Disclosure as proposed will need only be made if the registrant has physical properties that are material.
Management’s Discussion and Analysis (Item 303). Item 303(a) generally requires a discussion of the three-year period covered by the financial statements using a year-to-year comparison of each of the three years. In the FAST Act Report, the staff recommended revising Item 303(a) to require an issuer to provide period-to-period comparisons for only the two most recent fiscal years and to hyperlink to the prior year’s annual report for the earlier of the year-to-year comparison.
Instead of adopting the original recommendation, the SEC is proposing to amend Item 303(a) to eliminate discussion of the earliest year (when the financials included in the filing cover three years) if (i) that discussion is not material to an understanding of the issuer’s financial condition, changes in financial condition and results of operations, and (ii) the registrant has filed its prior Form 10-K on EDGAR containing MD&A of the earliest of the three years. The purpose of this amendment is to discourage repetition of disclosure no longer material. The SEC declined to adopt the recommendation of the FAST Act Report to hyperlink to the prior comparison because of the SEC’s intent to encourage issuers to re-evaluate disclosures in prior year MD&As and take a “fresh look” each year to determine whether the disclosure remains material.
The current proposal also would eliminate the reference to five-year selected financial data in Instruction 1 to Item 303(a). That instruction currently provides for reference to that selected financial data where trend information is relevant. The proposed amendment is intended to eliminate what the SEC perceives to be duplication because disclosure requirements for liquidity, capital resources and results of operations already require trend disclosure.
In addition, the SEC is proposing to revise Instruction 1 to Item 303(a) to provide that registrants may use any presentation that in the registrant’s judgment would enhance readability of the comparison. While nearly all registrants provide year-to-year comparisons, some may determine that a narrative discussion is more appropriate for one or more years and forego the year-to-year comparison. The revised Instruction will make this more evident.
The proposing release includes conforming changes to Instruction 5 to Form 20-F for foreign private issuers.
Directors, Officers, Promoters and Control Persons (Item 401). Item 401 requires disclosure relating to an issuer’s directors, executive officers, control persons and key employees. Typically, an issuer provides information about its directors in the annual meeting proxy statement which is incorporated by reference into Part III of the Form 10-K. Information about its executive officers need not be included in the proxy statement if it is set forth at the end of Part I of the Form 10-K under the heading “Executive Officers of the Registrant.”
Because the instruction to Item 401(b) about this permitted placement has caused some confusion, the SEC is proposing to make the instruction a general instruction to Item 401, to make clear that it applies to any disclosure required about executive officers in Item 401. The SEC also proposes to revise the Part I caption from “Executive Officers of the Registrant” to “Information about our Executive Officers.”
Compliance with Section 16(a) Reporting (Item 405). Item 405 requires issuers to disclose each Section 16 insider who failed to file on a timely basis a Form 3, 4 or 5 required under Section 16(a) in the preceding fiscal year. The disclosure is required to appear under the heading “Section 16(a) Beneficial Ownership Reporting Compliance.” The item provides that issuers must provide the required disclosure based “solely” on a review of the copies of Forms 3, 4 and 5 which are required to be provided to them and any written representation provided that no Form 5 is required.
Consistent with the FAST Act Report, the SEC is proposing to eliminate the requirement in Rule 16(a)(3)(e) that Section 16 insiders furnish copies of Section 16 reports to the registrant. Because of the availability of these reports on EDGAR now, the SEC believes there is no reason to impose a delivery requirement on the Section 16 insiders. The SEC is also proposing to change the language of Item 405 to provide that registrants may rely on Section 16 reports filed on EDGAR (as opposed to providing the disclosure based “solely” on a review of those forms) and a written representation by the reporting person.
The SEC declined to adopt the FAST Act Report recommendation that would permit an issuer to rely on the information in the filed report “unless it knows or has reason to believe that the information is not complete or accurate or that a report or amendment should have been filed but was not.” Instead, the SEC is intending to clarify that registrants are not required to limit their inquiry to the filings. Accordingly, if a registrant is aware of an incomplete, inaccurate or missing filing on EDGAR, the registrant could provide Item 405 disclosure.
In addition, the SEC has proposed adding an instruction to Item 405 to allow exclusion of the heading and disclosure if there are no delinquencies to report and changing the heading to “Delinquent Section 16(a) Reports.” Finally, the SEC is proposing the elimination of the “check box” on the cover of the Form 10-K relating to Item 405 disclosure and the related instruction in Item 10 of Form 10-K.
Corporate Governance (Item 407). Pursuant to recommendations of the FAST Act Report, the SEC is proposing two changes here. First is to correct a reference to a now outdated auditing standard in Item 407(d)(3)(i)(B), from “AU section 380” (Communication with Audit Committee) to refer more broadly to applicable requirements of the PCAOB and the SEC. Second, the proposal would amend Item 407 to explicitly exclude emerging growth companies (EGCs) from the Item 407(e)(5) requirement relating to the Compensation Committee Report because EGCs are not required to include a Compensation Discussion and Analysis in their proxy statements.
Registration Statement and Prospectus Provisions (Items 501, 503, 512).
Outside Front Cover Page of the Prospectus. The SEC is making several proposed changes to the disclosure requirements for the outside front cover page of the prospectus. A proposed change to Item 501(b)(3) relates to disclosure of the price of the securities being offered. In those cases where the offering price to the public is determined by a formula or particular method, cover page disclosure can be cumbersome. Under the proposal, the instructions would be amended to explicitly allow a registrant to include on the cover page only a statement that the offering price will be determined by a method or formula that is more fully explained in the prospectus, with a cross reference to the page where that disclosure appears.
In addition, the proposing release includes an amendment to Item 501(b)(4) to require disclosure of the principal U.S. market or markets for the securities being offered and the corresponding trading symbols. The existing rule only requires the name of any national securities exchanges that list the securities being offered.
The SEC is also proposing a change to the red herring legend. Item 501(b)(10) requires a registrant to include a legend on a preliminary prospectus that the information is not complete and will be amended, and that the prospectus is not an offer to sell or a solicitation of an offer to buy securities in any state where the offer or sale is not permitted. The SEC proposes to eliminate the latter statement to allow for more tailored prospectus cover page disclosure in recognition of the changes to the securities law under NSMIA.
Risk Factors (Item 503(c)). Item 503(c) requires disclosure of risk factors and includes a list of specific examples that could make an offering speculative or risky. Because risk factors now are included not only in registration statement prospectuses, the SEC proposes to relocate 503(c) to Subpart 100 as a new Item 105 to reflect the application of risk factor disclosure to periodic reports and Form 10. The list of example risk factors would be eliminated to encourage issuers to focus on their particular risks and not necessarily those listed in the Item.
Plan of Distribution (Item 508). Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about the underwriters. Paragraph (h) references payment to a dealer for acting as a “sub-underwriter” in the offering. The SEC is proposing to amend Rule 405 to add a definition of “sub-underwriter” as a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities but is not itself in privity of contract with the issuer of the securities.
Undertakings (Item 512). The SEC proposals relating to the Item 512 undertakings follow FAST Act Report recommendations to eliminate duplicative and obsolete undertakings.
Exhibits (Item 601).
The SEC is proposing an array of changes to Item 601, including:
Filing redacted agreements without need for concurrent request for confidential treatment. As proposed, Item 601(b)(10) would permit registrants to omit confidential information from material contracts and file redacted versions of those contracts without simultaneously submitting a confidential treatment request to the SEC, provided that the omitted information is both immaterial and competitively harmful if publicly disclosed. The staff would continue to review filings selectively, and assess whether redactions appear to be limited as required by the rule. Upon request, a registrant will be expected to provide supplemental materials to the staff similar to that currently required in a confidential treatment request. Also, the proposing release makes clear that current SEC guidance about how redactions should be reflected (and appropriately limited) remains in effect.
Material contracts with completed performance – the two-year look back. Currently, Item 601(b)(10) requires that a contract not made in the ordinary course of business be filed if one of two tests is met: either the contract is to be performed in whole or in part after the filing or the contract was entered into not more than two years before the filing. As amended, the Rule will limit the two-year look back to newly reporting registrants. Registrants with established reporting histories would not be required to comply with the two-year look back as investors would have access to material agreements previously filed.
New exhibit required: description of security (Item 601(b)(4)). As recommended in the FAST Act Report, this Item would be amended to require registrants to provide an exhibit to their Form 10-K with the description of their registered securities that is currently required in registration statements. Accordingly, this would cover capital stock, debt securities, warrants, rights, American Depositary Receipts and other securities that are registered under Section 12 of the Securities Exchange Act of 1934. This exhibit would be in addition to the current requirement to file a complete copy of the registrants’ articles of incorporation and/or bylaws under Item 601(b)(3).
Personally identifiable information omitted from exhibits. The SEC proposes to add new Item 601(a)(6) to permit the omission of personally identifiable information in material contract exhibits and to reduce the need for registrants to submit applications for confidential treatment of information in material contract exhibits. This would codify an informal practice permitted by the SEC staff for some time.
Omitting schedules and attachments to exhibits. Proposed Item 601(a)(5) will permit the omission of entire schedules and related attachments to exhibits, including material contracts, unless they contain material information and unless that information is not otherwise disclosed in the exhibit or the disclosure document. Currently, the rules allow this practice only in the case of M&A and similar agreements. The proposed change, of course, would reverse a long-standing SEC staff position which resulted in numerous comment letters in recent years. As with M&A agreements, a list of omitted schedules will be required, as well as an undertaking to provide supplementally such schedules to the SEC staff upon request.
Subsidiary and Entity Identifier. The proposal would amend the rule calling for an exhibit which lists subsidiaries of the registrant to require that the exhibit include the legal entity identifier (LEI), if one has been obtained, of the registrant and each of the listed subsidiaries. An LEI is a code that allows for unique identification of entities engaged in financial transactions.
Application to foreign private issuers. The proposed amendments will include conforming amendments to the exhibit requirements in Form 20-F.
Incorporation by Reference. The rules and instructions relating to incorporation by reference are included in a variety of regulations. As recommended in the FAST Act Report, the proposed amendments revise certain items and rules and a number of forms in an effort to simplify and modernize these rules. The proposal would eliminate the limit on incorporation by reference of documents that have been on file with the SEC for more than five years, currently included in Item 10(d). The proposal also would eliminate the requirement that copies of information incorporated by reference must be filed as an exhibit to the report (other than the exhibit 13 annual report to shareholders, which would still need to be filed as an exhibit to the Form 10-K). The proposal would require hyperlinking to information incorporated by reference, if available on EDGAR. With respect to financial statements, the proposed rule change would prohibit incorporating by reference or cross-referencing to information outside the financial statements unless otherwise specifically permitted or required by other SEC rules.
Tagging Data. The SEC is proposing amendments to require all of the information on the cover pages of Form 10-K, Form 10-Q, Form 8-K, Form 20-F and Form 40-F be tagged in Inline XBRL. A new rule 406 will be added to Regulation S-T, and a new 601(b)(104) and new instructions to Forms 20-F and 40-F will be included. In addition, the proposal would amend the cover pages of these forms to require the trading symbol for each class of registered securities and the cover pages of the Form 10-Q and Form 8-K to require disclosure of the title of each class of securities and each exchange on which they are registered (currently only on the Form 10-K).
The proposing release includes parallel amendment to several rules and forms applicable to investment companies and investment advisers.
As is clear from the above, the proposed changes in the release are varied and extensive, although admittedly not significantly substantive. The objective of modernizing and streamlining the integrated disclosure system is a theme that carries through the over one hundred pages of proposed changes and related explanations.
We will continue to monitor the developments related to the proposing release. If you have questions or would like to submit comments with respect to any of the proposals, please contact us.