The SEC has now posted its release regarding FAST Act Modernization and Simplification of Regulation S-K, which proposes amendments to rules and forms based primarily on the staff’s recommendations in its Report to Congress on Modernization and Simplification of Regulation S-K (required by the FAST Act). (See this PubCo post.) That Report, in turn, was premised on the review that the SEC conducted as part of its Disclosure Effectiveness Initiative and the related Concept Release, which addressed a broader range of potential changes. (See this PubCo post and this PubCo post.) A new approach to confidential treatment, not addressed in the Report, is also proposed. As indicated by the title, the proposed amendments are intended to modernize and simplify a number of disclosure requirements in Reg S-K, and related rules and forms, in a way that reduces the compliance and cost burdens on companies while continuing to provide effective disclosure for investors, including improvements designed to make the disclosures more readable, less repetitive and more easily navigable. (The release also proposes certain parallel amendments to investment company and investment adviser rules and forms, not discussed in this post.)
In his remarks at the open meeting to consider the proposal, SEC Chair Jay Clayton—chairing his first open meeting— observed that the proposed amendments “are intended to improve the quality and accessibility of disclosure in filings by simplifying and modernizing our requirements. These proposed rule changes should result in significant savings of time and money for registrants without any reduction in material information and with increased accessibility.” Moreover, he characterized the approach to disclosure taken in the proposal as “important,” and admonished corporate leaders to “respond to our disclosure requirements by conveying information to investors in a way that captures how they assess and manage their businesses.” Displaying his literary bent, Commissioner Michael Piwowar, in his metaphor-strewn remarks—remember that he began his career of SEC open meetings with remarks alluding to A Tale of Two Cities and has also done a turn adopting a Yogi Berra theme (see this PubCo post)—referred to the proposal as an effort to “prune the regulatory orchard. I choose the word ‘prune’ carefully. The object of these amendments is to shear away dead limbs and overgrown branches, thereby improving the fruitfulness and health of the trees. Today’s amendments are not an exercise in slash-and-burn clearcutting. They are incremental changes—a snip here, a snip there—designed to shape and guide the healthy plant so that our disclosure regime will continue to bear fruit.”
The proposed amendments with the potential to have the most significant impact relate to confidential treatment and other exhibit-related matters, MD&A, property, incorporation by reference and prospectus cover page and are summarized below:
Confidential Treatment. The proposal includes a new approach intended to “streamline” the confidential treatment process. Under proposed revisions to Item 601(b)(10), companies would be permitted to omit or redact from material contract exhibits confidential information that is not material and would cause competitive harm if publicly disclosed, without having to submit an unredacted copy and formal confidential treatment request in advance to the staff, as is currently required. Instead, companies would simply mark the exhibit index to indicate that portions of the exhibit have been omitted, mark the filed exhibit with brackets to show where information has been omitted and add a “prominent statement” on the first page of the redacted exhibit to indicate that marked information has been omitted. Companies would be required to provide an unredacted paper copy and supporting rationales supplementally upon request by the staff. Using Rule 83, companies could request confidential treatment of supplemental information provided while in the possession of the staff. If the supplemental rationale does not support the redactions, the staff may request that the exhibit be refiled to disclose additional information. At the open meeting, Clayton stressed that “exhibits would continue to be subject to filing reviews, and the staff would selectively assess whether redactions appear to be appropriate.”
Some of the most significant changes and efficiencies proposed relate to exhibits. The proposed new process for seeking confidential treatment, although not among those recommended by the staff in the Report, will certainly be among the most popular ideas. The new concept will allow a company to avoid preparing and submitting the typical letter exhaustively detailing its rationale for confidentiality at the time of submission of the exhibit, a process that can be time-consuming on the front end and can result in delays at the back end. At the open meeting, staff members describing the proposal emphasized that the change was a change to process only and was not intended to change the substantive requirements (e.g., that the redacted information is not material, has not been previously disclosed and is commercially sensitive information the disclosure of which would cause competitive harm). Moreover, the proposing release confirms that it is the company’s responsibility to determine that all material information has been disclosed and that the redactions include no more text than is necessary. Given the cautions in the proposing release regard the company’s responsibilities, the staff’s admonition at the meeting that no substantive change in the requirements for confidential treatment was intended, as well as Clayton’s emphasis on the continuation of staff review, it is clear that the same obligation to narrowly frame the redactions, to have a defensible basis under the rules for the request and to adhere to any other requirements would continue to apply. Only time will tell how strictly that would be enforced.
Omission of Personally Identifiable Information. Proposed new paragraph 601(a)(6) codifies the current staff practice of allowing companies to omit personally identifiable information from exhibits without the need for a CTR. Personal identifying information is information the disclosure of which would be “a clearly unwarranted invasion of personal privacy (e.g., disclosure of bank account numbers, social security numbers, home addresses and similar information).”
Omission of Schedules From Exhibits (Item 601(a)(5)). Generally, companies are required to file complete copies of exhibits, including every single attachment, no matter how immaterial; only Item 601(b)(2) allows acquisition agreements to be filed without schedules or similar attachments if they are not material. Proposed new paragraph 601(a)(5) would likewise permit the omission of schedules and similar attachments to other exhibits, so long as they do not contain material information and the information is not otherwise disclosed in the exhibit or the disclosure document. Companies would instead be required to file with each exhibit a list briefly identifying the contents of the omitted schedules and would be required to furnish them supplementally upon request (and no agreement to furnish them would be required). The SEC is considering whether to extend this accommodation to the exhibit requirements in Schedule 13E-3 and Schedule 13D.
Once again, this proposal should be among the most popular, as schedules can add substantially to the length of exhibits and very often will contain confidential information that must be redacted and, under the new proposal, potentially could require the submission of a lengthy rationale in support of confidential treatment.
Limit the Two-Year Look Back for Material Contracts (Item 601(b)(10)(i)). Currently, Item 601(b)(10)(i) requires companies to file every contract not made in the ordinary course of business if the contract is material and (i) to be performed after the filing of the registration statement or report or (ii) was entered into not more than two years before the filing. The proposed amendments would limit the two-year look-back requirement for exhibits to apply only to newly reporting companies (i.e., companies filing a registration statement that, at the time of filing, are not subject to Exchange Act reporting, certain shell companies and any company that has not filed an annual report since the revival of a previously suspended reporting obligation). The reason for the proposed change is that companies that are already reporting companies would have previously filed those contracts and they would be available on EDGAR.
Description of Securities (Item 601(b)(4)). Currently, a description of securities is required under Item 202 only in registration statements. To increase ease of access to information about classes of securities, the proposal requires companies to file a description of their securities registered under Section 12 of the Exchange Act as an exhibit to Form 10-K (Item 601(b)(4)). Companies would not be required to include in the exhibit Item 202(e) market information for securities other than common equity. Existing disclosure obligations regarding modifications to the rights of security holders and amendments to charters and bylaws under Form 8-K and Schedule 14A would remain in place, including the requirement to file a complete copy of any amended charter or bylaws.
Foreign Private Issuers. The proposal would require foreign private issuers to provide comparable information in exhibit filings for Form 20-F, but not 40-F.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 303)
Omission of Earliest Year. Currently, companies generally provide two comparative year-to-year discussions of three annual fiscal years (i.e., year 3 compared to year 2 and year 2 to year 1). The SEC is proposing to amend Item 303 to eliminate discussion of the earliest year, so long as “(i) that discussion is not material to an understanding of the registrant’s financial condition, changes in financial condition, and results of operations, and (ii) the registrant has filed its prior year Form 10-K on EDGAR containing MD&A” of that omitted year. No hyperlink to the prior Form 10-K would be required. (Note that the proposal would not affect smaller reporting companies or emerging growth companies that provide only two years of audited financials in their IPO registration statements. Conforming changes are also proposed for foreign private issuers in Item 5 of form 20-F.
Given that these discussions of the earliest year have already largely been written, what we’re talking about here is primarily a saving of space, but typically not much saving of effort. According to remarks by SEC Chair Jay Clayton at the open meeting to consider the proposal, the change “would encourage registrants to take a fresh look at their MD&A to determine whether a discussion of the oldest year remains material to investors, and should discourage repetition of disclosure that is no longer material.” But in what circumstances would a discussion of the prior year be considered material? Although no guidance is specifically provided, the SEC asks whether companies should be prohibited from excluding the earliest year “if there has been a material change to either of the two earlier years due to a restatement or a retrospective adoption of a new accounting principle.” Another possible example that comes to mind that could be material is a material trend that becomes evident through an understanding of multiple year-to-year comparisons.
Reference to Selecteds. Given that trend information is already required for liquidity, capital resources and results of operations, the proposal would also eliminate as duplicative the direction in Instruction 1 to refer to the five-year selected financial data where trend information is relevant.
Tailored Presentations. The revised instruction would also emphasize that companies may tailor their presentations using any format that would enhance a reader’s understanding, not solely year-to-year comparisons. For example, a company might want to provide narrative discussion of only material aspects regarding the otherwise-omitted earlier period. The proposal requests comment on whether this MD&A concept should be extended to other forms, such as Form 8-K.
Description of Property (Item 102)
Because the rule sometimes elicits disclosure regarding property that is not really material, such as information regarding corporate headquarters or other office space, the proposal would clarify that disclosure regarding properties is required only to the extent that the property is material to the company (as opposed to just its ongoing business operations). The proposed amendments would also 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.” The revisions would harmonize some of the descriptors by referring to a consistent materiality threshold. The SEC elected not to combine the descriptions of property and business, as suggested in the Report, on the basis that a combination of that type would require a broader evaluation. The proposal requests comment on whether there should be more disclosure about material properties, such as the potential for natural disasters in that location.
Incorporation by Reference
Streamline Rules. The proposed amendments would streamline the current hodgepodge of rules associated with incorporation by reference and facilitate investor access to incorporated documents through the use of hyperlinks. More specifically, the proposal would revise Item 10(d), Rule 411, Rule 12b-23, and a number of forms, as well as rescind Rule 12b-32, the substance of which would be included in Rule 12b-23.
Elimination of Five-Year Limitation on Incorporation (Item 10(d)). Currently, under Item 10(d), incorporation beyond five years is prohibited, except for documents contained in registration statements and documents identified by file number (unless the SEC has disposed of them). The proposal would eliminate the current five-year limitation, which, in light of the current electronic filing system, has become an anachronism. Companies would be required to describe the location of the information incorporated by reference and include hyperlinks to incorporated documents when filed on EDGAR. Note that the proposed requirements for incorporation hyperlinking would be similar to the requirements for exhibit hyperlinking (except that companies would not be required to correct inaccurate hyperlinks in an effective registration statement by including a corrected hyperlink in a subsequent periodic report or a post-effective amendment). (See this PubCo post.)
The provision in Item 10(d) prohibiting indirect incorporation (incorporating by reference a portion of a document that itself also incorporates pertinent information by reference) would be moved into other incorporation rules (Rule 411, Rule 12b-23) and the procedural incorporation rules would be consolidated in Reg C and Reg 12B.
Filing Copies of Incorporated Information (Rule 12b-23 and Rule 411). This proposal would eliminate another relic: the requirement in Rule 12b-23 and Rule 411 to file as exhibits copies of any information incorporated by reference. (Rule 12b-23 governs incorporation by reference for Exchange Act filings, and Rule 411 governs the more limited incorporation in Securities Act filings.) Likewise eliminated would be the corresponding exhibit requirement in Item 601, as well as the provision in Item 601 that requires Forms 10-Q to be filed as exhibits when they are incorporated by reference into a filing.
Financial Statements. Although the release encourages companies to incorporate from the financial statements to satisfy other disclosure requirements, such as with regard to legal proceedings and related person transactions, the SEC has not proposed to clarify the rules on incorporation by reference from the financial statements at this time. However, the SEC is proposing to prohibit (unless otherwise specifically permitted) incorporation by reference or cross-referencing in the financial statements to information outside the financial statements because it can raise questions as to the scope of an auditor’s responsibilities.
Outside Front Cover Page of the Prospectus (Item 501(b))
Determination of Offering Price. Currently, instruction 2 to Item 501(b)(3) states that “[i]f it is impracticable to state the price to the public, explain the method by which the price is to be determined” on the outside front cover page. The proposal would permit the method of determining pricing to be disclosed elsewhere in the prospectus than on the cover page, by including on the cover page a clear statement that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus along with a cross-reference to that disclosure with a page number highlighted by prominent type (similar to the cross-reference to “Risk Factors”). No change is proposed to the instruction regarding securities to be offered at market price, or if the offering price is to be determined by a formula related to market price.
Principal U.S. Public Trading Market. Companies are now required to disclose only the national securities exchange where the securities are listed. The proposal would require, if the securities are not listed on any national securities exchange, disclosure of the principal U.S. public trading market or markets for the securities being offered, so long as the company, through the engagement of a registered broker-dealer, has actively sought and achieved quotation on those markets. Disclosure of the corresponding trading symbols would also be required. (Item 501(b)(4)).
Red Herring Legend. In the prospectus “subject to completion” legend, companies would be permitted to reduce the length by eliminating the language regarding state law prohibitions if not applicable (e.g., because of preemption of state blue sky laws under NSMIA). The same legend would be used if the company relied on Rule 430A to omit pricing information. Here’s a version of the new legend as suggested in Item 501(b)(10): “The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.”
Confusing Company Names. The proposed amendments would also streamline the instruction to Item 501(b)(1) (which refers to misleading or confusing company names) by eliminating the portion that discusses when a name change may be required and the exception to that requirement.
XBRL Tagging. As a separate matter, the proposal would also require that 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 appear in HTML format and be tagged in Inline XBRL (i.e., embedded into the document) and that the cover page include the trading symbol for each class of registered securities.
The release also comprises a fair amount of useful streamlining and clean-up, such as revising outdated references and eliminating vestigial requirements and other unnecessary clutter, as summarized below:
Management, Security Holders and Corporate Governance
Directors, Executive Officers, Promoters, and Control Persons (Item 401)
- Clarifying that instruction 3 to Item 401(b) (which allows disclosure of information about executive officers to be included in Part I of Form 10-K without requiring repetition in the proxy statement) applies to Item 401 generally by making it a general instruction to Item 401; and
- Revising the Item 401 caption to read “Information about our Executive Officers.”
Compliance with Section 16(a) of the Exchange Act (Item 405)
- Allowing companies to rely on Section 16 reports filed on EDGAR (as opposed to paper) when assessing whether there are any Section 16 delinquencies that must be disclosed under Item 405;
- Eliminating the requirement for insiders to furnish Section 16 reports to the company on paper;
- Eliminating the need to include the caption “Section 16(a) Beneficial Ownership Reporting Compliance” when the company does not have Section 16(a) delinquencies to report; and
- Eliminating the checkbox on the cover page of Form 10-K relating to Item 405 disclosures and the related instruction in Item 10 of Form 10-K.
Corporate Governance (Item 407)
- Changing the outdated auditing standard, AU section 380, Communication with Audit Committees, referred to in the Audit Committee Report, Item 407(d)(3)(i)(B), to refer instead to the applicable requirements of the PCAOB and the SEC (which would accommodate future changes); and
- Revising Item 407(g) to clarify that, because an EGC is not required to provide a Compensation Discussion and Analysis, its compensation committee need not state, as would otherwise be required by Item 407(e)(5), whether it has reviewed and discussed the CD&A nor whether it recommended to the board that the CD&A be included in the annual report or proxy statement.
Risk Factors (Item 503(c))
- Relocating “Risk Factors” from Item 503(c) to a new, separate item (Item 105), to reflect the application of risk factor disclosure requirements to registration statements on Form 10 and periodic reports;
- Eliminating the currently enumerated examples of possible risk factors included in Item 503 to encourage companies to focus on their own risk identification processes and avoid leading companies to believe they must address these factors, regardless of the significance to their specific businesses.
Plan of Distribution (Item 508)
- Amending Rule 405 to define a “sub-underwriter” as a dealer that is not itself in privity of contract with the issuer, but is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter. Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about underwriters, including any sub-underwriters, currently an undefined term.
Undertakings (Item 512)
- Eliminating a number of undertakings as duplicative or obsolete, including Item 512(c) (warrants offerings), (d) (competitive bidding), (e) (delivery of incorporated annual report) and (f) (securities certificates).
Subsidiaries of the Registrant and Entity Identifiers (Item 601(b)(21)(i))
- Requiring disclosure of legal entity identifiers (“LEIs”)— 20-character, alpha-numeric codes that permit unique identification of entities engaged in financial transactions—if obtained, for the company and the significant subsidiaries identified on Exhibit 21 (Item 601(b)(21)).
In her remarks, Commissioner Kara Stein observed that LEIs were an important aspect of modernization. They function like SKUs in retail and allow global markets to identify companies, especially where there may be hundreds of subsidiaries, and better understand the interconnections among companies. In particular, “[i]f a crisis emerges, we want to know quickly and with precision which subsidiary or affiliate holds the money or can fix the issue. LEIs are a modern day way of identifying companies, their connections, and their overall market exposure.”
- Implementing various conforming amendments; and
- Amending Form 10, Form 10-K and Form 20-F to allow exclusion of those unsightly item numbers and captions and to permit companies to create their own captions tailored to their disclosure. Captions that are expressly required by the forms or Reg S-K, such as “audit fees” or “risk factors,” would not be affected. This change would permit companies more flexibility and avoid cross-referencing when information is responsive to more than one item.
Comments are due within 60 days after publication of the release in the Federal Register.