The SEC recently proposed amendments intended to update, streamline and improve its disclosure framework and to reduce the compliance burden for public companies. The proposed amendments, which are detailed in the proposing release, would implement the SEC’s mandate under the Fixing America’s Surface Transportation Act (FAST Act). Comments on the proposed amendments are due by January 2, 2018. Although they represent an encouraging first step in updating the SEC’s disclosure rules, the proposed amendments, if adopted, will result in only modest changes to existing disclosure requirements. The proposals nevertheless warrant careful review by those involved in disclosure compliance. The SEC continues to consider other changes to its rules as part of its disclosure reform project.
FAST Act mandate
Enacted in 2015, the FAST Act required the SEC to study the disclosure requirements in Regulation S-K with a goal of recommending ways to modernize and simplify those requirements, reduce the costs and burdens on companies while still requiring disclosure of all material information, improve the readability and navigability of disclosure, and discourage repetition and the disclosure of immaterial information. The SEC staff published its report on this study in November 2016. The staff report contained numerous recommendations that form the basis of the proposed amendments, although the Commission did not act on all of the staff’s recommendations. The SEC noted in the proposing release that it is continuing to assess other revisions to its disclosure regime.
The SEC has proposed changes to Regulation S-K and to forms under the Securities Act and the Exchange Act required to be filed by domestic registrants and foreign private issuers.
Description of property (Item 102). The SEC’s proposal would limit required disclosure under Item 102 of Regulation S-K to physical properties that are material to the company. Item 102 currently requires disclosure of a company’s “principal plants, mines and other materially important physical properties.” Responding to concerns that Item 102 may result in immaterial disclosures of physical properties, the SEC proposes to require disclosure of physical properties only to the extent they are material to the company. Companies that operate in industries in which properties may be of particular significance, such as the real estate, mining and oil and gas industries, will continue to comply with the existing instructions to Item 102 governing their industries and with the relevant industry guides. The proposed amendments could reduce or eliminate Item 102 disclosure for companies that conclude they do not have any physical properties that are material. For example, the SEC noted that some companies disclose properties such as company headquarters or office space. A company concluding that these properties are not material to it would be able to omit this disclosure under the proposal.
Management’s discussion and analysis of financial condition and results of operations (Item 303). The proposed amendments would streamline disclosure of a company’s financial condition and results of operations relating to the earliest fiscal year included in financial statements covering three fiscal years that are filed with the company’s annual report on Form 10-K (or Form 20-F if the company is a foreign private issuer). Item 103 of Regulation S-K requires companies to provide a discussion and analysis of the financial statements and other data the company believes will enhance a reader’s understanding of the company’s financial condition, changes in financial condition and results of operations. The instructions to Item 303 clarify that companies may do so using either year-to-year comparisons or other formats believed to enhance a reader’s understanding. Many companies provide year-to-year comparisons, which in the case of filings containing three years of financial statements include a year-to-year comparison for the earliest two years. In most cases, the earlier period comparison is presented in the prior year’s annual report and carried over to the new report. The proposal would amend Item 303 to allow companies presenting year-to-year comparisons for a three-year period to omit the comparison involving the earliest year where (1) that discussion is not material to an understanding of the company’s financial condition, changes in financial condition and results of operations, and (2) the company discusses the results of the earliest year in its prior-year annual report. The proposal thus would eliminate in many cases the need to repeat year-to-year comparisons that are already part of the company’s disclosure history. The proposed amendments also would modify the instructions to Item 303 to remove the current reference to year-to-year comparisons and clarify that a company may use any presentation that in its judgment enhances a reader’s understanding. This clarification is not intended to prevent companies from using year-to-year comparisons, but instead to enable companies to tailor their disclosure, within the bounds of Item 303’s requirements, to reflect their individual circumstances. The release identifies, as one possible approach, that a company might choose to present narrative disclosure about the earliest year of the three-year period and then present a year-to-year comparison for the two most recent years.
Section 16 compliance (Item 405). The proposed amendments would eliminate the requirement that directors, officers and ten percent shareholders furnish to their companies copies of the reports they file under Section 16(a) of the Exchange Act. The amended rules also would change the disclosure requirements associated with delinquent filings. Elimination of requirement to furnish copies of Section 16 reports. Rule 16a-3(e) under the Exchange Act requires that reporting persons furnish copies to the company of beneficial ownership reports they file under Section 16(a). In addition, Item 405 of Regulation S-K, which governs disclosure by companies of untimely Section 16 reports, allows a company determining whether Item 405 disclosure is required to rely on its review of those furnished reports as well as any written representation from the reporting person that no Form 5 is required. The requirement for reporting persons to furnish copies of Section 16(a) reports to their companies was adopted before the reports were required to be filed electronically. The SEC’s proposal would eliminate the requirement that insiders provide copies of their reports to the company separately from the filing of their reports on EDGAR. Further, in determining whether Item 405 disclosure on delinquent filings is necessary, the company would be able to rely on the copies of reports that are filed on EDGAR, as well as any written representation from the reporting person. Changes to disclosure of delinquent Section 16 filings. Item 405 currently requires companies to disclose in their proxy statements and annual reports on Form 10-K, under the caption “Section 16(a) Beneficial Ownership Compliance,” any failure by their reporting persons to file Section 16(a) reports in a timely manner. Many companies include the caption even when they disclose no reporting delinquencies, and indicate under the caption that the company is not aware of any reporting delinquencies. The SEC’s proposal would encourage companies to eliminate the caption and associated disclosure in these circumstances. In addition, the SEC proposes to change the required caption to “Delinquent Section 16(a) Reports” to indicate more precisely the nature of the required disclosure and to encourage companies not to include the caption or any related disclosure if they have no delinquent Section 16(a) reports to disclose. This proposal also would eliminate the box on the cover page of Form 10-K in which the company indicates whether the Form 10-K contains Item 405 disclosure of delinquent Section 16(a) reports or expects Item 405 disclosure to be contained in a proxy statement incorporated by reference into the report. This change recognizes that the checkbox will be less useful in monitoring Section 16(a) compliance once companies can search for Section 16(a) delinquencies under the amended Item 405 caption.
Exhibit requirements (Item 601). The proposed amendments to Item 601 of Regulation S-K would streamline the process for omitting confidential information from exhibit filings, permit omission of immaterial schedules or attachments to exhibits, require inclusion of legal entity identifiers in subsidiary exhibits, and require companies to file as an exhibit to Form 10-K a description of their equity securities registered under Section 12 of the Exchange Act.
Omission of confidential information from material contract exhibits. Under the proposed amendments, companies would be permitted to omit confidential information from exhibits filed as material contracts under Item 601 without complying with the current requirement to submit a confidential treatment request (CTR) to the SEC seeking an order authorizing the proposed redaction of confidential information. As under the current standards, companies would have the right to omit information from exhibits only if the information (1) is not material to investors and (2) would result in competitive harm if publicly disclosed. Although the SEC indicates that the staff would review redacted exhibits on a selective basis, the elimination of the CTR process would simplify reliance on the confidential information exception to the exhibit filing requirements.
Omission of personally identifiable information from exhibits. The proposed amendments to Item 601 also would codify the SEC staff’s longstanding practice of allowing companies to omit personally identifiable information (PII) from exhibits without the need to submit a confidential treatment request. PII includes information such as bank account numbers, social security numbers, home addresses and similar information. Omission of schedules and other attachments to exhibits. The proposals would extend to all exhibits filed under Item 601 the accommodation currently only in Item 601(b)(2) of Regulation S-K that permits the omission of schedules and other attachments to exhibits filed under that item (plans of acquisition, reorganization, arrangement, liquidation or succession). Under a new Item 601(a)(5) of Regulation S-K, a company could exclude schedules and other attachments if (1) they do not contain material information and (2) the information they contain is not disclosed elsewhere in the exhibit or in the disclosure document requiring the exhibit filing. As currently required by Item 601(b)(2), companies that omit schedules and other attachments from filed exhibits would be required to list briefly the contents of the omitted items.
Inclusion of legal entity identifiers. The proposals also would require that companies include in the exhibit listing subsidiaries under Item 601(b)(21) of Regulation S-K the legal entity identifier (LEI) for the company and for each named subsidiary for which an LEI has been obtained. An LEI is a unique identification code for an entity that engages in financial transactions. The SEC noted in the proposing release that the use of LEIs has increased in recent years, and that the proposal is intended to allow investors to identify companies and their subsidiaries more quickly and precisely.
Description of securities. The proposed amendments to Item 601 would require that companies include as an exhibit a description of their securities that are registered under Section 12 of the Exchange Act. A description of securities currently is required only in registration statements filed under the Securities Act or the Exchange Act. The proposal is intended to make disclosure concerning the terms of registered securities, and the rights of security holders, more accessible to investors. If a company already has filed a description of its equity securities as an exhibit to an SEC report or registration statement, the company would be able simply to hyperlink to that prior disclosure (assuming it is unchanged).
The SEC also has proposed technical changes to the undertakings for Securities Act registration statements required under Item 512 of Regulation S-K, to the cover pages of registration statements and prospectuses under the Securities Act, and to instructions to various items of Regulation S-K.
The proposal represents a welcome effort by the SEC to simplify disclosures while focusing on information that is material to investors. At the same time, most of the amendments are technical in nature and do not significantly alter the disclosure landscape. As a result, the proposals are unlikely to attract much attention in the C-suite or the board room.