SEC Adopts Amendments to Regulation S-K, Reinforcing a Principles-Based Disclosure Regime

In its continued march toward a more principles-based disclosure regime, the U.S. Securities and Exchange Commission (SEC) has adopted various amendments to Item 101 (Description of Business), Item 103 (Legal Proceedings) and Item 105 (Risk Factors) of Regulation S-K, which the SEC noted have not been significantly revised in over 30 years. The amendments, adopted on Aug. 26, 2020, will be effective on Nov. 9, 2020, 30 days after publication in the Federal Register (which occurred on Oct. 8, 2020).

The amendments were adopted by a 3-2 vote substantially in the form they were proposed. Commissioners Allison Herren Lee and Caroline Crenshaw dissented, arguing that the final rules fail to address climate change risk or diversity, and touch too lightly and generically on human capital, all of which are extremely relevant issues. Commissioner Crenshaw expressed that the SEC should form 1) an internal task force to analyze how investors use information on human capital management, climate change risk and other environmental, social and governance (ESG) matters to assess a company's long-term financial performance and 2) an ESG Advisory Committee made up of investors, issuers and subject matter experts to guide the SEC regarding ESG trends.

Item 101(a) – General Development of Business;
Item 101(h) – Smaller Reporting Companies

Item 101(a) of Regulation S-K currently requires a description of the general development of the registrant's business during the past five years (or longer if material) or such shorter period as the registrant has been engaged in business. Item 101(a)(1) includes a list of disclosure topics. Item 101(h) of Regulation S-K currently requires less detailed disclosure of the development of the business of a smaller reporting company (SRC) during the past three years. The amendments revise Items 101(a) and (h) to make the required disclosure more principles-based by, among other things, 1) eliminating the five-year and three-year time frames (although, for an SRC, the requirement in Item 101(h) to provide information for predecessors if the registrant has been in business for fewer than three years was retained), and 2) limiting disclosure to information that is material to an understanding of the general development of the registrant's business. The SEC believes that these revisions will allow registrants to tailor their disclosures to their specific circumstances, as some registrants may have relevant disclosure that spans more or less than five or three years, as applicable.

In addition, rather than retaining the existing requirement that a registrant repeatedly describe its business in significant detail across successive filings, the amendments shift the disclosure obligations to facilitate and focus disclosure on material updates to prior business descriptions. Specifically, amended Item 1.01(a) now requires that registrants describe any material change to their previously disclosed business strategy (a shift away from disclosure obligations related to material changes to the "mode" of conducting business). Registrants also will be permitted to include in their initial registration statement or other report a full discussion of the general development of the registrant's business, and in subsequent filings incorporate that discussion by reference and including material updates to the prior disclosure. Importantly, only one prior filing may be incorporated by reference under this method. Alternatively, registrants may include a full discussion without incorporating any prior discussion. The SEC believes that allowing for material updates to overall business strategy instead of a full discussion of a registrant's "mode" of conducting business will help highlight material developments instead of potentially burying them in a full discussion.

Item 101(c) – Narrative Description of Business

The amendments similarly extend the shift towards a more principles-based disclosure regime to the narrative description of a registrant's business. Prior to the effectiveness of the amendments, Item 101(c) of Regulation S-K requires registrants to describe the types of business that they and their subsidiaries engage or intent to engage in, with a focus on dominant segments or each reportable segment about which financial information is presented in the financial statements. To facilitate this description, Item 101(c) enumerates several different topics that should be discussed, to the extent material to an understanding of the registrant's business taken as a whole.

Consistent with the amendments to Item 101(a), Item 101(c) has been revised to be more principles-based, with a non-exclusive list of the types of information to disclose to the extent material to an understanding of the registrant's business. Many of the topics overlap with the current list, including information regarding a) revenue-generating activities, products and/or services and any dependence on key products, services, product families or customers, including government customers, b) development efforts for new or enhanced products, trends in market demand and competitive conditions, (c) sources and availability of raw materials, d) the duration and effect of all patents, trademarks, licenses, franchises and concessions, e) any material portion of the business that may be subject to renegotiation of profits or termination of government contracts or subcontracts at the election of the government and f) seasonality.

In addition, the amendments extend the types of information to be considered to include a broad-based regulatory compliance disclosure topic that encompasses more than environmental laws and regulations, as well as a description of the registrant's human capital resources, including any human capital measures or objectives that the registrant focuses on in managing its business. In the adopting release, the SEC noted attraction, development and retention of personnel as non-exclusive examples of subjects that may be material, depending on the nature of the registrant's business and workforce. The SEC emphasized that these are examples of potentially relevant subjects, not mandates, and that each registrant's disclosure must be tailored to its unique business, workforce, and facts and circumstances. The SEC declined to provide more prescriptive requirements because of its belief that the exact measures and objectives included in human capital management disclosure may evolve over time and may depend on several variables, including, among others, the registrant's industry, the geographic regions or jurisdictions in which it operates, and current macroeconomic and other conditions that affect human capital resources, such as national or global health matters.

Item 103 – Legal Proceedings

Item 103 currently requires disclosure of material pending legal proceedings and certain related information. In this round of amendments, the SEC addressed one of the instructions to Item 103 that currently requires disclosure of any proceeding arising under environmental laws if the government is a party to such proceeding unless the registrant reasonably believes that such proceeding will result in no monetary sanctions or in monetary sanctions of less than $100,000. The SEC amended Item 103 by increasing this quantitative threshold for environmental matters to $300,000. In addition, Item 303 will allow a registrant to utilize a different monetary threshold for environmental matters that the registrant determines is reasonably designed to result in disclosure of material environmental proceedings, provided that 1) such threshold may not exceed the lesser of $1 million or 1 percent of the registrant's consolidated current assets, and 2) the registrant disclosed the alternative threshold in each annual and quarterly report it files with the SEC.

In an effort to reduce duplicative disclosure, the SEC also amended Item 103 to expressly permit registrants to provide responsive disclosure by hyperlink or cross-reference to legal proceedings disclosure elsewhere in the filing. 

Item 105 – Risk Factors

The last area that the SEC addressed in this round of amendments was focused on Item 105 of Regulation S-K, which currently requires concise and logical disclosure of the most significant factors that make an investment in a registrant or an offering speculative or risky, as well as an explanation as to how each risk affects the registrant or the securities being offered. The SEC adopted three key amendments with respect to Item 105:

• If a registrant's risk factors section exceeds 15 pages, the registrant must include a risk factor summary of no more than two pages in the forepart of the prospectus included in a registration statement (i.e., immediately following the prospectus summary required by Item 503, or if no summary, then immediately following the cover page of the prospectus or the pricing information section that immediately follows the cover page) or the annual report. With limited success, the SEC has for a number of years discouraged the inclusion of generic risk factors, and this amendment may be a tactic toward that goal.
• The amendments refine Item 105's principles-based approach by requiring disclosure of "material" risks (i.e., those matters to which there is a substantial likelihood that a reasonable investor would attach importance in connection with an investment decision) rather than the "most significant" risks. 
• Finally, the Item 105 amendments require companies to organize their risk factor disclosures under relevant headings in addition to the sub-captions that are currently required. In the adopting release, with one exception, the SEC declined to specify what may be appropriate risk factor headings, instead deferring to the registrant to determine which headings, and their order of presentation, are most appropriate for the registrant. The one exception is that any risk factors that could apply generally to any registrant or offering of securities must be disclosed at the end of the risk factor section under a separate caption entitled "General Risk Factors."

Effectiveness and Transition Matters

The amendments will be effective on Nov. 9, 2020, and will affect domestic registrants (specifically, disclosure in registration statements, annual and quarterly reports and proxy statements), as well as "foreign private issuers" that have elected to file on domestic forms subject to Regulation S-K disclosure requirements. The amendments will initially affect Forms 10-Q for the quarter ended Sept. 30, 2020, filed on or after the effective date, although the greatest effects will likely be on the first annual reports on Form 10-K or registration statements under the Securities Act of 1933, as amended, filed after the effective date. 

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