SEC Adopts Rule Amendments to Modernize Disclosures of Business, Legal Proceedings, and Risk Factors
The SEC adopted amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items have not undergone significant revisions in over 30 years. The final amendments:
- Revise the requirements to discuss the general development of the business to be largely principles-based, requiring disclosure of information material to an understanding of the general development of the business.
- Adopt as a disclosure topic material changes to a registrant’s previously disclosed business strategy.
- Include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business.
- Require summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages.
The final amendments are effective 30 days after publication in the Federal Register.
Currently Item 101(a) requires a description of the general development of the business of the registrant during the past five years, or such shorter period as the registrant may have been engaged in business.
The final amendments revise Item 101(a) to be largely principles-based, requiring disclosure of information material to an understanding of the general development of the business, and eliminating the previously prescribed five-year timeframe. As discussed further below, this includes adopting as a disclosure topic material changes to a registrant’s previously disclosed business strategy.
The final amendments also revise Item 101(h) to eliminate the three-year timeframe for these disclosures with respect to smaller reporting companies.
In addition, the final amendments revise Items 101(a) and (h) to clarify that registrants, in filings made after a registrant’s initial filing, may provide an update of the general development of the business rather than a full discussion. The update must disclose all of the material developments that have occurred since the registrant’s most recent filing containing a full discussion of the general development of its business, and incorporate by reference that prior discussion.
Item 101(c) currently requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries, focusing on the registrant’s dominant segment or each reportable segment about which financial information is presented in its financial statements. To the extent material to an understanding of the registrant’s business taken as a whole, the description of each such segment must include disclosure of several specific matters.
The final amendments revise Item 101(c) to:
- Clarify and expand the principles-based approach of Item 101(c), with a nonexclusive list of disclosure topic examples (drawn in part from the topics currently contained in Item 101(c));
- As discussed further below, include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
- Refocus the regulatory compliance disclosure requirement by including as a topic compliance with all material government regulations, not just environmental laws.
Item 103 currently requires disclosure of any material pending legal proceedings including the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Similar information is to be included for any such proceedings known to be contemplated by governmental authorities. The Item contains a threshold for disclosure based on a specified dollar amount ($100,000) for proceedings related to Federal, State, or local environmental protection laws.
The final amendments revise Item 103 to:
- Expressly state that the required information may be provided by hyperlink or cross-referenced to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
- Implement a modified disclosure threshold that increases the existing quantitative threshold for disclosure of environmental proceedings to which the government is a party from $100,000 to $300,000, but that also affords a registrant the flexibility to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant and its subsidiaries on a consolidated basis.
Currently Item 105 requires disclosure of the most significant factors that make an investment in the registrant or offering speculative or risky and specifies that the discussion should be concise, organized logically, and furnished in plain English. The item also states that registrants should set forth each risk factor under a subcaption that adequately describes the risk. Additionally, Item 105 directs registrants to explain how each risk affects the registrant or the securities being offered and discourages disclosure of risks that could apply to any registrant.
As discussed further below, the final amendments revises Item 105 to:
- Require summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
- Refine the principles-based approach of Item 105 by requiring disclosure of “material” risk factors; and
- Require risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
The final amendments to Item 101(a) adopt as a disclosure topic material changes to a registrant’s previously disclosed business strategy. The SEC believes that once a registrant has disclosed its business strategy, it is appropriate for it to discuss changes to that strategy, to the extent material to an understanding of the development of the registrant’s business. The final amendments do not include a requirement to disclose a company’s business strategy annually.
Human Capital Management
Under the final amendments, Item 101(c) requires, to the extent such disclosure is material to an understanding of the registrant’s business taken as a whole, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business. The SEC believes that, in many cases, human capital disclosure is important information for investors. The final rules also note the Commission’s view that human capital is a material resource for many companies and often is a focus of management, in varying ways, and an important driver of performance.
The final amendments identify various human capital measures and objectives that address the 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. Each registrant’s disclosure must be tailored to its unique business, workforce, and facts and circumstances.
The SEC did not define “human capital” because it believes this term may evolve over time and may be defined by different companies in ways that are industry specific.
Under the final amendments, if a registrant’s risk factor disclosure exceeds 15 pages, Item 105(b) requires in the forepart of the document a series of concise, bulleted or numbered statements summarizing the principal factors that make an investment in the registrant or offering speculative or risky. Because the risk summary is not required to contain all of the risk factors identified in the full risk factor discussion, registrants may prioritize certain risks and omit others.
Amended Item 105 requires registrants to organize their risk factor disclosure under relevant headings, in addition to the subcaptions that are currently required. The final amendments, except for the heading “General Risk Factors”, do not specify risk factor headings that registrants should use. The final amendments require registrants to present risks that could apply generally to any company or offering of securities at the end of the risk factor section under the caption “General Risk Factors.”
The final amendments do not require registrants to prioritize the order in which they discuss their risk factors. Accordingly, if a registrant believes it is useful or important to emphasize the relative importance of certain risks, it is free to write those risk factors and other disclosures in such a way that their relative importance is apparent.