SEC Modernizes Business, Legal Proceedings, and Risk Factor Disclosures Under Regulation S-K

The US Securities and Exchange Commission announced that it voted on August 26 to adopt amendments to Regulation S-K to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make. The amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and the disclosure of information that is not material. The amendments will become effective 30 days after publication in the Federal Register, and we expect some of the amended rules to be relevant for calendar year companies in preparing their Forms 10‑Q for the quarterly period ending September 30, 2020.

The US Securities and Exchange Commission (SEC) had proposed amendments modernizing the business, legal proceedings, and risk factor disclosure requirements of Regulation S-K in August 2019, and announced on August 26 that it has adopted these amendments. Specifically, the amendments revise Items 101(a) (description of the general development of the business), 101(c) (narrative description of the business), 103 (legal proceedings), and 105 (risk factors) of Regulation S-K to emphasize a more principles-based approach.

The amendments are part of the SEC’s Disclosure Effectiveness Initiative and draw on extensive comments received in response to the 2016 concept release that revisited business and financial disclosure requirements in Regulation S-K.

The amendments to Items 101 and 103 affect only domestic registrants and foreign private issuers that file on domestic forms, since SEC forms reserved for foreign private issuers do not refer to those items. However, the amendments to Item 105 do affect foreign private issuers, since Forms F-1, F-3, and F-4, like their domestic counterparts, all refer to that item.

General Development of Business (Item 101(a))

The SEC revised Item 101(a) to be largely principles-based by

• requiring disclosure of information material to an understanding of the general development of the business, and eliminating a prescribed timeframe for such disclosure; and
• permitting a registrant, in filings made after the registrant’s initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which must be incorporated by reference.

In removing the five-year timeframe for Item 101(a) disclosure, the SEC noted in the adopting release that a fixed timeframe may not always elicit the most relevant disclosure. The SEC also emphasized that removal of the fixed timeframe offers registrants flexibility to tailor their disclosure, while some registrants may even prefer to describe the development of their business over a longer period in order to provide information that may be material to an investment or voting decision.

A registrant that chooses to provide only an update to the general development of its business will now be required to incorporate by reference through an active hyperlink to a registration statement or report that includes the full discussion of the general development of its business. According to the adopting release, a registrant is only permitted to incorporate the full discussion of the general development of its business from a single previously filed document, rather than from multiple filings.[1] If a registrant chooses to not take this approach of updating the general development disclosure, the registrant must provide a complete discussion of its business development, including any material updates.

Narrative Description of Business (Item 101(c))

The SEC amended Item 101(c) to

• clarify and expand its principles-based approach, with a nonexclusive list of disclosure topic examples;
• require a description of the registrant’s human capital resources, to the extent such disclosure would be material to an understanding of the registrant’s business (Item 101(c)(2)(ii)); and
• include material government regulations as a disclosure topic, expanding the focus beyond just environmental laws to other material government regulations (Item 101(c)(2)(i)).

The nonexclusive list of disclosure topic examples under Item 101(c) offers registrants the opportunity to provide disclosure relating to additional topics that may be material to an understanding of their specific businesses.

The disclosure requirement for human capital resources is largely principles-based and is required only to the extent such information would be material to an understanding of the registrant’s business. The adopting release does not define the term “human capital” and the SEC provides little guidance on the content of such disclosure, except that registrant should consider disclosing “measures or objectives that address the development, attraction and retention of personnel.” Given this is a new disclosure topic for many public companies, we expect to see divergent approaches as practice evolves over time.

The requirement to disclose the material effects of compliance with material government regulations largely codifies common practice among registrants. In response to prior Item 101(c)(1)(xii), which required disclosure of the material effect of compliance with environmental laws, many registrants included disclosure of government regulations that may be material to their business.

Legal Proceedings (Item 103)

The SEC amended Item 103 to

• indicate that the required information under Item 103 may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the filing; and
• increase the threshold for disclosure of environmental proceedings to which the government is a party to $300,000 from $100,000 to adjust for inflation.

We note that the ability to hyperlink and cross-reference disclosure to satisfy the Item 103 requirement is limited to disclosure provided within the same filing, rather from previously filed documents. Despite noting that Item 103 and US generally accepted accounting principles have overlapping disclosure requirements regarding legal proceedings, the SEC did not adopt substantive changes to the disclosure requirements of Item 103 to address this overlap.

In addition to increasing the disclosure threshold to $300,000, Item 103 will now also allow a registrant to use another threshold of the registrant’s choice. The conditions for this alternative threshold are

• the registrant must determine it is reasonably designed to result in disclosure of any legal proceeding that is material to the business or financial condition;
• the registrant discloses such threshold (including any change thereto) in each annual and quarterly report; and
• the threshold does not exceed the lesser of $1 million or 1% of the current assets of the registrant and its subsidiaries on a consolidated basis. Regardless of the alternative threshold adopted by the registrant, disclosure will be required in all cases for any proceeding when the potential monetary sanctions exceed the lesser of $1 million or 1% of the current assets.

Risk Factors (Item 105)

The SEC amended Item 105 to

• require a summary of risk factors no more than two pages long if the risk factor section exceeds 15 pages;
• change the disclosure standard from the “most significant” risk factors to the “material” risk factors; and
• require risk factors to be organized under relevant headings, with any risk factors that may generally apply to any registrant or an investment in securities disclosed at the end of the risk factor section under a separate caption entitled “General Risk Factors.”

If a registrant’s risk factor disclosure exceeds 15 pages, Item 105 will now require a series of concise, bulleted, or numbered statements summarizing the principal factors that make an investment in the registrant or the offering risky. The registrant must provide this summary in the forepart of the annual report or prospectus, and the summary must be limited to two pages.

The change from “most significant” to “material” in Item 105 is intended to focus registrants on disclosing risks to which reasonable investors would attach importance in making an investment or voting decision. The SEC believes this change will reduce the disclosure of generic risk factors and potentially shorten the length of risk factor disclosures.

Conclusion

We expect the amendments to Items 101, 103, and 105 of Regulation S-K to offer registrants more flexibility to provide more tailored disclosure specific to their businesses. We encourage public companies to consult with counsel to determine what adjustments and changes should be made to existing disclosures in SEC filings in response to these new rules.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Laurie Cerveny
Michael Conza
Bryan Keighery
Carl Valenstein
Julio Vega

Frankfurt
Torsten Schwarze

Hong Kong
June Chan
Eli Gao
Louise Liu
Edwin Luk
Billy Wong

London
Timothy J. Corbett
Iain Wright

Moscow/London
Carter Brod

New York
Thomas P. Giblin, Jr.
Howard A. Kenny
Christina Melendi
Kimberly M. Reisler

Palo Alto
Albert Lung

Philadelphia
Justin W. Chairman
James W. McKenzie
Joanne R. Soslow

Pittsburgh
Celia Soehner

Princeton
David C. Schwartz

Singapore
Bernard Lui
Joo Khin Ng

[1] As noted in the adopting release, this approach is more restrictive than the existing incorporation by reference requirements that generally allow registrants to provide disclosure by incorporating by reference from more than one previously filed document.