The US Securities and Exchange Commission (SEC or the Commission) voted on March 20 to adopt final rules to modernize and simplify disclosure requirements for public companies. The amendments, which were proposed in October 2017, are intended to implement the Commission’s mandate under the Fixing America’s Surface Transportation (FAST) Act and are based on recommendations from the Staff’s FAST Act Report published in November 2016.
Among other things, the amendments (i) provide registrants with greater flexibility in presenting management’s discussion and analysis of financial condition and results of operations (MD&A); (ii) allow registrants to redact certain portions of information from certain exhibits without requiring the submission of a confidential treatment request; and (iii) simplify additional disclosure requirements and the disclosure process, including disclosure rules under Regulation S-K of the Securities Exchange Act of 1934, as amended. Except as noted below, the rules become effective 30 days after their publication in the Federal Register.
Below we analyze some of what we believe are the most significant changes to the disclosure requirements and disclosure process for public companies.
Currently, Item 303(a) of Regulation S-K requires registrants to discuss their financial condition and changes in financial condition and results of operations in year-to-year comparisons that generally cover a three-year period presented by the financial statements in the filing. The amendments allow registrants to omit discussion of the earliest of the three years in the MD&A if the registrant’s prior filings with the SEC already contained such discussion and, in management’s view, such discussion is not necessary to understand the registrant’s financial condition, changes in condition, and results of operations. The amendments also eliminate the reference to five-year selected financial data for trend information in Instruction 1 of Item 303 and instead provide that the registrant may use any presentation that, in its judgment, would enhance a reader’s understanding of the registrant’s financial condition, changes in financial condition and results of operations. The Commission also adopted equivalent revisions to Item 5 of Form 20-F (Operating and Financial Review and Prospectus), which requires foreign private registrants to present disclosure substantively comparable to the MD&A requirements under Item 303.
We note that while omitting the discussion of the earliest year in the MD&A may streamline or reduce the burden on registrants, the SEC reiterated that the discussion must provide “such other information that the issuer believes to be necessary to an understanding of its financial condition, changes in condition, and results of operations.” Therefore, public companies must assess the materiality of the discussion of the earliest year in determining whether to omit such discussion.
Registrants may redact specific and confidential information from certain exhibits filed in response to Item 601 where such information is not material and is covered by an exemption from the Freedom of Information Act.[1] Such exhibits include material contracts under Item 601(b)(10) and material plans of acquisition, disposition, reorganization, readjustment, succession, or liquidation under Item 601(b)(2). However, to obtain confidential treatment under existing rules and procedures, registrants must submit a detailed application to the Commission that identifies the particular text for which confidential treatment is sought, addresses the legal grounds for the exemption, and explains why disclosure is unnecessary for the protection of investors. These confidential treatment requests (CTRs) are subject to review and possible comments by the Commission’s Staff.
Under the amended rules, registrants will be permitted to omit confidential information in exhibits filed under Item 601(b)(2) and (b)(10) without submitting a CTR, so long as the information to be redacted is (i) not material to investors, and (ii) would likely cause competitive harm to the registrant if disclosed publicly. Registrants must still clearly mark their exhibits to indicate where immaterial and competitively harmful information has been omitted, and that any redactions will remain subject to review and comment at the Staff’s discretion.
In light of this change in procedure, we recommend that registrants seeking to redact information from exhibits filed in response to Item 601(b)(2) or (b)(10) going forward still engage in the materiality and competitive harm analysis they did when submitting CTRs, and to maintain records of such analysis, should any questions arise involving such redactions. Indeed, the Adopting Release states that the revisions do not limit the Commission’s or the Staff’s ability to scrutinize the appropriateness of a registrant’s omissions of information from its exhibits. The Commission further noted that the Staff “may request that a registrant file an amendment that includes some, or all, of the information previously redacted from an exhibit.” We note the foregoing is effective upon the rule’s publication in the Federal Register, instead of the typical 30 days after publication.
Furthermore, as discussed in more detail below, the Commission amended Item 601 to allow registrants to omit schedules or similar attachments to exhibits under certain circumstances and to codify current Staff practice of not objecting to redactions of sensitive personally identifiable information from exhibits without submitting a CTR.
In addition to the above, the Commission adopted the following changes intended to reduce costs and burdens on registrants:
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Rule |
Change |
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Securities Act Rule 411(b)(4); Exchange Act Rules 12b-23(a)(3) and 12b-32; Rule 0-4 |
Registrants will no longer be required to file as an exhibit any documents that are incorporated by reference in a filing, but instead will be required to provide hyperlinks to documents incorporated by reference. The Commission noted that registrants are not required to refile information that is incorporated by reference from a document that was previously filed with the Commission on paper. The Commission also amended these rules to prohibit having financial statements incorporate information by reference from other filings or cross-reference to disclosure in other parts of a filing, unless otherwise specifically permitted or required by the Commission’s rules or by US GAAP or IFRS. The Commission’s intent is to address concerns that referencing information outside the audited financial statements to satisfy financial statement disclosure requirements could create confusion about which financial information has been audited or reviewed by the independent auditor. |
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Item 10(d) |
Item 10(d) has been revised to eliminate the prohibition of incorporating documents by reference that have been on file with the Commission for more than five years. The Commission noted that this prohibition now serves little purpose given the current practice of filing documents electronically. |
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Item 102 |
Disclosure about a physical property will be required only to the extent that it is material to the registrant. As revised, Item 102 will allow a reporting company to assess the materiality of its properties to its business. |
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Item 401 |
Instruction 3 to Item 401(b) has been moved as a general instruction to Item 401 to clarify that registrants need not duplicate disclosure about their executive officers required under Item 401 in their proxy statements if they have already provided it in Part I of Form 10-K. |
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Item 405; Form 10-K |
The caption required by Item 405(a)(1) has been changed from “Section 16(a) Beneficial Ownership Reporting Compliance” to the more specific “Delinquent Section 16(a) Reports.” Item 405 also has been revised to clarify that registrants are encouraged not to provide this caption if there are no delinquencies to report. The amendments also eliminate the checkbox on the cover page of Form 10-K (and the related instruction in Item 10 of Form 10-K) whereby a registrant must indicate that there is no disclosure of delinquent filers in the Form 10-K and, to the best of the registrant’s knowledge, will not be included in a definitive proxy incorporated by reference. |
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Item 407(e)(5) |
The revisions clarify that emerging growth companies (EGCs) are not required to provide a compensation committee report, given that EGCs are not required to provide compensation discussion and analysis under Item 402(b). |
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Item 501(b)(3) |
The “red herring” legend required on the cover page of a preliminary prospectus will no longer be required to include references to the need for offers and sales of the securities to comply with state law if such state laws are inapplicable. This revision acknowledges the federal preemption of state securities laws in registered offerings of exchange-listed securities. |
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Item 501(b)(10) |
If the prospectus cover page is unable to identify the offering price (because it is to be determined based on a formula or other method rather than a specified price known at the time of offering), the issuer may omit a lengthy description of the method for determining the offering price on the cover page and instead include a cross-reference to such detailed description later in the prospectus. |
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Item 503 |
The amendments eliminate the specific examples of risk factors currently identified in Item 503(c). As with other changes to Regulation S-K, the Commission noted that providing specific examples of disclosure is inconsistent with the Commission’s principles-based approach to disclosure requirements. The change is intended to encourage registrants to focus on their own risk identification processes. Moreover, Item 503 will become new Item 105, grouped with other disclosure requirements related to a registrant’s business. |
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Item 508 |
The Commission added a definition in Rule 405 to the term “sub-underwriter,” which is used in Item 508 but had not been defined previously. “Sub-underwriter” will be defined as a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities, but is not itself in privity of contract with the issuer of the securities. |
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Item 512 |
The amendments eliminate paragraph (c) of Item 512 because it is no longer necessary and paragraphs (d), (e), and (f) because they are obsolete. Item 512(c) requires a registrant to supplement the prospectus to disclose the results of the subscription offer and the terms of any subsequent reoffer to the public, but the registrant would already have to register and disclose the offering to existing security holders, as well as the reoffering to the public. Also, disclosure of material changes in the terms of the offering would also be required under Item 512(a)(1). Meanwhile, each of paragraphs (d), (e), and (f) is no longer necessary because of prior changes in rules. |
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Item 601(a)(5) |
Registrants may omit schedules or similar attachments to the exhibits required under Item 601 if they do not contain information that is material to an investment or voting decision and that information is not otherwise disclosed in the exhibits or the relevant filing. Exhibits must contain a list briefly identifying the contents of all omitted schedules. |
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Item 601(a)(6) |
The Commission has codified current Staff practice of not objecting to a registrant’s redaction of sensitive personally identifiable information (PII) for an exhibit filed under Item 601 without submitting a CTR. Examples of PII include bank account numbers, social security numbers, and home addresses. |
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Item 601(b)(4) |
Reporting companies will be required to include the “Description of Capital Stock” disclosure required by Item 202 as an exhibit to Form 10-K. The “Description of Capital Stock” is currently required in the prospectus for an IPO and in the Form 8-A Exchange Act registration statement for a newly public company, and is often incorporated by reference into prospectus filings thereafter. |
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Item 601(b)(10) |
Only newly reporting registrants will be required to provide material contracts entered into within two years of the applicable registration statement or report. This revision eliminates the requirement for registrants to file a contract that has been already fully performed but was entered into within two years prior to the filing date of the relevant filing. |
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Forms 8-K, 10-Q, 10-K, 20-F, and 40-F |
Registrants will be required to disclose on the cover page of each form the national exchange or principal US market for their securities, the trading symbol, and the title of each class of securities. Registrants also will be required to tag all cover page data in Inline XBRL. |
We expect the foregoing amendments generally to reduce costs and burdens on registrants. In particular, we note that the change in the requirement to submit confidential treatment requests for exhibits filed pursuant to Item 601(b)(2) and (b)(10) ought to alleviate much of the difficulty in complying with those exhibit requirements, especially for registrants in certain industries. Meanwhile, it remains to be seen the extent to which registrants will take advantage of some of the changes, such as altering the presentation format of their MD&A disclosure, limiting Item 102 disclosure only to those properties they deem material, or reassessing their risk factor disclosure in light of the changes to Item 503.
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
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
Singapore
Bernard Lui*
Joo Khin Ng*
Vanessa Ng*
*A solicitor of Morgan Lewis Stamford LLC, a Singapore law corporation affiliated with Morgan, Lewis & Bockius LLP
[1] Most applicants rely on the provision of FOIA that exempts certain trade secrets or privileged or confidential commercial or financial information. Refer to 5 U.S.C. 552(b)(4).