SEC Adopts Rules to Amend Regulation S-K
On March 20, 2019 the SEC adopted amendments to Regulation S-K as required by the Fixing America’s Surface Transportation Act (“FAST Act”). The proposed amendments were first published on October 11, 2017 (see HERE). A majority of the amendments were adopted as proposed. As part of the SEC’s ongoing Disclosure Effectiveness Initiative, the amendments are designed to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. For a detailed list of actions that have been taken by the SEC as part of its Disclosure Effectiveness Initiative, see my summary at the end of this blog.
The FAST Act, passed in December 2015, contained two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 required the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.”
Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in a report that was issued on November 23, 2016. Section 72003 specifically required that the report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information. The current amendments seek to implement the various findings and recommendations in the November report.
The new amendments are specifically intended to improve the readability and navigability of company disclosures, and to discourage repetition and disclosure of immaterial information. In particular, the amendments will: (i) increase flexibility in the discussion of historical periods in Management’s Discussion and Analysis; (ii) revise forms to update, streamline and improve disclosures including eliminating risk factor examples in form instructions and revising the description of property requirement to emphasize a materialitythreshold; (iii) eliminate certain requirements for undertakings in registration statements; (iv) allow companies to redact confidential information from most exhibits without filing a confidential treatment request; and (v) incorporate technology to improve access to information on the cover page of certain filings by requiring data tagging and hyperlinks.
The amendments relating to the redaction of confidential information in certain exhibits will become effective immediately. The rest of the amendments will be effective 30 days after they are published in the Federal Register, except that the requirements to tag data on the cover pages of certain filings are subject to a three-year phase-in, and the requirement that certain investment company filings be made in HTML format and use hyperlinks will be effective for filings on or after April 1, 2020.
- Description of Property (Item 102)
Item 102 requires disclosure of the location and general character of the principal plants, mines, and other materially important physical properties of the company and its subsidiaries. The instructions to Item 102 require the company to disclose information reasonable to inform investors as to the suitability, adequacy, productive capacity and utilization of facilities. The amendment emphasizes materiality and requires a company to disclose physical properties only to the extent that such properties are material to the company.
- Management’s Discussion and Analysis (MD&A) (Item 303)
Item 303(a) requires a company to discuss their financial condition, changes in financial condition, and results of operations using year-to-year comparisons. The discussion is required to cover the period of the financial statements in the report (i.e., 2 years for smaller reporting companies and emerging growth companies and 3 years for others). Where trend information is relevant, the discussion may include 5 years with a disclosure of selected financial data.
The amendments remove the reference to a “year to year comparison” and instead allow a company to present the disclosure in whatever format it believes will enhance the reader’s understanding of the information. The amendment will also eliminate the reference to a five-year look-back in the instructions, but rather a company will be able to use any presentation or information that it believes will enhance a reader’s understanding.
Where three years of financial statements are included, the amendments will allow the company to eliminate the earliest year in its discussion as long as the information has been included in a prior filing on EDGAR and the company identifies the location of the prior filing. This differs from the proposed amendment, which would have required the disclosure to have been included in a Form 10-K in order to be omitted and would have contained a specific reference to the materiality of the information. In the final adopting release, the SEC notes that materiality is always the standard and that adding a materiality qualifier to the rule itself was superfluous language that might cause confusion or a belief that some different standard of materiality was being adopted.
The amendments will flow through to foreign private issuers as well with conforming changes to the instructions for Item 5 of Form 20-F.
- Directors, Executive Officers, Promoters and Control Persons (Item 401)
Item 401 requires disclosure of identifying and background information about a company’s directors, executive officers, and significant employees. The amendments clarify the instructions to Item 401 to explain that the information is not required to be duplicated in various parts of a Form 10-K and/or proxy statement, but need only appear once and may be incorporated by reference in other parts of the documents.
- Compliance with Section 16(a) (Item 405)
Section 16(a) of the Exchange Act requires officers, directors, and specified types of security holders to report their beneficial ownership of a company’s equity securities using forms prescribed by the SEC, such as an initial Form 3, amendments on Form 4 and annual Form 5. Item 405 requires the company to disclose each person who failed to timely file a Section 16 report during the most recent fiscal year or prior years. Section 16 reporting persons are required to deliver a copy of their reports to the company, though in practice, this is rarely done. The amendments remove this requirement and allow the company to review EDGAR filings for compliance with Section 16(a).
In addition, the amendment eliminates the need to include the heading at all if there are no delinquencies to report, rather than include the heading with a statement such as “none” and removes the checkbox on the cover page of Form 10-K related to the disclosure. The amendment includes several changes to make the instructions and title of this section conform to the SEC’s “plain English” requirements.
- Corporate Governance (Item 407)
The amendment will update the instructions and information required under Item 407 to remove reference to an obsolete audit standard and rather just refer broadly to applicable PCAOB and SEC requirements. EGC’s and smaller reporting companies are both exempted from the Item 407 requirements, and the amendment clarifies the instruction language accordingly.
- Outside Front Cover Page of the Prospectus (Item 501(b))
The amendments are designed to streamline the front cover page of a prospectus and give a company flexibility in designing the page to tailor to their business and particular offering. The changes include (i) eliminating instructions related to changing or clarifying a name that may be confused with a well-known company; (ii) allowing for a statement that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus with a cross-reference to the page number; (iii) requiring the disclosure of the principal trading market and company symbol, even if such trading market is not a national exchange; and (iv) streamlining the “subject to completion” legend.
- Risk Factors (Item 503(c))
A company is required to disclose the most significant factors that make an offering speculative or risky. Although the disclosure is intended to be principles-based, many examples are included in the instructions. The amendments would move Item 503(c) to Subpart 100 to clarify that risk factors are also required in a Form 10 and Exchange Act periodic reports and not just offering-related disclosures. The amendment also eliminates the risk factor examples from the instructions.
- Plan of Distribution (Item 508)
Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about underwriters. The term “sub-underwriter” is referred to in the rule; however, it is not defined. The rules define a “sub-underwriter” 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.”
- Undertakings (Item 512)
Item 512 provides undertakings that a company must include in Part II of its registration statement, depending on the type of offering. The amendments simplify the undertakings requirements and eliminate provisions that are duplicative because the requirement already exists, or that are obsolete due to changes in the law. For example, Items 512(d), 512(e) and 512(f) are all obsolete and should be eliminated. Item 512(c) related to unsold rights offerings that are then offered to the public, can be eliminated as other provisions of the law would require the company to update the (or complete a new) registration statement regardless.
- Exhibits (Item 601)
The amendment makes several changes to the exhibit filing requirements to streamline and reduce the volume of documents which are required to be filed, many of which may not be material. Only newly reporting companies will be required to file material contracts that were entered into within two years of the applicable registration statement or report, thus reducing duplicative, voluminous disclosures.
The amendment adds exhibits related to Item 202 disclosures (registered capital stock, debt securities, warrants, rights, American Depository Receipts, and other securities) to Exchange Act periodic reports on Form 10-K and 10-Q. Such exhibits are currently only required in registration statements, Form 8-K and Schedule 14A.
Related to material agreement exhibits, the amendment also clarifies that schedules and exhibits to exhibits need not be filed unless they are, in and of themselves, material to an investment decision. Although historically the SEC did not object to the omission of schedules and exhibits to exhibits with personally identifiable information, the rules generally required the filing of a confidential treatment request for most omissions. The amendments allow a company to omit schedules and exhibits to exhibits as long as a description of the omitted documents is included. Likewise, the amendments will allow a company to redact information that is both (i) not material, and (ii) competitively harmful if disclosed without the need for a confidential treatment request. Exhibits with redacted information must be clearly labeled accordingly.
The amendments are not meant to alter what information is deemed confidential or can be omitted, but rather to streamline the process by allowing a company to redact without the confidentiality treatment process. The amendments related to redaction and confidential information only apply to material agreement exhibits under Item 601(b)(10) and not to other categories of exhibits, which would rarely contain competitively harmful information. The SEC may still randomly review company filings and “scrutinize the appropriateness of a registrant’s omissions of information from its exhibits.” I expect that for the first year or so following the implementation of these amendments, the SEC will review redactions on a regular basis, providing guidance via comment letters assisting practitioners in advising their clients.
- Incorporation by Reference
Currently rules related to incorporation by reference are spread among a variety of regulations, including Regulation S-K, Regulation C, Regulation 12B and numerous forms. The amendments will revise Item 10(d), Rule 411, Rule 12b-23 and a number of SEC forms to simplify and modernize these rules while still providing all material information. The amendments streamline the rules and further allow for incorporation by reference to eliminate duplicative disclosure.
The rules will require a hyperlink to information that is incorporated by reference if the information is available on EDGAR rather than having to file the document as an exhibit to the registration statement or report.
The rules specifically do not add or change the rules related to cross-references or other incorporation within the financial statements to other disclosure items. There is a concern as to the impact on auditor review requirements if such links or changes are added. In particular, items that are included within financial statements are subject to audit and internal review, internal controls over financial reporting and XBRL tagging. Furthermore, forward-looking statement safe-harbor protection is not available for information inside the financial statements.
The amendments include several amendments to forms to conform with and implement all the changes in the rules. Moreover, companies will now have to include the national exchange or principal U.S. trading market, the trading symbol and title of each class of securities on the cover page of Forms 8-K, 10-Q, 10-K, 20-F and 40-F.
The amendments will require all of the information on the cover pages of Form 10-K, Form 10-Q, Form 8-K, Form 20-F, and Form 40-F to be tagged in Inline XBRL in accordance with the EDGAR Filer Manual.
Further Background on SEC Disclosure Effectiveness Initiative
I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes.
In December 2018 the SEC approved final rules to require companies to disclose practices or policies regarding the ability of employees or directors to engage in certain hedging transactions, in proxy and information statements for the election of directors. To review my blog on the final rules, see HERE and on the proposed rules, see HERE.
In November, 2018, I published a blog on how to seek relief from the financial statement disclosure requirements pursuant to Rule 3-13 of Regulation S-X. See HERE.
In the fourth quarter of 2018, the SEC finalized amendments to the disclosure requirements for mining companies under the Securities Act and the Securities Exchange. The proposed rule amendments were originally published in June 2016. In addition to providing better information to investors about a company’s mining properties, the amendments are intended to more closely align the SEC rules with current industry and global regulatory practices and standards as set out in by the Committee for Reserves International Reporting Standards (CRIRSCO). In addition, the amendments rescinded Industry Guide 7 and consolidated the disclosure requirements for registrants with material mining operations in a new subpart of Regulation S-K. See HERE.
On June 28, 2018, the SEC adopted amendments to the definition of a “smaller reporting company” as contained in Securities Act Rule 405, Exchange Act Rule 12b-2 and Item 10(f) of Regulation S-K. See HERE and later issued updated C&DI on the new rules – see HERE. The initial proposed amendments were published on June 27, 2016 (see HERE).
In December 2017, the American Bar Association (“ABA”) submitted its fourth comment letter to the SEC related to the financial and business disclosure requirements in Regulation S-K. For a review of that letter and recommendations, see HERE.
In October 2017, the U.S. Department of the Treasury issued a report to President Trump entitled “A Financial System That Creates Economic Opportunities; Capital Markets” (the “Treasury Report”). The Treasury Report made specific recommendations for change to the disclosure rules and regulations, including those related to special-interest and social issues and duplicative disclosures. See more on the Treasury Report HERE.
On October 11, 2017, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”). The proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk-factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks. See my blog HERE. On March 20, 2019, the SEC adopted final rules on this proposal, which is the subject of this blog.
On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The new Rule went into effect on September 1, 2017 for most companies and on September 1, 2018 for smaller reporting companies and non-accelerated filers. See my blog HERE on the Item 601 rule changes and HERErelated to SEC guidance on same.
On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read HERE.
On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.
On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. Final amendments were approved on August 17, 2018 – see HERE.
The July 2016 proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.
In September 2015, the SEC also issued a request for public comment related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE. Taking into account responses to portions of that request for comment, in the summer of 2018, the SEC adopted final rules to simplify the disclosure requirements applicable to registered debt offerings for guarantors and issuers of guaranteed securities, and for affiliates whose securities collateralize a company’s securities. See my blog HERE.
As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the reporting requirements in general, see my blog HERE.
In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.
In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. See my blog HERE.