Recently, the SEC adopted amendments to the disclosure requirements in items 101, 103 and 105 of Regulation S-K. As we discussed last year when the SEC first proposed amendments to these disclosures, the amendments generally follow a principles-based approach that is, as SEC Chairman Jay Clayton stated, “rooted in materiality.” The final rule release includes a chart comparing the existing requirements to the final amendments, for which we've included a link at the end of this alert.
In this alert, we provide perspective on the new disclosure requirements, including the new requirement to describe a registrant’s human capital resources to the extent that such information is material to understanding the registrant’s business. The new rules will be effective 30 days after their publication in the Federal Register.
The SEC’s approach and open topics
The amendments are intended to give companies more flexibility in tailoring their disclosures to the nature of their business. They also are designed to enable companies to streamline certain disclosures by allowing them to (i) eliminate information that is not material to an understanding of their business; (ii) provide updates in subsequent filings instead of repeating full discussions of the historic development; (iii) provide hyperlinks to disclosures within their filing to avoid duplication; and (iv) have greater flexibility regarding the quantitative threshold for disclosing material environmental proceedings. At the same time, the amendments contain certain new or expanded disclosure topics registrants should include if material, including, for example, disclosures related to a company’s human capital resources and expanding the regulatory compliance disclosure requirement to include all material governmental regulations, instead of just environmental laws. Finally, the amendments restructure risk factor disclosure in an effort to facilitate investor understanding of material risks.
Notably, however, as highlighted in the dissents of Commissioners Caroline A. Crenshaw and Allison Herren Lee, the amendments do not address disclosures related to climate change risk or certain topical environmental, social and governance (ESG) information. The dissenters also criticized the “generic and vague” human capital disclosure requirements. See Commissioner Caroline Crenshaw’s dissent and Commissioner Herren Lee’s dissent.
Key aspects of the disclosure amendments
The adopting release provides useful guidance to companies as they begin to navigate the amended disclosure requirements, which become effective 30 days after publication in the Federal Register. We provide only a summary below.
Description of the business: items 101(a), 101(c) and 101(h)
General development of the business: items 101(a) and 101(h)
Item 101 requires a description of the registrant’s business. Prior to the amendments, the time frame of the description was the previous five or three years (or such shorter period as the registrant had been in business) plus earlier time periods if material to an understanding of the general development of the business. Item 101(a)(1) included in the required description certain specific events (such as bankruptcy proceedings, material reclassifications and mergers, the acquisition or disposition of material amounts of assets otherwise in the ordinary course of business) and any material changes in the conduct of the business. Subsection (c) also required a narrative description focusing on the registrant’s and its subsidiaries' dominant business segment and any other segments separately reported in the financial statements, with 10 to 12 specific items required in disclosure.
The amendments eliminate the specific five- and three-year disclosure timeframes related to the description of the general development of the business. Going forward, registrants must disclose information material to an understanding the development of their business “irrespective of a specific timeframe.” Also, after the registrant’s initial filing, subsequent filings may provide an update of the general development of the registrant’s business disclosing all material developments since the most recent full discussion of the general development of its business. Registrants may incorporate the full discussion by reference provided it appears in a single, previously filed document; otherwise, the registrant must include a full discussion in its subsequent filing.
The amendments also include a non-exclusive list of topics that a company should disclose if material:
- Any bankruptcy, receivership or similar proceeding
- The effects of any material reclassification, merger or consolidation
- Non-ordinary course acquisitions or dispositions of material amount of assets and
- Changes to a previously disclosed business strategy (note, that disclosure of a company’s business strategy is not required).
Narrative description of the business: item 101(c)
The amendments streamline the current list of required specific disclosure topics, replacing it with a non-exclusive list of disclosure topic examples. While certain topics included on the prior topic list were excluded from the new non-exclusive list, the SEC stressed that under its principles-based approach, registrants would have to provide disclosure about some of the no-longer listed topics if they are material to an understanding of the business and not otherwise disclosed. The adopting release provides illustrative examples. The final non-exclusive list of disclosure topics includes:
- Revenue-generating activities, key products, services, customers, including government customers
- Status of new/enhance product development efforts, market demand trends and competitive conditions
- Resources material to a registrant’s business (a combination of two previously listed disclosure topics and a topic in which the SEC stated that it declined to require registrants to specifically discuss climate change impact, since that requirement was not consistent with the principles-based nature of Item 101(c))
- Duration/effect of all patents, trademarks, licenses, franchises, and concessions held
- Renegotiation or termination of government contracts
- The extent to which the business is or may be seasonal (here again, the SEC declined to require registrants to specifically discuss the impact of climate change)
- Compliance with material government regulations, including environmental regulations (expanding the prior topic to include disclosure of the material effects of compliance with all government regulations, not just environmental regulations, with the SEC rejecting a comment that urged it to define the term environmental regulations to include a variety of regulations related to wildlife protection and climate change) and
- Human capital disclosure (requiring disclosure of, to the extent material of an understanding of the registrant’s business “taken as a whole,” a description of the company’s human capital resources, including any measures or objectives on which the registrant focuses in managing the business. The SEC expressed its belief that “in many cases, human capital disclosure is important information for investors. . . [it] is a material resource for many companies and often is a focus of management . . . and an important driver of performance. The final amendments identify examples of subjects that might be material in this context but stresses that they are examples, not mandates. The SEC did not include a definition of human capital.)
The amended rule deletes references to the following topics previously listed as required under Item 101(c): new segment disclosures (old Item 101(c)(1)(ii)), the dollar amount of backlog orders (old Item 101(c)(1)(viii)) and working capital practices (old item 101(c)(1)(vi)). In the adopting release, the SEC noted that it anticipated that working capital would be addressed in the MD&A section of the registrant’s filing if material to the registrant’s business. The amendments also remove references to quantitative disclosures such as the requirement to identify customers with sales equal to 10% or more of the registrant’s consolidated revenues, the loss of which would have a material adverse effect on the registrant and its subsidiaries.
Throughout its discussion of the amendments to Item 101(c), the SEC stressed that under its principles-based approach disclosures related to the individual topics are required only when material to an understanding of a registrant’s business and that registrants have the flexibility to make disclosures in a manner that will protect sensitive proprietary or competitive information. In addition, the SEC emphasized that under the principles-based approach, registrants will have an improved ability to tailor disclosures to those factors that are material to their business.
Legal proceedings: item 103
Prior Item 103 required disclosure of all material pending legal proceedings, including (through Instruction) environmental protection law proceedings with at least $100,000 in potential sanctions.
To help eliminate repetitive disclosure, the amendment to this item permits registrants to provide the disclosure using a hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the filing (for example, in the MD&A or risk factor sections or in the notes to the registrant’s financial statements). The SEC also updated the quantitative threshold for reporting environmental proceedings, increasing the $100,000 threshold to $300,000, and provided a range within which the registrant can select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings. A registrant must, however, disclose any environmental proceeding when the potential monetary sanctions exceed the lesser of $1 million or one percent of the assets of the registrant and its subsidiaries on a consolidated basis. Registrants who use a threshold other than $300,000 must disclose that threshold and any changes to it in each annual and quarterly report. Finally, the amendments incorporate Item 103’s instructions into the text of the rule.
Risk factors: item 105
Prior to the amendments, Item 105 required disclosure of the most significant factors that make an investment risky or speculative, mandated that the disclosure be logically organized and in plain English, and discouraged disclosures of risks that could apply to any registrant.
A key modification to this rule is the change from “most significant” risks to “material” risks. The SEC concluded that this “will result in risk factor disclosure that is more tailored to the particular facts and circumstances of each registrant, which should reduce the disclosure of generic risk factors and potentially shorten the length of the risk factor discussion, to the benefit of both investors and registrants.”
In an effort to eliminate lengthy and generic boilerplate risk disclosures, the SEC amended Item 105 in the following ways:
- Required risk factor disclosure summary: If a registrant’s risk factor disclosures are more than 15 pages long, the registrant must include a summary risk factor disclosure no more than two pages long in the front of the filing. The summary must include concise, bulleted or numbered statements summarizing the principal factors that make an investment in the registrant or offering speculative or risky. The summary should focus on risks material to investors. Registrants need not include in the summary all risk factors contained in the full risk factor discussion.
- Disclosure of “material” rather than “most significant” risks: The SEC changed the current requirement that registrants disclose their most significant risks to a requirement that they disclose their material risks.
- Required organization of risk factors under relevant headings: To help investors understand risk factors more easily, the amendments require registrants to organize risk factors under specific headings with risk factors that could apply to any company or offering appearing at the end of the risk factor section under a separate caption titled “General Risk Factors.” The SEC suggests no other specific headings but notes that registrants already organize risk factor disclosures by grouping related risk factors together under headings. The SEC also encouraged registrants to “tailor their risk factor disclosures to emphasize the specific relationship of the risk to the registrant or the offering.”
In making these changes to Item 105, the SEC intends for registrants to provide risk factors that are more tailored to the particular facts and circumstances of their business which will reduce the disclosure of generic risk factors. The SEC was careful to point out that the materiality standard encompasses information related to investment and voting decisions.
Implementing the new disclosure requirements: key takeaways
As registrants begin to assess their current disclosures in the context of the amended disclosure requirements, we suggest the following issues be considered:
- What is the appropriate time frame for describing the general development of the business, and what are likely material developments that may require disclosure going forward? Registrants should consider whether to disclose their approach for making these assessments so that investors understand the context of the disclosure. For example, we note that industries subject to rapid change may want to use a shorter timeframe. In this context, the SEC observed:“[f]or example, a long timeframe might be less appropriate for registrants operating in rapidly changing environments where historical information becomes irrelevant in a short period of time.”
- Has the company previously disclosed a business strategy, and if so, are any updates required? Registrants who have previously disclosed a business strategy must evaluate whether there have been any material changes to that previously disclosed business strategy. The SEC stated in the adopting release 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 SEC stressed, however, that the principles-based approach of the amendments will provide registrants with flexibility to determine the “appropriate level of detail” for such disclosures.
- What are the material effects of compliance with government regulations beyond environmental regulation? Registrants will need to assess the effects of compliance with government regulations that might impact capital expenditures, earnings and the competitive position of the company, including subsidiaries, to the extent material to an understanding of the business as a whole.
- Is human capital material to the business and, if so, what human capital disclosures are required? Registrants should consider describing their human capital resources and any human capital measures or objectives on which the company focuses when managing the business, if material to an understanding of the business as a whole or to the understanding of a segment of the business. Registrants should tailor the disclosures to the facts and circumstances of its business and workforce and appropriately adjust disclosures as facts and circumstances change. Companies should disclose how they define human capital metrics and disclose changes to those metrics. As companies assess whether and what to disclose regarding human capital, they should recognize that institutional investors and other organizations are developing ESG and related frameworks for such disclosures that may help inform the structure and content of human capital disclosures. We expect to publish another alert on this topic, including highlighting some recent trends we have observed.
- Are risk factors tailored to the business or offering and appropriately organized? Is a summary risk factor disclosure now required? In adopting the amendments, the SEC cautioned against the use of generic and boiler plate risk disclosures. The SEC noted that such disclosures could put at risk the registrant’s ability to claim the benefit of the PSLRA’s Safe Harbor for forward-looking statements. The SEC explained that “registrants often disclose risk factors that are similar to those used by others in their industry without tailoring the disclosure to their circumstances and particular risk profile.” Under the amended rules, registrants now have the opportunity to take a hard look at current risk disclosures and adjust them so that they are tailored to the business and maximize a company’s ability to benefit from the Safe Harbor.
- Look at factors affecting your supply chain. In discussing amended Item 101(c), the SEC explained: “For example, if supply chain finance arrangements used by a registrant are a significant part of its working capital practices, they may be material to understanding the nature of its commercial relationships. While MD&A disclosures on the topic are more focused on the potential material impact of such arrangements on the registrant’s periodic cash flows and financial condition, the proposed principles-based approach would call for additional disclosure if material to an understanding of those commercial relationships.” To be certain, this is one example of a factor potentially calling for additional disclosure – but it is an important topic given the disruption of supply chains due to the COVID-19 pandemic.
- In assessing materiality, has the company considered both investment and voting decisions? As noted above, the SEC stated that materiality encompasses both investment and voting decisions. Investors vote on transactions, for the election of directors and on a wide variety of other topics. The SEC’s focus on voting decisions in the context of Regulation S-K disclosures is a development companies should assess carefully as they implement the amended disclosure rules.
The overarching theme of the amendments is the SEC’s focus on the registrant’s responsibility for determining what is material to its business and disclosing that information in a manner that allows investors to understand the disclosure. We note that when a public company experiences adversity and its stock price declines, plaintiffs scrutinize the company’s disclosures to try to identify deficiencies. It remains to be seen how the amendments will affect the likelihood and outcome of securities litigation. Under the SEC’s principles-based disclosure regime, the burden will be on the registrant to make reasonable assessments of materiality based on known facts and circumstances. While this flexibility is intended to provide better disclosure, it may pose new risks to registrants when regulators and shareholders view disclosures in hindsight and question their adequacy.
See the SEC’s chart comparing the current disclosure requirements to the new requirements.
For further information about these amendments, please contact the authors or your DLA Piper relationship partner.
 Item 101 and Item 103 generally do not apply to foreign private issuers (FPIs). These changes would be applicable to an FPI that registers its securities on a domestic form, such as Form S-1. Revised Item 105, related to risk disclosures, does apply to FPIs.