On August 26, the SEC voted to adopt amendments to modernize the description of business (Item 101), legal proceedings (Item 103), and risk factor disclosures (Item 105) that registrants are required to make pursuant to Regulation S-K. The amendments reflect the SEC’s continued movement to a principles-based, registrant-specific approach to disclosure.
As detailed below, some of the changes are rather significant, particularly the changes to the business disclosures and the requirement to have a new risk factor summary section of no more than two pages if the risk factors exceed 15 pages. As a result, we expect most companies will need to make revisions and updates to their existing disclosures, specifically in connection with their Annual Report on Form 10-K where Items 101 and 105 of S-K are triggered. The rules are effective 30 days after their publication in the Federal Register.
The following table briefly summarizes the final amendments. We have presented some practical takeaways following the table.
Regulation S-K Item
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Summary of Existing Item Requirements
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Summary of the Final Amendments
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| Item 101 (Description of Business) (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. |
Revises 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.
Revises Item 101(h) to:
- Eliminate the three-year timeframe for smaller reporting companies.
Revises 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.
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| Item 101(c) |
Requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries, focusing upon 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. |
Revises Item 101(c) to:
- Clarify and expand the principles-based approach of Item 101(c), with a non-exclusive list of disclosure topic examples (drawn in part from the topics currently contained in Item 101(c)).
- 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.
- Refocus the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws.
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| Item 103 (Legal Proceedings) |
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.
Contains a threshold for disclosure based on a specified dollar amount ($100,000) for proceedings related to federal, state, or local environmental protection laws.
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Revises Item 103 to:
- Expressly state that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure.
- Implements 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 1% of the current assets of the registrant and its subsidiaries on a consolidated basis.
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| Item 105 (Risk Factors) |
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 sub-caption 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.
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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.
- Require risk factors to be organized under relevant headings in addition to the sub-captions 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.
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Practical Takeaways for Public Companies
Business Section Disclosures Will Now Be Principles-Based with Focus on Materiality
Significant updates were made to S-K Item 101 (Description of Business), as the rules further move the item to principles-based versus prescriptive disclosures. For example, the overarching standard is that only information material to an understanding of the general development of the business is required. While a principles-based disclosure regime has many benefits, including that registrants can tailor the disclosure to fit its facts and circumstances, potential drawbacks are that it could reduce the comparability of information and can, at times, require more time from management to prepare. (I am reminded of my time on the Dodd-Frank Rulemaking Task Force when certain outside parties would petition the SEC for the rules to be principles-based and less prescriptive, but the same parties would later complain that the rules did not provide enough specificity or clarity on what should be disclosed.)
To facilitate the application of the SEC’s principles-based revisions to Item 101 and help give companies some direction on what to include in their disclosure, the amendments include a non-exclusive list of disclosure topic examples.
Re-Double Efforts to Make Sure Business Strategy is Updated for Material Developments
One of the new non-exclusive disclosure topics is to disclose, if material to an understanding of the general development of the business, material changes to a registrant’s previously disclosed business strategy. While Item 101 does not mandate business strategy disclosure, it is quite common for registrants to include this disclosure in the “Business” section of the Form 10-K or a registration statement prospectus. The SEC states in the adopting release, “[W]e believe 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.”
Get Ready for (More) Human Capital Disclosure
Under the final amendments, Item 101(c) will require, 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 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. While such human capital disclosure was already gaining traction with larger-cap companies, we anticipate the new rules will catapult the disclosure topic into most companies’ 10-Ks.
In his statement accompanying the rule’s adoption, SEC Chair Jay Clayton stated, “As I noted, today’s rules require that, in crafting their human capital disclosure, companies must incorporate the key human capital metrics, if any, that they focus on in managing the business, again to the extent material to an understanding of the company’s business as a whole. Experience demonstrates that these metrics, including their construction and their use, widely from industry to industry and issuer to issuer, depending of a wide array of company-specific factors and strategic judgments. As I have said previously, I would expect that the material human capital information for a manufacturing company will be vastly different from that of a biotech startup, and again vastly different from that of a large healthcare provider.”
Don’t Look for Big Changes in the Legal Proceedings Disclosures
The changes to Item 103 (Legal Proceedings) were less significant for most companies. Often, in complying with Item 103, registrants repeat some or all of the disclosures provided in the notes to the financial statements under U.S. GAAP or include a cross-reference to the notes. The final rules simply clarify that registrants are permitted to provide disclosure responsive to Item 103 by hyperlink or cross-reference to legal proceedings disclosure elsewhere in the document, such as in MD&A, Risk Factors, or a note to the financial statements.
Many Companies Will Get a New Risk Factor Summary
To address the lengthy and generic nature of the risk factor disclosure presented by many registrants, the SEC amended Item 105 (Risk Factors) to provide that if the risk factor discussion is longer than 15 pages, the registrant must include in the forepart of the prospectus or annual report, as applicable, a series of concise, bulleted or numbered statements (i.e., risk factor summary) that is no more than two pages summarizing the principal factors that make an investment in the registrant or offering speculative or risky. In the adopting release, the SEC stated, “We estimate that this threshold will affect approximately 40% of registrants.”
Since the amendments will be effective 30 days after their publication in the Federal Register (i.e., likely effective in a couple of months), now is a good time for inside and outside SEC counsel to analyze the new rules and assess their impact on the company’s existing disclosures.
