On October 11, 2017, the Commissioners of the U.S. Securities and Exchange Commission (SEC) voted unanimously in an open meeting to propose amendments to Regulation S-K and related rules and forms. The proposing release is now available here.
The proposed amendments aim to make certain SEC disclosure requirements less burdensome for registrants by eliminating or updating provisions in Regulation S-K considered to be duplicative, overlapping, outdated or unnecessary, while ensuring that registrants continue to provide investors with all material information about their business and financial position. The proposal reflects a cautious, incremental approach toward streamlining technical disclosure obligations, rather than a comprehensive overhaul or reform.
The deadline for commenting on the SEC’s proposals is 60 days after publication of the proposal in the Federal Register. Disclosure requirements will not change until the SEC adopts a final rule on this proposal.
Executive Summary
As described more fully below under “The Proposed Amendments,” the SEC’s proposal addresses a broad range of disclosure requirements under Regulation S-K. The following are among the more notable proposed amendments.
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Management’s Discussion and Analysis: The proposal would allow registrants to omit the earlier year-over-year discussion from their MD&A if discussion of the earliest year is no longer material and was included in the registrant’s previously-filed annual report.
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Exhibits: The proposal would allow registrants to omit or redact certain immaterial information in schedules and exhibits to their SEC filings.
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Registrants would be permitted to omit attachments and schedules filed with all exhibits unless they contain material information that is otherwise undisclosed (currently, registrants are only permitted to omit attachments and exhibits to merger and acquisition-related agreements). Registrants would be required to provide copies of the omitted attachments or schedules to the Staff upon request.
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Registrants would be permitted to omit confidential information from material contract exhibits without submitting a confidential treatment request if they believe the information is immaterial and would be competitively harmful if disseminated.
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Registrants other than new reporting companies would not be subject to the current two-year look-back test for material contracts.
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Registrants who have obtained legal entity identifiers (LEIs) for themselves or their subsidiaries would need to disclose them.
Background
The proposed amendments respond to a Congressional mandate under the Fixing America’s Surface Transportation Act of 2015 (FAST Act), which instructed the SEC to review Regulation S-K to determine how its requirements could be modernized and simplified and to propose corresponding amendments. The proposals are the SEC’s first rule-making action under Chairman Jay Clayton and Director of the Division of Corporation Finance William Hinman, both of whom were recently appointed following long careers representing market participants in private legal practice.
We view the proposed amendments as small, incremental changes that would not substantially reduce the effort involved in SEC reporting but would marginally improve the efficiency and navigability of SEC registration statements and periodic reports. In his prepared remarks, Commissioner Michael Piwowar likened the proposal to pruning a regulatory orchard: “a snip here, a snip there—designed to shape and guide a healthy plant so that our disclosure regime will continue to bear fruit.” Commissioner Kara Stein noted that while she is supportive of the proposed amendments, she believes that “this proposal could go further to truly modernize both how companies provide disclosure and how investors receive it.”
We also note that the proposed rules may affect companies that are not SEC registrants if they offer securities in markets that analogize disclosure to SEC requirements. For example, to the extent SEC registrants change their approach to MD&A disclosure in response to the adoption of the proposed rules, issuers in the 144A and Regulation S markets may be expected to follow suit.
The proposed amendments largely adopt the recommendations made by the staff of the SEC (Staff) in its Report on Modernization and Simplification of Regulation S-K (Report) published on November 23, 2016. The Report was mandated by Section 72003 of the FAST Act and is part of the Staff’s broader Disclosure Effectiveness Initiative. In this memo, we highlight certain proposed amendments that depart from the Staff’s recommendations in the Report.
The proposed amendments take into account the comment letters the Staff received on a previous concept release that addressed certain of the same topics; a previous Staff study of Regulation S-K mandated by the Jumpstart Our Business Startups Act of 2012; the responses to the Staff’s request for comment on the requirements relating to management, security holders and corporate governance matters in Subpart 400 of Regulation S-K; and the Staff’s prior internal review of the history and development of Regulation S-K. The SEC made clear that the proposed amendments do not extend substantially beyond the Staff’s recommendations in the Report, and that the SEC continues to consider additional changes to its disclosure regime in connection with recent proposing releases and requests for comment.[1]
Proposed Amendments
The proposed amendments address a variety of disclosure requirements under Regulation S-K. We have summarized them below in the order they appear in Regulation S-K, although some of the proposed amendments may be significantly more meaningful for certain registrants than others.
Item 10(d) (General)
The SEC proposes to amend Item 10(d) of Regulation S-K to permit incorporation by reference of documents that have been on file with the SEC for more than five years, but require a hyperlink to such documents and specific descriptions of the locations of these documents. The proposed amendments also address incorporation by reference in filings made by investment companies and investments advisers under the U.S. Investment Company Act of 1940, as amended and the U.S. Investment Advisers Act of 1940.
In addition, the SEC noted that cross-references in a registrant’s financial statements to disclosure provided outside of the financial statements may raise questions regarding the scope of an audit of a company’s financial statements. Accordingly, the SEC proposes that registrants not be permitted to incorporate by reference into their financial statements disclosure found elsewhere, unless otherwise specifically contemplated by the applicable disclosure rules. The SEC noted that there is no prohibition on cross-referencing to or incorporating by reference information from the financial statements (or elsewhere in a prospectus) to satisfy narrative disclosure requirements of Regulation S-K, and encouraged registrants to make use of their financial statements for that purpose.
Item 102 (Description of Property)
The proposed amendments would revise Item 102 to require disclosure of physical properties only to the extent that such properties are material to the registrant. This proposal recognizes that many registrants today are less reliant on particular physical properties to operate their businesses.
In contrast to the Staff’s recommendations in the Report, the SEC is not proposing to combine the description of material physical properties with the description of business in Item 101(c) of Regulation S-K.
Item 303 (Management’s Discussion and Analysis)
The proposed amendments would revise Item 303(a) to clarify that when financial statements included in a filing cover three fiscal years, discussion about the earliest year (i.e., the earlier of the two year-over-year comparisons customarily included in MD&A) would not be required if (1) the discussion of the earliest year is not material to an understanding of the registrant’s financial condition, changes in financial condition and results of operation and (2) the registrant has filed its annual report for the prior fiscal year on EDGAR containing MD&A of the earliest year of the three-year period covered by the current filing. The SEC is not proposing the recommendation included in the Report to allow registrants to include a hyperlink to the prior year’s annual report for the additional year-over-year comparison.
The SEC also proposes to amend Instruction 1 to Item 303(a) to eliminate the statement that, where trend information is relevant, reference to the five-year selected financial data in Item 301 may be necessary. Specifically, the SEC proposes to eliminate the reference to trend information because it appears to be duplicative of the existing trend disclosure requirements for liquidity, capital resources and results of operation.
In addition, the SEC proposes to simplify Instruction 1 to Item 303(a) to emphasize that registrants may use any presentation that, in the registrant’s view, would enhance a reader’s understanding of trend information. Currently, Instruction 1 suggests that registrants use a year-to-year format, while the proposed amendments would encourage registrants tailor the presentation of their MD&A disclosure to reflect their particular circumstances, provided that they disclose the information required by Item 303.
The SEC indicated that these amendments will encourage registrants to take a “fresh look” at their MD&A.
The SEC is not proposing to adopt the recommendation included in the Report to amend Items 303(a)(1) and 303(a)(5) to eliminate the requirement to provide a tabular disclosure of contractual obligations.
With respect to foreign private issuers, the SEC noted that since the disclosure requirements for Item 5 of Form 20-F are substantively similar to the MD&A requirements under Item 303, it proposes changes to Form 20-F that are consistent with its proposed amendments to Instruction 1 of Item 303(a). The SEC, however, is not proposing to amend the MD&A requirements under Form 40-F since Form 40-F generally permits Canadian issuers to prepare their MD&A in accordance with Canadian disclosure standards.
Item 401 (Directors, Executive Officers, Promoters and Control Persons)
The SEC proposes to clarify that Instruction 3 to Item 401(b) also applies to Item 401(e) by moving it from Item 401(b) and making it a general instruction to Item 401. Essentially, this proposed amendment would eliminate the requirement that a registrant identify its executive officers by name, age, position and term of office in its proxy statement if such information is already disclosed in the registrant’s annual report on Form 10-K.
Item 405 (Compliance with Section 16(a) of the Exchange Act)
In the Report, the Staff had recommended that the SEC consider adding an instruction to Item 405 that would permit registrants to rely on a review of Forms 3, 4, and 5, and amendments thereto (Section 16 Reports), filed on EDGAR, unless it knew, or had reason to believe, that the information in such reports is not complete or accurate. In the proposing release, the SEC expressed concerns regarding the adoption of that recommendation and instead proposes to amend Item 405(a) to clarify that registrants may rely on Section 16 Reports filed on EDGAR, but are not required to limit their inquiry to those filings when determining whether there are any Section 16 delinquencies that must be disclosed pursuant to Item 405. The SEC also proposes to amend Item 405 to eliminate the requirement in Rule 16a-3(e) that reporting persons furnish their Section 16 Reports to the registrant since all Section 16 reporting persons are required to file such reports electronically on EDGAR.
Finally, the SEC proposes to amend Item 405 to include an instruction that encourages registrants to exclude the Section 16(a) Beneficial Ownership Reporting Compliance section in their filings if they have no Section 16(a) delinquencies to report. This would allow registrants’ filings to be more easily searched to determine whether any Section 16(a) delinquencies have been disclosed.
Item 407 (Corporate Governance)
The SEC proposes to amend Item 407 to remove the outdated reference to AU Section 380. In addition, the SEC proposes to amend Item 407(e)(5) to clarify that “emerging growth companies” are not required to provide a compensation committee report.
Item 501(Forepart of Registration Statement and Prospectus Cover Page)
The SEC proposes the following amendments to Item 501:
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eliminate the portion of the instruction to Item 501(b)(1) providing that a registrant may be required to change its name if the registrant’s name is the same as that of a “well-known” company or if the name leads to a misleading inference regarding the registrant’s line of business;
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amend Instruction 2 to Item 501(b)(3) to make explicit that registrants may include a clear statement on the cover page of a prospectus that the offering price will be determined by a method or formula that is disclosed elsewhere in the prospectus, provided that registrants provide a cross-reference on the cover page to the pricing method or formula disclosure (the proposal would not affect pricing disclosure for securities offered based on market prices);
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amend Item 501(b)(4) to require disclosure of the principal United States market or markets for the securities being offered and the corresponding trading symbols; and
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amend Item 501(b)(10) to reduce the length of the legend advising readers that the information in a preliminary prospectus will be amended or completed by allowing registrants to exclude the portion of the legend relating to state law prohibitions when such prohibitions are not applicable to the securities offering.
Item 503 (Risk Factors)
The SEC proposed to relocate “Risk Factors” from Item 503(c) to a new, separate item (Item 105) in Subpart 100 of Regulation S-K (which covers a broad category of business information and is not specific to securities offerings) to clarify that risk factor disclosure is required in offering documents and periodic reports filed with the SEC. In addition, although not recommended by the Staff in the Report, the SEC proposes to eliminate the risk factor examples that are currently enumerated in Item 503(c). The SEC stated that eliminating these examples would encourage registrants to focus on their own risk disclosure.
Item 508 (Plan of Distribution)
The SEC proposes to amend Rule 405 under the U.S. Securities Act of 1933, as amended, to define the term “sub-underwriters” in Item 508(h) 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.
Item 512 (Undertakings)
The SEC proposes to eliminate the following undertakings from Item 512 that, due to certain developments, have become unnecessary or duplicative since their adoption:
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Item 512(c), which requires a registrant to include an undertaking if it registers a warrant or rights offering to existing security holders and any unsold securities are reoffered to the public;
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Item 512(d), which requires a registrant to include undertakings if the securities it registers are to be offered at competitive bidding to underwriters, in connection with Congress’s repeal of the Public Utility Holding Company Act of 1935;
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Item 512(e), which requires a registrant to deliver, together with the prospectus, the annual and quarterly reports incorporated by reference in the prospectus, as required by Form S-2, in connection with the SEC’s elimination of Form S-2 as part of its Securities Offering Reform Act in 2005; and
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Item 512(f), which requires non-reporting registrants in an underwritten equity offering to undertake to provide to the underwriter at the closing certificates required by the underwriter to permit prompt delivery to each purchaser, since virtually all equity securities trades in the United States are cleared and settled through the National Securities Clearing Corporation and Depository Trust & Clearing Corporation.
Item 601 (Exhibits)
The SEC proposes to amend Item 601 to require registrants to file as an exhibit to their annual report on Form 10-K a description of the rights and obligations of each class of their securities that is registered under Section 12 of the U.S. Securities Exchange Act of 1934 (Exchange Act). This proposed amendment is intended to ease investors’ access to additional information about the terms of a registrant’s securities.
The SEC also proposes to amend Item 601 to permit registrants to omit attachments and schedules filed with any exhibits, unless they contain information that is material to an investment decision that has not been disclosed otherwise. Item 601(b)(2) currently allows such omissions only for agreements regarding acquisitions, dispositions, reorganizations and similar transactions. The proposed amendments would require registrants to file with each exhibit a list briefly identifying the nature and contents of the omitted schedules and attachments and an agreement to furnish the SEC with copies of the omitted schedules and attachments upon request.
In addition, while not addressed in the Report, the Staff also proposes to amend Item 601 to codify existing SEC practice which allows registrants to omit personally identifiable information from exhibits without making a formal confidential treatment request.
Further, the SEC proposes amending Item 601 to allow registrants to omit confidential information from material contracts filed pursuant to Item 601(b)(10) if such information is not material and would be competitively harmful if disseminated. Under the proposed amendments, a registrant would not be required to submit a confidential treatment request prior to omitting such information. Instead, registrants would be required to mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and include a prominent statement on the first page of each redacted exhibit that information in the marked sections of the exhibit has been omitted from the filed versions of the exhibit. Registrants would also be required to indicate with brackets where the information has been omitted from the filed version of the exhibit, and to furnish the SEC with copies of the unredacted documents and attachments upon request.
The SEC also proposes amending Item 601(b)(10)(i) to limit the two-year look back test for material contracts not made in the ordinary course of business such that it would only apply to newly reporting registrants. This proposed amendment would eliminate redundant disclosure without reducing material information available to investors.
Finally, the SEC proposes amending Item 601(b)(21) to require registrants to disclose in the exhibit the LEIs for the registrant and each subsidiary listed if they have been obtained. An LEI is a 20-character, alpha-numeric code that connects to key reference information that allows for unique identification of entities in financial transactions. The SEC indicated that this proposed amendment would allow investors to better understand a registrant’s corporate structure and certain transactional risks. Citing the importance of LEIs to investors, Commissioner Kara Stein commented that this proposed amendment “does not go as far as it could in requiring LEIs for registrants and subsidiaries” and she encouraged comments on this issue.
In order to maintain a consistent approach to the exhibit requirements for domestic and foreign private issuers, the SEC proposes to amend Form 20-F to conform the exhibit requirements in such form to the requirements in Item 601 as proposed. However, the SEC does not propose similar amendments to Form 40-F since the form allows Canadian issuers to use disclosure documents prepared in accordance with Canadian disclosure requirements to satisfy the SEC’s disclosure requirements.
Proposed Amendments to Manner of Delivery
The SEC proposes amendments that would require registrants to tag all of the information presented on the cover page of a registrant’s periodic and current reports in machine-readable tagging using Inline eXtensible Business Reporting Language (Inline XBRL).[2] In addition, the SEC proposes that registrants be required to include and tag on the cover page of all periodic and current reports the ticker symbol for each class of securities registered under the Exchange Act.
The SEC also proposes amendments to Rule 411, Rule 12b-23 and Rule 0-4 to require hyperlinks to information that is incorporated by reference if that information is available on EDGAR.
Finally, the SEC is not proposing to adopt the recommendation in the Report that would require registrants to use hyperlinks whenever the rules call for the inclusion of a web address.
[1] See Modernization of Property Disclosures for Mining Registrants, Release No. 33-10098 (June 16, 2016), available at: https://www.sec.gov/rules/proposed/2016/33-10098.pdf; Amendments to Smaller Reporting Company Definition, Release No. 33-10107 (June 27, 2016), available at: https://www.sec.gov/rules/proposed/2016/33-10107.pdf; Disclosure Update and Simplification, Release No. 33-10110 (July 13, 2016), available at: https://www.sec.gov/rules/proposed/2016/33-10110.pdf; and Exhibit Hyperlinks and HTML Format, Release No. 33-10201 (August 31, 2016), available at: https://www.sec.gov/rules/proposed/2016/33-10201.pdf.
[2] The Staff recently proposed to require the use of Inline XBRL format (see Inline XBRL Filing of Tagged Data, Release No. 33-10323 (Mar. 1, 2017)), where XBRL data is embedded into an HTML document, instead of the traditional XBRL format for the submission of operating company financial statements. If the Inline XBRL proposal is not adopted, the Staff proposes, as an alternative, to require operating company filers to tag each cover page data point in an XBRL exhibit to the relevant filing.
