On August 8, 2019, the U.S. Securities and Exchange Commission (SEC) proposed amendments to the description of business, legal proceedings and risk factor disclosure requirements of Regulation S-K. The proposal is one of the results of the SEC’s review of Regulation S-K’s disclosure requirements as mandated by the Jumpstart Our Business Startups Act (Jobs Act). The proposed revisions are intended to improve disclosure for investors and to simplify compliance for reporting companies.
Item 101(a) of Regulation S-K currently requires a description of the general development of business during the past five years and requires five specified areas of disclosure. The proposed amendment would eliminate the five year timeframe and would require a principles-based disclosure of information that is material to understanding the development of the filer’s business regardless of timeframe. The proposed amended rule suggests that a filer may need to disclose, among other information:
- Material transactions and events that affect or may affect operations, including material changes to a previously disclosed business strategy.
- Bankruptcy, receivership, or any similar proceeding.
- The nature and effects of any material reclassification, merger, or consolidation.
- The acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business.
For filings subsequent to a company’s initial registration statement under the Securities Act of 1933, as amended (Securities Act) or the Securities Exchange Act of 1934, as amended (Exchange Act), the company will only be required to update the initial disclosure, focusing on material developments during the reporting period. A company would need to incorporate by referencing the most recently filed disclosure, along with a hyperlink to that information. This method would allow for a full presentation of the development of the filer’s business, while also narrowing in on the most up-to-date pertinent facts relevant to an investor.
Item 101(c) of Regulation S-K currently requires a description of a filer’s business done and intended to be done, focusing on the filer’s dominant business segment or each segment for which financial information is provided in its financial statements. To the extent material to an understanding of filer’s business as a whole, the description of each such segment must include specific items. The following refashioned items would need to be disclosed, to the extent material to a filer’s business as a whole:
- Revenue-generating activities, products and/or services, and any dependence on key products, services, product families, or customers, including governmental customers.
- The status of development efforts for new or enhanced products, trends in market demand and competitive conditions.
- Resources material to registrant’s business, such as:
- Sources and availability of raw materials.
- The duration and effect of all patents, trademarks, licenses, franchises, and concessions held.
- A description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.
- The extent to which the business is or may be seasonal.
- The material effects that compliance with material government regulations, including environmental regulations may have on capital expenditures, earnings and competitive position.
- Human capital resources, including measures or objectives that management focuses on (such as those that address the attraction, development, and retention of personnel).
This list no longer refers to working capital practices, new segments, or the dollar amount of backlog believed to be firm, but they would still need to be disclosed, along with other non-listed topics, if material to an understanding of a filer’s business as a whole.
Item 103 of Regulation S-K currently requires a filer to disclose material legal proceedings other than ordinary routine litigation incidental to its business as well as certain other information such as the factual basis for the proceeding and the parties involved. Under Instruction 5 to Item 103, an environmental proceeding in which a governmental authority is a party that involves potential monetary sanctions is deemed material unless filer reasonably believes that it will result in monetary sanctions of less than $100,000. The proposed amendments would (1) permit a filer to provide the information required by Item 301 by including hyperlinks or cross references to legal proceeding disclosures elsewhere in the document to avoid repetitive disclosure, and (2) increase the threshold for the required disclosure of environmental proceedings in which the government is a party from $100,000 to $300,000.
Item 105 of Regulation S-K currently requires a filer to disclose the most significant factors that make an investment in the filer speculative or risky by providing logically organized and concisely stated disclosures of applicable factors. The proposed amendments are intended to address the increasing length of risk factor disclosures and the common use of generic boilerplate risk factors applicable to any offering or filer. The proposed new Item 105 requirements are:
- A summary risk factor disclosure if the risk factor section exceeds 15 pages. The summary would be included in the forepart of the prospectus or annual report under an appropriate heading and would consist of a series of short, concise, bullets or numbered statements summarizing the principal factors that make an investment speculative or risky.
- Replacing the requirement to disclose the most significant risks with a requirement to disclose material risks, using the definition of materiality in Securities Act Rule 405.
- The organization of risk factors under relevant headings. If a filer chooses to disclose a risk that could apply to other companies or offerings and does not explain why the risk is specifically relevant to it, that risk factor would need to be placed in a section at the end of the risk factor section entitled “General Risk Factors.”
The proposed amendments to Items 101 and 103 will affect only domestic registrants and foreign private issuers that have elected to file on domestic forms. The proposed amendments to Item 105 will affect both domestic and foreign registrants filing on Forms F-1, F-3, and F-4.
Comments on the proposed amendments should be received by the SEC on or before October 22, 2019.