SEC and Modernizing Regulation S-K

Holly J. Gregory is a partner and co-global coordinator of the Corporate Governance and Executive Compensation group at Sidley Austin LLP. This post is based on a Sidley update by Ms. Gregory, John P. Kelsh, Thomas J. Kim, Rebecca Grapsas, and Claire H. Holland. The complete publication, including footnotes and Appendix, is available here.

On April 13, 2016, the SEC issued a concept release requesting comment on existing disclosure requirements in Regulation S-K relating to a public company’s business and financial information. The concept release is part of a comprehensive “Disclosure Effectiveness Initiative” led by the SEC’s Division of Corporation Finance to review the effectiveness of public company disclosure requirements and to consider ways to improve them for the benefit of registrants and investors. The comment period will end 90 days after the concept release is published in the Federal Register.

The Concept Release

The concept release explores the following principal issues:

  • whether Regulation S-K’s business and financial information disclosure requirements continue to elicit information that is material to investment and voting decisions;
  • the costs and benefits of the disclosure requirements to registrants and investors; and
  • the optimal manner of presenting required disclosures to improve readability and investor access to the information.

The concept release addresses four categories of disclosure required by Regulation S-K:

  • core company business information (Items 101 and 102);
  • company performance, financial information and future prospects (Items 301, 302 and 303);
  • risk and risk management (Items 305 and 503); and
  • the registrant’s securities (Items 201, 202, 701 and 703).

The concept release also requests public comment on the following additional items:

  • Industry Guides;
  • disclosure of information relating to public policy and sustainability matters;
  • exhibits to periodic filings; and
  • scaled disclosure requirements applicable to certain registrants.

Finally, the concept release seeks comment on various alternatives to presenting and delivering information to investors, including through the use of cross-references, incorporation by reference, hyperlinks, standard formatting requirements and layered or structured disclosures.

The 341-page concept release sets forth 340 specific requests for comment. Several requests for comment apply to multiple business and financial disclosures required in periodic reports. These overarching questions are summarized below:

  • Does the disclosure requirement continue to provide useful information to investors? How can it be improved?
  • Should the SEC require additional or more specific information and, if so, what type? What would be the benefits and challenges of requiring additional disclosures?
  • What are the administrative and compliance costs of providing the required disclosure and how would they change if the SEC were to revise its requirements as contemplated by the concept release? (The SEC asks respondents to provide quantified estimates where possible.)
  • What type of investors are most likely to value the information required by the item? Is the information required by the item otherwise available? Would costs to investors increase if the item were eliminated?
  • Would an alternative format or presentation of the information improve its value? Should the disclosure be required where it currently appears or elsewhere?

The Appendix attached to the complete publication includes a summary of more specific requests for comment on the Regulation S-K items and additional topics covered in the concept release.

The Disclosure Effectiveness Initiative

As mandated by Section 108 of the Jumpstart Our Business Startups Act of 2012 (JOBS Act), the Division of Corporation Finance issued a Report on Review of Disclosure Requirements in Regulation S-K in December 2013. Among other things, the report recommended a comprehensive review of disclosure requirements for all public companies with a view toward streamlining them based on the information’s materiality and usefulness to investors. Based on this report and at the request of SEC Chair Mary Jo White, the Division of Corporation Finance launched the Disclosure Effectiveness Initiative. The goal of the project is to review existing disclosure requirements to determine whether improvements can be made to reduce the costs and burdens on public companies while also promoting the disclosure of material information to investors and eliminating duplicative disclosures.

A spotlight page on the SEC’s website discusses the status of the Disclosure Effectiveness Initiative. In September 2015, the SEC published a Request for Comment on the form and content of financial statements required under Regulation S-X. A subsequent phase of the project will focus on the compensation and corporate governance information required in proxy statements. In her remarks relating to the concept release, SEC Chair White announced that she has asked the Division of Corporation Finance to form an interdisciplinary working group dedicated to addressing issues relating to investors’ ability to access and navigate company information.

Registrants should review the concept release or the Appendix of the complete publication to determine whether they would like to provide input to the SEC on any of its requests for comment. As the Division proceeds with its Disclosure Effectiveness Initiative, registrants should consider evaluating their disclosures in periodic reports to look for areas for improvement. In particular, they should seek opportunities to (1) eliminate immaterial information, (2) reduce redundancies (e.g., by using cross-references) and (3) present disclosure in a clear and understandable way (e.g., by using summaries or graphs/charts). Registrants should also review the common disclosure deficiencies highlighted in the box below and revise their disclosures as necessary.

Common Disclosure Deficiencies Observed by the SEC

Throughout the concept release, the SEC noted various areas where the Division has observed that registrants often fail to fully comply with applicable disclosure requirements or related SEC guidance.

  • Duplicative Disclosure. The SEC noted that registrants commonly repeat information within a single filing in response to different item requirements in Form 10-K (e.g., disclosure about a registrant’s business may be included in the business section, MD&A, risk factors and financial statement footnotes). The SEC is seeking comment on how to encourage registrants to eliminate repetition and may encourage greater use of cross-references to reduce duplicative disclosure. The SEC has also cautioned that an introduction or overview should highlight important information rather than merely duplicate a more detailed discussion that follows.
  • Generic Risk Factors. Even though Item 503(c) instructs registrants not to present risks that could apply to any registrant, the SEC noted that registrants frequently disclose generic risks that are not tailored to their particular risk profile. The SEC provided the following examples of commonly disclosed generic risk factors: (1) the registrant’s failure to compete successfully, (2) the effect of general economic conditions on a registrant’s business, (3) changes in regulation and (4) dependence upon a registrant’s management team.
  • Lack of Detailed Analysis in MD&A. Despite Item 303(a)’s instruction to the contrary, the SEC noted that many registrants simply recite the amounts of changes from year to year, which are readily computable from their financial statements. In particular, the SEC noted that discussions of liquidity and capital resources often recite various changes in line items from the statement of cash flows without a detailed analysis and with only limited disclosure of known trends and uncertainties affecting their future cash needs and availability. The SEC seeks more detailed analysis of material year-to-year changes and trends by encouraging registrants to provide additional explanation of the underlying reasons for, or implications of, material changes in financial statement line items. In addition, the SEC noted that registrants typically do not discuss or analyze significant trends beyond the three year timeframe of Item 303 even though Instruction 1 to Item 303(a) specifies that reference to Item 301’s five-year selected financial data may be necessary where trend information is relevant.
  • Inadequate Disclosure of Critical Accounting Estimates in MD&A. The SEC noted that, despite its guidance in the 2003 MD&A interpretive release, many registrants repeat the discussion of significant accounting policies from the financial statement footnotes in their MD&A description of critical accounting estimates and provide limited additional discussion.
  • Failure to Discuss Stock Repurchases in MD&A. The SEC observed that registrants often do not analyze the impact of stock repurchases in MD&A, even in instances where the amount used to repurchase shares exceeds a registrant’s net income or cash generated from operating activities.
  • Failure to Include Footnotes to the Contractual Obligations Table. Despite the SEC’s recommendation to include footnotes to the contractual obligations table to promote greater understanding of the tabular data, the SEC noted that registrants typically do not supplement the table with narrative disclosure.

The complete publication, including footnotes and Appendix, is available here.

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