New Wave of Regulation S-K Amendments

Valerie Jacob, Pamela Marcogliese, and Sarah Solum are partners at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Ms. Jacob, Ms. Marcogliese, Ms. Solum, and Darya Cheban-Katz.

In a nutshell

On November 19, 2020, the U.S. Securities Exchange Commission (“SEC”) announced that it adopted final amendments under Regulation S-K and the related rules and forms in an effort to modernize, simplify and enhance certain financial disclosure requirements.

In particular, the SEC eliminated the requirement for Selected Financial Data (Item 301), streamlined the requirement to disclose Supplementary Financial Information (Item 302) and adopted certain amendments to Management’s Discussion & Analysis of Financial Condition and Results of Operations (“MD&A”) (Item 303). These new rules apply to registration statements and periodic reports. In addition, some of the rule changes are a codification of existing SEC guidance or an effort to clarify some of the Instructions to the Rules in Regulation S-K. Many of them opt for a principles-based approach in lieu of a prescriptive approach, allowing companies to decide how best to convey material information to investors. The SEC adopted certain parallel amendments applicable to foreign private issuers (FPIs), including to Forms 20-F and 40-F, in addition to other applicable conforming amendments to the SEC’s rules and forms.

These amendments come on the heels of the SEC’s prior set of amendments to Regulation S-K which came into effect on November 9, 2020 and relate to business, legal proceedings and risk factor disclosure (see related blog posts here and here).

The recent regulatory changes are driven by an ongoing SEC initiative intended to modernize and improve disclosure requirements by focusing on material information for the benefit of investors, eliminating duplicative disclosures and simplifying compliance efforts for companies.

Compliance deadline

The amendments will become effective 30 days after they are published in the Federal Register. Companies are required to comply with the amended rules beginning with the first fiscal year ending on or after the date that is 210 days after publication in the Federal Register (the “mandatory compliance date”). One interpretation of this language requires calendar year-end companies to initiate compliance with these rules beginning with their annual reports for the fiscal year ending December 31, 2021. Another interpretation requires calendar year-end companies to begin complying with these rules starting with their Form 10-Q filings for the period ending June 30, 2021, depending on when final publication occurs. Companies will be required to apply the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. Although companies will not be required to apply the amended rules until their mandatory compliance date, they may comply with the final amendments any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety.

Highlights of the final amendments

Described below are some of the changes that the SEC is adopting in connection with the new set of amendments to Regulation S-K.

Eliminates the requirement for selected financial data

The amendments eliminate Item 301 which required companies to provide 5 years of selected financial data. The SEC recognizes that technological developments allow for easy access to the type of information required by Item 301, which is typically made available in prior filings on EDGAR. Nonetheless, the SEC reminds companies to consider whether trend information for periods that predate those covered in the financial statements should be disclosed under existing SEC guidance relating to “provid[ing] material information relevant to an assessment of the [company’s] financial condition and results of operations.” This change simplifies company compliance obligations by reducing reporting burdens.

Streamlines the requirement to disclose supplementary financial data

Amended Item 302(a) replaces the current requirement for companies to provide 2 years of tabular selected quarterly financial data with a more limited requirement focused on material retrospective changes. Disclosure will be required only when there are material retrospective changes for any of the quarters within the last 2 fiscal years or any subsequent interim period. In such case, companies will need to explain the reasons for such material changes, and to disclose, for each affected quarterly period and the fourth quarter of the affected year, summarized financial information related to the statement of comprehensive income and earnings per share reflecting such changes. Since this amendment requires disclosure in more limited circumstances, it draws investor focus on the disclosure of material information. Companies will need to explain and disclose for any impacted quarter the material retrospective changes.

Amends the MD&A section

New Item 303(a)—Stating Principal Objectives of MD&A at the Forefront

New Item 303(a) calls for the following disclosure, which is designed to better enable investors to view the company from management’s perspective and serves as a reminder to companies that, under existing SEC guidance, MD&A should provide an analysis of both short-term results and future prospects:

  • Material information relevant to an assessment of the financial condition and results of operations of the company, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources.
  • Material events and uncertainties known to management that are reasonably likely to cause reported financial information not to be indicative of future operating results or of future financial condition. This includes descriptions and amounts of matters that have had a material impact on reported operations as well as matters that are reasonably likely based on management’s assessment to have a material impact on future operations.
  • The material financial and statistical data that the company believes will enhance a reader’s understanding of the company’s financial condition, cash flows and other changes in financial condition, and results of operations.

Companies should revisit these objectives which highlight the importance of materiality and trend disclosure as they prepare their MD&A.

Amended Item 303(b)—Incorporating reasons underlying material changes in MD&A narrative

Where financial statements reveal material changes from period-to-period in one or more line items, including where material changes within a line item offset one another, companies are required to describe the underlying reasons (instead of just the causes) for such changes in quantitative and qualitative terms. The SEC adopted this amendment to enhance analysis in MD&A and to encourage companies to provide a more meaningful discussion of the underlying reasons that may be contributing to material changes in the line items. Although this new requirement is largely consistent with prior SEC guidance, companies may face new hurdles in facilitating compliance with this requirement since it makes more explicit the scope and level of detail of MD&A disclosure.

Amended Item 303(b)—Full fiscal years—Focusing on disclosures relating to segment information…and other subdivisions

Where in the company’s judgment a discussion of segment information and/or of other subdivisions (e.g., geographic areas) of the company’s business would be appropriate to an understanding of such business, a company is currently required to disclose, each relevant, reportable segment and/or other subdivision of the business and on the company as a whole. The amendment includes “product lines” as an example of a subdivision of a company’s business that should be discussed where, in the company’s judgment, it is necessary to an understanding of the company’s business. The changes ultimately adopted by the SEC are limited in scope, and therefore other than a reminder to include disclosure relating to product lines, where relevant, we do not expect this change to significantly impact company disclosures.

New Item 303(b)(1) and amended Item 303(b)(1)(ii)—Liquidity and capital resources—Disclosing material cash requirements

Companies will be required to disclose material cash requirements, including, but not limited to, commitments for capital expenditures, as of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements, and the general purpose of such requirements. The SEC recognizes that certain expenditures and cash commitments that are not necessarily capital investments in property, plant, and equipment may be increasingly important to companies, especially those for which human capital or intellectual property are key resources. This new requirement enhances disclosure of capital resources by requiring disclosure of cash requirements that are not necessarily capital expenditures. Although this disclosure is largely consistent with existing SEC guidance, companies will need to carefully consider their cash requirements and ensure that required disclosure is provided.

Amended Item 303(b)(2)(ii)—Results of operations—Disclosing known trends or uncertainties

Companies will be required to disclose known events that are “reasonably likely” to cause (as opposed to “will” cause) a material change in the relationship between cost and revenues, such as known or reasonably likely future increases in costs of labor, materials, prices or inventory adjustments. Consistent with the SEC’s longstanding views, the SEC emphasized that the analysis should be based on an objective assessment of likelihood combined with a focus on materiality and what would be considered important by a reasonable investor in making an investment decision. The “reasonably likely” threshold applies throughout Item 303 and requires management to make an objective evaluation of whether disclosure of a known trend, commitment, event or uncertainty would be material to investors.

Amended Item 303(b)(2)(iii)—Result of operations—Disclosing changes in net sales and revenues

This amendment codifies existing guidance from the SEC by clarifying that a discussion of material changes in net sales or revenue is required (as opposed to discussing only material increases). Most companies already disclose increases and decreases to net sales and revenues, and therefore this change is not likely to have a significant impact on company disclosures.

Eliminating Item 303(a)(3)(iv) and current instructions 8 and 9 to Item 303(a)—Result of operations—Limiting inflation and price change disclosure

The SEC adopted rules that clarify that companies will be required to discuss the impact of inflation or changing prices only if they are part of a known trend or uncertainty that has had, or the company reasonably expects to have, a material favorable or unfavorable impact on net sales, or revenue, or income from continuing operations. As a result, this change is unlikely to have a significant impact on disclosures because companies will still be required to disclose the impact of inflation and price changes if material to the company.

New instruction integrating off-balance sheet arrangements within broader MD&A context

Previous Item 303(a)(4) will be replaced by a new principles-based instruction to MD&A. While disclosure of off-balance sheet arrangements in a separately-captioned section will no longer be required, companies will need to integrate their discussion of off-balance sheet arrangements into their broader discussion of liquidity and capital resources. Specifically, companies will be required to disclose commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons that have, or are reasonably likely to have, a material current or future effect on the company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements, or capital resources even when the arrangement results in no obligation being reported in the company’s consolidated balance sheets. This change will encourage companies to better integrate disclosure of off-balance sheet arrangements within the context of their MD&A.

Eliminating Item 303(a)(5)—Tabular disclosure of contractual obligations and amending Item 303(b)(1)—Liquidity and capital resources

Companies will no longer be required to provide a contractual obligations table. Instead, companies will be required to disclose material short-term and long-term cash requirements from known contractual and other obligations through an enhanced principles-based liquidity and capital resources requirement. In providing such disclosure, companies will need to specify the type of obligation along with the relevant time period for the cash requirements. The new principles-based approach relieves companies from the requirement of preparing contractual obligations charts which can be burdensome for companies, but the substance of the disclosure requirement has largely been preserved.

New Item 303(b)(3)—Disclosing critical accounting estimates

Companies will be explicitly required to disclose critical accounting estimates in order to promote meaningful analysis of measurement uncertainties. Critical accounting estimates are those made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the company’s financial condition or results of operations. The SEC notes that any disclosure should supplement, not duplicate, the description of accounting policies that are already required to be disclosed in the notes to the financial statements. For each critical accounting estimate, the new rules require registrants to disclose, to the extent material, why the estimate is subject to uncertainty, to the extent the information is material and reasonably available, how much each estimate and/or assumption has changed during a relevant period, and the sensitivity of the reported amounts to the methods, assumptions, and estimates underlying the estimate’s calculation.

Because prior SEC guidance already required companies to disclose critical accounting estimates, these changes help to clarify the required disclosures and facilitate compliance.

Amended Item 303(c)—Revisiting interim period discussion

Companies will be permitted to compare their most recently completed quarter to either the corresponding quarter of the prior year (as previously required) or to the immediately preceding quarter. The optionality in the type of comparison of interim periods will help companies provide a more customized and meaningful analysis that is relevant to their specific business cycles while also providing investors with material information to assess quarterly performance.

Application to foreign private issuers

The SEC adopted corresponding amendments that are applicable to FPIs in Form 20-F, 40-F and current Instruction 11 to Item 303 which applies to FPIs if they choose to file on domestic forms. In addition to eliminating the requirement for FPIs to provide 5 years of selected financial data, these changes substantially conform to the amended disclosure requirements set forth above.

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