On Aug. 26, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments to Regulation S-K to “modernize” Items 101, 103 and 105 of Regulation S-K, which relate to business description, legal proceedings and risk factor disclosures. The SEC previously released proposed rules on these items in August 2019. References in this alert to “Rule” or “Item” refer to the applicable provision of Regulation S-K.
Effective Date. The amendments in the final rule will become effective 30 days after publication in the Federal Register. Although the amendments have not yet been published in the Federal Register, based on historic practice, the amendments will likely apply before the end of October.
Purpose of Amendments. The SEC noted that the purpose of these amendments is to improve the readability of disclosures, limit repetition and the disclosure of immaterial information, and reduce disclosure costs and burdens. Items 101, 103 and 105 have not undergone significant revisions for over 30 years. The amendments provide businesses with more flexibility and also include a requirement for a registrant to describe human capital resources to the extent that these are material to the overall understanding of the business.
Item 101(a): Description of the General Development of the Business. Currently, Item 101(a) requires a description of the general development of the registrant’s business during the preceding five years or any shorter period that the registrant has been in business.
The amendments to Item 101(a) provide the registrant with more flexibility to tailor disclosures to specific circumstances by making the following changes:
- Including a nonexclusive list of four topics that companies’ disclosures should address to the extent that the information is material to understanding the general development of the business. The four topics are: any material changes to a previously disclosed business strategy; the nature and effects of any material bankruptcy, receivership or any similar proceeding with respect to the registrant or any of its significant subsidiaries; the nature and effects of any material reclassification, merger or consolidation of the registrant or any of its significant subsidiaries; and the acquisition or disposition of any material amount of assets outside the ordinary course of business.
- any material changes to a previously disclosed business strategy;
- the nature and effects of any material bankruptcy, receivership or any similar proceeding with respect to the registrant or any of its significant subsidiaries;
- the nature and effects of any material reclassification, merger or consolidation of the registrant or any of its significant subsidiaries; and
- the acquisition or disposition of any material amount of assets outside the ordinary course of business.
- Eliminating the five-year disclosure time frame. Companies should instead use a time frame for which the information presented would be considered material.
- Allowing a company, after its initial filing, to provide only an update on the general development of the business disclosure with a focus on material developments during the reporting period. The registrant would have to incorporate by reference the earlier discussion of the general development of the registrant’s business by including one active hyperlink to one previous filing that contains the full discussion.
Item 101(c): Narrative Description of the Business. Currently, Item 101(c) requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries, with a focus on the dominant segment or each segment for which financial information is presented. The current rule identifies 12 items that should be addressed in the description for each segment if the item is material to the understanding of the registrant’s business as a whole.
The amendments focus on making the disclosure more principles-based by replacing the list of specific items with a nonexclusive list of possible disclosure topics, which include:
- revenue-generating activities, products and/or services, and any dependence on key products, services, product families or customers;
- status of development efforts for new/enhanced products, trends in market demand and competitive conditions;
- all resources material to a registrant’s business, including sources of raw materials and the duration and effect of specified intellectual property;
- description of any material portion of the business that may be subject to renegotiation of profits or termination of government contracts; and
- seasonality.
The amendments also include, as a disclosure topic, a description of the company’s human capital resources, including any human capital measures or objectives on which management focuses, to the extent these are material to the company’s business as a whole. The SEC emphasized the importance of human capital disclosure for investors and noted that human capital is typically an important driver of company performance. The amendments identify certain measures and objectives but note that these are only examples of relevant subjects, not mandates. The human capital disclosure should be tailored specifically toward a company’s unique circumstances.
Currently, Item 101(c)(1)(xii) requires disclosure of the material effects of compliance with environmental laws on the registrant’s capital expenditures, earnings and competitive position, as well as any material estimated capital expenditures for a certain time period. The amendments refocus the regulatory compliance disclosure requirement by including as a topic the material effects of compliance with all material government regulations, not just environmental laws.
Item 103: Legal Proceedings. Item 103 currently requires that a registrant disclose any material pending legal proceedings, including the name of the court/agency where the proceedings are pending, the date the proceedings were instituted, the principal parties and a description of the underlying proceeding. Companies are not required to disclose environmental proceedings in which the government is a party if the monetary sanctions are reasonably believed to be under $100,000.
The amendments simplify the disclosure by:
- providing for the use of hyperlinks or cross-references to legal proceedings disclosures mentioned elsewhere in a filing in order to eliminate duplicative disclosure; and
- requiring disclosure for any environmental proceeding that involves sanctions of $300,000 or more, or at the registrant’s election, any other amount that the registrant believes will result in disclosure of a proceeding that would be material to the business or financial condition. However, the registrant is required to disclose the proceeding if sanctions are expected to exceed $1 million.
Item 105: Risk Factors. Item 105 currently requires disclosure of the most significant factors that make an investment in a registrant’s securities risky or speculative. The discussion should be organized in a way that is logical, simple, concise and easy for investors to understand. A specific subcaption for each risk factor must be included and the disclosure should include an explanation of how the risk affects the registrant.
The amendments attempt to eliminate “the lengthy and generic nature of the risk factor disclosure presented by many registrants” by making the following changes:
- Mandating a summary (not to exceed two pages) if the risk factor section exceeds 15 pages. The company must summarize the principal factors in “concise, bulleted or number statements … the principal factors that make an investment in the registrant or offering speculative or risky.”
- Creating a materiality threshold. The amendments now focus on “material” risks rather than “most significant” risks. The SEC intends that companies tailor the risk factors specifically to include those risks that are important to a reasonable investor. The definition of “material” in this case is defined in Rule 405 and Rule 12b-2.
- Requiring additional organization of risk factors. The amendments require companies to organize risk factors under relevant headings in addition to the subcaptions currently required and to include a specific section at the end of the risk factors titled “General Risk Factors” for those risk factors that could apply generally to any company or offering of securities.
Next Steps
In light of these amendments to Regulation S-K, registrants should consider taking the following actions.
Update General Development of the Business Disclosure. Registrants should review and refresh the disclosures on general development of their businesses in their Form 10-K and other relevant filings.
- Cover the following four topics, if material to investors’ understanding the general development of the business: any material changes to a previously disclosed business strategy; the nature and effects of any material bankruptcy, receivership or any similar proceeding; the nature and effects of any material reclassification, merger or consolidation; and the acquisition or disposition of any material amount of assets outside the ordinary course of business.
- any material changes to a previously disclosed business strategy;
- the nature and effects of any material bankruptcy, receivership or any similar proceeding;
- the nature and effects of any material reclassification, merger or consolidation; and
- the acquisition or disposition of any material amount of assets outside the ordinary course of business.
- Eliminate disclosures addressing a five-year (or, for smaller reporting companies, three-year) disclosure time frame if outdated or too long and adjust the time frame to address the period that is material to that registrant.
- Modify the disclosure to incorporate by reference prior disclosures of the general development of the registrant’s business with a hyperlink to that prior disclosure.
Update Narrative Description of the Business. RReporting companies should also refresh the narrative description of the business to cover the following five topics if relevant and material and eliminate topics that are no longer required or material:
- revenue-generating activities, products and/or services, and any dependence on key products, services, product families or customers;
- the status of development efforts for new/enhanced products, trends in market demand and competitive conditions;
- resources material to a registrant’s business, including sources of raw materials and the duration and effect of specified intellectual property;
- description of any material portion of the business that may be subject to renegotiation of profits or termination of government contracts; and
- seasonality of the business.
Develop Human Capital Disclosures. Each registrant should prepare a description of the registrant’s human capital resources, including any human capital measures or objectives on which management focuses in managing the business, to the extent such disclosures are material to understanding the registrant’s business. The disclosure should include the specific issues listed by the SEC — recruitment, development and retention. It may be relevant for the disclosure to address hot topics such as diversity and inclusion and pandemic-related safety precautions, after considering the company’s particular business and human capital exposures. In drafting these disclosures, it is helpful to consider how management evaluates success in its human capital initiatives. The company’s existing environmental, social and governance publications may already include sections on human capital that could be repurposed for this disclosure.
Expand Government Regulation Disclosures Beyond Environmental. Registrants should update their government regulation disclosure to cover all material areas of government regulation, not just environmental regulations. The disclosure should address the material effects that compliance with government regulations, including environmental regulations, may have upon the registrant’s capital expenditures, earnings and competitive position.
Modify Legal Proceedings Disclosures. Instead of including repetitive descriptions of legal proceedings in multiple sections of their SEC filings, such as the footnotes to financial statements and the legal proceedings section, registrants may revise their filings to include hyperlinks to other sections of their documents. Registrants may also update their disclosures to eliminate reporting of environmental proceedings with governmental authorities with sanctions below $300,000. They may also establish a higher threshold for disclosure, up to a maximum of the lesser of $1 million or 1 percent of consolidated current assets.
Reorganize, Streamline and Summarize Risk Factors. Registrants should update their risk factors to eliminate risks that are out of date or no longer material. If a risk factor is generic, registrants should consider eliminating or consolidating that risk factor or revising it to be more specific to the registrant’s particular circumstances. If the risk factors section exceeds 15 pages, the registrant must develop a summary of the risk factors, which summary should be no longer than two pages. Registrants should consider how to group risk factors under headings. These headings should logically organize the company’s risks. Registrants should also conduct their usual efforts to update the risk factors by (1) cataloging and reviewing peers’ risk factors to assess the material risks to their industry, and (2) tailoring risk factors to their companies’ particular risks, facts and circumstances.
Collaborate With Reporting Team. The company’s reporting team — including individuals focused on SEC disclosures, financial reporting, investor engagement, public relations and employee relations — and the executive team should review all new and updated disclosures, particularly those related to human capital. It is also important to consider whether adequate disclosure controls are in place to support any new disclosures and how to address any questions from investors and others about the new disclosures.
For additional guidance on the information in this alert, please contact any of the authors, any member of McGuireWoods’ securities compliance or securities enforcement teams, or your primary McGuireWoods contact.
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