SEC Issues Report On Regulation S-K
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As required by Section 72003 of the Fixing America’s Surface Transportation Act (the “FAST Act”), on November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K (the “Report”) including detailed recommendations for changes.
The Report continues the ongoing review and proposed revisions to Regulations S-K and S-X as related to reports and registration statements filed under the Exchange Act of 1934 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”). Regulation S-K, as amended over the years, was adopted as part of a uniform disclosure initiative to provide a single regulatory source related to non-financial statement disclosures and information required to be included in registration statements and reports filed under the Exchange Act and the Securities Act. Regulation S-X contains specific financial statement preparation and disclosure requirements.
The Disclosure Effectiveness Initiative began in December 2013, when the SEC, as required by the JOBS Act, issued its first report on the Regulation S-K disclosure requirements. The Disclosure Effectiveness Initiative is intended to evaluate the rules related to disclosure, how information is presented and disclosed and how technology can be utilized in the process and to implement changes to improve the current disclosure-related rules and regulations.
Since the initiative began, the SEC has been issuing reports, an in-depth concept release, and proposed rule changes as part of the Disclosure Effectiveness Initiative. However, as of the date of this blog, none of the proposed changes have been implemented. I have included a summary of the various proposals and SEC publications at the end of this blog. I suspect that following the change in administration, and re-staffing of the SEC, including the as of yet to be announced replacements for SEC Chair Mary Jo White, Division of Corporation Finance Director Keith Higgins, and Trading and Markets Director Stephen Luparello, there will be significant progress in many of the outstanding proposals as well as new and different proposals on the subject. It is my belief that the new leadership will take a pro-business viewpoint and that we will see that flow through to the disclosure requirements, especially as it impacts smaller reporting companies and emerging-growth companies.
The FAST Act, passed in December 2015, contains two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 requires the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.” In accordance with that requirement, On July 13, 2016, the SEC issued proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded. The S-K and S-X Amendments also seek comment on certain disclosure requirements that overlap with U.S. GAAP and possible recommendations to FASB, the regulatory body that drafts and implements GAAP, for conforming changes. See my blog on the proposed rule change HERE. The proposal remains pending.
Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in the Report issued on November 23, 2016. As required, the SEC consulted with the IAC and ACSEC as part of the process.
Section 72003 specifically requires that the Report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information.
The SEC Report includes a high level review of the rule proposals issued by the SEC specifically in response to their mandate under the FAST Act. In particular, the proposed rule changes related to mining companies, proposed amendment to the definition of a smaller reporting company, the July 13, 2016 proposed amendments to Regulation S-K and the August 31, 2016 proposed amendment to Item 601 were all required by the FAST Act. In the Further Reading section below, I have included links to my blogs on these proposals.
Specific SEC Staff Recommendations
A. Item 10(d) Related to Incorporation by Reference
The SEC staff recommends revising Item 10(d) to permit incorporation by reference to documents that have been filed with the SEC for at least 5 years, but require a detailed description of and hyperlink to such documents. Currently the rule specifically prohibits incorporation of documents that have been filed more than five years prior.
The SEC staff recommends allowing incorporation by reference to financial statement footnotes where such disclosures satisfy other Regulation S-K item requirements. For example, disclosures related to related party transactions (Item 404), selected financial data (Item 301) and off-balance-sheet arrangements (Item 303) are all repeated in financial statement footnotes. The SEC staff notes that allowing incorporation by reference from financial statements to other documents would increase audit costs and burdens and accordingly specifically recommends disallowing outside incorporation from the financial statements.
In addition, currently incorporation-by-reference rules are not consistent. For example, Rule 411 related to Securities Act registration statements has different requirements than Rule 12b-23 related to Exchange Act registration statements. Different forms also have different rules and requirements. The SEC recommends consolidating all the incorporation-by-reference rules into Item 10(d) and that such rules apply to all filings under the both the Securities Act and Exchange Act.
B. Business Information
The SEC staff recommends revising Item 102 to clarify that a description of property is only required to the extent that physical properties are material to the company’s business. Currently, Item 102 requires companies to “state briefly the location and general character of the principal plants, mines and other materially important physical properties of the registrant and its subsidiaries.” The SEC could also streamline the disclosure requirement by adding a description of material property to the Item 101 business description as opposed to leaving it as a stand-alone item.
C. Management Discussion and Analysis
The SEC staff recommends revising Item 303 to clarify that a company need only provide a period-to-period comparison for the two most recent years and that it may hyperlink to the prior year’s annual report for prior comparisons. The SEC staff also recommends considering requiring a discussion of material changes and known trends and uncertainties that impacted those changes, as opposed to the current granular line-item comparisons. In that regard, the MD&A focus would shift to longer-term trends and how those trends impacted the reported financial statements and may impact future results.
The SEC staff also recommends eliminating the requirement to provide a tabular disclosure of contractual obligations. I note that smaller reporting companies are not required to provide this disclosure. The staff recommends that instead of the table, a company should provide a hyperlink to financial statement footnotes and a liquidity discussion that describes material changes to contractual obligations and the ability to pay and perform such obligations.
D. Management, Security Holders, Corporate Governance
The SEC staff recommends clarifying the rules as to when and where the business experience of executive officers is required in proxy statements. In particular, the rules should clarify that the information is not required in a proxy statement when it is otherwise contained in a Form 10-K.
The SEC staff recommends allowing a company to simply review EDGAR filings to determine compliance with Section 16. Currently a Section 16 filer is required to also furnish a company with their filings. Similarly, the staff recommends eliminating the Section 16 disclosure requirement altogether where there are no delinquencies to report.
The SEC staff makes multiple recommendations to clarify and clean up certain corporate governance reporting requirements including further aligning the smaller reporting company and emerging-growth company requirements.
As related to registration statements, the SEC staff makes several recommendations to clean up redundancies, allow for hyperlinks, and add consistencies to the requirements related to registration statements. The following is a brief description of some of those recommendations.
The SEC staff recommends eliminating the provision of Item 501 related to the name of the company. In particular, the SEC rules have provisions related to the use of a name that is the same as a “well-known” company or could be misleading. The concept is already covered by intellectual property laws and it is not necessary for the SEC to have a specific regulation addressing same.
The staff recommends eliminating the requirement to provide an explanation of the method of determining the price of an offering in a registration statement from the cover page and allowing a hyperlink to the same disclosure elsewhere in the document.
The staff recommends adding a disclosure to specify if the company already trades on the OTC Markets and to provide the trading symbol. Currently the disclosure is only required for exchange-traded companies. In practice, OTC-traded companies already do this.
The staff recommends reducing the length of the “subject to completion” disclaimer on the front page by eliminating reference to state law where it is not applicable, such as when the offering pre-empts state law under the National Securities Market Improvement Act (NSMIA).
The staff recommends eliminating several of the Item 512 undertakings provisions as duplicative, redundant or obsolete.
The staff recommends adding a description of the company’s outstanding securities as an exhibit to Form 10-K. The staff also recommends adding the requirement that a subsidiaries legal entity identifier number (LEI) be included in the subsidiary list exhibit.
The staff recommends permitting the omission of attachments and schedules from exhibits unless the schedule or attachment has material information that is not disclosed elsewhere.
G. Manner of Delivery Requirements
The staff recommends adding XBRL tagging to the cover page of reports. The staff also recommends allowing the use of hyperlinks to websites when a disclosure of such website URL is required.
The following is a recap of the ongoing Disclosure Effectiveness Initiative-related reports and proposals. The Disclosure Effectiveness Initiative began in December 2013, when the SEC, as required by the JOBS Act, issued its first report on the Regulation S-K disclosure requirements. The Disclosure Effectiveness Initiative is intended to evaluate the rules related to disclosure, how information is presented and disclosed and how technology can be utilized in the process and to implement changes to improve the current disclosure-related rules and regulations.
On August 31, 2016, the SEC issued proposed amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The proposed amendments would require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the proposed amendment would also require that all exhibits be filed in HTML format. See my blog HERE on the Item 601 proposed changes. The proposal remains pending.
On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE. The changes remain pending.
On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. The proposal remains pending.
On June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE.
On June 16, 2016, the SEC proposed revisions to Item 102 of Regulation S-K and Industry Guide 7 related to the property disclosure requirements for mining companies. The revisions are intended to modernize the disclosure obligations to be better aligned with current industry and global regulatory practices. The SEC also proposed rescinding Industry Guide 7 and including the substantive provisions in a new subpart in Regulation S-K.
On April 15, 2016, the SEC issued a concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements. See my two-part blog on the S-K Concept Release HERE and HERE.
In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE.
As part of the Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.
In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.
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