The SEC Amends Regulation S-K Disclosure Rules to Empower Companies to Determine What and How Much Disclosure is Appropriate for Shareholders and Investors

 The SEC’s Regulation S-K disclosure amendments adopted last week provide a number of potential benefits for public companies, especially smaller ones, and an increasing ongoing role for legal counsel. In particular, the SEC’s release (Release Nos. 33-10825 and 34-89670) amends both the requirements for disclosure of a company’s business, legal proceedings and risk factors and the presentation of that disclosure. Taken together, the SEC has given back to a company’s management and board of directors significant discretion in determining, based on the company’s size and industry, what and how much disclosure is relevant to shareholders, investors and other market participants.

          Description of Business Amendments. One of the most significant amendments for public companies is the way a company’s business description may be presented. Essentially, a company may prepare one “master” business description to be contained in its registration statement for recent IPO companies or its most recent annual report for existing public companies. Thereafter, a company is permitted to (i) update its business section with “all of the material developments that have occurred, if any, since the most recent full discussion of the general development of its business disclosed in a previously filed registration statement or report,” and (ii) incorporate by reference the company’s master business description set forth in its previously filed registration statement or report with one active hyperlink to such information.

           According to the SEC release, this optional disclosure presentation approach is intended to eliminate repetition, encourage more concise filings and provide flexibility for a company’s management and board of directors to determine what they consider material information for disclosure. However, it is unclear how underwriters will respond to this disclosure approach in the context of preparing marketing-focused public offering prospectuses or how cautious legal counsel will advise clients to be regarding the parameters of incremental principles-based materiality disclosure to avoid liability under Rule 10b-5. By February 2021, we will see whether public companies with October 31 and November 30, 2020 fiscal years begin to implement this disclosure approach.

          In connection with the changes to business presentation, the SEC amended Regulation S-K Item 101(a) to eliminate the five-year disclosure framework for larger public companies and the three-year disclosure framework applicable to smaller reporting companies, giving companies substantial freedom to choose a different timeframe for “the most relevant disclosure.” Technology-based public companies – frequently operating in rapidly evolving industries – would therefore be able to de-emphasize older historical information. By freeing companies from prescriptive disclosure requirements, companies will be relying more on their counsel to determine disclosure start and end points.

           The SEC also added “human capital resources” to the non-exclusive list of topics that should be disclosed if material. For modern industries, especially in the so-called gig economy, the SEC indicated that a focused discussion on attracting, developing and retaining personnel is particularly material to an understanding of a company’s business.  

            Legal Proceedings Amendments. The SEC adopted an alternative quantitative threshold with regard to the disclosure by public companies involved in material environmental proceedings. Under the amended rule, disclosure is required for any proceeding that involves potential monetary sanctions of $300,000 or more, or, at the election of the company, “such other amount that the registrant determines is reasonably designed to result in disclosure of any such proceeding that is material to its business or financial condition.” However, disclosure is required in all cases for any proceeding when the potential monetary sanctions exceed the lesser of $1 million or 1% of the current assets of the company on a consolidated basis. Smaller public companies, in particular, will likely be able to set their own materiality threshold between $300,000 and $1 million for this disclosure requirement. It is possible that this hybrid disclosure approach portends similar changes to other prescriptive quantitative thresholds.

           The SEC also amended Regulation S-K Item 103 to allow for the use of hyperlinks or cross-references to avoid repetitive disclosure of legal proceedings, which sometimes appear multiple times in a filing under legal proceedings, MD&A and/or notes to the financial statements.

            Risk Factors Amendments. Another significant SEC amendment for public companies involves the presentation of a company’s risk factors. For companies that include in their filings a risk factor section exceeding 15 pages, they must provide a “bullet point” summary of the principal risk factors of no more than two pages in the front of the document. Many smaller, less regulated public companies have risk factors sections of less than 15 pages in length and would not be impacted by this rule change. Highly regulated companies, especially in the biotechnology area, frequently have long risk factor sections and counsel will need to be consulted in making judgments as to ranking the risks for the summary presentation. 

            The SEC also added a new requirement for public companies to organize their risk factors in groupings of related risks under specific headings. For example, in a biotech IPO, headings might include “risks related to our business, financial condition and capital requirements,” “risks related to our intellectual property,” “risks related to product development, regulatory approval, manufacturing and commercialization,” “risks related to government regulation of our industry,” and “risks related to ownership of our common stock and this offering.” The risks that generally apply to an investment in the company’s securities are required to be disclosed under a separate heading at the end of the risk factors section. 

            These current Regulation S-K amendments originate out of the 2012 Jumpstart Our Business Startups Act (JOBS Act), which required the SEC to conduct a review to modernize and simplify Regulation S-K. In doing so, the SEC has drawn on decades of studies, rule proposals and data. The description of business amendments, for example, appear to be remnants from the SEC’s so-called aircraft carrier release in 1998. With these amendments, SEC Chairman Jay Clayton has emphasized the SEC’s long-standing commitment to disclosure through a lens that benefits public companies as well as their shareholders and investors.

             The SEC’s mission to eliminate disclosure that is not material and to require more company-specific information is likely to result in reducing the overall compliance costs of being a public company. This is good news for smaller public companies which are more often financially constrained than larger companies. 

             The SEC’s amended rules will be effective 30 days after publication in the Federal Register.

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