SEC Proposes Rule Changes for Business Description, Legal Proceedings and Risk Factors Disclosures

Financial Services Law

Aiming to modernize the description of business, legal proceedings and risk factor disclosures that registrants are required to make pursuant to Regulation S-K, the Securities and Exchange Commission (SEC) recently proposed a number of important rule changes which affect periodic reports.

The proposed amendments, currently open for a 60-day public comment period, would not only update the rules to improve disclosures for investors, but would also simplify compliance efforts for covered entities, according to the SEC.

What happened

The changes focus on three areas: the description of business (Item 101), legal proceedings (Item 103) and risk factor disclosures (Item 105) that registrants are required to make pursuant to Regulation S-K.

Description of business. The proposed changes to Item 101 of Regulation S-K include a more principles-based approach to description-of-business disclosure, giving registrants more flexibility to tailor their disclosures to their specific facts and circumstances so that the information that is provided is material.

The proposed amendments would revise Item 101(a) (general development of business) to (1) eliminate the current five-year time frame for disclosure regarding the general development of the business; (2) limit the required full disclosure to the registrant’s initial registration statement, with subsequent filings only requiring an update of material changes, provided that the full discussion is incorporated by reference with an active hyperlink; and (3) provide a nonexclusive list of the type of information that may be included with disclosure required only for information that is material to an understanding of the general development of the registrant’s business.

Taking into account the changes that have occurred in the way businesses operate, the proposed amendments would also revise Item 101(c) (narrative description of business) to include an updated, nonexclusive list of disclosure topics, with disclosure required only for topics that are material to an understanding of the registrant’s business. The proposal retains the distinction between segment disclosure and disclosure with respect to the registrant’s business as a whole, with most of the listed topics falling into the segment category, other than the following two topics: (1) With respect to, and to the extent material to an understanding of, the registrant’s business taken as a whole, the proposed rule would require a discussion of the material effects of compliance with material government regulations, not just environmental laws (as currently required), recognizing that such disclosure is already the current practice of many registrants. (2) In addition, instead of the disclosure of the number of employees (as required by the current rule), the proposal would require, to the extent material to an understanding of the registrant’s business taken as a whole, a description of the registrant’s human capital resources, including any measures or objectives that management focuses on in managing the business. Similar to the current rule, if the information with respect to these two topics is material to a particular segment, the registrant would be required to identify that segment.

Legal proceedings. The proposed amendments to Item 103 of Regulation S-K, recognizing the overlapping disclosure requirements with U.S. GAAP, would expressly allow the required information about material legal proceedings to be provided using hyperlinks or cross-references to information located elsewhere in the document in order to avoid duplicative disclosure. In addition, the proposal would increase.

Risk factors. Finally, in order to address concerns with respect to lengthy and boilerplate risk factors and to facilitate more relevant and meaningful disclosure, the proposed amendments would revise Item 103 of Regulation S-K to: (1) require summary risk factor disclosure if the full risk factor discussion is longer than 15 pages, (2) revise the disclosure standard from the “most significant” risks to “material” risks, and (3) require that risk factors be organized under relevant headings, a practice many registrants already currently use.

To read the proposed rule, click here.

Why it matters

The proposed changes—currently open for public comment—would update and modernize the disclosure framework to reflect changes in businesses and markets and reflect an effort to adopt more principles-based disclosure. While the intent is to improve disclosure by discouraging inclusion of generic, repetitive and nonmaterial information, whether or not registrants will take advantage of the proposed simplification (particularly in the area of risk factors) remains an open question as registrants have historically been reluctant to simplify (or eliminate) disclosures, which may come back to haunt them in a securities disclosure-related lawsuit.



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