The Securities and Exchange Commission (SEC) has issued Proposed Rulemaking Release No. 33-10668, Modernization of Regulation S-K Items 101, 103, and 105, which would amend the following Regulation S-K disclosure items: (1) Item 101, Description of Business, (2) Item 103, Legal Proceedings, and (3) Item 105, Risk Factors, to improve the information content of such items and simplify registrant compliance. The proposed amendments, which are part of the SEC’s broader Disclosure Effectiveness Initiative, reflect changes that have occurred in the capital markets and in the availability of information.
PROPOSED AMENDED RULES
Following is a brief discussion of the main proposed amendments to Regulation S-K.
Description of Business
As it stands, Item 101 calls for a description of the general development of the registrant’s business during the past five years, or such shorter period as the registrant has been engaged in business, including a discussion of the following matters, among others: (1) the form of the entity’s organization; (2) the nature and outcome of any bankruptcy, receivership, or similar proceedings; (3) the nature of any mergers or consolidations; (4) the acquisition or disposition of any material amount of assets other than in the normal course of business; and (5) any changes in the entity’s mode of conducting business. In fact:
- As proposed, the list of required disclosure matters would be amended to include, to the extent material to an understanding of the registrant’s business, transactions and events that affect or may affect the company’s operations, including material changes to a registrant’s previously disclosed business strategy.
- Also, as proposed, the five-year time period would be eliminated. Rather, a registrant would focus on disclosing information material to an understanding of the development of its businesses, without the constraint of a specific timeframe. Note that, to be consistent, the requirement for a smaller reporting company to provide a description of the development of its business during the past three years would also be eliminated.
- The requirement to provide a narrative description of the registrant’s business focusing on the entity’s dominant segment or each reportable segment about which financial information is presented in the financial statements would be amended to include discussions concerning (1) revenue-generating activities, products and/or services, (2) the material effects that compliance with material government regulations, including environmental regulations, may have upon the capital expenditures, earnings, and the registrant’s competitive position, and (3) a description of the registrant’s human capital resources, including any human capital measures or objectives that management focuses on in managing the business.
- Currently, registrants are required to provide disclosures regarding the general development of the business in Securities Act and Exchange Act registration statements and in Exchange Act annual reports on Form 10-K. As proposed, for filings subsequent to a registrant’s initial registration statement, only an update of the disclosure would be required, with a focus on any material developments occurring in the reporting period, including whether the entity’s business strategy has changed.
Currently, Item 103 requires disclosure of any material pending legal proceedings that is outside ordinary routine litigation incidental to the business, including the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding, and the relief sought. Similar information is required for proceedings known to be contemplated by governmental authorities. Also pursuant to Item 103 as it stands, an administrative or judicial proceeding arising under any government provision enacted or adopted regulating the discharge of materials into the environment or to protect the environment is deemed not to be “ordinary routine litigation incidental to the business” and, thus, must be disclosed if, among other conditions, a governmental authority is a party to such proceeding that involves potential monetary sanctions, unless the registrant reasonably believes that such proceeding will result in no monetary sanctions or that such sanctions (exclusive of interest and costs) will be less than $100,000. As proposed, to adjust for inflation, the $100,000 threshold would be raised to $300,000.
In addition, Item 103 would be amended to permit the required information to be provided by including hyperlinks or cross-references to the disclosure of legal proceedings located elsewhere in the document.
Item 105 requires a concise and logically organized discussion of the most significant factors that make an investment in the registrant or in the securities offering speculative or risky.; The discussion should not include risks that could apply generically to any registrant or offering (i.e., boilerplate language), and each risk must be under a sub-caption that describes it. As proposed:
- The requirement to discuss the “most significant” risks would be replaced with the requirement to discuss “material” risks. The term “material” would be based on the definition in Securities Act Rule 405 (i.e., when used to qualify a requirement for the furnishing of information as to any subject, the term limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security).
- While discussions of generic risks would continue to be discouraged, if they are included and the disclosure does not provide an explanation of why the identified risk is specifically relevant to an investment in the registrant’s securities, such risk factors would have to be placed at the end of the risk factor section under the caption “General Risk Factors.”
- If the risk factor section exceeds 15 pages, summary disclosure would be required in the forepart of the prospectus or annual report, as applicable, under an appropriately captioned heading, and comprising a series of short, concise, bulleted or numbered statements summarizing the principal factors that make an investment in the register.