US Securities Law Briefing: SEC Proposes Changes to Risk Factor, Business Description Disclosure Requirements
The US Securities and Exchange Commission (the “SEC”) has proposed amendments to Regulation S-K, the principal source for disclosure requirements for US domestic companies, that focus on three disclosure areas: risk factors; description of the business; and legal proceedings.1 The proposal represents another step in the SEC’s ongoing review of its disclosure requirements, as required by the US Jumpstart our Business Startups Act of 2012. The SEC is not yet proposing parallel changes to Form 20-F, although it is requesting comment on whether it should.
In general, the SEC is proposing a more principles-based approach to Items 101(a) and (c) (Description of business) and Item 105 (Risk factors), while retaining a prescriptive approach for Item 103 (Legal proceedings). The proposed amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and disclosure of non-material information. The proposal does not suggest any changes to Item 303 (Management’s discussion and analysis).
Comments on the proposed amendments are due 60 days after they are published in the Federal Register.
Risk Factors (Item 105)
Citing a study finding that registrants had increased the length of risk factor disclosures from 2006 to 2014 by more than 50 percent in terms of word count, the SEC is proposing changes to the risk factor disclosure requirement intended to encourage companies to pare down their risk factors.
If adopted as proposed, the amendments to Item 105 would:
- require, if the risk factor section exceeds 15 pages, a series of short, concise, bulleted or numbered statements summarizing the principal factors that make an investment in the registrant or offering speculative or risky, to be placed at the forefront of the prospectus or annual report;
- change the risk factor disclosure standard from the “most significant” factors to the “material” factors;
- require risk factors to be organized under relevant headings (as many registrants already do and as required by the new EU ProspectusRegulation); and
- require any generic risk factors – i.e., risks that apply to other companies or securities offerings without an explanation of why the identified risk is specifically relevant to an investor in the company’s securities – to be disclosed at the end of the risk factor section under the separate caption “General Risk Factors.”
General Development of Business (Item 101(a))
Currently, Item 101(a) of Regulation S-K requires a description of the general development of the registrant’s business during the past five years, or such shorter period as the registrant may have been engaged in business. Item 101(a)(1) also currently requires disclosures on certain specific topics, such as M&A activity, if material to an understanding of the general development of the business.2
The proposed changes would revise Item 101(a) to be largely principles-based, by:
- emphasizing that the disclosure on the specific topics is only required to the extent such information is material to an understanding of the general development of a registrant’s business;
- making the list of specific topics of disclosure3 non-exclusive; and
- eliminating the five-year prescribed time frame for this disclosure.
The SEC is also proposing that for filings made after a registrant’s initial registration statement, a registrant would only need to include an update of the general development of the business, focusing on material developments in the reporting period. This would be permitted as long as the registrant incorporates by reference, and includes an active hyperlink to, the most recently filed disclosure that, together with the update, would present a full discussion of the general development of its business.
Narrative Description of Business (Item 101(c))
Item 101(c) currently requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries, focusing upon the registrant’s dominant segment or each reportable segment about which financial information is presented in the financial statements.
The SEC’s proposal would amend Item 101(c) as follows:
- adopting a more principles-based approach to disclosure;
- paring down and consolidating some of the line-item disclosure topics currently contained in Item 101(c);
- replacing the current requirement to disclose the number of employees with a requirement to disclose a description of the registrant’s human capital resources, including in such description any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business; and
- revising the regulatory compliance requirement to include material government regulations, not just environmental laws.
The proposed amendments would retain Item 101(c)’s distinction between disclosure topics for which segment disclosure should be the primary focus, and those for which the focus should be on the registrant’s business taken as a whole. The new language would clarify, however, that, for any listed topic, disclosure is required only to the extent that it is material to an understanding of the registrant’s business taken as a whole.
Legal Proceedings (Item 105)
Item 103 requires disclosure of any material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the registrant or any of its subsidiaries is a party or of which any of their property is the subject.
The proposed amendments would retain current Item 105’s prescriptive approach, but revise it to:
- expressly state that the required information may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to avoid duplicative disclosure; and
- increase the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000.
Foreign Private Issuers (Form 20-F)
Foreign private issuers are subject to similar risk factor, business description and legal proceedings disclosure requirements, but by Form 20-F rather than Regulation S-K. As proposed, the amendments would only revise Regulation S-K, and do not propose changes to Form 20-F or the foreign private issuer registration statements on Forms F-1, F-3 and F-4 (which refer to Form 20-F).
The proposing release requests public comment on whether the SEC should also make parallel amendments to Form 20-F, asking whether doing so would reduce a foreign private issuer’s ability to use a single disclosure document in multiple jurisdictions.
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The proposal may disappoint those who have been supporting the SEC’s recent efforts to make the US public markets more attractive by easing initial public offering and subsequent reporting disclosure obligations. The proposal appears to increase and complicate the burdens of risk factor disclosure, while only narrowly trimming the business-section disclosure.
We welcome clients’ thoughts as to whether these changes should also be applied to Form 20-F, and on any other aspects of the proposal.