Revised SEC rules that took effect in November are intended to modernize reporting requirements. Matthew Dolloff, Erica Hogan and William Mills explain what the changes are and how companies can comply with them.

The SEC has adopted amendments to the business description, legal proceedings and risk factor disclosures required by reporting companies in annual and quarterly reports and registration statements. The amendments are intended to modernize disclosure requirements, including by eliminating certain duplicative requirements and improving the usability of filings for investors. The SEC expects the amendments to elicit disclosures that are tailored to each registrant's particular circumstances.

The amendments became effective on November 9, 2020 and apply to any Form 10Qs, Form 10Ks or registration statements filed on or after that date. Item 103 (legal proceedings) disclosures need to be updated for Form 10Qs filed on or after November 9, 2020. Item 101 (description of business) and Item 105 (risk factors) are required only in a registrant's next Form 10K. But firms that voluntarily include their full risk-factor disclosure in their Form 10Qs should consider updating their disclosure to comply with the amended rule.

General development of business

The amendments to Item 101(a) of Regulation SK reflect the SEC's shift toward a principles-based approach, where disclosure objectives are set and registrants have more flexibility in determining what disclosure is important for their particular business, and away from the prescriptive approach requiring all registrants to disclose the same types of information.

  • Qualification of required disclosure: Under the pre-amendment version of Item 101(a), a registrant was required to make disclosures regarding the general development of the registrant's business, including bankruptcy and receivership proceedings, merger or consolidation of the registrant or its major subsidiaries, and the acquisition or disposition of a material volume of assets. The new rules require disclosure on these topics only to the extent that it would be material to understanding the general development of the registrant's business.
  • Broadening discussion topics: 'Material changes to a registrant's previously disclosed business strategy' is added to the list of disclosure topics. The list is now non-exclusive, however, and the registrant is required to disclose information not otherwise contemplated by the list of disclosure topics if such information would be material to understanding the general development of the registrant's business.
  • Elimination of the five-year timeframe: Discussion of the general development of the registrant's business is now made without respect to a specific timeframe. Instead, the registrant must provide information material to an understanding of the development of the business, regardless of the specific timeframe.
  • Require only updated disclosure: The new rules allow registrants, in filings made after a registrant's initial filing, to include only disclosure of all 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. If a registrant chooses this approach, it must incorporate by reference the most recent full discussion of the development of its business.

Practical advice for compliance

The SEC stated that the amendments 'do not make the disclosure of business strategy mandatory if a registrant has not previously disclosed its business strategy.' But the amendments impose an obligation to update disclosures of business strategy to the extent that there have been material changes.

Companies should determine whether they have made past disclosures regarding their business strategies and, if so, update the disclosures to reflect any material changes that have occurred. It may be helpful for companies to review high-level materials prepared and reviewed by management and the board, and materials shared at investor presentations, in assessing whether there have been material changes to their business strategy.

Companies that have not already made disclosures regarding their business strategies should consider the materiality of such disclosures in light of the obligation to update the disclosure for material changes.

The elimination of the five-year timeframe for business development disclosures allows companies to select a timeframe more appropriate for their own business. When preparing the disclosure for their next report, companies should take advantage of the opportunity and assess whether the five-year timeframe resulted in disclosures material to investors and adjust the timeframe as appropriate.

The SEC noted that 'a long timeframe might be less appropriate for registrants operating in rapidly changing environments where historical information becomes irrelevant in a short period of time'. Whether a longer or shorter timeframe is warranted will vary depending on the specific company and industry.

Narrative description of business

The amendments to Item 101(c) of Regulation SK follow the principles-based approach of the changes to Item 101(a) by eliminating the required disclosure of specific information, and instead requiring registrants to make disclosures that are more relevant to their particular business.

  • Qualification of required disclosure: The pre-amendment rule regarding the narrative description of a registrant's business lists 12 specific items that must be disclosed to the extent that they are material to an understanding of the registrant's business taken as a whole. The amendments shorten this list and make the items non-exclusive.
  • Human capital resources: The new rules add a requirement that, to the extent that such disclosure is material to an understanding of the registrant's business taken as a whole, a registrant must include a description of its human capital resources, including any human capital measures or objectives the registrant focuses on in managing the business, which may change depending on the registrant's specific industry.
  • Government regulation compliance: The new rules broaden the required discussion of the material impact of environmental regulations on the registrant's business to a required discussion of the material effects of compliance with any government regulations, including environmental regulations, on the registrant's business.

Practical advice for compliance

In addition to the existing requirement to disclose a company's number of employees, the amendments include a new requirement for companies to include a description of their human capital resources to the extent material to understanding their business.

Companies have broad discretion in determining what constitutes human capital and what metrics they disclose in their reports. In preparing this disclosure, the legal team should consider setting up a meeting with an appropriate member of the human resources team to discuss the metrics they provide regularly to senior management and the board, as well as any metrics disclosed in investor presentations and reports.

The disclosure should be tailored to each company's particular business and workforce, and should include how the company defines human capital. The examples mentioned in the rule include measures or objectives that address the development, attraction and retention of personnel. Other metrics that may be useful to investors include turnover rates, education, experience and training.

The amendments further require that companies disclose the material effects of compliance with government regulations on their business. Please note that although these disclosures are similar to those required in an MD&A or a company's financial statements, these disclosures are meant to be more comprehensive.

According to the SEC, the requirement 'seeks to elicit broader disclosure that may be material to an understanding of the registrant's business as a whole, whereas disclosure in a registrant's MD&A or financial statements may focus more narrowly on the specific impact on a registrant's financial results, liquidity and capital resources or balance sheet.'

Companies should assess the impact of compliance on capital expenditures, earnings and the competitive position of the company, and formulate disclosure addressing those regulations that have particular importance to the company. Recitation of every regulation affecting a company's business is not required.

Legal proceedings

Changes to the legal proceedings disclosure requirements in Item 103 of Regulation SK are meant to modernize the requirements by eliminating duplicative disclosure and using more up-to-date, tailored dollar thresholds.

  • Cross-references: A registrant is permitted to provide required disclosure about legal proceedings by using cross-references or hyperlinks to discussion elsewhere in the filing, such as in the registrant's financial statements.
  • Higher threshold for certain governmental environmental proceedings: The pre-amendment rules require that registrants disclose certain governmental environmental proceedings that could result in sanctions of $100,000 or greater. The amendments increase this threshold to $300,000. A registrant may also select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided the threshold does not exceed the lesser of $1 million or 1 percent of the current assets of the registrant. A registrant selecting a different threshold must disclose the threshold in each annual and quarterly report.

Practical advice for compliance

The amendments give companies the flexibility to choose a higher dollar threshold for the environmental proceedings they disclose. Companies should weigh the benefits and costs of choosing a threshold higher than the default $300,000 threshold.

Firms are required to explicitly state the threshold they are using in their annual and quarterly reports, which could raise questions from the SEC and investors as to how the company arrived at a threshold that results in significantly fewer disclosures.

Risk factors

Changes to the risk factors disclosure requirements in Item 105 of Regulation SK are meant to facilitate an investor's review of those risk factors that are particularly relevant to investing in the registrant. The SEC noted that the amendments are intended to address the lengthy and generic risk factors presented by many registrants.

  • Materiality standard: The new rules replace the 'most significant' risk factors standard with a 'material' risk factors standard, which focuses disclosure on 'the risks to which reasonable investors would attach importance in making investment or voting decisions.'
  • Summary for lengthy disclosure: Under the amendments, risk factor disclosures exceeding 15 pages need to be accompanied by a summary aimed at increasing the utility of the section for an investor. The summary is limited to no more than two pages.
  • Headings and general risk factors: The new amendments require that risk factors be organized under relevant headings, and that any risk factors that could apply generally to other companies or securities offerings be disclosed at the end of the section under the 'General risk factors' caption.

Practical advice for compliance

The amendments impose an obligation on companies to include a summary for risk factor disclosures exceeding 15 pages in length. Companies with long risk factor sections will need to evaluate their current risk factor disclosures and weigh the cost of preparing the summary against potential litigation risks from shortening the disclosure.

In preparing a summary for its risk factors, a company may find it helpful to look to its cautionary note on forward-looking statements, usually included at the front of annual and quarterly reports. These sections often have summaries of the significant risk factors in bullet form.

Note that the summary is not required to contain all of the risk factors identified in the full discussion.

Originally published by Corporate Secretary.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.