United States: SEC Proposes To Modernize Disclosures Of Business, Legal Proceedings And Risk Factors Under Regulation S-K

I. Overview

On August 8, 2019, the Securities and Exchange Commission (the "SEC") issued a release (the "Release") 1 proposing amendments to Regulation S-K Items 101, 103 and 105 in order to modernize the description of business, legal proceedings and risk factor disclosure requirements. The purposes of the amendments are to improve the readability of disclosure documents and to discourage repetition and disclosure of immaterial information. 2

II. The SEC's Approach to Disclosure Modernization

Regulation S-K consists of line-item requirements to elicit specific disclosure with broad categories of information material to an investment decision. Some of these are principles-based requirements, which offer management the flexibility to evaluate the overall significance of such topics to a company and tailor disclosure to its specific business and financial circumstances. Other disclosure requirements are prescriptive in nature, including quantitative thresholds and specific bright-line rules that require all companies to disclose the same type of information. While more rigid in nature, prescriptive requirements offer comparability and consistency and are easier to apply. In the Release, the proposed Items 101 (description of the business) and 105 (risk factors) are more principles-based because current rules may not reflect what is material to every business and prescriptive rules in these areas can become outdated. In contrast, the SEC uses a prescriptive approach for Item 103 (legal proceedings) that depends less on characteristics specific to individual companies and allows for consistency across issuers. 3

III. General Development of Business (Item 101(a))

The existing Item 101(a) of Regulation S-K requires a description of general development of a company's business during past five years, including the following specific disclosures: (i) the year and form of organization; (ii) any bankruptcy matter involving the company or its significant subsidiaries; (iii) any material reclassification, merger, consolidation of company of significant subsidiaries; (iv) any acquisition or disposition of a material amount of assets not in ordinary course of business; and (v) material changes in mode of conducting business. 4 The proposal would amend Item 101(a) to make it more principles-based by providing a non-exclusive list of the topics that companies may need to disclose if material to an understanding of the general development of a registrant's business. 5 The list includes three topics covered by the current rule (i.e., clauses (ii), (iii) and (iv) discussed above), plus one new topic – transactions and events that affect the company's operations, including material changes to a previously disclosed business strategy. 6 Additionally, instead of a prescribed five-year timeframe for the disclosure, each issuer would be required to focus on the information material to an understanding of the development of the business over the most relevant timeframe for that issuer. 7

Complete descriptions of the general development of the business would be required only in initial registration under the Securities Act of 1933 and the Securities Exchange Act of 1934. In subsequent filings, companies would be required only to update their existing disclosures, focusing on any material developments in the reporting period. Companies would also be required to include an active hyperlink to the most recently filed disclosure that would present a full discussion of the general development of the business. 8

IV. Narrative Description of Business (Item 101(c))

The existing Item 101(c) of Regulation S-K requires a narrative description "of the business done and intended to be done" by a company and its subsidiaries, focusing on the "dominant segment or each reportable segment for which financial information is presented in the financial statements." 9 To the extent material a company's business as a whole, the description of each such segment must include the following 10 items: (1) principal products and services, (2) the stage of its products and any new products, (3) sources and availability of raw materials, (4) intellectual property, (5) seasonality, (6) working capital practices, (7) dependence on certain customers, (8) dollar amount of backlog orders, (9) business subject to renegotiation or termination of government contracts and (10) competition. Additionally, with respect to the company's business in general, the material effects of compliance with environmental laws and the number of employees must also be disclosed. 10 The proposed rule would clarify and expand the principles-based approach, with disclosure topics drawn from a subset of topics currently in Item 101(c). 11

The proposed Item 101(c) would include a non-exclusive list of disclosure topics that the SEC believes would likely be material to many companies, while leaving flexibility for companies to tailor disclosure to their specific circumstances. Rather than line-item requirements, the proposed topics would need to be disclosed for each segment only when material to an understanding of the company's business taken as a whole. Likewise, topics that would no longer be explicitly listed in Item 101(c) (i.e., disclosure of working capital practices, the status of new products and segments and the dollar amount of backlog orders) would still need to be disclosed, along with any other topics, when material to an understanding of the company's business. 12

Below is an overview of the proposed disclosure topics that would be required with respect to each segment when material to an understanding of the company's business taken as a whole, including notes on any key changes: 13

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Footnote

1 For the full text of the release, see Securities and Exchange Commission, Modernization of Regulation S-K Items 101, 103, and 105, SEC Release Nos. 33-10668, 34-86614, available at https://www.sec.gov/rules/proposed/2019/33-10668.pdf (August 8,, 2019).

2 Id., at 1.

3 Id., at 6-9.

4 Id., at 12, citing 17 CFR 229.101(a).

5 Id., at 18.

6 Id., at 18-19.

7 Id., at 15.

8 Id., at 16-17.

9 Id., at 22, citing 17 CFR 229.101(c).

10 Id., at 22-23, citing 17 CFR 229.101(c).

11 Id., at 10.

12 Id., at 26-27.

13 Id., at 27-28.

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