On August 17, 2018, the Securities and Exchange Commission (SEC) announced the adoption of amendments to simplify and update disclosure requirements.1 Although the amendments are voluminous in length and breadth of provisions impacted, many of the changes are ministerial and are not expected to have a significant impact on the information that companies disclose or the time and cost associated with preparing periodic disclosures. The SEC adopted these changes to implement the Fixing America's Surface Transportation (FAST) Act2 and in furtherance of its objective3 to reform duplicative, overlapping or outdated disclosure in light of other SEC disclosure requirements, U.S. Generally Accepted Accounting Principles (GAAP) or changes in the information environment.
The final rules largely enact the SEC's proposed changes in the release published on July 13, 2016, for which we submitted a comment letter.4 In the adopting release, the SEC noted that "the amendments are intended to simplify and update the disclosure of information to investors, including long-term Main Street investors, and reduce compliance burdens for companies without significantly altering the total mix of information available to investors." Additionally, concurrent with the adoption, the SEC referred certain disclosure requirements that overlap with, but require information incremental to, GAAP, to the Financial Accounting Standards Board (FASB) for consideration of potential incorporation into GAAP.
Although the adopted amendments apply primarily to public reporting companies (including foreign private issuers in some instances), certain provisions also impact other entities regulated by the SEC, including Regulation A issuers, investment advisers, investment companies, broker-dealers and nationally recognized statistical rating organizations.
To assist with understanding the amendments that were adopted, the SEC prepared a "demonstration version" of the adopted amendments, which presents the added and deleted text in the affected rules.5
Key Revisions Impacting Most Public Reporting Companies
Set forth below is a summary of the key amendments made to disclosure requirements in periodic reports and registration statements. This list highlights the changes likely to affect most public reporting companies, but is not an exhaustive summary of all revisions.
Segment Financial Information. The Business section (as required by Item 101 of Regulation S-K) is no longer required to contain: financial information about segments since such information is already covered by GAAP and Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
Research and Development Expenditures. The Business section will not need to disclose research and develop expenditures, which are required by GAAP; however, the MD&A should discuss research and development expenditures in the context of material trends if applicable with respect to research and development expenditures.
Geographic Disclosures. The Business section can now omit financial information about geographic areas, such as revenues from external customers in the issuer's country of domicile and foreign countries since such information is already covered by GAAP. Where a discussion of elements of income from certain geographic areas is material and appropriate to an understanding of the business, the MD&A must include such information (e.g., as part of elements of income that are not indicative of the issuer's ongoing business).6 Furthermore, the Business section can exclude risks attendant to foreign operations and any dependence of one or more of the registrant's segments upon such foreign operations, but where material, the risk factors and MD&A should address this information.
Trading Symbol and Price. Trading symbols for securities must accompany identification of principal trading markets for equity securities along with the principal foreign public trading market for foreign issuers, but registrants (with common equity traded in an established trading market) no longer need to disclose high and low trading prices for each quarter in the last two full fiscal years and interim periods given that such information is easily accessible. Additionally, issuers with common equity that is not traded on an exchange are required to indicate, as applicable, that any over-the-counter quotations reflect inter-dealer prices and may not necessarily represent actual transactions.
Dividends. Only the notes to the financial statements need to include (a) dividend history for the previous two fiscal years and interim periods (covered by amended Rule 3-04 of Regulation S-X) and (b) restrictions on ability to pay dividends (covered by revised Rule 4-08(e)(3) of Regulation S-X). Nevertheless, issuers should consider including a discussion of restrictions on dividends in the MD&A in the context of the discussion of debt covenants, if material.
Ratio of Earnings to Fixed Charges. There is no longer a requirement to include historical and pro forma ratios of earnings to fixed charges and the related exhibit when registering debt securities or preferred stock. GAAP already covers disclosure of the components commonly used to calculate these ratios, and the SEC recognizes that debt investors are more focused on the information readily available from the financial statements and EBITDA or similar metrics.7
Internet Address. If an issuer has an internet address, disclosure is no longer simply "encouraged," but mandatory; registrants should be cognizant of the SEC's guidance about liability for website disclosures and include appropriate language in filings that information on company websites is not incorporated into such filings.
Public Reference Room. Registration statements no longer need to reference the availability of SEC filings in the public reference room at the SEC's headquarters or disclose its physical address and phone number. Given the availability of information on the internet and continued enhancements to EDGAR, physical review has become obsolete.
Foreign Private Issuers. Form 20-F will no longer require foreign private issuers to (a) provide exchange rate data when financial statements are prepared in a currency other than the U.S. dollar as such data is widely available on the internet and (b) seek a waiver to include audited financial statements in an initial public offering that are 15 months old compared to the 12 months aging requirement (assuming certain facts and circumstances apply).
Various Regulation S-X Changes. The final rules modify Regulation S-X to (a) reconcile provisions related to the presentation of consolidated and combined financial statements with GAAP and (b) delete other duplicative requirements that require substantially similar disclosure as required under GAAP, IFRS or other SEC requirements.
Changes Considered, but Not Adopted
Notably, the SEC did not implement a few proposed amendments, which merited consideration:
Legal Proceedings. The SEC did not modify the legal proceedings disclosure required under Regulation S-K or refer the relevant SEC disclosure requirements to the FASB for potential incorporation into GAAP. The SEC's inaction on the legal proceedings requirement can be attributed to several differences between the Regulation S-K requirement and the corresponding requirement under GAAP (for loss contingencies), and concern about negative implications of such integration (such as increasing liability or disclosure of immaterial items). Within the context of discussing legal proceedings disclosure under Item 103 of Regulation S-K, the adopting release does not explicitly address the SEC's proposal to eliminate the $100,000 disclosure threshold for potential monetary sanctions in connection with environmental proceedings involving a governmental authority.8
Seasonality. The Business section disclosure will still need to discuss annual seasonality (for annual reports and registration statements). The SEC retained the requirement due to a concern that GAAP, while generally useful for interim seasonality disclosure, may not elicit such information for the fourth quarter. Although the SEC deleted an MD&A instruction specifically requiring a seasonality discussion, such information should be included in interim reports to the extent that the effects of seasonality may become material.
Pro-Forma Dispositions. Under Rule 8-03(b)(4) of Regulation S-X, companies will still need to present pro forma financial information regarding business dispositions; however, the SEC indicated the issue warranted additional analysis and consideration.9
The SEC's adoption of the most recent disclosure simplification rules occurs on the heels of its proposal to streamline the guarantor financial statement and affiliate equity pledge rules contained within Rule 3-10 and Rule 3-16 of Regulation S-X 10 and another recent proposal for streamlining disclosure and reporting requirements issued in October 2017, on which we previously published a memo.11 Although these most recent disclosure simplification rules are not independently significant and will not likely result in a meaningful change to the time spent or cost associated with being a public company, the SEC's actions on these initiatives demonstrate its intention to move forward on the disclosure reform project that Chairman Clayton signaled shortly after his appointment.12 Additionally, in tandem with the SEC's disclosure reforms, Congress is considering legislative action in this area.
Although the disclosure simplification rules appear to simply focus on technical amendments that change the presentation of information in periodic reports by eliminating and combining overlapping, redundant and duplicative disclosure requirements, these revisions could have a greater impact in changing the way companies disclose information. For example, the relocation of disclosures into or outside of the financial statements could impact the scope of the disclosures that are provided. The Private Securities Litigation Reform Act of 1995 does not apply to financial statements and the absence of this protection may discourage registrants from using forward-looking statements in the footnotes to their financial statements. These disclosures when contained outside of the financial statements often reflect a thoughtful and careful consideration of factors material to a company's business. Relocation also may alter the prominence and/or the context of the disclosure, potentially impacting investors' review and perception of that disclosure. Additionally, if relocation moves disclosure into or out of the financial statements, it would also change whether such disclosure is subject to an annual audit or interim review by the issuer's auditors and XBRL tagging requirements. Greater reliance on financial statement disclosure may impact audit procedures and audit costs as well as the design and testing of internal controls. In addition, and possibly more importantly, certain of the new disclosure requirements eliminated bright-line disclosure requirements in SEC rules in reliance on corresponding GAAP requirements. The GAAP requirements generally lack a precise disclosure requirement. The SEC recognizes that the shift to the GAAP standard could alter the information provided to investors.
Additional revisions connected to this release should be forthcoming based on the SEC's referral of certain matters to FASB for review and potential integration into GAAP. One topic under FASB consideration worthy of mention is Item 201(d) of Regulation S-K, which provides for tabular disclosure regarding existing equity compensation plans approved and not approved by shareholders. The SEC noted that this provision overlaps with GAAP requirements, but Item 201(d) imposes incremental disclosure requirements.
The rules become effective thirty days after publication in the Federal Register, which will be around the time when many issuers will file their quarterly reports for the third quarter, and will also apply to any registration statements filed after the effective date (i.e., expected to apply to registration statements filed during the fourth quarter).
In advance of the effective date and imminent filing deadlines, we advise companies to understand how to reflect such changes in their disclosure and update their procedures accordingly. Forthcoming filings may not immediately change in response to the revised disclosure rules because some companies may not be fully aware of the nuances of the various changes or simply prefer to not alter the precedent disclosure, notwithstanding redundancy; other revisions will be widely adopted by companies and practitioners, as certain previously required information has been commonly viewed as immaterial. For further guidance in applying the new rules to upcoming filings, please reach out to any Shearman & Sterling contacts that have contributed to this memo.
2 Among other things, the FAST Act requires the SEC to eliminate provisions of Regulation S-K that are duplicative, overlapping, outdated or unnecessary.
3 The SEC press release more specifically outlines the amendments as eliminating certain: (i) redundant and duplicative requirements, which require substantially similar disclosures as GAAP, International Financial Reporting Standards (IFRS), or other SEC disclosure requirements; (ii) overlapping requirements, which are related to, but not the same as, GAAP, IFRS or other SEC disclosure requirements; (iii) outdated requirements, which have become obsolete as a result of the passage of time or changes in the regulatory, business or technological environment and (iv) superseded requirements, which are inconsistent with recent legislation, more recently updated SEC disclosure requirements, or more recently updated GAAP.
6 The amendments modify Item 303 (MD&A) to explicitly reference "geographic areas" to clarify that geographic discussion is required when management believes such discussion would be appropriate to an understanding of the business. As a corresponding change, the amendments eliminated the related geographic disclosure requirements in Item 101(d) of Regulation S-K.
7 The release cites to the discussion in our comment letter. See p. 59 of the adopting release, and the ratio of earnings to fixed charges discussion in our comment letter.
8 We note that the release cites our comment letter, including our reasoning for not eliminating disclosure of legal proceedings under Item 103 of Regulation S-K. See release, p. 91‑93. Please also see our comment letter for a discussion of the proposal to eliminate the $100,000 environmental liability disclosure threshold.
9 Conversely, the SEC deleted the requirement for pro forma financial information in interim filings for significant business combinations in Rule 8-03(b)(4) and Rule 10-01(b)(4) of Regulation S-X, on the basis that such information was already sufficiently covered by GAAP and Item 9.01 of Form 8-K.
11 https://www.sec.gov/rules/proposed/2017/33-10425.pdf. See our client memo summarizing these proposed changes at: https://www.shearman.com/perspectives/2017/10/sec-proposes-streamlining-disclosure-requirements.
12 Remarks by SEC Chairman Jay Clayton at the Economic Club of New York, July 12, 2017; https://www.sec.gov/news/speech/remarks-economic-club-new-york.
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