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The U.S. Securities and Exchange Commission (SEC) issued a 341-page concept release in April requesting market participants to comment on its proposals to update and modernize Regulation S-K.
Ivan Colao is a Partner in Holland &
Knight'sJacksonvilleoffice David Cole is a Partner in Holland &
Knight'sNorthern Virginiaoffice Laurie Green is a Partner in Holland &
Knight'sFort Lauderdaleoffice Tom McAleavey is a Partner in Holland &
Knight'sOrlandooffice Ira Rosner is a Partner in Holland &
Knight'sMiamioffice Michael Taylor is a Partner in Holland &
Knight'sPortlandoffice Shawn Turner is a Partner in Holland &
Knight'sDenveroffice
HIGHLIGHTS:
The U.S. Securities and Exchange Commission (SEC) issued a
341-page concept release in April requesting market participants to
comment on its proposals to update and modernize Regulation
S-K.
The Holland & Knight Public Companies and Securities Team
explores here several of the policies in the release to help market
participants understand the current regulatory environment and
suggest change.
The SEC issued a concept release in
April requesting market participants to comment on its proposals to
update and modernize one of the principal regulatory regimes,
Regulation S-K, which instructs public companies to disclose
material financial and other information to investors when offering
securities publicly and when reporting to the market and
shareholders periodically.
The concept release is massive – more than 341 pages
– so space simply does not permit an exhaustive analysis of
every Regulation S-K provision potentially affected by the concept
release. Nevertheless, we attempt below to help issuers, investors
and regulators reconsider the current integrated disclosure system
with an eye toward improving access to material information in an
efficient and cost effective manner, ultimately to foster capital
formation and well-functioning secondary markets.
Below, we highlight certain key Regulation S-K requirements. For
brevity's sake, we present our thoughts in concise points and
tables rather than lengthy narratives. First, we roadmap those
items we discuss in the first row of each table. Next, we discuss
how the market currently responds to the existing regulations,
pointing out problematic areas where possible. We then analyze how
the SEC suggests the existing disclosure requirements might change,
and we also offer some additional potential comments that market
participants may elect to make to the SEC. To help market
participants understand both the current regulatory environment and
the suggestions for change, we explore the policies supporting the
various Regulation S-K items discussed and the relevant suggested
changes. By using an outline and tabular form, we hope that readers
with a specific interest in an issue addressed by the concept
release can quickly move to that point in our discussion.
It remains uncertain how large a bite the SEC might take into
Regulation S-K, as the SEC rarely makes dramatic, sweeping changes
to the capital markets regulatory regimes. This makes it difficult
to predict where the SEC will focus its attention. However, change
to any one of the areas discussed below could have important
consequences to companies and investors, and even though much of
the concept release discusses streamlining certain required
disclosure, other portions consider expanding required disclosure
or shifting the emphasis or basis of the disclosure. As a result,
consistent, vociferous public comment could sway regulators in ways
meaningful to registrants and market makers.
We invite you to contact any of our contributors if you would
like to make your voice heard on any of these issues explored below
or another of importance to you. The deadline to submit comments to
the SEC is July 21, 2016.
Basis and Nature of Disclosure
Requirements
Disclosure
Requirements Examined
Sunset Provisions
Principles-Based vs. Prescriptive Disclosure Requirements
Audience for Disclosure
Cost of Compliance
Current
Regulatory Requirements
Regulation S-K Generally: Regulation S-K
regulates all non-financial statement disclosure made by companies
who desire access to the U.S. capital markets and who must make
periodic disclosure to the markets. Regulation S-K addresses a
company's business, activities, obligations, liabilities, risks
and a host of other items material to a decision to invest.
Sunset Provisions: A sunset provision in an
SEC regulation would cause it to cease to have effect after a
specified date unless the SEC staff took further action to make the
regulation permanent. Though favorably viewed by some in the
market, the SEC staff occasionally (but inconsistently) employs
sunset provisions. A sunset provision affords regulators and market
participants time to react to new regulatory requirements and can
provide an opportunity for more deliberative rule-making, and
ultimately, more thoughtful regulation. Given the durability of a
disclosure requirement once adopted, sunset provisions can inject
flexibility into the rule-making process to permit changes in the
economic and regulatory landscape to affect a rule before it
becomes permanent.
Prescriptive vs. Principles Based Disclosure:
The current disclosure regime includes a mix of
"principles-based" and "prescriptive"
disclosure requirements. Principles-based disclosure requirements
articulate a disclosure objective without clear direction on how to
satisfy the requirement, leaving the issuer and its advisors to
exercise substantially more discretion in the disclosure process.
Prescriptive disclosure requirements employ objective, quantitative
and, according to proponents, more easily identifiable disclosure
thresholds. In the concept release, the SEC suggests moving toward
a hybrid, "objectives-oriented" approach. Consistent with
the principles-based method, the objectives-oriented approach would
encourage issuers to make determinations about what is material to
their business while also offering a consistent framework to allow
for more meaningful comparisons of companies and their
performance.
Audience for Disclosure: The current
regulatory environment does not expressly distinguish among
institutional investors, retail investors, bondholders,
broker-dealers, analysts, lenders and others. However, the
requirement to tag financial disclosure in XBRL format aids the
financial community to compare financial performance among issuers
and registrants.
Cost of Compliance: The cost for companies to
comply with the nation's securities laws is material to many
public companies. The existing regulatory framework imposes
material administrative burdens on companies to prepare periodic
and other disclosure. Public disclosure can affect a company's
ability to compete against private companies or those regulated
overseas under less fulsome disclosure regimes. While issuers may
request confidential treatment of sensitive information, the SEC
indicated that it does not look upon such requests favorably in the
context of a public disclosure regime. The SEC also looks to
address the appropriateness of scaled disclosure to better adapt
disclosure requirements to the size of the disclosing company.
Summary of
Requests for Comment
Sunset Provisions
The SEC seeks comments on:
the benefits and disadvantages of automatic sunset provisions,
with particular emphasis on the types of disclosures that would
benefit from a sunset provision and on their potential cost to
issuers
whether further SEC staff study of sunset provisions would be
advantageous and cost effective, and what particular provisions
might benefit from such study
Principles Based vs. Prescriptive Disclosure
The SEC seeks comments on:
whether the SEC should revise the principles-based approach to
adopt a more consistent standard such as an objectives-oriented or
other approach
whether the definition of materiality should be revised for
disclosure purposes
the advantages and disadvantages of a principles-based approach
for issuers and investors
whether issuers should err on the side of inclusion or omission
if there is uncertainty in a disclosure requirement
whether additional disclosure provides useful information to
investors or obfuscates the disclosure
whether quantitative disclosures elicit important information
for investors
whether the SEC should develop qualitative thresholds for
disclosure
Audience for Disclosure
The SEC seeks comments on:
whether issuers assume some level of investor sophistication in
preparing disclosure and, if so, how such sophistication should be
measured
the risks and disadvantages to investors if the issuer
inaccurately estimates the investors' level of
sophistication
whether disclosure protects all investors if it is tailored to
a subset of the investor community
whether disclosure requirements should incorporate formatting
requirements that are tailored to various types of investors in a
manner that will facilitate such investors better use of disclosure
for investment and voting decisions
Cost of Compliance
The SEC seeks comments on:
whether the current disclosure requirements appropriately
consider the costs and benefits of registrants and investors
how the SEC can evaluate such benefits
whether there are accommodations such as scaled disclosure and
confidential treatment that could reduce costs for registrants
while still providing investors with important or useful
information to make educated investment and voting decisions
Policies
Supporting Existing, Expanded or Reduced Disclosure
The SEC
must balance the protection of investors against the nation's
interest in encouraging capital formation through open, efficient
and well-functioning capital markets to support the requirements of
business. Disclosure policy should consider the needs of retail
investors as well as sophisticated and experienced capital market
participants. Disclosure policy also must encourage disclosure of
what is material to an investment in any one particular issuer
given its industry, customer base, sensitivity to market risk and
other factors peculiar to it. Facts and circumstances material to
one company may not be material to another company. At the same
time, the cost to access the capital markets has increased
dramatically since the adoption of Sarbanes-Oxley, which can
discourage companies from tapping the capital markets. These
competing policies make it difficult to craft effective securities
regulation and can result in regulations that are difficult for
issuers and their advisors to reconcile.
Practical
Experience/ Market Approach to Disclosure Requirement
Compliance
with Regulation S-K varies among industries and among companies
within an industry. The threat of civil lawsuits plays an important
role in some companies over-disclosing information not material to
an investment decision or unresponsive to a Regulation S-K item.
Other companies with an eye toward market reaction disclose only
what is minimally responsive to an Item.
Suggestions
for Current Comment
While a one-size-fits-all disclosure regime makes little sense
in a diverse economy, re-examining whether the existing regulatory
environment approaches disclosure from a mid-20th century
industrial perspective and further consideration of what is most
material to companies and investors in an age of instant access to
information is worthy.
Where quantitative disclosure is necessary, consider
emphasizing consistent tabular disclosure with a focus on
comparative analysis in a system resembling eXtensible Business
Reporting Language (XBRL) analysis.
Taking a longer term perspective on certain disclosure may help
move companies away from focusing on quarterly earnings reporting
and toward maximizing shareholder value.
Incorporating on-ramps to reporting obligations can encourage
pre-public companies to consider accessing the U.S. capital markets
rather than remaining private or seeking capital elsewhere.
On-ramps provide issuers time to fine-tune the internal controls
and disclosure controls necessary for reliable and accurate public
disclosure of material information, which leads to more reliable
information for investment decisions.
Core Company Business
Information
Disclosure
Requirements Examined
General Description of Business During the Past Five Years
(Item 101)
Narrative Description of Business, including Specific Line
Items (Item 101)
Patents, Trademarks, Licenses, Franchises and Concessions (Item
101)
Government Contracts (Item 101)
Environmental Laws Compliance (Item 101)
Government Regulation (Item 101)
Employees (Item 101)
Physical Properties (Item 102)
Current
Regulatory Requirements
Items 101 and 102 of Regulation S-K prescribe what registrants
need to disclose about their operations. Beyond a general
description of the business, the rules require disclosure about
intellectual property, the effect of government regulation, the
number of employees, the physical plant, sources and availability
of raw materials, the effect of seasonality, environmental
compliance and certain government contracts risk.
Some items ask narrow questions, such as how many employees a
registrant has, while some, in contrast, ask for principles-based
disclosure, such as a description of the importance of the
company's intellectual property rights, franchises and
concessions to its business.
Summary of
Requests for Comment
Many of the
SEC suggestions for comment focus on whether the SEC should require
expanded disclosure of these various operational facts material to
a registrant.
Item 101
The SEC seeks comments on:
adding specific tabular disclosure concerning the nature of a
registrant's IP portfolio and its material contracts
whether changes in employee workforce numbers predict future
financial performance
whether changes in environmental compliance affect capital
expenditures
whether the SEC should modify disclosure requirements for
members of certain industries
whether the reporting period of five years should be lengthened
or shortened
whether registrants should disclose business strategies and
contacts with the government
Item 102
The SEC seeks comments on:
whether companies that lease premises should disclose more
information about their real property requirements
Policies
Supporting Existing, Expanded or Reduced Disclosure
A general
description of the business of a registrant is fundamentally
important to an informed investment decision. Inclusion of the
specific disclosure was intended to provide the investing public
with similar information available to venture capitalists, lenders,
underwriters and other professional investors.
Intellectual property has become increasingly important to
businesses and, therefore, to investors seeking to understand a
company's business performance and prospects. Disclosure of a
registrant's intellectual property position often is essential
information for an informed investor.
Business contracts with agencies of the U.S. government impose
terms and rights that are different from those typically found in
commercial contracts. They are subject to renegotiation and, as a
result, an estimate of the profit potential can be difficult to
determine.
Viability of a company often can depend significantly on
governmental approval of its products or the nature and extent of
its contacts with government officials. Understanding the need for
government approval and how pervasive the company's
governmental contacts are can inform an investment decision.
Changes in employee complements can signal trends, but number of
employees does not always correlate to revenue, earnings, cash flow
and other indicia of financial performance. To the extent that a
registrant depends materially on outsourced service or independent
contractors, an investor would benefit from understanding the risks
that independent contractors might be reclassified as employees.
This disclosure together with understanding the employee complement
and what it does would provide a more complete picture of a
registrant's workforce.
Twenty-first century business may rely less on physical plant than
when the SEC first introduces the regulations; what may matter to
investors is whether the registrant can scale production when
needed – so disclosure concerning the ability to access
physical plant as a company grows may concern investors.
Practical
Experience/ Market Approach to Disclosure Requirement
A general
description of a company's business is relevant to an informed
investment decision. However, some disclosure required by Item
101(a)(1) can duplicate information disclosed in other filings or
elsewhere in the same report, such as in notes to the financial
statements and the Management Discussion and Analysis
(MD&A).
The required disclosure concerning intellectual property does not
address all assets generally associated with intellectual property.
Many companies, nevertheless, disclose information concerning their
intellectual properties beyond the requirements of the regulation.
The lack of uniformity of disclosure makes it challenging to
compare companies' portfolios.
Disclosure concerning a government contractor's revenue and
backlog lack not only uniformity, but also have the potential to
mislead an investor unless the investor understands well the
appropriation and funding process of the federal government and
other governments. Disclosure of funded backlog under an IDIQ
contract has far more value to an investor than disclosing the
maximum value potentially awardable under that vehicle to the
registrant along with other awardees under that contract, yet
companies do not always plainly inform investors what task orders
they have received, focusing instead on potential awards.
Because loss of a governmental permit or approval can have material
consequences to a registrant, many already disclose the extent to
which they depend on permits and approvals and the risks involved
with the loss of a material permit or approval.
Suggestions
for Current Comment
The SEC should consider whether information called for in Item
101 is typically disclosed elsewhere and should permit registrants
to update previously disclosed information rather than regurgitate
it.
The list of 13 specific items to be disclosed pursuant to Item
101(c) should be reviewed in light of the changing business
environment since the disclosure requirement was implemented.
Distinguishing among registrants based on industry classification
might be appropriate in order to elicit more useful information
from registrants.
The SEC should consider tabular disclosure concerning
intellectual property to permit investors to compare portfolios and
to understand where certain intellectual property (IP) sits in the
registration process. This may also simplify the disclosure
requirements for registrants.
Expanding the disclosure requirement in Item 101(c)(1)(ix) to
apply to all material contracts would seem unnecessary given
existing MD&A and current reports disclosure requirements.
The SEC should consider revising the rule requiring disclosure
of the number of employees of a company to account for the changing
business environment, particularly the use of outsourced
resources.
The SEC should consider making Item 102 disclosure only
applicable to companies in industries for which physical plants and
properties are materially relevant.
Company Performance, Financial Information
and Future Prospects – Item 301: Selected Financial Data and
Item 302: Supplementary Financial Information
Disclosure
Requirements Examined
Five-Year Trend Data (Item 301, Instruction 1)
Items included in Selected Financial Data (Item 301,
Instruction 2)
All required disclosures (Item 302)
Current
Regulatory Requirements
Item 301 requires listed registrants to disclose certain
selected five-year financial data in their annual report on Form
10-K (but not in quarterly reports), including net sales or
operating revenues, income (loss) from continuing operations,
income (loss) from continuing operations per common share, total
assets, and long-term obligations and redeemable preferred stock
(including long-term debt, capital leases, redeemable preferred
stock and cash dividends declared per common share). Registrants
may include additional items to enhance an understanding of and
highlight trends in their financial condition and results of
operations.
Item 302 requires listed registrants to disclose quarterly
financial data of selected operating results, and the disclosure of
variances in these results from amounts previously reported.
Items 301 and 302 do not apply to smaller reporting
companies.
Summary of
Requests for Comment
Item 301
The SEC seeks comments on:
whether it should (a) retain, modify or eliminate the
disclosure requirements under Section 301, (b) add to or subtract
from the list of items required to be disclosed as Selected
Financial Data or (c) modify the number of fiscal years to be
disclosed as Selected Financial Data
whether the selected financial data effectively highlight
significant trends that are not described elsewhere
whether it should consider revising the current presentation
requirements for the selected financial information and whether or
not there should be auditor involvement on the reliability of the
disclosure
Item 302
The SEC seeks comments on:
whether it should (a) retain, modify or eliminate the
disclosure requirements under Section 302, or (b) require auditor
involvement on the reliability of the disclosure
whether the information required by Item 302 helps investors to
understand the pattern of corporate activities throughout a fiscal
period by disclosing trends over segments of time that are
sufficiently short to reflect business turning points
Policies
Supporting Existing, Expanded or Reduced Disclosure
Item 301 is intended to provide high level financial
information so a reader need not parse the registrant's prior
annual financial statements for that information. The high level
financial information should bring to light any significant trends
in the registrant's financial condition and performance over
the five-year period.
When adopted, the SEC stated its belief that the disclosure
required by Item 302 would "materially assist investors in
understanding the pattern of corporate activities throughout a
fiscal period" by disclosing trends over segments of time that
are sufficiently short to reflect business turning points. The SEC
also noted that this disclosure would reflect seasonal
patterns.
Practical
Experience/ Market Approach to Disclosure Requirement
The
required selected financial data looks back over the
registrant's last five fiscal years, which is longer than the
time periods covered by the annual audited financial statements
included in Form 10-K. Typically, the prior high-level, selected
financial information appears in prior annual reports. Prior
disclosure mitigates the burden of providing summary financial
information based on these prior years in a present-year annual
report. While the burdens placed on registrants to provide the
information required by Item 301 are not overly significant, it is
worth questioning whether such disclosure provides any meaningful
benefit to investors, since trends may be apparent elsewhere. The
advent of XBRL also should make continued disclosure of five- year
summary financial information less meaningful. The same analysis
applies to the quarterly information required by Item 302.
Suggestions
for Current Comment
Should registrants have flexibility to provide additional
information about their business that they believe is most relevant
to a reader's understanding of the registrant's financial
condition and performance. To the extent additional information is
not taken directly from the registrant's financial statements,
what role should auditors play (i.e., audit, review or specified
procedures) to opine on the additional information.
The SEC should consider eliminating Item 302, as it is
typically included as an unaudited note to the financial
statements.
Company Performance, Financial Information
and Future Prospects – MD&A
Disclosure
Requirements Examined
Content and Focus of MD&A
Results of Operations
Liquidity and Capital Resources
Off-Balance Sheet Arrangements
Contractual Obligations
Critical Accounting Estimates
Current
Regulatory Requirements
Item 303
requires registrants to analyze in an MD&A narrative three core
components relevant to assessing a registrant's financial
condition, changes in financial condition and results of
operations: (1) liquidity, (2) capital resources and (3) results of
operations. Registrants should focus on known trends and
uncertainties affecting liquidity, capital resources and results of
operations. Registrants should employ a "two-step test"
to assess whether (1) an uncertainty or trend is likely to come to
fruition or continue (if it is not reasonably likely to occur or
continue, no disclosure is required), and (2) if the registrant
cannot make that determination, disclosure is required unless
management determines that a material effect on its financial
condition or results of operations is not reasonably likely to
occur. Although the registrant should report trends and
uncertainties, the registrant is not required to address critical
accounting estimates in its MD&A.
Item 303 also requires disclosure of a registrant's off-balance
sheet arrangements that have or are reasonably likely to have a
current or future effect on its financial condition, changes in
financial condition or capital resources that are material to
investors.
Item 303 requires tabular disclosure of a registrant's known
contractual obligations for long-term debt, capital leases,
operating leases, purchase obligations and other long-term
liabilities reflected on its balance sheet under Generally Accepted
Accounting Principles (GAAP).
Summary of
Requests for Comment
Content and Focus of MD&A
The SEC seeks comments on:
whether the current requirements result in disclosure that
highlights the most important aspects of financial condition and
results of operations
whether there are requirements that result in immaterial
disclosure that obscure significant information
whether the SEC should consider a qualitative or quantitative
threshold other than materiality for MD&A
whether the SEC should consolidate its MD&A guidance in a
single source
whether registrants should be required to provide an
executive-level overview, and, if so, if the SEC be prescriptive in
its overview content requirements
whether there are additional rules the SEC should consider that
would result in more meaningful MD&A
whether the two-step test for requiring forward-looking
disclosure in MD&A results in the most meaningful
forward-looking disclosure
whether a standard other than "reasonably likely"
should be used in the first prong of the test, or whether a
different should standard apply, such as the probability/magnitude
standard from Basic v. Levenson (balancing the probability
of the event and the anticipated magnitude in light of the totality
of the registrant's activities)
whether registrants should be specifically required to quantify
the material effects of known trends and uncertainties
whether MD&A should include a principles-based requirement
to disclose performance metrics and other key variables important
to a registrant's business or whether the SEC should prescribe
requirements for discussing specific performance metrics applicable
to certain industries
Results of Operations
The SEC seeks comments on:
whether the SEC should retain, eliminate or modify the
period-to-period comparisons in MD&A
whether the three-year comparison should provide material
information about trends that would not be reflected in prior
filings, whether registrants should be permitted to omit the
earliest period if it does not provide important information to
investors, or whether registrants should be permitted to
cross-reference or link to prior period discussion or the earlier
period
whether a different format of disclosure – such as a
standardized tabular format – provide enhanced understanding
of results of operations or encourage greater analysis than the
period-to-period comparison
Liquidity and Capital Resources
The SEC seeks comments on:
whether the SEC should elicit more meaningful analysis of these
items or whether prescribed separate discussion of liquidity and
capital resources would lead to more useful analysis
whether the SEC should modify the definition of
"liquidity" or adopt a definition of "capital
resources"
for what periods should discussion and analysis of liquidity
and capital resources be required and whether additional measures
of intra-period liquidity and capital resources should be
required
whether registrants should be required to include a sensitivity
analysis
whether the SEC should require specific line-item disclosure of
use and analysis of short-term borrowing as a source of
funding
Off-Balance Sheet Arrangements
The SEC seeks comments on:
whether required information should otherwise be available in
SEC filings (in financial statements or elsewhere in MD&A)
whether additional disclosure should be required, such as an
analysis of the risks associated with the arrangements
Contractual Obligations
The SEC seeks comments on:
whether the required tabular disclosure present a meaningful
snapshot of cash requirements for contractual disclosure
whether disclosure should be required to accompany the
disclosure
whether there are other categories of contractual obligations
that should be included or whether the SEC should provide guidance
as to how to treat certain types of contractual obligations
Critical Accounting Estimates
The SEC seeks comments on:
whether the SEC should require disclosure about critical
accounting estimates, and if so, how they should be defined
how registrants can be encouraged to eliminate repeating in
MD&A the discussion of critical accounting policies provided in
the notes to the financial statements
whether the SEC should adopt prescriptive requirements on
critical accounting estimates
whether the SEC should require disclosure of management's
judgments and estimates that form the basis of MD&A disclosure,
such as the qualitative and quantitative factors used in its
assessment of materiality
whether the SEC should require management to disclose the
nature of its assessments of errors that it determined to be
immaterial and therefore were not corrected
Policies
Supporting Existing, Expanded or Reduced Disclosure
MD&A
Disclosure is intended to satisfy three principal objectives:
to provide a narrative explanation of the registrant's
financial statements that enables investors to see the registrant
through the eyes of management
to enhance the overall financial disclosure and to provide the
context within which financial information should be analyzed
to provide information about the quality of, and potential
variability of, the registrant's earnings and cash flow, so
investors can ascertain the likelihood that past performance is
indicative of future performance
The SEC has provided MD&A guidance on several occasions in an
effort to improve the quality of the analysis of known trends and
uncertainties and discourage the restatement of financial
statements in narrative form. In its guidance, the SEC has
reiterated the importance of materiality in its principles-based
approach to MD&A and encouraged registrants to de-emphasize or
remove immaterial information.
The SEC also has provided guidance specifically focused on the
quality and focus of the analysis, the use of forward-looking
information and the use of key performance indicators.
Practical
Experience/ Market Approach to Disclosure Requirement
Current MD&A drafting reflects an ongoing tension between
principles-based disclosure and prescriptive line item disclosure
with bright-line tests and required tabular disclosure. While
principles-based disclosure permits a registrant to more easily
tailor its disclosure to what it believes is relevant to investors,
prescriptive-based disclosure may lead to easier comparability
among registrants.
While some registrants include executive-level overviews in
MD&A as the SEC has suggested, these summaries generally do not
reduce the length or complexity of MD&A. Because of the risk of
liability for failure to disclose information that a registrant may
deem immaterial at the time of filing, but is then viewed to be
material in hindsight, registrants continue to provide a narrative
discussion of the financial statements and respond to every line
item, even where immaterial.
The demands of the capital markets sometimes discipline
registrants and force them to address the same key performance
indicators that others in their industry disclose even where Item
303 does not require disclosure.
The overlap of certain line items' MD&A disclosure
areas with financial statement disclosure appears to result in
duplicative disclosure rather than a nuanced distinction between
MD&A analysis and financial statement disclosure that the SEC
would prefer.
Suggestions
for Current Comment
Because liability concerns drive at least some of the lengthy
MD&A disclosure that appears to be immaterial, the SEC should
consider mitigating liability risk through safe harbors or similar
protections in order to encourage registrants to improve the
quality and conciseness of MD&A disclosure without fear of
incremental liability and second-guessing of business
judgment.
The SEC should move away from prescriptive-based line item
MD&A disclosure to more of a principles-based approach, relying
on the capital markets to impose discipline on registrants to
ensure that the most meaningful information is disclosed and
analyzed.
In a principles-based approach, the SEC should consider
consolidating its MD&A guidance to identify the factors to be
considered when registrants assess MD&A disclosure, without
prescribing additional line items. For example, the SEC could
specifically indicate that intra-period liquidity should be
considered in the registrant's analysis of liquidity in
MD&A, if material, without imposing a line item requiring a new
chart, graph or table.
Consistent with a principles-based approach, the SEC should
eliminate the two-step test for requiring forward-looking
disclosure in MD&A and instead apply the probability/magnitude
standard from Basic v. Levenson, consistent with its
approach to disclosure elsewhere, and thus easing the burden on
registrants of the application of different standards that
increases the risk of second-guessing business judgments.
Some of the current prescriptive-based disclosure in MD&A
– such as discussion of prior period results of operations
and off-balance sheet arrangement disclosure – overlaps with
prior disclosure documents or financial statement disclosure. To
eliminate unnecessary duplication, the SEC should permit
cross-referencing where appropriate and consider a principles-based
approach to these items.
Risk and Risk Management
Disclosure
Requirements Examined
Risk Factors (Item 503(c))
Quantitative and Qualitative Disclosures About Market Risk
(Item 305)
Current
Regulatory Requirements
Item 503(c) requires disclosure of the most significant factors
that make an investment in a registrant's securities
speculative or risky. Although principles-based, examples such as a
lack of operating history, lack of profit, financial position, the
nature of the registrant's business or the lack of a market
(liquidity) for a registrant's equity securities are
provided.
Item 305 requires quantitative and qualitative disclosure of
market risk sensitive instruments (such as derivative contracts,
floating rate instruments and hedges). Disclosure may be made
through one or more of the following three alternatives: (1)
tabular presentation of fair value information and contract terms,
(2) sensitivity analysis expressing the potential loss resulting
from hypothetical market movements or (3) value at risk disclosures
expressing potential loss from market movements over selected
periods and likelihoods.
Summary of
Requests for Comment
Risk Factors (Item 503(c))
The SEC requests comments on:
whether risks should be accompanied by risk management
disclosure (mitigation)
whether an assessment of risk probability should be
required
whether more specificity as to how a risk could affect a
particular issuer should be required
whether risk factors are too lengthy and hinder investors'
understanding of risk
whether issuers should be prohibited from including generic
risks
whether risks should be ranked in importance
whether boilerplate disclosure should be discouraged
whether the rules adequately capture emerging risks
Quantitative and Qualitative Disclosures About Market Risk
(Item 305)
The SEC requests comments on:
whether Item 305 facilitates effective market risk assessment
by investors
whether Item 305 generates adequate market risk information and
whether a more prescriptive approach would function better
whether Item 305 should be limited to certain kinds of issuers
such as financial institutions, what types of investors find market
risk disclosure valuable and the cost of providing market risk
whether the market risk disclosure alternatives adequately
reflect changes in market risk exposure
whether fair value disclosures required under GAAP since Item
305 was adopted in 1997 make Item 305 redundant
whether Item 305 should require more standardized disclosure to
promote comparability of market risk information among issuers
Policies
Supporting Existing, Expanded or Reduced Disclosure
SEC rules
and guidance have long acknowledged the need to provide investors
with adequate risk information, particularly where an issuer's
stage of development, business model, industry or capital structure
make its securities a speculative investment. In addition,
liability concerns of issuers have driven increasing amounts of
risk factor disclosure, particularly in light of the safe harbor
for forward-looking statements under the Private Securities
Litigation Reform Act and the court-created "bespeaks
caution" doctrine. Market risk disclosure is intended to
provide investors with adequate information regarding, among other
things, increasingly common complex financial instruments or
obligations, the effects of which on an issuer may vary as a result
of market forces that are outside an issuer's control.
Practical
Experience/ Market Approach to Disclosure Requirement
Risk factor disclosure has become increasingly extensive as
issuers develop and adopt additional risk factors. Studies indicate
that filings average 22 factors and 8 pages. Other studies indicate
that risk factors have grown by 85 percent in terms of word count
from 2006 to 2013. Given the potential for liability mitigation
resulting from risk factor disclosure, there is little incentive
for securities professionals to avoid adding risk factors and
increasing their detail and density. This adds to the length of
disclosure documents and the cost to prepare them, and leads to
including many generic risk factors not effective to aiding an
investor's understanding of the risk of investing in any
particular registrant.
Market risk information required by Item 305 is frequently
complex, and the item's requirements are often not well
understood. While Item 305 provides three disclosure alternatives,
these may not necessarily elicit effective disclosure in the
context of an issuer's actual market risk. Often issuers
include various contingencies in response to Item 305 that are not
true market risks. Summarizing and assessing market risks of many
instruments can be daunting given a variety of permutations and
market movements.
Suggestions
for Current Comment
Rule changes should encourage useful risk disclosure and
analysis that are relevant to an issuer rather than take a generic
form.
Risk factors should include mitigating factors and risk
management initiatives to promote increased contextualization of
risks; however, such disclosures should not vitiate safe harbor
protections for forward-looking statements.
To the extent that GAAP fair value disclosures overlap with
market risk disclosure requirements, greater integration should be
permitted.
Given the complexity and burden of market risk disclosure, Item
305 should be revised to permit broader disclosure alternatives
than the current three-pronged approach.
Securities of the Registrant
Disclosure
Requirements Examined
Number of Equity Holders (Item 201(b))
Description of Capital Stock (Item 202)
Recent Sales of Unregistered Securities (Item 701(a)-(e))
Use of Proceeds from Registered Securities (Item 701(f))
Purchases of Equity Securities by the Issuer and Affiliated
Purchasers (Item 703)
Current
Regulatory Requirements
Item 201(b)(1) requires disclosure of the number of holders of
each class of a registrant's common equity, which may be based
on the number of record holders or also may include the bank and
broker participants in Depository Trust Company (DTC).
Item 202 requires a description of the terms and conditions of
securities that are being registered.
Item 701(a) – (e) requires disclosure in Form 10-Q and
Form 10-K of recent sales of unregistered securities other than
those previously reported in Form 8-K. Item 3.02 of Form 8-K
requires disclosure if the amount of sales exceeds 1 percent of the
outstanding shares.
Item 701(f) requires disclosure of the use of proceeds from the
registrant's first registered offering in each subsequent
periodic report until all the proceeds have been applied or the
offering has terminated, as well as information regarding
termination of the offering, the name of the managing underwriters,
the amount sold, the offering price and the amount of
expenses.
Item 703 requires tabular disclosure, on a monthly basis, of
shares of equity securities purchased by the registrant and
affiliated purchasers, including: total number of shares
repurchased; average price paid per share; total number of shares
purchased as part of publicly announced plans or programs, and
maximum number or dollar of shares that may yet be purchased under
the plans or programs.
Summary of
Requests for Comment
Number of Equity Holders
The SEC seeks comments on:
whether disclosure about the number of record holders continues
to be important to investors, as the vast majority of investors now
hold their shares in street name
whether registrants should disclose the amount of each class of
equity securities held in street name or the number of beneficial
owners, and if so, how to define "beneficial owner"
what challenges registrants might face in tracking the number
of beneficial owner
Description of Capital Stock
The SEC seeks comments on:
how investors in the secondary market can access information
about the terms and conditions of the registrant's
securities
whether secondary market participants rely solely on the bylaws
and articles filed as exhibits to a Form 10-K
whether the description of securities should be provided each
year in the Form 10-K and whether changes to the terms should be
included in quarterly or annual reports, or whether the Form 8-K
disclosure of changes is sufficient
Recent Sales of Unregistered Securities
The SEC seeks comments on:
whether the disclosure provides important information that is
not already included in the MD&A or the financial
statements
whether requiring disclosure of issuances that exceed 1 percent
promptly in a Form 8-K and all other issuances quarterly are
appropriate, and whether 1 percent is the appropriate threshold in
any case
whether the disclosure should only be in Form 10-Q and Form
10-K, or only in Form 8-K
Use of Proceeds
The SEC seeks comments on:
whether the information should be expanded to cover the use of
offering proceeds from offerings other than a registrant's
first registered offering
whether the disclosure should only be required if the actual
use of proceeds differs materially from the description of the
offering
Purchases of Equity Securities
whether more detail should be provided about repurchases
– including whether the registrant incurred debt to fund the
repurchases and the impact repurchases had on performance measures,
such as earnings per share – given the increase in stock
repurchases in recent years
whether there should be a materiality standard or specify a
dollar threshold for the disclosure in periodic reports
whether disclosure should be provided on a more frequent basis
than quarterly, and whether Form 8-K disclosure is required for
purchases that exceed a certain threshold
Policies
Supporting Existing, Expanded or Reduced Disclosure
Having an
understanding of the terms and conditions of a security is critical
to making an investment decision to purchase or sell that security,
especially if the security is a preferred stock or a debt
instrument. Disclosure about transactions by registrants in their
own securities helps inform investment and voting decisions by
providing investors with information that may affect the value of
that security. Because registrants can raise significant sums of
capital in private placements, existing holders benefit from
disclosure of non-registered offerings.
Practical
Experience/ Market Approach to Disclosure Requirement
Given the large number of investors who beneficially hold their
securities in street name through a nominee, information regarding
the number of record holders does not provide meaningful
information about the number of actual shareholders of the
registrant. However, the disclosure provides information on whether
the registrant is subject to Section 12(g) of the Exchange Act,
which is based on a record holder test. It is difficult for
registrants to obtain information about the beneficial owners of
its securities. In order to obtain information about the number of
beneficial owners and the amount of securities held by such
beneficial owners, a registrant must request the information from
the banks and brokers who hold the securities for the beneficial
owners. This is a time- consuming and costly process. Registrants
that are subject to the proxy rules obtain information pursuant to
Rule 14a-13 about the number of copies of proxy materials brokers
and banks need in order to send them to the beneficial holders, but
this information may not provide an accurate count of the number of
actual beneficial owners.
Currently, a full description of the registrant's
securities is only required in registration statements and certain
proxy statements. Changes in the terms and conditions of the
registrant's securities are required to be disclosed in Form
8-K and Schedule 14A. However, frequently, these disclosures only
report on the discrete amendment. There is no comprehensive
discussion of the registrant's securities in periodic
reports.
Item 701 requires disclosure of all unregistered sales
of common equity, while Form 8-K does not require disclosure of
sales of less than 1 percent of the outstanding shares. Given the
overlap with Form 8-K, it is unclear whether information required
by Item 701(a)-(f) is necessary in periodic reports, particularly
given that it includes information regarding sales of less than 1
percent of the outstanding shares. Further, registrants are
required to provide information regarding material sales of
securities in the discussion of liquidity and capital resources
under MD&A.
Information regarding the proceeds for initial public offerings
is generally disclosed as a material source of cash in the
liquidity section of the MD&A. However, information about the
progress of an offering, such as when a registrant has not
commenced an offering or the offering is terminated before any
securities were sold, may not be available to investors outside of
the disclosure required by Item 701(b).
Item 703 requires registrants to disclose all repurchases of
equity securities by issuers and affiliated purchasers on a monthly
basis for the period covered by the report. There is no materiality
standard. Further, registrants do not generally analyze the impact
of stock repurchases in the context of MD&A.
Suggestions
for Current Comment
Consider whether the disclosure of the number of record holders
should be deleted given the vast number of holders who own shares
in street name. Also, address the ability to obtain the information
regarding the number and amount of beneficial holders, as well as
the cost of obtaining such information.
Consider whether including the complete description of capital
stock in one place in periodic reports would be helpful to
investors. Also, consider whether such information is necessary
given that it is otherwise available in previously filed reports,
the exhibits to the periodic report and Form 8-K and would add to
the length of the periodic report.
Consider whether disclosure of recent sales of unregistered
securities should be required in periodic reports and/or Form 8-K,
given than disclosure of material issuances is otherwise required
in the MD&A and financial statements. Further, if required,
consider whether there should be a materiality standard for
disclosure of the amount of sales of unregistered securities, and
what that amount should be, such as 1, 5 or 10 percent.
Consider whether disclosure of the use of proceeds should be
expanded to cover the use of offering proceeds from offerings other
than a registrant's first registered offering, particularly
given that if material information regarding the use of proceeds is
currently required in MD&A. Further, consider whether
disclosure only should be required if the actual use of proceeds
differs materially from the description of the offering.
Consider whether more detailed and frequent disclosure should
be required and whether such additional information would provide
material information to investors, particularly addressing the
additional cost of such disclosure.
Disclosure of Information Relating to Public
Policy and Sustainability Matters
Disclosure
Requirements Examined
Incorporating Public Policy Concerns into Securities Regulatory
Requirements
Incorporating Sustainability Concerns into Securities
Regulatory Requirements
Current
Regulatory Requirements
Congressional Mandates
In recent years, Congress has mandated new disclosure requirements
that address the following specific public policy concerns:
Section 1502 of the Dodd-Frank Act mandated that the SEC adopt
rules regarding registrants' use of "conflict
minerals" originating in specified countries.
Section 1504 of the Dodd-Frank Act directed the SEC to adopt
rules regarding the disclosure of payments made by resource
extraction issuers to foreign governments or the federal government
for the purpose of the commercial development of oil, natural gas
or minerals.
Section 1503 of the Dodd-Frank Act requires certain registrants
to disclose information about health and safety violations at
mining-related facilities.
SEC Initiatives
In its 1975 Environmental and Social Disclosure release, Release
No. 33–5627 (Oct. 14, 1975) (40 FR 51656 (Nov. 6, 1975)), the
SEC concluded that its proceedings did not support a specific
requirement for all registrants to disclose information describing
"corporate social practices." However, the SEC noted that
in specific cases, some information of this type might be necessary
in order to make the statements in a filing not misleading or
otherwise complete.
In 2010, the SEC issued an interpretive release, "Commission
Guidance Regarding Disclosure Related to Climate Change,"
Release Nos. 33-9106; 34-61469, to provide guidance to public
companies regarding the SEC's existing disclosure requirements
as they apply to climate change matters. For example, the SEC
reviewed the following disclosure requirements:
Item 101 of Regulation S-K requires disclosure of any material
estimated capital expenditures for environmental control facilities
for the remainder of a registrant's current fiscal year and its
succeeding fiscal year and for such further periods as the
registrant may deem material.
Depending on a registrant's particular circumstances, Item
503(c) of Regulation S-K may require risk factor disclosure
regarding existing or pending legislation or regulation that
relates to climate change.
Item 303 of Regulation S-K requires registrants to assess
whether any enacted climate change legislation or regulation is
reasonably likely to have a material effect on the registrant's
financial condition or results of operation.
Summary of
Requests for Comment
The SEC is
interested in receiving feedback on the importance of
sustainability and public policy matters to informed investment and
voting decisions. In particular, the SEC seeks feedback on which,
if any, sustainability and public policy disclosures are important
to an understanding of a registrant's business and financial
condition and whether there are other considerations that make
these disclosures important to investment and voting decisions. The
SEC also seeks feedback on the potential challenges and costs
associated with compiling and disclosing this information.
The SEC seeks comments on:
whether specific sustainability or public policy issues are
important to informed voting and investment decisions
if the SEC were to adopt specific disclosure requirements
involving sustainability or public policy issues, how its rules
could elicit meaningful disclosure on such issues
how the SEC should create a disclosure framework that would be
flexible enough to address such issues as they evolve over time,
and alternatively what additional SEC or staff guidance, if any,
would be necessary to elicit meaningful disclosure on such
issues
would line-item requirements for disclosure about
sustainability or public policy issues cause registrants to
disclose information that is not material to investors
whether the information provided on company websites sufficient
to address investor needs
The SEC also seeks comments on the following:
If the SEC were to propose line-item disclosure requirements on
sustainability or public policy issues: (a) which of the several
published third-party sustainability reporting frameworks should
the SEC consider; (b) what would be the additional costs of
complying with sustainability or public policy line-item disclosure
requirements; and (c) whether the disclosures should be scaled for
smaller reporting companies or some other category of
registrant?
In 2010, the SEC published an interpretive release to assist
registrants in applying existing disclosure requirements to climate
change matters. Are existing disclosure requirements adequate to
elicit the information that would permit investors to evaluate
material climate change risk?
Policies
Supporting Existing, Expanded or Reduced Disclosure
Disclosure of social and environmental information is material
to an investment decision regardless of its economic impact on the
financial performance of the company. This kind of information
reflects on the quality and character of management, which clearly
plays an important role in both investment and corporate suffrage
decision-making.
Disclosures made in response to the SEC's current rules do
not adequately address the risks associated with climate
change.
The SEC seeks to determine whether to expand disclosure
requirements relating to sustainability and public policy matters.
Sustainability disclosure encompasses a range of topics, including
climate change, resource scarcity, corporate social responsibility
and good corporate citizenship. These topics often are
characterized broadly as environmental, social or governance (ESG)
concerns. The SEC is asking registrants for input on the importance
of ESG disclosures to investors' decisions, what a disclosure
framework for ESG matters might look like, and the costs and
challenges related to providing these disclosures. In addition, the
SEC mentioned receiving many letters recommending that it adopt a
rule requiring disclosure of political spending.
Beyond congressional mandates such as under the Dodd-Frank Act,
the SEC should require disclosure of matters of social and
environmental significance only when the information in question is
material to informed investment or corporate suffrage
decision-making or required by laws other than the securities laws.
The SEC should classify social and environmental information as
material only when it reflects significantly on the economic and
financial performance of the company.
Beyond congressional mandates, such as under the Dodd-Frank
Act, the SEC should require disclosure of matters of social and
environmental significance only when the information in question is
material to informed investment or corporate suffrage
decision-making or required by laws other than the securities laws.
The SEC should classify social and environmental information as
material only when it reflects significantly on the economic and
financial performance of the company.
Disclosure to serve the needs of limited segments of the
investing public, even if otherwise desirable, may be
inappropriate, because the cost to registrants, which must
ultimately be borne by their shareholders, would likely outweigh
the resulting benefits to most investors.
Practical
Experience/ Market Approach to Disclosure Requirement
There are limited instances where registrants must respond to
questions rooted in policy or sustainability. One example is the
new conflict mineral regulatory regime. Another includes disclosure
related to mine safety.
Congress likely did not realize the extent of the cost involved
to comply with the conflict mineral regulations when Congress
appended the statutory requirement at the end of Dodd-Frank, but
after the SEC took pains to help clarify various potentially
ambiguous phrases in the law, what registrants faced was the
obligation to dig deep into their supply chains to learn whether
they produce products made from certain elements mined in the Congo
and adjacent Central African states, which are necessary to the
functionality or production of the product. The costs, both hard
and soft, to comply are significant given that an audit may be
required and registrants with significant supply chains need to
spend significant time researching to source of supply of these
minerals. Registrants file annually before May 31 a Form SD, a
specialized disclosure report, to comply with the prescriptive
disclosure requirements.
Suggestions
for Current Comment
Consider whether sustainability or public policy line-item
disclosure requirements are consistent with the SEC's
rulemaking authority and mission to protect investors, maintain
fair, orderly and efficient markets and facilitate capital
formation.
Consider whether existing disclosure requirements are adequate
to elicit the information that would permit investors to evaluate
material climate change risk and whether the existing requirements
are flexible enough to evolve over time.
In light of the experience with conflict mineral auditing and
disclosure, consider discussing the additional costs, hard and
soft, of complying with sustainability or public policy line-item
disclosure requirements.
Exhibits
Disclosure
Requirements Examined
Scope of Exhibits Filed
Schedules to Exhibits
Amendments to Exhibits
Changes to Exhibits
Material Contracts
Subsidiaries
Current
Regulatory Requirements
Item 601 prescribes specific agreements, corporate governance,
consents, certifications, reports, lists, statements, ratio
computations and other documentation that registrants must file
with periodic reports and registration statements.
SEC policy requires registrants filing a material agreement
outside the ordinary course of business to file the entire
agreement, including all exhibits, schedules, appendices and
documents incorporated into the material agreement by reference.
However, if filing certain material plans of acquisition,
disposition, reorganization, readjustment, succession, liquidation
or arrangement, Item 601 permits registrants to omit schedules
unless they contain information material to an investment decision
not otherwise disclosed.
Registrants must file amendments to previously filed exhibits
unless the amendment inserts closing information such as pricing,
underwriter names or commissions, and the like or to correct
typographical errors.
Registrants must file material agreements outside the ordinary
course of business entered into within the two years preceding the
filing. However, registrants must file ordinary course agreements
if the business substantially depends on that contract. For
example, the business might substantially depend on a sole source
of supply agreement or a requirements contract for a concentrated
customer.
Summary of
Requests for Comment
Scope of Exhibits Filed
The SEC requests comments on:
whether it should add to or subtract from the list of required
exhibits
what the cost is to compile and file the required exhibits
whether the exhibits are useful and, if so, to whom
whether presentation of exhibits could be improved
whether technology could make them more useful, such as by
making them searchable or by tagging information in them in a
manner similar to XBRL files
Schedules
The SEC requests comments on:
whether the exception for filing schedules for certain plans of
acquisition, disposition, reorganization and the like should
continue and whether the SEC should expand this exception to other
exhibits such as material contracts
if schedules are not filed, whether registrants should
undertake to file them upon request by the SEC
whether it should codify its office policy not to require
schedules to contain personally identifiable information
whether the staff should codify means to help registrants make
materiality determinations when filing schedules
Amendments and Changes
The SEC requests comments on:
whether it should permit incorporation by reference of a
previously filed exhibit into subsequent periodic reports if the
amendment or change is immaterial
Material Agreements
The SEC seeks comments on:
whether the ordinary course of business standard is clear
whether the two-year time period is appropriate and whether the
standard should look to whether the agreement remains material
whether or not it was entered into recently or in the past
quantitative materiality thresholds applicable to certain
agreements concerning property, plant and equipment upon which the
registrant substantially depends
Subsidiaries
The SEC seeks comments on:
whether a registrant should list all of its subsidiaries,
provide a graphic chart showing the organization of the registrant
on a consolidated basis and also indicate the basis for control
over a subsidiary
whether the significant subsidiary test remains appropriate to
exclude certain subsidiaries from the exhibit list
Policies
Supporting Existing, Expanded or Reduced Disclosure
A hallmark of federal securities law is full and complete
disclosure of information material to an investment decision.
Filing an exhibit allows the registrant to concisely report on the
material provisions of a transaction or the material nature of a
security it offers in the base filing, while allowing investors who
wish to explore a subject in more detail the opportunity to do so.
Filing exhibits also permits registrants the opportunity to provide
disclosure that may make what is disclosed in the base filing not
misleading.
Filing schedules to exhibits in some circumstances helps the
reader more fully understand the provisions of a transaction, such
as schedules to an agreement to sell a business that qualify
representations and warranties made in the purchase agreement.
However, some schedules to exhibits merely add to the total weight
of information disclosed without disclosing any information
material to an investment decision, such as when registrants file
schedules detailing specifications about intellectual property
licensed in a material non-ordinary course license agreement. Good
disclosure policy encourages registrants to supplement disclosure
in base filings with schedules to exhibits containing information
material to an investment decision.
Registrants amending previously filed agreements in a
non-material manner should not incur the expense to file the
non-material amendment or change.
Pricing changes to underwriting agreements and material
contracts filed as an exhibit to a registration statement should
not delay closing if filed as an exhibit to a post-effective
amendment. Incorporation by reference into a subsequent periodic
report should be permitted as long as the change was disclosed in
the body of the appropriate periodic report.
Investors, especially investors in secured bonds, want to
understand the value that a subsidiary generates for a consolidated
registrant. However, multi-nationals may have hundreds of
subsidiaries globally, and the cost to report on their performance
beyond merely listing them can become significant. Conglomerates
also can obtain significant revenue and earnings, and have
significant exposure, from a group of subsidiaries within the same
industry, even if any subsidiary within that industry standing
alone may not rise to the level of significance. Reporting based on
the significance of a group of subsidiaries within the same
industry can provide material information to investors.
Practical
Experience/ Market Approach to Disclosure Requirement
Filing exhibits requires issuers and registrants to cull
through files for material agreements and other documentation,
which can take significant time and expose them to the soft costs
involved in compiling the documentation at the expense of running
their businesses. But in the electronic age, most of these material
documents are readily available, and issuers and registrants can
spend more time determining whether to seek confidential treatment
for information contained in exhibits than gathering the
information. Filing exhibits undoubtedly adds to the length of
periodic reports, and registration statements thereby adding to the
cost of filing – the cost to Edgarize exhibits can be quite
substantial. However, having exhibits on file aids investors to
understand risk associated with material transactions often better
than reading boilerplate risk factors and can help to streamline
the mergers and acquisitions (M&A) due diligence process.
Filing schedules to exhibits can create difficult decisions for
issuers and registrants if the schedules contain sensitive
information that may or may not be material to an investment
decision, but the disclosure of which could be harmful to someone
associated with the registrant or issuer. An example of this is
when lead arrangers of credit facilities might prefer that certain
fees it charges a public company borrower that inure only to itself
and not to other lenders within a syndicate are made public through
an exhibit and schedule filing. Filing exhibits and the schedules
associated with them have created 10(b)-5 liability for registrants
where a representation and warranty in a purchase agreement has
proven untrue (e.g., Titan), which can cause problems
where a seller makes a purchase agreement representation
strategically but does not consider the effect such a
representation might have if filed with the SEC.
Registrants amend material agreements regularly, but the
amendments sometimes matter not to investors and only to the
parties, such as where lenders drop in and out of syndicated credit
facilities, but the total credit available and the terms for
borrowing do not change. Filing amendments that do not add to the
mix of information a reasonable investor finds material to an
investment decision adds no value, but such filings can incur hard
dollar costs for lawyers and financial printers and soft dollar
costs for those inside the registrant addressing the filing.
Sometimes, material agreements contain sensitive information
not material to an investment decision, however the disclosure of
which would be competitively harmful to the registrant. Registrants
can seek confidential treatment, but the process can take time and
can cost significant sums.
Registrants lack guidance on what qualifies as substantial
dependence when considering whether to file ordinary course
agreements.
Suggestions
for Current Comment
The exhibit requirement should focus on what is material to a
particular issuer, which might differ from industry to industry.
Taking less of a prescriptive approach and more of a
principles-based approach might be helpful.
Consider the timing for filing exhibits – it is less
helpful to investors to have an exhibit filed with the next 10-Q if
the transactions contemplated by the exhibit are disclosed in a
Form 8-K.
Prescribe a numbering convention for material contracts so that
registrants do not duplicate an exhibit number already on file.
This can aid investors tracking a registrant's material
agreements.
Test significance across similarly situated subsidiaries within
the same industry.
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.
