Reinventing Public Company Disclosure: SEC Requests Public Comment on Regulation S-K
On April 13, 2016, the U.S. Securities and Exchange Commission (SEC) issued a concept release discussing and requesting public comment on the business and financial disclosure required by Regulation S-K. The concept release represents an important first step toward the reform and modernization of Regulation S-K.
Background: The SEC’s Disclosure Effectiveness Initiative
The concept release is part of the SEC’s ongoing Disclosure Effectiveness Initiative, which is a broad-based review of the SEC’s disclosure requirements and the presentation and delivery of disclosures that registrants make to investors. The Disclosure Effectiveness Initiative began in 2013, following the SEC’s production of a report to Congress on its disclosure rules for U.S. public companies, as mandated by the Jumpstart Our Business Startups (JOBS) Act. Following that report, the SEC initiated a comprehensive review of the disclosure requirements in Regulation S-K and Regulation S-X to make recommendations on how to update those requirements to facilitate timely, material disclosure by companies and access to information by shareholders.
The purpose of the concept release is to revisit the business and financial disclosure requirements in Regulation S-K and to assess whether such requirements continue to provide the information that investors need to make informed investment and voting decisions and whether any of the existing rules have become outdated or unnecessary. The SEC intends to use the feedback collected from the concept release to further its goal of optimizing Regulation S-K, a goal that SEC Chair Mary Jo White has recently referred to as a crucial ongoing responsibility of the SEC.
Key Concepts and Elements
The concept release addresses an expansive list of topics and the SEC’s discussion of these topics is extensive; however, there are several key concepts and elements that are discussed throughout the concept release, including:
Principles-Based Disclosure vs. Prescriptive Disclosure
The concept release discusses and compares the merits of principles-based disclosure, which is based on principles such as “materiality,” and the merits of prescriptive disclosure, which is based on objective line-item requirements, bright-line tests, and/or required tabular presentation. The concept release notes that principles-based disclosure offers a more flexible, management-oriented approach that allows individual registrants to tailor disclosures to provide the information that is most relevant and material to the individual registrant and omit irrelevant or immaterial information. Conversely, the concept release notes that prescriptive disclosure provides investors with the ability to more easily make comparisons between registrants because information is presented in a more standardized form.
The SEC seeks input on which approach is the most effective and cost-efficient by requesting input on a variety of questions, including whether certain line-item disclosures (both narrative and tabular) should be added or removed from Regulation S-K; whether additional industry-specific disclosure should be required in periodic reports; and whether qualitative or quantitative thresholds should be added to or removed from existing disclosure requirements.
A significant portion of the concept release is devoted to determining how to make the existing disclosure framework under Regulation S-K more effective and cost-efficient to investors and registrants. The SEC asks whether certain required disclosures and disclosure frameworks should be consolidated with other, similar disclosure requirements or eliminated altogether.
In addition, the concept release includes a discussion of the scaled disclosure requirements available to smaller reporting companies and emerging growth companies. The SEC requests input on how to further scale or eliminate disclosures applicable to these companies in addition to exploring whether additional types of registrants, including larger registrants with established reporting histories, should be eligible for a form of scaled disclosure.
The SEC also seeks input on several alternate approaches to the periodic disclosure regime that could result in less year-to-year repetition and comparison of prior periods and less frequent periodic reporting.
In addition to requesting comments on methods for streamlining disclosure, the concept release examines the “other side of the coin” and requests comments on whether new or expanded disclosure is necessary to reflect changes in the market and recent stakeholder input. The concept release includes numerous requests for comment on whether the items of Regulation S-K should be expanded or modified to, among other things, adopt disclosure approaches that have become common in certain industries and require greater disclosure of industry-specific metrics. The SEC is also seeking input on the utility of increased periodic and intra-period reporting.
The concept release also explores the value of new disclosure topics not currently required under Regulation S-K. The SEC asks whether (and which) sustainability and public policy issues are important to voting and investment decisions and/or an understanding of a registrant’s business and financial condition. In addition, the SEC is requesting input on how to create disclosure requirements that adequately address such issues without resulting in disclosure that is immaterial or otherwise obscuring to investors.
Presentation of Information
The SEC acknowledges that technology and the way investors obtain information regarding registrants has changed over time, and is therefore seeking input on how these changes may be reflected in the presentation of information in periodic reports. In particular, the SEC cites the widespread use of the internet by investors when requesting comments on whether the SEC should permit the increased use of cross references, hyperlinks, and registrant website disclosure to satisfy the reporting requirements of Regulation S-K.
The concept release further discusses whether changes in technology have made it possible for registrants to provide information in a more disaggregated manner, or whether there is practical and regulatory value in requiring information to be contained in one consolidated source.
The concept release solicits information on the type of investors that are actually reading and utilizing the materials that are filed by registrants on EDGAR. Throughout the concept release, comments are requested regarding whether certain disclosures are for the benefit of, and, as a result, should be tailored toward, more sophisticated institutional investors or less sophisticated retail investors. The concept release indicates that this information is important, in part, because it provides insight into how disclosures should be tailored, including whether currently required disclosures should be expanded or eliminated. The concept release also discusses the use of third-party data aggregators by different types of investors, and questions whether the functions performed by such aggregators reduces the need for comparative or repetitive disclosure in SEC filings.
Adapting to Changes in the Market
The concept release discusses potential reforms to the SEC’s rulemaking process designed to allow new disclosure rules to be adapted or to expire in response to a changing market. The SEC seeks input on how to make its disclosure requirements more adaptive, including through the implementation of automatic sunset provisions on new disclosure rules or by requiring that the staff of the Division of Corporation Finance study and report on the impact of new disclosure requirements.
Specific Disclosure Areas
In addition to the overarching conceptual topics described above, the concept release discusses certain specific disclosure areas and seeks input on how to improve the quality of information disclosed in these areas without overburdening registrants or investors.
Core Company Business Information
The concept release seeks comment on expanding, contracting, and otherwise reforming the key business disclosures under Items 101 and 102 of Regulation S-K regarding development of the business; narrative description of the business; technology and intellectual property rights; government contracts; compliance with environmental laws; government regulation; employees; and description of property.
Company Performance, Financial Information, and Future Prospects
The concept release examines the disclosure of selected financial data and supplementary financial information under Items 301 and 302(a) of Regulation S-K, including the line items and time periods required to be covered by such disclosure. The SEC asks whether this disclosure is useful to investors, and whether the current requirements prescribed by Items 301 and 302(a) should be expanded or contracted. The SEC also seeks comment on whether there should be greater auditor involvement in preparing these disclosures.
The concept release also discusses potential improvements to the quality of Management’s Discussion & Analysis (MD&A) disclosure under Item 303, with the SEC requesting comment on the required content of MD&A, the thresholds for disclosure, the disclosure of forward-looking information, and key performance indicators. The SEC is also seeking input on whether to require an executive level overview of MD&A; whether to include a principles-based disclosure of key industry metrics; and whether to revisit the current “two-step” test for determining whether forward-looking disclosure is required in MD&A. The SEC is also seeking input on the key components of MD&A disclosure, including results of operations, liquidity and capital resources (including short-term borrowings), off-balance sheet arrangements, contractual obligations, and critical accounting estimates.
Risk and Risk Management
The concept release discusses improving the disclosure of risk and risk management in periodic reports pursuant to Items 503(c) and 305 of Regulation S-K. The SEC seeks comment on several new approaches to risk factor disclosure, including presentation of risks based on the order of magnitude and the identification of the ten most important risks to a registrant. The SEC has also requested input on whether the inclusion of “generic” risk factors should be discouraged. In addition, the concept release explores the possibility of including risk mitigation disclosure within the discussion of a registrant’s risk factors.
The concept release further examines the quantitative and qualitative disclosures about market risk under Item 305 of Regulation S-K, including a discussion of disclosure objectives, disclosure alternatives, and coordination and comparability of disclosure. In particular, the SEC seeks input on whether the disclosure required by Item 305 remains useful given changes in U.S. generally accepted accounting principles and Regulation S-X that have resulted in the inclusion of similar information in the presentation of financial statements.
Finally, the SEC has requested input on whether the consolidation of all risk-related disclosure would improve the overall quality of disclosure, and whether Regulation S-K should be revised to require new narrative disclosure from registrants describing their risk management processes.
Securities of the Registrant
The concept release discusses the current disclosure framework related to a registrant’s securities, with an emphasis on disclosure under Items 201(b)(1), 202, 701, and 703 of Regulation S-K regarding number of equity holders, description of capital stock, recent sales of unregistered securities, use of proceeds from registered securities, and registrant repurchases of equity securities. Generally, the SEC is seeking to understand whether these disclosures remain important to investors or whether they have become redundant in the face of overlapping disclosure requirements and other sources of information.
The concept release discusses the current filing requirements for exhibits to periodic and other reports, with an emphasis on the filing of material contracts and subsidiary information under Item 601 of Regulation S-K, as well as the filing of schedules, attachments, amendments, and other modifications to such exhibits.
The concept release considers the ongoing role of the SEC’s Industry Guides, and asks whether the Industry Guides continue to provide useful guidance for registrants and result in the disclosure of important information to investors. In particular, the concept release asks whether the Industry Guides should be updated or codified into Regulation S-K.
Topics Not Discussed
The concept release does not address certain disclosure requirements in Regulation S-K, such as executive compensation and governance, or the required disclosures for foreign private issuers, business development companies, or certain other categories of registrants. Although the concept release is silent on these requirements, it nonetheless welcomes comments on any disclosure topic not specifically addressed within its text.
Next Steps: Is Reform Imminent?
Although the concept release discusses a broad spectrum of potential changes to Regulation S-K, it is unlikely that such changes are imminent. First, the SEC will review comments received on the concept release, which are due 90 days following its publication in the Federal Register. After reviewing any comments submitted, the SEC may, at its discretion, issue one or more rule proposals, which will be made available for review and comment by the public prior to the publication of any final rules.
While the concept release is an important step toward the reform and modernization of Regulation S-K, it remains to be seen whether and how the input provided by registrants, investors, and other stakeholders is applied to reform the existing disclosure framework.