September 29, 2020

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September 29, 2020

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September 28, 2020

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SEC Approves Updated Disclosure Requirements

On August 17, 2018, the Securities and Exchange Commission (SEC) approved amendments to certain of its disclosure requirements that have become redundant, duplicative, overlapping, outdated, or superseded, in light of other SEC disclosure requirements, U.S. generally accepted accounting principles (GAAP), international financial reporting standards (IFRS), or changes in the information environment. These changes include amendments to Regulation S-K and Regulation S-X, which provide many of the disclosure requirements that apply to annual reports on Form 10-K, quarterly reports on Form 10-Q, proxy statements, registration statements and other documents filed with the SEC. These amendments become effective 30 days after publication in the Federal Register.

What is the purpose of these amendments?

 The SEC stated that these amendments are intended to facilitate the disclosure of information to investors and simplify compliance without significantly altering the total mix of information provided to investors. These amendments are part of an initiative by the SEC’s Division of Corporation Finance to review disclosure requirements applicable to issuers to consider ways to improve the requirements for the benefit of investors and issuers. In addition, these amendments are part of the SEC’s efforts to implement title LXXII, section 72002(2) of the Fixing America’s Surface Transportation (FAST) Act of 2015.

Which companies are impacted by these amendments?

All companies that are required to file reports with the SEC are impacted by these amendments. These amendments also impact, among others, acquirees for which financial statements are required under Rule 3-05 of Regulation S-X, broker-dealers and investment advisors.

What is an example of a redundant or duplicative disclosure requirement?

Most of the redundant or duplicative disclosure requirements affected by these amendments are contained in Regulation S-X, which mostly relates to requirements for the presentation of financial statements, including footnote disclosure for required financial statements. For example both Rule 4-08(k)(1) of Regulation S-X and ASC 850-10-50-1 under U.S. GAAP requires the identification of related party transactions. These amendments will eliminate this requirement under Regulation S-X.

What is an example of an overlapping disclosure requirement?

The SEC refers to disclosure requirements that are related to, but not the same as, U.S. GAAP, IFRS or other SEC disclosure requirements as overlapping requirements.

The existing disclosure requirements for the ratio of earnings to fixed charges is one example of an overlapping disclosure requirement. Item 503 of Regulation S-K requires issuers that register debt securities to disclose the historical and pro forma ratio of earnings to fixed charges. In addition, Item 601(b)(12) of Regulation S-K requires the filing of an exhibit setting forth the computation of any ratio of earnings to fixed charges that are included in a report or other document filed with the SEC.

On the other hand, U.S. GAAP and IFRS require disclosure of many of the components commonly used in this ratio (e.g., income, interest expense, lease expense), as well as information from which other ratios that convey reasonably similar information about an issuer’s ability to meet its financial obligations may be computed. The SEC also noted in its release that a variety of analytical tools are available today to investors that may accomplish a similar objective as the ratio of earnings to fixed charges and that all information that investors need to calculate any such ratios or other financial metrics is available in the financial statements which must be filed with the SEC in accordance with other disclosure requirements.

Finally, the SEC noted that lenders negotiate specific ratios (in the form of financial covenants) in connection with extending credit to companies through credit agreements, indentures or other agreements governing a company’s debt. The full text of such debt agreements generally must be attached as exhibits to documents filed with the SEC. The ratios and financial covenants included in such debt agreements are likely more relevant to investors since those ratios and covenants will be tailored to the specific company and such ratios and covenants are typically the result of substantial negotiation between the lenders and borrowers.

The Regulation S-K disclosure requirements related to the ratio of earnings to fixed charges will be eliminated as part of these amendments.

Are there other notable overlapping disclosure requirements being amended?

Another potentially significant amendment that may impact a substantial number of companies relates to segment reporting. Item 101(b) of Regulation S-K requires disclosure of segment financial information, restatement of prior periods when reportable segments change, and discussion of interim segment performance that may not be indicative of current or future operations. U.S. GAAP (namely, ASC 280-10-50-22, ASC 280-10-50-34, and ASC 280-10-50-35) and Item 303(b) of Regulation S-K require similar disclosure. As part of these amendments, Item 101(b) of Regulation S-K will be revised. Therefore, going forward, issuers may be able to avoid including segment financial information in the “Business” section of their annual report on Form 10-K and registration statements.

These amendments also remove other disclosures which are no longer necessary, such as historical stock price information required under Item 201 of Regulation S-K (which normally appears in a company’s annual meeting proxy statement). There are numerous websites that provide stock price information for free, such as Yahoo! Finance, Google Finance, and the Nasdaq and New York Stock Exchange websites. Each of these websites provide more detailed and interactive stock price-related information than the disclosure required by Item 201 of Regulation S-K. The SEC noted in its release that stock price-related information freely available online would be more up to date than the Regulation S-K Item 201 disclosure. As proposed to be amended, Item 201(a)(1) of Regulation S-K would eliminate the detailed disclosure requirement of sale or bid prices for most issuers whose common equity is traded in an established public trading market and replace it with disclosure of the trading symbol.

As another sign of the technological times, the amendments delete requirements in several rules to identify the SEC’s Public Reference Room, including its physical address and phone number. In its release, the SEC stated that the Public Reference Room is rarely used by the public to obtain or review issuer filings, as paper filings are only permitted (and sometimes required) in very limited circumstances.

What do I need to do now?

A reporting company should plan to conduct a more detailed “form check” of its next SEC filing since many of the disclosure rules will have changed by the time the next periodic report is required to be filed with the SEC. While we do not recommend checklists for form checking that are outside of the most recent SEC forms and regulations published by the SEC (such as Form 10-K, Schedule 14A, Regulation S-K and Regulation S-X), in the event internal compliance departments maintain any such supplemental extra-statutory checklists, such checklists should be updated well in advance of the next periodic report in order to reflect the upcoming changes to the disclosure rules. Internal accounting and legal departments could also get ahead of the game by starting to redraft segment, geographic and seasonality disclosure (all of which are being affected by these amendments) in their next quarterly report (i.e., the Form 10-Q for the quarter ended September 30, 2018 for calendar year companies) in order to reflect the more streamlined disclosures which will be permitted once the amendments become effective. Internal accounting departments should also begin to discuss these amendments with the company’s independent registered public accounting firm in preparation for future financial statement preparation since many of these amendments are technical and require an understanding of existing U.S. GAAP and IFRS disclosure requirements.

Copyright © 2020, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume VIII, Number 234

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About this Author

Robert L. Wernli, Jr., lawyer corporate attorney, Sheppard Mullin law firm
Special Counsel

Robert L. Wernli, Jr. is a special counsel in the Corporate Practice Group in the firm's Del Mar office.

Mr. Wernli specializes in corporate and securities law and has worked on numerous public and private capital raising transactions, mergers and acquisitions (buy-side and sell-side) and other strategic transactions. Mr. Wernli has also regularly advised clients on all aspects of SEC reporting and listing exchange compliance matters, corporate governance and general corporate law matters.

Areas of Practice

Securities. Mr....

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Jason Schendel, Attorney, Sheppard Mullin
Associate

Mr. Schendel is a partner in the Corporate Practice Group in the firm's Palo Alto and San Francisco offices.

Areas of Practice

Mr. Schendel's practice focuses on advising public and private companies in mergers & acquisitions, securities offerings, corporate governance, SEC reporting, and general corporate matters.  Mr. Schendel also has extensive experience working with private equity funds in connection with fund formation, general fund operating matters, and buy-side M&A.

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