SEC Updates Regulation S-K Disclosure Requirements for Business Description, Legal Proceedings and Risk Factors, and Mandates Human Capital Disclosure

On August 26, 2020, the U.S. Securities and Exchange Commission (SEC) adopted amendments to “modernize” its rules requiring disclosure about a company’s business description, legal proceedings and risk factors. Amendments to Items 101, 103 and 105 of Regulation S-K will:

give a company more flexibility to tailor the description of its business to its particular circumstances;
require a company to describe its human capital resources, including any human capital measures or objectives the company focuses on in managing its business, to the extent material to an understanding of the company’s business taken as a whole;
eliminate or reduce disclosure about matters that are not material to an understanding of a company’s business or legal proceedings; and
encourage risk factor disclosure that is streamlined, well-organized and limited to material risks.

The final amendments were adopted substantially as proposed by the SEC in August 2019 with certain modifications.

The amendments are part of the ongoing Disclosure Effectiveness Initiative led by the SEC’s Division of Corporation Finance (Corp Fin) to review and improve the effectiveness of its disclosure requirements for the benefit of investors and companies. It has been more than 30 years since the SEC has significantly revised Items 101, 103 and 105 of Regulation S-K. The SEC amended these items to make them more clearly principles-based as well as to enhance the readability of disclosures, discourage repetitive and immaterial disclosures and reduce the compliance burden on companies. The amendments are responsive to changes in the regulatory, business and technological environment since the adoption of Regulation S-K and increasing calls for the SEC to require human capital disclosure. The amendments also were informed by input from numerous public comment letters and Corp Fin’s disclosure review process, including a review of disclosures companies made in response to the COVID-19 pandemic.

The final amendments were adopted by a 3-2 vote. The two dissenting Commissioners, Caroline Crenshaw and Allison Herren Lee, expressed their disapproval that the release adopts “a generic and vague” principles-based disclosure requirement with respect to human capital rather than a more prescriptive approach and “is silent on two critical subjects: diversity and climate risk disclosures.”¹ Commissioner Crenshaw urged the SEC to form (1) an internal task force to study how investors use information about human capital management, climate change risk and other environmental, social and governance (ESG) metrics to assess long-term financial performance and (2) an external ESG Advisory Committee composed of investors, reporting companies and subject matter experts to guide the SEC in revising and expanding its approach to, and regulation of, ESG disclosures.

The amendments are summarized in the table below. They will become effective 30 days following publication in the Federal Register.

Disclosure Requirement

Summary of Amendment and Rationale

Description of Business

Regulation S-K Item 101(a) and 101(c)

Item 101(a) – Description of the General Development of the Business

Item 101(a) currently requires a description of the general development of the company’s business during the past five years (or earlier if material) or such shorter period as the company may have been engaged in the business. The discussion must include the year in which the company was organized and the nature and results of any bankruptcy proceeding or any merger of the company or its significant subsidiaries and any material changes in the mode of conducting the business.

Amendments

Will transition to a more flexible, principles-based approach to elicit more informative disclosure by:
- eliminating the five-year timeframe and requiring disclosure of information material to an understanding of the development of the company’s business, without regard to any specific timeframe.²
- clarifying that disclosure of developments is required only to the extent such information is material to an understanding of the general development of the company’s business.
- providing a non-exclusive list of four topics that a company should disclose pursuant to Item 101(a) if material. The SEC retained the current disclosure requirements addressing (1) any bankruptcy proceeding, (2) the effects of any material merger and (3) the acquisition or disposition of a material amount of assets not in the ordinary course of business. The SEC added a new topic that will require disclosure of material changes to a company’s previously disclosed business strategy. The amendments do not mandate disclosure of a company’s business strategy if it has not been previously disclosed.
Will allow a company, after its initial registration statement, to provide only an update on – rather than a full discussion of – the general development of the business disclosure that focuses on any material developments since the most recent registration statement or report that includes a full discussion of the general development of the company’s business. When taking this approach, the company will be required to incorporate by reference the earlier disclosure into the updated filing by including one active hyperlink to one previous filing that contains the full discussion of the general development of the business. The amendments prohibit the use of multiple hyperlinks to prior filings.³

The SEC views this amendment as a clarification of current rules rather than a substantive change because Securities Act of 1933 Rule 411 and Exchange Act Rule 12b-23 permit companies to provide Item 101(a) disclosure by incorporating by reference some or all of the required disclosure from a previous filing. The amendments are intended to reduce repetitive disclosures and focus investors on recent material developments.

Item 101(c) – Narrative Description of the Business

Item 101(c) currently requires a narrative description of the business done by a company and its subsidiaries and specifies 12 items that must be disclosed generally only if material to an understanding of the company’s business taken as a whole. The SEC has observed that many companies seem to interpret the current rule as requiring disclosure of each of the 12 specified items even if they are not relevant, which has resulted in immaterial disclosure.

Amendments

Will shift to a more principles-based approach by providing a non-exclusive list of seven topics that a company may need to disclose pursuant to Item 101(c), including some existing topics and some new topics, and clarifying that disclosure would be required only to the extent that it is material to an understanding of the company’s business taken as a whole.
- Will retain six existing disclosure topics as examples, with some changes: (1) principal products produced and services rendered, and dependence on certain customers, (2) new products and competitive conditions, (3) sources and availability of raw materials and the duration and effect of specified intellectual property (which disclosure requirements will now be combined to refocus disclosure on all resources material to a company’s business), (4) business subject to renegotiation or termination of government contracts, (5) seasonality of the business and (6) the number of persons employed. Despite numerous recommendations from commentators on the subject, the SEC did not expand the requirement to disclose the number of employees to prescribe disclosure of additional metrics (e.g., the breakdown of full-time, part-time and contingent workers, and employee turnover).
- Will require a description of the company’s human capital resources, including any human capital measures or objectives that the company focuses on in managing the business, to the extent material to an understanding of the company’s business taken as a whole. The SEC acknowledges that the exact measures or objectives will depend on the nature of the company’s business and workforce but identifies as non-exclusive examples measures and objectives that address the development, attraction and retention of personnel. Disclosure must be tailored to a company’s particular business, workforce and facts and circumstances, which will evolve over time.⁴
- Will require, if material, disclosure of the material effects that compliance with “government regulations, including environmental regulations” – as opposed to only environmental laws under the current rule – may have upon the capital expenditures, earnings and competitive position of the company and its subsidiaries. This expansion is consistent with current practice as many companies already provide voluntary disclosure about government regulations relevant to their business.
- If the information elicited about human capital resources or the material effects of compliance with government regulations is material to a particular segment of the company’s business, the company will also have to identify the segment.
Will delete the explicit references in the current rule to the following topics: (1) disclosure about new segments, (2) the dollar amount of backlog orders and (3) working capital practices. The SEC noted that it expects working capital to be discussed in the MD&A if material.

Legal Proceedings

Regulation S-K Item 103

Item 103 currently requires disclosure of material pending legal proceedings and certain related information (e.g., the name of the court, the date instituted, the principal parties involved and the alleged factual basis underlying the proceedings). An instruction to the current rule requires disclosure of any proceedings under environmental laws to which the government is a party unless the company reasonably believes that monetary sanctions resulting from the proceeding will be less than $100,000.

Amendments

Will expressly provide for the use of hyperlinks or cross-references to legal proceedings disclosure that appears elsewhere in the filing (e.g., in the notes to the financial statements, which is already a common practice, or the MD&A or risk factor section) to avoid repetitive disclosure.
Will implement a modified disclosure threshold for environmental proceedings to which the government is a party that increases the current threshold from $100,000 to $300,000 and also allows a company to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings so long as this company-specific threshold does not exceed the lesser of $1 million or 1% of the current assets of the company and its subsidiaries on a consolidated basis. The amendments are intended to adjust for inflation since the current threshold was adopted in 1982 as well as provide flexibility to use a disclosure threshold that is most indicative of materiality on a company-specific basis. If a company chooses to use a company-specific threshold rather than the bright-line threshold of $300,000, it must disclose the tailored threshold (including any change thereto) in each Form 10-K and 10-Q filing.

Risk Factors

Regulation S-K Item 105

Item 105 currently requires a concise and logically organized discussion of the most significant factors that make an investment in a company’s securities speculative or risky. Under the current rule, companies must not disclose risks that could apply generically to any company and must set forth each risk factor under a subcaption that describes the risk.

Amendments

The amendments seek to elicit material and concise risk factor disclosure that is tailored to the company’s specific circumstances and organized in a way that gives greater prominence to the most salient risks.

Will require summary risk factor disclosure if the risk factor section exceeds 15 pages (which the SEC estimates is true for approximately 40% of current filers). The summary disclosure must consist of a bulleted or numbered list summarizing the principal risk factors that is no longer than two pages and appears at the forepart of the filing.⁵ The summary disclosure need not contain all of the risk factors identified in the full risk factor discussion. The SEC acknowledges that the new rule may incentivize some companies to streamline their risk factor disclosure to avoid the summary disclosure requirement.
Will require disclosure of the “material” – rather than the “most significant” – risks facing the company to encourage companies to disclose the risks to which reasonable investors would attach importance in making investment decisions. Other than as described in the next bullet, the new rule will not require companies to prioritize the order in which they discuss their risk factors.
Will require companies to organize their risk factors under relevant headings (which is already common practice) and, if a company discloses any generic risk factors that could apply to any company or offering, they must appear at the end of the risk factor section under the caption “General Risk Factors.” The SEC encourages companies to tailor their risk factor disclosures to highlight the specific relationship of the risk to the company to avoid the need to include the risk under the general risk heading.

¹ Here are links to the public statements about the final amendments issued by Commissioner Caroline Crenshaw and Commissioner Allison Herren Lee.

² The SEC similarly eliminated the timeframe prescribed in Item 101(h), which currently requires smaller reporting companies to describe the development of their business during the past three years. As amended, Item 101(h) will direct smaller reporting companies, in describing the development of their business, to provide information for the period of time material to an understanding of the general development of the business.

³ The SEC adopted a corresponding amendment to Item 101(h) to permit a smaller reporting company, for filings after its initial registration statement, to provide an update to the general development of the business disclosure, instead of a full discussion, that complies with Item 101(a), including the option to provide one hyperlink to one previous filing that includes the full discussion of the general development of the company’s business.

⁴ SEC Chair Jay Clayton commented that, as is the case with non-GAAP financial measures, he expects companies to maintain any human capital metric definitions used constant from period to period or prominently disclose any changes to the metrics or definitions used.

⁵ As a model for summary risk factor disclosure, the SEC referred to the existing requirement in Form S-11.

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