On August 8, 2019, the SEC proposed rules to update and simplify risk factors, legal proceedings and business disclosures required in annual reports and registration statements. The proposed rules are open for comment until October 22, 2019. The proposed rules would not become effective unless and until the comment period ends and the SEC adopts final rules.1
The proposed rules are the latest release in the SEC’s comprehensive disclosure effectiveness initiative mandated by the JOBS Act in 2012.
Risk Factors (Item 105)
The SEC proposed the following changes to the risk factors section that is required by Item 105 of Regulation S-K to be included in annual reports and registration statements:
Summary Risk Factors: The SEC proposed requiring SEC filers to include a summary risk factors section if its risk factors exceed 15 pages. The SEC signaled that it hoped that the rule change would incentivize SEC filers to limit risk factor disclosure to less than 15 pages. The SEC solicited comment as to whether 15 pages is the appropriate cutoff, or whether a word limit would be more effective. The SEC also solicited comment as to whether the length of the summary risk factors section should be capped, such as at one page, and whether hyperlinks from the summary risk factors section to the full risk factors section should be required. The SEC indicated in its comment solicitation that it is also considering, as an alternative, requiring SEC filers to frontload the most important risks in the first 15 pages of the risk factors section.
The SEC proposed requiring that the summary risk factors section be included in the front of the annual report or prospectus under its own heading. The SEC indicated in its comment solicitation that it was considering, as an alternative, requiring the summary risk factors to immediately precede the full risk factors section. The SEC also solicited comment on whether the full risk factors section should continue to be required to immediately follow the summary of the prospectus, even if a summary risk factors section is included in the prospectus summary.
The SEC proposed requiring the summary risk factors section to be a short bulleted or numbered list.
Headings: The SEC proposed requiring SEC filers to organize risk factors under relevant headings. The SEC also proposed requiring companies to place under the heading “General Risk Factors” any risk factors that could apply to other companies or securities offerings if the disclosure does not provide an explanation of why the identified risk is specifically relevant to an investor in the company’s securities.
Most Significant vs. Material: The SEC proposed changing the standard for risk factor disclosure from the “most significant” risks to “material” risks. The SEC noted that “material” means there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security.
Order: The SEC solicited comment on whether to require SEC filers to order risk factors from greatest to least risk exposure.
Legal Proceedings (Item 103)
The SEC proposed the following changes to the legal proceedings section that is required by Item 103 of Regulation S-K to be included in annual reports and registration statements:
Cross-References & Hyperlinks: The SEC proposed allowing SEC filers to satisfy legal proceedings disclosure requirements by providing cross-references and/or hyperlinks to disclosure already located in another section of a document, such as the notes to the financials.
$300,000 Trigger for Environmental Disclosure: The SEC proposed increasing the threshold for disclosure of environmental proceedings in which the government is a party from $100,000 to $300,000. The SEC indicated in its comment solicitation that it is also considering higher trigger amounts, such as $500,000, $750,000 or $1 million, or a materiality standard with no dollar trigger. The SEC solicited comment on whether this trigger amount should be increased for inflation periodically going forward, such as every three years, and how the adjusted amount should be determined.
Business (S-K Item 101)
The SEC proposed the following changes to the business section that is required by Item 101 of Regulation S-K to be included in annual reports and registration statements:
Timeframe (five years → “material”): The SEC proposed eliminating the five-year timeframe (or shorter period that a company has been in existence) required to be covered by an SEC filer’s business description, in favor of giving SEC filers more flexibility to determine whether a shorter or longer timeframe should be covered so that investors are provided with all information material to an understanding of the development of the company’s business.
The SEC considers information “material” if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision.
The SEC indicated in its proposal that it is also considering, as an alternative, retaining a timeframe for business disclosure, but making it shorter or longer than five years.
Updates Only: The SEC proposed allowing SEC filers to include updates only in the business section, with one (and only one) hyperlink to a previously filed business description, such as the business description filed in the company’s IPO registration statement, which, together with the update, would provide investors with a full business description.
The SEC indicated in its proposal that it is also considering as an alternative model full business disclosure every three years (or a shorter or longer period), with summary business disclosure required in the interim years.
List of Topics: The SEC proposed eliminating two topics and adding one new topic in the list of topics currently required to be covered in the business section by Item 101(a) — General Development of Business — as follows:
- transactions and events that affect or may affect the company’s operations, including material changes to a previously disclosed business strategy (new);
- year and form of organization of the company (eliminated);
- material changes in the mode of conducting the company’s business (eliminated, but the SEC solicited comment on whether it should be retained);
- any bankruptcy, receivership or similar proceedings (retained);
- material reclassifications, mergers or consolidations (retained);
- acquisitions or dispositions of material assets (retained).
The SEC also proposed eliminating two topics currently required to be covered in the business section by Item 101(c) — Narrative Description of Business — and replacing the other topics in the list with a new revised list that can be mapped against the current requirements as follows:
Requirements vs. Suggestions: The SEC proposed converting the itemized list of disclosure topics required to be covered in the business section by Items 101(a) and (c) to a non-exhaustive list of suggestions that a company may want to consider covering in order to ensure the company discloses all information material to an understanding of the general development and narrative description of a registrant’s business.
Segments vs. Business as a Whole: The SEC did not propose changing the allocation of the suggested topics to be covered in the business section between topics that should be focused on in segment disclosure vs. disclosure about the business as a whole, but solicited comment about whether to retain the distinction and, if so, the appropriate allocation.
Websites: The SEC solicited comment on whether an SEC filer should be permitted to provide investors with business disclosure via its website instead of an SEC filing and, if so, whether all companies should have the option of website disclosure or only certain categories of filers, such as Well Known Seasoned Issuers (WKSIs).
Predecessors: The SEC solicited comment on whether to eliminate the requirement that certain companies provide business disclosure about predecessor companies.
1. The SEC’s proposed rules on risk factors, legal proceedings and business disclosures include certain accommodations and comment solicitations relating to foreign private issuers and smaller reporting companies that are not covered in the scope of this Alert.↩
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