Regulation S-K is a cornerstone of the financial regulatory system, but that doesn’t mean it doesn’t need some maintenance work every few decades. Reg S-K mandates various disclosures that public companies must make in their filings with the Securities and Exchange Commission, including a “Description of the Business” (aka Item 101), “Risk Factors” (Item 105) and “Legal Proceedings” (Item 103). More than 30 years have passed since the SEC adopted its current rules governing these business disclosures, and both Congress and the Commission are ready to freshen them up.
“The world economy and our markets have changed dramatically” in the last three decades, said SEC Chairman Jay Clayton last week in an announcement that the SEC voted (in a closed meeting) to propose amendments to the required descriptions for the three Items noted above. “Today’s proposal reflects these significant changes,” he said, “as well as the reality that there will be changes in the future.”
Depending on who you ask, the proposed amendments were put forward either as part of the implementation of 2015’s Fixing American’s Surface Transportation (FAST) Act, which tasked the SEC with modernizing and simplifying Reg S-K, or pursuant to the SEC’s own “Disclosure Effectiveness Initiative,” a regulatory streamlining project required by the JOBS Act. That debate is mostly academic, and in either case the proposed changes have been a long time coming.
They highlight an ever-present dilemma in rulemaking—the choice between drafting rules that speak in broad principles (which are great at capturing an intention, but offer much wiggle room), or specifics (which are great at pinning parties down, but don’t leave room for interpretation). Clayton’s statement said “[t]he proposals reflect a thoughtful mix of prescriptive and principles-based requirements,” but even the proposal itself notes that it puts forth “a more principles-based approach.” Notably, another Commissioner, Hester Peirce, recently sounded a similar alarm when she urged a “Marie Kondo” approach to regulation in which the SEC streamlines disclosure requirements, pares back regulation, and refuses to “nostalgically hang on to the rules of the past with the interpretive dust that has accumulated on them.”
In line with the new orientation toward principles, the revised Item 101 requires public companies to disclose only information “material” to understanding the general development of the business. The five-year time period previously specified for Item 101, for instance, would be ditched in recognition of the fact that for different businesses, different historical periods are relevant to their current operations.
The proposed amendments would also streamline the disclosure of risk factors. While Item 105 previously required disclosure of the “most significant” risk factors, the proposed amendments would require disclosure only of “material” risk factors. The new rules would also require a summary risk factor disclosure if that section exceeds 15 pages.
That’s not to say that every change in the proposed rules will decrease the burden on filers. For Item 101(c) (“Business narrative”), the SEC currently offers an enumerated list of disclosure topics, which many filers treat as mandatory. Consistent with its principles-based approach, the SEC emphasizes the materiality standard (and offers a trimmed-down list of disclosure topics). It also, however, includes “human capital” as a new disclosure topic, and makes clear that to the extent it is material, companies should go beyond the previous requirement to disclose only their number of employees.
Regarding legal proceedings (Item 103), the disclosure threshold for environmental matters would rise from $100,000 to $300,000. The Commission attributed the increase to an inflation adjustment.
Once the Reg S-K proposal is published in the Federal Register, it will be subject to a 60-day public comment period.