The Long and Winding Road to Modernization and Simplification of SEC Rules and Forms
Section 72003 of the Fixing America’s Surface Transportation Act (the “FAST Act”), enacted in December 2015, directed the Securities and Exchange Commission (the “SEC”) to carry out a study of the SEC’s disclosure requirements, with a view toward modernizing and simplifying certain requirements in Regulation S-K and related rules and forms. Regulation S-K is the “central repository” for most of the SEC’s disclosure requirements, and is referred to in forms regarding registration of securities, annual, quarterly and other reports required to be filed and proxy statements.
As required by the FAST Act, the staff of the SEC issued a report to Congress in November 2016 (the “FAST Act Report”), providing “specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information.” The FAST Act Report recommended ways “to improve the readability and navigability of disclosure and to discourage repetition and the disclosure of immaterial information.”
On October 11, 2017, the SEC proposed rules (the “Proposal”) to implement certain of the recommendations made in the FAST Act Report (Rel. No. 33-10425, available here).
The Proposal is a step in the right direction, and is consistent with Section 72003 of the FAST Act, the FAST Act Report and other releases and studies published by the SEC, such as:
The concept release on the business and financial disclosure requirements in Regulation S-K (Rel. No. 33-10064, April 13, 2016);
The prior staff Report on Review of Disclosure Requirements in Regulation S-K, mandated by the Jumpstart Our Business Startups Act (December 2013); and
The SEC’s request for comment on the requirements relating to management, security holders and corporate governance matters in Subpart 400 of Regulation S-K (Rel. No. 33-10198, August 25, 2016).
The following is a summary of the proposed changes, which are designed, in the words of the Proposal, to “update, streamline, or otherwise improve” the disclosure requirements of Regulation S-K and related SEC forms:
Description of Property (Item 102 of Reg. S-K): Item 102 requires a description of the location and general character of the registrant’s principal plants, mines and other materially important physical properties. The Proposal would clarify that disclosure regarding properties is required only to the extent that the property is material to the registrant, and that this decision can be made on a collective basis if appropriate.
Management’s Discussion and Analysis (Item 303 of Reg. S-K): Item 303 requires a discussion of the financial condition, changes in financial condition and results of operation of the registrant. The discussion is to cover the three-year period of the financial statements, and generally is based on a year-to-year comparison. Recognizing that the earliest period covered by the three-year discussion is largely duplicative of disclosures made in prior filings, the Proposal would eliminate the need to discuss the earliest year in the three-year period, where (i) the discussion would not be material to an understanding of the financial condition, changes in financial condition or results of operation and (ii) the registrant has filed its prior year Form 10-K, so that the discussion of the omitted period would already be available on EDGAR.
Directors, Executive Officers, Promoters and Control Persons (Item 401 of Reg. S-K): Instruction 3 to Item 401(b) of Reg. S-K allows the registrant to include information about its executive officers in Part I of Form 10-K, without also including the information in its annual proxy statement. The location of the instruction has caused some confusion, because other parts of Item 401 also include information about executive officers. The Proposal would move the instruction so that it would be a general instruction to all of Item 401.
Compliance with Section 16(a) of the Exchange Act (Item 405 of Reg. S-K): The Proposal would permit registrants to rely on Section 16 reports filed on EDGAR when determining whether there are Section 16 delinquencies that must be disclosed under Item 405. The requirement that paper copies of Section 16 reports must be submitted to the registrant would be eliminated. In addition, the box on the cover page of Form 10-K relating to Item 405 disclosures would be deleted.
Corporate Governance (Item 407 of Reg. S-K): Item 407 currently requires the registrant’s annual proxy or information statement to disclose the matters required by AU section 380, Communication with Audit Committees (“AU sec. 380”). AU sec. 380 was part of the interim standards previously adopted by the Public Company Accounting Oversight Board, and has been superseded by PCAOB Auditing Standard No. 16, Communications with Audit Committees (“AS 16”). The Proposal would amend Item 407 to reflect the application of AS 16. In addition, Item 407 requires that the board compensation committee state whether it recommended to the board of directors that the registrant’s Compensation Discussion and Analysis (“CD&A”) be included in the registrant’s annual report, proxy statement or information statement. The Proposal would make it clear that Emerging Growth Companies (“EGCs”) are excluded from this requirement, because they are not subject to a requirement to include a CD&A in their public disclosures.
Outside Front Cover Page of the Prospectus (Item 501(b) of Reg. S-K): The Proposal would revise certain of the instructions to Item 501(b) to (i) eliminate the instructions regarding misleading or confusing registrant names and (ii) allow registrants to disclose that the offering price will be determined by a particular method or formula that is clearly explained in the prospectus. In addition, the Proposal would revise Item 501(b)(4) to require the cover page to disclose the principal U.S. market or markets for the securities as well as the trading symbol. The “red herring” legend required by Item 501(b)(10) would also be updated to eliminate the portion of the legend relating to state law, if the securities being offered are not prohibited by state law, by virtue of federal preemption or otherwise.
Risk Factors (Item 503(c) of Reg. S-K): The Proposal would relocate “Risk Factors” from Item 503 to a new Item 105, in order to make it clear that the disclosure of risk factors would also apply to registration statements and periodic reports filed pursuant to the Securities Exchange Act of 1934, as amended. In addition, the examples of risk factors given in Item 503 would be deleted.
Plan of Distribution (Item 508 of Reg. S-K); Item 508 requires disclosure about the principal underwriters in the offering, and underwriters who have a material relationship with the registrant. Item 508(h) requires disclosure of discounts or commissions to be paid to dealers or dealers acting as “sub-underwriters”; however, the term “sub-underwriter” is not defined. The proposal would add a definition of “sub-underwriter” to Rule 405, to mean a dealer participating in the offering as an underwriter, but which is not itself in privity of contract with the issuer.
Undertakings (Item 512 of Reg. S-K): The Proposal would eliminate the following undertakings otherwise required to be included in Part II of the registration statement, because they are obsolete or no longer necessary: (c) (warrants offerings), (d) (competitive bidding), (e) (delivery of incorporated annual report) and (f) (securities certificates).
Exhibits (Item 601 of Reg. S-K): The Proposal includes several proposed changes to the requirements for filing exhibits to registration statements and reports, as well as the instructions thereunder:
Item 202 of Reg. S-K requires registrants to provide a brief description of their registered capital stock, debt securities, warrants, rights, American Depositary Receipts, and other securities. The Proposal would amend Item 601(b)(4) to require registrants to provide the information required by Item 202(a)-(d) and (f) of Reg. S-K as an exhibit to Form 10-K, rather than limiting this disclosure to registration statements.
Item 601(b)(2) states that registrants need not file schedules or similar attachments to material plans of acquisition, reorganization, arrangement, liquidation, or succession unless they contain information material to an investment decision and unless that information is not otherwise disclosed in the agreement or the disclosure document. The proposal would apply this exception to all exhibits, not just acquisition agreements.
The Proposal would also permit the omission of personally identifiable information from exhibit filings.
The Proposal would permit registrants to omit confidential information from material contracts where such information is both (i) not material and (ii) competitively harmful if publicly disclosed, even where the registrant has not submitted a confidential treatment request to the SEC. Instead, registrants would be required to mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and include a prominent statement on the first page of each redacted exhibit that information in the marked sections of the exhibit has been omitted from the filed version of the exhibit. Registrants would also be required to indicate with brackets where the information has been omitted from the filed version of the exhibit.
Item 601(b)(10)(i) requires registrants to file every material contract not made in the ordinary course of business, provided that one of two tests is met: (i) the contract must be performed in whole or in part at or after the filing of the registration statement or report, or (ii) the contract was entered into not more than two years before that filing. The Proposal would modify the instructions so that the two-year look back test would be limited to newly reporting registrants. A “newly reporting registrant” would be defined as any registrant filing a registration statement that, at the time of such filing, is not subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act, whether or not such registrant has ever previously been subject to the reporting requirements.
Finally, Item 10(d) of Reg. S-K generally prevents registrants from incorporating documents by reference if they have been on file with the SEC for more than five years and do not fall within one of the exceptions provided in the rule. The Proposal would eliminate the five-year limitation.
As is the case with all rule proposals, the SEC has included a number of specific requests for comment on these changes. The comment period expires 60 days from the publication of the Proposal in the Federal Register.