In September 2020, the Securities and Exchange Commission (SEC) voted 3-2 to adopt amendments to certain disclosure rules for public companies in an effort to modernize information that is presented to investors. The amendments were crafted from a proposed rule issued in August 2019 that was part of a comprehensive SEC review of the disclosure requirements required by the Jumpstart Our Business Startups Act (JOBS Act). The Regulation S-K rules that were amended consisted of description of business (Item 101), legal proceedings (Item 103), and risk factors (Item 105) and the amendments are effective Nov. 9. The SEC's significant revisions represent the first updates to these disclosure rules in over 30 years.

Chairman Jay Clayton noted in his opening remarks that the amendments were the product of the SEC's efforts to review and improve the disclosure framework. He stated that the world economy has changed significantly since the 1970s and 1980s when the rules were first created. He stressed that the amendments build upon the SEC's "materiality-based disclosure framework" and highlighted that the amendments covered a very important topic which received his full support, namely, increased focus on human capital disclosures. Clayton declared, "human capital accounts for and drives long-term business value in many companies much more so than it did 30 years ago." Commissioners Allison Herren Lee and Caroline Crenshaw submitted dissenting votes, taking the position that in failing to address matters of diversity and climate change risk, the amendments omitted two issues that today's investors, and investors of the future, consider important in determining a company's long term sustainability.

The Regulation S-K Amendments

In modernizing the rules, the SEC made the updates to Regulation S-K described below, each of which are intended to simplify and streamline a registrant's disclosure obligations, while also aiming to provide material information to investors.

• Description of Business (Item 101)

The SEC made several revisions to Item 101 of Regulation S-K, which requires disclosure regarding a company's business operations. First, paragraph (a), which requires a description of the general development of the business of the registrant, its subsidiaries and any predecessor(s) during the past five years, was modified to be more principles-based and to require disclosure only to the extent material to an understanding of the general development of a registrant's business. Therefore, the five-year lookback period was removed. Paragraph (h) of Item 101 previously prescribed a three-year lookback applicable to smaller reporting companies, which the SEC also eliminated with the rule amendments. By way of guidance, the amendments state that disclosure regarding material business developments may include, but is not limited to, material changes to a previously disclosed business strategy, the nature and effects of any material bankruptcy, receivership, or similar proceeding, the nature and effects of any material reclassification, merger or consolidation, and the acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business. A smaller reporting company may similarly satisfy its obligations under the amended rule by describing the material business developments. Besides accounting for the lookback periods, registrants were previously required to describe certain specific line items in order to satisfy their disclosure obligations under the rule. Accordingly, these amendments afford significant flexibility by requiring just material information and updates concerning a registrant's business.

In addition, the SEC added revised Item 101 by allowing registrants to provide an update that describes material business developments since the previous full discussion, instead of a full discussion, of the development of their business. This allowance, however, is only applicable to filings after a company's initial registration statement. In adhering to the amended rule, a company must disclose all of the material developments that occurred since the most recent full discussion of the general development of its business, and it must also incorporate by reference and include one active hyperlink to a registration statement or report that includes the full discussion of the general development of their business. It is worth noting, however, that a filing which includes an update and incorporates by reference to the more complete and comprehensive discussion could not be incorporated by reference into a subsequent filing.

Similarly, the SEC amended paragraph (c) of Item 101, which requires a narrative description of a registrant's business, to utilize a principles-based approach to the description of the business conducted and intended to be conducted, and which focuses on the registrant's dominant segment or each reportable segment. Under the amended rule, again, only information material to an understanding of the business is necessary; specific line items were eliminated in favor of a non-exhaustive list of topics for registrants to consider for disclosure. Notably, to the extent material, the SEC now requires discussion regarding the material effects of compliance with governmental regulations on capital expenditures, earnings, and competitive position. Paragraph (c) had previously called for description of the effects of compliance with environmental laws, but the amendments expand the breadth of these disclosure considerations to compliance with governmental regulations more broadly. Further, the SEC now calls for a description of the registrant's human capital resource and any human capital measures or objectives on which the company focuses in managing its business to the extent material to an understanding of the business. The SEC stated, by way of example, that such disclosure may include a discussion of a registrant's part-time employees, full-time employees, independent contractors and contingent workers, and employee turnover (in all or a portion of the registrant's business), if material to an understanding of the registrant's business.

• Legal Proceedings (Item 103)

The SEC revised Item 103 of Regulation S-K to expressly state that legal proceeding disclosures may be provided by hyperlinks or cross-references to disclosures located elsewhere in the applicable document, such as in Management's Discussion & Analysis, Risk Factors, or notes to the financial statements. In the view of the SEC, the use of hyperlinks reduces duplicative disclosure while also allowing registrants to present information in the manner they deem most effective.

The amendments to Item 103 also increased the quantitative threshold for disclosure of environmental proceedings to which a governmental authority is a party. The rule's previous threshold of $100,000 was established in 1982, and the amendment raises the threshold to $300,000, exclusive of interest and costs. Alternatively, a company may establish its own threshold provided that the threshold is reasonably designed to result in disclosure of any such proceeding that is material to its business or financial condition, the proceeding is disclosed (including any change thereto) in each annual and quarterly report, and such proceeding not exceed the lesser of $1 million or one percent of the current assets of the registrant and its subsidiaries on a consolidated basis. In providing this alternative, the SEC observed that bright line rules, such as the $300,000 threshold, can provide certainty as to when disclosure is necessary, but application of a single threshold can result in disclosure of proceedings that are immaterial to certain registrants.

• Risk Factors (Item 105)

The SEC amended Item 105 of Regulation S-K, the risk factors disclosure requirement, to provide that rather than describing "the most significant factors," a registrant must instead discuss "material factors" that make investments in the company speculative or risky. In addition, if the risk factor discussion is longer than 15 pages, registrants must include a preceding risk factor summary consisting of a series of concise, bulleted, or numbered statements no more than two pages, laying out the principal factors that make an investment speculative or risky. The amendments require that the risk factors discussion be organized logically with relevant headings, which is in addition to the current requirement that each risk factor be set forth under a caption adequately describing the risk. Finally, risk factors that would generally apply to the offering of securities must be disclosed at the end of the risk factor section under the caption "General Risk Factors," though the inclusion of such general risk factors is discouraged by the SEC. The risk factor amendments are intended to promote principles-based disclosure of risks specifically tailored to the registrant and its securities in a manner that is well-organized and clear to investors.

Conclusion

Since the passing of the JOBS Act, the SEC has made numerous rule changes intended to simplify and streamline its disclosure requirements, and the amendments to description of business (Item 101), legal proceedings (Item 103), and risk factors (Item 105) appear well-targeted for achieving this aim for investors and registrants alike. They collectively emphasize disclosure of material information, while also cutting back on duplicative discussions. Many registrants must begin considering these rule changes as they prepare their annual reports on Form 10-K since the rule changes are effective beginning Nov. 9, 2020, and should consult with their legal counsel regarding how best to adjust their disclosures under these amended Items.

Katayun I. Jaffari is chair of the corporate governance and securities group at Cozen O'Connor. She counsels public and private companies in the areas of corporate governance and securities law and compliance, including capital-raising transactions and reporting requirements under SEC, NYSE and Nasdaq regulations, as well as providing general corporate advice and execution with respect to executive compensation, mergers and acquisitions transactions and board and business counseling. She can be reached at [email protected] or 215-665-4622.

Paul D. Hallgren is an associate in the firm's corporate practice group. He has experience in corporate and transactional matters, including corporate governance and securities law compliance, mergers and acquisitions involving public and private companies, and capital-raising transactions. Contact him at [email protected] or 612-260-9019.