SEC Seeking Comment on Potential Modernization of Public Company Disclosure

May 12, 2016


On April 13, 2016, the Securities and Exchange Commission issued a concept release concerning potential improvements to the business and financial disclosures required by Regulation S-K, the backbone and foundation of the Commission’s public company disclosure regime.  The complete text of the concept release is available here, and comments are due no later than July 21, 2016.

The concept release, part of the Commission’s historic “disclosure effectiveness” initiative, presents 340 numbered requests for comments on a substantial variety of potential improvements to the public disclosures required by Regulation S-K.  The broad scope and significant depth of the release is explicitly designed to foster wide-ranging commentary on the effectiveness of the disclosure requirements in Regulation S-K to modern public enterprises; indeed, the text of the release explicitly welcomes responses to the specific questions posed, as well as with respect to “any other of [the Commission’s] disclosure requirements in Regulation S-K that commenters believe may be improved upon.”  At the open meeting for the concept release, Chair Mary Jo White called this release “a foundational product” of the effectiveness initiative and an analysis of “evolving business models, advancements in technology, and ongoing public dialogue on disclosure issues” that “seeks public input on how our business and financial disclosure requirements in Regulation S-K can best be modernized in the current context.”

The release covers nearly every section of Regulation S-K, as well as procedural and presentation issues related to the public disclosure regime (including, for example, cross-references, incorporation by reference, hyperlinks, use of company websites, and formatting).  The breadth of the release makes it clear that the disclosure effectiveness initiative is perhaps the best opportunity for interested persons to comment on the usefulness of the current public disclosure requirements since their inception, from the perspective of filers and the investing public.  As a result, companies and investors should consider a thorough review of the release, as well as the submission of comments with respect to any aspect of Regulation S-K.

The release covers conceptual issues and specific line-item requirements, with particular emphasis on the following categories:

I.  ITEM 101 - CORE COMPANY BUSINESS INFORMATION

A significant portion of the release is devoted to requests for comment concerning the disclosure of information about a registrant’s industry, business environment, and other factors affecting the business.  The Commission notes that disclosure about a registrant’s business “lays the groundwork for understanding and assessing a company, its operations and financial condition,” and further notes that such disclosures “help inform investment and voting decisions by placing other disclosure in context.”  The Commission therefore requests specific comment on, among other things:

  • Whether Item 101(a)(1) of Regulation S-K (requiring a description of the general development of a registrant’s business during the prior five years) provides useful disclosure that is not available elsewhere in the current filing or previous filings.
  • Whether Item 101(c) (requiring a narrative description of the registrant’s business, including thirteen specific line-items) continues to provide useful information to investors and whether the Item may be improved to better reflect changes in the way businesses operate.  
  • Whether the scope of Item 101(c)(1)(iv) (requiring disclosure of the importance of and the duration and effect of patents, trademarks, licenses, franchises, and concessions) should be expanded to include additional forms of intellectual property or other disclosures concerning the reliance on or importance of technology or intellectual property to the registrant.
  • Whether disclosures in connection with government contracts or subcontracts and government regulations (including, specifically, environmental regulations) under Items 101(c)(ix) and (c)(1)(xii) are important to investors and merit increases or decreases in required line-item disclosure.  In addition, the Commission explicitly noted that the impact of most government regulations is not required to be disclosed by specific line-item requirements but that many registrants provide such disclosures as a matter of practice.
II.  COMPANY PERFORMANCE, FINANCIAL INFORMATION, AND FUTURE PROSPECTS

The release also places significant emphasis on financial disclosures, calling such information “essential” to an investor’s understanding of a registrant’s performance, financial condition, and future prospects.  Although Regulation S-X contains the requirements related to annual and quarterly financial statements, the release identifies several Regulation S-K items related to additional disclosure about a registrant’s financial condition and results of operations, including:

  • Item 301 disclosures concerning selected financial information;
  • Item 302 disclosure of selected quarterly financial data; and
  • Item 303, concerning disclosure of management’s discussion and analysis of financial condition and results of operations.

The release poses a significant number of requests for comment in this area, including whether to eliminate or modify Item 301 (and if so, how), whether recent rulemaking in connection with financial information disclosures by emerging growth companies should be extended to other registrants, and whether financial and MD&A disclosures in their current form impose undue or duplicative costs on registrants.  The Commission asks, among other things:

  • Whether selected financial data should be required for the full five years only in certain instances.
  • Whether supplementary quarterly financial data should be retained, eliminated, or modified.
  • Whether there should be a qualitative or quantitative threshold rather than the current materiality standard for MD&A disclosure. 
  • Whether companies should be required to provide an executive-level overview in the MD&A that does not simply duplicate disclosure provided elsewhere. 

III.  RISK AND RISK MANAGEMENT

The third topic covered in the release concerns risk and risk management, disclosure of which is required by Regulation S-K and various other financial reporting requirements.  The release focuses explicitly on Items 503(c) and 305 of Regulation S-K, concerning risk factor disclosure and disclosure of quantitative and qualitative market risk, respectively.  The requests for comment in connection with risk-based disclosures note an interest by the Commission in feedback on potential improvements to the content and readability of risk disclosures, as well as potential approaches to modernization of risk-related disclosures.  For example, the Commission asks:

  • Whether risk factors should be accompanied by a specific discussion of how the registrant is addressing risk.
  • Whether registrants should disclose the probability of occurrence and the effect on performance of each risk factor.
  • Whether existing requirements should be modified to require or encourage description of risks with greater specificity and context (such as disclosure of specific facts and circumstances that make a given risk material to the registrant) and whether risks should be presented in order of management’s perception of the magnitude of the risk or by order of importance to management.
  • Whether disclosure in Item 305 results in meaningful discussion of information that allows investors to effectively assess aggregate market risk exposure and the impact of market risk sensitive instruments on results of operations and financial condition.
  • Whether additional or different principles should guide the market disclosure requirements, including whether additional risks such as credit risk, liquidity, funding risk, and operational risks should also be required to be disclosed.

IV.  SECURITIES OF THE REGISTRANT

The release also assesses the impact of disclosure in connection with the outstanding securities of the registrant, noting that disclosure about a registrant’s capital stock and transactions in its own securities “helps inform investment and voting decisions by providing investors with information about a security that can be useful in assessing its value.”  The release explicitly covers Items 202, 701, and 703 of Regulation S-K (concerning the description of terms and conditions of securities being registered, disclosure of recent sales of unregistered securities, and tabular disclosure of repurchases and affiliate purchases, respectively), as well as Item 201(b)(1), concerning disclosure of the number of holders of each class of the registrant’s common equity.  Like other sections of the release, the Commission is clear that comments are welcome about the specific disclosures discussed in the release and with respect to any other related issues.  Requests for comment in this area touch a variety of concepts, including:

  • Whether Item 201(b)(1) should be eliminated given that the vast majority of investors hold their shares in street name.
  • Whether Item 202 disclosures should be required in Form 10-K filings.
  • Whether the disclosure requirements of Item 701 and Form 8-K Item 3.02 for issuances of one percent or greater strike a fair balance with respect to disclosure of unregistered sales of equity securities.
  • Whether the Item 701 disclosure requirement should be removed from Forms 10-Q and 10-K. 
  • Whether more frequent disclosure of share repurchases should be required.

V.  OTHER MISCELLANEOUS AND PROCEDURAL ISSUES

The release further tackles a variety of procedural and miscellaneous disclosure issues, including industry guides, sustainability, and other public policy-related disclosures, exhibits, cross-references, incorporation by reference, hyperlinks, websites, formatting, and layered and structured disclosures.  The release also covers the topics of scaled disclosure requirements and the frequency of interim reporting.  Requests for comment in these areas address a number of practical and conceptual questions, including requests such as:Whether there are specific sustainability or public policy issues that are important to informed voting and investment decisions and how the adoption of specific disclosure requirements in this area would elicit meaningful improvements in the quality of company disclosures on such issues.

  • Whether registrants should be permitted to omit immaterial schedules and attachments from filed exhibits (as currently permitted only for acquisition agreements).
  • Whether the “not made in the ordinary course of business” standard in connection with disclosure of material contracts provides a clear standard for agreements covered by the rule.
  • Whether registrants should be required to disclose all subsidiaries, without exception, and whether filers should be required to include an organization or corporate structure chart depicting subsidiaries and their basis of control.
  • Whether registrants should be permitted to include external hyperlinks and whether increased use of hyperlinks and further disaggregation of company disclosure into multiple filings would hinder the quality or readability of disclosure.
  • Whether registrants should be permitted to provide certain required disclosure on their website in lieu of including it in their periodic reports or should be allowed to incorporate such information in their periodic reports by reference to their website, whether and how such website disclosures should be required to be preserved or updated, and how the use of website disclosures to satisfy disclosure requirements would impact registrants’ liability under the securities laws for such information.
  • Whether current formatting requirements appropriately consider the need for both standardization and flexibility in presentation of disclosure or whether the Commission could improve the presentation of disclosure by registrants.
  • Whether eligibility for scaled disclosure should be tied to a certain proportion of companies and whether one or more categories of larger companies (such as companies with a longer reporting history or more readily available public information) should be allowed to benefit from scaled disclosure requirements.
  • Whether the frequency of interim reporting should differ depending on the type of company and whether companies should be permitted to file abbreviated quarterly reports for the first and third quarters.

The concept release is a first step towards possible future rulemaking by the Commission on the topics raised in the concept release.  Because the concept release raises the possibility of impactful rule changes to public company disclosure requirements, we encourage companies and investors to review the release and to consider submission of responses to the Commission’s requests for comments.  If you have any questions regarding the concept release discussed in this alert or would like to discuss the submission of responses to the Commission’s requests for comments, please contact the authors of this alert or your OMM advisor.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Rob Plesnarski, an O'Melveny partner licensed to practice law in the District of Columbia and Pennsylvania, Shelly Heyduk, an O’Melveny partner licensed to practice law in California, Su Lian Lu, an O’Melveny counsel licensed to practice law in California, and James M. Harrigan, an O'Melveny associate licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted. 

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