October 13, 2017
On October 11, 2017, the Securities and Exchange Commission (SEC) unanimously voted to propose amendments to modernize and simplify disclosure requirements for public companies, as well as investment advisers and investment companies. The rule proposals, available here, represent a significant first step by the SEC toward implementing Congress’ mandate under the Fixing America’s Surface Transportation (FAST) Act to reduce compliance costs and burdens on companies while continuing to provide all material information to investors.
Chairman Jay Clayton said the proposals will reduce the burdens on issuers while providing investors with the information they need to make informed decisions. This viewpoint is consistent with the guiding principles Chairman Clayton outlined at the start of his tenure, available here. Chairman Clayton stated that “[t]he proposed amendments are intended to improve the quality and accessibility of disclosure in filings by simplifying and modernizing our requirements.… The proposed amendments also clarify ambiguous disclosure requirements, remove redundancies and further optimize the use of technology.”
In December 2015, Congress passed the FAST Act, available here. The FAST Act required the SEC to conduct a study on Regulation S-K, the primary disclosure regulation, and eventually to enact related rules, to “(1) determine how best to modernize and simplify such requirements in a manner that reduces the costs and burdens on issuers while still providing all material information; (2) emphasize a company-by-company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static requirements…; [and] (3) evaluate methods of information delivery and presentation and explore methods for discouraging repetition and the disclosure of immaterial information.”
The SEC submitted its report on this study – the FAST Act Report – on November 23, 2016, available here. The FAST Act further required the SEC to propose amendments implementing recommendations from the report within 360 days of the report date. At the open Commission meeting, Chairman Clayton and Division of Corporation Finance Director William Hinman indicated the proposed amendments are a result of recommendations in the FAST Act Report and cover all areas of improvement previously identified by the SEC staff.
Several of the proposed amendments are discussed in further detail below.
Management’s Discussion and Analysis (MD&A) – Item 303 of Regulation S-K
Under the proposed amendment to Item 303, registrants that provide financial statements covering three years in their filings would not be required to include in MD&A a discussion of the earliest year if (i) discussion of the earliest year is not material to understanding the registrant’s financial condition, and (ii) the registrant has filed its prior year Form 10-K containing MD&A of the earliest of these three years. For example, under the proposed amendment, if a registrant files its 2017 Form 10-K that includes financial statements for fiscal years 2015, 2016, and 2017, the registrant would be able to eliminate the discussion comparing fiscal year 2016 to 2015 in its 2017 Form 10-K, and instead address 2016 solely in the context of the discussion comparing 2017 to 2016, if a discussion about 2015 is not material to an understanding of the registrant’s current financial condition and the registrant included this information in its 2016 Form 10-K.
One of the priorities of this proposed amendment is to encourage registrants to take a “fresh look” at their MD&A to determine whether such disclosures remain material. Omission of the information that is no longer material is intended to reduce repetition in filings. As such, the proposed amendment does not include the FAST Act Report’s recommendation requiring a hyperlink to the prior year’s annual report for the earlier year-to-year comparison.
The proposed amendment would also eliminate the reference to trends related to five-year selected financial data in Instruction 1 to Item 303(a) because disclosure requirements for liquidity, capital resources, and results of operations already require trend disclosure.
Exhibits – Item 601 of Regulation S-K
Omission of Information From Material Contracts Without Confidential Treatment Request
Under the proposed amendments, registrants would be allowed to omit confidential information from material contracts filed pursuant to Item 601(b)(10) where such redacted information is both (i) not material and (ii) competitively harmful if publicly disclosed, without requesting confidential treatment from the SEC. As is the current practice, registrants would still be required to (i) mark the exhibit index to indicate portions of the exhibit have been omitted, (ii) include a prominent statement on the first page of the redacted exhibit indicating certain information has been omitted, and (iii) indicate with brackets where such information has been omitted within the exhibit.
Although registrants would not be required to file confidential treatment requests, it would remain the responsibility of these registrants to ensure all material information is disclosed and the redactions are limited to those portions necessary to prevent competitive harm. The SEC staff would continue to selectively review registrant filings and assess whether registrants have satisfied their disclosure responsibility with respect to these omissions. Upon request, registrants would be required to provide supplemental materials similar to those currently required in confidential treatment requests. Registrants could request confidential treatment pursuant to Rule 83 for these supplemental materials. If the supplemental materials do no support the redactions, the SEC staff may instruct registrants to file an amendment disclosing some, or all, of the previously redacted information.
Omission of Schedules and Attachments to Exhibits
Under the proposed amendments, registrants would be permitted to omit entire schedules and similar attachments to exhibits, unless these schedules or attachments contain material information that is not otherwise disclosed in the exhibit or SEC filing. This proposed amendment would extend the existing accommodation in Item 601(b)(2) for plans of acquisition, reorganization, arrangement, liquidation, or succession to all exhibits, including credit agreements and purchase agreements. As with Item 601(b)(2), registrants would be required to provide, on a supplemental basis, a copy of any omitted schedules or attachments to the SEC staff upon request.
Omission of Personally Identifiable Information (PII)
The proposed amendments would permit registrants to omit PII (such as bank account numbers, social security numbers and home addresses) from all exhibits without submitting a confidential treatment request. Additionally, registrants would not be required to provide an analysis in order to redact PII from exhibits. This is consistent with the SEC staff’s current practice of not objecting when registrants seek confidential treatment and omission of PII.
Two-Year Look Back Period for Material Contracts
Under the proposed amendments, with the exception of “newly reporting registrants,” registrants would no longer be subject to the two-year look back period under Item 601(b)(10)(i). The two-year look back period currently requires all registrants to include all material exhibits entered into during its last two years in their Form 10-K. Under the proposed amendment, registrants would only file exhibits that are still material at the time of the filing.
Legal Entity Identifiers (LEIs)
LEIs are 20-character, globally-recognized alpha-numeric codes that allow for unique identification of entities engaged in financial transactions. Under the proposed amendment to Item 601(b)(21)(i), all registrants and subsidiaries that have LEIs would be required to disclose each of these LEIs in this exhibit on the theory that this additional information could allow investors to better understand the registrant’s corporate structure and certain transactional risks at minimal additional cost to registrants. While Commissioner Kara Stein voted to approve the proposed amendments, she expressed concern that the proposed amendments do not go far enough in this area because they would not require registrants and subsidiaries to obtain LEIs if they do not currently have them.
Description of Securities
The proposed amendments to Item 601(b)(4) would require registrants provide a brief description of all securities registered under Section 12 of the Exchange Act (i.e., the information required by Item 202(a)-(d) and (f)) as an exhibit to their Form 10-K. Currently, such disclosure is only required in registration statements. The SEC noted that requiring Item 202 disclosure as an exhibit to annual reports would improve investors’ access to information about their rights as security holders, thereby facilitating more informed investment and voting decisions.
Description of Property – Item 102 of Regulation S-K
Under the proposed amendment to Item 102, registrants would only be required to disclose physical properties to the extent such properties are material to the registrant’s business, which contrasts with the current requirement to disclose “principal” plants, mines, and other “materially important” physical properties. However, given the significance of the disclosure of properties for registrants’ operating in the mining, real estate, and oil and gas industries, the SEC does not propose to modify the instructions to Item 102 specific to these industries and they remain subject to their existing industry guides.
Other Proposed Technical Amendments
The comment period for the proposed rules will expire 60 days after the proposed rules are published in the Federal Register.
Chairman Clayton’s statement during the open meeting proposing rules to modernize and simplify disclosure requirements is available here, Commissioner Stein’s statement is available here, and Commissioner Michael Piwowar’s statement is available here. In her remarks, Commissioner Stein specifically asked for comments regarding whether the release goes as far as it can with respect to LEI requirements, as well as for comments on MD&A disclosure and redactions of sensitive information in exhibits.
The proposed amendments are generally consistent with the FAST Act Report, so they do not present any great surprises. Registrants will welcome the opportunity for less redundancy in their disclosure. However, a number of technical issues are presented by the proposals. For example, registrants may have to revise the format of their MD&A so that the discussion of current year to prior year results addresses material aspects of both years. As well, there are uncertainties related to the elimination of the confidential treatment request process, including, but not limited to: the treatment and expiration of current confidential treatment orders; whether companies will need to revise their exhibits as time passes to ensure that previous redactions remain limited to those portions necessary to prevent competitive harm; and whether companies conducting initial public offerings will be able to go effective if the SEC staff decides to review a redacted exhibit during its review process.
Regardless of whether or when the proposed amendments are adopted, this release provides registrants with a good reason to take a fresh look at the disclosure in their Exchange Act reports. Registrants will want to evaluate how their reports and registration statements can be revised to improve readability and navigability and eliminate repetitive or immaterial disclosure.
Registrants should evaluate, together with their legal counsel and other advisors, how the proposed amendments may impact their future compliance costs and burdens and the content of their future disclosures. Based on those reviews, registrants may wish to submit comments on the proposed amendments.
Gibson Dunn lawyers are available to assist in addressing any questions you may have about these developments. To learn more about these issues, please contact the Gibson Dunn lawyer with whom you usually work, any lawyer in the firm’s Securities Regulation and Corporate Governance and Capital Markets practice groups, or any of the following practice leaders and members
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Hillary H. Holmes – Houston (+1 346-718-6602, [email protected])
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