Yesterday at an open meeting, the SEC adopted amendments to parts of Regulation S-K – specifically relating to Item 101 (business description), Item 103 (legal proceedings) & Item 105 (risk factors). As anticipated, the amendments include increased focus on human capital.
These are the first significant amendments to these disclosure items in 30 years – and the updates have been many years in the making, as they’re part of the “disclosure effectiveness initiative” that emerged with the SEC’s 2016 concept release and continued up through last year’s proposal. These go beyond the “cleaning out the garage” amendments of a couple years ago and are intended to simplify the substantive disclosure requirements while also improving the readability of disclosure documents. The amendments shift away from prescriptive disclosures to a more principles-based disclosure framework. Here’s an excerpt from the SEC’s press release with highlights:
– Amend Item 101(a) by:
- making it largely principles-based, requiring disclosure of information material to an understanding of the general development of the business;
- replacing the previously prescribed five-year timeframe with a materiality framework; and
- permitting a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference;
– Amend Item 101(c) by:
- clarifying and expanding its principles-based approach, with a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in Item 101(c);
- including, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
- refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws;
– Amend Item 103 by:
- expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
- implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant; and
– Amend Item 105 by:
- requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
- refining the principles-based approach of Item 105 by requiring disclosure of “material” risk factors; and
- requiring risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
The Commission adopted the amendments by a 3-2 vote – Commissioners Allison Herren Lee and Caroline Crenshaw dissented. Some may have hoped for more prescriptive human capital disclosure requirements and the two dissenting statements each express concern with the principles-based nature of the rule. In Commissioner Lee’s dissenting statement, she said she would have supported the final rule “if it had included even minimal expansion on the topic of human capital to include simple, commonly kept metrics such as part time vs. full time workers, workforce expenses, turnover, and diversity.” Commissioner Lee also cited the rule’s “ill-advised omissions” of diversity and climate change. Commissioner Crenshaw’s dissenting statement says the rule fails to deal adequately with climate change risk and human capital and suggests the Commission form an external ESG Advisory Committee to help the Commission respond to ESG trends.
One aspect of the amendments some companies likely aren’t thrilled with is the new requirement to include summary risk factor disclosure when risk factor disclosure exceeds 15 pages. Commissioner Hester Peirce’s statement says she views this change as a “bit of an experiment” and wonders whether the “penalty” of needing to prepare a summary will overcome the fear of litigation that leads companies to produce voluminous risk factor disclosures.
The rules will be effective 30 days after publication in the Federal Register and we’ll be posting the avalanche of memos in our “Reg S-K” Practice Area. We’ll also be updating our Handbooks on these topics.
There’s More! SEC Amends Definition of “Accredited Investor” & QIBs
Before yesterday’s meeting even began, the SEC also adopted amendments to the definition of “accredited investor” in Reg D and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act. The new “accredited investor” definition expands the number of investors eligible for this status – by allowing individuals to qualify based on their professional knowledge, experience or certifications while also expanding the list of entities that may qualify. In determining whether an individual would qualify as an accredited investor based on a particular certifications or credentials, under the amended definition, the SEC will consider, among other things, whether the certification, designation or credential arises out of an examination designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing – examples being a Series 7, 65 or 82 license.
The SEC’s amendments to the definition of “qualified institutional buyer” broaden it by including LLCs, RBICs and any institutional accredited investor not already listed in Rule 144A when they meet the existing threshold of $100 million in securities owned and invested.
Although the SEC’s Press Release says the “SEC Modernizes the Accredited Investor Definition”, Commissioners Allison Herren Lee and Caroline Crenshaw issued a joint dissenting statement on the “Failure to Modernize the Accredited Investor Definition” that says despite support for indexing the accredited investor wealth thresholds to inflation, the amended definition fails to do so while also putting vulnerable investors at risk. And Commissioner Hester Peirce tweeted about her statement that the rule didn’t go far enough.
The new rules will be effective 60 days after publication in the Federal Register – and we’ll be posting memos in our “Accredited Investor” and “Rule 144A” Practice Areas. We’ll also be updating our “Regulation D Handbook”.
SEC Calendars Open Meeting: Amendments to Whistleblower Rules on the Agenda
Yesterday, the SEC also scheduled another open meeting – it’s scheduled for this coming Wednesday, September 2nd. The Sunshine Act notice says that the Commission will consider whether to adopt amendments to rules relating to the SEC’s whistleblower program – it’s not clear whether they’ll move forward on some of the controversial amendments that were under consideration last year. Here’s an excerpt from the notice:
The amendments would enhance claim processing efficiency, and clarify and bring greater transparency to the framework used by the Commission in exercising its discretion in determining award amounts, as well as otherwise address specific issues that have developed during the whistleblower program’s history. The Commission will also consider whether to adopt interpretive guidance concerning the term “independent analysis” in the Commission’s rules implementing its whistleblower program.
– Lynn Jokela