Takeaways

The amendments show recent SEC efforts to simplify compliance without significantly altering the total mix of information provided to investors.
The amendments bring about numerous discrete, technical changes to various sections of SEC disclosure regulations.
The effective date of the amendments is November 5, 2018.

Discussion

On August 17, 2018, the SEC adopted technical amendments (Amendments) to streamline the SEC’s disclosure framework for public companies, investment advisers and investment companies. The Amendments attempt to condense and harmonize the requirements of disclosure regulations and the related rules and forms required by the SEC, along with those required by the Financial Accounting Standards Board (FASB) under United States Generally Accepted Accounting Principles (U.S. GAAP), to elicit more useful and efficient disclosure.

In addition, the SEC submitted to the FASB certain SEC disclosure requirements that overlap with U.S. GAAP, along with a request that the FASB determine whether to add the submitted items to its agenda within 18 months after publication of the adopting release in the Federal Register (Release). According to Bloomberg BNA, the FASB agreed to discuss the request at an upcoming public meeting.

The Amendments are in response to a congressional mandate that the SEC modernize and simplify Regulation S-K under Section 72003 of the Fixing America’s Surface Transportation Act (FAST Act), pursuant to which the SEC staff also previously issued its November 2016 Report on Modernization and Simplification of Regulation S-K and October 2017 request for comment on SEC proposed amendments. The Amendments, as required by the FAST Act mandate, are intended to implement the salient contours of the report, which outline specific recommendations for cleaning up Regulation S-K in a way that reduces the burdens associated with duplicative and immaterial disclosure without compromising a public company’s obligation to provide investors with all information necessary to make an informed investment decision. As a general matter, the SEC has articulated a standard of materiality measured in the context of the public company itself as opposed to only its business.

The final rules remedy certain cumbersome elements of the current disclosure framework that could have led to inapposite or repetitious disclosure, including in the items relating to description of business, public reference room, market prices, dividends, equity compensation plans, ratio of earnings to fixed charges, exhibits and statements of comprehensive income, as well as certain changes in nomenclature. Public companies should note the overall substantive effect on future filings.

The most significant sections affected by the Amendments are summarized below. 

  • Description of Business: Many changes implicate prominence and financial statement considerations because such disclosures are located in the business description section of an annual report filing, while corresponding disclosures are located in different sections of the filing (e.g., risk factors or MD&A) or in the notes to the financial statements and, where applicable, in the MD&A. Of particular note are the following:

- Segment Financial Information: Item 101(b) of Regulation S-K requires disclosure of segment financial information, restatement of prior periods when reportable segments change and discussion of interim segment performance that may not be indicative of current or future operations. The Amendments eliminate these requirements as duplicative because they remain available in the notes to the financial statements required by U.S. GAAP and, where applicable, in the MD&A. (Item 3-03(e) under Regulation S-X and Item 302(a)(3) under Regulation S-K were also eliminated in the Amendments.)

- Research and Development Activities: Item 101(c)(1)(xi) and Item 101(h)(4)(x) of Regulation S-K require disclosure of amounts spent on research and development activities, if material. The Amendments eliminate the requirement to disclose the amount spent on research and development activities, if material, as U.S. GAAP and the IFRS require reasonably similar disclosures. However, Item 303 of Regulation S-K requires disclosure of trend information related to those items in the business description section, where material, and companies should continue to provide such required disclosures as needed. In addition, companies may continue to provide voluntary disclosures of their R&D activities in their business description or elsewhere outside of the financial statements.

- Geographic Areas: In order to address the overlap of obligatory risk factor disclosures, the SEC deleted Item 101(d)(3) of Regulation S-K, which requires disclosure of “any” risk outside the financial statements relating to geographic areas and requires disclosures of a segment’s dependence on foreign operations. Such information is sufficiently covered by Item 503(c) of Regulation S-K, which requires disclosure of “significant” risk factors that make an offering speculative or risky. Furthermore, dependence on foreign operations from Item 101(d)(3) is similarly covered by Item 303(a) of Regulation S-K, which requires disclosure of trends and uncertainties by segment, if appropriate to an understanding of the issuer as a whole. The Amendments add an explicit reference to “geographic areas” under Item 303(a) to reduce the likelihood of loss of information due to the deletion of Item 101(d)(3). Discussion of geographic areas is not required in all circumstances as geographic areas are an example of a business’s subdivision and must be discussed when management believes it would be appropriate to understand the business.

- Seasonality: The SEC retained Item 101(c)(1)(v) of Regulation S-K requiring an annual seasonality disclosure. However, the Amendments eliminate Instruction 5 to Item 303(b) of Regulation S-K because U.S. GAAP and other portions of Item 303 require disclosures in interim reports that convey similar information. This deletion could result in less supplemental forward-looking information disclosed to investors with regard to seasonality because the safe harbor under the Private Securities Litigation Reform Act of 1995 is not available for such information when disclosed in the notes to the financial statements. The Release explains that even without Instruction 5, the requirements in Item 303 promote disclosure of forward-looking information in interim reports such that the effects of seasonality may become material.

- Material Events Subsequent to the End of the Most Recent Fiscal Year: The Amendments eliminate Rule 8-03(b)(2) and Rule 10-01(a)(5) of Regulation S-X, which require disclosure of material events subsequent to the end of the most recent fiscal year in interim financial statements. This disclosure is already required in order to remain in compliance with U.S. GAAP and Regulation S-K.

  • Public Reference Room: The Amendments eliminate portions of Item 101(e) and Item 101(h)(5)(iii) under Regulation S-K, which require filers to identify the Public Reference Room and disclose its physical address and phone number. However, the Amendments retain the requirement to disclose the SEC’s internet address and a statement that electronic SEC filings are available on the SEC website. Additionally, all issuers will be required to disclose their internet addresses, if they have one. This change will impact each registration statement, prospectus and Form 10-K.
  • Market Prices: Item 201(a) of Regulation S-K requires a company to disclose basic information regarding public trading markets (or absence thereof) and historical trading prices for the company’s common equity. The Release explains that this disclosure requirement is now outdated, given that a company’s stock price information is easily available for free on numerous websites. As a result, the Amendments eliminate the requirement to disclose equity trading price as of a recent date (Item 201(a)(1)(v)), and the high and low sales prices of the company’s common equity for each full quarterly period within the two most recent fiscal years and interim periods (Item 201(a)(1)(ii)) and replaces this portion with a trading symbol(s) disclosure requirement for each class of the company’s common equity (Item 201(a)(1)(i)). Other specific disclosure requirements also apply to issuers with common equity traded over-the-counter and issuers with no class of publicly traded common equity. This change will impact each Form 10-K, Form S-1 and each corresponding prospectus for equity securities.
  • Dividends: The Amendments eliminate the requirement under Item 201(c)(1) of Regulation S-K to disclose the frequency and amount of cash dividends declared in a Form 10-K, Part 1 of a Form S-1 and other relevant filings, as such disclosure remains available under amended Rule 3-04 of Regulation S-X for interim periods. Additionally, the frequency of dividends will be evident from this disclosure. The Amendments consolidate disclosure requirements pertaining to restrictions that may materially limit an issuer’s ability to pay dividends on its common equity into a single requirement in Regulation S-X. This change will impact each Form 10-K, Form S-1 and corresponding prospectus for equity securities.
  • Ratio of Earnings to Fixed Charges: Item 503(d) of Regulation S-K requires issuers that register debt securities to disclose the historical and pro forma ratios of earnings to fixed charges. It also requires issuers that register preference equity securities to disclose the historical and pro forma ratio of combined fixed charges and preference dividends to earnings. Regulation S-K requires the filing of an exhibit setting forth the computation of any ratio of earnings to fixed charges. The Amendments eliminate the above requirements under Item 503(d) of Regulation S-K and the related exhibit requirements under Item 601(b)(11) and (12) of Regulation S-K because they are duplicative. U.S. GAAP and the IFRS already require disclosure of many of the components commonly used in the pro forma ratio above, such as income, interest expense and lease expense, as well as information used in other relevant ratios that conveys information as to an issuer’s ability to address its financial obligations. This change is relevant to each registration statement, prospectus, Form 10-K and 10-Q.
  • Exhibits: The following exhibit requirements, among others, were eliminated. The existing exhibit-numbering system has been preserved and the below items have been replaced with “[Reserved]”:

- Item 601(b)(11) – Required disclosure of computation of earnings per share.

- Item 601(b)(12) – Statement regarding computation of ratios.

- Item 601(b)(19) – Provides instructions to allow incorporation by reference into Form 10-Q of information that is separately made available to security holders.

- General Instruction D(3) to Form 10-Q, which refers to Item 601(b)(13) of Regulation S-K, provides specific instructions to address incorporation by reference into Form 10-Q information that is separately made available to security holders, making this Item 601(b)(19) duplicative.

- Item 601(b)(22) – Published report regarding matters submitted to vote of security holders.

- This provision became unnecessary due to 2009 changes to reporting rules allowing shareholder voting results to be disclosed in Forms 10-K and 10-Q and Item 5.07 of Form 8-K.

- Item 601(b)(26) – Invitations for competitive bids.

- This provision was deleted as it did not provide additional value to investors. Those participating in a competitive bid would directly receive the invitation, and all other investors would have access to the registration statement covering the securities offered at competitive bidding, as well as the results of the competitive bidding and the terms of reoffering.

  • Statement of Comprehensive Income: The SEC changed the nomenclature from “income statement” to “statement of comprehensive income” to conform with the FASB’s replacement of the former with the latter.
  • Extraordinary Items and Cumulative Effect: Several changes were made throughout the Amendments to reflect the elimination of accounting disclosures related to “extraordinary items” and “cumulative effect of a change in accounting principle.” “Extraordinary items” has been removed because the FASB eliminated this concept and “cumulative effect of a change in accounting principle” has been eliminated because it is no longer required by the FASB in statements of comprehensive income.

Effective Date and SEC Guidance

The Amendments will become effective on November 5, 2018, 30 days after publication in the Federal Register. Reporting companies should prepare to incorporate these changes into future filings, including third quarter 2018 reports on Form 10-Q that are filed on or after November 5, 2018. However, the SEC has explained there would be some leeway in the form of an adjustment period.

According to the SEC’s Questions and Answers of General Applicability Question 105.09 updated September 25, 2018, in light of the effective date and its proximity to the filing date for most issuers’ quarterly reports, SEC staff would not object if an issuer’s first presentation of the changes in shareholders’ equity is included in its Form 10-Q for the quarter that begins after the effective date of the Amendments. For example, given the effective date of November 5, a December 31 fiscal year-end issuer could omit this disclosure from its September 30, 2018 Form 10-Q; however, the issuer should include the disclosures in its March 31, 2019 Form 10-Q. Similarly, a June 30 fiscal year-end issuer could omit this disclosure from its September 30, 2018 and December 31, 2018 Forms 10-Q; however, the issuer should include the disclosures in its March 31, 2019 Form 10-Q.