In a recent postwe began reviewing the changes made by the SEC’s March 20, 2019 Disclosure Modernization and Simplification final rule to disclosures in Part III of Form 10-K and the proxy statement. This post concludes the discussion of changes to these areas, focusing on S-K Item 405 disclosures about delinquent Section 16 filers and a minor change to S-K Item 407 governance disclosures. Changes in both areas are fairly straightforward and, like most of the changes in the final rule, are effective for filings made after May 2, 2019.
Section 16 Delinquent Filer Disclosures
As a brief review, Section 16 of the 1934 Act requires directors, executive officers and owners of over 10% of a registrant’s stock to provide filings on Forms 3, 4 and 5 about stock ownership and transactions. This is important information as investors have a high level of interest in insider stock transactions.
Because there are so many Section 16 filers it would be tactically difficult for the SEC to assure that all Section 16 reports were timely filed. To deal with this situation, S-K Item 405 requires companies to disclose information about delinquent Section 16 filers in their proxy statement or Form 10-K if they do not file a proxy.
In the Disclosure Modernization and Simplification final rule the SEC dealt with three aspects of this disclosure:
1. Eliminated a very confusing S-K 405 check-box from the cover page of Form 10-K. You can read about the cover page change in this post.
2. Simplified the Section 16 reporting process by allowing registrants to rely on a review of Section 16 reports submitted on EDGAR instead of gathering copies of reports from Section 16 filers. The rule also removed a requirement in Rule 16a-3(e) that mandated Section 16 reporting persons to provide a duplicate copy of their reports to the company. In an EDGAR world, this furnishing of paper copies was clearly redundant. However, in some circumstances a company may need to look beyond reports on the EDGAR system.
The relevant section of old S-K Item 405 read:
(a) Based solely upon a review of Forms 3 and 4 (17 CFR 249.103 and 249.104) and amendments thereto furnished to the registrant under 17 CFR 240.16a-3(e) during its most recent fiscal year and Forms 5 and amendments thereto (17 CFR 249.105) furnished to the registrant with respect to its most recent fiscal year, and any written representation referred to in paragraph (b)(1) of this section.
The new S-K Item 405 now includes this instruction:
(b) Scope of the Inquiry. In determining whether disclosure is required pursuant to paragraph (a) of this section, the registrant may rely only on the following:
(1) A review of Forms 3 and 4 (17 CFR 249.103 and 249.104) and amendments thereto filed electronically with the Commission during the registrant’s most recent fiscal year;
(2) A review of Forms 5 (17 CFR 249.105) and amendments thereto filed electronically with the Commission with respect to the registrant’s most recent fiscal year; and
(3) Any written representation from the reporting person that no Form 5 is required. The registrant must maintain the representation in its records for two years, making a copy available to the Commission or its staff upon request.
3. Changed the required title of the disclosure from “Section 16(a) Beneficial Ownership Reporting Compliance” to “Delinquent Section 16(a) Reports”. Also, to help minimize unnecessary disclosure, the new S-K Item 405 encourages that the disclosure not be included in a company’s proxy or Item 12 of Form 10-K when there are no delinquent filers to disclose.
This change was made with the following new instruction:
Instruction 1 to paragraph (a) of Item 405. If no disclosure is required, registrants are encouraged to exclude the caption “Delinquent Section 16(a) Reports.”
As a bonus to this discussion, and as a response to a question that arises frequently in our workshops, here is the definition of “executive officer”:
240.3b-7 Definition of “executive officer”.
The term executive officer, when used with reference to a registrant, means its president, any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions for the registrant. Executive officers of subsidiaries may be deemed executive officers of the registrant if they perform such policy making functions for the registrant
The SEC made one “technical” correction to S-K Item 407 and also added a clarification for emerging growth companies (“EGCs”).
Regulation S-K Item 407(d)(3)(i) used to include this requirement:
The audit committee must state whether:
(B) The audit committee has discussed with the independent auditors the matters required to be discussed by the statement on Auditing Standards No. 61, as amended (AICPA, Professional Standards, Vol. 1. AU section 380), as adopted by the Public Company Accounting Oversight Board in Rule 3200T;
The reference to AU Section 380 is out of date as this was a reference to the old PCAOB standard system and not the new PCAOB organization of their auditing standards. This S-K requirement has been updated to read:
(B) The audit committee has discussed with the independent auditors the matters required to be discussed by the applicable requirements of the Public Company Accounting Oversight Board (“PCAOB”) and the Commission;
The other change in S-K Item 407 is related to EGCs. Because EGCs are not required to provide a Compensation Discussion and Analysis (S-K Item 402), there was some ambiguity about whether or not S-K Item 407(e)(5) applied to EGCs. This is the language in that paragraph:
(5) Under the caption “Compensation Committee Report:”
(i) The compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) must state whether:
(A) The compensation committee has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) (§229.402(b)) with management; and
(B) Based on the review and discussions referred to in paragraph (e)(5)(i)(A) of this Item, the compensation committee recommended to the board of directors that the Compensation Discussion and Analysis be included in the registrant’s annual report on Form 10-K (§249.310 of this chapter), proxy statement on Schedule 14A (§240.14a-101 of this chapter) or information statement on Schedule 14C (§240.14c-101 of this chapter).
(ii) The name of each member of the registrant’s compensation committee (or other board committee performing equivalent functions or, in the absence of any such committee, the entire board of directors) must appear below the disclosure required by paragraph (e)(5)(i) of this Item
This ambiguity has been removed by adding this instruction to S-K Item 407(g):
(2) A registrant that qualifies as an “emerging growth company,” as defined in Rule 405 of the Securities Act (§230.405 of this chapter) or Rule 12b-2 of the Exchange Act (§240.12b-2 of this chapter), is not required to provide the disclosure required by paragraph (e)(5) of this Item.
As always, your thoughts and comments are welcome!