Many thanks to Gary Brown of Nelson Mullins, who leads our SEC Reporting and Practice Skills for Lawyers and many other PLI programs, for his thoughts in this post!

In the “What We Do” section of the SEC’s web page, the very first thing the SEC states is its mission:

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

 In the public company reporting world we frequently focus on the investor protection part of this mission. These words are often heard when the staff speaks and even arise occasionally in the comment process.

Facilitation of capital formation can be at odds with protection of investors.  The 1933 Act requires that all securities offers and sales be registered unless there is an exemption.  When one hears a comment about the “protection of the ’33 Act,” what that means is the information that one would find in a registration statement – that, in conjunction with potential liability for sellers of securities, is what protects investors.  The basis for many of the exemptions from registration is that there is an alternative scheme of regulation (e.g. bank stocks) that provides the information or that sales are limited to accredited and other sophisticated investors who can, in the words of the Supreme Court, “fend for themselves” and do not need the protection of the 1933 Act.

Which brings us to the SEC’s recent proposed rule to allow “testing-the-waters” communications by all issuers.  To understand the importance of this rule and why it is necessary requires one to understand the SEC’s “gun-jumping” rules.  The heart of these rules is Section 5 of the 1933 Act, which, in part:

• prohibits “offers” (verbal or written) before a registration statement is filed; and
• limits the use of certain “prospectuses” (which essentially is a written “offer”) after the filing of the registration statement but before it is declared effective.

A violation of section 5 is a serious matter – at a minimum, investors in essence have a “put” back to the issuer in the form of a rescission right under Section 12(a)(1). There doesn’t have to be fraud – it’s a simple matter of making an unlawful “offer” or using an unlawful “prospectus.”

The problem begins with the broad definition of “offer” in the 1933 Act.  As many know, it includes “conditioning the market” for a securities offering.

Dealing with business and communication realities in the face of the definition of “offer” began with the drafters of the 1933 Act.  Preliminary negotiations with and among underwriters were carved out of the statutory definition of “offer”.  That’s the first acknowledgement that some communications are essential to the offering process (capital formation) and pose no real danger to investors (investor protection).

Over the years, we have seen the SEC, through guidance or rulemaking, as well as Congress, through amendments to the Securities Act, add to the list of items that would not run afoul of the “gun jumping” rules.  These include:

• Statutory carve out in Section 2(a)(10) definition of “prospectus” of certain notices containing information specified by the SEC (think “tombstone” ads). This forms the basis for Rule 135 (Notice of Proposed Registered Offerings), which allows communications that otherwise would be unlawful “offers.”

• Securities Act Rel. 33-5180, which allows ordinary business communications to continue after a company is “in registration.”

• Rule 163, which conditionally exempts “well-known seasoned issuers” from the rules relative to pre-filing communications.

• Rule 163A, which conditionally exempts communications made more than 30 days before filing a registration statement.

• Rule 164, which conditionally allows “free writing” prospectuses by deeming them “section 10(b) prospectuses”.

• Rule 165, which conditionally exempts communications in business combination transactions from both the pre-filing prohibitions of section 5(c) and the “prospectus” requirements of section 5(b).

• Rules 168 and 169, which expand on Securities Act Rel. 33-5180, and conditionally allow ordinary business communications to continue while “in registration” by deeming such communications not to be “offers” for purposes of section 5.

• Research reports on emerging growth companies are not deemed “offers” (amendment to definition of “offer” in Section 2(a)(3))

• “Testing the waters” allowed for “emerging growth companies” with respect to “qualified institutional buyers” (“QIBs”) and institutional accredited investors (“IAIs”) (Amendment to Securities Act section 5) – the theory being that this facilitates capital formation and restricting the communications to QIBs and IAIs is consistent with investor protection because they do not need the “protection of the Act”.

• “Testing the waters” allowed in Regulation A offerings with respect to QIBs and IAIs (Rule 255) – again, the theory being that this facilitates capital formation and restricting the communications to QIBs and IAIs is consistent with investor protection because they do not need the “protection of the Act”.

This situation addressed by these statutory provisions and rules is a great example of how the three parts of the SEC’s mission are frequently in conflict with each other.  A reduction in the amount of information required to be provided to investors, which would likely make raising capital easier, may well leave investors less well informed as they make investment decisions.  That’s why in many of these cases, either the scope or the recipients (e.g., limited to QIBs and IAIs) is restricted – that addresses the investor protection mission.

The balancing act between what information investors really need and the cost of this information and its impact on the capital formation process is complex.  It is not a simple or cut-and-dried decision-making process. Dealing with the conflict in these parts of the SEC’s mission requires judgment.

This capital formation part of the SEC’s mission has received more attention in recent years.  Perhaps the clearest example is the bi-partisan passage of the JOB’s Act in 2012 to create the “IPO On-Ramp” for Emerging Growth Companies or EGCs.  Simplifications such as allowing Emerging Growth Companies to provide two years of financial statements clearly reduces information available to investors, and just as clearly reduces the cost of capital formation.  Time, and hopefully a retrospective analysis of the effect of this change, will tell whether it was good for investors and issuers.

The current administration at the SEC has clearly put more emphasis on the capital formation part of the SEC’s mission, which brings us to recent development in this area.  On February 19, 2019,  the SEC issued  proposed Rule 163B, which would extend the “testing the water” provisions (prefiling communications to QIBs and IAIs) provided to EGCs (as well as WKSIs and companies doing Reg A offerings) to all offerings.

Taken as a whole, proposed Rule 163B , coupled with several of the other exemptions referenced above, should substantially reduce the risks of mistimed communications about proposed offerings (“gun jumping” violations), which can result in significant costs and delays. Summarizing its rationale for proposing Rule 163B, the SEC states in the adopting release:

We believe that, by allowing more issuers to engage with certain sophisticated institutional investors while in the process of preparing for a contemplated registered securities offering, the proposed rule could help issuers to better assess the demand for and valuation of their securities and to discern which terms and structural components of the offering may be most important to investors. This in turn could enhance the ability of issuers to conduct successful offerings and lower their cost of capital.

As you can read in the SEC’s Fact Sheet the proposal would enable all issuers to engage in test-the-waters communications with QIBs and IAIs.  All issuers would be able to test-the-waters with QIBs and IAIs about contemplated registered securities offerings to determine whether such investors might have an interest in such an offering.  These communications could occur prior to or following the filing of a registration statement.

Importantly, these communications would be exempt from the “prospectus” restrictions imposed by Section 5(b)(1) of the Securities Act and the restrictions on “offers” imposed by Section 5(c) o the Securities Act. These communications, however, are nevertheless deemed to be “offers,” which means that they are subject to antifraud liabilities.  In other words – they are “offers,” just not prohibited“offers.”

From the Fact Sheet:

The proposed rule would be non-exclusive and an issuer could rely on other Securities Act communications rules or exemptions when determining how, when, and what to communicate related to a contemplated securities offering.

Under the proposed rule:

• there would be no filing or legending requirements;
• test-the-waters communications may not conflict with material information in the related registration statement; and
• issuers subject to Regulation FD would need to consider whether any information in a test-the-waters communication would trigger disclosure obligations under Regulation FD or whether an exemption under Regulation FD would apply.

Some of the actions here (just as those exempted under other provisions described above) would have been unlawful “gun jumping” without these changes.  They represent a big change from a long-standing part of the offering process. While the proposals would only apply communications to QIBs and IAIs, investors who are assumed to be knowledgeable and experienced enough to protect themselves, this kind of change is always uncertain.  What will the ultimate impact be as the SEC works to balance the contradictory parts of its mission?  In the proposal’s words:

“The expanded test-the-waters provision, as proposed, would provide all issuers with appropriate flexibility in determining when to proceed with a registered public offering while maintaining investor protections.”

This nicely describes the balancing act!

The proposal will have a 60-day public comment period.

As always, your thoughts and comments are welcome.

Environmental, sustainability and governance (“ESG”) issues and disclosures are becoming a more important part of the planning and disclosure regimens of companies around the world.

If you are looking for information and concrete approaches to deal with these topics, PLI is presenting “ESG and Promoting Corporate Sustainability” on June 25, 2019.  Topics that will be addressed include:

• What constitutes a valid and robust CSR and sustainability program?
• What is driving employee, shareholder, and investor expectations around social responsibility and sustainability?
• Corporate governance issues: creating a long-term strategy and actively involving the board
• Dealing with shareholders, including employees and activists
• Environmental issues: how should companies assess, measure, and engage with these matters?
• Understanding and getting ahead of labor and employment issues that have long-term growth consequences

You can learn more about the program here.

As always, your thoughts and comments are welcome!

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

Governance Disclosures

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!

In the last several weeks we have been delving into the details of each change in the SEC’s March 20, 2019 Disclosure Modernization and Simplification final rule.  This is the first of two posts that review changes to areas that are included in Part III of Form 10-K and in proxy statement disclosures about executive officers and delinquent Section 16 filers.  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.

Executive Officer Disclosures

A question that frequently arises in our workshops is “Why do companies sometimes include a list of executive officers at the end of Part I of their Form 10-K?” Answering this question starts with S-K Item 401, which requires disclosure of a wealth of information about both executive officers and directors.  These disclosures are required in Part III of Form 10-K and in the proxy statement disclosures in Schedule 14A:

Item 7. Directors and executive officers. If action is to be taken with respect to the election of directors, furnish the following information in tabular form to the extent practicable. If, however, the solicitation is made on behalf of persons other than the registrant, the information required need be furnished only as to nominees of the persons making the solicitation.

(a) The information required by instruction 4 to Item 103 of Regulation S-K (§229.103 of this chapter) with respect to directors and executive officers.

(b) The information required by Items 401, 404(a) and (b), 405 and 407 of Regulation S-K (§§229.401, 229.404(a) and (b), 229.405 and 229.407 of this chapter), other than the information required by:

The proxy, however, is essentially about the election of directors and by including the information about executive officers with the information about directors could create confusion for shareholders in the voting process.

To mechanically deal with this potential problem many years ago the SEC added this instruction to S-K 401:

Instructions to paragraph (b) of Item 401:

…

3. The information regarding executive officers called for by this Item need not be furnished in proxy or information statements prepared in accordance with Schedule 14A under the Exchange Act (§240.14a-101 of this chapter) by registrants relying on General Instruction G of Form 10-K under the Exchange Act (§249.310 of this chapter); Provided, that such information is furnished in a separate item captioned “Executive officers of the registrant” and included in Part I of the registrant’s annual report on Form 10-K.

The Disclosure Modernization and Simplification final rule addressed two issues surrounding this instruction:

1. The instruction was part of paragraph “(b) Identification of executive officers”, so it was not clear whether or not the instruction applied to all the S-K Item 401 disclosures about executive officers, and
2. The title for the disclosure, “Executive officers of the registrant” read in a formal kind of compliance language and is not particularly focused on communication.

To address these issues the SEC made two changes in their final rule.  The SEC:

1. Moved the instruction so that it now is clear it applies to all the S-K Item 401 disclosures, and
2. Reworded the title so that it now has a more “plain English” communication focus.

The now moved and reworded instruction reads:

Instruction to Item 401. The information regarding executive officers called for by this Item need not be furnished in proxy or information statements prepared in accordance with Schedule 14A or Schedule 14C under the Exchange Act (§240.14a-101 and §240.14c-101 of this chapter) if you are relying on General Instruction G of Form 10-K under the Exchange Act (§249.310 of this chapter), such information is furnished in a separate section captioned “Information about our Executive Officers,” and is included in Part I of your annual report on Form 10-K.

As always, your thoughts and comments are welcome!

Over the last several years the SEC’s focus on disclosure effectiveness and capital formation have driven significant change in public company reporting.  From the 2015 and 2016 requests for comment on a variety of S-K and S-X requirements to the latest proposal to amend the definition of accelerated filer this process has generated much to watch and implement.

In addition,the FASB has also reviewed disclosures and made improvements to many areas in the Codification.

One area where there has been overlap between the SEC’s and the FASB’s activities is the SEC’s August 2018 Disclosure Update and Simplification final rule.  This rule included a number of changes to Regulation S-K and S-X and also identified places where the SEC required information that in part overlapped and also sometimes went beyond current GAAP requirements.  The SEC referred these areas to the FASB for consideration in the standard-setting process.

On May 6, 2019, the FASB issued an exposure draft related to this “referral” from the SEC.  The proposed amendments in the exposure draft would modify disclosure or presentation requirements in a variety of topics in the Codification, ranging from removing the impracticability exception, to the requirement to disclose revenues for each product and service or each group of similar products and services, to adding disclosure of where derivative instruments and their related gains and losses are reported in the statement of cash flows.  The exposure draft has a very helpful table of all the proposed changes.

As always. your comments and questions are welcome!

In June 2018, when the SEC changed the definition of “smaller reporting company” (SRC) by increasing the public float threshold from $75 million to $250 million and adding a revenue test, the Commission also directed the staff to review the issues in changing the definitions of accelerated and large accelerated filer. (The current definition is at the end of this post if you would like to review it.)

These instructions to the staff came to fruition on May 9, 2019.  As we mentioned in this post the SEC met on that date to consider changing the definitions of accelerated and large accelerated filers.  At the meeting the Commission voted to issue this proposed rule.  You can read a summary of the proposal in this fact sheet.

The proposed rule does have an interesting level of complexity.  It would not completely conform the definitions involved. According to the proposed rule:

“The proposed new conditions would only be available to issuers that are eligible to be an SRC under the SRC revenue test. Issuers that are eligible to be an SRC that have a public float between $75 million and $250 million would be accelerated filers if their annual revenues are $100 million or more, and thus they would remain subject to all of the requirements applicable to accelerated filers.”

The actual regulatory language that would be added to Rule 12b-2 in the definitions of accelerated and large accelerated filer is:

(iv) The issuer is not eligible to use the requirements for smaller reporting companies under the revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the “smaller reporting company” definition in this section.

Thus, the dollar thresholds in the definitions would not be changed.  For example, the new definition of accelerated filer would read as follows:

(1) Accelerated filer. The term accelerated filer means an issuer after it first meets the following conditions as of the end of its fiscal year:

(i) The issuer had an aggregate worldwide market value of the voting and non-voting common equity held by its non-affiliates of $75 million or more, but less than $700 million, as of the last business day of the issuer’s most recently completed second fiscal quarter;

(ii) The issuer has been subject to the requirements of section 13(a) or 15(d) of the Act (15 U.S.C. 78m or 78o(d)) for a period of at least twelve calendar months; and

(iii) The issuer has filed at least one annual report pursuant to section 13(a) or 15(d) of the Act.

(iv) The issuer is not eligible to use the requirements for smaller reporting companies under the revenue test in paragraph (2) or (3)(iii)(B), as applicable, of the “smaller reporting company” definition in this section.

The relevant paragraph in the SRC definition refers to the $100 million-dollar revenue test. (That definition is at the end of this post.)

This table provides a summary of how the proposed rule would work:

The big issue in this change of course is that more companies would become non-accelerated filers and would not be required to have an annual audit of their internal control over financial reporting.   The affected companies would also be subject to the longer deadlines for non-accelerated filers.

 In the economic analysis section of the proposed rule the SEC provides a wealth of data and analysis, along with the estimate that an additional 539 companies would become non-accelerated filers.

 The proposed rule also would increase the thresholds for exiting accelerated filer status (from $50 to $60 million) and large accelerated filer status (from $500 to $600 million).

As always, your thoughts and comments are welcome!

Lastly, here, as mentioned above, is the SRC definition:

Smaller reporting company. As used in this part, the term smaller reporting company means an issuer that is not an investment company, an asset-backed issuer (as defined in §229.1101 of this chapter), or a majority-owned subsidiary of a parent that is not a smaller reporting company and that:

(1) Had a public float of less than $250 million; or

(2) Had annual revenues of less than $100 million and either:

(i) No public float; or

(ii) A public float of less than $700 million.

In the last week there have been two very interesting developments in the SEC’s disclosure effectiveness process. 

On May 3, 2019, the SEC formally proposed a rule to “improve the information that investors receive regarding the acquisition and disposition of businesses.”  The SEC indicated that “[t]he proposed amendments are also intended to facilitate more timely access to capital and to reduce complexity and compliance costs of these financial disclosures.” 

The proposed rules would change Regulation S-X Rules 3-05 and 3-14, Article 11, and other related rules and forms.  Among the many changes in the proposed rule are: 

• Updates to the investment test and the income test in the significant subsidiary test 
• Expanding the use of pro forma financial information in measuring significance 

• Conforming the significance threshold and tests for a disposed business 
• Requiring the financial statements of the acquired business to cover up to the two most recent fiscal years rather than up to the three most recent fiscal years 
• Permitting disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity. 

There are a raft of details in the proposed rule and you can find an extensive Fact Sheet with a link to the proposed rule here. 

 On May 9, 2019, in an open meeting, the SEC will consider proposing changes to the definitions of accelerated and large accelerated filers.  According to the meeting agenda: 

 The Commission will consider whether to propose new rule amendments to the accelerated filer and large accelerated filer definitions to promote capital formation for smaller reporting issuers by more appropriately tailoring the types of issuers that are included in the categories of accelerated and large accelerated filers and revising the transition thresholds for these filers. 

 As always, your thoughts and comments are welcome! 

When reading the results of operations section in MD&A it is not unusual to experience a feeling of  déjà vu. When comparing the current year to last year companies will explain why financial statement line items changed with the goal of helping readers understand quality of earnings and the likelihood that past performance predicts future performance. (For a quick review of these objectives you could re-read the SEC’s 2003 MD&A release, FR 72.)

Unfortunately, when companies write the next part of this discussion and compare last year to the third year back, they frequently follow a sort of literal interpretation of the S-K Item 303 guidance and end up repeating this discussion but with the prior year numbers.

It is difficult to argue that this repetition does much to add to an investor’s understanding of earnings quality and predictability, and in fact this information is already available in prior year filings.

This was the issue that the SEC addressed in their March 20, 2019 Disclosure Modernization and Simplification rule in the one MD&A area they changed – S-K Item 303(a) instruction 1.  (As you likely have heard, most of the changes in this rule, including MD&A changes, are effective for filings after May 2, 2019.)

Here is the new language in this instruction, with changes bolded:

Instructions to paragraph 303(a): 1. The registrant’s discussion and analysis shall be of the financial statements and other statistical data that the registrant believes will enhance a reader’s understanding of its financial condition, changes in financial condition, and results of operations. Generally, the discussion shall cover the periods covered by the financial statementsincluded in the filing and the registrant may use any presentation that in the registrant’s judgment enhances a reader’s understanding. A smaller reporting company’s discussion shall cover the two-year period required in Article 8 of Regulation S-X and may use any presentation that in the registrant’s judgment enhances a reader’s understanding. For registrants providing financial statements covering three years in a filing, discussion about the earliest of the three years may be omitted if such discussion was already included in the registrant’s prior filings on EDGAR that required disclosure in compliance with Item 303 of Regulation S-K, provided that registrants electing not to include a discussion of the earliest year must include a statement that identifies the location in the prior filing where the omitted discussion may be found. 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), may provide the discussion required in paragraph (a) of this Item for its two most recent fiscal years if, pursuant to Section 7(a) of the Securities Act of 1933 (15 U.S.C 77g(a)), it provides audited financial statements for two years in a Securities Act registration statement for the initial public offering of the emerging growth company’s common equity securities.

This instruction used to read:

Instructions to paragraph 303(a): 1. The registrant’s discussion and analysis shall be of the financial statements and other statistical data that the registrant believes will enhance a reader’s understanding of its financial condition, changes in financial condition and results of operations. Generally, the discussion shall cover the three-year periodcovered by the financial statementsand shall use year-to-year comparisons orany other formats that in the registrant’s judgment enhance a reader’s understanding. However, where trend information is relevant, reference to the five-year selected financial data appearing pursuant to Item 301 of Regulation S-K (§229.301) may be necessary. A smaller reporting company’s discussion shall cover the two-year period required in Article 8 of Regulation S-X and shall use year-to-year comparisonsor any other formats that in the registrant’s judgment enhance a reader’s understanding. 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), may provide the discussion required in paragraph (a) of this Item for its two most recent fiscal years if, pursuant to Section 7(a) of the Securities Act of 1933 (15 U.S.C 77g(a)), it provides audited financial statements for two years in a Securities Act registration statement for the initial public offering of the emerging growth company’s common equity securities.

As you can see in the highlighted sections above, the key changes from the old instruction to the new instruction are:

1. Removing the language referring to “year-to-year” comparisons and replacing it with “registrants may use any presentation that in the registrant’s judgment enhances a reader’s understanding”.

2. Removing the reference to the five-year summary.

3. Allowing registrants who provide financial statements covering three years in a filing to omit discussion of the earliest of the three years if such discussion is already included in any other of the registrant’s prior filings on EDGAR. While the proposal had some limitations on this provision, companies can make this election with no limitations, but they must identify the location in the prior filing where the omitted discussion may be found.

As a point of interest, it is worth noting that the prior year MD&A does not have to be in a Form 10-K and in fact could be in any prior SEC filing.

Consistently with the other changes we have discussed so far and in alignment with CorpFin Director Hinman’s speech we reviewed in this post, these new requirements are not bright-line standards.  They are based on principles consistent with providing investors information they need to make investment and voting decisions and call on us to exercise judgment.

In the final rule release the SEC made these comments:

We believe the revisions to Item 303 that we are adopting give registrants the flexibility to tailor their presentation in MD&A in a manner that is most suitable for their varying circumstances, while at the same time continuing to require that they provide all of the information necessary to an understanding of their financial condition, changes in financial condition and results of operations. In that respect, we view the elimination of references to year-to-year comparisons and the new language in Instruction 1 of Item 303 allowing registrants to omit discussion of the earliest of the three years covered by the financial statements as complementary.

These amendments emphasize the flexibility available to registrantswith respect to the form of MD&A presentation. The major benefit of flexibility is that it allows registrants to frame the information in a way that emphasizes material information and allows registrants to omit information that is not material. One potential cost associated with this aspect of the amendment is that, to the extent the amendments lead to disclosure that varies more across firms and across a single firm’s filings, they also may make disclosure less comparable across registrants and over time.

The combined effects of these amendments will be to eliminate the burden on registrants to prepare and provide repetitive disclosure that is not material. The amendments are of particular significance because MD&A is typically one of the most labor-intensive sections of any form in which it is required. We anticipate that the amendments to simplify and clarify the MD&A requirements will reduce the paperwork burden associated with affected forms.

It will be interesting to see how companies use these new rules.

As always, your thoughts and comments are welcome!

This is a revised version of an earlier post, and demonstrates the risks in trying to get out with information as early as possible!  Drafting this post late yesterday and early this morning the SEC had not yet released updated versions of the cover pages for the forms and I created a version for this post.  And, shortly after I posted our suggested version the SEC updated the forms.  So, you can find the official revised cover pages for Forms 10-K, 10-Q and 8-K here.

As always, your thoughts and comments are welcome!

Risk factor disclosure frequently presents a conundrum in public reporting.  The SEC’s risk factor disclosure requirements focus on what makes an investment in a company’s securities “risky or speculative”.  Buy many companies present so many risk factors that questions arise about their relevance to investors.  This is one among a number of reasons the SEC included this disclosure in their March 20, 2019 Disclosure Modernization and Simplification rule.

As you likely have heard, most of the changes in this rule, including risk factor changes, are effective for filings after May 2, 2019.

To begin reviewing the changes in risk factor disclosures, Item 1A in Form 10-K previously read:

Item 1A. Risk Factors.

Set forth, under the caption “Risk Factors,” where appropriate, the risk factors described in Item 503(c) of Regulation S-K (§229.503(c) of this chapter) applicable to the registrant. Provide any discussion of risk factors in plain English in accordance with Rule 421(d) of the Securities Act of 1933 (§230.421(d) of this chapter). Smaller reporting companies are not required to provide the information required by this item.

Item 1A has been changed to now read:

Item 1A. Risk Factors.

Set forth, under the caption “Risk Factors,” where appropriate, the risk factors described in Item 105 of Regulation S-K (§ 229.105 of this chapter) applicable to the registrant.

The specific disclosure requirements surrounding risk factors have been moved to S-K Item 105 and out of Item 503. Since most of the disclosures in Part 500 of S-K deal with prospectus disclosures and risk factors are, since 2005, a regular ‘34 Act report disclosure requirement, this change makes sense.

In addition, as you will see below, the removal of the plain English language that was in the Item 1A instructions is not really a change as the requirement is now incorporated in new S-K Item 105.

The old text of Item 503(c), which has been removed, read:

 (c) Risk factors. Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make the offering speculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply to any issuer or any offering. Explain how the risk affects the issuer or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk. The risk factor discussion must immediately follow the summary section. If you do not include a summary section, the risk factor section must immediately follow the cover page of the prospectus or the pricing information section that immediately follows the cover page. Pricing information means price and price-related information that you may omit from the prospectus in an effective registration statement based on §230.430A(a) of this chapter. The risk factors may include, among other things, the following:

(1) Your lack of an operating history;

(2) Your lack of profitable operations in recent periods;

(3) Your financial position;

(4) Your business or proposed business; or

(5) The lack of a market for your common equity securities or securities convertible into or exercisable for common equity securities.

The new requirement in S-K Item 105 now reads:

229.105 (Item 105) Risk factors.

Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make an investment in the registrant or offeringspeculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply generically to any registrant or any offering. Explain how the risk affects the registrant or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk. If the risk factor discussion is included in a registration statement, it must immediately follow the summary section. If you do not include a summary section, the risk factor section must immediately follow the cover page of the prospectus or the pricing information section that immediately follows the cover page. Pricing information means price and price-related information that you may omit from the prospectus in an effective registration statement based on Rule 430A (§ 230.430A(a) of this chapter). The registrant must furnish this information in plain English. See § 230.421(d) of Regulation C of this chapter.

New S-K Item 105 has some subtle wording changes which are highlighted above.  The addition of the phrase “an investment in the registrant” makes the application of this disclosure clearer for ‘34 Act periodic reports.  And, the addition of the phrase “apply generically” helps clarify that the requirement should not be interpreted too broadly.

Also, the removal of the examples makes it clear that this is intended to be a registrant specific, principles-based requirement.  In the Final Rule Release the SEC included these comments:

The Commission also proposed amendments that would eliminate the specific risk factor examples that are currently enumerated in Item 503(c). Although Item 503(c) is principles based, and the Commission has eschewed “boiler plate” risk factors that are not tailored to the unique circumstances of each registrant, the …. examples of factors that may make an offering speculative or risky have remained unchanged since the Commission first published guidance on risk factor disclosure in 1964.

As discussed in the Proposing Release, the Commission’s principles-based approach to risk factor disclosure is not consonant with the item’s list of examples of material risks. These examples may not apply to all registrants and may not correspond to the material risks of any particular registrant. In addition, the inclusion of these examples could suggest that a registrant must address each one in its risk factor disclosures, regardless of the significance to its business. Finally, the Commission was concerned that the inclusion of any examples in Item 503(c), whether to illustrate the specific kinds of risks that should be disclosed or generic risks that should be avoided, could anchor or skew the registrant’s risk analysis in the direction of the examples.

 It will be interesting to watch and see how or if companies take advantage of this new requirement.

As always, your thoughts and comments are welcome!