Without going back into a lot of history, the “scandal” in the early 2000’s surrounding several banks manipulating LIBOR has resulted in a very real likelihood that when the obligation banks have to provide information to determine LIBOR expires, this index rate may “disappear”.  Given the number of instruments and number of markets that use LIBOR, the transition from this rate to some other reference rate has the potential to create significant risks and cause significant disruption.

Both the SEC and the FASB have been working on guidance to assist companies in their disclosure and reporting obligations before, during, and after this potential transition.

On July 12, 2019, the SEC published a “Staff Statement on LIBOR Transition”.  The Staff Statement addresses several issues companies may want to consider in managing this transition including addressing risks in existing contracts, processes for new contracts, IT considerations, and impact on risk management practices.  The Staff Statement also reviews disclosure considerations for companies before, during, and after a transition.

In addition, the FASB has undertaken a project and on September 5, 2029 issued a proposed ASU to provide accounting and reporting relief will be appropriate for this transition.  The project summary is available here, and the proposed ASU is available here.  While no decisions are final, the Board is considering relief for hedging relationships and whether such a change in reference rate could be a debt modification.

In case you are not familiar with one of the likely new reference rates, “SOFR” or Secured Overnight Financing Rate, here is information about this rate from the Federal Reserve Bank of New York.

As we approach third quarter-end and year-end, these resources hopefully  provide helpful information as we evaluate the impact of this risk of change.

As always, your thoughts and comments are welcome!

On August 8, 2019 the SEC issued a proposed rule to continue its disclosure modernization, update and simplification process.  Interestingly, this rule was issued without an open meeting for discussion.  Continuing the work of the SEC’s 2018 Disclosure Update and Simplification Final Rule and the March 2019 Disclosure Modernization and Simplification Final Rule, this proposed rule would update disclosures in three parts of Regulation S-K:

            S-K Item 101 – Description of the Business

            S-K Item 103 – Legal Proceedings

            S-K Item 105 – Risk Factors

According to the proposed rule release:

“The proposed amendments are intended to update our rules to account for developments since their adoption or last amendment, to improve these disclosures for investors, and to simplify compliance efforts for registrants. Specifically, the proposed amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and disclosure of information that is not material.”

Here is a list of details from the proposed rule organized by S-K Item.  You can read more about each proposed change starting at page 10 of the release.

Revise Item 101(a) to be largely principles-based, requiring:

Disclosure of information material to an understanding of the general development of the business and eliminating a prescribed timeframe for this disclosure; and

In filings made after a registrant’s initial filing, only an update of the general development of the business with a focus on material developments in the reporting period with a hyperlink to the registrant’s most recent filing (e.g., initial registration statement or more recent filing if one exists) that, together with the update, would contain the full discussion of the general development of the registrant’s business.

Revise Item 101(c) to:

Clarify and expand its principles-based approach, with disclosure topics drawn from a subset of the topics currently contained in Item 101(c);

Include, as a disclosure topic, human capital resources, including any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business; and

Refocus the regulatory compliance requirement by including material government regulations, not just environmental laws, as a topic.

Revise Item 103 to:

Expressly state that the required information may be provided by including hyperlinksor cross-references to legal proceedings disclosure located elsewhere in the document in an effort to encourage registrants to avoid duplicative disclosure; and

Revise the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation.

Revise Item 105 to:

Require summary risk factor disclosure if the risk factor section exceeds 15 pages;

Refine the principles-based approach of Item 105 by changing the disclosure standard from the “most significant” factors to the “material” factors; and

Require risk factors to be organized under relevant headings, 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.

It is interesting to note that may of the changes emphasize the principles-based nature of the SEC’s disclosure requirements, and the proposed rule contains an interesting discussion about using this principles-based model.

As a last note, if you want to dig deeply into the proposed revised wording in Regulation S-K, you can find the proposed changes beginning at page 108 of the proposed rule.

As always, your thoughts and comments are welcome!

This is the last of our posts reviewing the changes made by the SEC’s March 20, 2019 Disclosure Modernization and Simplification Final Rule.  In this post we review the changes made to the exhibit requirements, including confidential treatment and incorporation by reference.  Changes in these areas are fairly detailed.  The changes for confidential treatment were effective for filings made after the date the rule was published in the Federal Register, which was April 2, 2019, and the other changes are effective for filings made after May 2, 2019.

Confidential Treatment Streamlining

Prior to the Disclosure Modernization and Simplification rule, confidential treatment processes were spelled out in Exchange Act Rule 24b-2 and Securities Act Rule 406.  These rules contained procedures which required submission of a request to obtain confidential treatment for exhibits filed under the Exchange Act and Securities Act.  With a goal of “Substantially reduc(ing) the burden borne by registrants in preparing and responding to confidential treatment requests while still providing all material information to investors,” the SEC replaced the existing procedures with a process for companies to make decisions to redact information without advance SEC approval.  To redact information the company must conclude that the information:

 (i) is not material and

(ii) would be competitively harmful if publicly disclosed.

If a company chooses to redact information in an exhibit it must:

1. Mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted;
2. Include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both (i) not material and (ii) would be competitively harmful if publicly disclosed; and
3. Indicate with brackets where the information has been omitted from the filed version of the exhibit.

To make this change the SEC has added this language to S-K 601(b)(10):

(iv) The registrant may redact provisions or terms of exhibits required to be filed by this paragraph (b)(10) if those provisions or terms are both not material and would likely cause competitive harm to the registrant if publicly disclosed. If it does so, the registrant should mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both not material and would likely cause competitive harm to the registrant if publicly disclosed. The registrant also must indicate by brackets where the information is omitted from the filed version of the exhibit. If requested by the Commission or its staff, the registrant must promptly provide an unredacted copy of the exhibit on a supplemental basis. The Commission or its staff also may request the registrant to provide its materiality and competitive harm analyses on a supplemental basis. Upon evaluation of the registrant’s supplemental materials, the Commission or its staff may request the registrant to amend its filing to include in the exhibit any previously redacted information that is not adequately supported by the registrant’s materiality and competitive harm analyses. The registrant may request confidential treatment of the supplemental material submitted under this paragraph (b)(10)(iv) pursuant to Rule 83 (§ 200.83 of this chapter) while it is in the possession of the Commission or its staff. After completing its review of the supplemental information, the Commission or its staff will return or destroy it at the request of the registrant if the registrant complies with the procedures outlined in Rules 418 or 12b-4 (§ 230.418 or § 240.12b-4 of this chapter).

In this Announcement from Corp Fin, the Division provides guidance about the provisions in the March 20, 2019 Disclosure Modernization and Update Final Rule, including discussion of how they will perform compliance reviews (see the bolded text in the preceding paragraph) dealing with how companies use these provision to redact information.

Changes for Schedules and Attachments to Exhibits

Along the same lines as the changes for redacting information in exhibits discussed in the previous section, the Final Rule also makes changes to the requirements for exhibits that include schedules and attachments.  The revised language is in new S-K Item 601(a)(5):

(5) Schedules (or similar attachments) to the exhibits required by this Item are not required to be filed provided that they do not contain information material to an investment or voting decision and that information is not otherwise disclosed in the exhibit or the disclosure document. Each exhibit filed must contain a list briefly identifying the contents of all omitted schedules. Registrants need not prepare a separate list of omitted information if such information is already included within the exhibit in a manner that conveys the subject matter of the omitted schedules and attachments. In addition, the registrant must provide a copy of any omitted schedule to the Commission or its staff upon request.

Personally Identifiable Information

In a change that essentially codifies the Commission’s existing practice, the Final Rule adds a provision that companies may remove personally identifiable information from exhibits without a confidential treatment request.  This is in S-K Item 601(a)(6):

(6) The registrant may redact information from exhibits required to be filed by this Item if disclosure of such information would constitute a clearly unwarranted invasion of personal privacy (e.g., disclosure of bank account numbers, social security numbers, home addresses, and similar information).

Hyperlinks for Information Incorporated by Reference

In an extension of hyperlinking, the Final Rule includes a provision that if information that is on the EDGAR System (for example a previously filed Form 10-K) is incorporated by reference into another filing, a hyperlink to that information is required.  This is  accomplished via the following addition to Rule 12b-23:

(d) Hyperlinks. You must include an active hyperlink to information incorporated into a registration statement or report by reference if such information is publicly available on the Commission’s Electronic Data Gathering, Analysis and Retrieval System (“EDGAR”) at the time the registration statement or form is filed. For hyperlinking to exhibits, please refer to Item 601 of Regulation S-K (§ 229.601 of this chapter) or the appropriate form.

This is viewed by the Commission as a part of the FAST Act requirements:

“By requiring an active hyperlink to information on EDGAR if it has been incorporated by reference into a registration statement or prospectus, we believe these amendments will improve the readability and navigability of disclosure documents and discourage repetition, consistent with our FAST Act mandate.”

There are a variety of other non-substantive changes in the exhibit provisions, which you can find in the Final Rule, with page 80 as a starting point.

Two Year Look-Back for Material Contracts

Another change in S-K Item 601(b)(10) relates to the two-year “look-back” for material contracts.  This requirement has been removed for companies other than “newly reporting” companies with this new language:

(10) Material contracts. (i)(A) Every contract not made in the ordinary course of business that is material to the registrant and is to be performed in whole or in part at or after the filing of the registration statement or report. In addition, for newly reporting registrants, every contract not made in the ordinary course of business that is material to the registrant and that was entered into not more than two years before the date on which such registrant:

(1) First files a registration statement or report; or

(2) Completes a transaction that had the effect of causing it to cease being a public shell company.

The definition of a “newly reporting company” is fairly detailed and is in the same section of S-K 601(b)(10).

Incorporation by Reference

As part of the “modernization” provisions of the Final Rule the SEC fixed a pre-EDGAR incorporation by reference issue.  In the days before EDGAR, the SEC did not retain paper filings forever, and so some exhibits would have to be re-filed after five years.  This is clearly no longer relevant in the EDGAR world.  To “modernize” incorporation by reference this paragraph was removed from S-K Item 10:

(d) Incorporation by Reference. Where rules, regulations, or instructions to forms of the Commission permit incorporation by reference, a document may be so incorporated by reference to the specific document and to the prior filing or submission in which such document was physically filed or submitted. Except where a registrant or issuer is expressly required to incorporate a document or documents by reference (or for purposes of Item 1100(c) of Regulation AB (§229.1100(c)) with respect to an asset-backed issuer, as that term is defined in Item 1101 of Regulation AB (§229.1101), reference may not be made to any document which incorporates another document by reference if the pertinent portion of the document containing the information or financial statements to be incorporated by reference includes an incorporation by reference to another document. No document on file with the Commission for more than five years may be incorporated by reference except:

(1) Documents contained in registration statements, which may be incorporated by reference as long as the registrant has a reporting requirement with the Commission; or

(2) Documents that the registrant specifically identifies by physical location by SEC file number reference, provided such materials have not been disposed of by the Commission pursuant to its Records Control Schedule (17 CFR 200.80f).

Cross-Referencing in the Financial Statements

While for most of us this is not a major issue, the SEC has “formalized” the position that it is not appropriate to incorporate information by reference into the financial statements from other parts of a report or registration statement.  The 1934 Act part of this change is this revised paragraph in Rule 12b-23:

(b) Financial information. Except as provided in the Commission’s rules, financial information required to be given in comparative form for two or more fiscal years or periods must not be incorporated by reference unless the information incorporated by reference includes the entire period for which the comparative data is given. In the financial statements, incorporating by reference, or cross-referencing to, information outside of the financial statements is not permitted unless otherwise specifically permitted or required by the Commission’s rules or by U.S. Generally Accepted Accounting Principles or International Financial Reporting Standards as issued by the International Accounting Standards Board, whichever is applicable.

The rational for this change, as explained in the Final Rule, is to reduce confusion about what information is covered by the auditor’s report:

“By generally prohibiting this practice, with certain exceptions as noted above, the amendments address concerns that referencing information outside the audited financial statements to satisfy financial statement disclosure requirements could create confusion about which financial information has been audited or reviewed by the independent auditor.”

There is a wealth of details in these changes, but hopefully none will be that challenging to implement.

As always, your thoughts and comments are welcome!

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!