This is the second in a series of blog posts delving into the practical aspects of implementing the Regulation S-K changes in the SEC’s August 26, 2020 Final Rule that modernizes and updates three disclosure areas in Regulation S-K:
Item 101 – Description of business
Item 103 – Legal proceedings
Item 105 – Risk Factors
The Final Rule was published in the Federal Register on October 8, 2020 and is effective for filings made on or after November 9, 2020, regardless of the accounting period-end of the financial statements included in a filing.
This post focuses on the description of the business disclosures required by S-K Item 101. You can find the first post in this series, dealing with the new disclosure for general developments of the business, here. The changes discussed in this post are effective for 10-Q’s and 10-K’s filed on or after November 9, 2020.
The overall theme of all these changes is to make disclosure requirements less prescriptive and more principles based with a focus on information that is material. It has been over 30 years since there were any significant changes in these disclosure requirements, and it would be fair to say that the world and businesses have changed a lot over these 30 years. It makes sense that these disclosures could stand some “modernization.”
This is a pretty long post. To help you navigate it is divided into three main sections.
Section One is a list of some of the possible steps you may need to take to implement this new disclosure requirement. You can read this section to get the “big picture” of the changes.
Section Two is a side by side comparison of the description of the business disclosure guidance before and after the new rule, along with thoughts and a few examples to help begin updating disclosures for the new rule. At the end of this section are examples of human capital disclosures.
Section Three is a helpful reminder list of the issues to consider as you draft and revise this disclosure for you next Form 10-K.
Section One – A Preview of Possible Steps.
The new principles-based rule will require thoughtful consideration and several materiality evaluations. Here is a preview of some of the judgments implementation may involve. The issues behind each step in this list are described in the next section which presents a side-by-side comparison of the old and new rules.
- Review your previous business description disclosures and assess whether, based on the more detailed requirements in the old rule, you included any information that is not really material.
- Discuss within your disclosure committee or other participants in your disclosure process whether there is information not included in previous disclosures which might be relevant based on the principles in the new rule.
- Use the concept of “tell your story” as you draft this disclosure.
- With respect to products, services, major customers, etc., review previous disclosures based on old quantitative thresholds and assess materiality.Also consider whether there may be issues surrounding “Revenue-generating activities, products and/or services, and any dependence on revenue-generating activities, key products, services, product families or customers, including governmental customers” that should be disclosed based on the new principles-based language in S-K Item 101.
- Consider disclosure committee or disclosure process discussion of “Status of development efforts for new or enhanced products, trends in market demand and competitive conditions.”Note that the trends in market demand and competitive conditions involve principles-based judgments beyond those in the old disclosure requirements.
- Consider disclosure committee or disclosure process discussion of “resources material to a company’s business” beyond the two items listed in the new rule, raw materials and intellectual property.
- Assess the materiality of old working capital and backlog disclosures and consider removing them if the information is not material.In particular the new revenue recognition disclosures about unfulfilled performance obligations may make backlog disclosures not material.
- Consider the impact of governmental regulation beyond environmental matters and where material include appropriate disclosure.
- Review human capital policies, processes and procedures and determine which are “human capital measures or objectives that the registrant focuses on in managing the business” and assess materiality for disclosure.
Section Two – Side-by-Side Comparison of Old and New Requirements.
As a beginning to this section, this is the overall guidance for the description of the business disclosure:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (c) Narrative description of business. (1) Describe the business done and intended to be done by the registrant and its subsidiaries, focusing upon the registrant’s dominant segment or each reportable segment about which financial information is presented in the financial statements. To the extent material to an understanding of the registrant’s business taken as a whole, the description of each such segment shall include the information such segment shall include the information specified in paragraphs (c)(1) (i) through (x) of this section.
The matters specified in paragraphs (c)(1) (xi) through (xiii) of this section shall be discussed with respect to the registrant’s business in general; where material, the segments to which these matters are significant shall be identified. |
(c) Description of business. (1) Describe the business done and intended to be done by the registrant and its subsidiaries, focusing upon the registrant’s dominant segment or each reportable segment about which financial information is presented in the financial statements. When describing each segment, only information material to an understanding of the business taken as a whole is required.
Disclosure may include, but should not be limited to, the information specified in paragraphs (c)(1)(i) through (v) of this section. |
As you can see, the overall approach to the description of the business is the same, using the words “Describe the business done and intended to be done by the registrant and its subsidiaries, focusing upon the registrant’s dominant segment or each reportable segment about which financial information is presented in the financial statements.”
Immediately following, however, is the more principles-based approach to the new rule. It states that “only information material to an understanding of the business is required.” And, the words “Disclosure may include, but should not be limited to” also makes this disclosure less checklist and more principles based. The first step in implementing this new disclosure requirement may well be to review your previous disclosures and consider whether you included information that is not really material based on the more detailed requirements in the old rule. The second step might be a disclosure committee discussion about whether, based on the knowledge and experience of your disclosure committee members or other people in your disclosure process, there is information that likely should be included in this disclosure.
A relevant perspective for this disclosure is to “tell the story” of your business, so this could be a helpful framing issue for discussions.
Next, here are the first of the changes in the details of S-K Item 101.
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (i) The principal products produced and services rendered by the registrant in the segment and the principal markets for, and methods of distribution of, the segment’s principal products and services. In addition, state for each of the last three fiscal years the amount or percentage of total revenue contributed by any class of similar products or services which accounted for 10 percent or more of consolidated revenue in any of the last three fiscal years or 15 percent or more of consolidated revenue, if total revenue did not exceed $50,000,000 during any of such fiscal years.
Note: See also old paragraph (vii) below regarding major customer disclosures. |
(i) Revenue-generating activities, products and/or services, and any dependence on revenue-generating activities, key products, services, product families or customers, including governmental customers;
|
The new disclosure guidance is very broad and principles based, essentially requiring disclosure of all material information about products, services, customers and related matters. This may require some complex materiality judgments. For example, the old S-K Item 101 provided quantitative thresholds for disclosure of revenue for a class of similar products and services. In addition, the old quantitative guidelines, including those for major customers in old paragraph (vii) below are all removed in this transition to a principles-based disclosure.
The next change deals with development of new or enhanced products and related issues:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (ii) A description of the status of a product or segment (e.g. whether in the planning stage, whether prototypes exist, the degree to which product design has progressed or whether further engineering is necessary), if there has been a public announcement of, or if the registrant otherwise has made public information about, a new product or segment that would require the investment of a material amount of the assets of the registrant or that otherwise is material. This paragraph is not intended to require disclosure of otherwise nonpublic corporate information the disclosure of which would affect adversely the registrant’s competitive position. | (ii) Status of development efforts for new or enhanced products, trends in market demand and competitive conditions; |
Clearly, the new more principles-based disclosure requirements, including trends in market demand or competitive conditions require consideration, particularly in the uncertain COVID-19 environment.
These next disclosures are not changed significantly, but the new disclosure includes a broad, principles-based judgment:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (iii) The sources and availability of raw materials.
(iv) The importance to the segment and the duration and effect of all patents, trademarks, licenses, franchises and concessions held. |
(iii) Resources material to a registrant’s business, such as:
(A) Sources and availability of raw materials; and (B) The duration and effect of all patents, trademarks, licenses, franchises, and concessions held;
|
Note that while the paragraph numbers are rearranged, the old disclosure requirements are essentially carried over into the new S-K language. What is different is the new language requiring disclosure of resources material to a company’s business beyond the two items listed. This again would be a relevant issue for disclosure committee members or others involved in your disclosure process to discuss. Issues such as transportation availability could require disclosure.
These sections are essentially carried over from the old rule to the new rule:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (ix) A description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government. | (iv) A description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government; and |
Note that while the paragraph numbers are rearranged, the old disclosure requirement is essentially carried over into the new S-K language
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (v) The extent to which the business of the segment is or may be seasonal.
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(v) The extent to which the business is or may be seasonal.
|
This paragraph was also carried over from the old to the new disclosure requirements.
These next disclosures from old S-K Item 101 are not included directly in the new principles-based language, but in essence could be required disclosure if the information is material to an understanding of your business.
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (vi) The practices of the registrant and the industry (respective industries) relating to working capital items (e.g., where the registrant is required to carry significant amounts of inventory to meet rapid delivery requirements of customers or to assure itself of a continuous allotment of goods from suppliers; where the registrant provides rights to return merchandise; or where the registrant has provided extended payment terms to customers). | Note: There is no requirement about working capital items in the new S-K Item 101 disclosure requirements |
| (vii) The dependence of the segment upon a single customer, or a few customers, the loss of any one or more of which would have a material adverse effect on the segment. The name of any customer and its relationship, if any, with the registrant or its subsidiaries shall be disclosed if sales to the customer by one or more segments are made in an aggregate amount equal to 10 percent or more of the registrant’s consolidated revenues and the loss of such customer would have a material adverse effect on the registrant and its subsidiaries taken as a whole. The names of other customers may be included, unless in the particular case the effect of including the names would be misleading. For purposes of this paragraph, a group of customers under common control or customers that are affiliates of each other shall be regarded as a single customer. | See paragraph (i) above for the new guidance about customer disclosures. |
| (viii) The dollar amount of backlog orders believed to be firm, as of a recent date and as of a comparable date in the preceding fiscal year, together with an indication of the portion thereof not reasonably expected to be filled within the current fiscal year, and seasonal or other material aspects of the backlog. (There may be included as firm orders government orders that are firm but not yet funded and contracts awarded but not yet signed, provided an appropriate statement is added to explain the nature of such orders and the amount thereof. The portion of orders already included in sales or operating revenues on the basis of percentage of completion or program accounting shall be excluded.) | Note: There is no requirement about backlog orders in the new S-K Item 101 disclosure requirements. This is replaced in part by the new GAAP disclosure requirements in ASC 606 about unfulfilled performance obligations. |
To implement these changes it might be advisable to review historical disclosures and ask if the information is material, and if not remove these disclosures.
The next change deals with disclosures that have been for the business as a whole:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| The old S-K Item 101 guidance included the following language in the beginning paragraph:
The matters specified in paragraphs (c)(1) (xi) through (xiii) of this section shall be discussed with respect to the registrant’s business in general; where material, the segments to which these matters are significant shall be identified. |
(2) Discuss the information specified in paragraphs (c)(2)(i) and (ii) of this section with respect to, and to the extent material to an understanding of, the registrant’s business taken as a whole, except that, if the information is material to a particular segment, you should additionally identify that segment. |
| (xii) Appropriate disclosure also shall be made as to the material effects that compliance with Federal, State and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries. The registrant shall disclose any material estimated capital expenditures for environmental control facilities for the remainder of its current fiscal year and its succeeding fiscal year and for such further periods as the registrant may deem materials. | (i) The material effects that compliance with government regulations, including environmental regulations, may have upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries, including the estimated capital expenditures for environmental control facilities for the current fiscal year and any other material subsequent period; and
|
This disclosure requirement has been broadened to include all governmental regulation. Many companies have included such discussion and now includes more descriptive language including effect on “capital expenditures, earnings and competitive position.” The capital expenditures disclosure guidance is in substance the same.
The last change deals with human capital:
| Old Regulation S-K Item 101 | New Regulation S-K Item 101 |
| (xiii) The number of persons employed by the registrant. | (ii) A description of the registrant’s human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the development, attraction and retention of personnel). |
This is perhaps the most changed, or at least expanded, disclosure in the description of the business. Beyond the number of employees, companies will have to grapple with what “human capital measures and objectives” are material to investors and should be disclosed. Issues could range from talent acquisition challenges, training, turnover and other performance-related information.
To help you think about what issues could be relevant for this disclosure, here are two examples. This first example is from Intel’s Corporate Responsibility Report 2019-2020.
Growth and Development
Each year, we deliver millions of hours of web-based and face-to-face training for different employee segments: New to Intel, Employee Development, Manager Development, and Leader Development. In 2019, we launched a new performance management system to support our cultural transformation and increase focus on continuous learning and development.
We also create on-the-job development opportunities through rotation or temporary assignment programs. Our web-based development tool enables employees to apply for part-time or temporary assignments across the company. In addition, our U.S. sabbatical program creates growth opportunities through job coverage assignments; many of the employees who completed sabbatical coverage assignments in 2019 gained valuable management experience by covering for their direct managers.
This example is from General Motor’s Sustainability Report 2109:
GM’s people will always be our greatest strength. In order to stay competitive and relevant as a company, we must attract and retain the brightest talent around the world.
Today, we compete for that talent against other automotive companies and, increasingly, against businesses in other sectors, such as technology. To win and keep talent, we must provide a workplace culture that encourages employee behaviors aligned with our values, fulfills their long-term individual aspirations and achieves full engagement.
We do this by adhering to a responsible employer philosophy, which includes commitments to create job opportunities, pay workers fairly, ensure safety and promote wellness. GM pays a living wage. GM also offers quality health care coverage to all our employees, 401(k) plans with matches and paid time off to cover vacations, sick leave, parental leave and military leave. We also protect workers from harmful and hazardous conditions by adhering to strict health and safety standards.
Our efforts to be a responsible employer have been recognized for the past two years by the JUST 100, a list developed JUST Capital that ranks companies on the issues that Americans care about. The criteria for inclusion on the JUST 100 come directly from a survey of more than 80,000 Americans, and the number-one priority for survey participants is that they want to see fair treatment of workers from the nation’s biggest businesses. Our inclusion on the list and increasing rank since 2017 is a useful barometer to demonstrate that when it comes to people, GM is doing the right things.
Section Three – Implementation Steps.
Here is a review of steps you might want to take as you implement this new disclosure requirement.
- Review your previous business description disclosures and assess whether, based on the more detailed requirements in the old rule, you included any information that is not really material.
- Discuss with your disclosure committee or other participants in your disclosure process whether there is information not included in previous disclosures which might be relevant based on the principles in the new rule.
- Use the concept of “tell your story” as you draft this disclosure.
- With respect to products, services, major customers, etc., review previous disclosures based on old quantitative thresholds and assess materiality.Also consider whether there may be issues surrounding “Revenue-generating activities, products and/or services, and any dependence on revenue-generating activities, key products, services, product families or customers, including governmental customers” that should be disclosed based on the new principles-based language in S-K Item 101.
- Consider disclosure committee or disclosure process discussion of “Status of development efforts for new or enhanced products, trends in market demand and competitive conditions.”Note that the trends in market demand and competitive conditions involve principles-based judgments beyond those in the old disclosure requirements.
- Consider disclosure committee or disclosure process discussion of “resources material to a company’s business” beyond the two items listed in the new rule, raw materials and intellectual property.
- Assess the materiality of old working capital and backlog disclosures and consider removing them if the information is not material.In particular the new revenue recognition disclosures about unfulfilled performance obligations may make backlog disclosures not material.
- Consider the impact of governmental regulation beyond environmental matters and, where material, include appropriate disclosure.
- Review human capital policies, processes and procedures and determine which are “human capital measures or objectives that the registrant focuses on in managing the business” and assess materiality for disclosure.
As always, your thoughts and comments are welcome!