The Securities and Exchange Commission has proposed a plan intended to reduce disclosure obligations and their inherent compliance burden, for public companies.
The rule amendments proposed on Oct. 11 would “modernize and simplify” disclosure requirements for public companies, investment advisers, and investment companies and to implement a mandate under the Fixing America's Surface Transportation (FAST) Act.
Companies would be able to omit certain references to risk factors and incorporate online references in disclosures offered to investors.
The proposal reflects changes based on recommendations in the staff's FAST Act Report and amendments developed as part of a broader review of the Commission's disclosure system.
The FAST Act, enacted in 2015, directs the Commission to issue a report providing specific and detailed recommendations on modernizing and simplifying Regulation S-K in a manner that reduces costs and burdens on registrants, while still providing all material information. It also requires recommendations to make it easier to read and navigate disclosure documents and to discourage unnecessary repetition and immaterial disclosure.
The Commission, in response the law and the ensuing staff report, moved forward with proposed amendments intended to meet the FAST Act objectives.
“The amendments to several individual rules would update, streamline, or otherwise improve our well-established and robust disclosure framework,” the SEC’s proposal says. These include proposed changes to: Description of Property (Item 102); Management’s Discussion and Analysis (Item 303); Directors, Executive Officers, Promoters, and Control Persons (Item 401); Compliance with Section 16(a) of the Exchange Act15 (Item 405); Outside Front Cover Page of the Prospectus (Item 501(b)); Risk Factors (Item 503(c)); Plan of Distribution (Item 508); Material Contracts (Item 601(b)(10)); and various rules related to incorporation by reference.
Among other things, the SEC’s proposed amendments would:
Revise rules or forms to update, streamline or otherwise improve the Commission’s disclosure framework by eliminating the risk factor examples listed in the disclosure requirement and revising the description of property requirement to emphasize the materiality threshold;
Update rules to account for developments since their adoption or last amendment by eliminating certain requirements for undertakings in registration statements;
Simplify disclosure or the disclosure process, including proposed changes to exhibit filing requirements and the related process for confidential treatment requests and changes to Management's Discussion and Analysis that would allow for flexibility in discussing historical periods; and
Incorporate technology to improve access to information by requiring data tagging for items on the cover page of certain filings and the use of hyperlinks for information that is incorporated by reference and available on EDGAR.
The proposal also includes parallel amendments to several rules and forms applicable to investment companies and investment advisers, including proposed amendments that would require certain investment company filings to include a hyperlink to each exhibit listed in the exhibit index of the filings and be submitted in HyperText Markup Language (HTML) format. The Commission will seek public comment on the proposed rules for 60 days.
“This proposal is a welcome first item on the Commission’s rulemaking calendar during my tenure, Chairman Jay Clayton said prior to consideration of the proposed amendments. “It is important that the Commission and staff periodically review our rules to ensure that our disclosure requirements are achieving their important investor information and protection objectives in an effective and efficient manner.”
The proposed amendments to MD&A “would permit registrants to forgo discussion of the oldest period if the information has been previously reported and, I emphasize, it is no longer material,” Clayton said. “This change would encourage registrants to take a fresh look at their MD&A to determine whether a discussion of the oldest year remains material to investors, and should discourage repetition of disclosure that is no longer material.”
Another rule changes would create efficiencies in the process to seek confidential treatment for commercially sensitive or confidential information, including personally identifiable information (PII).
The recommended proposal would permit registrants to omit from material contract exhibits confidential information that is not material and would cause competitive harm if publicly disclosed, without having to request confidential treatment from the Commission. This would change the current practice of requiring a registrant to provide an un-redacted copy of each exhibit and request confidential treatment.
Companies would be permitted to omit PII in all cases without submitting a confidential treatment request.
“I want to emphasize that exhibits would continue to be subject to filing reviews, and the staff would selectively assess whether redactions appear to be appropriate,” Clayton sad. “Streamlining the confidential treatment process is consistent with the FAST Act mandate and should better safeguard confidential and sensitive information.”
The proposal includes amendments that are intended to modernize the disclosure requirements in Regulation S-K by requiring certain registrants to provide legal entity identifiers, known as LEIs.
“Specifically, the proposals recognize that many registrants and their subsidiaries may not have LEIs, so the proposals would require disclosure of LEIs only for those registrants and subsidiaries that choose to obtain this identifier,” Clayton said. “Since these proposals are intended to allow investors to use LEIs to more quickly and precisely identify registrants and their subsidiaries, the proposing release also seeks feedback on the structured data format for LEIs that would be most useful to investors.”
Commissioner Michael Piwowar said he was “delighted” to support the proposed amendments.
“The proposed amendments respond effectively to our mandate under the FAST Act to prune the regulatory orchard. I choose the word ‘prune’ carefully,” he said. “The object of these amendments is to shear away dead limbs and overgrown branches, thereby improving the fruitfulness and health of the trees. [These] amendments are not an exercise in slash-and-burn clearcutting. They are incremental changes—a snip here, a snip there—designed to shape and guide the healthy plant so that our disclosure regime will continue to bear fruit.”
Commissioner Kara Stein, during the meeting, discussed the importance of modernizing the disclosure regime, in particular the implementation of LEIs.
“An LEI is a globally recognized reference code used across markets and jurisdictions to uniquely identify companies,” she said. “In short, it is like a stock keeping unit, or SKU, that you see on the items you purchase from a grocery store.”
LEIs allow investors, and the market, to accurately and easily identify companies, she explained, adding that “this is imperative for investors and regulators alike to understand the corporate structures of companies, many of which have hundreds of subsidiaries.”
“The notion of providing a means for investors and regulators to more quickly identify companies assumed greater importance following the financial crisis of 2007,” Sein said. “A key question for us and investors then was how best to make sense of, and piece together, a complex financial system.” LEIs, which are a result of a public and private partnership, “emerged as a means of piecing together that puzzle and understanding those connections.”
There is often talk about how one company is buying another or how a bank is rolling out a new product. “We all know that the realities of such a transaction are not that simple,” Stein said.
For example, the acquisition company may be a subsidiary company two layers below its reporting parent company. A bank providing financing for a multi-billion dollar deal may be issuing a new product through one of several thousand affiliates. Many of those subsidiaries and affiliates may have incredibly similar names, or names that include suffixes with variations of punctuation and format.
“These distinctions may not matter in casual conversation but we do not always have the luxury of casual imprecision,” Stein said. “If a crisis emerges, we want to know quickly and with precision which subsidiary or affiliate holds the money or can fix the issue. LEIs are a modern-day way of identifying companies, their connections, and their overall market exposure.”
She praised the “significant progress” made in encouraging the acceptance of LEIs and requiring them in Commission rules and other rules by both U.S. and foreign regulators. The new proposal, however, “does not go as far as it could in requiring LEIs for registrants and subsidiaries.”
The proposal would also change the process that companies follow when they want to redact sensitive information from their publicly filed business contracts. Currently, this process involves the company applying to the Commission staff for permission to redact information that may be competitively harmful and which they can prove to the staff is not material.
The new process proposes allowing the company to make this decision for themselves, without prior staff review. “Is this streamlining of process something that will impact the substance and quality of the information reaching the marketplace and investors? Again, I encourage comment on these issues,” Stein said.
Seward & Kissel partner Edward Horton, says the proposals represent “a step in the right direction” in reducing burdens on public company’s reporting obligations “by modernizing substantive disclosure provisions and enhancing investors’ ability to navigate relevant information.”
“The proposed rules relating to information that can be incorporated by reference also builds on recently exacted rules relating to the use of hyperlinks to streamline investors’ navigation of SEC filings,” he says.
“The proposed rules are unlikely to change the expansive risk factor disclosure in the near term since such disclosure provides some measure of protection for registrants given the litigious nature of our society,” says Keith Billotti, partner at law firm Seward & Kissel. “For this reason, many registrants will be reluctant to be a first mover in reducing their risk factor disclosure. These proposed rules, if adopted, will hopefully help issuers over time to streamline their risk factor disclosure to be more narrowly tailored to their businesses.”