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On April 13, 2016, the U.S. Securities and Exchange Commission issued a concept release on the business and financial disclosures required by Regulation S-K. The release is part of an ongoing comprehensive evaluation by the SEC of disclosure requirements in response to statutory mandates in the FAST Act and JOBS Act (more information on which can be found at the Disclosure Effectiveness Initiative). This review also includes the Report on Review of Disclosure Requirements in Regulation S-K and forthcoming reports on Regulation S-X.
This concept release, which fills 93 pages in the Federal Register and poses 340 numbered requests for comment, is organized around three general areas: disclosure framework, specific information requirements and the presentation of information.
Due to the significance of potential changes, both from a disclosure and cost perspective, companies and investors may want to provide input on the matters addressed by the release through the comment process. The deadline for comments is July 21, 2016.
Materiality Standard. Notably, the release poses multiple questions about whether the longstanding materiality standard for Regulation S-K disclosure should be replaced with rules mandating disclosure that may be “important or useful” to certain audiences of investors, regardless of whether a “reasonable investor would consider the information important in deciding how to vote or make an investment decision.” These questions tie into the release’s distinction between “principles-based” and “rules-based” disclosure requirements, and its inquiry as to whether disclosure rules should trend toward being principles- or rules-based.
Audience. The SEC requests comments on how the disclosure framework might address the needs of investor audiences with differing levels of sophistication more effectively. In this context, the release notes that some required disclosures may be useful to unsophisticated investors but not to sophisticated institutional investors and vice-versa. The discussion of this topic in the release is not conclusive, but it does suggest that future rulemaking may call for increased requirements for XBRL, XML or other structured or interactive data disclosures in order to help different audiences conduct comparative analyses using company disclosure, particularly when considered in connection with the release’s discussion of the presentation and delivery of information.
Costs. The release discusses compliance and competitive costs, and acknowledges that additional disclosure requirements can increase administrative and compliance costs, but suggests that technological advances can offset the increases. The SEC also notes that new mandatory disclosures could increase companies’ competitive risks or economic costs, but indicates that its confidential treatment request system mitigates these concerns. Presumably, future specific rulemaking proposals will address regulatory costs in greater detail. However, the release, taken as a whole, appears to focus more on increasing disclosure requirements, as opposed to simplifying disclosure burdens and reducing costs.
Business Disclosures. The SEC requests comments on the scope of several specific line item disclosure requirements in Regulation S-K, including:
Of these, the release emphasizes company performance, risk factors and public policy and sustainability matters. For performance disclosures, the SEC suggests that it may consider eliminating requirements that overlap with financial statement disclosures, such as selected financial data and supplementary financial information.
MD&A. The release invites comments on how MD&A disclosures can be made more useful and whether the many sources of guidance on MD&A preparation from prior reform efforts should be consolidated into a single source to aid companies and investors in understanding the requirements. More generally, the SEC is considering whether to propose more or updated industry-specific disclosure requirements and whether certain requirements adopted in the past are no longer sufficiently relevant to be required due to changes in business practices.
Risk Disclosures. The release repeats familiar observations about risk factors and related disclosures: they are frequently lengthy and somewhat generic, while acknowledging that requirements for safe harbor treatment under the Private Securities Litigation Reform Act contributes to the length of risk factor disclosure. The SEC is considering requirements to disclose the probability of adverse outcomes and to require presentation of risk factors in the order of significance, with a separate summary of the most significant risks. The release also asks for comments on how to make the risk factor requirements more effective at requiring disclosure “capturing emerging risks” such as those associated with cybersecurity, climate change and arctic drilling.
Social Issues. The SEC gives a significant amount of attention to public policy and sustainability topics, sometimes also referred to as environmental, social and governance matters. The release notes the SEC’s past determination in 1975 that disclosure requirements regarding such social matters should not be broadly imposed absent a “specific congressional mandate or unless, under the particular facts and circumstances, such matters are material.” At the same time, the SEC is considering whether a variety of public policy or sustainability matters are material or “of increasing significance to voting and investment decisions.” Topics being considering for disclosure requirements include climate change, political spending and lobbying activities, resource scarcity, corporate social responsibility, carbon asset risks and stranded asset risks. The SEC suggests that it may propose disclosure requirements on such topics on the basis that some investors consider the information significant or important to voting and investment decisions, without necessarily being information that a reasonable investor would consider material.
Scaled Disclosure. The FAST Act calls for a general review of the SEC’s disclosure requirements to further scale or eliminate burdens on Emerging Growth Companies, accelerated filers, smaller reporting companies and other smaller issuers. In response, the release seeks comments on whether the categories of smaller companies and methods for evaluating company size can be improved and whether certain companies should be disqualified from reduced disclosure requirements due to “bad actor” or similar characteristics. Noteworthy requests for comment include whether smaller reporting companies should be exempt from XBRL structured data tagging requirements and whether semiannual reports, instead of existing quarterly report requirements, should be required.
“Layered” Disclosure. The release discusses the potential to reduce duplicative disclosure and improve navigation in large company reports by increased use of cross-references, hyperlinks and incorporation by reference. This discussion builds on the suggestion of increasingly “layered” disclosure: using summaries and overview sections with references and links to more detailed disclosure in other parts of a report. The discussion of cross-referencing and increased use of incorporation by reference is inherently inconclusive because, as the SEC notes, repeating similar information in more than one part of a report may improve the usefulness of disclosure by combining relevant information in one place in a discussion of a particular topic, but has the risk of obscuring important information due to repetition. In contrast, the extensive use of cross-referenced or incorporated information may decrease the level of undesirable repetition but make it more difficult to form a coherent view of all information important to a particular topic. These competing effects will be important in evaluating many of the suggested reforms, such as allowing companies to disclose information on their websites, rather than through the SEC’s EDGAR reporting system, and allowing reports to omit previously reported information, such as early years of selected and supplemental financial data.
Data Tagging. Building on prior initiatives, the release seeks input on whether increased use of “structured” disclosures, which are disclosures that have been formatted and labeled with specified machine-readable data labels or “tags” using XBRL, XML or a similar protocol, should be required, including possible extension of XBRL requirements to MD&A and other narrative disclosures. Sophisticated investors increasingly take advantage of existing structured disclosures for comparative and trend analysis. However, the SEC also notes significant costs and risks of data entry errors due to the redundant nature of preparing tagged presentation of information in addition to conventional financial statements and reports. To address initial startup and ongoing costs of structured data tagging, the release seeks input on whether the requirements should be scaled to exempt smaller companies and what approaches may decrease the costs for smaller companies and investors to use structured data.
Appendix A: Key Questions for Comment
Noteworthy questions from the release to which companies and investors may wish to respond include the following. Numbers in parentheses correspond to the numbering in the release.