The Securities and Exchange Commission (the “SEC”) recently announced proposed amendments in order to update and simplify its disclosure requirements. The proposed amendments are intended to simplify compliance efforts and reduce the disclosure burden on companies subject to the SEC’s public reporting requirements, while maintaining the integrity of publicly disclosed information available to market participants. The proposed amendments address a number of SEC disclosure requirements that may have become redundant, duplicative, overlapping, outdated, or superseded, in light of other SEC disclosure requirements, U.S. generally accepted accounting principles (“GAAP”), International Financial Reporting Standards (“IFRS”) and changes in technology and the information environment. In addition, the SEC is also soliciting comments on certain SEC disclosure requirements that overlap with, but require information incremental to, GAAP to determine whether to retain, modify, eliminate or refer them to the Financial Accounting Standards Board (“FASB”) for potential inclusion in GAAP.
The proposed amendments are part of the SEC’s ongoing disclosure effectiveness initiative, which is a review of the Commission’s disclosure, presentation, and delivery requirements for public companies. As part of the initiative, the SEC also issued a concept release in April of this year that sought feedback on modernizing certain business and financial disclosure requirements of Regulation S-K as well as a request for comment in September 2015 on the effectiveness of certain financial disclosure requirements in Regulation S-X. The proposed amendments are also a part of the SEC’s efforts to implement the Fixing America’s Surface Transportation (FAST) Act which requires the SEC to eliminate duplicative or unnecessary provisions of Regulation S-K.
The proposed amendments cover or discuss:
- the deletion of redundant or duplicative SEC disclosure requirements;
- the deletion, integration, or referral to FASB of overlapping SEC disclosure requirements;
- (i) the availability of the safe harbor under the Private Securities Litigation Reform Act of 1995 (“PSLRA”) as a result of “disclosure location considerations” and (ii) judgments as to the materiality of information as a result of “bright-line disclosure threshold” considerations;
- the relocation of disclosure requirements to financial statements and the effect on smaller reporting companies;
- the deletion or amendment of outdated SEC disclosure requirements;
- amendments to superseded SEC disclosure requirements.
Redundant or Duplicative Requirements
The SEC has identified certain redundant or duplicative SEC disclosure requirements that require substantially the same disclosures as GAAP, IFRS, or other SEC disclosure requirements. The SEC is proposing to delete these duplicative requirements. More specifically, the SEC proposes to eliminate certain redundant and duplicative requirements related to (i) foreign currency, (ii) consolidation of financial statements, (iii) debt obligations, (iv) income tax disclosure, (v) warrants, rights and convertible instruments, (vi) related parties, (vii) contingencies, (viii) earnings per share, (ix) certain requirements for insurance companies and bank holding companies, (x) changes in accounting principles, (xi) interim financial statements and (xii) reports furnished to security holders. The majority of the redundant or duplicative requirements relate to Regulation S-X with a few that involve Regulation S-K Item 601 exhibits.
For example, Rule 4-08(i) of Regulation S-X requires disclosure of the title and amount of securities subject to warrants or rights, the exercise price, and the exercise period. However, certain Accounting Standards Codification rules relating to non-compensatory and compensatory warrants already require much of the same disclosure under GAAP. More particularly, for compensatory warrants or rights, GAAP requires disclosure of the nature and terms of such arrangements, the number and weighted-average exercise price, and the weighted-average contractual term.
The SEC has identified certain overlapping disclosure requirements, which are similar to, but not the same as GAAP, IFRS, or other SEC disclosure requirements. Depending on the nature of the overlapping requirement, the SEC is considering whether to (i) delete; (ii) integrate; or (iii) refer to the matter to FASB.
The proposal's request for comment on overlapping requirements notes that proposals related to some topics would result in the relocation of disclosures from outside to inside the financial statements, subjecting this information to annual audit and/or interim review, internal control over financial reporting, and XBRL tagging requirements, referred to as “disclosure location considerations”. Disclosure location considerations raise the issue that relocating such disclosure to the financial statements would make the PSLRA safe harbor unavailable. Conversely, relocating disclosure outside the financial statements would have the opposite effect and potentially make available the PSLRA safe harbor. Further, any disclosure requirements moved to GAAP could affect smaller reporting companies and private companies unless exempted by FASB. Smaller reporting companies are eligible for relief from some of the disclosures required by larger public entities. If those disclosure requirements are made part of GAAP, they would become applicable to smaller reporting companies in the same manner as any other public company.
In addition, the proposal may result in the removal or addition of certain quantitative disclosure thresholds, referred to as “bright-line disclosure thresholds”. Any change to a bright-line disclosure threshold could reduce the amount of required disclosures and increase the judgment required to determine what disclosures are meaningful to investors. For example, Regulation S-K requires disclosure of the amount of revenue from any class of similar products and services that account 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; in contrast, GAAP requires disclosure for each product or service, or group of similar products and services, unless impracticable.
Deletion of Overlapping Requirements
The SEC is proposing to delete certain SEC disclosure requirements that either require disclosures that convey information reasonably similar to, or that are encompassed by the disclosures that result from compliance with, the overlapping GAAP, IFRS or SEC disclosure requirements, or require disclosure incremental to the overlapping GAAP, IFRS or SEC disclosure requirements and that may no longer be useful to investors. There are 19 proposed deletions which include, among others, (i) Rule 3A-02(b)(1) of Regulation S-X relating to the presentation of consolidated financial statements where an issuer and its subsidiaries have different fiscal periods, (ii) the majority of Rule 4-08(m)(1)(ii) of Regulation S-X related to disclosure covering repurchase and reverse repurchase agreements, (iii) Rule 8-03(b)(2) and Rule 10-01(a)(5) of Regulation S-X relating to the disclosure, in interim financial statements, of material events subsequent to the end of the most recent fiscal year, (iv) Rule 8-03(b)(2) and Rule 10-01(b)(6) of Regulation S-X relating to the disclosure in the notes to the interim financial statements of the dates of any material accounting change, (v) Rule 8-03(b)(4) and Rule 10-01(b)(4) of Regulation S-X relating to the disclosure of supplemental pro forma information about business combinations in the notes to interim financial statements, (vi) Item 101(b) of Regulation S-K relating to the disclosure of certain segment financial information, (vii) Item 101(d)(3) of Regulation S-K relating to the disclosure of risks associated with a company’s foreign operations and any segment dependence on foreign operations, (ix) Item 101(c)(1)(xi) and Item 101(h)(4)(x) of Regulation S-K for domestic issuers and Item 5.C of Form 20-F for foreign private issuers relating to the disclosure of the amount spent on research and development activities for all years presented, and (x) Item 201(d) of Regulation S-K and references to it relating to the disclosure of the securities authorized of issuance under equity compensation plans.
For example, under Item 503(d) of Regulation S-K companies that register debt securities must disclosure the historical and pro forma ratio of earnings to fixed charges. Furthermore, Item 601(b)(12) of Regulation S-K mandates the filing of an exhibit setting forth the computation of the ratio of earnings to fixed charges. In the proposed amendment, the SEC notes that both GAAP and IFRS require disclosure of many of the components of this ratio, as well as information from which other ratios that convey reasonably similar information about a company’s obligation to meet its financial obligations may be computed. As a result, disclosure of the ratio of earnings to fixed charges may no longer be needed for an investor to extrapolate whether or not a company has the ability to repay its debts.
Integration of Overlapping Requirements
Certain SEC disclosure requirements overlap with, but require information incremental to, other SEC disclosure requirements and in these circumstances the SEC is proposing to integrate the overlapping disclosure requirements. There are three areas of overlapping SEC disclosure requirements the SEC has identified (i) foreign currency restrictions; (ii) restrictions on the payment of dividends for domestic and foreign private issuers; and (iii) financial data in interim financial statements related to geographic performance.
For example, there are a number of requirements for domestic issuer to discuss restrictions on the payment of dividends in Regulation S-X (Rule 4-08(d)(2) and Rule 4-08(e)) as well as in Regulation S-K (Item 201(c)(1)), which require disclosure of restrictions that currently or are likely to materially limit the issuer’s ability to pay dividends on its common equity. The SEC is proposing to revise and streamline these disclosure requirements into a single requirement in Rule 4-08(e) of Regulation S-X for the disclosure of material restrictions on dividends and to eliminate the requirements in Rule 4-08(d)(2) of Regulation S-X and Item 201(c)(1) of Regulation S-K.
Similarly, foreign private issuers are required under Item 10.F of Form 20-F to disclose any dividend restrictions and to disclose under the Instruction to Item 14.B of Form 20-F any limitations on the payment of dividends. Foreign private issuers are already required to disclose dividend restrictions in the notes to the financial statements. Specifically, foreign private issuers that report under GAAP or another comprehensive body of accounting principles, other than IFRS, with a reconciliation to GAAP must comply with Rule 4-08(e) of Regulation S-X. Foreign private issuers that report under IFRS must comply with paragraph 79(a)(v) of International Accounting Standard 1, Presentation of Financial Statements, which requires disclosure of restrictions on the distribution of dividends and the repayment of capital for each class of share capital. As a result, the SEC is proposing to delete the requirements in Item 10.F and the Instruction to Item 14.B of Form 20-F.
Referral to FASB
Finally, as part of the SEC’s review of the overlapping requirements, the SEC is seeking to solicit comment on certain SEC disclosure requirements that overlap with, but require information incremental to, GAAP to determine whether to retain, modify, eliminate, or refer such requirements to the FASB for potential incorporation into GAAP.
For example, GAAP requires disclosure of loss contingencies while Item 103 of Regulation S-K requires disclosure of certain legal proceedings. In practice, to comply with Regulation S-K, companies commonly repeat some or all of the disclosures provided in the notes to the financial statements under GAAP or include a cross-reference thereto. Incorporation of the requirements in Item 103 of Regulation S-K into GAAP would result in more instances of disclosure of the possible range of loss, more disclosure that is subject to audit or review, internal control and XBRL requirements, more disclosure of prescribed facts (such as the court or agency, the date instituted, the principal parties involved, the alleged factual basis to the proceeding and the relief sought) and a more general materiality threshold in connection with environmental legal proceedings instead of the 10% and $100,000 thresholds in Regulation S-K.
The SEC is proposing to amend certain SEC disclosure requirements that have become obsolete due to the passage of time or changes in the regulatory, business or technological environment, such as stale transition dates and the requirement to identify the Public Reference Room. The SEC is proposing to eliminate or amend such requirements and add, where necessary, additional disclosure requirements so that investors do not lose information but issuers do not bear additional costs.
For example, Item 3.A.3 of Form 20-F requires foreign private issuers to provide exchange rate data where the financial statements provided in the Form 20-F are prepared in a currency other than the U.S. dollar. In these situations, the exchange rate between the financial reporting currency and the U.S. dollar must be provided. However, the SEC notes that exchange rate information is readily available for free on a number of websites and investors may obtain information that is more current than the information provided in the Form 20-F. As a result, the SEC is proposing to delete Item 3.A.3 of Form 20-F.
The SEC is proposing to amend requirements that are inconsistent with new accounting, auditing, disclosure requirements, and more recently updated SEC disclosure requirements.
For example, the SEC is proposing to resolve inconsistencies between GAAP and Regulation S-X as to the date on which pro forma financial information should assume that a business combination occurred and deleted reference to extraordinary items from the SEC’s rules and forms since the FASB eliminated extraordinary items from GAAP in January 2015.
The proposed amendments do not fundamentally change the SEC disclosure requirements to which public reporting companies are subject. However, the impact of the proposed amendments, if adopted, will vary depending on the category of the change under which an SEC disclosure requirement appears (i.e. redundant, overlapping, outdated or superseded). Changes to address redundant or superseded requirements will have little or no effect since the only purpose of the change is to eliminate such requirement. The effect of changes to overlapping requirements could potentially affect all public reporting companies as a result of the movement of SEC disclosure from one location to another (disclosure location considerations) or judgments as to the materiality of certain disclosure as a result of changes to bright line disclosure thresholds. In addition, smaller reporting companies and private companies may be affected by the proposed amendments as discussed above under “Overlapping Requirements”.
Currently, no action is required by public reporting companies or their counsel. However, if the proposed amendments are adopted such companies and their counsel will have to update their form check compliance procedures for the next quarterly or annual report that may be due when, and if, the proposed amendments take effect. Depending upon the final rules, some issuers (particularly smaller reporting issuers) may find that the amendments impose new or expanded disclosure requirements.
The SEC is seeking comment on the proposed rules. Comments are due 60 days after the proposed rule is published in the Federal Register. For the full text of the proposed rule please see the following link here.