On 8 August 2019, the US Securities and Exchange Commission (SEC) issued for public comment certain proposed amendments to Regulation S-K.1 Regulation S-K principally governs the content of disclosure documents filed by US domestic issuers. Therefore, generally speaking, most of these proposed amendments to Regulation S-K will not affect foreign private issuers (FPIs). This alert briefly discusses the portions the Proposing Release that would apply to FPIs and certain additional information in the Proposing Release that may be of interest to them.
Background: Regulation S-K
Regulation S-K is the central source of the information required to be disclosed by US domestic issuers in registration statements under the US Securities Act of 1933, as amended (the Securities Act) and in periodic reports under the US Securities Exchange Act of 1934, as amended (the Exchange Act).2 The SEC issued these recent proposed amendments as part of its broader efforts to make disclosure documents more readable and easier for investors to navigate, and in response to a legislative mandate to the SEC to review Regulation S-K and pare it back where possible.
The proposed amendments would affect parts of Item 101 (Business Description),3 Item 103 (Legal Proceedings) and Item 105 (Risk Factors). The SEC characterizes its current disclosure requirements as “prescriptive” in that the same quantitative disclosure thresholds apply to all issuers or require all issuers to disclose the same type of information, which may not reflect information that is material to every business. The proposed amendments to Items 101 and 105 reflect SEC determinations to adopt “principles-based” disclosure, which the SEC believes will be tailored to issuers’ particular circumstances and, at least for these items, to move away from the “prescriptive disclosure” requirement. The SEC also believes that the changes to these items may elicit disclosure with a greater focus on information that is material to individual businesses. In contrast, Item 103 (Legal Proceedings), would remain prescriptive, reflecting the SEC’s belief that disclosure of such matters depends less on the specific characteristics of individual issuers. The proposed revisions to Item 103 include amendments intended to eliminate repetitive disclosure and raise the monetary threshold for disclosure of certain proceedings.
The immediate reaction to the proposed amendments has been mixed. Many public companies – particularly larger that are more closely watched by shareholders and the media and those that face “activist” shareholders — tend to over disclose, rather than potentially face shareholders lawsuits arising out of adverse events. The SEC’s intention to address such over disclosure is particularly evident in the proposed revisions to Item 105 (Risk Factors) discussed below.
Application of Proposing Release to FPIs
Regardless of the proposal’s ultimate effects on US domestic issuers, the immediate effects on FPIs would be limited since, as noted above, Regulation S-K applies principally to US domestic issuers.4 The content of disclosure documents filed by FPIs is set forth primarily in SEC Form 20-F. Form 20-F is, essentially, a stand-alone catalog of required disclosures by FPIs. FPIs must file Form 20-F both to register a class of securities under the Exchange Act (generally in connection with a listing) and as an annual report under the Exchange Act. Form 20-F is also the source of most of the information required to be included in registration statements under the Securities Act filed by FPIs. However, an FPI that registers its securities for sale under the Securities Act is required to provide a discussion of risk factors in accordance with Item 105 of Regulation S-K. Thus, the proposed changes to Item 105 will affect disclosure by FPIs should they choose to conduct a registered public offering in the US.
The SEC’s Proposing Release contains the following key changes to Regulation S-K Item 105 (Risk Factors):
- Documents containing risk factor disclosure exceeding 15 pages would have to include summary risk factor disclosure in the forepart of the prospectus or report, under an appropriate heading.
- In lieu of disclosing the “most significant” risk factors as now required, issuers would be required to disclose “material” risk factors.
- Risk factors would be required to be organized under relevant headings.
The SEC is proposing these revisions to Item 105 “to address the lengthy and generic nature of the risk factor disclosure presented by many registrants,” and notes that a contributing factor to the increased length of risk factor disclosure appears to be the inclusion of “generic, boilerplate risks that could apply to any offering or registrant.”5 The first and third bullets above appear to reflect existing practices by many issuers, and should be familiar to many FPIs. The EU Prospectus Directive requires a risk factors summary and, as noted by the SEC in the Proposing Release, many issuers already organize their risk factors disclosure under relevant headings.6 The second bullet above, replacing disclosure of the “most significant risks” with disclosure of “material” risks, is intended to emphasize disclosure of the risks to which a reasonable investor would attach importance in making investment decisions.7 The SEC believes that this change could result in risk factor disclosure more tailored to the facts and circumstances of each issuer, reducing immaterial disclosure and thereby shortening risk factor disclosure.
Apart from the specific changes to Item 105 that will affect FPIs when they register securities under the Securities Act, FPIs will also be interested in the SEC’s requests for comments on all the proposed revisions at pages 53-54, 64 and 74 of the Proposing Release. On these pages, the SEC solicits comments specifically addressing whether comparable changes should be made to the analogous disclosure requirements of Form 20-F. It is interesting to note that question 27, on page 53, acknowledges that the requirements of Form 20-F are largely prescriptive, rather than principles-based. Paradoxically perhaps, the prescriptive nature of Form 20-F for FPIs may be contrasted with the principles-based approach for financial statements embodied in International Financial Reporting Standards (IFRS), used by many FPIs to prepare the financial statements included in their SEC filings. Unlike IFRS, US GAAP used by US domestic issuers is considered to be “rules-based,” i.e., prescriptive. Thus, if the amendments to Regulation S-K are adopted as proposed, the use of prescriptive versus principles-based disclosure for the non-financial and financial portions of disclosure documents filed by US domestic companies and FPIs could reflect contrasting trends, with US issuers providing principles-based non-financial disclosure and rules-based financial statements and FPIs doing just the opposite. If any such contrasting trend were perceived as an impediment to comparability of disclosure by US issuers and FPIs, that might ultimately motivate the SEC to revise Form 20-F to provide for principles-based disclosure requirements as well. A countervailing consideration could be the fact that the present non-financial portions of Form 20-F were revised in 1999 to harmonize Form 20-F with the non-financial international disclosure standards endorsed by the International Organization of Securities Commission (IOSCO). One of IOSCO’s objectives was the promotion of the use of a single disclosure document that would be accepted in multiple jurisdictions. In its request for comments regarding possible revisions to Form 20-F comparable to the proposed Regulation S-K amendments, the SEC asked specifically whether such revisions would reduce the ability of FPIs to use a single document in multiple jurisdictions.8
The comment period for the proposed amendments expires 60 days following publication of the Proposing Release in the Federal Register.
1. See Securities and Exchange Commission Release No. 33-10668, Modernization of Regulation S-K Items 101, 103, and 105, available at https://www.sec.gov/rules/proposed/2019/33-10668.pdf (the Proposing Release).
2. The full title of Regulation S-K is “Standard Instructions for Filing Forms Under the Securities Act of 1933, the Securities Exchange Act of 1934 and Energy Policy and Conservation Act of 1975.” The complete text of Regulation S-K is set forth as Part 229 of Title 17 of the Code of Federal Regulations.
3. This Alert does not discuss the proposed revisions to Item 101 of Regulation S-K, the business description required to be provided by US domestic issuers. The Proposing Release includes an extensive description and explanation of these proposed amendments at pp. 12-54 of the release.
4. Regulation S-K also governs disclosures by non-US companies that elect to use US domestic registration and reporting forms, and by foreign issuers that do not qualify as FPIs. The SEC’s rules define “foreign private issuer” as any foreign issuer other than a foreign issuer that has more than 50 percent of its outstanding voting securities owned directly or indirectly owned of record by US residents and having (i) a majority of its executive officers or directors who are US citizens or residents, (ii) more than 50% of its assets located in the US, or (iii) its business administered principally in the US.
5. Proposing Release at pp. 65, 66. The Proposing Release also acknowledges that commentators attribute the growing length of risk factor disclosure to the litigation risk associated with a failure to disclose if events turn negative.
6. Proposing Release at p. 71.
7. The SEC’s position reflects the definition of “material” in Rule 405 under the Securities Act, under which material information is “information . . . to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security.
8. Proposing Release at p. 53.