Key SEC disclosure changes in 2020

During 2020, U.S. public companies have dedicated a significant amount of time and resources (both internally and externally) to revising and updating their Securities and Exchange Commission filings to both adequately and accurately report the effects and risks of COVID-19 on their business, financial condition, and results of operations.

During the first and second quarters of 2020, the SEC provided targeted regulatory relief from filing requirements, while urging public companies to provide disclosures that would allow investors to evaluate the current and expected impact of COVID-19 and to revise and update their disclosures as facts and circumstances changed. Apart from COVID-19 disclosure considerations, the commission has also continued to press forward with its regular rulemaking agenda, which has significantly focused on updating disclosure requirements to improve disclosure for investors and, in many cases, simplify compliance obligations.

The most significant of these changes are summarized below.

Continued modernization of Regulation S-K
On Aug. 26, 2020, the SEC approved amendments to the description of business, legal proceedings and risk factor disclosure requirements under Regulation S-K as part of its ongoing initiative to update and modernize its disclosure requirements.

While the amendments generally aim to eliminate specific line-item disclosures in favor of a more materiality-based disclosure framework, two new disclosure requirements were added (discussed below), which public companies will need to comply with in their upcoming Form 10-Ks.
Reg S-K: Human capital resources disclosure under Item 101 (Description of Business)
SEC chairman Jay Clayton
The amended rules require, to the extent material to an understanding of the company’s business, a description of human capital resources, including the number of employees (as currently prescribed), and any human capital measures or objectives that the company focuses on in managing the business. The SEC did not define “human capital” or mandate any specific metrics, noting that each company’s disclosure must be tailored to its unique business, workforce, and facts and circumstances.

In response to this new disclosure item, SEC Chairman Jay Clayton (pictured) made clear in his remarks that he expects to see “meaningful qualitative and quantitative disclosure” and, similar to non-GAAP financial measures, would also expect companies to “maintain metric definitions constant from period to period or to disclose prominently any changes to metrics used or the definitions of those metrics.”
Reg S-K: Risk factor disclosure under Item 105 (Risk Factors)
SEC building with official seal
To the extent a company’s risk factor disclosure exceeds 15 pages, the amended rules now require such disclosure to be preceded by a summary of the principal factors that cause an investment in the company to be speculative or risky. The summary must consist of concise, bulleted or numbered statements on no more than two pages.

Additionally, companies are required to present risks that could apply generally to any company at the end of the risk factor section under the heading “General Risk Factors.” Such changes are aimed at addressing the lengthy and generic nature of risk factor disclosures that are presented by many companies, notwithstanding SEC Staff guidance emphasizing that risk factors should be focused on the “most significant” risks and should not be “boilerplate.”
New guidance regarding KPIs
Effective Feb. 25, 2020, the SEC issued new Interpretive Guidance regarding the disclosure of key performance indicators and metrics in management’s discussion and analysis of financial condition and results of operations (MD&A). (Per the SEC guidance, metrics that may be considered KPIs include operating margin, same-store sales, sales per square foot, total customers/subscribers, average revenue per user, daily/monthly active users/usage, and net customer additions.)

In particular, the guidance provides that the SEC expects all of the following disclosures to accompany any KPIs presented in the MD&A:
  • A clear definition of the metric and how it is calculated.
  • A statement indicating the reasons why the metric provides useful information to investors.
  • A statement indicating how management uses the metric in managing or monitoring the performance of the business.

If a company changes the method by which it calculates or presents the metric from one period to another, the guidance provides that a company should consider the need to disclose the following, to the extent material:
  • The differences in the way the metric is calculated or presented compared to prior periods.
  • The reasons for such changes.
  • The effects of any such change on the amounts or other information being disclosed and on amounts or other information previously reported.
  • Such other differences in methodology and results that would reasonably be expected to be relevant to an understanding of the company’s performance or prospects.

Depending on the significance of the change(s) in methodology and results, the company should further consider whether it is necessary to recast prior metrics to conform to the current presentation and place the current disclosure in an appropriate context.

On the heels of the new KPI guidance, the SEC issued a press release announcing an enforcement action based on KPI disclosure failures. KPIs have also been addressed in recent SEC comment letters.
Significant acquisitions and dispositions
Clayton-Jay-SEC 2018
On May 21, 2020, the SEC revised disclosure requirements for financial statements relating to acquisitions and dispositions of businesses. According to SEC Chairman Clayton in the accompanying press release, the action was designed to “enhance the quality of information that investors receive while eliminating unnecessary costs and burdens.” Among other things, the final amendments:
  • Updated the significance tests for disposed and acquired businesses.
  • Required financial statements for an acquired business to cover no more than the two most recent fiscal years.
  • Provided that separate acquired business financial statements are no longer required once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year (depending on significance).
  • Amended pro forma adjustment criteria.
Reporting relief for subsidiary guarantors
On March 2, 2020, the SEC adopted amendments to Rule 3-10 of Regulation S-X that, among other things, significantly reduced the subsidiary guarantor financial statement requirements in periodic reports for companies that have registered debt that is guaranteed by subsidiaries. More specifically, the amendments:
  • Replaced the condition that a subsidiary guarantor be 100-percent-owned by the parent company with a condition that it be consolidated in the parent company’s consolidated financial statements.
  • Reduced the information that is required to be disclosed by replacing condensed consolidating financial information with summarized financial information of the issuers and guarantors.
  • Permitted the amended disclosures to be unaudited and provided outside the financial statement footnotes.
  • Reduced the length of time the disclosures must be provided by only requiring the disclosures for as long as any guarantor has a reporting obligation for the guaranteed securities (rather than for as long as the guaranteed securities are outstanding).
Looking ahead
The SEC is expected to continue to revise public company disclosure requirements as part of its Disclosure Effectiveness Initiative. While efforts to date have significantly focused on business and financial disclosures, subsequent phases are expected to address compensation and governance information included in proxy statements. Financial and legal advisors must therefore closely monitor rule-making developments to ensure public company disclosures are kept up-to-date.