Business and Financial Disclosure Required by Regulation S-K, 23915-24008 [2016-09056]

Download as PDF Vol. 81 Friday, No. 78 April 22, 2016 Part III Securities and Exchange Commission mstockstill on DSK4VPTVN1PROD with PROPOSALS3 17 CFR Parts 210, 229, 230, et al. Business and Financial Disclosure Required by Regulation S–K; Concept Release; Proposed Rule VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 PO 00000 Frm 00001 Fmt 4717 Sfmt 4717 E:\FR\FM\22APP3.SGM 22APP3 23916 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 210, 229, 230, 232, 239, 240 and 249 [Release No. 33–10064; 34–77599; File No. S7–06–16] RIN 3235–AL78 Business and Financial Disclosure Required by Regulation S–K Securities and Exchange Commission. ACTION: Concept release. AGENCY: Table of Contents The Commission is publishing this concept release to seek public comment on modernizing certain business and financial disclosure requirements in Regulation S–K. These disclosure requirements serve as the foundation for the business and financial disclosure in registrants’ periodic reports. This concept release is part of an initiative by the Division of Corporation Finance to review the disclosure requirements applicable to registrants to consider ways to improve the requirements for the benefit of investors and registrants. DATES: Comments should be received on or before July 21, 2016. ADDRESSES: Comments may be submitted by any of the following methods: SUMMARY: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/concept.shtml); • Send an email to rule-comments@ sec.gov. Please include File Number S7– 06–16 on the subject line; or • Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Paper Comments • Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE., Washington, DC 20549–1090. All submissions should refer to File Number S7–06–16. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method of submission. The Commission will post all comments on the Commission’s Web site (https:// www.sec.gov/rules/concept.shtml). Comments also are available for Web site viewing and printing in the Commission’s Public Reference Room, 100 F Street NE., Washington, DC 20549, on official business days VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available. FOR FURTHER INFORMATION CONTACT: Angie Kim, Special Counsel in the Office of Rulemaking, at (202) 551– 3430, in the Division of Corporation Finance; 100 F Street NE., Washington, DC 20549. I. Introduction II. Relevant History and Background A. History of Regulation S–K B. Broad Economic Considerations C. Prior Regulation S–K Modernization Initiatives and Studies III. Disclosure Framework A. Basis for Our Disclosure Requirements 1. Statutory Mandates 2. Commission Responses to Market Developments B. Nature of Our Disclosure Requirements 1. Principles-Based and Prescriptive Disclosure Requirements 2. Audience for Disclosure 3. Compliance and Competitive Costs IV. Information for Investment and Voting Decisions A. Core Company Business Information 1. General Development of Business (Item 101(a)(1)) 2. Narrative Description of Business (Item 101(c)) 3. Technology and Intellectual Property Rights (Item 101(c)(1)(iv)) 4. Government Contracts and Regulation, Including Environmental Laws (Items 101(c)(1)(ix) and (c)(1)(xii)) 5. Number of Employees (Item 101(c)(1)(xiii)) 6. Description of Property (Item 102) B. Company Performance, Financial Information and Future Prospects 1. Selected Financial Data (Item 301) 2. Supplementary Financial Information (Item 302) 3. Content and Focus of MD&A (Item 303— Generally) 4. Results of Operations (Item 303(a)(3)) 5. Liquidity and Capital Resources (Item 303(a)(1) and (a)(2)) 6. Off-Balance Sheet Arrangements (Item 303(a)(4)) 7. Contractual Obligations (Item 303(a)(5)) 8. Critical Accounting Estimates C. Risk and Risk Management 1. Risk Factors (Item 503(c)) 2. Quantitative and Qualitative Disclosures About Market Risk (Item 305) 3. Disclosure of Approach to Risk Management and Risk Management Process 4. Consolidating Risk-Related Disclosure D. Securities of the Registrant 1. Related Stockholder Matters—Number of Equity Holders (Item 201(b)) 2. Description of Capital Stock (Item 202) 3. Recent Sales of Unregistered Securities (Items 701(a)–(e)) PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 4. Use of Proceeds From Registered Securities (Item 701(f)) 5. Purchases of Equity Securities by the Issuer and Affiliated Purchasers (Item 703) E. Industry Guides 1. Comments Received 2. Discussion 3. Request for Comment F. Disclosure of Information Relating to Public Policy and Sustainability Matters 1. Comments Received 2. Discussion 3. Request for Comment G. Exhibits 1. Request for Comment 2. Schedules and Attachments to Exhibits 3. Amendments to Exhibits 4. Changes to Exhibits (Instruction 1 to Item 601) 5. Material Contracts (Item 601(b)(10)) 6. Preferability Letter (Item 601(b)(18)) 7. Subsidiaries and Legal Entity Identifiers H. Scaled Requirements 1. Categories of Registrants Eligible for Scaled Disclosure 2. Scaled Disclosure Requirements for Eligible Registrants 3. Frequency of Interim Reporting V. Presentation and Delivery of Important Information A. Cross-Referencing 1. Comments Received 2. Discussion B. Incorporation by Reference 1. Comments Received 2. Discussion 3. Request for Comment C. Hyperlinks 1. Comments Received 2. Discussion 3. Request for Comment D. Company Web Sites 1. Comments Received 2. Discussion 3. Request for Comment E. Specific Formatting Requirements 1. Comments Received 2. Discussion 3. Request for Comment F. Layered Disclosure 1. Comments Received 2. Discussion 3. Request for Comment G. Structured Disclosures 1. Comments Received 2. Discussion 3. Request for Comment VI. Conclusion I. Introduction Regulation S–K was adopted to foster uniform and integrated disclosure for registration statements under the Securities Act of 1933 (‘‘Securities Act’’), registration statements under the Securities Exchange Act of 1934 (‘‘Exchange Act’’), and other Exchange Act filings, including periodic and current reports.1 Over thirty years ago, the Commission expanded and reorganized Regulation S–K to be the 1 See Item 10(a) of Regulation S–K [17 CFR 229.10]. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 central repository for its non-financial statement disclosure requirements.2 When adopting the integrated disclosure system, the Commission’s goals were to reduce the costs to registrants and eliminate duplicative disclosures while continuing to provide material information.3 In this concept release, we revisit the business and financial disclosure requirements in Regulation S–K. We seek to assess whether they continue to provide the information that investors need to make informed investment and voting decisions and whether any of our rules have become outdated or unnecessary. We focus this release on business and financial disclosures that registrants provide in their periodic reports, which are a subset of the disclosure requirements in Regulation S–K.4 We focus on these requirements because many of them have changed little since they were first adopted. We are not at this time revisiting other disclosure requirements in Regulation S–K, such as executive compensation and governance, or the required disclosures for foreign private issuers, business development companies, or other categories of registrants. Although the specific scope of this concept release is as indicated, we welcome and encourage comments on any other disclosure topics not specifically addressed in this concept release. This release begins with a discussion of the regulatory history of the integrated disclosure system and Regulation S–K as well as an overview of prior initiatives to review and modernize our disclosure requirements. We then present the framework for our current disclosure regime and explore potential alternative approaches. We proceed to review the business and financial disclosure requirements that apply to periodic reports. We first consider what financial and business information should be required and whether any of these requirements are appropriate to scale for smaller registrants. We then explore how registrants can most effectively present this information to improve its 2 See Adoption of Integrated Disclosure System, Release No. 33–6383 (Mar. 3, 1982) [47 FR 11380 (Mar. 16, 1982)] (‘‘1982 Integrated Disclosure Adopting Release’’). 3 See id. 4 The scope of this release does not include certain disclosure requirements for information other than business and financial disclosures, such as Subpart 400, which requires disclosure about management and certain security holders as well as corporate governance matters. We also have not included offering-specific disclosure requirements under Subpart 500, which generally apply to registration statements and prospectuses but not periodic reports. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 usefulness to investors. In this release, we consider input we have received from letters submitted in response to disclosure modernization efforts 5 as well as the staff’s experience with particular disclosure requirements, regulatory history and changes in the regulatory and business landscape since the rule’s adoption. Through this release, we are reviewing and seeking public comment on whether our business and financial disclosure requirements continue to elicit important information for investors and how registrants can most effectively present this information. We are specifically seeking comment on: • Whether, and if so, how specific disclosures are important or useful to making investment and voting decisions and whether more, less or different information might be needed; • whether, and if so how, we could revise our current requirements to enhance the information provided to investors while considering whether the action will promote efficiency, competition, and capital formation; 6 • whether, and if so how, we could revise our requirements to enhance the protection of investors; • whether our current requirements appropriately balance the costs of disclosure with the benefits; • whether, and if so how, we could lower the cost to registrants of providing information to investors, including considerations such as advancements in technology and communications; • whether and if so, how we could increase the benefits to investors and facilitate investor access to disclosure by modernizing the methods used to present, aggregate and disseminate disclosure; and • any challenges of our current disclosure requirements and those that may result from possible regulatory responses explored in this release or suggested by commenters. While we set forth a number of general and specific questions, we welcome comments from investors, registrants and other market participants on any other concerns related to our disclosure requirements. In addition to comments received on this release, we will 5 See infra notes 9 to 10 and accompanying text. 3(f) of the Exchange Act [15 U.S.C. 78c(f)] requires that, whenever the Commission is engaged in rulemaking under the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition and capital formation. Section 2(b) of the Securities Act [15 U.S.C. 77b(b)] sets forth this same requirement. See also Section 23(a)(2) of the Exchange Act [15 U.S.C. 78w(a)(2)]. 6 Section PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 23917 consider any input from investor focus group studies or surveys, the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies. This concept release is part of a comprehensive evaluation of the Commission’s disclosure requirements recommended in the staff’s Report on Review of Disclosure Requirements in Regulation S–K (‘‘S–K Study’’), which was mandated by Section 108 of the Jumpstart Our Business Startups Act (‘‘JOBS Act’’).7 Based on the S–K Study’s recommendation and at the request of Commission Chair Mary Jo White,8 Commission staff initiated a comprehensive evaluation of the type of information our rules require registrants to disclose, how this information is presented, where and how this information is disclosed and how we can leverage technology as part of these efforts (collectively, ‘‘Disclosure Effectiveness Initiative’’). The overall objective of the Disclosure Effectiveness Initiative is to improve our disclosure regime for both investors and registrants. In connection with the S–K Study 9 and the subsequent launch of the Disclosure Effectiveness Initiative,10 we received public comments on various topics discussed in this release. Below and elsewhere throughout this release, we discuss these comments as further context for the topics under consideration. Comments received in connection with the Disclosure Effectiveness Initiative that are outside the scope of this release are not discussed here. These comment letters are being considered as part of the staff’s continued evaluation of Regulation S–K 7 Public Law 112–106, Sec. 108, 126 Stat. 306 (2012). Section 108 of the JOBS Act required the Commission to conduct a review of Regulation S– K to determine how such requirements can be updated to modernize and simplify the registration process for emerging growth companies (‘‘EGCs’’). For a further discussion of the S–K Study, see Section II.C. 8 See SEC Issues Staff Report on Public Company Disclosure (Dec. 20, 2013), available at https://www. sec.gov/News/PressRelease/Detail/PressRelease/ 1370540530982. 9 In connection with the S–K Study, we received public comments on regulatory initiatives to be undertaken in response to the JOBS Act. See Comments on SEC Regulatory Initiatives Under the JOBS Act: Title I—Review of Regulation S–K, available at https://www.sec.gov/comments/jobstitle-i/reviewreg-sk/reviewreg-sk.shtml. Some of the comments received in connection with the S–K Study were specific to EGCs. 10 To facilitate public input on the Disclosure Effectiveness Initiative, members of the public were invited to submit comments. Public comments we have received to date on the topic of Disclosure Effectiveness are available on our Web site. See Comments on Disclosure Effectiveness, available at https://www.sec.gov/comments/disclosureeffectiveness/disclosureeffectiveness.shtml. E:\FR\FM\22APP3.SGM 22APP3 23918 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules from which the staff expects to make further recommendations to the Commission for consideration. The staff is also working on recommendations for our consideration to propose specific revisions to update or simplify certain of our business and financial disclosure requirements, as required by the recently enacted Fixing America’s Surface Transportation Act of 2015 (‘‘FAST Act’’).11 Those recommendations relate to specific proposals to help address ‘‘duplicative, overlapping, outdated or unnecessary’’ disclosure and are not specifically addressed in this concept release, which seeks to explore both general considerations and specific questions that we believe would benefit from further evaluation and input before proposing any changes to the related rules.12 II. Relevant History and Background A. History of Regulation S–K Regulation S–K mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Enactment of the Securities Act and the Exchange Act resulted in the creation of two separate disclosure regimes. These disclosure regimes remained distinct for approximately thirty years and often resulted in overlapping and duplicative disclosure requirements. Regulation S–K reflects the Commission’s efforts to harmonize disclosure required under both the Securities Act and the Exchange Act by creating a single repository for disclosure regulation that applies to filings by registrants under both statutes. The current integrated disclosure system resulted from a series of efforts triggered by a 1964 amendment to the Exchange Act,13 which added Section 12(g) to the Exchange Act and extended the Exchange Act’s reporting requirements to companies meeting specified thresholds, including those that were not exchange listed.14 In light 11 Public Law 114–94, Sec. 72002, 129 Stat. 1312 (2015). 12 Id. 13 See, e.g., Disclosure to Investors—A Reappraisal of Federal Administrative Policies under the ’33 and ’34 Acts, Policy Study, Mar. 27, 1969, available at https://www.sechistorical.org/ museum/galleries/tbi/gogo_d.php (‘‘Wheat Report’’) (stating that one of the reasons for a broad reexamination of disclosure policy was the 1964 amendment to the Exchange Act). See also infra note 15. 14 15 U.S.C. 781(g). Congress enacted Section 12(g) of the Exchange Act in 1964, which required an issuer to register a class of securities under Section 12(g) if the securities were ‘‘held of record’’ by 500 or more persons and the issuer had total assets exceeding $1 million. Prior to the enactment of Section 12(g), the Exchange Act reporting requirements were applicable only to listed VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 of the Exchange Act’s broadened reporting requirements, Professor Milton Cohen suggested in a seminal 1966 law review article greater coordination between the Securities Act and Exchange Act.15 He recommended that the continuous reporting obligations under the Exchange Act serve as the foundation for corporate disclosure while relaxing or eliminating overlapping Securities Act disclosure requirements.16 Subsequent to the publication of this article, the Commission initiated several studies that advanced efforts to integrate the Securities Act and Exchange Act disclosure regimes. These efforts included the Disclosure Policy Study led by Commissioner Francis Wheat 17 and the report issued by the Advisory Committee on Corporate Disclosure led by former Commissioner A. A. Sommer, Jr. (‘‘Sommer Report’’).18 In 1969, the Wheat Report concurred with Cohen’s proposal for a coordinated disclosure companies. The Commission used its authority under Section 12(h) to raise the asset threshold for Section 12(g) registration from $1 million to $3 million in 1982, $5 million in 1986 and $10 million in 1996. As a result of amendments made by the JOBS Act and the FAST Act, Section 12(g)(1) of the Exchange Act now requires an issuer that is not a bank, bank holding company, or savings and loan holding company to register a class of equity securities if the securities are held of record by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors and the issuer has total assets exceeding $10 million. Banks, bank holding companies and savings and loan holding companies with total assets exceeding $10 million must register a class of equity securities if the securities are held of record by 2,000 or more persons. Public Law 112– 106, Sec. 501, 126 Stat. 306 (2012) and Public Law 114–94, Sec. 85001, 129 Stat. 1312 (2015). 15 See Milton H. Cohen, ‘‘Truth in Securities’’ Revisited, 79 Harv. L. Rev. 1340, 1350 (1966) (‘‘With the 1934 Act now extended to thousands of additional companies by the 1964 Amendments, the need of a reexamination with an eye to coordination of the 1934 Act with the earlier one is all the greater’’). 16 See id. at 1341–42, stating ‘‘[i]t is my thesis that the combined disclosure requirement of these statutes would have been quite different if the 1933 and 1934 Acts (the latter as extended in 1964) had been enacted in opposite order, or had been enacted as a single, integrated statute—that is, if the starting point had been a statutory scheme of continuous disclosures covering issuers of actively traded securities and the question of special disclosures in connection with public offerings had been faced in this setting. Accordingly, it is my plea that there now be created a new coordinated disclosure system having as its basis the continuous disclosure system of the 1934 Act and treating ‘‘1933 Act’’ disclosure needs on this foundation.’’ 17 See supra note 13. 18 See Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, Cmte. Print 95–29, House Cmte. On Interstate and Foreign Commerce, 95th Cong., 1st. Sess (Nov. 3, 1977) available at https:// opc-ad-ils/InmagicGenie/DocumentFolder/report %20of%20the%20advisory%20committee%20on %20corporate%20disclosure%20to%20the%20sec %2011011977.pdf. PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 system. It recommended an enhanced degree of coordination between the disclosures required by the Securities Act and the Exchange Act and formulated specific proposals for integrating disclosure between the two Acts.19 In 1977, the Sommer Report suggested adopting a single, integrated disclosure system and recommended developing one coordinated disclosure form.20 Following the Sommer Report, the Commission adopted the first version of Regulation S–K, which included only two disclosure requirements—a description of business and a description of properties.21 While additional disclosure requirements were added in 1978 and 1980,22 Regulation S–K was significantly expanded and reorganized in 1982 as the repository for the uniform non-financial statement disclosure requirements under both the Securities Act and Exchange Act.23 With this expansion and reorganization, the Commission moved much of the guidance in the prior Industry Guides into Regulation S–K and amended the forms and schedules to reference requirements in Regulation S–K.24 Many of the disclosure requirements in Regulation S–K originated in Schedule A of the Securities Act, which lists 27 items that must be disclosed in a registration statement and prospectus.25 Section 7 of the Securities Act provides that the registration statement shall contain the information and be accompanied by the documents specified in Schedule A, except the Commission may exercise its rulemaking authority to prescribe additional information or may permit prescribed information to be omitted as it deems necessary or appropriate in the public interest or for the protection of 19 See generally Wheat Report. Sommer Report at 420–432. 21 See Adoption of Disclosure Regulation and Amendments of Disclosure Forms and Rules, Release No. 33–5893 (Dec. 23, 1977) [42 FR 65554 (Dec. 30, 1977)] (‘‘1977 Regulation S–K Adopting Release’’). 22 See S–K Study at 10, footnote 27. 23 See id. at 10, footnote 28. 24 For a discussion of the Industry Guides, see infra notes 639 to 644 and accompanying text. 25 15 U.S.C. 77aa. Schedule A requires companies to provide information such as: General information about the company, its business and capital structure; information about the directors, principal officers, promoters and ten percent stockholders and remuneration of officers and directors; information about the offering; financial statements of the company and of any business to be acquired through the proceeds of the issue; and copies of agreements made with underwriters, opinions of counsel on legality of the issue, material contracts, the company’s organizational documents and agreements or indentures affecting any securities offered. 20 See E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 investors.26 Over the years, the Commission has exercised this authority to adopt various registration forms and disclosure requirements. While many of the disclosure requirements currently in Regulation S–K originated in Schedule A, the Commission has amended Regulation S–K numerous times since its adoption.27 B. Broad Economic Considerations The purpose of corporate disclosure is to provide investors with information they need to make informed investment and voting decisions. Lowering information asymmetries between managers of companies and investors may enhance capital formation and the allocative efficiency of the capital markets. In particular, disclosure of information that is important for investment and voting decisions may lead to more accurate share prices, discourage fraud, heighten monitoring of the managers of companies, and increase liquidity. Effective disclosure requirements also should increase the integrity of securities markets, build investor confidence, and support the provision of capital to the market. In addition, such requirements can facilitate the coordination of registrants around consistent disclosure standards, increasing the efficiency with which investors can process the information. There are potential drawbacks associated with disclosure requirements. Disclosure can be costly for registrants to produce and disseminate, and disclosure of certain sensitive information can result in competitive disadvantages. There is also a possibility that high levels of immaterial disclosure can obscure important information or reduce incentives for certain market participants to trade or create markets for securities. The appropriate choice of disclosure requirements therefore involves certain tradeoffs. These tradeoffs may depend on the nature of the audience for disclosure and the characteristics of registrants. Markets are composed of a broad spectrum of investors with different information needs. Some investors may be highly sophisticated and have access to substantial resources to process and interpret data, while others may lack sophistication or have fewer resources to process and interpret data. Investors also may differ in their reliance on disclosure or on third-party analyses of disclosure. The breadth of the audience 26 15 U.S.C. 77g. a comprehensive discussion of prior revisions to Regulation S–K, please see Sections II and III of the S–K Study at 8–92. 27 For VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 for disclosure may inform choices about what information is important to investment and voting decisions and should therefore be disclosed. The diversity of the audience for disclosure, and how different subsets of this audience access and digest information about registrants, will also affect decisions about how best to format and disseminate disclosure. The trade-off between the benefits and costs of disclosure requirements may vary across different types of registrants. For example, to the extent that our disclosure requirements impose fixed costs, they may impose a disproportionate burden on smaller registrants. At the same time, these registrants may have relatively simple operations and thus be able to promote an understanding of their business and financial condition with less disclosure than larger, more complex registrants. Accordingly, it may be appropriate to provide disclosure accommodations for certain types of registrants, while remaining cognizant of the potential adverse impacts that reduced disclosure may have on capital formation and the allocative efficiency of the capital markets. The benefits associated with disclosing certain items of information may be greater in some cases than in others, such as when an item of disclosure reflects an important part of one registrant’s operations but an immaterial part of another’s. In this context, it may be important to consider various approaches to trigger disclosure where it is more likely to be important, rather than in all cases. It may also be useful to have disclosure requirements, or guidance in fulfilling these requirements, that are specific to certain industries or other subsets of registrants. We seek to understand if disclosure requirements can be more appropriately tailored to registrants given the likely variation across registrants in the benefits and the costs of disclosing certain types of information. We discuss specific economic considerations in more detail below. C. Prior Regulation S–K Modernization Initiatives and Studies From time to time, the Commission has assessed its disclosure requirements. Several of these studies focused on modernizing or simplifying disclosure requirements. Other initiatives focused on different aspects of the regulatory framework, such as the securities offering process or the financial reporting system, but had the effect of raising disclosure issues for further consideration or shaping current disclosure requirements. The Disclosure PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 23919 Effectiveness Initiative builds upon these prior studies and initiatives. Task Force on Disclosure Simplification The Task Force on Disclosure Simplification (‘‘Task Force’’), comprising staff from across the Commission, was formed in 1995 to review regulations affecting capital formation with a view towards ‘‘streamlining, simplifying, and modernizing the overall regulatory scheme without compromising or diminishing important investor protections.’’ 28 In its report to the Commission in 1996, the Task Force recommended the Commission ‘‘eliminate or modify many rules and forms, and simplify several key aspects of securities offerings.’’ 29 Based on the Task Force’s recommendations, the Commission rescinded forty-five rules and six forms and adopted other minor or technical rule changes to eliminate unnecessary requirements and to streamline the disclosure process.30 The Task Force also made the following recommendations on Regulation S–K: • Streamline Item 101’s description of business disclosure by eliminating duplication of quantitative information about business segments and foreign operations provided in the financial statements; 28 See Report of the Task Force on Disclosure Simplification, available at www.sec.gov/news/ studies/smpl.htm (Mar. 5, 1996) (‘‘Task Force Report’’). To facilitate its review, the Task Force met with issuers, investor groups, underwriters, accounting firms, law firms and other active participants in the capital markets. 29 See id. stating ‘‘ . . . recommendations [of the task force] roughly fall into three categories: (1) Weeding out forms and regulations that are duplicative of other requirements or have outlived their usefulness; (2) Requiring more readable and informative disclosure documents; and (3) Reducing the cost of securities offerings and increasing access of smaller companies to the securities markets.’’ 30 See Phase One Recommendations of Task Force on Disclosure Simplification, Release No. 33–7300 (May 31, 1996) [61 FR 30397 (June 14, 1996)] (‘‘Phase One Recommendations of Task Force on Disclosure Simplification Release’’). For example, changes to Regulation S–K included eliminating four infrequently used (or otherwise already available) items from the list of required exhibits in Item 601(b) (opinion regarding discount on capital shares, opinion regarding liquidation preference, material foreign patents, and information from reports furnished to state insurance regulatory authorities). See also Phase Two Recommendations of Task Force on Disclosure Simplification, Release No. 33– 7431 (July 18, 1997) [62 FR 43581 (Aug. 14, 1997)] (‘‘Phase Two Recommendations of Task Force on Disclosure Simplification Release’’) (rescinding two forms and one rule and amending a number of rules and forms). The Commission further implemented certain of the recommendations in the Task Force Report relating to accounting disclosure rules that were identified as being largely duplicative of U.S. GAAP or other Commission rules. E:\FR\FM\22APP3.SGM 22APP3 23920 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules • revise Item 102’s description of property disclosure to elicit ‘‘more meaningful and material disclosure;’’ and • eliminate Item 103’s instruction to replace the $100,000 standard with a general materiality standard for certain environmental legal proceedings to ensure registrants will not be required to disclose non-material information.31 While the Commission made a number of changes in response to the Task Force recommendations, the three items identified above were not adopted by the Commission. We revisit some of these issues in the questions presented below. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Report of the Advisory Committee on the Capital Formation and Regulatory Process Also in 1995, the Commission established the Advisory Committee on the Capital Formation and Regulatory Processes (‘‘1995 Advisory Committee’’) to advise on, among other things, the regulatory process and disclosure requirements for public offerings. The 1995 Advisory Committee’s primary recommendation was implementing a system of ‘‘company registration.’’ 32 Noting the Task Force Report, the 1995 Advisory Committee did not focus on specific line-item disclosure requirements but suggested disclosure enhancements as part of its recommendations for a system of ‘‘company registration.’’ These enhancements included a management certification to the Commission for all periodic and current reports, a management’s report to the audit 31 The Task Force also generally recommended adjusting certain dollar thresholds in Regulation S– K and Regulation S–X for inflation since the time of their adoption. The Task Force cited, among other items, the $50,000 threshold in Item 509 of Regulation S–K (relating to disclosure of payments to experts and counsel) [17 CFR 229.509] and the $100,000 threshold in Rule 3–11 of Regulation S– X (relating to the definition of an inactive registrant) [17 CFR 210.3–11]. See Task Force Report. 32 Under a ‘‘company registration’’ system, a company would, on a one-time basis, file a registration statement (deemed effective immediately) that includes information similar to that currently provided in an initial short-form shelf registration statement. This registration statement could then be used for all types of securities and all types of offerings. All current and future Exchange Act reports would be incorporated by reference into that registration statement, and around the time of an offering, transactional and updating disclosures would be filed with the Commission and incorporated into the registration statement. As part of this ‘‘company registration’’ system, companies would be required to adopt certain disclosure enhancements (and encouraged to adopt others) that seek to improve the quality and timeliness of disclosure provided to investors and the markets. See Securities Act Concepts and Their Effects on Capital Formation, Release No. 33– 7314 (July 25, 1996) [61 FR 40044 (July 31, 1996)] (‘‘Securities Act Concept Release’’). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 committee to be filed as an exhibit to the Form 10–K, expansion of current reporting obligations on Form 8–K and a risk factor disclosure requirement in Form 10–K.33 After receiving reports from both the Task Force and the 1995 Advisory Committee, the Commission issued a concept release on regulation of the securities offering process and also sought input on the 1995 Advisory Committee’s proposed disclosure enhancements.34 Committee did not recommend specific changes to Regulation S–K, several of its suggestions sought to improve the usefulness of information in periodic reports.39 The Commission adopted some of these suggestions, which included updating the Commission’s interpretive guidance on use of electronic media for disseminating information on a registrant’s financial performance 40 and adopting rules to require filing of interactive data-tagged financial statements.41 Plain English In 1998, the Commission adopted rules intended to improve the readability of prospectuses by promoting clear, concise and understandable disclosure (‘‘Plain English Rules’’).35 These rules required registrants to write the cover page, summary and risk factors section of prospectuses in plain English 36 and were extended to Exchange Act reports in 2005.37 JOBS Act Report on Review of Disclosure Requirements in Regulation S–K The JOBS Act required the Commission to review Regulation S–K to determine how its disclosure requirements can be updated to modernize and simplify the registration process for EGCs.42 In response to this mandate, Commission staff published the S–K Study in December 2013. Although the Congressional mandate Advisory Committee on Improvements to Financial Reporting In 2007, the Commission chartered the Advisory Committee on Improvements to Financial Reporting (‘‘CIFiR Advisory Committee’’) to examine the U.S. financial reporting system.38 While the CIFiR Advisory 33 See Report of The Advisory Committee on the Capital Formation and Regulatory Processes (July 24, 1996), available at https://www.sec.gov/news/ studies/capform.htm. 34 See the Securities Act Concept Release. Many of the issues raised in the concept release were revisited in the Commission’s 1998 proposal to modernize the securities offering process (known as the ‘‘Aircraft Carrier’’ release), and in the Commission’s 2005 Securities Offering Reform rulemaking. Some of the proposals from the Aircraft Carrier release were later adopted. For example, the Aircraft Carrier release recommended inclusion of risk factor disclosure in Exchange Act registration statements and annual reports. This recommendation was adopted as part of Securities Offering Reform. See The Regulation of Securities Offerings, Release No. 33–7606A (Nov. 17, 1998) [63 FR 67174 (Dec. 4, 1998)] (‘‘Aircraft Carrier Release’’) and Securities Offering Reform, Release No. 33–8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] (‘‘Securities Offering Reform Release’’). 35 See Plain English Disclosure, Release No. 33– 7497 (Jan. 28, 1998) [63 FR 6370 (Feb. 6, 1998)] (‘‘Plain English Disclosure Adopting Release’’). 36 Id. 37 See Securities Offering Reform Release. As part of the Securities Offering Reform Release, Form 10– K was amended to require risk factor disclosure to be written in accordance with the same Plain English Rules that apply to risk factor disclosure in Securities Act registration statements. See also Part I, Item 1A of Form 10–K. 38 The dual goals of the CIFiR Advisory Committee were ‘‘to examine the U.S. financial reporting system in order to make recommendations intended to increase the usefulness of financial information to investors, while reducing the complexity of the financial reporting system to investors, preparers, and auditors.’’ See Final PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 Report of the Advisory Committee on Improvements to Financial Reporting to the United States Securities and Exchange Commission (Aug. 1, 2008), (‘‘CIFiR Advisory Committee Report’’), available at https://www.sec.gov/about/offices/oca/ acifr/acifr-finalreport.pdf. 39 See CIFiR Advisory Committee Report (stating that ‘‘[i]ncreasing the usefulness of information in SEC reports’’ was one of five themes underlying the CIFiR Advisory Committee’s recommendations). 40 In 2008, the Commission published interpretive guidance on the use of company Web sites as a means for companies to communicate and provide information to investors in compliance with the federal securities laws and, in particular, the Exchange Act. See Commission Guidance on the Use of Company Web sites, Release No. 34–58288 (Aug. 1, 2008) [73 FR 45862 (Aug. 7, 2008)] (‘‘2008 Web site Guidance’’). When it published the 2008 Web site Guidance, the Commission noted that the guidance was prompted, in part, by the CIFiR Advisory Committee’s efforts. 41 In 2008, the Commission announced the 21st Century Disclosure Initiative, with the goal of preparing a plan for future action to modernize the Commission’s disclosure system. The Initiative’s report, issued in 2009, recommended a new disclosure system in which interactive data would replace plain-text disclosure documents while retaining the substantive content and filing schedule of the current system. See 21st Century Disclosure Initiative: Staff Report, Toward Greater Transparency: Modernizing the Securities and Exchange Commission’s Disclosure System (Jan. 2009), available at https://www.sec.gov/spotlight/ disclosureinitiative/report.pdf. The Commission adopted rules in 2009 requiring companies to provide financial statement information in interactive data format using the eXtensible Business Reporting Language (‘‘XBRL’’) format. See Interactive Data to Improve Financial Reporting, Release No. 33–9002 (Jan. 20, 2009) [74 FR 6776 (Feb. 10, 2009)] (‘‘Interactive Data Release’’). This adopting release notes the CIFiR Advisory Committee’s recommendation to require filing of interactive data-tagged financial statements. 42 Public Law 112–106, Sec. 108, 126 Stat. 306 (2012). For a discussion of EGCs, including the definition of ‘‘emerging growth company,’’ see Section IV.H.1. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules focused on EGCs, the report was intended to facilitate the improvement of disclosure requirements applicable to companies at all stages of development.43 The S–K Study recommended a comprehensive review of disclosure requirements in the Commission’s rules and forms, including Regulations S–K and S–X, and identified specific areas for further review.44 It also recommended the Commission consider the following principles when reviewing and evaluating changes to disclosure requirements: • Improving and maintaining the informativeness of disclosure; • historical objectives of the rule and their continued or recurring relevance; • whether the required information is available on a non-discriminatory basis from reliable sources and, if so, any costs or benefits from obtaining the information other than from the registrant; • administrative and compliance costs of the requirements; • any competitive or economic costs of disclosing proprietary information; • maintenance of the Commission’s ability to conduct an effective enforcement program and deter fraud; and • importance of maintaining investor confidence in the reliability of registrant information, in order to, among other things, encourage capital formation.45 FAST Act Disclosure Modernization and Simplification Under the FAST Act,46 the Commission is required to carry out a study to determine how best to modernize and simplify the disclosure requirements in Regulation S–K and to propose revisions to those 43 See S–K Study at 4. id at 92–104. The S–K Study identified four issues for further study: (1) Generally, any recommended revisions should emphasize a principles-based approach as an overarching component of the disclosure framework while preserving the benefits of a rules-based system; (2) any review of the disclosure requirements should evaluate the appropriateness of current scaled disclosure requirements and consider whether further scaling is appropriate for EGCs or other categories of companies; (3) any review of the disclosure requirements should evaluate methods of information delivery and presentation, both through EDGAR and other means; and (4) any review of disclosure requirements should consider ways to present information to improve the readability and navigability of disclosure and explore methods for discouraging repetition and disclosure of immaterial information. As to this fourth issue, the S–K Study suggested reevaluating quantitative thresholds and other materiality standards in Regulation S–K as well as reassessing requirements for information that is readily accessible, such as historical stock price information. Id. at 97–98. 45 See id. at 94–95. 46 Public Law 114–94, 129 Stat. 1312 (2015). mstockstill on DSK4VPTVN1PROD with PROPOSALS3 44 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 requirements.47 The FAST Act requires that the study of Regulation S–K: • Emphasize a company-by-company approach that allows relevant and material information to be disseminated to investors without boilerplate language or static requirements while preserving completeness and comparability of information across registrants; and • evaluate methods of information delivery and presentation and explore methods for discouraging repetition and the disclosure of immaterial information. In conducting this study, the Commission is required to consult with the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies and to issue a report of findings and recommendations to Congress.48 The FAST Act also requires the Commission to revise Regulation S–K to further scale or eliminate requirements to reduce the burden on EGCs, accelerated filers, smaller reporting companies (‘‘SRCs’’), and other smaller issuers, while still providing all material information to investors, and to eliminate duplicative, overlapping, outdated or superseded provisions.49 Consistent with the S–K Study’s recommendations and the FAST Act mandates, and in furtherance of the Commission’s prior modernization studies and initiatives, we seek to evaluate components of our disclosure framework and revisit certain of our business and financial disclosure requirements to assess whether they continue to provide investors with information that is important to making informed investment and voting decisions. We also seek to evaluate whether current disclosure requirements should be revised to include different formats to facilitate the readability and navigability of disclosure, which we discuss in Section V of the release. III. Disclosure Framework A. Basis for Our Disclosure Requirements The Securities Act and the Exchange Act authorize the Commission to promulgate rules for registrant disclosure as necessary or appropriate in the public interest or for the 47 Public Law 114–94, Sec. 72003, 129 Stat. 1312 (2015). 48 Id. 49 Public Law 114–94, Sec. 72002, 129 Stat. 1312 (2015). The required revisions would not apply to provisions for which the Commission determines that further study is necessary to determine their efficacy. PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 23921 protection of investors.50 The Commission has used this authority to require disclosure of information it believes is important to investors in both registration statements for public offerings and in ongoing reports. 1. Statutory Mandates The Securities Act and Exchange Act A central goal of the federal securities laws is full and fair disclosure.51 In enacting these laws, Congress recognized that investors must have access to accurate information important to making investment and voting decisions in order for the financial markets to function effectively. Thus, our disclosure rules are intended not only to protect investors but also to facilitate capital formation and maintain fair, orderly and efficient capital markets. Schedule A of the Securities Act sets forth certain items of disclosure to be included in registration statements filed in public offerings and provides the basis for many of the disclosure requirements currently in Regulation S– K. Items in Schedule A are largely financial in nature and were intended to help investors assess a security’s value. According to the House Report that preceded the Securities Act: The items required to be disclosed . . . are items indispensable to any accurate judgment upon the value of a security . . . The type of information required to be disclosed is of a character comparable to that demanded by competent bankers from their borrowers, and has been worked out in light of these and other requirements. They are . . . adequate to bring into full glare of publicity those elements of real and unreal values which may lie behind a security.52 The Exchange Act requires similar business and financial information to be 50 See generally, Sections 7, 10, and 19(a) of the Securities Act [15 U.S.C. 77g(a)(10), 77j; and 77s(a)]; and Sections 3(b), 12, 13, 14, 15(d), and 23(a) of the Exchange Act [15 U.S.C. 78c(b), 78l, 78m(a), 78n(a), 78o(d), and 78w(a)]. 51 See Preamble of the Securities Act (stating it is an Act to provide full and fair disclosure of the character of securities sold in interstate and foreign commerce and through the mails, and to prevent frauds in the sale thereof, and for other purposes.). In enacting the mandatory disclosure system under the Exchange Act, Congress sought to promote complete and accurate information in the secondary trading markets. See S. Rep. No. 73–1455, 73rd Cong., 2nd Sess., 1934 at 68 (stating ‘‘[o]ne of the prime concerns of the exchanges should be to make available to the public, honest, complete, and correct information regarding the securities listed’’) and H.R. Rep. No. 73–1383, 73rd Cong., 2nd Sess., 1934 at 11 (stating ‘‘[t]here cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy.’’). 52 H.R Rep. No. 73–85, 73rd Cong., 1st Sess., 1933. E:\FR\FM\22APP3.SGM 22APP3 23922 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules disclosed in Exchange Act registration statements and periodic reports.53 In addition to mandating certain disclosure requirements, the Securities Act and the Exchange Act grant the Commission authority to modify and supplement these requirements as necessary or appropriate to implement the purpose of the statutes.54 Moreover, whenever it is engaged in rulemaking and is required to consider whether the action is necessary or appropriate in the public interest, the Commission must consider whether the action will promote efficiency, competition, and capital formation.55 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Business and Financial Legislation From time to time, Congress has introduced additional disclosure requirements through other statutory mandates. Recent mandates have focused on corporate responsibility, corporate governance and providing enhanced business and financial information to investors. The SarbanesOxley Act of 2002 (‘‘Sarbanes-Oxley Act’’) 56 mandated numerous changes to strengthen the accountability of public companies for their financial disclosure and required substantial Commission rulemaking to implement its provisions, many of which resulted in additions to Regulation S–K.57 In 2010, the DoddFrank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’) 58 required the Commission to adopt an array of disclosure provisions on corporate governance, executive 53 See Section 12(b)(1)(A) of the Exchange Act [15 U.S.C. 78l]. 54 See, e.g., Sections 19(a) and 28 of the Securities Act and Sections 3(b), 23(a)(1) and 36(a)(1) of the Exchange Act. [15 U.S.C. 77s(a), 15 U.S.C. 77z–3] and [15 U.S.C. 78c(b), 15 U.S.C. 78w(a)(1), 15 U.S.C. 78mm(a)(1)]. Section 19(a) of the Securities Act and Section 23(a)(1) of the Exchange Act grant the Commission authority to make such rules and regulations as may be necessary to carry out the provisions of each title; Section 3(b) of the Exchange Act provides that the Commission shall have power to define technical, trade, accounting, and other terms used in the Exchange Act, consistently with the provisions and purposes of the Exchange Act; Section 28 of the Securities Act and Section 36(a)(1) of the Exchange Act provide that the Commission may conditionally or unconditionally exempt any person, security, or transaction, or any class or classes of persons, securities, or transactions, from any provision or provisions of each title or of any rule or regulation thereunder, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors. 55 See, e.g., Section 2(b) of the Securities Act [15 U.S.C. 77b(b)] and Section 3(f) of the Exchange Act [15 U.S.C. 78c(f)]. See also Section 23(a)(2) of the Exchange Act [15 U.S.C. 78w(a)(2)]. 56 Public Law 107–204, 116 Stat. 745 (2002). 57 See S–K Study at 21–23, footnotes 57–62 and corresponding text for a discussion of additions made to Regulation S–K as a result of the SarbanesOxley Act. 58 Public Law 111–203, 124 Stat. 1376 (2010). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 compensation and specialized disclosure.59 business activities relating to Iran in their periodic reports.65 Other Legislation In some instances, Congress has mandated disclosure that is not necessarily financial in nature. These mandates have ranged from broad policy considerations to prescriptive directives. For example, under the National Environmental Policy Act of 1969 (‘‘NEPA’’),60 Congress required all federal agencies to include consideration of the environment in regulatory action. In response to this mandate, the Commission adopted environmental compliance and litigation disclosure requirements.61 Similarly, Section 1503 of the DoddFrank Act required registrants to include information about mine safety and health in their periodic reports. Although the disclosure requirements in Section 1503 were self-executing,62 the Act authorized the Commission to issue such rules or regulations as necessary for the protection of investors and to carry out the purposes of Section 1503.63 To facilitate consistent compliance, the Commission adopted rules to codify the statutory disclosure requirements.64 More recently, the Iran Threat Reduction and Syria Human Rights Act of 2012 (‘‘ITRSHRA’’) requires registrants to disclose certain 2. Commission Responses to Market Developments Our disclosure regime includes requirements that we have adopted in response to market developments or advancements in technology. In response to the disorderly markets and damage to investors caused by the hot issue securities markets between 1967 and 1971, the Commission initiated hearings to determine the adequacy of existing disclosure requirements 66 and adopted new disclosure requirements to elicit more meaningful information concerning all registrants and to communicate more effectively the economic realities of new registrants.67 Similarly, in 1994 in response to significant and sometimes unexpected losses in market risk sensitive instruments due to, among other things, changes in interest rates, foreign currency exchange rates and commodity prices, the Commission adopted Item 305 (quantitative and qualitative disclosures about market risk).68 Significant advancements in technology have also prompted some of our disclosure requirements. The 59 See S–K Study at 28–29, footnotes 73–77 and corresponding text for a discussion of provisions in the Dodd-Frank Act that impact requirements in Regulation S–K. 60 42 U.S.C. 4321–4347. 61 As a result of NEPA, the Commission issued an interpretive release in 1971 alerting companies to potential disclosure obligations that could arise from material environmental litigation and the material effects of compliance with environmental laws. The Commission later adopted more specific disclosure requirements relating to these matters and, in 1976, the Commission amended its forms to require disclosure of any material estimated capital expenditures for environmental control facilities. See Disclosures Pertaining to Matters Involving the Environment and Civil Rights, Release No. 33– 5170 (July 19, 1971) [36 FR 13989 (July 29, 1971)], Disclosure with Respect to Compliance with Environmental Requirements and Other Matters, Release No. 33–5386 (April 20, 1973) [38 FR 12100 (May 9, 1973)], Disclosure of Environmental and Other Socially Significant Matters, Release No. 33– 5569 (Feb. 11, 1975) [40 FR 7013 (Feb. 18, 1975)] (‘‘Notice of Public Proceedings on Environmental Disclosure Release’’), Conclusions and Final Action on Rulemaking Proposals Relating to Environmental Disclosure, Release No. 33–5704 (May 6, 1976) [41 FR 21632 (May 27, 1976)] (‘‘1976 Environmental Release’’), Natural Resources Defense Council et al., v. SEC, 389 F. Supp. 689 (D.D.C. 1974) (‘‘Natural Resources Defense Council’’). 62 See Section 1503(f) of the Dodd-Frank Act. The disclosure requirements took effect 30 days after enactment of the Act. 63 Id. at Section 1503(d)(2). 64 See Mine Safety Disclosure, Release No. 33– 9286 (Dec. 21, 2011) [76 FR 81762 (Dec. 28, 2011)] (‘‘Mine Safety Disclosure Release’’). PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 65 Public Law 112–158, 126 Stat. 1214 (2012). Section 219 of ITRSHRA amended Section 13 of the Exchange Act to add subsection (r). This subsection requires a company that files annual and quarterly reports under Section 13(a) of the Exchange Act to provide disclosure if, during the reporting period, it or any of its affiliates knowingly engaged in certain specified activities involving contacts with or support for Iran or other identified persons involved in terrorism or the creation of weapons of mass destruction. ITRSHRA was self-executing and required no substantive rulemaking by the Commission. 66 Hot issues result when the price of a new issuance of securities rises to a substantial premium over the initial offering price immediately or soon after the securities are first distributed to the public. In 1967–1971, the new issues markets experienced a resurgence. See Report of the Securities and Exchange Commission Concerning the Hot Issues Markets, August 1984, available at https:// 3197d6d14b5f19f2f440-5e13d29c4c016cf96 cbbfd197c579b45.r81.cf1.rackcdn.com/collection/ papers/1980/1984_0801_SECHotIssuesT.pdf. Between 1968 and 1970, the value of stocks traded on national securities exchanges fell a total of $78.8 billion, from $759.5 billion to $680.7 billion. See Securities and Exchange Commission, ThirtySeventh Annual Report, appendix Table 5 at 221 (1971) available at https://www.sec.gov/about/ annual_report/1971.pdf. 67 See New Ventures, Meaningful Disclosure, Release No. 33–5395 (June 1, 1973) [38 FR 17202 (June 29, 1973)] (‘‘Hot Issues Adopting Release’’). 68 See Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments, Release No. 33– 7386 (Jan. 31, 1997) [62 FR 6044 (Feb. 10, 1997)] (‘‘Disclosure of Market Risk Sensitive Instruments Release’’). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Commission’s efforts in Securities Offering Reform recognized the impact of technology on market demand for more timely corporate disclosure and the ability of issuers to capture, process, and disseminate this information.69 Similarly, modernization of our oil and gas rules was intended to update oil and gas disclosure requirements to align them with current practices and changes in technology.70 We are considering changes to our disclosure requirements and seeking public input on how our disclosure requirements could be improved for the benefit of investors and registrants and whether the requirements could be revised to adapt to future changes in market conditions and advancements in technology. We also are seeking input on the utility of mechanisms such as sunset provisions or temporary rules. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Comments Received S–K Study. One commenter stated that a sunset provision would require the Commission to consider changes in the economic, business and regulatory landscape in assessing whether new disclosure requirements should be made permanent.71 For significant new disclosure requirements, this commenter suggested a sunset provision of five or ten years and that formal Commission action should be required to indefinitely extend or modify any significant new disclosure requirement. Disclosure Effectiveness Initiative. We received a few comment letters that discussed potential regulatory mechanisms to review and update our disclosure requirements.72 To determine the continuing need for disclosures in light of the then current economic, business and regulatory landscape, one commenter suggested a formal, postadoption review process for significant new disclosure requirements.73 This 69 See Aircraft Carrier Release; Securities Offering Reform Release. 70 See Modernization of Oil and Gas Reporting, Release No. 33–8995 (Dec. 31, 2008) [74 FR 2157 (Jan. 14, 2009)] (‘‘Oil and Gas Release’’). 71 See letter from Ernst & Young (Sept. 11, 2012) (‘‘Ernst & Young 1’’). 72 See, e.g., letters from the Society of Corporate Secretaries and Governance Professionals (Sept.10, 2014) (‘‘SCSGP’’), Securities Industry and Financial Markets Association (Oct. 13, 2014) (‘‘SIFMA’’), and letter and articles referenced therein from Arthur J. Radin (May 29, 2015) (‘‘A. Radin’’). 73 See SCSGP. This commenter also suggested that the staff issue ‘‘closing guidance’’ when topics on which the staff had previously focused are no longer areas of primary concern. The commenter cited 2003 MD&A guidance on disclosure of critical accounting policies estimates as an example of guidance that could be considered closed. See Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition and Results of Operation, Release No. 33–8350 (Dec. 19, 2003) (‘‘2003 MD&A Interpretive Release’’) [68 FR VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 review process, or ‘‘sunset review,’’ would require formal Commission action to make a new disclosure requirement permanent. Another commenter recommended that the Commission develop a mechanism to timely update disclosure requirements to address new topical issues and to delete existing disclosure when the informational value for investors is diminished.74 One commenter generally recommended sunset rules and finding a means to evaluate user demand and disclosure effectiveness for potentially outdated requirements.75 b. Discussion When adopting disclosure requirements that have departed from traditional disclosure concepts, the Commission has historically taken an incremental approach to change by first adopting modest revisions and then expanding their application after observing and evaluating the rules’ effectiveness. For example, the initial adoption of simplified registration and reporting requirements for smaller businesses on Form S–18 were ‘‘in the nature of an experiment’’ 76 and a departure from traditional disclosure concepts.77 After observing relative, widespread acceptance of Form S–18 and the absence of significant disclosure or enforcement problems, the Commission expanded the form’s availability,78 and it eventually served as a model for our current system of scaled disclosure for SRCs.79 75056 (Dec. 29, 2003)]. This commenter stated ‘‘it is not clear that investors are unaware of the uncertainties associated with the methods, assumptions and estimates underlying a company’s critical accounting measurements.’’ 74 See SIFMA. This commenter did not propose a particular mechanism that the Commission should use. 75 See A. Radin. 76 See Simplified Registration and Reporting Requirements for Small Issuers, Release No. 33– 6049 (Apr. 3, 1979) [44 FR 21562 (Apr. 10, 1979)] (‘‘Form S–18 Release’’) at 21564. 77 Id. at 21562 (‘‘The Commission will monitor closely the use of Form S–18 for an appropriate period . . .’’). 78 See Availability of Simplified Registration Form to Certain Mining Companies, Release No. 33–6299 (Mar. 27, 1981) [46 FR 18947 (Mar. 27, 1981)]. See also Revisions to the Optional Form for the Registration of Securities to Be Sold to the Public by the Issuer for an Aggregate Cash Price Not To Exceed $5,000,000, Release No. 33–6406 (June 4, 1982) [47 FR 25126 (June 10, 1982)] (expanding Form S–18’s availability to non-corporate registrants and registrants engaged, or to be engaged, in oil and gas related operations). 79 See Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33–8876 (Dec. 19, 2007) [73 FR 934 (Jan. 4, 2008)] (‘‘SRC Adopting Release’’). In adopting the current scaled disclosure regime, the Commission stated ‘‘[t]he amendments that we are adopting address the need to revisit and adjust the Commission’s small company policies to reflect changes in our PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 23923 The Commission has, on occasion, adopted temporary rules or rules with automatic sunset provisions to better assess the effect of or necessity for a particular rule before adopting the rule on a permanent basis. For example, Securities Act Rule 415, which permits delayed and continuous offerings under certain circumstances, was initially adopted on a temporary basis for a period of nine months during which the Commission monitored the operation and impact of the new rule.80 Following public hearings and comment on Rule 415, the Commission determined additional experience with the rule was necessary to study its operation and impact 81 and extended the temporary nature of this rule.82 The Commission permanently adopted Rule 415 following 18 months of monitoring the operation and impact of the rule.83 While the Commission acted to permanently adopt Rule 415, it has allowed other temporary rules to expire. The Commission adopted on a temporary basis Securities Act Rules 702 and 703. Rule 702 required the filing of a Form 701 after sales under Rule 701 exceeded a particular threshold. Rule 703 disqualified registrants from relying on the Rule 701 exemption from registration where the registrant failed to make the filing required by Rule 702.84 In adopting Rules 702 and 703, the Commission noted the importance of monitoring new exemptive provisions and stated that it would use Form 701 to ‘‘assess the utility of the exemption and, oversee securities markets as well as changes to the regulatory landscape since 1992, when the Commission first adopted an integrated scaled disclosure system for small business in Regulation S–B. The Commission adopted Regulation S–B and its associated Forms SB–1 and SB–2 based upon the success of Form S–18 . . .’’ 80 See 1982 Integrated Disclosure Adopting Release. 81 See Delayed or Continuous Offering and Sale of Securities, Release No. 33–6423 (Sept. 2, 1982) [47 FR 39799 (Sept. 10, 1982)]. 82 Id. In June 1983, the Commission published the shelf registration rule for comment again in order to provide all interested parties another opportunity to share their views and experience under the Rule before the Commission made its final determination. See Delayed or Continuous Offering and Sale of Securities, Release No. 33–6470, (June 9. 1983) [48 FR 27768 (June 17, 1983)]. 83 See Shelf Registration, Release No. 33–6499 (Nov. 17, 1983) [48 FR 52889 (Nov. 23, 1983)]. 84 See Compensatory Benefit Plans and Contracts, Release No. 33–6768 (Apr. 14, 1988) [53 FR 12918 (Apr. 20, 1988)] (adopting Rule 701, an exemption from registration for certain offers and sales made pursuant to the terms of compensatory benefit plans or written compensation agreements for issuers that are not subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, and adopting rules 702 and 703 on a temporary basis of five years). E:\FR\FM\22APP3.SGM 22APP3 23924 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules any abuses.’’ 85 The Commission did not extend Rules 702 and 703 based on its belief that the sunset of these rules had not compromised investor interests and that their reinstitution of the rules would serve little purpose.86 Even in the absence of a temporary rule or sunset provision, the Commission has undertaken efforts to study the effects of new rules or amendments. The Commission uses these studies to guide future amendments or rulemaking. For example, our staff has examined the effects on capital formation through private placements after adoption of amendments to Regulation D in accordance with the JOBS Act.87 In adopting amendments to Rule 506 of Regulation D 88 to eliminate the prohibition against general solicitation for a subset of Rule 506 offerings, the Commission stated that the staff will monitor developments in the market for these offerings.89 In addition, in connection with recently adopted amendments to Regulation A, an exemption from registration for smaller issues of securities, and the adoption of Regulation Crowdfunding, a new exemption for smaller securities offerings using the Internet through crowdfunding, the Commission stated, in each case, that the staff will study and submit a report to the Commission on the impact of the regulation on capital formation and investor protection.90 Requiring affirmative Commission action to extend or make permanent certain requirements, the utility of mstockstill on DSK4VPTVN1PROD with PROPOSALS3 85 See Regulation D Revisions; Exemption for Certain Employee Benefit Plans, Release No. 33– 6683 (Jan. 16, 1987) [52 FR 3015 (Jan. 30, 1987)] at 3021. 86 See Phase One Recommendations of Task Force on Disclosure Simplification Release. 87 Scott Bauguess, Rachita Gullapalli, and Vladimir Ivanov, Capital Raising in the U.S.: An Analysis of the Market for Unregistered Securities Offerings, 2009–2014, Oct. 2015, available at https://www.sec.gov/dera/staff-papers/whitepapers/unregistered-offering10-2015.pdf. 88 17 CFR 230.506. 89 See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33– 9415 (July 20. 2013) [78 FR 44771 (July 24, 2013)]. 90 See Amendments to Regulation A, Release No. 33–9741 (Mar. 25, 2015) [80 FR 21805 (Apr. 20, 2015)] (‘‘2015 Regulation A Release’’); See Crowdfunding, Release No. 33–9974 (Oct. 30, 2015) [80 FR 71387 (Nov. 16, 2015)] (‘‘Crowdfunding Adopting Release’’). When proposing the crowdfunding rules, the Commission directed the staff to develop a work plan to review and monitor use of the crowdfunding rules, focusing on the types of issuers using the exemption, level of compliance by issuers and intermediaries, and whether the exemption is promoting new capital formation while providing key protections for investors. See Crowdfunding, Release No. 33–9470 (Oct. 23, 2013) [78 FR 66427 (Nov. 5, 2013)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 which may change over time, could require us to more frequently consider the effectiveness of our requirements. Alternatively, the Commission could commit to studying the impact of certain rule changes on a specified schedule, without making the rules temporary or applying automatic sunset provisions. Any such review would be in addition to the periodic review currently required by the Regulatory Flexibility Act (‘‘RFA’’),91 under which the Commission reviews its rules that have a significant economic impact on a substantial number of small entities within ten years of their publication as final rules.92 These approaches would, however, require significant Commission resources and could compete with other Commission priorities. c. Request for Comment 1. Should the Commission consider including automatic sunset provisions in new disclosure requirements? If so, what types of disclosure requirements should include these provisions? What factors should we consider in identifying them? What would be an appropriate length of time for any sunset provisions? Would this length of time vary with the nature of the rule in question? 2. What are the advantages and disadvantages of automatic sunset provisions? Would automatic sunset provisions result in unnecessary regulatory uncertainty for investors or registrants? 3. How would the use of automatic sunset provisions affect registrants, investors and other users of disclosure? Would registrants, investors or other users incur increased costs associated with the use of automatic sunset provisions? 4. Should we consider requiring the staff to study and report to the Commission on the impact of new disclosure requirements when adopting them, in addition to the review the Commission performs under the RFA? 91 [5 U.S.C. 610(a)]. year, since 1981, the Commission provides the public with notice that these rules are scheduled for review and invites public comment on whether the rules should be continued without change, or should be amended or rescinded to minimize any significant economic impact of the rules upon a substantial number of such small entities. As a matter of policy, the Commission reviews all final rules that are published for notice and comment to assess not only their continued compliance with the RFA, but also to assess generally their continued utility. See, e.g., List of Rules to be Reviewed Pursuant to the Regulatory Flexibility Act, Release No. 33–9965 (Oct. 22, 2015) [80 FR 65973 (Oct. 28, 2015)]. In the past, the Commission has received little or no comment on the rules that it publishes for review. 92 Each PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 For what type of disclosure requirements would such an approach be appropriate? What are the advantages and disadvantages of such a study and report on a new rule? 5. Are there other ways our disclosure requirements could be revised to adapt more easily to future market changes and technological advancements? B. Nature of Our Disclosure Requirements The concept of materiality has been described as ‘‘the cornerstone’’ of the disclosure system established by the federal securities laws.93 Schedule A to the Securities Act identifies certain categories of information that are generally viewed as material to investors.94 Those categories are incorporated and expanded upon in the categories of information that registrants are required to disclose under Regulation S–K. In creating and implementing our system of integrated disclosure, identification of material information was one of two principal objectives. In the 1982 Integrated Disclosure Adopting Release, the Commission stated: The Commission’s program to integrate the disclosure systems has focused on two principal objectives: First, a comprehensive evaluation of the disclosure policies and procedures under both Acts to identify the information which is material to security holders and investors in both the distribution process and the trading markets . . . and, second, a determination of the circumstances under which information should be disseminated to security holders, investors and the marketplace.95 The Commission adopted line-item requirements in Regulation S–K and its predecessors to provide investors with specific disclosure within broad categories of material information.96 Through its disclosure requirements, the Commission has adopted different approaches to guide registrants in 93 See Sommer Report at 320. id. at 324. 95 See 1982 Integrated Disclosure Adopting Release at 11382. See also Proposed Comprehensive Revision to System for Registration of Securities of Securities Offerings, Rel. No. 33–6235 (Sept. 2, 1980) [45 FR 63693 (Sept. 25, 1980)] (‘‘1980 Proposed Revisions’’) at 63694. This proposing release states ‘‘[t]he shape of the [Commission’s integrated disclosure] program will be influenced by the answer to two fundamental questions: (1) What information is material to investment decisions in the context of public offerings of securities; and (2) Under what circumstances and in what form should such material information be disseminated and made available by companies making public offerings of securities to the various participants in the capital market system? The task of identifying what information is material to investment and voting decisions is a continuing one in the field of securities regulation.’’ 96 See Sommer Report at 324. 94 See E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules evaluating materiality for purposes of disclosure, including in some cases using quantitative thresholds to address uncertainty in the application of materiality. 1. Principles-Based and Prescriptive Disclosure Requirements mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Principles-based disclosure requirements. Many of our rules require disclosure when information is material to investors.97 These rules rely on a registrant’s management to evaluate the significance of information in the context of the registrant’s overall business and financial circumstances and determine whether disclosure is necessary.98 The requirements are often referred to as ‘‘principles-based’’ because they articulate a disclosure objective and look to management to exercise judgment in satisfying that objective.99 For example, Item 303(a)(2) requires registrants to disclose material commitments for capital expenditures, known material trends in the registrant’s capital resources, and expected material changes in the mix and relative cost of 97 On several occasions, the Commission has reiterated that its requirements seek disclosure of material information. See, e.g., Commission Guidance Regarding Disclosure Related to Climate Change, Release No. 33–9106 (Feb. 8, 2010) [75 FR 6290 (Feb. 8, 2010)] (‘‘Climate Change Release’’) at 6292–6293 (stating ‘‘During the 1970s and 1980s, materiality standards for disclosure under the federal securities laws also were more fully articulated. Those standards provide that information is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to vote or make an investment decision, or, put another way, if the information would alter the total mix of available information.’’); Statement of the Commission Regarding Disclosure of Year 2000 Issues and Consequences by Public Companies, Investment Advisers, Investment Companies, and Municipal Securities Issuers, Release No. 33–7558 (Jul. 29, 1998) [63 FR 41394 (Aug. 4, 1998)] (‘‘Year 2000 Release’’) at 41395 (stating ‘‘Our disclosure framework requires companies to disclose material information that enables investors to make informed investment decisions.’’); Timely Disclosure of Material Corporate Events, Release No. 33–5092 (Oct. 15, 1970) [35 FR 16733 (Oct. 29, 1970)] at 16733–16734 (‘‘Notwithstanding the fact that a company complies with such [annual, semiannual and current] reporting requirements, it still has an obligation to make full and prompt announcements of material facts regarding the company’s financial condition . . . Corporate managements are urged to review their policies with respect to corporate disclosure and endeavor to set up procedures which will insure that prompt disclosure be made of material corporate developments . . .’’). See also infra note 107. 98 See Sommer Report at 322 (‘‘Although the initial materiality determination is management’s, this judgment is, of course, subject to challenge or question by the Commission or in the courts.’’). 99 See Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption of a Principles-Based Accounting System, July 2003, available at https://www.sec.gov/news/studies/ principlesbasedstand.htm (‘‘Section 108 Study’’). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 such resources.100 Similarly, Item 101(c)(1)(xi) requires registrants to disclose the estimated amount spent during each of the last three fiscal years on company-sponsored research and development activities, if material.101 Prescriptive disclosure requirements. Some of our rules employ objective, quantitative thresholds to identify when disclosure is required, or require registrants to disclose information in all cases. These requirements are sometimes referred to as ‘‘prescriptive’’ or ‘‘rules-based’’ because they rely on bright-line tests rather than management’s judgment to determine when disclosure is required. For example, disclosure requirements specific to environmental proceedings in Item 103 enumerate thresholds for disclosure based on a percentage of current assets (10%) or a specified dollar amount ($100,000).102 Meeting or exceeding the applicable thresholds necessitates disclosure. Similarly, Item 101(c)(1)(i), requires registrants to disclose for each of the last three fiscal years the amount or percentage of total revenue contributed by any class of similar products or services which accounted for ten percent or more of consolidated revenue in any of the last three fiscal years or fifteen percent or more of consolidated revenue, if total revenue did not exceed $50 million during any of such fiscal years.103 As another example, Item 703 establishes a requirement for registrants to disclose all repurchases of equity securities by issuers and affiliated purchasers.104 Materiality. The concept of materiality is used throughout the federal securities laws. The Commission has used a definition of materiality since at least 1937. Previously, the Commission defined ‘‘material,’’ when used to qualify a requirement for the furnishing of information, as ‘‘those matters as to which an average prudent investor ought reasonably to be informed before buying or selling the security registered.’’ 105 In 1982, the Commission 100 Item 303(a)(2) of Regulation S–K [17 CFR 229.303(a)(2)]. 101 Item 101(c)(1)(xi) of Regulation S–K [17 CFR 229.101(c)(1)(xi)]. 102 Instructions 5.B and 5.C to Item 103 of Regulation S–K [17 CFR 229.103]. See also infra note 120. 103 Item 101(c)(1)(i) of Regulation S–K [17 CFR 229.101(c)(1)]. 104 Item 703 of Regulation S–K [17 CFR 229.703]. 105 Proposed Revisions of Regulation C, Registration and Regulation 12B, Registration and Reporting, Release No. 33–6333 (August 6, 1981) [46 FR 41971 (Aug. 18, 1981)] (‘‘1981 Proposed Revisions’’). The proposing release notes that, prior to proposing this definition, the definition of ‘‘material’’ was the same as adopted in 1937. This definition provided ‘‘[t]he term ‘material’, when used to qualify a requirement for the furnishing of PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 23925 revised Rule 12b–2, which defines ‘‘material’’ when used to qualify a requirement for the furnishing of information, to adopt the Supreme Court’s definition of materiality.106 The Court has held that information is material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.107 The Court further explained that information is material if there is a substantial likelihood that disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘‘total mix’’ of information available.108 information as to any subject, limits the information required to those matters as to which an average prudent investor ought reasonably to be informed before buying or selling the security registered.’’ See, e.g., Adoption of Amendments to General Rules and Regulations, Release No. 34–4194 (Dec. 17, 1948) [not published in the Federal Register] (‘‘1948 Adoption of Amendments to General Rules and Regulations Release’’). 106 See 1982 Integrated Disclosure Adopting Release. Rule 12b–2 of the Exchange Act provides that the term ‘‘material,’’ when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to buy or sell the securities registered. [17 CFR 240.12b–2]. In addition to the information required to be disclosed, Exchange Act Rule 12b–20 requires registrants to disclose such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. Rule 12b–20 of the Exchange Act [17 CFR 240.12b–20]. 107 See Basic Inc. v. Levinson, 485 U.S. 224 (1988) (‘‘Basic’’ or ‘‘Basic v. Levinson’’) at 231, quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976) (‘‘TSC Industries’’) at 449. In TSC Industries, the Supreme Court adopted a standard for materiality in connection with proxy statement disclosure under Schedule 14A and Rule 14a–9 of the Exchange Act. This standard was supported by the Commission. See TSC Industries at footnote 10 (‘‘. . . the SEC’s view of the proper balance between the need to insure adequate disclosure and the need to avoid the adverse consequences of setting too low a threshold for civil liability is entitled to consideration . . . The standard we adopt is supported by the SEC.’’). In Basic, the Court reaffirmed this standard of materiality and applied it in the Section 10(b) and Rule 10b–5 context. Exchange Act Rule 10b–5(b) prohibits any person from making an untrue statement of material fact or omitting a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading in connection with the offer or sale of any security. Rule 10b–5 of the Exchange Act [17 CFR 240.10b– 5]. 108 See Matrixx Initiatives, Inc. v. Siracusano, 131 U.S. 1309 (2011) (‘‘Matrixx Initiatives’’) at 1318, quoting TSC Industries at 449. In Matrixx Initiatives, the Court applied the materiality standard, as set forth in TSC Industries and Basic. In articulating these standards, the Supreme Court recognized that setting too low of a materiality standard for purposes of liability could cause management to ‘‘bury shareholders in an avalanche E:\FR\FM\22APP3.SGM Continued 22APP3 23926 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 In proposing to revise Rule 12b–2 to adopt the Court’s definition of ‘‘material,’’ the Commission noted the trend to apply the Court’s definition in every type of federal securities law violation and concluded that the same test would be applied for any purpose under the Securities Act and the Exchange Act.109 Although some commenters recommended retaining the current definition or modifying the proposed one, the Commission adopted the definition as proposed because it was based on the definition set forth by the Court.110 From time to time, the Commission has provided guidance to assist management in the types of assessments to make and issues to consider in determining whether information is material.111 For example, based on a review of MD&A disclosure to evaluate the adequacy of disclosure practices and identify any common deficiencies, the Commission provided interpretive guidance on assessments management should make to determine whether disclosure of forward-looking information is required under Item 303 of Regulation S–K.112 Similarly, in the context of determining whether financial statements must be restated, Commission staff has expressed the view that materiality determinations cannot be reduced to a numerical of trivial information.’’ Id. at 1318, quoting TSC Industries at 448–449. 109 See id. 110 See 1982 Integrated Disclosure Adopting Release. Article 1–02(o) of Regulation S–X retains the definition of ‘‘material’’ prior to TSC Industries. In Staff Accounting Bulletin No. 99, the staff indicated that it views this definition in Regulation S–X to be similar to the definitions of ‘‘material’’ in Rule 12b– 2 of the Exchange Act and Rule 405 of the Securities Act, which are consistent with TSC Industries. See footnote 6 of Staff Accounting Bulletin No. 99, Release No. SAB 99 (Aug. 12, 1999) [64 FR 45150 (Aug. 19, 1999)] (‘‘SAB 99’’). As with any staff guidance referenced in this release, the views of the staff are not rules or interpretations of the Commission. The Commission has neither approved nor disapproved the views of the staff. 111 See, e.g., Climate Change Release (providing guidance as to how registrants should evaluate climate change-related issues when considering what information to disclose to investors under existing disclosure requirements and confirming that, if material, registrants should provide climate change-related disclosure); 2003 MD&A Interpretive Release (providing guidance on MD&A and emphasizing that registrants should focus on materiality). 112 See, e.g., Management’s Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures, Release No. 33–6835 (May 18, 1989) [54 FR 22427 (May 24, 1989)] (‘‘1989 MD&A Interpretive Release’’) (setting forth a two-step analysis for disclosure of material forward-looking information in MD&A). For a discussion of the Commission’s forward-looking guidance under Item 303 of Regulation S–K and recent court of appeals decisions, see Section IV.B.3.c. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 formula and evaluations of materiality require both quantitative and qualitative considerations.113 a. Comments Received S–K Study. We received three comment letters that discussed principles-based requirements or made recommendations about quantitative disclosure thresholds.114 Two commenters suggested that we move towards a more principles-based disclosure regime in which ‘‘companies [would be] expected to take the initiative to identify material information rather than simply respond to an extensive list of potentially relevant line-item disclosure requirements.’’ 115 Another commenter stated that it is counterintuitive to define disclosure requirements using a ‘‘one-size-fits-all quantitative thresholds.’’ 116 Disclosure Effectiveness Initiative. Several commenters addressed whether disclosure requirements should be principles-based or prescriptive.117 The majority of these commenters supported a principles-based system.118 Some of these commenters suggested revising or eliminating existing prescriptive disclosure requirements.119 One of these commenters stated that the ‘‘touchstone for any disclosure requirement must be materiality as seen through the eyes of a reasonable investor’’ and suggested reviewing the quantitative disclosure 113 See SAB 99. letters from Fenwick & West LLP, Cooley LLP and Wilson Sonsini Goodrich & Rosati, PC (June 19, 2012) (‘‘Silicon Valley’’), Mike Liles (Apr. 10, 2013) (‘‘M. Liles’’) (endorsing the comments expressed in the Silicon Valley letter) and Ernst & Young 1. 115 See Silicon Valley and M. Liles. 116 See Ernst & Young 1. 117 See, e.g., letters from Center for Capital Markets Competitiveness, U.S. Chamber of Commerce (July 29, 2014) (‘‘CCMC’’) (expressing support for a more principles-based approach to disclosure); SCSGP (recommending that we eliminate line-item disclosure requirements that apply without regard to materiality or that contain quantitative disclosure thresholds that do not appropriately reflect materiality); Standards & Financial Market Integrity Division, CFA Institute (Nov. 12, 2014) (‘‘CFA Institute’’) (stating that a principles-based system could lead to standards that are inconsistently applied); Shearman & Sterling LLP (Nov. 26, 2014) (‘‘Shearman’’) (stating that a principles-based approach would better withstand the pace at which the business environment changes); letter from the Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Mar. 6, 2015) (‘‘ABA 2’’); UK Financial Reporting Council (Mar. 10, 2015) (‘‘UK Financial Reporting Council’’); Corporate Governance Committee of the Business Roundtable (Apr. 5, 2015) (‘‘Business Roundtable’’); A. Radin. 118 See, e.g., CCMC; SCSGP; ABA 2; Shearman; UK Financial Reporting Council; Business Roundtable. 119 See, e.g., CCMC; SCSGP; Shearman; ABA 2. 114 See PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 thresholds in Items 103 and 404 of Regulation S–K 120 to consider whether they are appropriate.121 Another one of these commenters suggested amending Item 10 122 of Regulation S–K to permit registrants to omit information otherwise required by Regulation S–K if the information is not material and if the inclusion of the information is not necessary to make any required statements not materially misleading.123 However, this commenter noted that this provision should not apply in all instances.124 This commenter also suggested revisions to some of the quantitative disclosure thresholds in Regulation S–K to ‘‘better calibrate’’ such requirements 125 and recommended that the Commission determine whether disclosure standards other than materiality should be harmonized to ‘‘lessen ambiguity as to how these undefined disclosure standards should be applied.’’ 126 120 Item 103 of Regulation S–K requires disclosure of material pending legal proceedings. Instruction 2 specifies that no information need be given with respect to a proceeding that involves primarily a claim for damages if the amount involved, exclusive of interest and costs, does not exceed ten percent of current assets of the registrant and its subsidiaries on a consolidated basis. Instruction 5 to Item 103 requires disclosure of proceedings related to federal, state, or local environmental protection laws when (i) the proceeding is material to the registrant’s business or financial condition; (ii) the proceeding involves primarily a claim for damages, or involves potential monetary sanctions, capital expenditures, deferred charges or charges to income and the amount involved, exclusive of interest and costs, exceeds ten percent of current assets of the registrant and its subsidiaries on a consolidated basis; or (iii) a governmental authority is a party to a proceeding involving monetary sanctions, unless the registrant believes that the proceeding will result in no monetary sanctions, or in monetary sanctions, exclusive of interests and costs, of less than $100,000. [17 CFR 229.103]. Item 404 requires disclosure of transactions with related parties where the related party had or will have a direct or indirect material interest and the amount involved exceeds $120,000 or, in the case of SRCs, where the amount involved exceeds the lesser of $120,000 or one percent of the average of the SRC’s total assets at year end for the last two completed fiscal years. [17 CFR 229.404]. 121 See CCMC (noting that quantitative thresholds similar to the ones in Item 103 ‘‘may not in fact be set at levels material for all, or even most companies’’). 122 Item 10 of Regulation S–K contains general requirements on the application of Regulation S–K, Commission policies on projections and security ratings, incorporation by reference and the use of non-GAAP financial measures in Commission filings. [17 CFR 229.10]. 123 See ABA 2. 124 See id. (citing the $120,000 threshold in Item 404 as an example of an instance in which the use of a quantitative disclosure threshold is appropriate). 125 See id. For example, this commenter suggested increasing the quantitative threshold in Instruction 5.C to Item 103 from $100,000 to $1,000,000. 126 Id. As an example, this commenter noted that ‘‘major’’ is used as a standard in Items 101(h)(4)(vi), 102, and 601(b)(10)(ii)(B). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Two commenters stated that a principles-based approach would provide additional flexibility to registrants by allowing them to disclose material information based on all relevant facts and circumstances.127 One commenter, in lieu of creating new item requirements, encouraged greater staff guidance through disclosure guidance topics or staff bulletins to provide companies with factors to consider when making materiality determinations.128 One commenter stated that using materiality as a guiding principle ‘‘carries with it the recognition that what is important to a reasonable investor may change over time.’’ 129 Another commenter suggested that accounting professionals should readdress the concept of materiality and this would help reduce the volume of unnecessary disclosure.130 One commenter opposed a principlesbased system, stating such a system could result in inconsistent application of the principles-based threshold and thus non-comparable information across companies.131 This commenter also stated that the use of prescriptive disclosure requirements does not prevent companies from including additional principles-based disclosure if the company would like to do so.132 b. Discussion In 2003, the staff prepared a study on the adoption of a principles-based accounting system.133 Although it did not address disclosure requirements under Regulation S–K, many of the study’s conclusions may be relevant to our general consideration of principlesbased disclosure standards. The study found drawbacks to establishing accounting standards on either a rulesbased or a principles-based approach.134 The study noted that principles-only standards may present enforcement difficulties because they are, by their nature, imprecise.135 They can also result in a significant loss of comparability among reporting entities. Prescriptive standards, on the other hand, can be circumvented more easily by structuring around the bright-line requirements of the standard.136 In the S–K Study, the staff stated that any recommended revisions to Regulation S–K should emphasize a principles-based approach as an overarching component of the disclosure framework while preserving the benefits of a rules-based system, which affords consistency, completeness and comparability across registrants.137 In assessing this recommendation, we recognize the merits and drawbacks of our principlesbased and prescriptive disclosure requirements. Limiting prescriptive disclosure requirements and emphasizing principles-based disclosure could improve disclosure by reducing the amount of information that may be irrelevant, outdated or immaterial. Because prescriptive disclosure requirements may result in disclosure that is not necessarily material or important to investors, greater use of principles-based disclosure requirements may allow registrants to more effectively tailor their disclosure to provide only the information about their specific business and financial condition that is important to investors. A principles-based approach also may allow registrants to readily adapt their disclosure to facts and circumstances that may change over time. On the other hand, reducing prescriptive disclosure requirements and shifting towards more principlesbased disclosure requirements may limit the comparability, consistency and completeness of disclosure. Also, in the absence of clear guidelines for determining when information is material, registrants may have difficulty applying principles-based disclosure requirements,138 and the disclosure provided may not give investors sufficient insight into how registrants apply different principles-based disclosure thresholds. Potentially important information that may be 136 See id. S–K Study at 98. 138 See Financial Reporting Council, Cutting Clutter, available at https://www.frc.org.uk/OurWork/Publications/FRC-Board/Cutting-ClutterCombating-clutter-in-annual-report.pdf. In this report, the Financial Reporting Council, the United Kingdom’s independent regulator responsible for corporate governance and reporting, refers to a ‘‘threshold’’ problem, and lists the many words used to describe when disclosure is required. The report listed the following descriptors triggering disclosure: Critical, essential, fundamental, important, key, main, major, primary, principal, and significant. Id. The Financial Reporting Council’s report pertains to the requirements of companies listed in the United Kingdom, but there are similarly several disclosure ‘‘thresholds’’ used in Regulation S–K. 137 See 127 See SCSGP; Shearman. SCSGP. 129 See Business Roundtable. 130 See A. Radin. 131 See CFA Institute (also citing MD&A disclosure during the financial crisis as evidence that principles-based reporting requirements alone are not sufficient). 132 Id. 133 See Section 108 Study. Section 108(d) of the Sarbanes-Oxley Act directed the Commission to conduct a study on the adoption by the United States financial reporting system of a principlesbased accounting system. 134 See Section 108 Study. 135 See id. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 128 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 23927 disclosed in response to a prescriptive disclosure requirement might not be included in response to a principlesbased disclosure requirement. In the context of accounting standards, some have noted practical challenges associated with principles-based standards as ‘‘auditors and accountants may be less able to predict how regulators or courts will apply these principles in particular contexts.’’ 139 Additionally, the use of prescriptive disclosure requirements does not prevent registrants from including additional, principles-based disclosures that the registrant deems important. The Section 108 Study proposed a third alternative for developing new accounting standards, which the staff referred to as an ‘‘objectives-oriented’’ approach.140 Under this approach, standard setters would develop new rules by clearly articulating the accounting objective of the standard and providing sufficient detail and structure so that the standard can be applied on a consistent basis. The staff further recommended that such standards should be based on a consistentlyapplied conceptual framework, minimize exceptions and avoid the use of bright-line tests.141 We are soliciting comment below on whether such an approach might be appropriate for business and financial disclosures. c. Request for Comment 6. Should we revise our principlesbased rules to use a consistent disclosure threshold? If so, should a materiality standard be used or should a different standard, such as an ‘‘objectives-oriented’’ approach or any other approach, be used? If materiality should be used, should the current definition be retained? Should we consider a different definition of materiality for disclosure purposes? If so, how should it be defined? 7. Should we limit prescriptive disclosure requirements and emphasize a principles-based approach? If so, how? How can we most effectively balance the benefits of a principles-based approach while preserving the benefits of prescriptive requirements? 8. What are the advantages and disadvantages of a principles-based approach? Would a principles-based approach increase the usefulness of disclosures? What would be the costs and benefits of such an approach for investors and registrants? 139 See C. Coglianese, E. Keating, M. Michael and T. Healey, The Role of Government in Corporate Governance, NYU Journal of Law & Business 1: 233–251 (2004). 140 See Section 108 Study. 141 See id. E:\FR\FM\22APP3.SGM 22APP3 23928 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 9. Do registrants find it difficult to apply principles-based requirements? Why? If they are uncertain about whether information is to be disclosed, do registrants err on the side of including or omitting the disclosure? If registrants include disclosure beyond what is required, does the additional information obfuscate the information that is important to investors? Does it instead provide useful information to investors? 10. Do registrants find quantitative thresholds helpful in preparing disclosure? Do such thresholds elicit information that is important to investors? Do they require registrants to provide some disclosure that investors do not need? To the extent our rules contain quantitative thresholds, how should we define them? Are specified dollar amounts more or less effective than amounts based on a registrant’s financial condition, such as a percentage of revenues or assets? 11. Should we develop qualitative thresholds for disclosure? Should there be a combination of quantitative and qualitative thresholds? 12. Do registrants find principlesbased disclosure requirements helpful in preparing disclosure? Do such requirements elicit information that is important to investors? 13. Would principles-based disclosure affect corporate compliance and governance structures? If so, how? 2. Audience for Disclosure The Securities Act and the Exchange Act require registrants to provide information prescribed by the Commission as necessary or appropriate in the public interest or for the protection of investors.142 The legislative history of the federal securities laws speaks broadly to the ‘‘buying public,’’ 143 without addressing variation in the needs or sophistication of investors. Nearly fifty years ago, the Wheat Report recognized variation among the investor audience for disclosure and suggested that the Commission’s disclosure requirements should strike a ‘‘pragmatic balance . . . between the needs of unsophisticated investors and those of the knowledgeable student of finance.’’ 144 The Sommer Report also recognized the broad spectrum of investors but recommended that the Commission should not expect 142 See Section 7(a) of the Securities Act [15 U.S.C. 77g(a)(1)] and Section 13(a) of the Exchange Act [15 U.S.C. 78m(a)]. 143 See H.R. Rep. No. 85, 73d Cong., 1st Sess. 4 (1933) (broadly referring to the ‘‘public,’’ ‘‘buying public’’ or ‘‘investing public’’). 144 Wheat Report at 10. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 corporate filings ‘‘to be readily understandable in total by uninformed investors.’’ 145 Instead, the Sommer Report concluded that the Commission’s rules should ‘‘emphasize disclosure of information useful to reasonably knowledgeable investors willing to make the effort needed to study the disclosures, leaving to disseminators the development of simplified formats and summaries usable by less experienced and less knowledgeable investors.’’ 146 When adopting format and content changes to Form 10–K and the annual report to security holders as part of integrated disclosure, the Commission characterized users of Form 10–K as different from users of the annual report to security holders.147 Specifically, the Commission viewed annual reports to shareholders as readable documents designed to be delivered to shareholders 148 and stated that the 145 Sommer Report at D–9. See also A.A. Sommer Jr,. The U.S. SEC Disclosure Study, 1 U. Pa. J. Int’l L. 145, 148 (1978) (‘‘[T]he Committee did not believe that the Commission should design a variety of formats and degrees of summarization to serve the diverse needs of various investors. It is evident that the sophistication and knowledge of investors varies broadly, from the small, occasional [investor] through the sophisticated portfolio managers. The Committee believed that by having the Commission concentrate on the needs of sophisticated investors, the needs of other types of investors would be adequately served through the many private services which collect, synthesize, summarize and comment upon data concerning issuers.’’). 146 Sommer Report at D–9. The Advisory Committee on Corporate Disclosure identified as information disseminators the ‘‘organizations commonly thought of as the financial press,’’ id. at 163, that ‘‘condense, summarize and disseminate available information and thereby assist analysts and investors in obtaining investment decision making information in forms suitable to their respective needs and abilities to use it.’’ Id. at D– 5. 147 See Amendments to Annual Report Form, Related Forms, Rules, Regulations and Guides; Integration of Securities Act Disclosure Systems, Release No. 33–6231, (Sept. 2, 1980) [45 FR 63630 (Sept. 25, 1980)] (‘‘1980 Form 10–K Adopting Release’’). 148 See Proposed Amendments to Annual Report Form; Integration of Securities Acts Disclosure Systems, Release No. 33–6176 (Jan. 15, 1980) [45 FR 5972 (Jan. 24, 1980)] (‘‘1980 Form 10–K Proposing Release’’). See also 1980 Form 10–K Adopting Release, citing Annual Reports—Information Required in Proxy Statement, Release No. 34–10591 (Jan. 10, 1974) [39 FR 3820 (Jan. 30, 1974)] for the statement that ‘‘[t]he annual report to security holders has long been recognized as the most effective means of communication between management and security holders. Such reports are readable because they generally avoid legalistic and technical terminology and present information in an understandable, and often innovative, form . . . The Commission believes it is in the public interest that all security holders be provided with meaningful information regarding the business, management, operations and financial position of the issuer and that the annual report to security holders is the most suitable vehicle presently available for providing this information.’’ See also Annual Reports, Release No. 34–11079 (Oct. 31, 1974) [39 FR 40766 (Nov. 20, 1974)] at 40766. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 disclosure requirements in these reports ‘‘evolved in the context of shareholders making voting decisions.’’ 149 Meanwhile, the Commission noted that Form 10–K was a more technical document,150 and the Form 10–K disclosure was developed for ‘‘investors and other users making economic decisions about the company.’’ 151 The Commission further noted that the most frequent users of Form 10–K disclosure were institutional investors, professional security analysts and sophisticated individual investors. In the adopting release for these changes, the Commission stated its belief that focusing primarily on these frequent users is appropriate in formulating Form 10–K disclosure requirements, but ‘‘such a focus would not be appropriate in formulating requirements for annual reports to security holders.’’ 152 While the Commission acknowledged the benefit of uniformity of certain minimum disclosures in the annual report to security holders and the Form 10–K, it stated that not all disclosure requirements would be identical between the Form 10–K and the annual report to security holders, which potentially served different purposes and user constituencies. a. Comments Received S–K Study. Two commenters noted that, in some contexts, customers, vendors and competitors of registrants typically understand certain disclosures, but that the same information is likely to be less meaningful to investors who typically would lack the necessary industryspecific knowledge and interest.153 Disclosure Effectiveness Initiative. Two commenters discussed the profile of the investor contemplated by our disclosure requirements and the intended audience for public company disclosures.154 Both commenters recommended that we should assume that investors using registrants’ disclosures have some level of sophistication. One of these commenters suggested that a contributing factor to increased disclosure is the current assumption that the typical investor is a novice.155 The other commenter 149 1980 Form 10–K Adopting Release at 63630. 1980 Form 10–K Proposing Release. 151 1980 Form 10–K Adopting Release at 63630. 152 Id. 153 See Silicon Valley and M. Liles. 154 See, e.g., CFA Institute; Shearman. 155 See Shearman (stating ‘‘it seems that disclosure if often premised on the assumption that the reasonable investor has little or no knowledge of a company’s business, its industry or the merits or risks associated with its business. We believe 150 See E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules recommended an empirical study of the audience for financial statements and a review of who makes investment decisions and how such decisions are made.156 This commenter stated that sophisticated investors are likely the most appropriate audience for Commission filings, as they are generally the investors performing detailed analysis and acting as pricemakers. This commenter also stated that most of these investors do not express concern about the volume of disclosure. One commenter suggested that current disclosure is too complicated for the everyday person to read and that it should be less duplicative and more straightforward.157 Another commenter noted the diversity of the investor community and that the Commission’s mandate is to protect all investors.158 This commenter acknowledged that some disclosures may not be useful to retail investors but may be useful to institutional investors or vice versa and that in such circumstances, disclosure should still be required. This commenter also stated that each segment of the investor community is ‘‘entitled to have access to all necessary and relevant information.’’ Additionally, this commenter noted that broad based disclosure improves transparency and builds public trust, confidence and understanding of capital markets. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 b. Discussion We recognize the diverse composition and varied informational needs, sophistication and financial resources of investors and that some investors may obtain their analysis or advice from or through third parties who use registrant disclosures. Investors using registrant disclosure directly may include both individual investors and institutional investors, such as banks, insurance companies, mutual funds, exchange traded funds, pension funds, hedge funds and managed accounts. These investor types may also use registrant disclosure indirectly through professional data aggregators, financial advisors, proxy advisors, professional analysts, journalists, and other third parties who process and synthesize disclosures for end user investors. Different investor types and third parties may focus on different filings or that the profile of the reasonable investor has devolved to the ‘neophyte investor’ . . .’’). 156 See CFA Institute. 157 See letter from Carrie Devorah (Sept. 25, 2015). 158 See letter from the American Federation of Labor and Congress of Industrial Organizations (Nov. 20, 2015) (‘‘AFL–CIO’’). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 items of disclosure.159 Accordingly, the audience for disclosure is an important consideration in determining the means for disclosure, and specifically, in which filings or locations certain information should be directly provided and where cross-references, hyperlinks or incorporating by reference to information elsewhere is appropriate.160 Similarly, as different investors and third parties use disclosure in different ways and seek varying degrees of information, the audience for disclosure is also an important consideration in determining what information is disclosed. Institutional investors, their financial advisors and some third parties often use, and have supported requiring complex information and interactive data.161 These types of investors are likely to use disclosures of large numbers of registrants and therefore, may be relatively more interested in standardized disclosure formats well-suited for large-scale processing and analysis, including machine-readable formats. Other investors may seek disclosure that emphasizes, within the universe of information that is disclosed, the information and analysis that management believes is most important.162 To the extent some investors rely on market prices to efficiently incorporate all public information, rather than relying on disclosures directly, it could be argued that disclosures should be tailored to those users most likely to actively follow a registrant, transact in the registrant’s securities and set the market price.163 Investors in registrants that do 159 See, e.g., 1980 Form 10–K Adopting Release. See also, e.g., M. Drake, D. Roulstone, and J. Thornock, The Determinants and Consequences of Information Acquisition via EDGAR, 32 Contemp. Acct. Res. 1128, at 1128–1161 (2015) (documenting that, of the 9.8 million users who directly searched the EDGAR database from 2008 to 2011, 86% are infrequent users accessing the database less than three times a quarter and generally accessing only one filing, although there is a small percentage of users accessing EDGAR at least every other trading day). 160 For a further discussion of cross-referencing, incorporation by reference and hyperlinks, see Sections V.A., V.B., and V.C., respectively. 161 See, e.g., CFA Institute, Financial Reporting Disclosures: Investor Perspectives on Transparency, Trust, and Volume, July 2013, (‘‘CFA Report’’), available at https://www.cfapubs.org/doi/pdf/ 10.2469/ccb.v2013.n12.1; see also Interactive Data Release at footnote 98. 162 For a discussion of tailoring disclosure to meet the diverse or potentially competing needs of the investor audience, see SectionV.F. 163 The efficient market theory suggests that under certain assumptions, most investors, when making investment decisions, could rely on market prices to incorporate all available information. According to this theory, most investors would not need to individually examine much of the information in disclosures. See, e.g., Stephen J. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 23929 not have a public trading market for their securities, however, may rely more directly on disclosure to evaluate their investments. c. Request for Comment 14. Should registrants assume some level of investor sophistication in preparing their disclosures? If so, what level or levels of sophistication? How should investor sophistication be measured? What are the risks or other disadvantages to investors if registrants either underestimate or overestimate the level of investor sophistication and resources when preparing their disclosures? Does disclosure protect all investors if it is tailored to a subset of the investor community? 15. Should we revise our rules to require disclosure that is formatted to provide information to various types of investors in a manner that will facilitate their use of disclosure for investment and voting decisions? 16. Commenters have suggested that disclosure should be written for a more sophisticated investor than current disclosure appears to contemplate,164 and that tailoring disclosure to less sophisticated investors contributes to excessive disclosure.165 Should our disclosure requirements be revised to address these views? If so, how could we revise our disclosure requirements, and which requirements should we revise, to encourage more appropriately targeted disclosure? If we revised our disclosure requirements to address these views, would there be any harm or costs to investors? 17. How do investors and other users of disclosure currently access and use this information? How does this vary across different subsets of the audience for the disclosure? 18. Should we use investor testing, such as focus groups or electronic surveys, to provide input on investors’ use of and access to disclosure? 19. To what extent should the reliance of certain investors on market prices or third-party analyses, rather than using Choi, Company Registration: Towards a StatusBased Antifraud Regime, 64 U. Chi. L. Rev. 567, 569–70 (1997); Eugene F. Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 J. Fin. 383, 383–417 (1970). The Sommer Report stated that the efficient market theory is silent as to the optimum amount of information required or whether the optimum should be achieved on a mandatory or voluntary basis. The Sommer Report also stated that market forces alone are insufficient to cause all material information to be disclosed. See Sommer Report at D–6. Other studies have noted the limitations of the efficient market theory. See, e.g., Robert J. Shiller, From Efficient Markets Theory to Behavioral Finance, J. Econ. Persp. 83, 83–104 (2003). 164 See CFA Institute. 165 See Shearman. E:\FR\FM\22APP3.SGM 22APP3 23930 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules disclosure directly, be a factor in determining the type of investor to which disclosures should be targeted? 20. To what extent should we consider the needs of other market participants, such as professional securities analysts and other third parties, in revising our disclosure requirements? What would be their needs? 3. Compliance and Competitive Costs When the Commission is engaged in rulemaking it is statutorily required to consider, in addition to the protection of investors, whether an action will promote efficiency, competition, and capital formation.166 Disclosure requirements can help reduce information asymmetries from management to investors,167 improving the allocative efficiency of the capital markets and enhancing capital formation by lowering the cost of capital.168 Lack of information may affect investors’ willingness to invest and may decrease the allocative efficiency of the capital markets. Thus, requiring an appropriate level of disclosure is critical to a wellfunctioning capital market. Disclosure may also have costs to registrants that could negatively affect these factors, although advances in technology and communications have the potential to reduce these costs. As disclosure costs rise, registrants’ costs of capital may increase, which can reduce investment, lower the value of a company and impede economic growth. Registrants may also choose to exit the Commission’s reporting system, when eligible, or remain private if the disclosure requirements are sufficiently costly.169 166 See supra note 6. Robert Verrecchia, Essays on Disclosure, 32 J. Acct. Econ. 91, 91–180 (2001) (demonstrating that a credible commitment to disclosure reduces uncertainty and information asymmetries between a firm and its investors or among investors). 168 See, e.g., Richard Lambert, Christian Leuz, and Robert E. Verrecchia, Accounting Information, Disclosure, and the Cost of Capital, 45 J. Acct. Res. 385, 385–420 (May 2007) ; Luzi Hail and Christian Leuz, Cost of Capital Effects and Changes in Growth Expectations around U.S. Cross-Listings, 93 J. Fin. Econ. 428, 428–454 (2009). Lambert, Leuz, and Verrecchia (2007) demonstrate theoretically that the quality of accounting information can influence the cost of capital. Hail and Leuz (2009) find empirical evidence that firms, especially firms from countries with weaker institutional structures that cross-list securities on U.S. exchanges, experience a decrease in their costs of capital. 169 See Brian J. Bushee & Christian Leuz, Economic Consequences of SEC Disclosure Regulation: Evidence from the OTC Bulletin Board, 39 J. Acct. Econ. 233, 233–264 (2005). Bushee and Leuz find seventy-six percent of firms trading on the OTC Bulletin Board (‘‘OTCBB’’), many of which tended to be on average significantly smaller by market capitalization, left the market after the mstockstill on DSK4VPTVN1PROD with PROPOSALS3 167 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 a. Comments Received S–K Study. One commenter stated its belief that ‘‘certain Regulation S–K disclosures impose unnecessary costs while not providing concomitant value to investors . . . because the original purposes of the disclosure requirements have been achieved or are no longer as important.’’ 170 Two commenters stated that potential first-time registrants evaluate Exchange Act reporting and compliance costs in weighing the costs and benefits of an initial public offering.171 Disclosure Effectiveness Initiative. Some commenters expressed general support for changes in disclosure requirements that would reduce costs for registrants while still providing needed information to investors.172 Other commenters, in making specific recommendations, acknowledged compliance costs of these recommendations 173 or suggested ways to minimize the cost of such recommendations.174 One commenter noted the high cost of regulations, especially those promulgated by the Commission.175 b. Discussion We are sensitive to the costs of disclosure, including the administrative and compliance costs of preparing and disseminating disclosure as well as the potential costs of disclosing sensitive information to competitors. While the S–K Study did not specifically consider costs to investors, the staff identified economic principles that should be given consideration when reviewing OTCBB eligibility rule required registrants whose securities were quoted on the OTCBB to file updated financial reports with the Commission or with their banking or insurance regulators. 170 See Ernst & Young 1. 171 See Silicon Valley and M. Liles. 172 See, e.g., letters from Ernst & Young, dated Nov. 20, 2015 (‘‘Ernst & Young 2’’); letter from the Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Nov. 14, 2014) (‘‘ABA 1’’); ABA 2; Business Roundtable; Arthur Mboue (Jun 24, 2015); and the Biotechnology Industry Organization (July 14, 2015) (‘‘Biotech Industry Organization’’). 173 See, e.g., SCSGP at 14 (acknowledging that seeking repeal of requirements only a few years after their enactment would impose ‘‘an additional layer of costs’’); ABA 2 (stating that, in its review of specific Regulation S–K items, it considered whether certain requirements could be better calibrated to provide investors with relevant and useful disclosure while balancing compliance costs to companies); letter from Allianz Global Investors (Aug. 13, 2015) (‘‘Allianz’’) (stating that its goal in requesting certain additional environmental data is to improve disclosure while minimizing any additional reporting burden) and letter from Data Transparency Coalition (Oct. 29, 2015) (‘‘Data Transparency Coalition’’). 174 See letter from Sustainability Accounting Standards Board (Nov. 12, 2014) (‘‘SASB’’). 175 See A. Radin. PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 and considering changes to our disclosure requirements, including: (1) The extent to which a given disclosure requirement entails high administrative and compliance costs; and (2) the extent to which disclosure of a company’s proprietary information may have competitive or other economic costs.176 To address the potential negative effects that would result from disclosing sensitive information, our rules permit registrants to request confidential treatment of proprietary information, if disclosure of such information would cause competitive harm to the registrant.177 The Commission generally does not consider confidential treatment to be appropriate for information that is necessary for the protection of investors.178 If the Commission grants a request for confidential treatment, the registrant may redact the proprietary information from its public filings. The Commission also has addressed the costs of disclosure through regulatory relief in the form of scaled disclosure requirements for certain smaller registrants. These accommodations are intended to promote capital formation and provide relief where the fixed costs of compliance may be particularly high relative to the size of the company while also considering investor protection.179 176 See S–K Study at 94. 80(b)(4) [17 CFR 200.80(b)(4)] (adopted under the Freedom of Information Act [5 U.S.C. 552] (‘‘FOIA’’)) (identifying as ‘‘nonpublic’’ records those that disclose trade secrets and commercial or financial information obtained from a person and privileged or confidential); Securities Act Rule 406 [17 CFR 230.406]; Exchange Act Rule 24b–2 [17 CFR 240.24b–2] See also National Parks and Conservation Association v. Morton, 547 F.2d 673 (D.C. Cir. 1974) (holding that information is confidential for purposes of FOIA if it is of the type not usually released to the public and, if released, would cause substantial competitive harm) and National Parks and Conservation Association v. Kleppe, 547 F.2d 673 (D.C. Cir. 1976) (holding that information is confidential if its release is likely to cause substantial competitive harm and that actual competitive harm need not be shown). 178 Securities Act Rule 406(b)(2)(iii) [17 CFR 230.406(b)(2)(iii)]. The staff has provided guidance that, except in unusual circumstances, disclosure required by Regulation S–K or any other applicable disclosure requirement is not an appropriate subject for confidential treatment. See Staff Legal Bulletin 1A, Confidential Treatment Requests (July 11, 2001) (‘‘Staff Legal Bulletin 1A’’), available at https://www. sec.gov/interps/legal/slbcf1r.htm. 179 See, e.g., SRC Adopting Release at 942 (stating that the SRC definition ‘‘is appropriately scaled in that it reduces costs to smaller companies caused by unnecessary information requirements, consistent with investor protection’’); Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33–8819 (July 5, 2007) [72 FR 39670 (July 19, 2007)] at 39678 (stating the Commission’s objective to ‘‘provide maximum flexibility for [SRCs] without disadvantaging investors [by] establishing a baseline of required disclosure, [while encouraging SRCs] to determine for themselves the proper balance and mix of 177 Rule E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Throughout this concept release, we seek comment on changes to specific disclosure requirements that could reduce costs for registrants, while still providing investors with information that is important or useful to making informed investment and voting decisions. Separately, we address the effectiveness of our scaled disclosure requirements.180 In addition to those discussions, we are interested in public comment on other methods we could consider to reduce costs for registrants that would not compromise investors’ access to important information. c. Request for Comment 21. Do current disclosure requirements appropriately consider the costs and benefits of disclosure to registrants and investors? How should the Commission evaluate benefits, such as those arising from disclosure, that cannot be easily quantified? 22. In addition to scaled disclosure and confidential treatment, are there other accommodations that we could make to reduce costs for registrants while still providing investors with the information that is important or useful to making informed investment and voting decisions? 23. Are there other benefits and costs that we should consider when evaluating disclosure effectiveness? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 IV. Information for Investment and Voting Decisions A. Core Company Business Information Disclosure about a registrant’s business lays the groundwork for understanding and assessing a company, its operations and financial condition. Information about a registrant’s industry, business environment and other factors affecting the business helps inform investment and voting decisions by placing other disclosure in context. Schedule A of the Securities Act requires disclosure of the general character of the business transacted or to be transacted by the registrant. Item 101 of Regulation S–K similarly requires a description of a registrant’s business. Item 102 requires disclosure about a registrant’s materially important physical properties. We are reviewing the disclosure required by Item 101(a)(1) and (c) 181 and Item 102 of Regulation S–K to determine whether disclosure . . . given the costs of compliance and the market demand for information’’). 180 For a discussion of our scaled disclosure requirements, see Section IV.H. 181 The staff is separately considering certain aspects of Item 101 in developing recommendations for potential changes to update or simplify certain disclosure requirements. For a description of this project, see supra Section I. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 they continue to provide investors with the information they need to understand the nature of a registrant’s business and properties. We are seeking public input on whether there are any disclosure requirements that should be eliminated or modified and whether we should add any new disclosure requirements to these Items. 1. General Development of Business (Item 101(a)(1)) Item 101(a) of Regulation S–K requires a description of the general development of the business of the registrant during the past five years, or such shorter period as the registrant may have been engaged in business.182 In describing the general development of the business, Item 101(a)(1) requires disclosure such as the following: The year in which the registrant was organized and its form of organization; the nature and results of any bankruptcy, receivership or similar proceedings with respect to the registrant or any of its significant subsidiaries; the nature and results of any other material reclassification, merger or consolidation of the registrant or any of its significant subsidiaries; the acquisition or disposition of any material amount of assets otherwise than in the ordinary course of business; and any material changes in the mode of conducting the business. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter, as part of a general recommendation to limit disclosure requirements asking for the same or very similar information on multiple occasions, noted redundancies between current reports on Form 8–K and annual reports on Form 10–K and recommended that redundant disclosure in reports subsequent to disclosure in a Form 8–K should not be required.183 For example, and as noted by this commenter, Items 1.03 (Bankruptcy or Receivership) and 2.01 (Completion of Acquisition or Disposition of Assets) of Form 8–K require disclosure similar to the disclosure required under Item 101(a)(1). This commenter also recommended making a distinction 182 17 CFR 229.101(a)(1). Item 101(a)(1) states information shall be disclosed for earlier periods if material to an understanding of the general development of the business. 183 See CCMC (also noting redundancies between Item 4.01 of Form 8–K (Changes in Registrant’s Certifying Accountant) and Item 304 of Regulation S–K (disclosure of changes in and disagreements with accountants) and Item 3.02 of Form 8–K (Unregistered Sales of Equity Securities) and Item 701 of Regulation S–K (disclosure of recent sales of unregistered securities)). PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 23931 under Item 101(a)(1) for new registrants, which may be disclosing the general development of their business for the first time in a registration statement, and established reporting registrants, which would have disclosed such information in a previous filing. b. Discussion A requirement to provide a brief outline of the general development of the business for the preceding five years was included in the earliest forms of registration statements and annual reports.184 The first version of Regulation S–K adopted in 1977 included Item 101(a)(1) as part of the description of business disclosure requirements.185 At that time, the Commission amended Item 101(c) to delete a requirement to discuss specific business changes during the past three fiscal years noting ‘‘[a]ny material changes would be described pursuant to paragraph (a) of the item.’’ 186 Business developments and other disclosure called for by Item 101(a)(1) are often reflected elsewhere in the filing, such as in the financial statements or MD&A. Additionally, in 2004, the Commission expanded the number of reportable events on Form 8– K to include items that may result in disclosure that overlaps with the requirements of Item 101(a)(1), such as disclosure of entry into a material definitive agreement, including business combination agreements.187 c. Request for Comment 24. Does the current requirement in Item 101(a)(1) to describe the general development of a registrant’s business during the past five years provide useful disclosure that is not available either elsewhere in the current filing (e.g., MD&A or the notes to the financial 184 See, e.g., Item 6 of Form A–2 adopted in 1935, which required registrants to outline briefly ‘‘the general development of the business for the preceding five years.’’ See Release No. 33–276 (Jan. 14, 1935) [not published in the Federal Register]. Additionally, Item 5 of Form A–1, adopted in 1933, required registrants to briefly describe the length of time the registrant had been engaged in its business. See Release No. 33–5 (July 6, 1933) [not published in the Federal Register]. See also S–K Study at 32, footnote 88. 185 See 1977 Regulation S–K Adopting Release. 186 Id. at 65553. (‘‘The disclosure requirement relating to descriptions of products or services has also been amended to delete the requirement that changes in the kinds of products produced or services rendered or in the markets or methods of distribution during the past three fiscal years be discussed. Any material changes would be required to be described pursuant to paragraph (a) of the item.’’). 187 See Additional Form 8–K Disclosure Requirements and Acceleration of Filing Date, Release No. 33–8400 (Mar. 16, 2004) [69 FR 15594 (Mar. 25, 2004)] (‘‘2004 Form 8–K Adopting Release’’). E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 23932 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules statements) or in any prior filing, including current reports on Form 8–K? Should we require additional or more specific information under Item 101(a)(1) and, if so, what type of information and why? 25. How could we improve Item 101(a)(1)? For example, is the five-year time frame for this disclosure appropriate? Would a shorter or longer time frame be more appropriate? If so, what time frame would be appropriate and why? 26. Does this disclosure continue to be useful for registrants with a reporting history? Once a registrant has disclosed this information in a registration statement should we allow registrants to omit this disclosure from subsequent periodic reports unless material changes occur? Alternatively, should we require registrants to describe its business as currently conducted as well as any material changes that have occurred in the last five years? 27. Should we revise Item 101(a)(1) to require disclosure of a registrant’s business strategy? Would investors find such a disclosure important or useful? If so, should this requirement be included in a registrant’s MD&A? Should we define ‘‘business strategy’’? If so, how? 28. Should we permit a summary disclosure of the general development of a registrant’s business in all filings except the initial filing? For example, should we require a more detailed discussion of a registrant’s business in the initial filing, and in subsequent filings only require a summary of the registrant’s business along with a discussion of material changes in the business as previously disclosed in the registrant’s Form 10–K? Alternatively, should we require a more detailed discussion of a registrant’s business on a periodic basis, such as every three years, and a summary disclosure in other years? Should any such requirement be conditioned on timely reporting or some other consideration? 29. What types of investors or audiences are most likely to value the information required by Item 101(a)(1)? 30. What is the cost of providing the disclosure required by Item 101(a), including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 101(a). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 2. Narrative Description of Business (Item 101(c)) While Item 101(a) requires disclosure of the general development of the business, Item 101(c) requires a narrative description of a registrant’s business and identifies thirteen specific items that must be disclosed: 188 (i) principal products produced and services rendered; (ii) new products or segments; (iii) sources and availability of raw materials; (iv) intellectual property; (v) seasonality of the business; (vi) working capital practices; (vii) dependence on certain customers; (viii) dollar amount of backlog orders believed to be firm; (ix) business subject to renegotiation or termination of government contracts; (x) competitive conditions; (xi) company-sponsored research and development activities; (xii) compliance with environmental laws; and (xiii) number of employees. a. Comments Received S–K Study. Two commenters recommended eliminating the requirement in Item 101(c) to disclose the amount of backlog orders believed to be firm for EGCs, stating the concept of backlog is not a ‘‘meaningful metric’’ for most of these companies.189 These commenters stated that eliminating this requirement for EGCs would not ‘‘compromise the delivery of meaningful disclosure to investors.’’ These commenters also raised the question of whether the concept of backlog (or for businesses other than industrials, some other measure of committed revenue that is not yet reflected in the financial statements) would be addressed more appropriately in MD&A. Another commenter recommended eliminating disclosure requirements that no longer apply due to market or other changes and noted backlog as an example.190 This commenter recommended eliminating this requirement for all 188 17 CFR 229.101(c). Item 101(c)(1) specifies that, to the extent material to an understanding of the registrant’s business taken as a whole, the description of each segment must include the information specified in subsections (i) through (x). Information in subsections (xi) to (xiii) is required to be discussed for the registrant’s business in general; where material, the segments to which these matters are significant also must be identified. 189 See Silicon Valley and M. Liles. Item 101(c)(1)(viii) requires disclosure of the dollar amount of backlog orders believed to be firm, as of a recent date and as of a comparable date in the preceding fiscal year, together with an indication of the portion thereof not reasonably expected to be filled within the current fiscal year, and seasonal or other material aspects of the backlog. 190 See Ernst & Young 1. PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 registrants, not only EGCs, or moving this requirement to MD&A. Disclosure Effectiveness Initiative. One commenter stated that many of the subsections of Item 101(c) would be more appropriately addressed elsewhere in the filing, stating that when such information is material to a registrant, investors would be better served by having the registrant address that information in its MD&A or risk factors.191 b. Discussion Consistent with Schedule A of the Securities Act, the earliest forms of registration statements and annual reports required a brief outline of the general character of the business done and intended to be done by a registrant.192 Many of the disclosure requirements that currently appear in Item 101(c) were adopted in 1973 following investigation of the hot issues markets.193 The adopting release notes that, in making investment decisions, venture capitalists and underwriters typically obtain specific information from companies about their competitive position and the methods of competition in their respective industries, and accordingly, the new requirements were expected to provide similar information to the investing public.194 At the same time, the Commission also added requirements for the disclosure of the amount of backlog orders, the sources and availability of raw materials essential to the business, the number of employees and working capital practices.195 In the S–K Study, the staff recommended reviewing the description of business for continuing relevance in 191 See SCSGP (stating that the following subsections of Item 101 would be more useful if included in MD&A: backlog ((c)(1)(viii)), working capital practices ((c)(1)(vi)), sources and availability of raw materials ((c)(1)(iii)), dependence on certain customers ((c)(1)(vii)), competitive conditions ((c)(1)(x)), compliance with environmental laws ((c)(1)(xii)) and risks attendant to foreign operations ((d)(3))). 192 See, e.g., Item 5 of Form A–2 adopted in 1935, which required registrants to outline briefly ‘‘the general character of the business done and intended to be done by the registrant and its subsidiaries.’’ See Release No. 33–276 (Jan. 14, 1935) [not published in the Federal Register]. Additionally, Items 3 through 5 of Form A–1, adopted in 1933, required registrants to briefly describe the ‘‘character of business done or intended to be done,’’ disclose a list of states where the issuer owned property and was qualified to do business, and the length of time the registrant had been engaged in its business. See Release No. 33–5 (July 6, 1933) [not published in the Federal Register]. See also S–K Study at 32, footnote 88. 193 See Hot Issues Adopting Release. See also Hot Issues; Meaningful Disclosure, Release No. 33–5274 (July 26, 1972) [37 FR 16005 (Aug. 9, 1972)]. 194 See Hot Issues Adopting Release. 195 See id. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules light of changes that have occurred in the way businesses operate, which may make other disclosures relevant that are not expressly addressed under current requirements.196 As an example, the S– K Study noted that requirements could be more specific as to additional disclosure that would be necessary where a business relies heavily on intellectual property owned by a third party or relies on a service agreement with third parties to perform necessary business functions.197 c. Request for Comment 31. Do the disclosure requirements in Item 101(c) continue to provide useful information to investors? How could we improve Item 101(c)’s requirements? 32. How could we update Item 101(c) to better reflect changes in the way businesses operate? Are there particular categories or types of registrants for which these disclosure requirements are more or less relevant? 33. Are there additional line-item disclosure requirements about a registrant’s business that would improve the quality and consistency of disclosure? Are there any categories of information that certain registrants voluntarily provide, and are not required to disclose under Item 101(c), that we should include in Item 101(c)? 198 What would be the benefits and challenges of requiring disclosure of additional categories of information? 34. Currently, some registrants include in their business section a general description of their industry. Should industry disclosure be a separate requirement? If so, would this requirement be more useful to investors in the business section or in MD&A? 35. Should we require additional specific disclosure relevant to particular industries, such as manufacturing or technology companies? If so, which industries and why? What are the benefits and challenges of requiring industry-specific disclosure? 199 36. What is the impact on disclosure of listing the thirteen item requirements in Item 101(c)? In practice, do registrants view Item 101(c) as a checklist? Do the prescriptive items result in disclosure of information that is not important by some registrants? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 196 See S–K Study at 99–100. and in other parts of this release, we discuss other areas where our requirements could be revised to reflect changes in the way businesses operate. 198 For example, the staff has observed that many registrants provide disclosure about the regulatory environment in which their business operates although no specific line-item disclosure requirement for this exists. 199 For a discussion of industry-specific disclosures, see Section IV.E. 197 Below, VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 37. Should we require Item 101(c) disclosure only in the initial filing with follow-up disclosure of any material changes for subsequent years? Should any such requirement be conditioned on timely reporting or some other consideration? Should the requirements differ for registration statements and periodic reports? 38. Is there any information currently disclosed in the description of business that should be presented in a different context such as MD&A or risk factors? Why? 39. In some circumstances, disclosure is required under Item 101(c)(1) if material. The item specifies that, to the extent material to an understanding of the registrant’s business taken as a whole, the description of each segment shall include the information in (c)(1)(i) through (x) and that matters in (c)(1)(xi) through (xiii) shall be discussed for the registrant’s business in general; where material, the segments to which these matters are significant shall be identified. Additionally, some sub-items of Item 101(c)(1) require disclosure if material, such as (c)(1)(ii) and (c)(1)(ix),200 while others do not.201 Should we require disclosure of all line items in Item 101(c) in all circumstances, regardless of materiality? Why or why not? Alternatively, would a principles-based approach to disclosure about a registrant’s business and operations allow flexibility to disclose information that is important to investors? If so, how should such a disclosure requirement be structured? What factors should we consider in developing such a requirement? 40. What types of investors or audiences are most likely to value the information required by Item 101(c)? Would an alternative format or presentation of the information improve the value of such disclosure to a particular type of investor or audience? If so, what type of format or presentation? 41. What is the cost of providing the disclosure required by Item 101(c), 200 For example, Item 101(c)(1)(ii) requires a description of the status of a product or segment (e.g., whether in the planning stage, whether prototypes exist, the degree to which product design has progressed or whether further engineering is necessary), if there has been a public announcement of, or if the registrant otherwise has made public information about, a new product or segment that would require the investment of a material amount of the assets of the registrant or that otherwise is material. In addition, Item 101(c)(1)(ix) requires a description of any material portion of the business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the Government. 201 For example, Item 101(c)(1)(xiii) requires disclosure of the number of persons employed by the registrant. PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 23933 including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 101(c). 3. Technology and Intellectual Property Rights (Item 101(c)(1)(iv)) Item 101(c)(1)(iv) requires disclosure of the importance to the segment and the duration and effect of all patents, trademarks, licenses, franchises and concessions held.202 a. Comments Received S–K Study. None Disclosure Effectiveness Initiative. None. b. Discussion A broad range of industries benefit from intellectual property, both directly and indirectly,203 and intellectual property has become increasingly important to business performance.204 Certain industries produce or use significant amounts of intellectual property or rely more heavily on these rights.205 Accordingly, certain registrants provide detailed disclosure in response to Item 101(c)(1)(iv), and disclosure varies among registrants and across industries. In the biotechnology and pharmaceutical industries, registrants that provide detailed patent disclosure often disclose the jurisdiction in which the patent was filed, year of expiration, type of patent (e.g., composition of 202 17 CFR 229.101(c)(1)(iv). Economics and Statistics Administration and United States Patent and Trademark Office, Intellectual Property and the U.S. Economy: Industries in Focus (March 2012) at iv, available at https://www.uspto.gov/sites/default/files/news/ publications/IP_Report_March_2012.pdf (‘‘Intellectual Property and the U.S. Economy’’). 204 See, e.g., Kelvin W. Willoughby, What impact does intellectual property have on the business performance of technology firms?, Int. J. Intellectual Property Management, Vol. 6, No. 4 (2013). 205 See Intellectual Property and the U.S. Economy. This report identifies seventy-five industries as ‘‘IP-intensive.’’ In this report, patents, trademarks and copyrights were the categories of intellectual property assessed. The methodology for designating each of these subcategories as ‘‘IPintensive’’ is outlined further in this report. For patent intensive industries, the report utilized the North American Industry Classification System (NAICS) codes and identified, as the four most patent-intensive industries, those industries classified in computer and electronic product manufacturing (NAICS 334). This three-digit NAICS industry includes computer and peripheral equipment; communications equipment; other computer and electronic products; semiconductor and other electronic components; and navigational, measuring, electro-medical, and control instruments. 203 See E:\FR\FM\22APP3.SGM 22APP3 23934 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 matter, method of use, method of delivery or method of manufacturing), products or technologies to which the patent relates and how the patent was acquired (e.g., licensed from another entity or owned and filed by the registrant). Some registrants in these industries aggregate patent disclosure by groups of patents, potentially making disclosure about individual material patents difficult to discern. As registrants in the biotechnology and pharmaceutical industries regularly sell one or a few patented products that generate substantial revenue, disclosure of ‘‘patent cliffs,’’ 206 which often result in material adverse financial effects, may be required in the risk factors section or MD&A. In the information technologies and services industry, registrants protect their intellectual property through the use of patents, trademarks, copyrights, trade secrets, licenses and confidentiality agreements.207 Registrants with large portfolios of intellectual property often disclose that their products, services and technologies are not dependent on any specific patent, trademark, copyright, trade secret or license. As a result, these registrants often provide only high-level discussions of their intellectual property portfolios, which include general statements of a registrant’s development, use and protection of its intellectual property. Registrants with smaller intellectual property portfolios tend to provide slightly more detailed discussions, including, for example, disclosure of their total number of issued patents, a range of years during which those patents expire and their total number of pending patent applications. In general, registrants in the information technologies and services industry use copyrights to protect against the unauthorized copying of software programs 208 and trade secrets 206 The term ‘‘patent cliff’’ as used in the biotechnology and pharmaceutical industry refers to a future loss of patent protection and consequential loss of revenue. These potential future losses are known to registrants far in advance of their onset. When they occur, they often precipitate material adverse financial effects. See, e.g., Andrew Jack, Pharma tries to avoid falling off ‘patent cliff,’ Financial Times, May 6, 2012 and Cliffhanger, Economist, Dec. 3, 2011. See also Ed Silverman, Big Pharma Faces Some Big Patent Losses, but Pipelines are Improving, Wall St. J.: L. Blog, available at https://blogs.wsj.com/pharmalot/ 2015/02/09/big-pharma-faces-some-big-patentlosses-but-pipelines-are-improving/. 207 See Bruce Abramson, Promoting Innovation in the Software Industry: A First Principles Approach to Intellectual Property Reform, 8 B.U. J. Sci. & Tech. L. 75 (2002) (discussing the software industry’s use of intellectual property law). 208 See Dennis S. Karjala, Copyright Protection of Operating Software, Copyright Misuse, and VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 to protect proprietary and confidential information that derives its value from continued secrecy.209 Since Item 101(c)(1)(iv) does not require disclosure about copyrights or trade secrets, registrants currently make disclosure about such matters voluntarily. c. Request for Comment 42. Should we retain the current scope of Item 101(c)(1)(iv), which requires disclosure of a registrant’s patents, trademarks, licenses, franchises and concessions? Should we expand the rule to include other types of intellectual property, such as copyrights? Should we remove the individual categories and instead require disclosure of ‘‘intellectual property’’? If so, should we define that term and what should it encompass? 43. What, if any, additional information about a registrant’s reliance on or use of technology and related intellectual property rights should we require and why? Should we revise Item 101(c)(1)(iv) to require more detailed intellectual property disclosure, similar to the disclosure currently provided by some biotechnology and pharmaceutical registrants? If so, should we require such detailed disclosures for all or only some of a registrant’s intellectual property, such as those that are material to the business? 44. For registrants with large intellectual property portfolios, does aggregate disclosure of the total number of patents, trademarks and copyrights and a range of expiration dates provide investors with sufficient information? If not, what additional information do investors need about a company’s portfolio of intellectual property? Would tabular disclosure or an alternate format or presentation of a registrant’s intellectual property portfolio make the information more useful to investors? What would be the benefits and challenges of requiring disclosure of this information in this format? 45. Should we limit these disclosure requirements to registrants in particular industries? If so, which industries should we specify and why? Is disclosure about a registrant’s intellectual property most useful in the context of the description of business, disclosure about trends and developments affecting results of Antitrust, 9 Cornell J.L. & Pub. Pol’y 161, 172 (1999) (discussing the dependence of software technology companies on copyright). 209 See Raymond T. Nimmer & Patricia Ann Krauthaus, Software Copyright: Sliding Scales and Abstracted Expression, 32 Hous. L. Rev. 317, 325 (1995) (distinguishing between the software industry’s use of trade secret law, patent law and copyright law). PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 operations, or in a discussion of risk and risk management? 46. What are the competitive costs of disclosure under Item 101(c)(1)(iv)? 4. Government Contracts and Regulation, Including Environmental Laws (Items 101(c)(1)(ix) and (c)(1)(xii)) Item 101(c)(1)(ix) requires disclosure of any material portion of a business that may be subject to renegotiation of profits or termination of contracts or subcontracts at the election of the government.210 Item 101(c)(1)(xii) requires disclosure of the material effects of compliance with environmental laws on the capital expenditures, earnings and competitive position of the registrant and its subsidiaries, as well as any material estimated capital expenditures for the remainder of the fiscal year, the succeeding fiscal year, and such future periods that the registrant deems material.211 There is no separate lineitem requirement to discuss government regulation that may be material to a registrant’s business. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter suggested including an instruction to Item 101(c)(1)(ix) to specify that, to the extent disclosure responsive to this item is included in the notes to the financial statements, cross-references should be used to avoid duplicative disclosure.212 Another commenter stated that registrants in the pharmaceutical industry noted that high levels of regulatory disclosure and other issues common to all pharmaceutical registrants have become commonplace and have detracted from meaningful disclosure.213 Two commenters sought 210 17 CFR 229.101(c)(1)(ix). CFR 229.101(c)(1)(xii). 212 See ABA 2. U.S. government contracts generally contain provisions that enable the contract to be terminated, in whole or in part, without prior notice, at the government’s convenience (due to lack of funding or for other reasons) or for default based on performance. ASC 912–275–50–1 requires footnote disclosure of renegotiation uncertainties, their significance, and renegotiation discussions relating to the current year. In addition, ASC 912–275–50– 6 states that if there are indications that a contract termination may occur and the termination would have a material effect on the contractor’s operations, disclosure of the circumstances and the potential effects shall be made in the notes to financial statements. The staff has observed that, rather than provide duplicative disclosure, some government contractors cross-reference their discussion of the government’s right to terminate a contract under Item 101(c)(1)(ix) to either their accounting policy disclosure for revenue recognition in the critical accounting estimates disclosure in MD&A or to their significant accounting policies in the notes to the financial statements. 213 See Shearman. 211 17 E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules increased disclosure of a registrant’s corporate structure and tax strategy.214 One of these commenters recommended specific disclosures such as a list of each country of operation and the name of each entity of the issuer group domiciled in each country of operation and the total pre-tax gross revenues of each member of the issuer group in each country of operation.215 b. Government Contracts (Item 101(c)(1)(ix)) mstockstill on DSK4VPTVN1PROD with PROPOSALS3 i. Discussion Business contracts with agencies of the U.S. government and the various laws and regulations relating to procurement and performance of U.S. government contracts impose terms and rights that are different from those typically found in commercial contracts. In a 1972 Notice to Registrants, the Commission noted that government contracts are subject to renegotiation of profit and to termination for the convenience of the government.216 At any given time in the performance of a government contract, an estimate of its profitability is often subject not only to additional costs to be incurred but also to the outcome of future negotiations or possible claims relating to costs already incurred.217 Registrants with U.S. government contracts tend to disclose that the funding of these contracts is subject to the availability of Congressional appropriations and that, as a result, long-term government contracts are partially funded initially with additional funds committed only as Congress makes further appropriations. These registrants disclose that they may be required to maintain security clearances for facilities and personnel in order to protect classified information. Additionally, these registrants state that they may be subject to routine government audits and investigations, and any deficiencies or illegal activities identified during the audits or investigations may result in the forfeiture or suspension of payments and civil or criminal penalties. 214 See letter from US SIF and US SIF Foundation (Sept. 18, 2014) (‘‘US SIF 1’’) (stating that a lack of information about a registrant’s subsidiaries ‘‘prevent investors from accurately assessing corporate tax structure and tax strategy and the attendant contingent liabilities, as well as exposures to political risks in these countries’’), and AFL–CIO (‘‘Even minor changes to US or foreign tax policy could lead to major changes in the issuer’s financial performance.’’). 215 See AFL–CIO. 216 See Defense and Other Long Term Contracts; Prompt and Accurate Disclosure of Information, Release No. 33–5263 (June 22, 1972) [37 FR 21464 (Oct. 11, 1972)]. 217 Id. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 ii. Request for Comment 47. Is disclosure about government contracts important to investors? Why? Is there any additional information about a registrant’s contracts with the government that would be important to investors? 48. Rather than focusing specifically on government contracts, should we require registrants to briefly describe all material contracts? Would such a requirement elicit disclosure not otherwise provided in MD&A or the description of business? c. Compliance with Environmental Laws (Item 101(c)(1)(xii)) i. Discussion Pursuant to NEPA, which mandated consideration of the environment in regulatory action, the Commission adopted Item 101(c)(1)(xii) in 1973 to require disclosure of the material effects compliance with federal, state and local environmental laws may have on the capital expenditures, earnings and competitive position of the registrant.218 Subsequent litigation concerning both the denial of a rulemaking petition and adoption of the 1973 environmental disclosure requirements resulted in the Commission initiating public proceedings in 1975 primarily to elicit comments on whether the provisions of NEPA required further rulemaking.219 As a result of these proceedings, the Commission in 1976 amended the requirements to specifically require disclosure of any material estimated capital expenditures for environmental control facilities for the remainder of the registrant’s current and succeeding fiscal years, and for any further periods that are deemed material.220 ii. Request for Comment 49. Should we increase or reduce the environmental disclosure required by Item 101(c)(1)(xii)? Why? What kind of information should we add to or remove from this requirement? 50. Is disclosure about the material effects that compliance with provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, may have upon a registrant’s capital expenditures, earnings and competitive position important to investors? If so, should we require registrants to present this disclosure in a specific format? Would this disclosure be more appropriate in MD&A or the business section? 218 See supra note 61. Notice of Public Proceedings on Environmental Disclosure Release. 220 See 1976 Environmental Release. 219 See PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 23935 51. Should we require specific disclosure about the material effects that other regulations may have on a registrant’s capital expenditures, earnings and competitive position? If so, are there specific laws and regulations that our rules should cover? d. Government Regulation i. Discussion Although not referenced in Item 101, many registrants discuss government regulations relevant to their business.221 Healthcare and insurance providers regularly disclose the registrant’s collection, use and protection of individually-identifiable information and its compliance with the Health Insurance Portability and Accountability Act of 1996,222 as well as the impact of the Patient Protection and Affordable Care Act 223 on its business. Biotechnology or medical device companies often disclose the status of and process for FDA approval of significant new drugs or medical devices. Public utilities typically discuss regulation by various federal, state and local authorities and include information about state ratemaking procedures, which determine the rates utilities charge and the return on invested capital they earn. Registrants in the financial services industry regularly describe federal and state regulation as well as supervision by the Federal Reserve Board, while registrants with a material amount of U.S. government contracts disclose the laws and regulations for government contracts. Registrants with tax strategies involving foreign jurisdictions typically disclose that they are subject to income taxes in both the U.S. and numerous foreign jurisdictions, and that future changes to U.S. and non-U.S. tax law could adversely affect their anticipated financial position and results. Some disclose the impact on their business of tax treaties between the U.S. and one or more foreign jurisdictions. 221 However, the disclosure requirements applicable to SRCs do require some of this information, to the extent material. Item 101(h)(4)(viii) requires disclosure of the need for any government approval of principal products or services. If government approval is necessary and the SRC has not yet received that approval, SRCs are required to discuss the status of the approval within the government approval process. The staff has observed that biotechnology or medical device companies that are not SRCs also provide this disclosure. Additionally, Item 101(h)(4)(ix) requires disclosure of the effect of existing or probable governmental regulations on the business. For a discussion of scaled disclosure requirements, see Section IV.H.2. 222 Public Law 104–191, 110 Stat. 1936 (1996). 223 Public Law 111–148, 124 Stat. 119 (2010). E:\FR\FM\22APP3.SGM 22APP3 23936 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules ii. Request for Comment 52. Given that many registrants provide disclosure of material government regulations without a specific line-item requirement, are the current disclosure requirements sufficient? Would a specific requirement seeking this disclosure provide additional information that is important to investors? If so, what specific information and level of detail should we require and why? What would be the costs of requiring disclosure of this information? 53. Foreign regulations, including foreign tax rates and treaties, may have a material impact on a registrant’s operations. Should we specifically require registrants to describe foreign regulations that affect their business? If so, what specific information and level of detail should we require? How would any additional information inform investment and voting decisions? Would there be challenges for registrants to provide such disclosure? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 5. Number of Employees (Item 101(c)(1)(xiii)) Item 101(c)(1)(xiii) requires disclosure of the number of persons employed by the registrant. The Division of Corporation Finance (‘‘Division’’) has provided interpretive guidance on this requirement stating that, in industries where the general practice is to hire independent contractors rather than employees, companies should disclose the number of persons retained as independent contractors as well as the number of regular employees.224 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter suggested requiring disclosure of the number of employees for each of a registrant’s subsidiaries along with other information about the subsidiaries, to provide investors with the information necessary to understand the structure of the registrant and its international strategy.225 This commenter stated that disclosure of a subsidiary in a known tax haven with ‘‘zero employees and billions in profits, for example, would signal to investors the use of a particularly aggressive and potentially risky strategy to hide profits from regulators.’’ b. Discussion The number of persons employed by the registrant can help investors assess 224 See Regulation S–K Compliance and Disclosure Interpretations Question 203.01, available at https://www.sec.gov/divisions/corpfin/ guidance/regs-kinterp.htm. 225 See US SIF 1. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 the size and scale of a registrant’s operations. Changes in the number or type of persons employed can also be indicative of trends or shifts in a registrant’s operations. Disclosure of the number of employees varies among registrants. Some registrants distinguish between the number of full-time and part-time employees, and others specify the number of employees in each department or division. Registrants with large numbers of employees often disclose the approximate number of employees and discuss their employees’ membership in a union or similar organization. Other registrants characterize the state of their employee relations and disclose whether their employees are covered by a collective bargaining agreement or represented by a labor union. c. Request for Comment 54. Does disclosure of the number of persons employed by the registrant help investors assess the size, scale and viability of a registrant’s operations and any trends or shifts in operations? Is this disclosure important to investors and why? Is there any additional information about employees that would be important to investors? If so, what information? 55. For new registrants filing a registration statement that have not had revenue from operations during each of the preceding three fiscal years, Item 101(a)(2)(iii) requires disclosure of any anticipated material changes in the number of employees in the various departments such as research and development, production, sales or administration.226 Is this information useful to investors? Should we include a similar requirement for all registrants in periodic and current reports? Should this requirement be in addition to or in lieu of the current requirement to disclose the number of employees? 56. Should we require registrants to distinguish among their total number of persons employed, such as by distinguishing between: • Full-time and part-time or seasonal employees; • Employees and independent contractors; or • Domestic and foreign employees? Why or why not? 57. Rather than requiring registrants to disclose the number of employees or independent contractors, should we 226 Item 101(a)(2) applies to registrants filing a registration statement on Form S–1 or Form 10 that are not subject to Sections 13(a) or 15(d) of the Exchange Act and have not received revenue from operations during each of the three fiscal years immediately before the filing of such registration statement. PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 require or permit registrants to provide a range? Why? Should we allow for different ranges based on the size of the registrant? Would reporting a range rather than a specific number reduce the costs of producing this disclosure? 58. Should we require disclosure of additional information about a registrant’s employees or employment practices? What would be the challenges of requiring disclosure of any additional information, and what would be the benefits to investors? 59. As outsourcing and subcontracting have become more prevalent in the last few decades,227 what, if any, additional information about a registrant’s outsourcing or subcontracting arrangements should we require? Would this information be most useful in the context of the description of the registrant’s business, disclosure about trends and developments affecting results of operations, or in a discussion of risk and risk management? What would be the challenges of requiring disclosure of this information? 6. Description of Property (Item 102) Item 102 of Regulation S–K requires disclosure of the location and general character of the principal plants, mines and other materially important physical properties of the registrant and its subsidiaries. Item 102 also requires registrants to identify the segments, as reported in the financial statements, that use the properties described. Instruction 1 states that registrants must disclose such information as reasonably will inform investors as to the suitability, adequacy, productive capacity and extent of utilization of the facilities by the registrant.228 Instruction 2 provides that, in determining whether properties should be described, registrants should take into account both quantitative and qualitative factors.229 227 See, e.g., Deloitte, Deloitte’s 2014 Global Outsourcing and Insourcing Survey (2014), available at https://www2.deloitte.com/content/ dam/Deloitte/us/Documents/strategy/us-2014global-outsourcing-insourcing-survey-report123114.pdf (noting a significant rise in offshoring in the last two decades but also a small but growing reversal where companies that had previously offshored functions are bringing them back to their home country); Here, there and everywhere, Economist, Jan. 19, 2013 (discussing offshoring trends in the last several decades, but also noting such trends are ‘‘maturing, tailing off and to some extent being reversed’’). 228 Detailed descriptions of the physical characteristics of individual properties or legal descriptions by metes and bounds are not required. See Instruction 1 to Item 102. 229 Disclosure specific to the mining industry in Item 102—Instructions 3, 5 and 7 refer to the mining industry—is outside of the scope of this release. Commission staff is undertaking a separate review of disclosure requirements for mining activities. Instructions 4, 6 and 8 apply to the oil E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules a. Comments Received S–K Study. One commenter recommended that property disclosure should not be required for entities where physical plant or properties are not a significant element of enterprise value.230 Disclosure Effectiveness Initiative. Two commenters noted that if material to a registrant’s business, MD&A would require a discussion of the importance of a property or facility and, in these instances, Item 102 may result in immaterial or duplicative disclosure.231 One commenter recommended eliminating Item 102 disclosure, stating that disclosure of physical properties does not, in most cases, provide investors meaningful information, particularly for registrants not engaged in manufacturing.232 Another commenter cautioned against disclosing only material properties and eliminating requirements to list locations, capacity and ownership.233 This commenter stated that investors need a complete understanding of the scope of a registrant’s operations and assets in order to evaluate the scope of its risks and opportunities. One commenter noted different triggers for disclosure in Item 102 such as the item’s reference to ‘‘materially’’ important physical properties and ‘‘major’’ encumbrance. This commenter recommended a Commission study to determine whether these varied formulations should be harmonized to lessen ambiguity on their application.234 b. Discussion mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Since 1935, we have required disclosure similar to that required under Item 102.235 The predecessor to Item 102 called for a brief description of the general character and location of ‘‘principal plants and other important units’’ of the registrant and its subsidiaries and, for property not held in fee, a description of how the property was held.236 In 1977, a similar requirement was one of two original requirements in Regulation S–K and additionally, required registrants to and gas industry. Disclosure specific to the oil and gas industry was considered in 2008 and is also outside of the scope of this release. See Oil and Gas Release. Instruction 9 applies to the real estate industry. For a general discussion of Industry Guides, see Section IV.E. 230 See Ernst & Young 1. 231 See CCMC; SCSGP. 232 See Shearman. 233 See US SIF 1. 234 See ABA 2. 235 See Release No. 33–276 (January 14, 1935) [not published in the Federal Register]. 236 Id. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 identify the segments that use the properties described.237 In 1996, the Task Force on Disclosure Simplification recommended the Commission revise Item 102 to more effectively elicit disclosure of material facts about a registrant’s principal properties, rather than lists of properties and their immaterial characteristics.238 The S–K Study recommended reviewing Item 102 for continuing relevance given that many businesses no longer require or depend on physical locations.239 For businesses that do have material properties, the S–K Study suggested refocusing disclosure on the significance of the property to the business and any trends or uncertainties in connection with that property, rather than requiring a list of locations, capacity and ownership.240 In response to Item 102, registrants typically disclose information about their headquarters such as the location, size and whether they own or lease the property, as well as information about other properties material to the business. In addition to this disclosure, some registrants cross-reference to the discussion in the notes to the financial statements such as to the note on purchase and lease commitments or to the note on property, plant and equipment. Registrants in certain industries may provide more specific disclosures. For example, registrants with retail stores often disclose the number of their stores, location, size and lease termination dates. Registrants in the hotel and lodging industry tend to disclose the location and number of rooms at each of their properties. Some registrants with casino operations disclose the number of table games and slot machines at each location. Registrants in the restaurant industry tend to disclose the number of their restaurants, location and whether they are registrant-operated or franchiseeoperated stores. In the paper mill or paper production industry, registrants typically provide tabular disclosure for facilities including their geographic location and related products or use. By contrast, some registrants, such as those that provide services or information technology, may not have material physical properties and tend to disclose information about their corporate headquarters, office space and other facilities. 1977 Regulation S–K Adopting Release. Task Force Report. 239 See S–K Study at 99–100. 240 See id. 23937 c. Request for Comment 60. Should we retain or eliminate Item 102? Why or why not? How could Item 102 be improved? 61. Would any additional disclosure about a registrant’s properties be important to investors? If so, what additional disclosure would be important? What would be the challenges to registrants of requiring disclosure of any such additional information, and what would be the benefits to investors? 62. For registrants that may not have material physical properties, is the disclosure that registrants typically provide about their corporate headquarters, office space and other facilities important to investors? 63. Should we require property disclosure only for registrants in certain industries? If so, how should we identify these industries? 64. Should the disclosure requirements focus instead on the risks to a registrant’s business resulting from the availability and cost of properties it needs for its operations? 65. What types of investors or audiences are most likely to value the information required by Item 102? 66. What is the cost of providing the disclosure required by Item 102, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 102. B. Company Performance, Financial Information and Future Prospects Financial information is essential to understanding a registrant’s performance, financial condition and future prospects. The Commission has long recognized the need for a narrative explanation of the financial statements, as a numerical presentation and accompanying footnotes alone may be insufficient for an investor to assess the quality of the earnings and the likelihood that past performance is indicative of future performance.241 Regulation S–X requires companies to provide annual and quarterly financial statements,242 while several items in Regulation S–K require additional disclosure about a registrant’s financial condition and results of operations: • Item 301 requires disclosure of selected financial data; 237 See 238 See PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 241 See, e.g., 1989 MD&A Interpretive Release. 3, 8 and 10 of Regulation S–X [17 CFR 210.3, 210.8 and 210.10]. 242 Articles E:\FR\FM\22APP3.SGM 22APP3 23938 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules • Item 302(a) requires disclosure of selected quarterly financial data; 243 and • Item 303 requires disclosure of management’s discussion and analysis of financial condition and results of operations. We are reviewing these disclosure requirements to determine whether they continue to provide investors with information that is important to evaluating a registrant’s performance, financial condition and prospects for the future and what, if any, aspects of the disclosure requirements are duplicative. We are seeking public input on whether we should consider any new disclosure requirements and whether we should eliminate or modify any existing disclosure requirement related to such matters. 1. Selected Financial Data (Item 301) Item 301 requires registrants to disclose selected financial data that highlight significant trends in the registrant’s financial condition and results of operations.244 Disclosure must be provided in comparative columnar form for each of the registrant’s last five fiscal years and any additional fiscal years necessary to keep the information from being misleading. Instruction 2 to Item 301 lists specific items that must be included, subject to appropriate variation to conform to the nature of the registrant’s business, and provides that registrants may include additional items they believe would enhance an understanding of and would highlight other trends in their financial condition and results of operations.245 Registrants must include selected financial data in their annual reports but this is not a requirement for quarterly reports. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. Two commenters suggested eliminating Item 301.246 One of these commenters noted that readers can discern trends from a registrant’s financial statements 243 The staff is separately considering Item 302(b), which requires certain disclosures of oil and gas activities, as part of its work to develop recommendations for the Commission for potential changes to update or simplify certain disclosure requirements. For a description of this project, see Section I. 244 Item 301 of Regulation S–K [17 CFR 229.301]. 245 Instruction 2 to Item 301 of Regulation S–K lists the following items that must be included in the table of financial data: net sales or operating revenues; income (loss) from continuing operations; income (loss) from continuing operations per common share; total assets; long-term obligations and redeemable preferred stock (including longterm debt, capital leases, and redeemable preferred stock); and cash dividends declared per common share. 246 See Shearman; SCSGP. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 and MD&A,247 while the other commenter stated the information required by this item can be readily obtained from sources other than Commission filings.248 Two commenters suggested revising Item 301 to allow registrants to omit the earliest two of the last five fiscal years where the information cannot be provided without unreasonable cost or expense.249 One of these commenters suggested limiting the required disclosure to the last three fiscal years, unless all five years are necessary to illustrate a material trend in the registrant’s business.250 The other commenter also noted challenges to registrants in recasting annual periods prior to those presented in the financial statements to reflect a retrospective accounting change and suggested allowing registrants to present a retrospective accounting change only for the periods presented in the financial statements if the earlier periods cannot be recast without unreasonable effort and cost.251 To inform investors why this information is unavailable, this commenter suggested ‘‘clear disclosure about the unreasonable effort’’ that would be required to recast these earliest periods.252 b. Five-Year Trend Data (Instruction 1) i. Discussion Item 301 is intended to provide selected financial data in a convenient and readable format that highlights significant trends in the registrant’s financial condition and results of operations.253 In adopting this requirement, the Commission stated that Item 301 was relevant primarily where it related to trends in the registrant’s continuing operations.254 When adopted, this item replaced a previous requirement that called for a summary of operations.255 247 See Shearman. SCSGP. 249 See ABA 2 (stating this accommodation should be allowed where the information is unavailable or not obtainable without unreasonable cost or expense as long as information (qualitative and, if reasonably available without unreasonable cost or expense, quantitative) about a material trend is otherwise provided for such two fiscal years) and Ernst & Young 2 (noting Item 3.A of Form 20–F provides this accommodation for foreign private issuers and that EGCs are also allowed a similar accommodation). 250 See ABA 2. 251 See Ernst & Young 2. 252 Id. 253 Instruction 1 to Item 301 [17 CFR 229.301]. See also 1980 Form 10–K Adopting Release. 254 See 1980 Form 10–K Adopting Release. See also 1980 Form 10–K Proposing Release. 255 See 1980 Form 10–K Adopting Release. While the item in its current form was not adopted until 1980, the concept of providing a five-year 248 See PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 Most of the items required by Item 301 are also required in the annual financial statements. Unlike the financial statements required in a Form 10–K, however, Item 301 information covers each of the registrant’s last five fiscal years. Accordingly, Item 301 disclosure for items such as net sales and income or loss from continuing operations in the income statement 256 and total assets and redeemable preferred stock in the balance sheets,257 overlaps with disclosure in the financial statements for the most recent three and two years, respectively.258 Earlier years required to be disclosed under Item 301 are typically available in prior annual reports. When the precursor to Item 301 was adopted in 1970, prior annual reports were not readily accessible.259 Today, these reports can be readily accessed through EDGAR and other public sources, including company Web sites. Despite some overlap with current and prior financial statements, Item 301 disclosure can provide information that might not be available to investors for all five years. Specifically, retrospective changes to the annual financial statements would typically be reflected in the selected financial data table across all five years instead of the three years covered in the financial statements.260 For example, a registrant that retrospectively revises its annual financial statements to reflect discontinued operations typically may need to consider whether it should adjust years four and five in its selected financial data table in addition to the three most recent years covered in the annual audited financial statements. presentation of certain significant line items was suggested as early as 1967. See Wheat Report at 338–39 (recommending that the Commission require registrants to provide a five-year earnings summary annually). In October 1970, the Commission expanded Form 10–K to include ‘‘Item 2—Summary of Operations,’’ which required registrants to furnish in comparative columnar form a five-year summary of operations and any additional fiscal years necessary to keep the summary from being misleading. See Annual Reports by Certain Companies Having Registered Securities, Release No. 34–9000 (Oct. 21, 1970) [35 FR 16919 (Nov. 3, 1970)] (‘‘1970 Revised Form 10–K Adopting Release’’). 256 Rule 5–03 of Regulation S–X [17 CFR 210.5– 03]. 257 Rule 5–02 of Regulation S–X [17 CFR 210.5– 02]. 258 SRCs are not subject to the requirements of Item 301. Item 301(c) of Regulation S–K [17 CFR 229.301(c)]. 259 Before adopting the precursor to Item 301, the Commission implemented a microfiche system in 1968 that supplemented its hard copy reproduction service and was intended to ‘‘facilitate wider, more economical and more rapid distribution’’ of Exchange Act reports. See Wheat Report at 313. 260 See Division of Corporation Finance Financial Reporting Manual, Section 1610.1. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Item 301 disclosure reflecting the discontinued operations for these earlier two years would not be available in either the current or prior financial statements. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 ii. Request for Comment 67. Is the Item 301 disclosure that is not otherwise available or readily accessible important to investors? Are there benefits to having the five-year information in one table? 68. Should we retain, modify or eliminate Item 301? Why? Does it achieve the goal of highlighting significant trends in a registrant’s financial condition and results of operation? Does it also achieve the goal of providing selected financial data in a convenient and readable format? How would the elimination of Item 301 affect investors? Would elimination of this requirement increase costs to investors because they would then need to obtain this information from prior filings? 69. If we retain Item 301, should we modify this requirement and, if so, how? Should we modify the item to require additional disclosure and, if so, what additional disclosure would be important to investors and why? 70. Instruction 1 to Item 303(a) specifies that, where trend information is relevant, reference to the five-year selected financial data pursuant to Item 301 may be necessary.261 Despite this instruction, registrants generally do not discuss or analyze trends outside the three-year timeframe of Item 303. Does selected financial data effectively highlight significant trends that are not described elsewhere? If so, is five years an appropriate period or should we modify the number of fiscal years required to be included in the selected financial data? If selected financial data does not effectively highlight significant trends that are not described elsewhere, how could we modify our requirements to best achieve the objective of highlighting significant trends in registrants’ financial condition and results of continuing operations? 71. EGCs are not required to present selected financial data for any period prior to the earliest audited period presented in connection with its first effective registration statement.262 Should we revise Item 301 to provide a similar accommodation for all registrants? Why or why not? 72. Should we require Item 301 disclosure for the full five years only in certain instances such as when a registrant revises its annual financial statements or if information on the earliest two of the last five years is available without unreasonable cost or expense? 73. Currently, Item 301 disclosure is required in comparative columnar form. If we continued to require this disclosure, should we consider other presentation or format requirements? 74. What types of investors or audiences are most likely to value the information required by Item 301? 75. What is the cost of providing the disclosure required by Item 301, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 301. c. Items Included in Selected Financial Data (Instruction 2) i. Discussion When proposing the requirement for selected financial data, the Commission sought to strike a reasonable balance between specified content and a flexible approach that permits registrants to select the data that best indicates performance.263 The Commission noted that commenters requested increased flexibility in the form and content of this disclosure in response to an advanced notice of proposed rulemaking.264 Accordingly, while Instruction 2 to Item 301, as adopted, contains prescriptive requirements, such as disclosure of total assets and income (loss) from continuing operations, it also permits registrants the flexibility to include additional items they believe would enhance an understanding of and would highlight other trends in their financial condition and results of operations.265 For registrants that provide additional items in their selected financial data, disclosure varies. Financial institutions commonly provide additional metrics that may include return on average assets and capital ratios. Registrants in the telecommunications industry may include the number of subscribers while retailers may include the number of stores or average store size. While such information is not required under U.S. GAAP, it is not considered a ‘‘non263 See 1980 Form 10–K Proposing Release. 1980 Form 10–K Proposing Release; see also Annual Report Form, Release No. 34–15068 (Aug. 16, 1978) [43 FR 37460 (Aug. 23, 1978)]. 265 Instruction 2 to Item 301 of Regulation S–K [17 CFR 229.301]. 264 See 261 Instruction 1 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. 262 Public Law 112–106, Sec. 102, 126 Stat. 306 (2012). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 23939 GAAP financial measure’’ such that reconciliation under Item 10(e) of Regulation S–K would be required.266 Additionally, some registrants include non-GAAP financial measures in their Item 301 disclosures. ii. Request for Comment 76. Does Instruction 2 provide a reasonable balance between specified content and a flexible approach that permits registrants to select the data that best indicates performance? Why or why not? If not, how should we modify Instruction 2? For example, should we modify Instruction 2 to be more prescriptive or provide for a more flexible approach? If a flexible approach should be used, should we require registrants to disclose their reasons for the items it included? 77. Should we require auditor involvement (e.g., audit, review or specified procedures) for this disclosure, and if so, what should the nature of the involvement be? What would be the benefits and costs to registrants and to investors? 78. What is the impact of listing specific items of disclosure in Instruction 2? Do registrants view the items listed in Instruction 2 as a checklist? Should additional items be considered? 2. Supplementary Financial Information (Item 302) Item 302(a)(1) requires certain registrants to disclose quarterly financial data of selected operating results 267 and Item 302(a)(2) requires 266 Item 10(e)(4) states that, for purposes of paragraph (e), non-GAAP financial measures exclude operating and other statistical measures; and ratios or statistical measures calculated using exclusively one or both of (i) financial measures calculated in accordance with GAAP, and (ii) operating measures or other measures that are not non-GAAP financial measures. [17 CFR 229.10(e)(4)]. See also Conditions for Use of NonGAAP Financial Measures, Release No. 33–8176 (Jan. 22, 2003) [68 FR 4819 (Jan. 30, 2003)] (‘‘NonGAAP Measures Release’’) (stating that operating and other statistical measures such as unit sales, numbers of employees, numbers of subscribers, or numbers of advertisers are not non-GAAP financial measures). 267 Item 302(a)(1) of Regulation S–K [17 CFR 229.302(a)(1)]. Item 302(a)(1) specifies disclosure of net sales, gross profit (net sales less costs and expenses associated directly with or allocated to products sold or services rendered), income (loss) before extraordinary items and cumulative effect of a change in accounting, per share data based upon such income (loss), net income (loss) and net income (loss) attributable to the registrant, for each full quarter within the two most recent fiscal years and any subsequent interim period for which financial statements are included or are required to be included by Article 3 of Regulation S–X. The staff is separately considering Item 302(b), which requires certain disclosures of oil and gas activities, as part of its work to develop E:\FR\FM\22APP3.SGM Continued 22APP3 23940 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules disclosure of variances in these results from amounts previously reported.268 Registrants must provide quarterly information for each full quarter within the two most recent fiscal years and any subsequent period for which financial statements are included or required by Article 3 of Regulation S–X. Under Item 302(a)(3), registrants must describe the effect of any disposals of segments of a business and extraordinary, unusual or infrequently occurring items recognized in each quarter, as well as the aggregate effect and the nature of year-end or other adjustments that are material to the results of that quarter.269 If a registrant’s financial statements have been reported on by an accountant, Item 302(a)(4) requires that accountant to follow appropriate professional standards and procedures regarding the data required by Item 302(a).270 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended eliminating Item 302(a)(1), stating that this disclosure has been previously reported.271 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 b. Discussion A few years after adopting Form 10– Q, in 1974, the Commission noted that quarterly data was still being ‘‘reported on an extremely abbreviated basis and annual financial statements [had] generally been presented without regard for or disclosure of trends occurring within a year.’’ 272 To help remedy this information deficiency, the Commission adopted the precursor to Item 302(a), Rule 3–16(t) of Regulation S–X. This rule required, for certain registrants, recommendations for the Commission for potential changes to update or simplify certain disclosure requirements. For a description of this project, see Section 0. 268 Item 302(a)(2) of Regulation S–K [17 CFR 229.302(a)(2)]. When disclosure in Item 302(a) varies from amounts previously reported on the Form 10–Q filed for any quarter, such as if a combination between entities under common control occurs or where an error is corrected, the registrant must disclose a reconciliation of the amounts given with those previously reported and describe the reason for the difference. 269 Item 302(a)(3) of Regulation S–K [17 CFR 229.302(a)(3)]. The requirement applies to items recognized in each full quarter within the two most recent fiscal years and any subsequent interim period for which financial statements are included or are required to be included. 270 Item 302(a)(4) of Regulation S–K [17 CFR 229.302(a)(4)]. 271 See letter from Gregg L. Nelson, VP Accounting Policy & Financial Reporting, IBM Corporation (Aug. 7, 2014) (‘‘IBM’’). 272 See Interim Financial Data; Proposals to Increase Disclosure, Release No. 34–11142 (Dec. 19, 1974) [40 FR 1079 (Jan. 6, 1975)] (‘‘Proposals to Increase Disclosure of Interim Results by Registrants’’) at 1080. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 disclosure of selected quarterly financial data in the notes to the annual financial statements.273 The Commission recognized that numerous commenters opposed the requirements, suggesting that interim results are materially affected by random events and that including such data in annual financial statements would lend them an appearance of reliability that could be misleading.274 The Commission nevertheless adopted the disclosure requirement, stating its belief that this disclosure would ‘‘materially assist investors in understanding the pattern of corporate activities throughout a fiscal period’’ by disclosing trends over segments of time that are sufficiently short to reflect business turning points.275 By contrast, the Commission stated that annual periods ‘‘may obscure such turning points and may reflect a pattern of stability and growth which is not consistent with business reality.’’ 276 The Commission also noted that quarterly data would reflect seasonal patterns. Recognizing the costs of providing quarterly data, the Commission provided an exemption for smaller registrants and registrants whose shares were not actively traded.277 Because the selected quarterly 273 See Interim Financial Reporting: Increased Disclosures, Release No. 33–5611 (Sept. 10, 1975) [40 FR 46107 (Oct. 6, 1975)] (‘‘1975 Interim Financial Reporting Release’’). Rule 3–16(t) of Regulation S–X required disclosure in a note to the financial statements of net sales, gross profit, income before extraordinary items and cumulative effect of a change in accounting, per share data based upon such income, net income for each full quarter within the two most recent fiscal years and any subsequent interim period for which income statements are presented. It also required registrants to describe the effect of any disposals of segments of a business and extraordinary, unusual or infrequently occurring items recognized in each quarter, as well as the aggregate effect and the nature of year-end or other adjustments which are material to the results of that quarter. Furthermore, it required a reconciliation of amounts previously reported on Form 10–Q to the quarterly data included in the note to financial statements if the amounts differ. See id. 274 Id. 275 Id. at 46107. 276 Id. at 46108. 277 See id. at 46107 (‘‘The Commission believes that the greatest investor need for these data exists in the case of such companies whose activities are most closely followed by analysts and investors. Accordingly, registrants whose shares are not actively traded or whose size is below certain limits have been exempted from this rule at the present time.’’). See also Audit Committee Disclosure, Release No. 34–42266 (Dec. 22, 1999) [64 FR 73389 (Dec. 30, 1999)] (summarizing the requirements for application of Item 302(a) that had been in effect since 1980). The requirements only applied to registrants who met certain tests, including but not limited to: (1) Two of the three following requirements: (a) Shares outstanding have a market value of at least $2.5 million; (b) the minimum bid PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 financial data was unaudited, and recognizing that information contained within the financial statements should be audited, the Commission moved the requirement to Regulation S–K in 1980.278 While most of the disclosure required by Item 302(a) is required in prior quarterly reports, Item 302(a)(1) also requires a separate presentation of certain items for a registrant’s fourth quarter, which is not otherwise required. Although there is no similar requirement for disclosing the fourth fiscal quarter, U.S. GAAP typically allows investors to infer fourth quarter data by requiring disclosure of disposals of components of an entity and unusual or infrequently occurring items recognized in the fourth quarter.279 Additionally, as Item 302(a)(2) requires disclosure of variances in results from amounts previously reported for the two most recent fiscal years, the effect of a retrospective change in any quarter for which a Form 10–Q was filed in the more recent of the two fiscal years will be disclosed in the selected quarterly data. Absent Item 302(a)(2), this variance would not be disclosed until the following year in the corresponding fiscal quarter in which the retrospective change occurred. Disclosure in the Form 10–Q for this corresponding fiscal quarter would not include the effects of this change in the earliest of the two years presented in the Form 10–K, as this Form 10–Q would be limited to the current and prior-year interim periods. c. Request for Comment 79. Should we retain or eliminate Item 302(a)? Why? If we retain Item price is at least $5 per share; or (c) the registrant has at least $2.5 million of capital, surplus, and undivided profits; and (2) the registrant and its subsidiaries: (a) Have had net income after taxes but before extraordinary items and the cumulative effect of a change in accounting of at least $250,000 for each of the last three fiscal years; or (b) had total assets of at least $200 million for the last fiscal year end. See id. 278 See General Revision of Regulation S–X, Release No. 33–6233 (Sept. 2, 1980) [45 FR 63660 (Sept. 25, 1980)]. See also General Revision of Regulation S–X, Release No. 33–6178 (Jan. 15, 1980) [45 FR 5943 (Jan. 24, 1980)] at 5945 (‘‘Based upon the premise that information contained within the financial statements should be audited, the proposed rules would remove from [Regulation] S– X the requirement relating to unaudited information concerning selected quarterly financial data and place this requirement under Regulation S–K.’’). 279 ASC 270–10–50–2 requires the disclosure of certain information if interim data and disclosures are not separately reported for the fourth quarter. This information includes ‘‘disposals of components of an entity and unusual, or infrequently occurring items recognized in the fourth quarter, as well as the aggregate effect of year-end adjustments that are material to the results of that quarter.’’ E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules 302(a), should we modify the item and, if so, how? For example, should we modify the item to require additional disclosure and, if so, what additional disclosure would be important to investors and why? 80. Is fourth quarter information, which is required under Item 302(a) but not in the annual financial statements, important to investors? Do the other instances where disclosure required by Item 302(a) is not duplicative of previously provided disclosure merit retaining the item? Why or why not? 81. The disclosure required by Item 302(a) was originally intended to help investors understand the pattern of corporate activities throughout a fiscal period by disclosing trends over segments of time that are sufficiently short to reflect business turning points.280 Does this objective remain important today? If so, does the item achieve this objective? If the item does not achieve this objective, how could we modify it to do so? 82. Should we require auditor involvement (e.g., audit, review or specified procedures) on the reliability of the disclosure, and if so, what should the nature of the involvement be? What would be the benefits and costs to registrants and to investors? 83. Item 302(a) disclosure is commonly provided either as an unaudited note to the financial statements in Form 10–K 281 or separately outside of the financial statements. To the extent a registrant’s Item 302(a) disclosure is provided in the notes to the financial statements, it must be tagged as XBRL data. Registrants’ financial statements and footnotes presented in quarterly reports must also be tagged in XBRL.282 Given some of Item 302(a) disclosure is available in prior quarterly reports and also tagged in XBRL, do investors use the disclosure required by Item 302(a)? 84. What types of investors or audiences are most likely to value the information required by Item 302? 85. What is the cost of providing the disclosure required by Item 302, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those 280 See Interim Reporting Amendments Release. may be due to the fact that the requirements to provide annual financial statements and Item 302 disclosure are both in Item 8(a) of Form 10–K [17 CFR 249.310]. 282 Rule 405 of Regulation S–T [17 CFR 232.405]. See also Interactive Data Release. 281 This VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 costs associated with providing disclosure under Item 302. 86. Would costs to investors increase if Item 302 was eliminated and if so, how? 87. What are the benefits of providing the disclosure required by Item 302? How could the benefits change if we made any of the changes contemplated here? Please provide quantified or qualitative estimates where possible relating to disclosure under Item 302. 3. Content and Focus of MD&A (Item 303—Generally) Item 303 of Regulation S–K requires disclosure of information relevant to assessing a registrant’s financial condition, changes in financial condition and results of operations.283 Item 303(a) contains three core components that registrants must analyze in their MD&A disclosures: Liquidity, capital resources, and results of operations.284 Item 303(a) also requires disclosure of off-balance sheet arrangements and contractual obligations.285 Overall, these MD&A requirements are intended to satisfy three principal objectives: • Provide a narrative explanation of a registrant’s financial statements that enables investors to see the registrant through the eyes of management; • enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and • provide information about the quality of, and potential variability of, a registrant’s earnings and cash flow, so investors can ascertain the likelihood that past performance is indicative of future performance.286 The Commission has provided substantial guidance in the past intended to improve the quality of MD&A disclosures.287 Much of this 283 Instruction 2 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. 284 Item 303(a)(1), (a)(2) and (a)(3) of Regulation S–K [17 CFR 229.303(a)(1), (a)(2) and (a)(3)]. 285 Item 303(a)(4) and (a)(5) of Regulation S–K [17 CFR 229.303(a)(4) and (a)(5)]. See also Disclosure in Management’s Discussion and Analysis About Off-Balance Sheet Arrangements and Aggregate Contractual Obligations, Release No. 33–8182 (Jan. 28, 2003) [68 FR 5982 (Feb. 5, 2003)] (‘‘Off-Balance Sheet and Contractual Obligations Adopting Release’’). 286 See 2003 MD&A Interpretive Release. 287 See, e.g., Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis, Release No. 33–9144 (Sept. 17, 2010) [75 FR 59894 (Sept. 28, 2010)] (‘‘2010 Liquidity and Capital Resources Interpretive Release’’); 2003 MD&A Interpretive Release; Commission Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 33–8056 (Jan. 22, 2002) [67 FR 3746 PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 23941 guidance has focused on the following topics: • Quality and focus of analysis; • forward-looking information; and • use of key performance indicators.288 To help achieve the principal objectives of MD&A, and before evaluating specific subsections of Item 303(a), we seek public input on these topics and how we could improve the overall quality of MD&A disclosure. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter stated that MD&A requirements are too principlesbased.289 Another commenter stated that MD&A’s principles-based approach results in disclosure that is ‘‘among the most meaningful disclosure contained in periodic reports.’’ 290 Another commenter recommended reexamining MD&A to, among other things, reinforce the guiding principle of materiality so that MD&A is more useful for investors.291 One commenter recommended, in addition to MD&A, adopting a rule requiring registrants to provide an overview of their performance in the most recent year as well as expectations and concerns for the coming year, similar to what a CEO might report to the Board of Directors.292 This commenter suggested placing the disclosure at the beginning of annual reports on Forms 10–K and 20–F. One commenter stated there should be ‘‘greater clarity’’ between the type of forward-looking information required in MD&A versus the ‘‘futureoriented’’ information that the Financial Accounting Standards Board (‘‘FASB’’) believes is appropriate.293 One commenter suggested consolidating Commission and staff guidance on MD&A, stating that consolidation would reduce the time and effort necessary to identify and read all applicable sources and improve the (Jan. 25, 2002)] (‘‘2002 Commission Statement about MD&A’’); 1989 MD&A Interpretive Release. 288 See generally 2003 MD&A Interpretive Release (addressing each of these topics throughout). 289 See CFA Institute. This commenter also stated that disclosure effectiveness efforts should prioritize improving financial statement presentation and enhancing challenging disclosures, such as estimates, judgments, and choices; risks and uncertainties; off-balance sheet items; commitments and contingencies; intangible assets; and going concern issues. 290 See Shearman. 291 See CCMC. 292 See letter from Committee on Financial Reporting, New York City Bar (Sept. 3, 2014) (‘‘NYC Bar’’). 293 See SCSGP. E:\FR\FM\22APP3.SGM 22APP3 23942 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules quality of MD&A disclosure.294 This commenter recommended consolidating all applicable guidance in a single, electronically-accessible location with hyperlinks to relevant sources, or alternatively, revising Item 303 to codify prior staff guidance.295 This commenter also recommended adding instructions throughout Item 303 indicating that, to the extent disclosure in response to the item is included in the notes to the financial statements, registrants should use cross-references to avoid duplicative disclosure.296 b. Quality and Focus of Analysis mstockstill on DSK4VPTVN1PROD with PROPOSALS3 i. Discussion MD&A requires not only a discussion but also an analysis of known material trends and uncertainties and should not reiterate financial statement information in a narrative form.297 The Commission has previously stated that a thorough analysis should assess both the effects of known material trends and uncertainties and the reasons underlying those effects.298 The Commission has also stated that, if there is a reasonable likelihood that reported financial information is not indicative of a registrant’s future financial condition or future operating performance, then registrants should disclose the underlying reasons.299 The Commission has focused on improving the analysis in MD&A for many years. For example, the 1989 MD&A Interpretive Release explained that MD&A is intended to give investors an opportunity to look at a registrant through the eyes of management by providing both a short and long-term analysis of the business of the registrant.300 Despite Item 303(a)’s instruction to the contrary,301 many registrants simply recite the amounts of changes from year to year which are readily computable from their financial statements. In 2003 guidance, the Commission added that such recitation of financial statements in narrative form 294 See ABA 2. See also letter from Henry T. C. Hu (Oct. 7, 2015) (‘‘Hu’’) (referencing a ‘‘bewildering stream of guidance of varying degrees of formality and legal import’’ since Item 303’s adoption in 1980). 295 See ABA 2. 296 See id. (specifying Items 303(a)(1), (a)(4), (a)(5) and disclosure of critical accounting estimates). 297 See 2003 MD&A Interpretive Release. 298 See id. 299 See id. As an example, the Commission stated that if a change in an estimate has a material favorable impact on earnings, the change and the underlying reasons should be disclosed so that readers do not incorrectly attribute the effect to operational improvements. 300 See 1989 MD&A Interpretive Release. 301 Instruction 4 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 fails to provide the unique perspective available to management that MD&A is meant to capture.302 An effective analysis of known material trends, events, demands, commitments and uncertainties should include an explanation of the underlying reasons or implications, interrelationships between constituent elements, or the relative significance of those matters.303 Prior to 1980, Commission rules required registrants to provide a summary of earnings, including a discussion of unusual conditions that affected the appropriateness of the earnings presentations.304 The rules also required registrants to discuss items of revenue or expense that changed more than ten percent from the prior period or changed more than two percent of the average net income or loss for the most recent three years presented. In adding MD&A to Regulation S–K in 1980, the Commission replaced the percentage thresholds with a principles-based approach that primarily focused on materiality.305 The Commission noted that the percentage tests applied without regard to any concept of materiality or significance to the registrant’s business, resulting in meaningful discussion often being obscured by information of little relevance.306 Commission guidance has continued to stress the importance of materiality in MD&A and stated that disclosure should emphasize material information and deemphasize or, if appropriate, delete immaterial information.307 The text of Item 303 ties several specific requirements to materiality. For example, disclosure of known trends in liquidity is required if such trends are reasonably likely to affect liquidity ‘‘in 302 See 2003 MD&A Interpretive Release. 303 See id. 304 See Guidelines for Registration and Reporting, Release No. 33–5520 (Aug. 14, 1974) [39 FR 31894 (Sept. 3, 1974)] (‘‘Guidelines Adopting Release’’). These guidelines, known as Guide 22, were the precursor to MD&A that predated Regulation S–K. See infra note 344. 305 See 1980 Form 10–K Adopting Release. 306 See id. at 63636 (‘‘The changes in Management’s Discussion and Analysis were proposed as the result of the Commission’s concerns that the disclosure elicited by the present requirement of Guides 1 and 22 is not fulfilling originally contemplated objectives. Instead, existing percentage tests are applied without regard to any concept of materiality or significance to the registrant’s business. Accordingly, although some portions of the resulting discussion may be meaningful, the meaningful discussion is often obscured by the inclusion of material which is of little relevance.’’). The Commission also clarified that causes of material changes in line items must be described only to the extent necessary to an understanding of a company’s business as a whole. 307 See 2003 MD&A Interpretive Release. PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 any material way.’’ 308 Commitments for capital expenditures that are material must be described as of the end of the latest fiscal period.309 Registrants also must describe certain events, transactions, or economic changes that ‘‘materially affected’’ reported income from continuing operations.310 In addition to emphasizing materiality, the Commission has also recommended a ‘‘layered approach’’ as a way to improve the quality of analysis in MD&A.311 A layered approach requires registrants to present information in a manner that emphasizes, within the universe of material information that is disclosed, the information and analysis that is most important.312 While not required by Item 303, providing an executivelevel overview to MD&A may be one way of taking a layered approach. Executive-level overviews should discuss the most important matters to MD&A, and the Commission has cautioned that this overview should not be a duplicative layer of disclosure repeated elsewhere.313 Rather than summarize information already disclosed, the executive overview should provide a balanced, high-level discussion that identifies the most important themes or other significant matters with which management is concerned primarily in evaluating the registrant’s financial condition and operating results. The overview should provide insight into material opportunities, challenges and risks, such as those presented by known material trends and uncertainties, on which the registrant’s executives are most focused for both the short and long term, as well as the actions they are taking to address these opportunities, challenges and risks.314 ii. Request for Comment 88. What requirements in Item 303 are important to investors? How could Item 303 be improved? 89. Do the current requirements of Item 303 result in disclosure that 308 Item 303(a)(1) of Regulation S–K [17 CFR 229.303(a)(1)]. 309 Item 303(a)(2) of Regulation S–K [17 CFR 229.303(a)(2)]. 310 Item 303(a)(3) of Regulation S–K [17 CFR 229.303(a)(3)]. 311 See 2003 MD&A Interpretive Release at 75059 (‘‘While all required information must of course be disclosed, companies should consider using a ‘layered’ approach. [. . .] This presentation would assist readers in identifying more readily the most important information. Using an overview or introduction is one example of a layered approach.’’). 312 See id. For further discussion of layered disclosure, see SectionV.F. 313 See 2003 MD&A Interpretive Release. 314 See id. E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules highlights the most significant aspects of the registrant’s financial condition and results of operations? Are there any requirements in Item 303(a) and (b) that result in immaterial disclosures that may obscure significant information? If so, how? Should we consider a qualitative or quantitative threshold rather than materiality for requiring MD&A disclosure? If so, what threshold would be appropriate and why? Would adopting a different standard impede the flexibility of analysis and assessment under the current materiality standard? If so, how? 90. There are various sources of Commission and Division guidance on MD&A. These include Commission releases, sections of the Division’s Financial Reporting Manual and staff Compliance and Disclosure Interpretations.315 Given the amount of Commission and staff guidance on MD&A, should we consolidate guidance in a single source? If so, which guidance remains helpful, and is there guidance that we should not include in a consolidation? Would consolidation of this guidance facilitate registrants’ compliance with the item’s requirements, or is the existing form of this guidance sufficient? 91. Should we revise our rules to require registrants to provide an executive-level overview? If so, should our rules prescribe the information that must be covered? What would be the benefits and challenges of prescribing the content of the overview and what content should we require? For example, should we require an executive-level overview to discuss the most significant accounting estimates and judgments? Should any requirement for an executive-level overview be limited to registrants of a certain size? 92. If we were to require an executivelevel overview, how could we encourage registrants to provide an overview that does not simply duplicate disclosure provided elsewhere? 93. Are there other methods that registrants could employ or new rules that we should consider that would result in more meaningful analysis in MD&A? 94. What types of investors or audiences are most likely to value the information required by Item 303 and does the audience for disclosure vary across the different parts of Item 303 disclosure? If so, how? Would the manner of presentation affect how various types of investors benefit from Item 303 disclosure? 315 See ABA 2 (providing a six-page exhibit illustrating the various sources of guidance on MD&A). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 95. Should we require a different format or presentation of MD&A such as a requirement for the discussion to be tagged or presented in a structured manner? 96. Should we require auditor involvement (e.g., audit, review or specified procedures) regarding the reliability of MD&A disclosure, and if so, what should the nature of the involvement be? What would be the benefits and costs to registrants and to investors? 97. What is the cost of providing the disclosure required by Item 303, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 303. 98. What are the benefits of providing the disclosure required by Item 303? How could the benefits change if we made any of the changes contemplated here? Please provide quantified or qualitative estimates where possible relating to disclosure under Item 303. c. Forward-Looking Information i. Discussion Discussion and analysis of known trends, demands, commitments, events and uncertainties requires disclosure of forward-looking information.316 This information is significant to understanding a registrant’s expected future performance. The Commission previously has provided guidance relating to the standard for disclosure of forward-looking information and encouraged registrants to provide such forward-looking disclosure.317 316 For example, the following provisions in Item 303 require disclosure of prospective information: Item 303(a)(1) (any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way); Item 303(a)(2)(ii) (any known material trends in capital resources and any expected material changes in the mix and relative cost of capital resources); Item 303(a)(3)(ii) (any known trends or uncertainties that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations); and Instruction 3 to Item 303(a) (descriptions and amounts of matters that would have an impact on future operations and have not had an impact in the past and matters that have had an impact on reported operations and are not expected to have an impact upon future operations.). 317 See 2003 MD&A Interpretive Release at 75059 (‘‘In addressing prospective financial condition and operating performance, there are circumstances, particularly regarding known material trends and uncertainties, where forward-looking information is required to be disclosed. We also encourage PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 23943 In 1987, the Commission distinguished between required and optional forward-looking disclosure: Required forward-looking disclosure is based on currently known trends, events and uncertainties that are reasonably expected to have material effects, while optional forward-looking disclosure involves either anticipating a future trend or event or anticipating a less predictable impact of a known event, trend or uncertainty.318 In 1989, the Commission articulated a two-step test (‘‘two-step test’’) for assessing when forward-looking disclosure is required in MD&A: Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments: (1) Is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required. (2) If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.319 For forward-looking information, the Commission distinguished the standard for disclosure under Item 303 from the standard for disclosure necessary to avoid liability for fraud under Rule 10b– 5 and stated that the ‘‘probability/ magnitude test for materiality approved by the Supreme Court in Basic, Inc., v. Levinson . . . is inapposite to Item 303 disclosure.’’ 320 The Commission has companies to discuss prospective matters and include forward-looking information in circumstances where that information may not be required, but will provide useful material information for investors that promotes understanding.’’). 318 Concept Release on Management’s Discussion and Analysis of Financial Condition and Operations, Release No. 33–6711 (Apr. 17, 1987) [52 FR 13715 (Apr. 24, 1987)]. In 1989, the Commission also explained that the safe harbors of Securities Act Rule 175(c) and Exchange Act Rule 3b–6(c) apply to required statements concerning the future effect of known material trends and uncertainties. See 1989 MD&A Interpretive Release. The Commission adopted the foregoing rules in 1979 to encourage the disclosure of projections and forward-looking information as recommended by the Sommer Report. See Safe Harbor Rule for Projections, Release No. 33–6084 (June 25, 1979) [44 FR 38810 (July 2, 1979)]. 319 See 1989 MD&A Interpretive Release at 22430. 320 Id. In Basic, the Supreme Court framed the issue of materiality of forward-looking disclosure as depending upon a balancing of both ‘‘the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.’’ 485 U.S. at 231 E:\FR\FM\22APP3.SGM Continued 22APP3 23944 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules also stated that this ‘‘reasonably likely’’ standard is a lower threshold than ‘‘more likely than not.’’ 321 Several federal courts of appeals have since referenced the Commission’s twostep test and addressed its role in potential liability under Exchange Act Section 10(b) and Rule 10b–5 thereunder. Although the courts are divided on the issue of whether Item 303 requirements create a general duty to disclose in the Rule 10b–5 context, these courts have agreed that the Supreme Court’s standard in Basic v. Levinson is the appropriate standard for determining liability under Rule 10b–5 rather than the Commission’s two-step test.322 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 ii. Request for Comment 99. Does the two-step test for disclosure of a known trend, demand, commitment, event or uncertainty result in the most meaningful forward-looking disclosure? Why or why not? How do registrants determine when something is ‘‘reasonably likely’’ to occur? 100. Should we revise the two-step test to apply a different standard in the first prong and if so, how? For example, should we require disclosure when a trend, event or uncertainty is more likely than not, probable, or reasonably possible to occur, rather than ‘‘reasonably likely’’ to occur? 323 (quoting SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968)). 321 See 2002 Commission Statement about MD&A at 3748. 322 See Stratte-McClure v. Morgan Stanley, 776 F.3d 94, 100–104 (2d Cir. 2015) (holding that Item 303 requirements do give rise to a duty to disclose that may serve as the basis for liability under Rule 10b–5, but indicating that the Basic test for materiality of forward-looking disclosures controls instead of the Commission’s two-step test); In re NVIDIA Corp. Sec. Lit., 768 F.3d 1046, 1054–56 (9th Cir. 2014) (holding that Item 303 does not create a duty to disclose for Rule 10b–5 purposes and distinguishing the two-step test from the Basic materiality standard for forward-looking disclosure); Oran v. Stafford, 226 F.3d 275, 287–288 (3d Cir. 2000) (leaving open the question of whether an Item 303 violation could ever serve as the basis for liability under Rule 10b–5, but holding that Basic supplied the applicable standard for testing 10b–5 liability for forward-looking disclosures). 323 See ASC 450–20–25–1. Under U.S. GAAP, when a loss contingency exists, the likelihood that the future event or events will confirm the loss or impairment of an asset or the incurrence of a liability can range from probable to remote. The areas within that range are: Probable (the future event or events are likely to occur), reasonably possible (the chance of the future event or events occurring is more than remote but less than likely) and remote (the chance of the future event or events occurring is slight). In the context of Item 303(a)(4) (off-balance sheet arrangements), the Commission previously considered whether the ‘‘reasonably likely’’ threshold was appropriate for prospective information. Most commenters supported the ‘‘reasonably likely’’ standard. Many commenters opposed a ‘‘remote’’ threshold stating it would be VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 101. Should we eliminate the twostep test in favor of a different standard for identifying required and optional forward-looking disclosure and, if so, what test would be appropriate? For example, should we revise Item 303 to incorporate the probability/magnitude standard from Basic v. Levinson? 324 Which standard—the two-part test, Basic’s probability/magnitude standard, or some other standard—should we require, and why? Would any particular formulation be more or less burdensome for registrants? 102. We have stated previously that quantification of the material effects of known material trends and uncertainties can promote understanding and may be required to the extent material.325 Should we revise Item 303 to specifically require registrants, to the extent practicable, to quantify the material effects of known trends and uncertainties as well as the factors that contributed to those known trends and uncertainties? Why? d. Key Indicators of Financial Condition and Operating Performance i. Discussion The Commission has previously stressed that registrants should identify and address those key variables and other qualitative and quantitative factors that are peculiar to and necessary for an understanding and evaluation of the individual registrant.326 Key performance indicators include both financial and non-financial measures. Non-financial measures may relate to external or macro-economic matters as well as those specific to a registrant or industry.327 The Commission has also difficult for management to apply, yield voluminous disclosures; attribute undue prominence to information that is not important to investors; confuse or mislead investors; and elicit information that would not be comparable among firms. The Commission adopted the ‘‘reasonably likely’’ threshold concluding that it focused on the information most important to an understanding of a registrant’s off-balance sheet arrangements and their material effects. The Commission also noted potential difficulty in attempting to comply with the ‘‘remote’’ threshold and that use of a consistent threshold throughout MD&A would preclude the potential confusion that could result from disparate thresholds. See Off-Balance Sheet and Contractual Obligations Adopting Release. 324 See supra note 320. 325 See 2003 MD&A Interpretive Release. 326 See id. (quoting the 1989 MD&A Interpretive Release, which quotes Management’s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 33–6349 (Sept. 28, 1981) [not published in the Federal Register]). 327 External or macro-economic matters, such as interest rates or economic growth rates, and their anticipated trends can be important variables for many registrants. The Commission has further encouraged registrants to consider disclosing information that may be peripheral to the accounting function, but is integral to the business PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 encouraged registrants to consider whether disclosure of all key variables and other factors that management uses to manage the business would be material to investors or would promote an understanding of MD&A.328 Some registrants discuss industryspecific key performance indicators in MD&A, although there is not a specific requirement for this disclosure. For example, electronic gaming or social media companies typically discuss their numbers of monthly active users; numbers of unique users; numbers of unique payers; and other metrics relating to usage. Software service companies typically discuss their numbers of subscribers; customer renewal rates; and customer retention rates. Hospitals typically discuss their numbers of admissions; numbers of beds; the average length of inpatient stays; and occupancy rates. Retailers typically discuss comparable store sales, sales per square foot or gross merchandise value. Recent academic studies find that the industry-specific key factors disclosed by retailers and manufacturers provide incremental information that can help to predict registrants’ future performance beyond traditional financial statement variables.329 Where there is no commonly accepted method of calculating a particular nonfinancial metric, the Commission has said that the registrant should provide an explanation of the calculation of the metric to promote comparability across registrants within the industry.330 In addition, key performance indicators, where disclosed, should be included in a format that will enhance the understanding of the discussion and analysis.331 or operating activity. Examples of such measures, depending on the circumstances of a particular registrant, can include those based on units or volume, customer satisfaction, time-to-market, interest rates, product development, service offerings, throughput capacity, affiliations/joint undertakings, market demand, customer/vendor relations, employee retention, business strategy, changes in the managerial approach or structure, regulatory actions or regulatory environment, and any other pertinent macroeconomic measures. See 2003 MD&A Interpretive Release at note 27 and accompanying text. 328 See id. 329 See, e.g., C. Cole and C. Jones, The Usefulness of MD&A Disclosures in Retail Industry, 30 J. Acct. Auditing Fin. 127, 127–149 (2015). See also Y. Sun, Do MD&A Disclosures Help Users Interpret Disproportionate Inventory Increases?, 85 Acct. Rev. 1411, 1411–1440 (2010) (measuring the informativeness of this disclosure by measuring to what degree the information in the disclosure can help to predict variables such as future revenues and earnings or contemporary stock returns, beyond financial statement variables or other factors that can help to predict these variables). 330 See 2003 MD&A Interpretive Release. 331 See id. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 ii. Request for Comment 103. Should we revise Item 303 to include a principles-based requirement for all registrants to disclose performance metrics and other key variables important to their business? Why or why not? 104. Should we require disclosure of any commentary, analysis, performance indicators or business drivers related to a registrant’s key indicators? If so, why? For example, would it be feasible to adopt prescriptive requirements for discussion of specific performance metrics that are applicable to an entire industry and are easily comparable between registrants? 105. What types of investors or audiences are most likely to value industry-specific key performance indicators? 106. What would be the costs and benefits of requiring registrants in certain industries to disclose standardized performance metrics? How could we identify which performance metrics should be standardized across an industry? 4. Results of Operations (Item 303(a)(3)) Item 303(a)(3) requires a discussion and analysis of a registrant’s results of operations and specifies four areas of disclosure: • Any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and the extent to which income was so affected; 332 • known trends or uncertainties that have had, or that the registrant reasonably expects will have, a material impact on net sales or revenues or income from continuing operations; 333 • material increases in net sales or revenues, including the extent such increases are attributable to increases in prices, increases in the volume or amount of goods or services being sold, or to the introduction of new products or services; 334 and • for the three most recent fiscal years, a discussion of the impact of inflation and changing prices on the registrant’s net sales and revenues, and on income from continuing operations.335 Instruction 1 to Item 303(a) states that the discussion and analysis shall cover the three-year period covered by the 332 Item 303(a)(3)(i) of Regulation S–K [17 CFR 229.303(a)(3)(i)]. 333 Item 303(a)(3)(ii) of Regulation S–K [17 CFR 229.303(a)(3)(ii)]. 334 Item 303(a)(3)(iii) of Regulation S–K [17 CFR 229.303(a)(3)(iii)]. 335 Item 303(a)(3)(iv) of Regulation S–K [17 CFR 229.303(a)(3)(iv)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 financial statements and use year-toyear comparisons or any other format that in the registrant’s judgment would enhance a reader’s understanding.336 Instruction 4 to Item 303(a) provides that registrants need not recite the amounts of changes from year to year that are readily computable from the financial statements.337 a. Comments Received S–K Study: One commenter recommended that we eliminate the requirement to include prior-period results in MD&A as this information is readily available in prior filings.338 This commenter added that the existing requirements in Item 303 should be sufficient to result in a comprehensive discussion of a three-year trend without a year-to-year comparison. Disclosure Effectiveness Initiative: A few commenters recommended eliminating prior period results in MD&A as this information is readily available in previous filings.339 One of these commenters stated it would be more appropriate to require a discussion of only the most recently completed annual or quarterly period and that discussion of prior periods ‘‘can create more confusion and distraction than elucidation among investors.’’ 340 Another one of these commenters stated its belief that two years of financial statements is sufficient disclosure as the five-year selected financial data would provide multiyear trend information.341 This commenter also stated its belief that a two year financial statement requirement would eliminate ‘‘clutter’’ in MD&A and ‘‘allow users to focus on new, material information about the latest fiscal year.’’ One commenter disagreed with eliminating the requirement to include prior-period results in MD&A because doing so would require investors to look for the information elsewhere.342 One commenter suggested revising Instruction 4 to Item 303(a) to allow registrants to omit a discussion of 336 SRCs may limit their disclosure to the twoyear period covered by their financial statements. Instruction 1 to Item 303(a) of Regulation S–K [17 CFR 229.303(a)]. 337 Instruction 4 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. 338 See Ernst & Young 1. 339 See, e.g., CCMC; IBM; SCSGP (noting that the existing requirements in Item 303 are sufficient to elicit a discussion of trends over the relevant threeyear period, if such a trend exists and is material); A. Radin; Ernst & Young 2. 340 See CCMC. 341 See Ernst & Young 2 (also noting that financial statements covering three years are more voluminous and costly to prepare and that most foreign jurisdictions only require two years of financial statements). 342 See CFA Institute. PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 23945 changes in line items on the financial statements, to the extent those changes are not material and such omission would not materially impair an investor’s understanding of the registrant’s results of operations.343 b. Discussion Prior to the Commission’s adoption of the MD&A disclosure requirements, Guide 22 and Guide 1 called for a summary of earnings and operations, as well as a full narrative explanation of the summary. The Guides also called for a separate discussion and analysis of the summary, including explanations of material changes from period to period in revenues and expenses.344 This discussion was intended to enable investors to compare periodic results of operations and to assess the source and probability of recurrence of earnings or losses.345 When adding MD&A to Regulation S–K in 1980, the Commission eliminated the summary of operations disclosure in favor of new requirements for a discussion ‘‘focused on the financial statements’’ with an emphasis on favorable or unfavorable trends and the identification of significant events or uncertainties.346 The Commission also expressed its view that a three-year financial statement requirement provides the minimum data necessary for an understanding of the changes in performance for two years.347 In 2003, the staff conducted a review of annual reports filed by all Fortune 500 registrants and issued a significant number of comments seeking, among other things, greater analysis of 343 See ABA 2. 22 applied only to registration statements under the Securities Act. Guide 1, applicable to Exchange Act filings, was adopted in 1974 to require disclosure similar to that of Guide 22. While Guide 22 focused on a summary of earnings, Guide 1 required a discussion and analysis of a registrant’s summary of operations. Both Guides were eliminated in 1980 when their requirements were merged into a single requirement, now Item 303, calling for discussion and analysis of financial condition and results of operations. This represented a shift in focus towards the financial statements rather than upon a summary of operations. See Guidelines Adopting Release. When eliminating the Guides, the Commission noted that the ‘‘narrow approach’’ set forth in Guides 1 and 22 did not ordinarily produce a discussion that focused upon the financial condition of a registrant as a whole. The Commission also noted that ‘‘there is a growing need to analyze an enterprise’s liquidity and capital resources, in addition to its revenues and income.’’ See 1980 Form 10–K Adopting Release at 63636. 345 See Guidelines Adopting Release. 346 1980 Form 10–K Adopting Release at 63636. 347 See Uniform Instructions as to Financial Statements—Regulation S–X, Release No. 33–6179 (Jan. 15, 1980) [45 FR 5963 (Jan. 24, 1980)]. 344 Guide E:\FR\FM\22APP3.SGM 22APP3 23946 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules registrants’ results of operation.348 The staff also discouraged registrants from providing rote calculations of percentage changes of financial statement items and boilerplate explanations of immaterial changes to these figures, encouraging them to include instead a detailed analysis of material year-to-year changes and trends.349 The staff continues to seek greater analysis of material year-to-year changes and trends by encouraging registrants to quantify components of material changes in financial statement line items and provide additional explanation of the underlying factors that cause such changes. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 c. Request for Comment 107. Should we retain, eliminate or modify the period-to-period comparisons provided in MD&A? Why? 108. How could Item 303(a)(3) be improved? Would any additional disclosure about a registrant’s results of operations be important to investors? If so, what additional disclosure would be important and why? 109. Does the three-year comparison provide material information about trends or uncertainties that would not be reflected in filings for prior periods? Should we permit registrants to omit the earliest period in the three-year comparison when the earliest of the three years does not provide information that is important to investors? What would be the advantages and disadvantages of limiting the period-to-period comparisons in MD&A to the most recent two fiscal periods? 110. Should we allow registrants to eliminate the earliest of the two periods discussed so long as they crossreference or include a hyperlink to the prior periods discussion in earlier Forms 10–K and 10–Q? Why or why not? 111. In complying with Item 303(a)(3), registrants almost exclusively rely on period-to-period comparisons even though our rules permit ‘‘any other format that in the registrant’s judgment would enhance a reader’s understanding.’’ 350 Why do registrants 348 See Summary by the Division of Corporation Finance of Significant Issues Addressed in the Review of the Periodic Reports of the Fortunate 500 Companies (2003), available at https://www.sec. gov/divisions/corpfin/fortune500rep.htm. 349 See id. The staff also commented on boilerplate analyses that did not provide any insight into registrants’ past performance or business prospects as understood by management. 350 Instruction 1 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)] states the discussion must cover the three-year period covered by the financial statements and use year-to-year comparisons or any other format that in the registrant’s judgment would enhance a reader’s understanding. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 rely almost exclusively on year-to-year comparisons? Would formats or presentations other than period-toperiod comparisons enhance a reader’s understanding of results of operations or encourage greater analysis of the income statement? If so, how? What other formats or presentations could result in a discussion and analysis of the material information necessary to an understanding of a registrant’s performance, financial condition and prospects for the future? Should we require registrants to provide the comparison in a standardized tabular format or any other format? 112. Does the disclosure required by Item 303(a)(3) provide useful information about registrants that have not yet generated revenue or begun operations? Would additional disclosure about these registrants, such as a description of their plans of operations be more useful to investors? If so, what additional information, if any, that is not already required under Item 101(a)(2) would be useful to investors? 351 5. Liquidity and Capital Resources (Item 303(a)(1) and (a)(2)) Analysis of a registrant’s liquidity and capital resources is critical to assessing a registrant’s future prospects.352 Item 303(a)(1) requires a registrant to identify any known trends or any known demands, commitments, events or uncertainties that will result in or that are reasonably likely to result in the registrant’s liquidity increasing or decreasing in any material way.353 If a material deficiency is identified, a registrant must indicate the course of action it has taken or proposes to take to remedy the deficiency.354 Item 303(a)(1) also requires a registrant to identify and separately describe its internal and external sources of liquidity and briefly discuss any 351 Item 101(a)(2) requires first-time registrants that have not generated revenues from operations in each of the last three fiscal years and are offering securities to the public to provide a plan of operations. The item requires disclosure relating to the registrant’s ability to fund its operations, research and development, anticipated material acquisition of plant and equipment, and any anticipated material changes in number of employees. 352 See 2003 MD&A Interpretive Release. 353 Item 303(a)(1) of Regulation S–K [17 CFR 229.303(a)(1)]. The two-step test for disclosure of prospective information set forth in the 1989 MD&A Interpretive Release also applies to disclosure of a known trend, demand, commitment, event or uncertainty materially affecting liquidity and capital resources. See supra note 319 and accompanying text. 354 Item 303(a)(1) of Regulation S–K [17 CFR 229.303(a)(1)]. PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 material unused sources of liquid assets.355 Item 303(a)(2) requires discussion and analysis of a registrant’s capital resources. A registrant must describe its material commitments for capital expenditures and indicate the general purpose of those commitments and the anticipated source of funds needed to fulfill those commitments.356 A registrant also must describe any known material trends, favorable or unfavorable, in its capital resources, including changes in equity, debt and any off-balance sheet financing arrangements.357 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter generally suggested requiring increased disclosure of liquidity funding gaps.358 b. Analysis of ‘‘Liquidity’’ and ‘‘Capital Resources’’ i. Discussion The Commission first adopted requirements for disclosure of liquidity and capital resources in 1980 to address what it viewed as a growing need to analyze enterprise liquidity and capital resources in addition to revenues and income.359 More recently, the Commission has observed that disclosure about liquidity and capital resources is critical to an assessment of a registrant’s prospects for the future and even the likelihood of its survival.360 The Commission also has provided guidance regarding the type of information that a registrant should disclose about its liquidity and capital resources.361 In determining appropriate disclosure, registrants should evaluate separately their ability to meet upcoming cash requirements over both the short and long term.362 Registrants are expected to use the statement of cash flows and other indicators in analyzing their liquidity and to present a balanced discussion dealing with cash 355 Id. 356 Item 303(a)(2)(i) of Regulation S–K [17 CFR 229.303(a)(2)(i)]. 357 Item 303(a)(2)(ii) of Regulation S–K [17 CFR 229.303(a)(2)(ii)]. 358 See CFA Institute. 359 See 1980 Form 10–K Adopting Release. 360 See 2003 MD&A Interpretive Release. See also 2010 Liquidity and Capital Resources Interpretive Release (stating that as financing activities undertaken by registrants become more diverse and complex, it is increasingly important that the discussion and analysis of liquidity and capital resources provided by registrants meet the objectives of MD&A). 361 See, e.g., 1989 MD&A Interpretive Release and 2003 MD&A Interpretive Release. 362 See id. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 flows from investing and financing activities as well as from operations.363 Despite the Commission’s guidance, the staff has observed that discussions of liquidity and capital resources often recite various changes in line items from the statement of cash flows without a detailed analysis. Although registrants generally discuss their liquidity needs and the sources of cash available to meet those needs as of the end of the reporting period, disclosure of known trends and uncertainties affecting their future needs and availability of cash often is less detailed. When adopting disclosure requirements for liquidity and capital resources, the Commission recognized that the terms ‘‘liquidity’’ and ‘‘capital resources’’ lacked precision in definition but stated that ‘‘additional specificity would decrease the flexibility needed by management for a meaningful discussion.’’ 364 The Commission stated its intent for management to use ‘‘whatever liquidity parameters they deem to be most appropriate.’’ 365 To that end, Item 303 does not define ‘‘capital resources’’ and defines ‘‘liquidity’’ only in general terms, as the ability of an enterprise to generate adequate amounts of cash to meet its needs for cash.366 ii. Request for Comment 113. How could we revise Item 303(a) to elicit a more meaningful analysis of a registrant’s liquidity and capital resources while retaining the flexibility of registrants to analyze liquidity and capital resources in the context of their business and the way they manage liquidity? 114. Item 303(a) provides that discussions of liquidity and capital resources may be combined whenever the two topics are interrelated. Would it lead to more useful analysis if we required registrants to provide separate disclosure of these two topics? Why? Would doing so encourage greater disclosure of trends, events and uncertainties affecting capital resources? 115. When drafting MD&A, how do registrants currently interpret the term ‘‘capital resources’’? Would defining the term ‘‘capital resources’’ be helpful for registrants or, alternatively, is the plain meaning of the term sufficiently clear? In light of the reference to capital expenditures and the sources of funds needed to fulfill those expenditures in Item 303(a)(2)(i), do registrants currently 363 See 1989 MD&A Interpretive Release. Form 10–K Adopting Release at 63636. 365 Id. at 63636. 366 Instruction 5 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. See also 1980 Form 10–K Adopting Release. 364 1980 VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 interpret the term ‘‘capital resources’’ as including mostly funds committed for material capital expenditures and the source of those funds? 116. Should we modify the definition of ‘‘liquidity’’ in Instruction 5 to Item 303(a) and, if so, how? 117. For what periods should we require discussion and analysis of liquidity and capital resources and why? Should our requirements include more periods than what is required by the statement of cash flows? Why? Are developments in the most recent fiscal year sufficient to constitute a ‘‘trend’’ as the term is used in Item 303? 118. Should we require registrants to provide a sensitivity analysis in the discussion and analysis of liquidity and capital resources? If so, what should be the nature of such an analysis? If not, why not? 119. Should the registrant provide additional measures of intra-period liquidity and capital resources? For example, should the registrant provide measures of average daily liquidity, average quarterly liquidity, or other measures? Should the registrant provide a chart or graph of intra-period liquidity? How should such information be considered in connection with the information provided at the end of the quarter? 120. Should we consider more detailed disclosure requirements for liquidity, such as liquidity risks and maturity mismatches? c. Short-Term Borrowings i. Discussion Access to short-term borrowings for working capital and to fund operations can be an important component of a registrant’s liquidity and capital resources.367 Short-term borrowings include federal funds purchased and securities sold under agreements to repurchase,368 commercial paper,369 borrowings from banks, borrowings from factors or other financial 367 See D. Booth & J. Renier, Fed Policy in the Financial Crisis: Arresting the Adverse Feedback Loop, FRBD Economic Letter, Sept. 2009, available at https://www.dallasfed.org/assets/documents/ research/eclett/2009/el0907.pdf (‘‘Many businesses were hampered by the squeeze on short-term financing, a key source of working capital needed to prevent deeper reductions in inventories, jobs and wages.’’). 368 ASC 860–10 defines a repurchase agreement as an arrangement under which the transferor (repo party) transfers a security to the transferee (repo counterparty or reverse party) in exchange for cash and concurrently agrees to reacquire the security at a future date for an amount equal to the cash exchanged plus a stipulated interest factor. 369 Commercial paper consists of short-term promissory notes issued primarily by corporations. Maturities range up to 270 days but average about 30 days. PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 23947 institutions, and any other short-term borrowings reflected on the registrant’s balance sheet.370 Short-term borrowings are common among financial institutions and industrial companies alike.371 In the last few years, low interest rates have prompted many non-financial registrants to take advantage of lower borrowing costs and use short-term borrowings to, among other things, buy back stock and pay off longer-term debt.372 For one type of short-term borrowing, repurchase agreements, advancements in technology and changes in the regulatory landscape have made it more efficient for parties to engage in these transactions, likely increasing the amount of activity in this market.373 Short-term borrowings can be affected, sometimes severely and rapidly, by illiquidity in the markets as a whole.374 This market illiquidity can 370 See Rules 5–19 and 9–03.13(3) of Regulation S–X [17 CFR 210.5–19 and 210.9–03.13(3)]. 371 For example, the Federal Reserve Board reported that domestic outstanding commercial paper balances at the end of December 2015 were $174.5 billion for non-financial issuers and $206.6 billion for financial issuers respectively. See Commercial Paper Outstanding (last visited March 21, 2016) available at https://www.federal reserve.gov/releases/cp/outstanding.htm. 372 See, e.g., David Randall, Fed Delay Could Spur More Debt Issues to Fund Share Buybacks, Reuters, Sept. 23, 2015, available at https://www.reuters.com/ article/2015/09/23/us-usa-fed-buybacks-analysisidUSKCN0RN0D320150923 (suggesting the Federal Reserve’s decision to delay raising interest rates will likely encourage companies to incur more debt to repurchase their own shares); Serena Ng and Vipal Monda Companies Use Short-Term Debt to Advantage, The Wall Street Journal, Sept. 11, 2013, available at https://www.wsj.com/articles/SB10001 424127887323893004579059473557078830 (noting that the low cost of short-term funds due to low interest rates has prompted companies to engage in short-term borrowings to repurchase stock, fund acquisitions, pay off longer-term debt, or profit from the gap between short and long-term interest rates); John Atkins, Economy: Short-term Business Borrowing Hits Highest Level Since 2001, Forbes, Feb. 22, 2013, available at https://www.forbes.com/ sites/spleverage/2013/02/22/economy-short-termbusiness-borrowing-hits-highest-level-since-2001. 373 See Victoria Baklanova, Adam Copeland, and Rebeca McCaughrin, Reference Guide to U.S. Repo and Securities Lending Markets, Federal Reserve Bank of NY Staff Report, Sept. 2015, available at https://www.newyorkfed.org/medialibrary/media/ research/staff_reports/sr740.pdf, at 16 (noting that, while dealers appear to represent the largest participants in the market for repurchase agreements, non-dealer activity has likely increased such as through service providers that allow nondealer counterparties to engage directly in a repurchase agreement without an intermediary). 374 See Philip E. Strahan, Liquidity Risk and Credit in the Financial Crisis, FRBSF Economic Letter (May 14, 2012), available at https://www.frbsf. org/economic-research/publications/economicletter/2012/may/liquidity-risk-credit-financialcrisis/. See also, Adonis Antoniades, Liquidity Risk and the Credit Crunch of 2007–2008: Evidence from Micro-Level Data on Mortgage Loan Applications, Dec. 2014, available at https://www.bis.org/publ/ E:\FR\FM\22APP3.SGM Continued 22APP3 23948 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 present increased risks to registrants who rely on short-term borrowings.375 Due to their short-term nature, a registrant’s use of such arrangements can fluctuate significantly during a reporting period. As a result, presentation of period-end amounts of short-term borrowings alone may not accurately capture a registrant’s funding needs or use of such borrowings during the relevant period.376 Our rules require a liquidity analysis on both a long-term and short-term basis.377 The Commission has stated that registrants should consider describing the sources of short-term funding and the circumstances that are reasonably likely to affect those sources of liquidity.378 In addition, the Commission and its staff have provided guidance that certain registrants should disclose short-term borrowings to the extent relevant and material to the operations of the entity.379 work473.pdf; Marcia Millon Cornett, Jamie John McNutt, Philip E. Strahan, Hassan Tehranian, Liquidity Risk Management and Credit Supply in the Financial Crisis, 101 J. Fin. Econ. (2011), 297– 312; Jose Berrospide, Bank Liquidity Hoarding and the Financial Crisis: An Empirical Evaluation, Federal Reserve Board Finance and Economics Discussion Series, Nov. 29, 2012; A. Martin et al., Repo Runs, FRBNY Staff Report No. 444 (Apr. 2010) (demonstrating that institutions funded by shortterm collateralized borrowings are subject to the threat of runs similar to those faced by commercial banks). 375 For instance, financing rates may increase or terms may become unfavorable, it may become more costly or impossible to roll over short-term borrowings, or for financial institutions, demand depositors may withdraw funds. See, e.g., Gary B. Gorton, Andrew Metrick, Lei Xie, The Flight from Maturity, Yale School of Management May 2015–, available at https://www.nber.org/papers/ w20027.pdf.; M. Brunnermeier, Deciphering the Liquidity and Credit Crunch 2007–2008, 23 J. Econ. Persp. 77 (2009), at 79–80, available at https:// www.princeton.edu/∼markus/research/papers/ liquidity_credit_crunch.pdf. 376 See Short-Term Borrowings Disclosure, Release No. 33–9143 (Sept. 17, 2010) [75 FR 59866 (Sept. 28, 2010)] (‘‘Short-Term Borrowings Proposing Release’’). 377 Instruction 3 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. 378 See 2002 Commission Statement about MD&A at 3748 (‘‘MD&A disclosures should not be overly general. For example, disclosure that the registrant has sufficient short-term funding to meet its liquidity needs for the next year provides little useful information. Instead, registrants should consider describing the sources of short-term funding and the circumstances that are reasonably likely to affect those sources of liquidity.’’). 379 See 2010 Liquidity and Capital Resources Interpretive Release at 59895 (stating that, ‘‘if the registrant’s financial statements do not adequately convey the registrant’s financing arrangements during the period, or the impact of those arrangements on liquidity, because of a known trend, demand, commitment, event or uncertainty, additional narrative disclosure should be considered and may be required to enable an understanding of the amounts depicted in the financial statements’’); Industry Guide 3, Statistical Disclosure by Bank Holding Companies (‘‘Industry Guide 3’’), available at https://www.sec.gov/about/ VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 The Commission has previously considered the applicability of shortterm borrowing disclosure requirements for all registrants. In 1994, in connection with the elimination of various financial statement disclosure schedules, the Commission eliminated a short-term borrowings disclosure requirement for registrants that were not bank holding companies.380 Former Rule 12–10 of Regulation S–X required those registrants to include with their financial statements a schedule of shortterm borrowings that disclosed the maximum amount outstanding during the year, the average amount outstanding during the year, and the weighted-average interest rate during the period, with amounts broken out into specified categories of short-term borrowings.381 In proposing to eliminate this schedule, the Commission noted ‘‘the disclosures concerning the registrant’s liquidity and capital resources that are required in the MD&A would appear to be sufficiently informational to permit elimination of the short term borrowing schedule.’’ 382 In repealing Rule 12–10, the Commission ‘‘concluded that the costs of furnishing the information outweigh[ed] its usefulness.’’ 383 In 2010, the Commission proposed new disclosure requirements for shortterm borrowings.384 When proposing forms/industryguides.pdf; and Staff Accounting Bulletin, Topic 11:K (Application of Article 9 and Industry Guide 3), available at https://www.sec.gov/ interps/account/sabcodet11.htm (‘‘In the staff’s view, Article 9 [of Regulation S–X] and Guide 3, while applying literally only to bank holding companies, provide useful guidance to certain other registrants . . . Thus, to the extent particular guidance is relevant and material to the operations of an entity, the staff believes the specified information, or comparable data, should be provided.’’). 380 See Financial Statements of Significant Foreign Equity Investees and Acquired Foreign Businesses of Domestic Issuers and Financial Schedules, Release No. 33–7118 (Dec. 13, 1994) [59 FR 65632 (Dec. 20, 1994)] (‘‘Financial Schedules Adopting Release’’). 381 The categories in former Rule 12–10 were amounts payable to: Banks for borrowings; factors or other financial institutions for borrowings; and holders of commercial paper. 382 See Financial Statements of Significant Foreign Equity Investees and Acquired Foreign Businesses of Domestic Issuers and Financial Schedules, Release No. 33–7055 (Apr. 19, 1994) [59 FR 21814 (Apr. 26, 1994)] at 21818. 383 See Financial Schedules Adopting Release at 65635. 384 See Short-Term Borrowings Proposing Release. As proposed, these rules would have codified the provisions in Industry Guide 3 for disclosure of short-term borrowings in Regulation S–K for all registrants. These proposed rules were intended to provide important information so investors could better understand the role of shortterm financing and the related risks to the registrant. At that time, the Commission proposed amending its MD&A requirements to include a new section that would provide tabular information of PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 these rules, the Commission stated its belief that they differed from former Rule 12–10 by, among other things, requiring short-term borrowings disclosure in MD&A, in tabular form, alongside a discussion and analysis to provide context for the quantitative data.385 Some commenters expressed concern about these proposed rules and emphasized the costs associated with compliance, which they asserted would outweigh the usefulness of the disclosure. A significant number of commenters were financial institutions 386 and related organizations,387 with only a small number of investors submitting comments.388 While the Commission did not adopt these rules, there have been other regulatory actions relating to short-term borrowings disclosure.389 While a number of commenters generally supported the proposed rules’ objectives of greater transparency of short-term borrowings as part of a registrant’s overall liquidity profile, they also expressed numerous concerns about the quantitative requirements of the proposed rule. For example, commenters were opposed to the a registrant’s short-term borrowings, as well as a discussion and analysis of these borrowings. These proposed amendments would have (i) expanded the Industry Guide 3 provisions for disclosure of shortterm borrowings in Regulation S–K, (ii) required disclosure on an annual and quarterly basis, and (iii) expanded Industry Guide 3 disclosure to all registrants that provide an MD&A. If the proposals had been adopted, the Commission would have authorized the staff to eliminate the corresponding provisions of Industry Guide 3 to avoid redundant disclosure requirements. See id. at 59868, footnote note 21 and accompanying text. 385 See id. 386 See, e.g., comment letters to File No. S7–22– 10 from Credit Suisse Group AG (Nov. 29, 2010), Barclays Bank PLC (Nov. 29, 2010), JP Morgan Chase & Co. (Nov. 29, 2010), Morgan Stanley (Nov. 29, 2010) and Citigroup Inc. (Nov. 29, 2010) available at https://www.sec.gov/comments/s7-2210/s72210.shtml. 387 See, e.g., comment letters to File No. S7–22– 10 from the American Bankers Association (Nov. 29, 2010) and British Bankers’ Associations (Dec. 1, 2010). 388 See comment letters to File No. S7–22–10 from Fidelity Management & Research Company (Nov. 29, 2010), Doug Morgan (Sept. 20, 2010) and Yong Zheng (Dec. 13, 2010). Fidelity supported the proposed requirements and recommended ‘‘more granular disclosure on repo portfolios.’’ Some of Fidelity’s recommendations have since been addressed by revised FASB guidance on accounting for repurchase financings. Registrants currently are required to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements. In addition, registrants must provide increased transparency about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. See ASU 2014–11 ‘‘Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.’’ 389 See supra note 388. See also 2010 Liquidity and Capital Resources Interpretive Release. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules proposed requirement to further disaggregate amounts in the table by currency, interest rate or other meaningful category 390 as well as the proposed requirement to disclose all categories of short-term borrowings by eliminating a threshold for allowing aggregation into categories.391 ii. Request for Comment 121. Do current disclosure requirements under Item 303 elicit adequate disclosure of a registrant’s reliance on short-term borrowings? 122. Should we revise Item 303 to require specific line-item disclosure of a registrant’s use and analysis of shortterm borrowings as a source of funding? Are there aspects of the 2010 proposal we should revisit? Would doing so lead to any additional disclosure or analysis that registrants do not already provide under current requirements and guidance? Should we consider other qualitative or quantitative measures for disclosure of short-term borrowings? If so, what measures should we consider? 123. Should we consider different disclosure requirements for financial institutions versus non-financial institutions? If so, which disclosure should we require and why? 124. Should we require registrants to provide chart or graph of its short-term borrowings? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 6. Off-Balance Sheet Arrangements (Item 303(a)(4)) Item 303(a)(4) requires, in a separately-captioned section, disclosure of a registrant’s off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on a registrant’s financial condition, changes in financial 390 See comment letters to File No. S7–22–10 from the American Bar Association (Dec. 17, 2010), American Bankers Association (Nov. 29, 2010), Barclays Bank PLC (Nov. 29, 2010), Citigroup Inc. (Nov. 29, 2010), Cleary Gottlieb Steen & Hamilton LLP (Nov. 29, 2010), Chevron Corp. (Nov. 16, 2010), Credit Suisse Group AG (Nov. 29, 2010), Institute of Management Accountants (Nov. 16, 2010), New York City Bar Association (Nov. 29, 2010), Regions Financial Corp. (Nov. 29, 2010), UBS AG (Nov. 29, 2010). 391 See comment letters to File No. S7–22–10 from the American Bankers Association (Nov. 29, 2010), Barclays Bank PLC (Nov. 29, 2010), Cleary Gottlieb Steen & Hamilton LLP (Nov. 29, 2010), Davis Polk & Wardwell LLP (Nov. 29, 2010), Institute of Management Accountants (Nov. 16, 2010), Morgan Stanley (Nov. 29, 2010), Regions Financial Corp. (Nov. 29, 2010), Barclays Bank PLC (Nov. 29, 2010), Ford Motor Company (Nov. 29, 2010), BDO USA LLP (Nov. 22, 2010) and American Bar Association (Dec. 17, 2010). The proposed rule was a change from existing Industry Guide 3 instructions, which allows categories of short-term borrowings to be aggregated where they do not exceed thirty percent of the company’s stockholders’ equity at the end of the period. Instruction to Item VII of Industry Guide 3. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.392 To the extent necessary to an understanding of such arrangements and effect, registrants must disclose the following items and such other information that the registrant believes is necessary for such an understanding: • The nature and business purpose of such off-balance sheet arrangements; • the importance to the registrant of such off-balance sheet arrangements in respect of its liquidity, capital resources, market risk support, credit risk support or other benefits; • the amounts of revenues, expenses and cash flows arising from such arrangements; the nature and amounts of any interests retained, securities issued and other indebtedness incurred in connection with such arrangements; and the nature and amounts of any other obligations or liabilities (including contingent obligations or liabilities) of the registrant arising from such arrangements that are or are reasonably likely to become material and the triggering events or circumstances that could cause them to arise; and • any known event, demand, commitment, trend or uncertainty that will result in or is reasonably likely to result in the termination, or material reduction in availability of a registrant’s off-balance sheet arrangements that provide material benefits, and the course of action that the registrant has taken or proposes to take in response to any such circumstances. Item 303(a)(4)(ii) defines off-balance sheet arrangements as certain guarantees, retained or contingent interests in assets transferred to an unconsolidated entity, obligations under certain derivative instruments,393 and variable interests in an unconsolidated entity. a. Comments Received S–K Study. One commenter stated that disclosure of off-balance sheet arrangements was redundant with financial statement disclosure requirements.394 392 Item 303(a)(4) of Regulation S–K [17 CFR 229.303(a)(4)]. 393 For registrants whose financial statements are prepared in accordance with U.S. GAAP, the definition includes a contract that would be accounted for as a derivative instrument, except that it is both indexed to the registrant’s own stock and classified in the registrant’s statement of stockholders’ equity. See ASC 815–10–15–74. For other registrants, the definition includes derivative instruments that are both indexed to the registrant’s own stock and classified in stockholders’ equity, or not reflected, in the company’s statement of financial position. 394 See Ernst & Young 1. PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 23949 Disclosure Effectiveness Initiative. A few commenters stated that disclosure of off-balance sheet arrangements was redundant of disclosure in the financial statements.395 These commenters suggested either eliminating this requirement or expressly allowing registrants to cross-reference to the disclosure in the financial statements. One of these commenters also noted that disclosures under this item are ‘‘generally boilerplate and/or redundant’’ and recommended a more ‘‘principles-based’’ approach to this disclosure.396 One commenter listed offbalance sheet disclosure as ‘‘some of the most challenging disclosures’’ that could be improved.397 b. Discussion The Sarbanes-Oxley Act required the Commission to adopt rules providing that each annual and quarterly financial report required to be filed with the Commission must include disclosure about off-balance sheet arrangements.398 Earlier in 2002, prior to enactment of the Sarbanes-Oxley Act, the Commission issued a statement on the desirability of enhanced disclosure in MD&A of off-balance sheet arrangements.399 Much of the language and many of the concepts in the Sarbanes-Oxley Act were consistent with the language and concepts in this Commission statement.400 In its 2002 statement, the Commission noted that off-balance sheet arrangements often are integral to both liquidity and capital resources and that registrants should ‘‘consider all of these items together, as well as individually,’’ 395 See, e.g., CCMC, SCSGP, ABA 1, and ABA 2. ABA 1. For example, this commenter suggested requiring registrants to disclose the potential impact on the registrant of the acceleration or increase of material off-balance sheet arrangements. 397 See CFA Institute. This commenter did not provide specific recommendations on how to improve this disclosure. 398 Section 401(a) of the Sarbanes-Oxley Act added Section 13(j) to the Exchange Act [15 U.S.C. 78m(j)], which directed the Commission to adopt rules requiring each annual and quarterly financial report filed with the Commission to disclose ‘‘all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses.’’ 399 See 2002 Commission Statement about MD&A. 400 See id. See also Disclosure in Management’s Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments, Release No. 33–8144, Nov. 4, 2002 [67 FR 68054 (Nov. 8, 2002)] (‘‘Off-Balance Sheet and Contractual Obligations Proposing Release’’). 396 See E:\FR\FM\22APP3.SGM 22APP3 23950 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 when drafting MD&A disclosure.401 The Commission further noted that offbalance sheet arrangements and transactions with unconsolidated, limited purpose entities should be discussed pursuant to Item 303(a) when they are ‘‘reasonably likely to affect materially liquidity or the availability of or requirements for capital resources.’’ 402 The 2002 statement was consistent with Commission rules and guidance existing at the time. For example, Item 303(a)(2)(ii) specifically required registrants to disclose off-balance sheet financing arrangements in their discussion of capital resources.403 Similarly, the 1989 MD&A Interpretive Release indicated that a registrant’s discussion of long-term liquidity and long-term capital resources must address demands or commitments, including any off-balance sheet items.404 In response to the Sarbanes-Oxley Act, the Commission adopted more specific disclosure requirements for offbalance sheet arrangements in 2003.405 When adopting these rules, the Commission reiterated that, while only one item in its MD&A rules specifically identifies off-balance sheet arrangements,406 other requirements ‘‘clearly require disclosure of offbalance sheet arrangements if necessary to an understanding of a registrant’s financial condition, changes in financial condition or results of operations.’’ 407 The new rules were intended to clarify the disclosures that registrants must make about off-balance sheet arrangements and required registrants to provide those disclosures in a separately designated section of MD&A.408 In 2004, as part of a broader effort to expand the events that registrants must report on a current basis, the Commission adopted additional 401 See 2002 Commission Statement about MD&A at 3748. 402 See id. at 3748. 403 Item 303(a)(2)(ii) of Regulation S–K [17 CFR 229.303(a)(2)(ii)]. The item specifies that the discussion shall consider changes between equity, debt and any off-balance sheet financing arrangements. 404 See 1989 MD&A Interpretive Release at 22431 (‘‘The discussion of long-term liquidity and longterm capital resources must address material capital expenditures, significant balloon payments or other payments due on long-term obligations, and other demands or commitments, including any offbalance sheet items, to be incurred beyond the next 12 months, as well as the proposed sources of funding required to satisfy such obligations.’’). 405 See Off-Balance Sheet and Contractual Obligations Adopting Release. 406 Item 303(a)(2)(ii) of Regulation S–K [17 CFR 229.303(a)(2)(ii)]. 407 See Off-Balance Sheet and Contractual Obligations Adopting Release at 5983. 408 See id. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 requirements for disclosing off-balance sheet arrangements on Form 8–K.409 These new provisions of Form 8–K, which remain in effect today, require registrants to file a report upon the creation of a direct financial obligation or an obligation under an off-balance sheet arrangement (Item 2.03) and to file a report if a triggering event occurs that causes the increase or acceleration of a such an obligation and the consequences of the event are material to the registrant (Item 2.04).410 While the Form 8–K requirements rely on the definition of ‘‘off-balance sheet arrangement’’ in Item 303(a)(4)(ii), the substance of the disclosure is different. Unlike Item 303(a)(4), Form 8–K does not require registrants to provide an analysis of off-balance sheet arrangements or their importance to the registrant. In the proposing release for Item 303(a)(4), the Commission recognized that parts of the proposed off-balance sheet disclosure requirements might overlap with disclosure presented in the footnotes to the financial statements. The Commission stated that the proposed rules were designed to provide more comprehensive information and analysis in MD&A than what was provided in the footnotes.411 Since the adoption of Item 303(a)(4), the FASB has issued additional requirements that further overlap with this item.412 Currently, U.S. GAAP requires disclosure about transactions or arrangements that overlap with Item 303(a)(4)’s definition of off-balance sheet arrangements. For example, U.S. GAAP requires disclosure in the notes to the financial statements of the nature and amount of a guarantee,413 retained or contingent interests in assets transferred to unconsolidated entities,414 pertinent information of derivative instruments that are classified as stockholder’s equity under U.S. GAAP,415 and obligations under 409 See 2004 Form 8–K Adopting Release. CFR 249.308. 411 See Off-Balance Sheet and Contractual Obligations Proposing Release. 412 In June 2009, the FASB issued SFAS No. 166, Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140, which requires enhanced disclosures about transfers of financial assets and a transferor’s continuing involvement with transfers of financial assets accounted for as sales. Also in June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), which requires enhanced disclosures about an enterprise’s involvement in a variable interest entity, including unconsolidated entities. SFAS No. 166 and 167 have been codified as ASC Topics 860 (Transfers and Servicing) and 810 (Consolidation), respectively. 413 See ASC 460–10–50. 414 See ASC 860–10–50–3, ASC 860–20–50. 415 See ASC 815–40–50–5, ASC 505–10–50. 410 17 PO 00000 Frm 00036 Fmt 4701 Sfmt 4702 variable interests in unconsolidated entities.416 Because of this overlap, in response to Item 303(a)(4), registrants often provide cross-references to the relevant notes to their financial statements or provide disclosure that is duplicative of information in the notes. While many of the requirements in Item 303(a)(4) overlap with U.S. GAAP, some of the requirements related to the location, presentation and nature of the disclosure are not the same. Additionally, Item 303(a)(4) disclosure is not audited. Location of Disclosure. In its 2002 statement, the Commission observed that investors will often find information relating to a particular matter more meaningful if it is disclosed in a single location, rather than presented in a fragmented manner throughout the filing.417 In proposing the off-balance sheet disclosure requirements, the Commission identified as one of its objectives to provide investors with information necessary to understand a registrant’s off-balance sheet arrangements that are neither readily apparent nor easily understood from reading the financial statements alone.418 Item 303(a)(4)(i) specifies that offbalance sheet arrangements should be discussed in a separately-captioned section. The instructions to Item 303(a)(4) permit that discussion to cross-reference to information provided in the footnotes to the financial statements, rather than repeat it, provided that the MD&A disclosure integrates the substance of the footnotes in a manner designed to inform readers of the significance of the information that is cross-referenced.419 By contrast, U.S. GAAP does not prescribe the location of these disclosures, which may be dispersed throughout the notes to the financial statements. However, interactive data allows investors to isolate disclosures about off-balance sheet arrangements even when it is dispersed within the notes to the financial statements. Presentation of Disclosure. Item 303(a)(4) requires disclosure for the most recent period and a discussion of changes from the previous year where necessary to an understanding of the disclosure.420 U.S. GAAP does not 416 See ASC 810–10–50–4. 2002 Commission Statement about MD&A. 418 See Off-Balance Sheet and Contractual Obligations Proposing Release. 419 Instruction 5 to Item 303(a)(4) of Regulation S– K [17 CFR 229.303(a)(4)]. 420 Instruction 4 to Item 303(a)(4) [17 CFR 229.303(a)(4)]. 417 See E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 require discussion of changes from the previous year. Nature of Disclosures. While Item 303(a)(4) and U.S. GAAP both require disclosure of the nature and amounts associated with off-balance sheet arrangements, Regulation S–K requires additional disclosure about the business purpose of the off-balance sheet arrangement 421 and the importance of the off-balance sheet arrangement to the registrant’s liquidity, capital resources, market risk support, credit risk support, and other benefits.422 Item 303(a)(4) also requires disclosure of any known event, demand, commitment, trend, or uncertainty that will result in or is reasonably likely to result in the termination or material reduction in the availability of material off-balance sheet arrangements to the registrant and the course of action the registrant has taken or proposes to take to address such circumstances. U.S. GAAP does not require this disclosure. c. Request for Comment 125. Does Item 303(a)(4) elicit disclosure that is important to investors? Is this information otherwise available in Commission filings? 126. If we retain the disclosure requirements in Item 303(a)(4), should we expand the disclosure required by this item? If so, what additional disclosure would be important to investors and why? For example, should we revise our rules to require registrants to analyze the risks and financial potential associated with its off-balance sheet arrangements? 127. If we retain the disclosure requirements in Item 303(a)(4), should this information be located in MD&A, the notes to the financial statements, or both? Is the location of the disclosure important? Are there challenges associated with auditing this information? 128. If we eliminate Item 303(a)(4), do the other requirements in Item 303 and the requirements in U.S. GAAP require adequate disclosure in terms of the location, presentation and nature of information about off-balance sheet arrangements? Would eliminating Item 304(a)(4) result in costs to investors? 129. In the adopting release for Item 303(a)(4), the Commission noted that ‘‘[t]he MD&A rules already require disclosure regarding off-balance sheet arrangements and other contingencies.’’ 423 Do the disclosure 421 Item 303(a)(4)(i)(A) of Regulation S–K [17 CFR 229.303(a)(4)(i)(A)]. 422 Item 303(a)(4)(i)(B) of Regulation S–K [17 CFR 229.303(a)(4)(i)(B)]. 423 See Off-Balance Sheet and Contractual Obligations Adopting Release at 5982. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 requirements in Item 303 regarding liquidity and capital resources require adequate disclosure about matters that will result in or is reasonably likely to result in the termination or material reduction in the availability of material off-balance sheet arrangements to the registrant and the course of action the registrant has taken or proposes to take to address such circumstances? 130. Should we require additional disclosure of off-balance sheet arrangements that occurred during a reporting period, such as an exhibit identifying all such arrangements? 7. Contractual Obligations (Item 303(a)(5)) Item 303(a)(5) requires tabular disclosure of a registrant’s known contractual obligations for long-term debt, capital leases, operating leases, purchase obligations and other longterm liabilities reflected on the registrant’s balance sheet under U.S. GAAP.424 The Commission has defined the first three categories of obligations (long-term debt, capital leases and operating leases) by reference to the relevant U.S. GAAP accounting pronouncements that require disclosure of these obligations in the financial statements or notes thereto.425 For purchase obligations, the Commission defined this term as an agreement to purchase goods or services that is enforceable, legally binding on the registrant and specifies all significant terms.426 The Commission stated that the definition of ‘‘purchase obligations’’ is designed to capture the registrant’s capital expenditures for purchases of goods or services over a five-year period.427 Some purchase obligations are executory contracts, and therefore are not recognized as liabilities in accordance with U.S. GAAP.428 The fifth category of contractual obligations, ‘‘Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP,’’ captures all other long-term liabilities that are reflected on the registrant’s balance sheet under the registrant’s applicable U.S. GAAP. Common examples of other obligations disclosed in this line-item of the table include postretirement 424 17 CFR 229.303(a)(5) of Regulation S–K [17 CFR 229.303(a)(5)]. 425 Item 303(a)(5)(ii) of Regulation S–K [17 CFR 229.303(a)(5)(ii)] (referring to ASC Topics 470–10– 50–1 and 840 in defining the terms ‘‘long-term debt obligation,’’ ‘‘capital lease obligation’’ and ‘‘operating lease obligation’’). 426 Item 303(a)(5)(ii) of Regulation S–K [17 CFR 229.303(a)(5)(ii)]. 427 See Off-Balance Sheet and Contractual Obligations Adopting Release. 428 See id. PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 23951 benefits, interest on debt, and tax liabilities for uncertain tax positions. Item 303(a)(5) requires registrants to disclose the amounts of payments due by specified time periods, aggregated by the type of contractual obligation.429 Registrants must disclose payments due in less than 1 year, 1–3 years, 3–5 years and more than 5 years, as well as the total, aggregate amount of obligations in each category. Amounts are required to be set forth in the aggregate and there is no materiality qualifier. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter called for improvements in the ability to contextualize the table of contractual obligations, but did not provide additional details.430 Another commenter recommended that we add an instruction to Item 303(a)(5) indicating that, to the extent disclosure in response to the item is included in the notes to the financial statements, registrants should use cross-references to avoid duplicative disclosure.431 b. Discussion In response to a 2001 petition for an interpretive release,432 the Commission issued a statement in 2002 recommending that registrants present information about contractual obligations and commercial commitments in a single location within the filing.433 The statement included a recommended table of contractual obligations resembling that of current Item 303(a)(5).434 This recommended table became a line-item requirement when the Commission adopted Item 303(a)(5) in 2003.435 When adopting Item 303(a)(5), the Commission recognized that much of the disclosure required by this item is addressed under U.S. GAAP requirements.436 Similarly, disclosure 429 Item 303(a)(5)(i) of Regulation S–K. Registrants may disaggregate the categories specified in the item and use other categories suitable to their businesses, so long as the presentation includes all of the registrant’s obligations that fall within the specified categories. 430 See CFA Institute. 431 See ABA 2. 432 See Petition for Issuance of Interpretive Release Concerning MD&A under Regulation S–K, Item 303, (Dec. 31, 2001), available at https:// www.sec.gov/rules/petitions/petndiscl12312001.htm. 433 See 2002 Commission Statement about MD&A. 434 See id. The recommended table included longterm debt, capital lease and operating lease obligations and covered similar periods. 435 See Off-Balance Sheet and Contractual Obligations Adopting Release. 436 See Off-Balance Sheet and Contractual Obligations Adopting Release at 5986 (‘‘The E:\FR\FM\22APP3.SGM Continued 22APP3 23952 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 about other obligations not required by U.S. GAAP, ‘‘such as purchase contracts, may or may not be disclosed, but if disclosed, it is usually dispersed throughout the filing and may not be presented in a consistent manner among registrants.’’ 437 By providing aggregated information of contractual obligations in a single location and appropriate context for investors to assess the impact of offbalance sheet arrangements with respect to liquidity and capital resources, Item 303(a)(5) was intended to improve transparency of a registrant’s short- and long-term liquidity and capital resource needs. This disclosure was also intended to ‘‘improve an investor’s ability to compare registrants.’’ 438 The Commission has issued guidance on Item 303(a)(5) on one occasion since its adoption.439 In a 2010 interpretive release, the Commission noted that registrants and industry groups had raised questions about how to treat a number of items under the contractual obligations requirement, including: interest payments, repurchase agreements, tax liabilities, synthetic leases, and obligations that arise under off-balance sheet arrangements.440 Because the questions tended to be factspecific and closely related to a registrant’s particular business and circumstances, the Commission declined to provide specific guidance about these items or the presentation of the contractual obligations table. Instead, the Commission noted that the requirement itself permits flexibility and encouraged registrants to develop a presentation method that is clear, understandable and appropriately reflects the categories of obligations that are meaningful in light of its capital structure and business.441 preparation of financial statements in accordance with GAAP already requires registrants to assess payments under all of the above categories of contractual obligations, except for purchase obligations.’’). Item 303(a)(5) directly refers to ASC Topics in defining three of the five required categories of contractual obligations that must be included within the table. See supra note 425 and accompanying text. 437 See Off-Balance Sheet and Contractual Obligations Adopting Release at 5990. 438 Id. at 5990. 439 In the 2003 MD&A Interpretive Release, the Commission stated that it was not addressing specifically disclosures of contractual obligations because it had had little experience with companies’ application of the new rule, adopted a few months earlier. Nevertheless, the Commission noted that the overall guidance in the 2003 MD&A Interpretive Release is applicable to all MD&A discussions. See 2003 MD&A Interpretive Release. 440 See 2010 Liquidity and Capital Resources Interpretive Release. 441 See id. The Commission noted that the staff has observed that divergent practices have VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 The Commission’s guidance also explained that tabular disclosure of contractual obligations should be prepared with the goal of presenting a meaningful snapshot of cash requirements arising from contractual payment obligations. Registrants were instructed to highlight any changes in presentation that are made so that investors may use the information to make comparisons from period to period. The Commission suggested that footnotes should be used to provide information necessary for an understanding of the timing and amount of specified contractual obligations. Registrants also should consider additional narrative discussion outside of the table to promote understanding of the tabular data.442 In practice, however, registrants typically do not include additional narrative with their contractual obligations table. c. Request for Comment 131. Does the table of contractual obligations present a meaningful snapshot of a registrant’s cash requirements for contractual obligations? How could the format of the disclosure in the table be improved? Should we consider an alternative presentation or format for this disclosure? 132. Should we require narrative disclosure to accompany the tabular disclosure? For example, should we require registrants to discuss how they plan to meet current and future obligations disclosed in the table? If so, what additional narrative disclosure would be useful to investors? 133. Item 303(a)(5) was intended to provide aggregated information of contractual obligations in a single location and appropriate context for investors to assess the impact of offbalance sheet arrangements with respect to liquidity and capital resources. Would narrative disclosure improve readers’ ability to compare registrants by reconciling the information in the table to information elsewhere in MD&A and financial statements? Should comparability among registrants continue to be a goal? Should we continue to require this disclosure in a single location or is disclosure elicited under U.S. GAAP, in various parts of a registrant’s filings, sufficient? developed in connection with Item 303(a)(5) disclosure, with registrants drawing different conclusions about the information to be included in the table, but also acknowledged that the rule permits flexibility so the presentation can reflect company-specific information suitable to a company’s business. 442 See id. PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 134. Item 303(a)(5) requires disclosure of five categories of contractual obligations. Should we expand the rule to include other categories of contractual obligations and if so, what categories should we consider? 135. Would additional guidance or instructions about how to treat certain types of obligations, such as interest payments, repurchase agreements or tax liabilities, be helpful to registrants in preparing this disclosure? Would such guidance limit the intended flexibility of the rule? 136. In the 2010 Liquidity and Capital Resources Interpretive Release, the Commission suggested that separating amounts in the table into those that are reflected on the balance sheet and those arising from off-balance arrangements might be useful to a clear understanding of the information presented. Should we revise Item 303(a)(5) to require registrants to separate amounts in the table of contractual obligations into those that are reflected on the balance sheet and those arising from off-balance sheet arrangements? Should we require this disclosure pursuant to some threshold amount? 8. Critical Accounting Estimates A registrant’s results of operations, financial condition, and changes to financial condition often depend on estimates involved in applying accounting policies that entail uncertainties and subjectivity. Critical accounting estimates are those accounting judgments and estimates that relate to the items that are material to the financial statements, taken as a whole, and that management believes are most critical—that is, those that are most important to portraying the registrant’s financial condition and results and require management’s most difficult, subjective or complex judgments.443 While U.S. GAAP requires financial statement footnote disclosure about accounting policies,444 Item 303 requires disclosure of trends, events or uncertainties known to management that could materially affect reported financial information. Item 303 does not specifically address critical accounting estimates. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended amending Item 303 to require disclosure about management’s significant 443 See Accounting Policies; Cautionary Advice Regarding Disclosure, Release No. 33–8040 (Dec. 12, 2001) [66 FR 65013 (Dec. 17, 2001)] (‘‘Cautionary Advice Release’’). 444 See ASC Topic 235–10–50–1. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules judgments and assumptions underlying its use of critical accounting estimates.445 This commenter also recommended amending Item 303 to explain that the disclosure about critical accounting estimates required in MD&A is meant to supplement, not duplicate, the information provided in the notes to the financial statements.446 In addition, this commenter suggested that we consider whether requiring independent auditor negative assurance would enhance the quality of the recommended disclosures by imposing more rigor in its preparation.447 Another commenter recommended that the Commission work with accounting standard-setters to improve financial statement presentation and related disclosures, such as estimates, judgments and choices.448 One commenter also suggested that the Commission work with the auditing profession to eliminate descriptions of recent accounting changes for pronouncements that have no effect on a registrant.449 Another commenter recommended that the Commission coordinate with the FASB to review and clarify the disclosure objectives of critical accounting estimates in MD&A and significant accounting policies in the financial statements to determine whether they provide distinct and useful information and provide guidance on how both requirements should work best.450 b. Discussion In 2001, the Commission encouraged registrants to explain in their MD&A the judgments and uncertainties affecting the application of their critical accounting policies, as well as the likelihood that materially different amounts would be reported under different conditions or using different assumptions.451 The Commission also stated its intent to consider new rules to elicit more precise disclosures about the critical accounting policies.452 445 See ABA 1. id. See also ABA 2. The Commission has also stated that critical accounting estimates should supplement and not duplicate the description of accounting policies in the notes to the financial statements. See, e.g., 2003 MD&A Interpretive Release. 447 See ABA 1. 448 See CFA Institute. 449 See A. Radin. 450 See SCSGP. 451 See Cautionary Advice Release. The Commission alerted registrants to the need for greater investor awareness of the sensitivity of financial statements to the methods, assumptions and estimates underlying their preparation and stated that the objective of this disclosure is consistent with the objective of MD&A. 452 See id. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 446 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 In 2002, the Commission proposed new rules that would have required, among other things, disclosure of accounting estimates resulting from the application of critical accounting policies.453 The proposed rules would have defined a ‘‘critical accounting estimate’’ as an accounting estimate that meets the following two criteria: (i) The accounting estimate must require the registrant to make assumptions about matters that are highly uncertain at the time the accounting estimate is made; and (ii) it must be the case that different estimates that the registrant reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the presentation of the registrant’s financial condition, changes in financial condition or results of operations.454 As proposed, registrants would have been required to: • Describe the critical accounting estimates (including the methodology underlying each critical accounting estimate, assumptions about highly uncertain matters and other assumptions that are material) and identify where and how they affect the registrant’s reported financial results, financial condition and changes in financial condition; 455 • provide a better understanding of the sensitivity of the reported operating results and financial condition to changes in the critical accounting estimates or their underlying assumptions; 456 and • state whether or not senior management discussed the 453 See Disclosure in Management’s Discussion and Analysis about the Application of Critical Accounting Policies, Release No. 33–8098 (May 10, 2002) [67 FR 35620 (May 20, 2002)] (‘‘Critical Accounting Proposing Release’’). The Commission also proposed rules requiring a registrant that has initially adopted an accounting policy with a material impact on its financial presentation to disclose information that includes: what gave rise to the initial adoption; the impact of the adoption; the accounting principle adopted and method of applying it; and the choices it had among accounting principles. See id. 454 See id. 455 Disclosure would have been required, if applicable, regarding why the accounting estimate was reasonably likely to change in future periods with a material impact on the registrant’s financial presentation. In certain situations, disclosures would have been required for individual segments of the registrant’s business. 456 More specifically, the rules would have required, for each critical accounting estimate, discussion of changes that would result either from (i) making reasonably possible, near-term changes in the most material assumptions underlying the estimate, or (ii) using in place of the recorded estimate the ends of the range of reasonably possible amounts that the registrant likely determined when formulating its recorded estimate. PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 23953 development, selection and disclosure of those critical accounting estimates with the registrant’s audit committee.457 The Commission did not adopt these rules, but subsequently provided interpretive guidance on disclosure of critical accounting estimates.458 In the 2003 MD&A Interpretive Release, the Commission stated that registrants should provide disclosure about critical accounting estimates or assumptions in MD&A where: • The nature of the estimates or assumptions is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change; and • the impact of the estimates and assumptions on financial condition or operating performance is material.459 The Commission also clarified that this disclosure should supplement, not duplicate, the description of accounting policies that are already disclosed in the notes to the financial statements.460 While accounting policy notes in the financial statements generally describe the method used to apply an accounting principle, the discussion in MD&A should present a registrant’s analysis of the uncertainties involved in applying the principle.461 Despite Commission guidance, many registrants repeat the discussion of significant accounting policies from the notes to the financial statements in their discussion of critical accounting estimates in MD&A and provide limited additional discussion of the critical accounting estimates. We are seeking public input on how to revise our requirements to improve the discussion of critical accounting estimates in MD&A. 457 See Critical Accounting Proposing Release. interpretive guidance was provided based on the Division staff’s review of registrant disclosures, including its Fortune 500 review. The Commission concluded that additional guidance would be especially useful in a few areas of MD&A, including disclosure of critical accounting estimates. See 2003 MD&A Interpretive Release. 459 See id. 460 See id. The Commission further stated that ‘‘[e]qually important, companies should address the questions that arise once the critical accounting estimate or assumption has been identified, by analyzing, to the extent material, such factors as how they arrived at the estimate, how accurate the estimate/assumption has been in the past, how much the estimate/assumption has changed in the past, and whether the estimate/assumption is reasonably likely to change in the future.’’ See id. at 75065. The FASB has also stated that distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult, and in some cases, a change in accounting estimate is effected by a change in accounting principle. See ASC Topic 250–10–45–18. 461 See 2003 MD&A Interpretive Release. 458 This E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 23954 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules c. Request for Comment 137. Should we revise Item 303 to require disclosure about critical accounting estimates? If so, what information would be important to investors? 138. Should we define ‘‘critical accounting estimates’’? If so, should the definition be based on our 2001 guidance,462 the definition proposed in 2002,463 or something else? Why? Are there any other elements to a ‘‘critical accounting estimate’’ that have not been captured in prior definitions? 139. Why do registrants repeat the discussion of accounting policies presented in the notes to the financial statements? How can we encourage registrants to eliminate repetition in MD&A of the discussion of accounting policies provided in the notes to the financial statements? 140. Do registrants find the guidance for disclosing critical accounting estimates from the 2003 MD&A Interpretive Release helpful in determining whether such disclosure is required? Would it be helpful for registrants if we incorporated this or other elements of our guidance on critical accounting estimates into Regulation S–K? 141. Should we revise our requirements to elicit more comparable disclosure among registrants? If so, how? Should we adopt prescriptive requirements relating to critical accounting estimates? Are there any accounting estimates common to a particular industry that are ‘‘critical’’ to all participants in that industry? 142. Should we require the disclosure of management’s judgments and estimates that form the basis for MD&A disclosure? For example, should we require registrants to disclose the quantitative and qualitative factors that form its assessment of materiality? Should we require registrants to disclose how they assessed materiality? 143. Should we require management to disclose the nature of its assessment of errors that it determined to be immaterial and therefore were not corrected? 144. Should we require disclosure of other critical accounting estimates, such as those that impact other metrics or measures, such as the number of new customers or the number of subscribers? C. Risk and Risk Management Disclosure of a registrant’s most significant risks provides investors with important context for assessing the registrant’s financial potential. Risk462 See 463 See Cautionary Advice Release. Critical Accounting Proposing Release. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 related disclosure is required by multiple items of Regulation S–K and certain financial reporting requirements.464 In this section, we focus on: • Item 503(c), which requires disclosure of the most significant factors that make an investment in a registrant’s securities speculative or risky; 465 and • Item 305, which requires quantitative and qualitative disclosure about market risk.466 Also in this section, we explore different approaches to risk-related disclosure. Specifically, we consider whether requiring additional disclosure of management’s approach to risk and risk management and consolidating riskrelated disclosure would, on balance, be beneficial to investors and registrants. We also seek to better understand how our disclosure requirements could be updated to enhance investors’ ability to evaluate a registrant’s risk exposures. We are especially interested in feedback on how we can improve the content and readability of the risk factors included in a filing as well as the potential advantages and disadvantages of different approaches to risk-related disclosure. 1. Risk Factors (Item 503(c)) Item 503(c) requires disclosure of the most significant factors that make an investment in a registrant’s securities speculative or risky and specifies that the discussion should be concise and organized logically.467 Although the requirement is principles-based, it includes the following specific examples as factors that may make an offering speculative or risky: • A registrant’s lack of an operating history, • a registrant’s lack of profitable operations in recent periods, • a registrant’s financial position, • a registrant’s business or proposed business, or 464 Although we focus on Items 503(c) and 305 of Regulation S–K, risk-related disclosure may be provided in response to other requirements, such as Items 101(d)(3) (risk attendant to foreign operations), 103 (legal proceedings), or 303 (MD&A). For financial reporting requirements, riskrelated disclosure may be included in the financial statements in response to ASC Topics 275 (risks and uncertainties), 450 (contingencies), or 825 (financial instruments), among others. The staff is separately considering Items 101(d)(3) and 103 in developing recommendations for the Commission for potential changes to update or simplify certain disclosure requirements. For a description of this project, see Section I. For a discussion of Item 303, see Section IV.B.3 to IV.B.7. 465 Item 503(c) of Regulation S–K [17 CFR 229.503(c)]. 466 Item 305 of Regulation S–K [17 CFR 229.305]. 467 Item 503(c) of Regulation S–K [17 CFR 229.503(c)]. PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 • the lack of a market for a registrant’s common equity securities or securities convertible or exercisable for common equity securities.468 Additionally, Item 503(c) directs registrants to explain how each risk affects the registrant and discourages disclosure of risks that could apply to any registrant. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. We received several comment letters with recommendations on risk factor disclosure.469 One commenter suggested a comprehensive default framework for risk factor disclosure that would classify risk factors based upon relative likelihood and relative impact.470 This proposed framework would require registrants to classify both relative likelihood and relative impact into one of three tiers based on the risk’s probable occurrence and the relative seriousness of the consequences if a risk materializes. One commenter stated that risk factors should be more entity-specific and connected to financial results.471 Another commenter noted that registrants disclose risk factors that ‘‘go well beyond those that make an investment ‘speculative’’’ and stated that any new risk factor disclosure requirements should be principlesbased. This commenter suggested revising Item 503(c) to include examples of generic disclosure that need not be included as risk factors.472 One commenter generally recommended reducing lengthy, unnecessary risk factor disclosure.473 Another commenter urged that any such requirement be grounded in the principle of materiality, suggesting that we consider whether a 468 Id. 469 See, e.g., letter from Tom C.W. Lin and attached law review article, (July 30, 2014) (‘‘Lin’’); CFA Institute; Shearman; A. Radin; CCMC; letters from Reps. Langevin and Himes (June 17, 2015) (‘‘Reps. Langevin and Himes’’); Reps. Grijalva, Waters and Lowenthal (July 24, 2015) (‘‘Reps. Grijalva, Waters and Lowenthal’’); Sens. Cardin, et al. (Aug. 18, 2015) (‘‘Sens. Cardin, et al.’’). 470 See Lin. 471 See CFA Institute (stating that the ability to price risk is important to disclosure effectiveness). 472 See Shearman. The commenter suggested the following factors could be included in a revised Item 503(c) as examples of generic risks that do not need to be disclosed as risk factors: macroeconomic risks that effect all businesses in a particular industry; general stock market risks, such as volatility in a company’s stock price; summaries of regulation; and risk disclosure that repeats disclosure provided in response to other specific requirements or financial disclosures, such as risks related to key management, legal proceedings and the payment of dividends. 473 See A. Radin (noting the ‘‘excessive volume’’ of disclosures required by Regulations S–K and S– X). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules reformulated risk discussion should highlight the risks that management views as most significant.474 Several comment letters stated there should be additional risk-related disclosure on specific topics.475 One set of commenters encouraged us to require additional disclosure about cybersecurity and related risks.476 Another group of commenters focused on additional disclosure of risks associated with oil and gas exploration, including drilling in the Arctic Ocean.477 We received two comment letters on the impact of the Private Securities Litigation Reform Act (‘‘PSLRA’’) on risk-related disclosure. One commenter acknowledged that liability concerns may contribute to the length of Exchange Act documents but expressed concern about any effort to require issuers to reduce the length or number of risk factors included in a filing.478 Another commenter attributed the growing length of risk factor disclosure to liability concerns and noted that any efforts to reduce risk factor disclosure, without concomitant changes to the relevant rules or the protection of a safe harbor, are unlikely to be effective because there is little incentive for registrants to scale-back risk factor disclosure.479 b. Discussion The five factors specified in Item 503(c) as factors that may make an offering speculative or risky have not changed since the Commission published its initial guidance on risk factor disclosure in 1964. These factors were derived from previous stop order proceedings under Section 8(d) of the Securities Act where the Commission suspended the effectiveness of previously filed registration statements due, in part, to inadequate disclosure about speculative aspects of the registrant’s business.480 474 See CCMC. e.g., Reps. Langevin and Himes; Reps. Grijalva, Waters and Lowenthal; Sens. Cardin, et al. 476 See, e.g., Reps. Langevin and Himes. 477 See, e.g., Reps. Grijalva, Waters and Lowenthal; Sens. Cardin, et al. 478 See SCSGP (referencing the Commission’s proposal to limit the number of risk factors included in a filing in connection with the Commission’s Plain English initiative and comments received in connection with that initiative, one of which states ‘‘no issuer should ever be put in the position of choosing significant material risks in order to satisfy a numerical limitation.’’). 479 See Shearman (stating that the PSLRA’s safe harbor, which requires issuers that disclose forward-looking information to also disclose cautionary information, contributes to lengthy risk factors disclosures). 480 See Guides for Preparation and Filing of Registration Statements, Release No. 33–4936 (Dec. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 475 See, VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Since the Commission first published guidance on risk factor disclosure in 1964,481 it has been reiterated that this disclosure should be: • Focused on the ‘‘most significant’’ or ‘‘principal’’ factors that make a registrant’s securities speculative or risky, 482 • placed in the forefront of the filing,483 and • organized and concise.484 Commission and Division guidance also has emphasized that registrants should avoid ‘‘boiler plate’’ risk factors, and that a discussion of risk in purely generic terms does not indicate how a risk may affect an investment in a particular registrant.485 When adding risk factor requirements to annual and quarterly reports and Exchange Act registration statements on Form 10, the Commission discouraged the unnecessary restatement of risk factors in quarterly reports, emphasizing that quarterly reports need only disclose material changes from risk factors previously disclosed in other Exchange Act reports.486 The length and number of risk factors disclosed by registrants varies. Although Item 503(c) directs registrants to provide a concise risk factors discussion, one study found that registrants include an average of 22 different risk factors in disclosure spanning an average of 8 pages.487 Another study found that registrants increased the length of risk 9, 1968) [33 FR 18617 (Dec. 17, 1968)] (‘‘1968 Guides’’) (citing In the Matter of Doman Helicopters, Inc., 41 SE.C. 431 (Mar. 27, 1963); In the Matter of Universal Camera Corporation, 19 SE.C. 648 (June 28, 1945)). 481 See Guides for Preparation and Filing of Registration Statements, Release No. 33–4666 (Feb. 7, 1964) [29 FR 2490 (Feb. 15, 1964)] (‘‘1964 Guides’’). 482 ‘‘Principal’’ was the term used in the 1982 Integrated Disclosure Adopting Release and ‘‘most significant’’ was the term used in the Plain English Disclosure Adopting Release. 483 See 1964 Guides; 1968 Guides; and 1982 Integrated Disclosure Adopting Release. 484 See 1964 Guides; 1968 Guides; 1982 Integrated Disclosure Adopting Release; and Securities Offering Reform Release. 485 See Plain English Disclosure Adopting Release. See also Updated Staff Legal Bulletin No. 7: Plain English Disclosure (June 7, 1999), available at https://www.sec.gov/interps/legal/cfslb7a.htm (‘‘Updated Staff Legal Bulletin No. 7’’). 486 See Securities Offering Reform Release. In adopting new item requirements in Forms 10–K, 10–KSB, and 10 to require risk factor disclosure, the Commission noted that, though not previously required, many registrants had included for several years risk factor disclosure in their Exchange Act reports, perhaps to take advantage of the safe harbor in Securities Act Section 27A and the judiciallycreated ‘‘bespeaks caution’’ defense. 487 See Investor Responsibility Research Center Institute, The Corporate Risk Factor Disclosure Landscape, Jan. 2016, available at https:// irrcinstitute.org/wp-content/uploads/2016/01/ FINAL-EY-Risk-Disclosure-Study.pdf. PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 23955 factor disclosures from 2006 to 2013 by more than eighty-five percent in terms of word count relative to the total word count of Form 10–K filings, and that this increase in quantity may not be associated with better disclosure.488 A third study found that the average number of risk factors disclosed in certain sectors of the energy industry ranged between twelve and fifty-one.489 For quarterly reports, it is not unusual for registrants to repeat the entire risk factor discussion from their previously filed annual reports,490 even though registrants are required to disclose only material changes from previously disclosed risks.491 Although Item 503(c) instructs registrants not to present risks that could apply to any registrant, risk factor disclosure typically includes generic risk factors. Registrants often use risk factors that are similar to those used by others in their industry or circumstances as the starting point for risk disclosure, and the disclosure is not always tailored to each registrant’s particular risk profile. Examples of generic disclosures include risk factors about a registrant’s failure to compete successfully, the effect of general economic conditions on a registrant’s business, changes in regulation, and dependence upon a registrant’s 488 See Anne Beatty et al., Sometimes Less is More: Evidence from Financial Constraints Risk Factor Disclosures, Mar. 2015, available at https:// papers.ssrn.com/sol3/papers.cfm?abstract_ id=2186589 (‘‘Beatty et al.’’). To examine the ‘‘informativeness’’ of risk factor disclosures, the authors of this study analyzed risk factor disclosures about financial constraints and argue that as litigation risk increased during and after the financial crisis, registrants were more likely to disclose immaterial information, resulting in a deterioration of disclosure quality. 489 See PricewaterhouseCoopers LLP, Stay Informed, 2012 Financial Reporting Survey: Energy industry current trends in SEC reporting, Feb. 2013, available at https://www.pwc.com/en_GX/gx/oil-gasenergy/publications/pdfs/pwc-sec-financialreporting-energy.pdf. This report reviewed financial reporting trends of 87 registrants with market capitalizations of at least $1 billion that apply U.S. GAAP in the following subsectors of the energy industry: downstream, drillers, independent oil and gas, major integrated oil and gas, midstream and oil field equipment and services. Based on this study, the average number of risk factors in the major integrated oil and gas sector was 12 while the average number of risk factors in the midstream sector was 51. In one sector, the maximum number of risk factors was 95. 490 See PricewaterhouseCoopers LLP, Stay Informed: 2014 technology financial reporting trends, Aug. 2014, available at https:// www.pwc.com/en_US/us/technology/publications/ assets/pwc-2014-technology-financial-reportingtrends.pdf. This report reviewed the annual and periodic filings of 135 registrants in the software and Internet, computers and networking, and semiconductors sectors. Based on this study, over half of the registrants surveyed repeated all of their risk factors in their quarterly filings. 491 See Item 1A of Part II of Form 10–Q. E:\FR\FM\22APP3.SGM 22APP3 23956 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 management team. Despite the inclusion of generic risks, however, academic studies find that risk factor disclosure is informative and that the public availability of this information decreases information asymmetry among investors.492 c. Request for Comment 145. How could we improve risk factor disclosure? For example, should we revise our rules to require that each risk factor be accompanied by a specific discussion of how the registrant is addressing the risk? 146. Should we require registrants to discuss the probability of occurrence and the effect on performance for each risk factor? If so, how could we modify our disclosure requirements to best provide this information to investors? For example, should we require registrants to describe their assessment of risks? 147. How could we modify our rules to require or encourage registrants to describe risks with greater specificity and context? For example, should we require registrants to disclose the specific facts and circumstances that make a given risk material to the registrant? How should we balance investors’ need for detailed disclosure with the requirement to provide risk factor disclosure that is ‘‘clear and concise’’? Should we revise our rules to require registrants to present their risk factors in order of management’s perception of the magnitude of the risk or by order of importance to management? Are there other ways we could improve the organization of registrants’ risk factors disclosure? How would this help investors navigate the disclosure? 148. What, if anything, detracts from an investor’s ability to gain important information from a registrant’s risk factor disclosure? Do lengthy risk factor disclosures hinder an investor’s ability to understand the most significant risks? 149. How could we revise our rules to discourage registrants from providing risk factor disclosure that is not specific to the registrant but instead describes risks that are common to an industry or to registrants in general? Alternatively, are generic risk factors important to investors? 150. Should we specify generic risks that registrants are not required to disclose, and if so, how should we identify those risks? Are there other ways that we could help registrants focus their disclosure on material risks? 492 See, e.g., John Campbell et al., The Information Content of Mandatory Risk Factor Disclosures in Corporate Filings, 19 Rev. Acct. Stud. 396, 396–455 (Sept. 2010); Beatty et al. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 151. Should we retain or eliminate the examples provided in Item 503(c)? Should we revise our requirements to include additional or different examples? Would deleting these examples encourage registrants to focus on their own risk identification process? 152. Should we require registrants to identify and disclose in order their ten most significant risk factors without limiting the total number of risk factors disclosed? 493 If so, should other risk factors be included in a separate section of the filing or in an exhibit to distinguish them from the most significant risks? Alternatively, should we require registrants to provide a risk factors summary in addition to the complete disclosure? Would a summary help investors better understand a registrant’s risks by highlighting certain information? Are there challenges associated with requiring a summary of the most significant risks? 153. Are there ways, in addition to those we have used in Item 503, our Plain English Rules and guidance on MD&A, to ensure that registrants include meaningful, rather than boilerplate, risk factor disclosure? 154. Risk profiles of registrants are constantly changing and evolving. For example, registrants today face risks, such as those associated with cybersecurity, climate change, and arctic drilling,494 that may not have existed when the 1964 Guides and 1968 Guides were published. Is Item 503(c) effective for capturing emerging risks? If not, how should we revise Item 503(c) to make it more effective in this regard? 155. What types of investors or audiences are most likely to value the Item 503(c) disclosures? 156. What is the cost of providing the disclosure required by Item 503(c), including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 503(c). 493 The Commission has previously considered proposals to either limit the number of risk factors included in a filing or require registrants to list risk factors in the order of priority to the registrant. The Commission did not adopt either of these requirements in response to comments received from investors. See Plain English Disclosure Adopting Release at 6370 (‘‘In response to comments, the new rules will not require issuers to limit the length of the summary, limit the number of risk factors, or prioritize risk factors.’’). 494 For a discussion of some emerging risks that registrants may face, see Section 0. PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 2. Quantitative and Qualitative Disclosures About Market Risk (Item 305) Item 305 requires quantitative and qualitative disclosure of market risk sensitive instruments that affect a registrant’s financial condition.495 Item 305(a) requires registrants to provide quantitative disclosure about market risk sensitive instruments using one or more of three disclosure alternatives: (1) Tabular presentation of fair value information and contract terms relevant to determining future cash flows, categorized by expected maturity dates; (2) Sensitivity analysis expressing the potential loss in future earnings, fair values, or cash flows from selected hypothetical changes in market rates and prices; or (3) Value at risk (‘‘VaR’’) disclosures expressing the potential loss in future earnings, fair values, or cash flows from market movements over a selected period of time and with a selected likelihood of occurrence.496 Registrants are required to categorize market risk sensitive instruments into instruments entered into for trading purposes and instruments entered into for purposes other than trading.497 To the extent material, within both the trading and other than trading portfolios, registrants must provide separate quantitative information for each market risk exposure category (e.g., interest rate risk, foreign currency exchange rate risk, commodity price risk, and other relevant market risks, such as equity price risk).498 Item 305(b) requires qualitative information about market risk. Registrants must describe, to the extent material, their primary market risk exposures, how those exposures are managed, and any changes to either the primary market risk exposures or the way that risk exposures are managed.499 495 Item 305 of Regulation S–K [17 CFR 229.305]. For the purposes of Item 305(a) and (b), market risk sensitive instruments include derivative financial instruments, other financial instruments, and derivative commodity instruments. Each of these terms is defined in General Instruction 3 to Items 305(a) and (b). See Disclosure of Market Risk Sensitive Instruments Release. 496 Item 305(a) of Regulation S–K [17 CFR 229.305(a)]. 497 Id. 498 Id. In their materiality assessment, registrants are required to evaluate both the materiality of the fair values of derivative financial instruments, other financial instruments, and derivative commodity instruments as of the end of the latest fiscal year and the materiality of potential, near-term losses in future earnings, fair values, and/or cash flows from reasonably possible near-term changes in market rates or prices. See General Instruction 5 to Items 305(a) and (b) of Regulation S–K [17 CFR 229.305(a) and (b)]. 499 Item 305(b) of Regulation S–K [17 CFR 229.305(b)]. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules One of Item 305’s primary objectives is to provide investors with forward looking information about a registrant’s potential market risk exposure.500 To specifically cover the forward-looking aspects of disclosure provided in response to Item 305, the Commission adopted a safe harbor as part of the rule.501 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Comments Received S–K Study. A few commenters suggested that EGCs should be exempt from Item 305 disclosure.502 Another commenter expressed concern that the FASB’s 2012 Exposure Draft on liquidity risk and interest rate risk disclosures could have created redundancies with some of the disclosures currently required in Items 305 and 303.503 Disclosure Effectiveness Initiative. Several commenters noted that, while financial reporting in accordance with evolving accounting standards has greatly expanded since the adoption of Item 305, including the adoption of ASC Topic 815, Item 305 and other disclosure requirements in Regulation S–K have not been revisited to identify and eliminate redundancies.504 One of these commenters suggested eliminating Item 305 in light of current U.S. GAAP requirements, or, alternatively, re500 See Disclosure of Market Risk Sensitive Instruments Release. 501 Item 305(d) of Regulation S–K [17 CFR 229.305(d)]. 502 See, e.g., Silicon Valley and M. Liles. 503 See Ernst & Young 1 (referring to Proposed Accounting Standards Update on FASB’s Web site, Financial Instruments (Topic 825): Disclosures about Liquidity Risk and Interest Rate Risk). The 2012 Exposure Draft is no longer on the FASB’s active agenda. See FASB Technical Agenda (last visited Mar. 2, 2016), available at https:// www.fasb.org/jsp/FASB/Page/ TechnicalAgendaPage&cid=1175805470156#tab_ 1175805486413. The 2012 Exposure Draft aimed to provide more useful information on exposures to liquidity risk and to interest rate risk by requiring, among other things, tabular disclosure of liquidity risk related to financial assets and financial liabilities or cash flow obligations, disaggregated by expected maturities; carrying amounts of classes of financial assets and financial liabilities, segregated according to time intervals based on contractual repricing; an interest rate sensitivity table showing the effects on net income and shareholder equity of specific hypothetical shifts of interest rates; and quantitative or narrative disclosure as necessary to understand exposures to liquidity risk and interest rate risk. For a discussion of the 2012 Exposure Draft, see Section IV.C.2.b.iii. 504 See, e.g., CCMC (noting that ASC Topic 815 provides substantial guidance about hedge accounting and also stating there is some redundancy between Item 305 and Item 303, evidenced by the fact that some public companies do not provide stand-alone disclosure in response to Item 305); SCSGP (noting overlap between certain market risk disclosures required by S–K Item 305, ASC 820 Fair Value Measurements, and ASC 815 Derivatives and Hedging); ABA 2. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 focusing Item 305 to permit principlesbased disclosure of market risk.505 Another commenter stated that improving market risk disclosures should be a high priority and that there should be a better linkage among the financial statements and other riskrelated disclosure.506 One commenter asserted that there is confusion in the marketplace about what specific disclosure is required under Item 305.507 Another commenter stated that updating Item 305 should be a ‘‘central aspect’’ of disclosure effectiveness efforts and included specific suggestions for revisions, including improving VaR.508 Though not commenting on Item 305 specifically, one commenter stated its belief that standardized disclosure of common exposures to derivatives is warranted.509 b. Discussion i. Disclosure Objective The adequacy of market risk disclosure emerged as an important financial reporting issue in the 1990s following a substantial increase in the use of derivatives and other instruments subject to market risk and the significant, sometimes unexpected, losses registrants experienced from their use of these instruments.510 The Commission adopted Item 305 in 1997 505 See ABA 2 (citing ASC 820 Fair Value Measurements and ASC 815 Derivatives and Hedging and suggesting that any such principlesbased disclosure of market risk could be included in MD&A). The degree of overlap between Item 305 and U.S. GAAP depends on which of Item 305’s presentations is chosen and on whether information that is encouraged to be provided by ASC 820, including qualitative disclosure on risk management, is actually provided. Using a tabular presentation under Item 305 generally results in greater overlap with ASC 820 and ASC 815. Item 305 also requires that disclosure be made outside the financial statement footnotes. 506 See CFA Institute. This commenter did not provide a suggestion as to how to better link financial statement disclosures with risk-related disclosure provided elsewhere in a filing. 507 See CCMC. This commenter stated Item 305 is ‘‘one of the most complicated disclosure requirements to parse in all of Regulation S–K.’’ 508 See Hu. In research cited in the comment letter, this commenter perceived three problems with Item 305’s VaR presentation: (i) Too much ‘‘latitude as to (a) the models, assumptions, and parameters used, as well as (b) the confidence level and time horizon [registrants can] choose to report at;’’ (ii) no evidence as to the quality of the VaR model is required; and (iii) VaR ‘‘is not intended to gauge possible losses in times of high economic stress.’’ See Henry T. C. Hu, Disclosure Universes and Modes of Information: Banks, Innovation, and Divergent Regulatory Quests, 31 Yale J. on Reg. 565, 598 (2014) (‘‘Hu 2014’’). 509 See AFL–CIO. As an example of common exposures, this commenter cited credit triggers under swaps contracts where ‘‘banks may require companies to fully collateralize credit exposures under certain conditions.’’ 510 See Disclosure of Market Risk Sensitive Instruments Release. PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 23957 to improve disclosures about market risk and help investors better understand and evaluate a registrant’s market risk exposures.511 The required disclosures were also intended, where applicable, to provide a mechanism for registrants to disclose that their use of derivatives represents risk management rather than speculation.512 To achieve these goals, the Commission used the following guiding principles in adopting Item 305: • Disclosures should make transparent the impact of derivatives on a registrant’s statements of financial position, cash flows, and results of operations; • Disclosures should provide information about a registrant’s exposures to market risk; • Disclosures should explain how market risk sensitive instruments are used in the context of the registrant’s business; • Disclosures about market risk exposures should not focus on derivatives in isolation, but rather should reflect the risk of loss inherent in all market risk sensitive instruments; • Market risk disclosure requirements should be flexible enough to accommodate different types of registrants, different degrees of market risk exposure, and alternative ways of measuring market risk; • Disclosures about market risk should address, where appropriate, special risks relating to leverage, option, or prepayment features; and • New disclosure requirements should build on existing requirements, where possible, to minimize compliance costs.513 Item 305 was designed to address concerns that market risks associated with derivatives and other marketsensitive instruments were not adequately disclosed.514 In the adopting 511 See id. In conjunction with adopting Item 305, the Commission amended Rule 4–08 of Regulation S–X and Item 310 of Regulation S–B, which is no longer in effect, to require enhanced descriptions of accounting policies for derivatives in the footnotes to the financial statements. These revisions were designed to address footnote disclosures of accounting policies that were often too general to convey adequately the diversity in accounting that exists for derivatives. In contrast to Item 305, which applies to all financial instruments, the new disclosure requirements under Rule 4–08 and Item 310 applied only to derivatives; disclosure requirements for other financial instruments were addressed by existing U.S. GAAP and Commission guidance. Id. (citing Accounting Principles Board Opinion No. 22 (April 1972)). SRCs are not required to provide Item 305 information. Item 305(e) of Regulation S–K [17 CFR 229.305(e)]. 512 See Disclosure of Market Risk Sensitive Instruments Release. 513 See id. 514 See id. The disclosure issues were noted as part of the staff’s review of more than 500 annual E:\FR\FM\22APP3.SGM Continued 22APP3 23958 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 release for Item 305, the Commission noted that disclosure about reported items in the footnotes to the financial statements, MD&A, schedules and selected financial data may not have adequately reflected the effect of derivatives on such reported items.515 In addition, disclosures about different types of market risk sensitive instruments were often reported separately, making it difficult to assess a registrant’s aggregate market risk exposures.516 Accordingly, Item 305 was intended to help investors understand a registrant’s risk management activities and to help place those activities in the context of the registrant’s business by requiring enhanced disclosure about specific market risk sensitive instruments.517 Division staff has observed that the instructions to Item 305 may inadvertently discourage some disclosure. For example, a sensitivity analysis requires disclosure of the potential loss to the future earnings, fair values, or cash flows of market risk sensitive instruments from a hypothetical change in rates or prices.518 The instructions to Item 305(a) state that registrants should select hypothetical changes in market rates or prices that are expected to reflect reasonably possible near-term changes in those rates and prices; however, absent economic justification for the selection of a different amount, ‘‘registrants should use changes that are not less than ten percent of end of period market rates or prices.’’ 519 Many registrants apply the ten percent threshold even when market conditions, such as persistently low interest rates or volatile exchange rates, may suggest that a different threshold, or even multiple thresholds, would be more appropriate.520 reports in 1994 and 1995 to evaluate the adequacy of market risk disclosure and assess the effect of new FAS 119 on market risk disclosure. See id. 515 See id. 516 See id. 517 See id. 518 Item 305(a)(1)(ii) of Regulation S–K [17 CFR 229.305(a)(1)(ii)]. 519 Instruction 3A to paragraph 305(a). 520 For example, the prime rate in the U.S. has been 3.5% or 3.25% for a number of months. See https://online.wsj.com/mdc/public/page/2_3020moneyrate.html?mod=mdc_bnd_pglnk. Many registrants present their interest rate risk under the sensitivity analysis showing only a shift of 10% of this amount, or 35 or 33 (rounded) basis points. Financial services and financial institution registrants, on the other hand, often provide analyses of various shifts in interest rates and evaluate shifts of 50, 100, and 200 basis points, both up and down. This more comprehensive presentation may provide investors with a better understanding of how various shifts in market risk, both more moderate and more pronounced, might impact the registrant. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Considering commenters’ differing views on the efficacy of Item 305 and the complexity of Item 305’s required disclosures, we seek input on whether, and how, changes to Item 305 would be beneficial to both investors and registrants. (a) Request for Comment 157. Is Item 305 effective in eliciting disclosure about market risks and risk management practices that investors consider important? If not, how could Item 305 be improved? 158. Does Item 305 result in information that allows investors to effectively assess (1) a registrant’s aggregate market risk exposure, and (2) the impact of market risk sensitive instruments on a registrant’s results of operations and financial condition? If not, how could we revise Item 305 to achieve these goals? 159. Do the disclosure alternatives in Item 305(a) elicit adequate quantitative disclosure about market risk? Do the rules or the instructions discourage registrants from fully evaluating and disclosing their market risk exposures, such as in a sensitivity analysis? Should the rules be more prescriptive? If so, in what ways should we revise the rules and instructions to Item 305(a)? 160. Should additional or different principles guide the market risk disclosure requirements? Should we expand our definition of ‘‘market risk sensitive instruments’’ to require registrants to provide additional disclosure about other risks, including credit risk, liquidity and funding risk and operational risk? 161. Should we limit the quantitative disclosure requirement to certain registrants such as financial institutions or registrants engaged in financial services? Why or why not? 162. What types of investors or audiences are most likely to value the information required by Item 305? 163. What is the cost of providing the disclosure required by Item 305, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 305. ii. Disclosure Alternatives and Coordination With Financial Statement Disclosures Item 305(a) specifies three disclosure alternatives for registrants to present quantitative information about market risk: Tabular disclosure, sensitivity PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 analysis, and VaR.521 In adopting Item 305, the Commission recognized the evolving nature of market risk sensitive instruments, market risk measurement systems, and market risk management strategies.522 The Commission stated that it expected to ‘‘continue considering how best to meet the information needs of investors.’’ 523 Accordingly, we are seeking input on whether and how we should revise Item 305 to reflect changes in market risk exposures and methods for measuring market risk. In response to the proposing release for Item 305, some commenters suggested greater flexibility and recommended a ‘‘management approach’’ to disclosure. As suggested by the commenters, this disclosure would focus on the information and methods that management actually uses internally to evaluate, monitor, and manage market risk.524 The Commission did not adopt this approach, believing that a presentation of market risk using a management approach outside of the framework articulated in Item 305 could make it difficult for investors to assess market risk across registrants.525 We are interested in whether a ‘‘management approach’’ to disclosure is preferable to the alternatives specified in the current rule. We are also interested in whether we should modify Item 305 given accounting developments since the item’s adoption. When the Commission adopted Item 305 in 1997, minimal authoritative literature on the accounting for options and complex derivatives existed.526 Since that time, accounting requirements have evolved to provide for greater disclosure of market risk sensitive instruments.527 As a result, there may be redundancies 521 Item 305(a)(1) of Regulation S–K [17 CFR 229.305(a)(1)]. 522 See Disclosure of Market Risk Sensitive Instruments Release. 523 See id. at 6046. 524 See id. at 6055. Commenters believed that ‘‘the approaches in the proposing release (i) do not appear to allow gap and duration analyses, which are currently used by some to measure market risk, and (ii) may become outdated as new measurement approaches are developed in the market place.’’ Id. at 6055. 525 See id. The Commission noted that, in adopting Item 305, it sought to strike a balance between those seeking a ‘‘management approach’’ and those supporting a more consistent reporting framework for the sake of comparability. See id. 526 See Disclosure of Market Risk Sensitive Instruments Release. 527 FASB Accounting Standards Update No. 2011–04, May 2011, Fair Value Measurement (Topic 820). ASC 820 requires the disclosure of fair value of all financial instruments, including derivatives and non-derivative financial instruments, but does not require any expected maturity information. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules between the disclosure provided in response to Item 305 and U.S. GAAP. Commission staff has observed that, the degree of repetition in the disclosure depends on which Item 305 disclosure alternative a registrant utilizes and whether a registrant provides information that is encouraged by U.S. GAAP in addition to the disclosure that is required.528 Item 305 disclosure also tends to vary among registrants. Many registrants provide a sensitivity analysis to present market risk information, while others rely on tabular presentation or VaR. For large financial institutions, it is not unusual to use some combination of the three to capture different market risk sensitive instruments. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 (a) Request for Comment 164. How have standard risk management practices and methods of reporting market risk evolved since the adoption of Item 305 in 1997? Should we revise Item 305 to reflect those changes and if so, how? Should we provide for new disclosure alternatives in addition to, or in lieu of, existing alternatives? 165. What revisions should we consider to better link disclosure that identifies, quantifies, and analyzes a registrant’s material market risks to its: (a) Market risk sensitive instruments, (b) financial statements, (c) capital adequacy, and (d) any other metrics important to an understanding of market risk exposures? 166. Should we eliminate the prescribed disclosure alternatives and allow registrants to discuss market risk according to the methods used by management to manage the risk? Would allowing a ‘‘management approach’’ provide investors with more insight about the way management actually assesses market risks, or would this approach unduly hinder investors’ ability to compare market risk disclosures across registrants? 167. Is the disclosure required by Item 305 repetitive of the disclosure required by U.S. GAAP and Rule 4–08 of Regulation S–X? Conversely, does Item 305 result in disclosure that is important to investors and is not found elsewhere in a registrant’s filing? Even considering any repetition, do investors benefit from disclosure about market 528 For example, ASC 815 encourages but does not require that disclosure about a registrant’s objectives and strategies for using derivatives be described in the context of the entity’s overall risk exposures. The standard indicates that if these additional qualitative disclosures are made, they should include a discussion of those risk exposures even though the registrant does not manage some of those risk exposures using derivatives. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 risk exposure outside of the audited financial statements? iii. Comparability of Disclosure In adopting Item 305, the Commission acknowledged the tension between approaches to market risk disclosure that favor comparability and approaches that favor flexibility.529 The approach taken in the final rules sought to strike a balance between different commenters’ perspectives.530 The Commission designed Item 305 to be flexible by prescribing three disclosure alternatives without stipulating standardized methods and procedures specifying how to comply with each alternative.531 Registrants may choose which methods, model characteristics, assumptions, and parameters they use in complying with the item, and registrants may use more than one disclosure alternative across each market risk exposure category.532 To address comparability, the Commission included a requirement that registrants describe the characteristics of the model and the assumptions used to prepare the quantitative market risk disclosures. By requiring a description of the model and its assumptions, the Commission intended to assist investors in evaluating the potential effect of variations in the model’s characteristics and assumptions.533 In 2012, the FASB examined the question of comparability and considered standardizing liquidity and interest rate risk disclosure as part of a project that is currently in Exposure Draft form.534 The Exposure Draft would 529 See Disclosure of Market Risk Sensitive Instruments Release at 6048 (‘‘The Commission has provided flexibility in the quantitative and qualitative disclosure requirements . . . even though such flexibility is likely to reduce the comparability of disclosures.’’). 530 See id. 531 See id. For example, the terms used to describe two of the three disclosure alternatives— ‘‘sensitivity analysis’’ and ‘‘value at risk’’—describe a general class of models. They are not meant to refer to any one model for quantifying market risk. In addition, Item 305 permits registrants to change disclosure alternatives or key model characteristics, assumptions, and parameters used in providing quantitative information about market risk, with disclosure if the effects of such a change are material. The Commission also noted that two methods of measuring market risk then in use, gap analysis and duration analysis, would, with minor revisions, satisfy the tabular and sensitivity analysis disclosure requirements respectively. Id. 532 See id.; Item 305(a)(1)(i)(B) of Regulation S–K [17 CFR 229.305(a)(1)(i)(B)]; Item 305(a)(1)(ii)(B) of Regulation S–K [17 CFR 229.305(a)(1)(ii)(B)]; Item 305(a)(1)(iii)(B) of Regulation S–K [17 CFR 229.305(a)(1)(iii)(B)]. 533 See Disclosure of Market Risk Sensitive Instruments Release. 534 See Proposed Accounting Standards Update 2012–200 Disclosure about Liquidity Risk and PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 23959 have required all reporting entities to provide standardized quantitative disclosure about liquidity risk, but only financial institutions would have been required to provide additional, standardized quantitative disclosure about interest rate risk. Although initiated, in part, as a response to comments received from financial statement users to an earlier FASB release on financial statements, the majority of respondents to the Exposure Draft, eighty-four percent of whom were preparers, did not support the proposed disclosures.535 Most respondents stated that standardizing information about liquidity and interest rate risk is not appropriate and not achieved by the proposals.536 Some commenters questioned whether standardization is an appropriate objective and if it could ever be achieved.537 (a) Request for Comment 168. Should we revise Item 305 to provide for more standardized disclosure that would enhance comparability among registrants? How should we balance standardization with different methods and assumptions that registrants may use to evaluate, monitor, and manage market risk? How would standardization affect investors and registrants? Interest Rate Risk—Financial Instruments (Topic 825), Financial Accounting Standards Board (Issued June 27, 2012), available at https://www.fasb.org/jsp/ FASB/Document_C/ DocumentPage?cid=1176160135003. This Exposure Draft was partly in response to demand by users for audited, standardized, and consistent disclosures by public companies. The Exposure draft noted that, as part of a May 2010 proposed Accounting Standards Update (Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815)), the FASB performed extensive outreach and received feedback that the risks inherent in a class of financial instruments and the way in which an entity manages those risks through its business operations should be instrumental in developing the reporting model for financial instruments. The important risks identified by users of financial statements during the FASB’s outreach efforts were credit risk, liquidity risk, and interest rate risk. See also supra note 503. 535 See Accounting for Financial Instruments Disclosures About Liquidity Risk and Interest Rate Risk Comment Letter Summary, Financial Accounting Standards Board, available at https:// www.fasb.org/cs/ContentServer?c=Document_ C&pagename=FASB%2FDocument_ C%2FDocumentPage&cid=1176160500931. 536 See id. These respondents also asserted that institutions are required by regulation to ensure that risks are monitored using processes that are commensurate with the complexity of their business. See id. 537 See id. E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 23960 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules 3. Disclosure of Approach to Risk Management and Risk Management Process Item 503(c) focuses exclusively on disclosure of significant risks and does not address disclosure of a registrant’s strategy for managing risk. Item 305(b), however, requires disclosure about a registrant’s primary market risks and how those risks are managed. In the past, Commission staff has discouraged registrants from including mitigating language in their Item 503 risk factor disclosure because of concern that mitigating language could dilute investors’ perception of the magnitude of the risk. As a result, registrants typically do not discuss their efforts to mitigate risk in connection with their risk factors disclosure, although some registrants describe their risk management practices elsewhere in their filings, such as in MD&A and as required by Item 305 for market risk. Disclosure about a registrant’s approach to risk management could enhance investor understanding of the possible impact of a disclosed risk and the registrant’s overall risk profile. Division staff has observed that most large financial institutions have implemented enterprise risk management programs and currently include detailed disclosure about those programs in their filings. Additional disclosure about changes to, or significant deviations from, the stated policies could provide investors with important information about the registrant’s exposure to risk.538 Registrants that do not provide disclosure about a formal enterprise risk management program may instead provide disclosure about management’s general approach to risk management as well as specific efforts to mitigate individual significant risks. We are mindful of the potential drawbacks of requiring registrants to provide risk management or risk mitigation disclosure. Disclosure of management’s efforts to mitigate risk may suggest to investors that the registrant’s risk exposure is not significant. In addition, risk management strategies could include confidential or proprietary information and disclosure could result in competitive harm to the registrant. For example, a registrant may develop and rely on a proprietary method for hedging financial risk, and disclosure of 538 For an example of a registrant deviating from its stated risk management policies, see Report of Anton R. Valukas, Examiner, In Re Lehman Brothers Holdings Inc., et al., Vol. I at 167–168 (discussing evidence that management disregarded its risk controls with respect to bridge equity and bridge debt). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 the method could allow others to exploit or trade against the method such that it is no longer effective or becomes too expensive.539 a. Request for Comment 169. Should we require registrants to describe their risk management processes? If so, what level of detail would be appropriate? If a registrant has no formal risk management approach or process, should we require it to describe how it monitors and evaluates risk? 170. Should we require registrants also to describe their assessment of any risk management process? If so, how often should such disclosure be required? 171. Should we require registrants with complex risk management approaches or processes to provide only an enterprise-level description, or is a more granular description appropriate for these registrants? 172. Should we require registrants to disclose when risk tolerance limits or other fundamental aspects of its risk management approach are waived or changed, including any assumptions or relevant changes in business strategy that underlies the new limits or policies? 173. Should we require registrants to identify, if material, other ‘‘primary risk exposures’’ not already addressed and to disclose actions taken to manage those risks? 174. How could we facilitate a more integrated discussion of risk exposure and risk mitigation? Should we require registrants to disclose management’s view of how material risk exposures are related and how risk mitigation actions are connected? 175. To the extent we require disclosure of risk management and risk management processes, should we move the disclosure about the extent of a board of directors’ oversight of risk from Item 407(h) to this new requirement? Similarly, should we move compensation risk disclosure to this new requirement, or should we otherwise provide an option for compensation risk disclosure to be given in the risk management 539 Commission concern for protecting proprietary strategies in connection with Item 305 disclosures is reflected in four provisions addressing proprietary concerns. See Disclosure of Market Risk Sensitive Instruments Release. The four provisions are: (i) The sensitivity analysis and VaR alternatives for quantitative information; (ii) the option to report average, high, and low sensitivity analysis and VaR instead of year end information; (iii) for interim reports, the need for disclosure of material changes since the end of the most recent fiscal year; and (iv) requiring a combined, not separate, sensitivity or VaR disclosures for voluntarily disclosed instruments, positions, or transactions. PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 discussion rather than in the compensation discussion? 176. Should we require registrants to disclose their efforts to manage or mitigate each risk factor disclosed, similar to the risk management disclosure required for market risk under Item 305(b)(1)(ii)? What are the challenges, including those associated with preparation and competitive harm, with this disclosure? 177. Would additional disclosure about risk mitigation inhibit investors’ ability to fully appreciate the significance of the risk? Would requiring a registrant to explain how it addresses a disclosed risk discourage registrants from disclosing generic or insignificant risks? Alternatively, would registrants provide boilerplate disclosure about how they address less meaningful risks, thereby resulting in even longer risk factor disclosure? 178. Should we require registrants to address mitigation or management of each risk factor as part of the risk management discussion? If so, should we also clarify that, although references to the general risk management discussion will not satisfy this requirement, cross-references to appropriate portions of MD&A or the financial statements will, if disclosure otherwise would be redundant? 179. Should we require registrants to disclose their known uncertainties about their risk management and risk management policies and how these might affect the registrant? 4. Consolidating Risk-Related Disclosure Outside of Items 503(c) and 305, a number of Items in Regulation S–K elicit risk-related disclosures. These include Item 103, related to material litigation and certain environmental proceedings; Item 101(d)(3), in connection with risk related to foreign operations; Item 303(a), in that material trends, uncertainties, or events that are required to be described may also speak to certain risks; and Item 407(h), regarding the extent of a board’s role in risk oversight. In the S–K Study, the staff recommended that we consider whether to consolidate requirements relating to risk factors, legal proceedings, and other quantitative and qualitative information about risk and risk management into a single requirement.540 We seek input on whether investors would benefit from such a consolidation of risk-related disclosures and whether such a requirement would present any challenges to registrants. 540 See E:\FR\FM\22APP3.SGM S–K Study at 99. 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One comment letter supported the suggestion to consider consolidating all risk-related requirements, positing that consolidation would reduce redundant disclosure and provide investors with a ‘‘holistic view of risk through the eyes of management.’’ 541 Another commenter recommended requiring better integration among the financial statements, business description, risk disclosures, market risk disclosures and the discussion of results in MD&A.542 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 b. Request for Comment 180. Should we require registrants to provide a consolidated discussion of risk and risk management, including legal proceedings, in a single section of a filing? If so, what information should be included? How should this information be presented? 181. How could investors benefit from a consolidated discussion of risk factors, legal proceedings and other quantitative and qualitative information about market risk and risk management? What would be the challenges of requiring such a presentation? 182. How would a consolidation of risk-related disclosure affect the cost of preparing a filing, if at all? D. Securities of the Registrant Disclosure about a registrant’s capital stock and transactions by registrants in their own securities helps inform investment and voting decisions by providing investors with information about a security that can be useful in assessing its value. Several items in Regulation S–K require this and related disclosure about a registrant’s securities: • Item 202 requires a description of the terms and conditions of securities that are being registered; 543 • Item 701 requires disclosure of recent sales of unregistered securities and use of proceeds from registered offerings of securities; 544 and • Item 703 requires tabular disclosure of shares of equity securities purchased by the registrant and affiliated purchasers.545 Additionally, Item 201(b)(1) requires disclosure of the number of holders of each class of a registrant’s common equity.546 We are seeking public input 541 See CCMC. CFA Institute. 543 Item 202 of Regulation S–K [17 CFR 229.202]. Item 202 disclosure is not required in Forms 10– Q or 10–K. 544 Item 701 of Regulation S–K [17 CFR 229.701]. 545 Item 703 of Regulation S–K [17 CFR 229.703]. 546 Item 201(b)(1) of Regulation S–K [17 CFR 229.201(b)(1)]. 542 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 on the disclosure requirements of Items 201(b)(1),547 202, 701 and 703 to help assess whether any of the disclosure requirements should be modified and whether we should add any new disclosure requirements. In addition, we welcome comment on the challenges for registrants related to complying with these disclosure requirements or any new disclosure requirements. 1. Related Stockholder Matters— Number of Equity Holders (Item 201(b)) Item 201(b)(1) requires disclosure of the approximate number of holders of each class of common equity as of the latest practicable date.548 Instruction 3 to Item 201 specifies that the number of holders may be based upon the number of record holders or also may include individual participants in security position listings, as provided under Rule 17Ad–8 549 of the Exchange Act.550 Instruction 3 to Item 201 provides that the method of computation chosen shall be indicated. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended eliminating the requirement to disclose the number of security holders under Item 201(b), stating that it does not provide meaningful information since many stockholders hold their securities through a nominee.551 b. Discussion Several decades ago, most investors of U.S. publicly traded registrants owned their securities in registered form, meaning that the securities were directly registered in the name of a specific investor on the record of 547 As part of its work to develop recommendations for the Commission for potential changes to update or simplify the requirements, the staff is separately considering paragraphs (a), (c) and (d) of Item 201 relating to market information, the effect of an offering or business combination on shareholder ownership, dividends and securities authorized for issuance under equity compensation plans. For a description of this project, see Section I. Item 201(e) (performance graph) falls outside the scope of this release because this disclosure is required only in proxy statements. 548 Id. 549 Exchange Act Rule 17Ad–8 [17 CFR 240.17Ad–8]. The rule defines ‘‘securities position listing,’’ with respect to the securities of any issuer held by a registered clearing agency in the name of the clearing agency or its nominee, as a list of those participants in the clearing agency on whose behalf the clearing agency holds the issuer’s securities and of the participants’ respective positions in such securities as of a specified date. The rule also states that, upon request, a registered clearing agency must furnish a securities position listing promptly to each issuer whose securities are held in the name of the clearing agency or its nominee. 550 Item 201 of Regulation S–K [17 CFR 229.201]. 551 See Shearman. PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 23961 security holders maintained by or on behalf of the registrant. Today, the vast majority of investors own their securities as a beneficial owner 552 through a securities intermediary,553 such as a broker-dealer or bank.554 This is often referred to as holding securities in nominee or ‘‘street name.’’ The Commission first adopted a requirement to disclose the number of record holders of a class of securities in 1938, when it adopted the requirement that registrants submit proxy statements to each shareholder whose proxy is being solicited.555 In 1964, the Commission proposed amending Form 10–K to require registrants to disclose, in addition to the number of record holders, the amount of each class of equity securities known by the registrant to be held ‘‘in street names.’’ 556 Commenters generally opposed the proposal on the grounds that the required information would be difficult to obtain and of little use to investors, and the Commission decided 552 We recognize the term ‘‘beneficial owner’’ and ‘‘beneficial ownership’’ are defined in certain of our rules, such as under Exchange Act Rules 13d–3, 16a–1 and 14b–2. Our use of the term here is not intended to suggest that individuals holding in ‘‘street name’’ are, or should be, ‘‘beneficial owners’’ for purposes of these Exchange Act rules. [17 CFR 240.13d–3; 17 CFR 240.16a–1; 17 CFR 240.14b–2]. 553 For purposes of Commission rules pertaining to the transfer of certain securities, a ‘‘securities intermediary’’ is defined under Exchange Act Rule 17Ad–20 [17 CFR 240.17Ad–20] as a clearing agency registered under Exchange Act Section 17A [15 U.S.C. 78q–1] or a person, including a bank, broker, or dealer, that in the ordinary course of its business maintains securities accounts for others in its capacity as such. 554 In 1976, the Commission reported to Congress on the effects of the practice of registering securities in other than the name of the beneficial owner. In its report the Commission stated that 23.7% of shares were held in nominee and street name in 1964 and 28.6% of shares were held in nominee and street name in 1975. Final Report of the Securities and Exchange Commission on the Practice of Recording the Ownership of Securities in the Records of the Issuer in Other than the Name of the Beneficial Owner of Such Securities Pursuant to Section 12(m) of the Securities Exchange Act of 1934, Dec. 3, 1976. Based on an analysis of available data over the period 2008 through 2010, the Commission’s Division of Economic and Risk Analysis (‘‘DERA’’) estimates that over 85% of the holders of securities in the U.S. markets hold through a broker-dealer or a bank that is a DTC participant. More recently, and according to one study, shares held in street name continue to account for over 80% of all shares outstanding of U.S. publicly listed companies. See PricewaterhouseCoopers LLP, Proxy Pulse, Third Edition 2015 at 8. 555 See Amended Proxy Rules, Release No. 34– 1823 (Aug. 11, 1938) [3 FR 1991 (Aug. 13, 1938)]. This rule required registrants to furnish, upon written request of the record holder being solicited, the approximate number of record holders of any specified class of securities of which any of the holders had been or were being solicited. 556 See Annual Reports; Notice of Proposed Amendments, Release No. 34–7494 (Dec. 31, 1964) [30 FR 346 (Jan. 12, 1965)]. E:\FR\FM\22APP3.SGM 22APP3 23962 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules not to require disclosure of this information.557 In 1980, the Commission adopted Item 4 to Form 10–K, which consolidated disclosures relating to the market for the registrant’s securities, including the number of holders of common stock, into a single item.558 As adopted, Item 4 to Form 10– K integrated the disclosure requirements of a new Item 9 in Regulation S–K, which the Commission adopted concurrently.559 Item 201(b)’s reference to record holders is consistent with Section 12(g) of the Exchange Act. Section 12(g) requires issuers that are not banks, bank holding companies or savings and loan holding companies and have total assets exceeding $10 million to register a class of equity securities if the securities were ‘‘held of record’’ by either (i) 2,000 persons, or (ii) 500 persons who are not accredited investors.560 When Congress enacted Section 12(g) in 1964, most security holders in the United States owned their securities as record holders. c. Request for Comment mstockstill on DSK4VPTVN1PROD with PROPOSALS3 183. Should we retain or eliminate Item 201(b)(1)? Why? If retained, should we modify the item and if so, how? 184. As the vast majority of investors now hold their shares in street name, does disclosure about the number of record holders continue to be important to investors? Should we require registrants to disclose the amount of each class of equity securities held in street name? Should we require registrants to disclose the number of beneficial owners? If so, how should we define ‘‘beneficial owner’’ for purposes of Item 201(b)(1)? How would investors benefit from this additional information? What would be the challenges registrants might face in tracking the number of beneficial owners? 185. What types of investors or audiences are most likely to value the information required by Item 201(b)(1)? 557 See General Form for Annual Reports, Release No. 34–7545 (Mar. 5, 1965) [30 FR 3430 (Mar. 16, 1965)] (‘‘1965 Amendments to Form 10–K Adopting Release’’). 558 See 1980 Form 10–K Adopting Release (noting that the new item to Form 10–K constituted ‘‘an amalgam’’ of various other existing requirements.). 559 Id. Among other things, Item 9 of Form 10– K required registrants to ‘‘[s]et forth the approximate number of holders of common stock securities of the registrant as of the latest practicable date.’’ Instruction 1 to Item 9 provided that the computation of the approximate number of holders ‘‘may be based upon the number of record holders or may also include individual participants in security position listing.’’ Id. 560 15 U.S.C. 781(g). See also supra note 14. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 2. Description of Capital Stock (Item 202) Item 202(a)–(d) and (f) requires a brief description of the capital stock, debt, warrants, rights, American Depositary Receipts or any other securities that are being registered.561 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. None. b. Discussion Item 202 derives from Schedule A of the Securities Act, which requires disclosure of the capitalization of the registrant, including a description of the classes of capital stock and funded debt and any securities covered by options.562 These requirements were included in the earliest forms of registration statements.563 As part of revision and simplification efforts in 1947, the Commission amended this requirement to eliminate the description of securities that are not being registered, except to the extent material to an evaluation of the securities being registered.564 In 1982, Item 202 was included in Regulation S–K 565 as part of the ‘‘offering-oriented items’’ 566 and is currently required only in registration 561 Items 202(a)–(d) and (f) of Regulation S–K [17 CFR 229.202(a)–(d) and (f)]. Item 202(e) is outside the scope of this release. This item requires that if securities other than common stock are to be registered and there is an established trading market for such securities, registrants are required to provide market information for such securities comparable to that required by Item 201(a) of Regulation S–K. The staff is separately considering Item 201(a) in developing its recommendations for potential changes to update or simplify certain disclosure requirements. For a description of this project, see Section I. 562 Paragraphs 9–12 of Schedule A of the Securities Act [15 U.S.C. 77aa(9)–(12)]. 563 See Form A–2, Items 9 through 20. Tabular disclosure included details about amounts authorized, amounts outstanding, related balance sheet information, amounts held in treasury, amounts held by subsidiaries and parent companies, amounts reserved for officers and employees and amounts reserved for options and warrants. See S–K Study at footnote 238. 564 See Miscellaneous Amendments, Release No. 33–3186 (Jan. 8, 1947) [12 FR 224 (Jan. 15, 1947)]. See also Notice of Proposed Rules and Form and Proposed Repeal of Certain Forms, Release No. 33– 3171 (Nov. 18, 1946) [11 FR 13764 (Nov. 22, 1946)]. 565 See 1982 Integrated Disclosure Adopting Release. In adding Item 202 of Regulation S–K, the Commission revised the item to require registrants to discuss the effect on control of the company of certain charter and bylaw antitakeover provisions. Item 202(a)(5) of Regulation S–K [17 CFR 229.202(a)(5)]. 566 See Reproposal of Comprehensive Revision to System for Registration of Securities Offerings, Release No. 33–6331 (Aug. 6, 1981) [46 FR 41902 (Aug. 18, 1981)] at 41917. PO 00000 Frm 00048 Fmt 4701 Sfmt 4702 statements and some proxy statements.567 While registrants are required to file as exhibits complete copies of their articles of incorporation and bylaws as currently in effect, registrants are not required to describe these documents or their registered securities in their periodic filings.568 A summary description of the material terms and conditions of the registrant’s securities, as provided under Item 202, is not required in periodic reports and most registrants do not include such disclosure. To find this information, investors typically must locate this disclosure either in the registrant’s exhibits, as amended, or in the registrant’s Form 8–A, which often incorporates by reference from a prior Form S–1. Changes in the terms and conditions of registered securities are disclosed in Form 8–K and Schedule 14A, which require discussion of modifications to the rights of any class of securities and amendments to the articles of incorporation or bylaws.569 Frequently, these disclosures report discrete and specific changes to the overall terms and conditions of the registered securities such as individual amendments to the articles of incorporation to increase the number of shares authorized. A Form 8– K filed to report an amendment to the articles of incorporation or bylaws may be limited to the text of the amendment, however, the registrant must file a 567 See, e.g., Item 9 of Form S–1, Item 9 of Form S–3 and Item 1 of Form 8–A. Item 202 disclosure is also required in proxy statements with respect to the authorization or issuance of securities or the modification or exchange of any class of securities of a registrant. See Items 11 and 12 of Schedule 14A [17 CFR 240.14a–101]. 568 See Item 601(b)(3) of Regulation S–K [17 CFR 229.601(b)(3)]. Under ASC 505–10–50–3, registrants are required to summarize the ‘‘pertinent rights and privileges of the various securities outstanding.’’ 569 Item 3.03 of Form 8–K requires disclosure of material modifications to rights of security holders while Item 5.03 requires disclosure of amendments to the articles of incorporation or bylaws for amendments not disclosed in a proxy or information statement. Item 5.03 of Form 8–K also requires disclosure of changes in fiscal year other than by means of a submission to a vote of security holders through the solicitation of proxies (or otherwise) or an amendment to the articles of incorporation or bylaws [17 CFR 249.308]. Item 12 of Schedule 14A requires disclosure if action is to be taken regarding the modification of any class of securities of the registrant, or the issuance or authorization for issuance of securities of the registrant in exchange for outstanding securities. Section (b) of Item 12 requires disclosure of any material differences between the outstanding securities and the modified or new securities in respect of any of the matters concerning which information would be required in the description of the securities in Item 202 of Regulation S–K. Item 19 of Schedule 14A requires disclosure of amendments to the charter, bylaws or other documents. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules nature of the transaction and the nature and aggregate amount of consideration received by the registrant; the exemption from registration claimed; and the terms of conversion or exercise.571 These disclosure requirements also apply to securities issued in exchange for property, services, or other securities.572 c. Request for Comment 186. How do investors in the secondary market access information about the terms and conditions of a registrant’s securities? Do investors rely only on the bylaws and articles of incorporation filed as exhibits to the registrant’s Form 10–K? 187. In addition to the disclosure requirements in registration statements and certain proxy statements, should we require registrants to provide Item 202 disclosure each year in Form 10–K? Would requiring this information in the annual report facilitate investor access to important disclosure? Should we require registrants to disclose in their quarterly and annual reports whether changes have been made to the terms and conditions of their securities during the reporting period? Why? Are the Form 8–K requirements sufficient? 188. What types of investors or audiences are most likely to value the information required by Item 202? 189. What is the cost of providing the disclosure required by Item 202, including the administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates where possible and include only those costs associated with providing disclosure under Item 202. 190. What are the benefits of providing the disclosure required by Item 202? How could the benefits change if we made any of the changes contemplated here? Please provide quantified or qualitative estimates where possible relating to disclosure under Item 202. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 complete copy of the articles of incorporation or bylaws with its next Securities Act registration statement or periodic report.570 We are seeking public input on whether a comprehensive discussion of registered securities in periodic reports would facilitate access to important disclosure for investors in the secondary market. a. Comments Received S–K Study. Two commenters stated that disclosure of Item 701 information is not meaningful for investors.573 They also stated that such disclosure should not be required in registration statements because, to the extent recent sales of securities are material to investors, registrants would be required to disclose that information in their discussion of liquidity and capital resources under MD&A pursuant to Items 303(a)(1) and (2).574 Disclosure Effectiveness Initiative. One commenter recommended that the disclosure of sales of unregistered securities be limited to sales that are material to the issuer.575 This commenter also suggested reconciling the disclosure requirements of Item 701, which requires disclosure of all unregistered sales of common equity, with those of Item 3.02 of Form 8–K, which does not require disclosure of sales of less than one percent of the number of shares outstanding of the equity securities being sold. Another commenter recommended eliminating Item 701, noting overlap with Form 8– K and also stating that, for a material sale of securities, registrants typically discuss the transaction in MD&A.576 3. Recent Sales of Unregistered Securities (Items 701(a)–(e)) Item 701(a)–(e) requires disclosure of all sales of unregistered securities sold by the registrant within the past three years and specifies disclosure of: The date, title and amount of securities sold; the principal underwriters and other purchasers, if the securities were not publicly offered; the aggregate offering price for securities sold for cash and the 570 See Item 601(b)(3) of Regulation S–K [17 CFR 229.601(b)(3)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 b. Discussion Item 701’s requirement to disclose recent sales of unregistered securities is based, in part, on Schedule A.577 A 571 Item 701(a)–(e) of Regulation S–K [17 CFR 229.701(a)–(e)]. For a discussion of Item 701(f), see Section IV.D.4. 572 Id. 573 See Silicon Valley and M. Liles (also stating that cash flow statements would contain ‘‘more detailed information’’ about the proceeds of securities issuances in those periods, as would the statements of stockholders’ equity for the sales of equity securities). 574 See id. Both commenters also noted that registrants would be required to disclose the terms of any material sales of securities made to related persons pursuant to Item 404. 575 See SCSGP. 576 See CCMC. 577 Paragraph 19 of Schedule A of the Securities Act is broader than Item 701 because it calls for the net proceeds derived from any security sold by the issuer during the two years preceding the filing of the registration statement, including the price at which such security was offered. See Securities Act of 1933 Schedule A Paragraph 19 [15 U.S.C. 77aa(19)]. Other differences include Item 701’s three-year timeframe, as opposed to two years in PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 23963 disclosure requirement in Form S–1 578 of sales of unregistered securities for the past three years predated Regulation S– K.579 The requirement was moved to Regulation S–K in connection with adoption of the integrated disclosure system, but it continued to apply only to certain registration statements.580 In 1996, the Commission adopted amendments to require timely disclosure of unregistered equity offerings and amended Forms 10–K and 10–Q to include Item 701(a)–(e).581 This amendment was intended to address concerns that unregistered offerings were frequently undisclosed and such offerings could materially affect the financial condition of registrants or result in significant dilution to existing shareholders.582 The Commission also expanded Item 701 to require registrants to disclose terms of conversion or exercise for convertible or exchangeable equity securities.583 In 2004, the Commission sought more timely disclosure of unregistered equity offerings and added Item 3.02 to Form 8–K. Item 3.02 requires registrants to Schedule A, and the fact that Item 701 is limited to unregistered sales of equity securities while Schedule A contains neither of these limitations. 578 17 CFR 239.11. 579 See, e.g., Adoption of Amendments to Form S–1, Release No. 33–3434 (Jan. 31, 1952) [17 FR 1177 (Feb. 7, 1952)] (adopting disclosure requirements to Form S–1 substantially similar to current Item 701(a)–(e) of Regulation S–K). See also 1980 Proposed Revisions (noting that the requirement to disclose sales of unregistered securities during the past three years in proposed Form C was the same as in Item 25 of Form S–1 at that time). 580 See 1982 Integrated Disclosure Adopting Release. When Item 701 was moved to Regulation S–K, this disclosure was required in Forms 10–Q, S–1, S–11 and 10. The Commission had adopted a similar requirement for Forms 10–K and 10–Q in 1972. See Adoption of Amendments to Annual Report Form 10–K and Quarterly Report Form 10– Q Under the Securities Exchange Act of 1934, Release No. 34–9443 (Jan. 10, 1972) [37 FR 601 (Jan. 14, 1972)]. The Commission eliminated this requirement from Form 10–K in 1980, consistent with recommendations by the Sommer Report. See 1980 Form 10–K Adopting Release. According to the Sommer Report, the requirement was unnecessary in Form 10–K because the same information was available in the financial statements and required to be disclosed in Form 10–Q. See Sommer Report at 486. 581 See Periodic Reporting of Unregistered Equity Sales, Release No. 34–37801 (Oct. 10, 1996) [61 FR 54506 (Oct. 18, 1996)] (‘‘Periodic Reporting of Unregistered Equity Sales Release’’). 582 See, e.g., Streamlining Disclosure Requirements Relating to Significant Business Acquisitions and Requiring Quarterly Reporting of Unregistered Equity Sales, Release No. 33–7189 (Jun. 27, 1995) [60 FR 35656 (July 10, 1995)] (expressing concern about the lack of disclosure in the context of addressing issues with Regulation S offerings); Periodic Reporting of Unregistered Equity Sales Release. 583 See id. See also Item 701(e) of Regulation S– K [17 CFR 229.701(e)]. E:\FR\FM\22APP3.SGM 22APP3 23964 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 disclose, within four business days,584 the information specified in paragraphs (a) and (c) through (e) of Item 701 585 when aggregate equity securities sold are equal to or exceed one percent of the number of shares outstanding of the class of equity securities sold.586 The Commission initially proposed to move the Item 701 disclosure requirement out of Forms 10–Q and 10–K and into Form 8–K.587 This proposal was based on the Commission’s belief that more timely disclosure of this information would benefit investors due to the potentially significant dilutive effect on existing investors’ holdings.588 In response to comments on the proposing release, the Commission adopted the one percent threshold for disclosure on Form 8–K, noting that registrants would still be required to report all other unregistered sales of equity securities in their periodic reports.589 Concurrently, the Commission revised Forms 10–K and 10–Q to require disclosure only of unregistered sales of equity securities not previously disclosed on Form 8– K.590 584 See Item 3.02(a) of Form 8–K (stating the registrant has no obligation to disclose information under this Item 3.02 until the registrant enters into an agreement enforceable against the registrant, whether or not subject to conditions, under which the equity securities are to be sold. If there is no such agreement, the registrant must provide the disclosure within four business days after the occurrence of the closing or settlement of the transaction or arrangement under which the equity securities are to be sold). 585 See 2004 Form 8–K Adopting Release. 586 Item 3.02(b) of Form 8–K. SRCs are not required to file a Form 8–K if the securities sold, in the aggregate, constitute less than five percent of the number of shares outstanding of the class of equity securities sold. 587 Additional Form 8–K Disclosure Requirements and Acceleration of Filing Date, Release No. 33– 8106 (June 17, 2002) [67 FR 42914 (June 25, 2002)] (‘‘2002 Form 8–K Proposing Release’’). 588 See id. The Commission solicited comment on whether there was value to requiring the ‘‘aggregate listing’’ of sales made during quarterly and annual periods even though Form 8–K would report each sale as it occurred. The Commission also solicited comment on the question of whether the Form 8– K disclosure should be limited to large unregistered sales and suggested possible disclosure thresholds equal to a percentage of the company’s outstanding shares or a percentage of the company’s market float. See id. at 42923. 589 See 2004 Form 8–K Adopting Release at 15603 (‘‘In response to concerns raised by commenters, we have limited the disclosure of sale of unregistered equity securities required to be filed on Form 8–K. Under the new item, no Form 8–K need be filed if the equity securities sold in the aggregate since the company’s last report filed under this item or last periodic report, whichever is more recent, constitute less than 1% of the company’s outstanding securities of that class.’’). 590 See id. Item 701 information need not be disclosed in a Form 10–K if it has been previously included in a Form 10–Q or Form 8–K. See Item 5(a) of Form 10–K. Similarly, Item 701 information need not be disclosed in a Form 10–Q if it has been previously disclosed in a Form 8–K. See Item 2(a) of Part II of Form 10–Q. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Some of the disclosure required by Item 701(a)–(e) may overlap with disclosure in the statement of stockholders’ equity, which is required in the annual financial statements,591 or in the notes to the financial statements. For example, under U.S. GAAP, registrants must disclose the number of shares sold, title of class of stock sold and net proceeds.592 Registrants are also required to discuss the rights and privileges of the securities outstanding, such as conversion or exercise prices and pertinent dates.593 On the other hand, U.S. GAAP does not require disclosure of underwriters, underwriting discounts, the exemption claimed or the identity of the purchasers, as required by Item 701. In addition, accounting standards do not distinguish between registered and unregistered sales of securities. c. Request for Comment 191. Should we retain or eliminate Item 701(a)–(e)? Why? Does the disclosure required under Item 701(a)– (e) provide important information that is not available in either MD&A or the financial statements? 192. Does the Item 3.02 of Form 8–K disclosure requirement for issuances of one percent or greater and the Item 701 requirement for all issuances strike the right balance between disclosing larger issuances promptly and all others quarterly? Is one percent an appropriate threshold? If not, what would be an appropriate threshold and why? 193. Should we revise Forms 10–K and 10–Q to require disclosure of all unregistered sales of securities during the reporting period, including those already reported on Form 8–K? What would be the benefits to investors? Alternatively, should we require registrants to cross-reference or include a hyperlink to any previously filed Form 8–K containing Item 701 information for the reporting period or incorporate such forms by reference? What would be the advantages or disadvantages associated with either of these approaches? 194. Should we remove the Item 701 disclosure requirement from Forms 10– K and 10–Q? If so, should we revise Item 3.02 of Form 8–K to remove the one percent threshold and require registrants to disclose all unregistered 591 Rule 3–04 of Regulation S–X [17 CFR 210.3– 04]. Registrants are not required to provide a statement of stockholders’ equity with their interim financial statements. 592 See ASC Topic 505–10–50–2. Registrants are not required to disclose the aggregate offering price. 593 See ASC Topic 505–10–50–3. ASC Topic 470– 10–50–5 requires the same information for debt securities. While the date of sale is not required, registrants usually include it in their discussions of the rights and privileges of securities sold. PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 sales of securities on Form 8–K? Alternatively, should we eliminate Item 3.02 of Form 8–K and instead require disclosure only in Forms 10–K and 10– Q? 195. Disclosure provided in response to Item 701(a)–(e) can range from a single paragraph to multiple pages. In Form 10–K, this disclosure is provided as part of Item 5 of Part II (Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities) while in Form 10–Q this disclosure is provided as Item 2 of Part II (Unregistered Sales of Equity Securities and Use of Proceeds). Should we require this disclosure where it currently appears, in the context of the liquidity discussion in MD&A, or elsewhere? 196. Do registrants face any particular challenges in complying with the item’s disclosure requirements? 4. Use of Proceeds From Registered Securities (Item 701(f)) Item 701(f) requires a registrant to disclose the use of proceeds from its first registered offering.594 The registrant must provide the following disclosure in its first Exchange Act periodic report after effectiveness of the Securities Act registration statement: • The effective date of the Securities Act registration statement; • the offering date or an explanation of why the offering has not commenced; • if the offering terminated before any securities were sold, an explanation of the termination; • if the offering did not terminate before any securities were sold, registrants must disclose (i) whether the offering has terminated and, if so, whether it terminated before the sale of all securities registered; (ii) the names of the managing underwriters, if any; (iii) the title of each class of securities registered; (iv) for each class of securities, the amount registered, the aggregate offering price of the amount registered, the amount sold, and the aggregate offering price of the amount sold to date; (v) the amount of expenses incurred by the registrant in connection with the issuance and distribution of the securities registered; (vi) net offering proceeds after deducting expenses; (vii) the amount of net offering proceeds used for certain enumerated purposes; and (viii) a brief description of any material change from the prospectus disclosure about the use of proceeds.595 Item 701(f) requires registrants to provide disclosure in each subsequent 594 Item 701(f) of Regulation S–K [17 CFR 229.701(f)]. 595 Id. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules periodic report to the extent it has changed since the last periodic report filed. Registrants must continue to provide this disclosure until the application of all of the offering proceeds or termination of the offering. a. Comments Received S–K Study. Two commenters recommended eliminating Item 701(f), indicating the requirement does not result in useful information for investors since companies cannot necessarily determine whether a dollar spent was derived from revenue or from the net proceeds of a securities offering, and that the discussion of cash flow in MD&A should already address material uses of cash.596 Disclosure Effectiveness Initiative. None. b. Discussion The precursor to Item 701(f) originated in Rule 463 of the Securities Act, which was adopted with related Form SR in 1971.597 In proposing this rule, the Commission noted that disclosure about the progress of an offering of registered securities would enable the Commission to know whether the registrant is required to file and use an updated Section 10(a)(3) prospectus and whether ‘‘dealers effecting transactions in the registered security must furnish a copy of the prospectus to purchasers.’’ 598 The Commission further noted that, if registrants have used offering proceeds for purposes different from those stated in the prospectus, investors may have been misled as to the purposes for which the funds supplied by them would be applied. Information about the actual use of proceeds following the offering would indicate whether statements in the prospectus were borne out by the registrant’s subsequent actions.599 596 See Silicon Valley; M. Liles. Adoption of Rule 463 and Form SR Requiring Reports by First-Time Registrants of Sales of Registered Securities and Use of Proceeds Therefrom, Release No. 33–5141 (Apr. 19, 1971) [36 FR 7896 (Apr. 28, 1971)] (‘‘Rule 463 Adopting Release’’). Form SR was a stand-alone report required to be filed once every six months following the effective date of a registrant’s first Securities Act registration statement. 598 Notice of Proposal to Require Reports by FirstTime Registrants of Sales of Registered Securities and Use of Proceeds Therefrom, Release No. 33– 5130 (Feb. 8, 1971) [36 FR 3429 (Feb. 24, 1971)] at 3430. 599 See id. As adopted, Rule 463 did not require a Form SR to be filed with respect to any offering of securities issued by any investment company registered under the Investment Company Act of 1940; any public utility company or public utility holding company required to file reports with any state or federal authority; or with respect to American depositary receipts for foreign securities. See Rule 463 Adopting Release. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 597 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 In 1980, the Commission proposed revisions to Rule 463 and Form SR to require, among other things, disclosure of use of proceeds beyond first-time registered offerings.600 After considering comments on the proposal, the Commission concluded it was not clear that the benefits from such an extension would outweigh the additional reporting burdens imposed on registrants.601 At the same time, the Commission affirmed the use of Form SR for first-time issuers and noted that commenters generally did not object to the use of Form SR to elicit information about use of proceeds from first-time issuers.602 In 1997, the Commission eliminated Form SR and adopted Item 701(f) to require disclosure about the use of offering proceeds in periodic reports.603 The Commission stated its belief that relocating the disclosure to periodic reports would make it more accessible to investors, since periodic reports were more commonly monitored by the public than Form SR.604 The adoption of Item 701(f) led to use of proceeds information being reported on a quarterly basis instead of semi-annually through Form SR. Other disclosure requirements may elicit information about the use of offering proceeds. For example, registrants may disclose the proceeds from initial public offerings as a material source of cash in the liquidity discussion within MD&A.605 Changes in a registrant’s statement of cash flow and statement of stockholders’ equity in the financial statements may also indicate the progress of its initial registered offering. However, certain information about the progress of an offering, such as when a registrant has not commenced 600 See Report of Sales of Securities, Release No. 33–6251 (Oct. 23, 1980) [45 FR 71811 (Oct. 30, 1980)]. The proposed requirement was intended to facilitate the determination of whether an issuer of a direct distribution or a best efforts underwritten offering that was not a first-time offering was complying with the prospectus delivery and updating requirements of Sections 4(3) and 10(a)(3) of the Securities Act. 601 See Report of Sales of Securities and Use of Proceeds, Release No. 33–6346 (Sept. 21, 1981) [46 FR 48137 (Oct. 1, 1981)]. 602 See id. 603 See Phase Two Recommendations of Task Force on Disclosure Simplification Release. 604 See id. The Commission also noted that consolidating the disclosure requirements into the periodic report forms should ease reporting burdens on registrants by reducing the number of forms required to be filed. 605 See Item 303(a)(1) of Regulation S–K [17 CFR 229.303(a)(1)] (requiring registrants to discuss and analyze ‘‘internal and external sources of liquidity’’) and Item 303(a)(2)(ii) of Regulation S–K (requiring registrants to discuss and analyze any known material trends, favorable or unfavorable, in capital resources, including changes between equity, debt and any off-balance sheet financing arrangements). PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 23965 an offering or the offering is terminated before any securities were sold, may not be available to investors outside of disclosures required by Item 701(f). c. Request for Comment 197. Should we retain or eliminate disclosure about the use of offering proceeds required by Item 701(f)? Why? If we retain this requirement, how could we improve it? For example, should we modify the item, such as by expanding it to offerings other than a registrant’s first registered offering or by requiring other additional disclosure? Why? 198. In Form 10–K, this disclosure is provided as part of Item 5 of Part II (Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities) while in Form 10–Q this disclosure is provided as Item 2 of Part II (Unregistered Sales of Equity Securities and Use of Proceeds). Should we require this information in its current location, in the context of liquidity or elsewhere? Should we require disclosure only if the actual use of proceeds differs materially from the description of the offering? 5. Purchases of Equity Securities by the Issuer and Affiliated Purchasers (Item 703) Item 703 requires tabular disclosure of purchases of registered equity securities by the registrant or any affiliated purchaser including: • Total number of shares repurchased; • average price paid per share; • total number of shares purchased as part of publicly announced plans or programs; and • maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs.606 Item 703 also requires footnote disclosure of (1) the date each plan or program was announced, (2) the dollar amount (or share amount) approved, (3) the expiration date (if any) of each plan or program, (4) each plan or program that has expired during the period covered by the table, and (5) each plan or program the registrant has determined to terminate prior to expiration, or under which the issuer does not intend to make further purchases.607 Item 703 requires disclosure for each month included in the period covered by the report. Form 10–Q requires this information for any equity repurchase made in the quarter covered by the 606 Item 703 of Regulation S–K [17 CFR 229.703]. 2 to paragraphs (b)(3) and (b)(4) of Item 703 of Regulation S–K [17 CFR 229.703]. 607 Instruction E:\FR\FM\22APP3.SGM 22APP3 23966 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules report,608 while Form 10–K requires this disclosure for repurchases made in the fourth fiscal quarter of the registrant’s fiscal year.609 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended the Commission and the FASB coordinate efforts to review and clarify the different disclosure objectives of Item 703 and U.S. GAAP to determine whether both requirements continue to provide distinct and useful information.610 This commenter also recommended, alternatively, that if the Commission and the FASB determine that the requirements are still useful, that they issue joint guidance on how both requirements should work together. Another commenter recommended enhanced disclosure of the ‘‘pros’’ and ‘‘cons’’ of share repurchase programs by addressing, among other things, (i) the time period specified for each program, (ii) the maximum number of shares authorized by the board to be repurchased, (iii) the cash (including any borrowings) spent on repurchases and dividends compared to that spent on reinvestment, and (iv) the impact of repurchase programs on corporate indebtedness.611 This commenter also recommended that companies consider disclosing the sources of funds to finance stock buybacks. b. Discussion mstockstill on DSK4VPTVN1PROD with PROPOSALS3 In 2003, the Commission adopted Item 703 to increase the transparency of security repurchases by registrants and their affiliates and to inform investors of registrants’ stated repurchasing intentions and subsequent repurchases.612 The Commission noted in the adopting release that public announcement of a repurchase is often followed by a rise in the registrant’s stock price, and that studies have shown some registrants publicly announce repurchase programs but either do not repurchase shares or only repurchase a small portion of the publicly disclosed amount. Item 703 was intended to inform investors whether, and to what extent, registrants follow through on their original repurchase plans and to 608 Item 2(c) of Part II of Form 10–Q [17 CFR 249.308a]. 609 Item 5(c) of Form 10–K [17 CFR 249.310]. 610 See SCSGP (specifying overlap between Item 703 and ASC Topic 505). 611 See letter from William J. Klein and Thomas J. Amy (May 12, 2015) (‘‘Klein and Amy 3’’). 612 See Purchases of Certain Equity Securities by the Issuer and Others, Release No. 33–8335 (Nov. 10, 2003) [68 FR 64952 (Nov. 17, 2003)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 provide investors with information that could affect a registrant’s stock price.613 In recent years, stock repurchases by registrants have increased significantly.614 According to media reports, since 2004 U.S. companies have spent nearly $7 trillion repurchasing their own shares.615 Common reasons for engaging in repurchases include returning excess cash to shareholders,616 boosting earnings per share 617 and offsetting share dilution resulting from employee benefit plans.618 Repurchases typically affect earnings per share by reducing the amount of shares outstanding,619 except 613 See id. e.g., Oliver Renick and Michael P. Regan, Getting High on Their Own Supply, Bloomberg Businessweek, July 16, 2015, available at https:// www.bloomberg.com/news/articles/2015-07-16/ corporate-stock-buybacks-make-earnings-lookbetter (citing data that companies in the S&P 500 spent more than $550 billion in stock repurchases in 2014); John Waggoner, Beware the Stock-Buyback Craze, The Wall Street Journal, June 19, 2015, available at https://www.wsj.com/articles/bewarethe-stock-buyback-craze-1434727038 (noting that stock repurchases are returning to pre-financial crisis levels and citing research indicating that companies in the S&P 500 repurchased about $148 billion of their own shares in the first quarter of 2015); Audit Analytics, Research and Development Up Despite Stock Buybacks, June 15, 2015, available at https://www.auditanalytics.com/blog/ research-and-development-up-despite-stockbuybacks (citing research that stock buybacks have surpassed $2.1 trillion since the beginning of the first quarter of 2009 among S&P 500 companies). 615 See Andrew Ross Sorkin, Stock Buybacks Draw Scrutiny from Politicians, The New York Times, Aug. 10, 2015, available at https:// www.nytimes.com/2015/08/11/business/stockbuybacks-draw-scrutiny-from-politicians.html (citing data from Mustafa Erdem Sakinc of the Academic-Industry Research Network). 616 See, e.g., Maxwell Murphy and John Kester, Buybacks Can Juice Per-Share Profit, Pad Executive Pay, The Wall Street Journal, Oct. 19, 2014, available at https://www.wsj.com/articles/buybackscan-juice-per-share-profit-executive-pay1414453356 (‘‘Murphy and Kester’’). 617 See, e.g., Maxwell Murphy, The Big Number, The Wall Street Journal, Apr. 6, 2015, available athttps://www.wsj.com/articles/the-big-number1428362150 (‘‘Murphy’’). 618 See, e.g., Gerrit De Vynck, BlackBerry Plans Share Buyback to Offset Employee Incentives, Bloomberg Business, May 21, 2015, available at https://www.bloomberg.com/news/articles/2015-0521/blackberry-planning-share-buyback-to-offsetemployee-incentives; Ford Announces $1.8 Billion Share Buyback Program, Can Reduce Debt, Chicago Tribune, May 7, 2014, available at https:// articles.chicagotribune.com/2014-05-07/ marketplace/sns-rt-us-ford-stocks-buyback20140507_1_ford-motor-co-ford-stock-103-millionshares. See also Karen Brettell, David Gaffen and David Rohde, The Cannibalized Company, Reuters, Nov. 16, 2015, available at https://www.reuters.com/ investigates/special-report/usa-buybackscannibalized (stating that the prevalence of share repurchases is the result of several factors: Pressure from activist investors; executive compensation programs that tie pay to earnings per share and share prices; increased global competition; and ‘‘fear of making long-term bets on products and services that may not pay off’’). 619 See E.S. Browning, Is the Surge in Stock Buybacks Good or Evil?, The Wall Street Journal, 614 See, PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 when repurchased shares are distributed to employees as compensation. Recent studies have found that, since the Commission adopted Item 703, registrants have announced smaller open market repurchases 620 and have completed announced open market repurchases at a higher rate.621 The staff has observed that registrants generally comply with the item requirements but often do not analyze the impact of stock repurchases in the context of MD&A. Even when the amount used to repurchase shares exceeds a registrant’s net income or cash generated from operating activities for the reporting period, registrants do not always analyze these repurchases in MD&A. While some of the disclosure required under Item 703 overlaps with requirements under U.S. GAAP,622 there are differences between the two standards. Item 703 disclosure is required on a quarterly basis while U.S. GAAP requires annual disclosure. Additionally, disclosure requirements under U.S. GAAP vary depending on the type of transaction through which shares are repurchased, and in some situations U.S. GAAP disclosures are more extensive than those required under Item 703.623 Disclosure provided Nov. 22, 2015, available at https://www.wsj.com/ articles/is-the-surge-in-stock-buybacks-good-or-evil1448188684; Murphy and Kester. See also Murphy (noting that 22 companies in the S&P 500 reported lower profits but still posted flat or positive earnings per share in 2014 solely from share repurchases, and that 308 companies in the index ended the year with fewer shares outstanding). 620 See Alice A. Bonaime, Mandatory Disclosure ´ and Firm Behavior: Evidence from Share Repurchases, 90 Accounting Review 4, 1333 (2015) ´ (‘‘Bonaime 2015’’). 621 See Michael Simkovic, The Effect of Mandatory Disclosure on Open Market Repurchases, 6 Berkley Bus. L.J. 1, 96 (2009) (comparing a sample of post-2003 open market repurchases with literature on open market ´ repurchases predating Item 703); Bonaime 2015. 622 The dollar amount and the number of shares repurchased are disclosed in the annual Statement of Shareholders’ Equity, because U.S. GAAP requires the repurchase of stock to be deducted from capital stock, additional paid-in capital, and retained earnings. See ASC Topics 505–10–50, 505– 30–30 and Rule 3–04 of Regulation S–X. This financial statement presents shareholders’ equity activity in a roll forward of each of the shareholders’ equity components from the beginning to the end of the annual period. Article 10 of Regulation S–X does not require an interim period statement of shareholders equity. Instead, Rule 10–01(a)(5) requires disclosure of events subsequent to the end of the most recent fiscal year that have occurred which have a material impact on the registrant. 623 For example, for shares repurchased through accelerated share repurchase programs, registrants must disclose the nature and terms of the arrangement with the seller from which the registrant is acquiring its shares, including the number of shares subject to the contract, per share price terms and settlement options available. See ASC Topic 815–40–50–5. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 under U.S. GAAP is also audited, unlike Item 703 disclosure. Typically, registrants provide disclosure about share repurchases in both the notes to the financial statement and in nonfinancial statement disclosures. While Item 703 requires disclosure of all monthly repurchases on a quarterly basis,624 other jurisdictions require this disclosure more frequently.625 We seek comment on whether we should require more frequent or more granular information about repurchases or whether the current disclosure requirements are sufficient. c. Request for Comment 199. Is the information required under Item 703 about repurchases of a registrant’s equity securities important to investors? If so, are there any revisions we could make to Item 703 to improve the disclosure provided to investors? 200. Should we require more granular information on repurchases of a registrant’s equity securities? If so, what additional detail or more granular information should we require? For example, should we require disclosure about incurrence of indebtedness to fund repurchases or the impact repurchases had on performance measures, such as earnings per share or other items? If so, how should this information be formatted and presented? 201. Does Item 703 provide important information that is not also disclosed in a registrant’s financial statements? Are there benefits to investors in providing this information in both the financial statements and in non-financial statement disclosure? 202. Item 703 requires disclosure of all repurchases of registered securities and does not have a de minimis requirement. Do investors find disclosure of all repurchases of securities during a registrant’s fiscal quarter important to making a voting or investment decision? Should we adopt a general materiality standard or specify a monetary threshold for Item 703 disclosure in periodic reports? 203. Item 703 disclosure is required on a quarterly basis, while relevant U.S. GAAP disclosure is required on an annual basis. Should we require more frequent Item 703 disclosure? If so, what timeframe for reporting repurchases would be appropriate? 624 See Item 2(c) of Part II of Form 10–Q and Item 5(c) of Form 10–K. 625 For example, exchange listing requirements in Australia require disclosure of share repurchases by the next business day. See Australian Securities Exchange Listing Rule 3.8A, available at https:// www.asx.com.au/documents/rules/Chapter03.pdf. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 204. Should we require registrants to report repurchases on Form 8–K? For example, should we require Form 8–K disclosure only of repurchases that exceed a certain threshold, similar to Item 3.02 of Form 8–K, which requires registrants to disclose sales of equity securities that constitute more than one percent of the shares outstanding of the class of equity securities? If so, what should this threshold be and why? E. Industry Guides The Industry Guides express the disclosure policies and practices of the Division and are intended to assist registrants and their counsel in preparing disclosure for their filings.626 Currently, there are five Industry Guides that address disclosures by: (i) Bank holding companies,627 (ii) oil and gas programs,628 (iii) real estate limited partnerships,629 (iv) property-casualty 626 Although the Commission published the Industry Guides, they do not constitute Commission rules and instead are statements of staff policy. See Rescission of Guides and Redesignation of Industry Guides, Release No. 33–6384 (Mar. 3, 1982) [47 FR 11476 (Mar. 16, 1982)] (‘‘Industry Guide Release’’) (‘‘These guides remain as an expression of the policies and practices of the Division of Corporation Finance and their status is unaffected by [the listing of the Industry Guides in Regulation S–K].’’ Id. at 11476). 627 Securities Act and Exchange Act Industry Guide 3—Statistical Disclosure by Bank Holding Companies. Industry Guide 3 was first published in 1976 as Securities Act Guide 61 and Exchange Act Industry Guide 3. See Guides for Statistical Disclosure by Bank Holding Companies, Release No. 33–5735 (Aug. 31, 1976) [41 FR 39007 (Sept. 14, 1976)]. There have been only minor revisions to the text of Industry Guide 3 since its redesignation as an Industry Guide in 1982. Revisions relating to non-performing loan disclosure requirements were implemented in 1983, and revisions relating to exposures to borrowers in certain foreign countries were implemented in 1986. See Revision of Industry Guide Disclosures for Bank Holding Companies, Release No. 33–6478 (Aug. 11, 1983) [48 FR 37609 (Aug. 19, 1983)]; Amendments to Industry Guide Disclosures by Bank Holding Companies, Release No. 33–6677 (Nov. 25, 1986) [51 FR 43594 (Dec. 3, 1986)]. 628 Securities Act Industry Guide 4—Prospectuses Relating to Interests in Oil and Gas Programs. Industry Guide 4 was first published in 1970 as Guide 55, which was redesignated as Securities Act Industry Guide 4 in 1982. See Definitive Guide for the Preparation of Prospectuses Relating to Interests in Oil and Gas Programs, Release No. 33–5036 (Jan. 19, 1970) [35 FR 1233 (Jan. 30, 1970)]. While the disclosure requirements for oil and gas producing activities were modernized in 2008 (at which time Industry Guide 2 was eliminated), the changes did not affect Securities Act Industry Guide 4. Securities Act Industry Guide 4 is focused on disclosure relating to the offering of interests in oil and gas programs, such as the terms of the offering, the participation in costs and revenues, application of proceeds and risk factors. 629 Securities Act Industry Guide 5—Preparation of Registration Statements Relating to Interests in Real Estate Limited Partnerships. Industry Guide 5 was originally published in 1976 as Guide 60 and redesignated as Securities Act Industry Guide 5 in 1982. See Preparation of Registration Statements Relating to Interests in Real Estate Limited PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 23967 insurance underwriters,630 and (v) mining companies.631 All five of the Industry Guides apply to disclosure in Securities Act registration statements. The Industry Guides for bank holding companies, property-casualty insurance underwriters, and mining companies also apply to disclosure in Exchange Act filings.632 We are seeking public input on whether the Industry Guides elicit disclosure that is important to investment and voting decisions. We are interested in commenters’ views on Partnerships, Release No. 33–5692 (March 17, 1976) [41 FR 17403 (Apr. 26, 1976)]; Industry Guide Release. In 1991 the Commission expanded the application of Industry Guide 5 to include the preparation of registration statements for real estate investment trusts and all other limited partnership offerings, as applicable. See Limited Partnership Reorganizations and Public Offerings of Limited Partnership Interests, Release No. 33–6900 (June 17, 1991) [56 FR 28979 (June 25, 1991)]. 630 Securities Act Industry Guide 6 and Exchange Act Industry Guide 4—Disclosures Concerning Unpaid Claims and Claim Adjustment Expenses of Property-Casualty Insurance Underwriters. These Industry Guides were first published in 1984 and there have been no significant revisions since their adoption. See Rules and Guide for Disclosure Concerning Reserves for Unpaid Claims and Claim Adjustment Expenses of Property-Casualty Underwriters, Release No. 33–6559 (Nov. 27, 1984) [49 FR 47594 (Dec. 6, 1984)]. 631 Securities Act and Exchange Act Industry Guide 7—Description of Property by Issuers Engaged or To Be Engaged in Significant Mining Operations (‘‘Industry Guide 7’’). Industry-specific disclosure requirements for mining companies were previously included in various Securities Act Forms. In 1992, in connection with the Commission’s small business initiatives that rescinded Form S–18, Item 17A of Form S–18 was redesignated as Industry Guide 7, so that the industry specific guidance would be applicable to all issuers engaged in mining operations, not only to small business issuers. See Small Business Initiatives, Release No. 33–6949 (July 30, 1992) [57 FR 36442 (Aug. 13, 1992)] (‘‘Small Business Initiatives Adopting Release’’). A rulemaking petition to amend Industry Guide 7 was submitted to the Commission in October 2012. See letter from the Society for Mining, Metallurgy and Exploration, Oct. 1, 2012, available at https://www.sec.gov/rules/ petitions/2012/petn4-654.pdf. 632 Guidance contained in Exchange Act Industry Guides 3 and 4 applies to the description of business portion of registration statements filed on Form 10; in proxy and information statements relating to mergers, consolidations, acquisitions, and similar matters (Item 14 of Schedule 14A and Item 1 of Schedule 14C); and in reports filed on Forms 10–K. See Item 802 of Regulation S–K [17 CFR 229.802]. Exchange Act Industry Guide 7 does not specify the Exchange Act filings to which the guidance applies. In proposing to re-designate the Industry Guides, the Commission noted that industry guidelines ‘‘maximize’’ the quality of disclosure in certain industries. Accordingly, though not specifically applicable to Exchange Act filings, Industry Guide 5 may be useful in determining the type of information that might be important in an Exchange Act filing for a real estate program. See Proposed Revision of Regulation S–K and Guides for the Preparation and Filing of Registration Statements and Reports, Release No. 33–6276 (Dec. 23, 1980) [46 FR 78 (Jan. 2, 1981)] (‘‘1980 Proposed Revision of Regulation S–K’’). E:\FR\FM\22APP3.SGM 22APP3 23968 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules whether the Industry Guides provide useful guidance for registrants that improves disclosure to investors. Additionally, we are seeking input on whether the Industry Guides or portions of the Industry Guides should be codified in Regulation S–K.633 1. Comments Received mstockstill on DSK4VPTVN1PROD with PROPOSALS3 S–K Study. None. Disclosure Effectiveness Initiative. A few commenters recommended general updates to all Industry Guides.634 One commenter recommended that we consider additional industry-specific disclosure requirements and consider whether changes in the economy require additional industry-specific disclosure in either or both Regulations S–X and S–K.635 This commenter also stated that the Industry Guides should be updated to reflect changes in disclosure requirements within Regulations S–X and S–K and stated that the Industry Guides, relative to U.S. GAAP and Regulation S–X, could use improvement. One commenter suggested that improved Industry Guides could be helpful in highlyregulated or specialized industries, such as financial institutions and banks, mining, oil and gas exploration, and the pharmaceutical industry.636 This commenter also suggested moving industry-specific disclosure requirements currently in Regulation S– K to the relevant Industry Guide.637 One commenter recommended requiring additional disclosure from oil and gas companies about the carbon asset risk to such companies.638 633 We focus only on the Industry Guides in this section of the release. We do not address items of Regulation S–K that contain industry-specific disclosure requirements, such as Item 104, which requires disclosure about mine safety that is applicable only to registrants that operate coal or other mines. Additionally, this section focuses on the Industry Guides generally and does not pose questions specific to any of the Industry Guides, although we welcome comments on specific revisions to any of the Industry Guides. As part of the Disclosure Effectiveness Initiative, the staff is currently considering recommendations for Industry Guides 3 and 7. Comment letters received specific to Industry Guides 3 and 7 are being considered as part of these staff recommendations. 634 See, e.g., letters from Rep. Shelley Moore Capito, et al. (July 7, 2014); Senators Dean Heller, Mike Crapo and Jon Tester (Aug. 13, 2014); Shearman. 635 See CFA Institute (listing the technology and social media sectors as examples of industries where industry-specific disclosure may be useful). 636 See Shearman (suggesting that new industry guides could address issues such as the regulatory environments in which industries operate). 637 Id. (citing Item 104—Mine Safety Disclosure as an industry-specific disclosure requirement in Regulation S–K that could be moved to an Industry Guide). 638 See letter from Ceres (Apr. 17, 2015) (‘‘Ceres’’). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 2. Discussion Between 1962 and 1992, the Commission published various Guides and Industry Guides to assist registrants in preparing and filing registration statements and periodic reports and to shorten the comment process.639 The Guides represented policies and practices followed by the Division and were published in response to an increase in the number of filings reviewed by the Division and an associated increase in the amount of time between the filing and effective dates of a registration statement.640 The Guides were intended to provide uniformity and enhance comparability of disclosure while reducing the necessity for staff comment on matters addressed in the Guides.641 The Guides were modified and expanded over time, in part, to address anticipated disclosure issues.642 In connection with the adoption of the integrated disclosure system in 1982, the Guides relating to specific industries were re-designated as Industry Guides and the titles of the Securities Act Industry Guides and Exchange Act Industry Guides were listed in Items 801 and 802 of Regulation S–K, respectively.643 639 The first Guides were published in 1962. By 1979, there were 63 Guides for the preparation and filing of registration statements and five Guides for the preparation and filing of periodic reports. See 1980 Proposed Revision of Regulation S–K (discussing the history of the guides) 1964 Guides; S–K Study at 7, footnote 16, and 10, footnote 28. 640 See id. The backlog of filings and inordinate length of the pre-effective period was attributed in part to the low-quality of first-time filings and inexperience of counsel and accountants. See Acceleration of Registration Statements, Release No. 33–4475 (Apr. 13, 1962) [27 FR 3990 (Apr. 26, 1962)]; 1980 Proposed Revision of Regulation S–K. 641 See 1964 Guides (‘‘It is expected that the publication of these policies and practices will not only be of assistance to registrants, their counsel and accountants in the preparation of registration statements, but also that it will relieve the staff of the Commission of the necessity for commenting on these matters in respect of such statements.’’ Id. at 2490); Proposed Guides Concerning Prospectuses Relating to a Public Offering of Interests in Oil and Gas Programs, Release No. 33–5001 (Aug. 27, 1969) [34 FR 14125 (Sept. 6, 1969)] (‘‘The guide is designed to accomplish, to the extent feasible, uniformity in both the sequence of disclosures and their general content. The guide should thus serve to assist issuers in preparing registration statements involving oil and gas drilling programs and to facilitate the understanding and analysis of the program by the investor, enabling him also to compare more readily one offering with another.’’ Id. at 14125). 642 See 1980 Proposed Revision of Regulation S– K (also citing the Commission’s investigation of the hot issues securities markets, recommendations of the Industrial Issuers Advisory Committee and recommendations in the Sommer Report as factors to which the expansion and modification of the Guides can be attributed). 643 See Industry Guide Release (rescinding all guides other than those which contain industry- PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 Although the Industry Guide titles are listed in Items 801 and 802 of Regulation S–K, these guides are not part of Regulation S–K and are not rules, regulations or statements of the Commission.644 In 1996, the Task Force on Disclosure Simplification recommended incorporating the Industry Guides into Regulation S–K, based on the Task Force’s understanding that registrants find the role of the Industry Guides within our disclosure regime confusing.645 The Task Force also recommended eliminating Industry Guide 1 (Disclosure of Principal Sources of Electric and Gas Revenues) because the Task Force believed that the information required by the Industry Guide was provided in response to other disclosure requirements.646 Although it did not incorporate the Industry Guides into Regulation S–K,647 the Commission did follow the Task Force’s recommendation 648 to eliminate Industry Guide 1 (Disclosure of Principal Sources of Electric and Gas Revenues) because the information requested by the Industry Guide is covered by other Commission rules, including Items 101 and 303 of Regulation S–K.649 In 2008, the Commission modernized the reporting requirements applicable to oil and gas reserves and codified the disclosure items formerly in Industry Guide 2 by relocating them into Regulation S–K.650 The S–K Study recommended reviewing the Industry Guides to evaluate whether they continue to elicit useful information that would not otherwise be disclosed. The S–K Study also recommended considering whether any Industry Guide provisions should specific disclosure); Items 801 and 802 of Regulation S–K [17 CFR 229.801; 17 CFR 229.802]. 644 See Industry Guide Release. 645 See Task Force Report (recommending that the Industry Guides be placed intact at the end of Regulation S–K, in the manner that industryspecific disclosure requirements are currently placed in Regulation S–X). The Task Force also recommended that the Commission consider adopting rules applicable to additional industries and recommended general modernization of the Industry Guides. Id. 646 See Task Force Report. The Task Force stated that the disclosure provided by Guide 1 appears to be adequately covered by the requirements of Regulation S–K, primarily Items 101 and 303 of Regulation S–K. 647 In addressing other Task Force recommendations, the Commission stated that its action for certain Task Force recommendations was not intended to indicate either approval or disapproval of any of the remaining recommendations or suggestions in the Task Force Report. See Phase One Recommendations of Task Force on Disclosure Simplification Release. 648 See Task Force Report. 649 See Phase One Recommendations of Task Force on Disclosure Simplification Release. 650 See Oil and Gas Release. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules be codified in Regulation S–K, whether any information is duplicative of U.S. GAAP requirements and whether industry-specific disclosure requirements should be scaled or transition periods be provided for certain classes of registrants.651 In proposing the re-designation of the Industry Guides, the Commission cited industry guidelines as an example of the limited instances where the use of guidelines is appropriate, stating that guidelines should pertain only to areas such as industry-specific information, where more specific guidance is appropriate yet flexibility is necessary to tailor disclosures to particular facts and circumstances.652 The Commission cited findings of the Sommer Report in concluding that the use of industry guidelines minimizes the extent to which registrants must comply with inapplicable disclosure requirements, maximizes the quality of the disclosure made for particular industries, and provides Commission staff with a reference for examining filings by particular industries.653 We are seeking input on whether the Industry Guides continue to achieve the benefits cited by the Commission when it re-designated the guides in 1980. Today, the Division publicly releases its comment letters.654 These letters are often analyzed by third parties that publish reports about comment trends in an industry.655 We believe that registrants look to filings in their industry and recently-issued staff comment letters to anticipate and proactively address industry-specific issues. We also are seeking public input on the advantages and disadvantages of codifying industry-specific disclosure requirements in Regulation S–K. Codifying the Industry Guides in Regulation S–K would be consistent with the approach taken by the Commission in 2008 when former Industry Guide 2 was codified as Subpart 1200 of Regulation S–K.656 This approach could help provide 651 See S–K Study at 103. 1980 Proposed Revision of Regulation S– K (stating waiver procedures would be necessary if Industry Guides were codified as formal regulations to address scenarios in which the rule technically applies but where disclosure was neither necessary nor appropriate). 653 See id. 654 See Commission Staff to Begin Publicly Releasing Comment Letters and Responses, May 9, 2005, available at https://www.sec.gov/news/press/ 2005-72.htm. 655 See, e.g., PricewaterhouseCoopers LLP, SEC Comment Letter Trends, available at https:// www.pwc.com/us/en/cfodirect/publications/seccomment-letter-trends.html. 656 See Oil and Gas Release. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 652 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 consistency in the disclosure provided by registrants in certain industries by making such disclosure a regulatory requirement. A potential disadvantage of this approach, however, is that over time registrants may be required to provide industry-specific disclosure that has become obsolete due to changes in industry practices or technology. Codifying the Industry Guides may afford registrants less flexibility in determining the industry-specific disclosures that are most applicable to them. Another possible approach is to update but not codify the Industry Guides in Regulation S–K. While this approach may allow registrants the flexibility to omit obsolete disclosures, the fact that the guidance is not a regulatory requirement may result in less uniformity in compliance and therefore less comparability across an industry. 3. Request for Comment 205. Do the Industry Guides result in disclosure that is important to investors that registrants might not otherwise disclose under Regulation S–K or Regulation S–X? If so, what are examples of this type of disclosure? 206. Do registrants find the Industry Guides useful in preparing disclosure for periodic reports? 207. To the extent that the Industry Guides call for information that registrants would not otherwise disclose but for the Industry Guides, what are the challenges of providing this disclosure? 208. Should we include additional industry-specific disclosure requirements in Regulation S–K by codifying all or portions of the Industry Guides? What are the advantages and disadvantages of including industryspecific disclosure requirements in Regulation S–K versus retaining the Industry Guides? 209. Should some or all of the Industry Guides be updated? If so, which ones? Should additional Industry Guides or industry-specific rules for other industries be developed? If so, which industries would benefit from such guidance? Should industryspecific disclosure in Regulation S–K or staff guidance be limited to certain industries? If so, what criteria should be used to identify those industries? 210. What additional costs or costs savings, including the administrative and compliance costs of preparing and disseminating disclosure, do registrants experience because of the Industry Guides? Would registrants’ disclosure costs be higher, lower or the same if the disclosures currently detailed in Industry Guides were incorporated into PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 23969 Regulation S–K or Regulation S–X? Please provide quantitative estimates if possible. 211. The Industry Guides originally were intended to assist registrants, their counsel and accountants in the preparation of disclosure by publishing staff policies and practices related to staff review of registrant filings.657 Does the public release of the staff’s comment letters and increased availability of tools that aggregate information about disclosure included in Commission filings and comment letters reduce the need for the Industry Guides as guidance for registrants? 212. Does the status of the Industry Guides as staff policy rather than Commission rules have any impact on the extent to which registrants provide disclosure consistent with the Industry Guides? 213. Regulations S–K and S–X include some industry specific disclosures. For example, Form S–11 658 and Schedules III and IV prescribed by Articles 12–28 and 12–29 of Regulation S–X, respectively, include industry specific disclosure requirements for certain real estate companies. If we update and codify the Industry Guides in Regulation S–K, should we also move and consolidate other industry-specific disclosure requirements currently located elsewhere to Regulation S–K at the same time? If so, how should we identify those disclosure requirements? Are any of these other industry-specific disclosure requirements already substantially addressed by nonindustry-specific required disclosures either in Regulation S–K or by U.S. GAAP? 214. Should industry-specific disclosure requirements apply to every registrant in a particular industry or should they be limited to certain categories of registrants? If they should be limited, to which registrants should they apply? 215. What types of investors or audiences are most likely to value the information that registrants would not disclose but for the Industry Guides? F. Disclosure of Information Relating to Public Policy and Sustainability Matters In recent years, Congress has mandated new disclosure requirements that address specific public policy concerns. For example, Section 1502 of the Dodd-Frank Act mandated that the Commission adopt rules regarding registrants’ use of ‘‘conflict minerals’’ originating in specified countries, and Section 1504 of the Dodd-Frank Act 657 See 658 17 E:\FR\FM\22APP3.SGM 1964 Guides. CFR 239.18. 22APP3 23970 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 directed the Commission to adopt rules regarding the disclosure of payments made by resource extraction issuers to foreign governments or the federal government for the purpose of the commercial development of oil, natural gas, or minerals.659 In addition, Section 1503 of the Dodd-Frank Act requires certain registrants to disclose information about health and safety violations at mining-related facilities.660 Some investors and interest groups also have expressed a desire for greater disclosure of a variety of public policy and sustainability matters, stating that these matters are of increasing significance to voting and investment decisions.661 For example, some have urged the Commission to adopt disclosure requirements on political spending.662 The Commission, however, 659 15 U.S.C. 78m(p) and 15 U.S.C. 78m(q)(2)(A). The Commission adopted Exchange Act Rule 13p– 1 and Form SD to implement Section 1502 and proposed Rule 13q–1 and an amendment to Form SD to implement Section 1504. Rule 13q–1 was initially adopted by the Commission on August 22, 2012, but it was subsequently vacated by the U.S. District Court for the District of Columbia. See Conflict Minerals, Release No. 34–67716 (Aug. 22, 2012) [77 FR 56274 (Sept. 12, 2012)] and Disclosure of Payments by Resource Extraction Issuers, Release No. 34–76620 (Dec. 11, 2015) [80 FR 80057 (Dec. 23, 2015)]. See Section III.A.1 for a discussion of the Commission’s statutory mandates. 660 15 U.S.C. 78m–2. Pursuant to authority granted in Section 1503(d) of the Dodd-Frank Act, the Commission adopted Item 104 of Regulation S– K to implement the statute. See Item 104 of Regulation S–K [17 CFR 229.104]. See also Mine Safety Disclosure Release. 661 See, e.g., Ernst & Young LLP, Tomorrow’s Investment Rules 2.0, 2015 (‘‘Tomorrow’s Investment Rules 2015’’), at 19, available at https://www.ey.com/Publication/vwLUAssets/EYtomorrows-investment-rules-2/$FILE/EYtomorrows-investment-rules-2.0.pdf (stating that, in a survey of more than 200 institutional investors around the world, ‘‘. . . almost two-thirds of respondents say companies do not adequately disclose information about ESG risks, and nearly 40% call for companies to do so more fully in the future.’’); Mark Carney, Breaking the Tragedy of the Horizon—Climate Change and Financial Stability, Speech given at Lloyd’s of London, Sept. 29, 2015, available at https://www.bankofengland.co.uk/ publications/Pages/speeches/2015/844.aspx (stating that a new disclosure ‘‘framework for firms to publish information about their climate change footprint, and how they manage their risks and prepare (or not) for a 2 degree world, could encourage a virtuous circle of analyst demand and greater use by investors in their decision making’’); Gibson Dunn, Shareholder Proposal Developments During the 2015 Proxy Season, July 15, 2015 (stating that the most common 2015 shareholder proposal topics, along with the approximate number of proposals submitted were: Political and lobbying activities (110 proposals); proxy access (108 proposals); and independent chair (76 proposals)). 662 See Petition for Rulemaking from the Committee on Disclosure of Corporate Political Spending, Aug. 3, 2011, available at https:// www.sec.gov/rules/petitions/2011/petn4-637.pdf. The Consolidated Appropriations Act of 2016 prohibits the Commission from using appropriated funds to ‘‘finalize, issue, or implement any rule, regulation, or order regarding the disclosure of VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 has determined in the past that disclosure relating to environmental and other matters of social concern should not be required of all registrants unless appropriate to further a specific congressional mandate or unless, under the particular facts and circumstances, such matters are material.663 We are interested in receiving feedback on the importance of sustainability and public policy matters to informed investment and voting decisions. In particular, we seek feedback on which, if any, sustainability and public policy disclosures are important to an understanding of a registrant’s business and financial condition and whether there are other considerations that make these disclosures important to investment and voting decisions. We also seek feedback on the potential challenges and costs associated with compiling and disclosing this information. 1. Comments Received S–K Study. None. Disclosure Effectiveness. We received a number of comment letters on a variety of sustainability and public policy matters, including climate change.664 Sustainability disclosure encompasses a range of topics, including climate change, resource scarcity, corporate social responsibility, and good corporate citizenship.665 political contributions, contributions to tax exempt organizations, or dues paid to trade associations.’’ Public Law 114–113, Sec. 707, 129 Stat. 2242 (2015) (requirement in Division O, Title VII). This appropriations limitation applies with respect to the Commission’s current fiscal year. 663 See Environmental and Social Disclosure, Release No. 33–5627 (Oct. 14, 1975) [40 FR 51656 (Nov. 6, 1975)] (‘‘1975 Environmental Disclosure Release’’). In this release, the Commission concluded that, although it is generally not authorized to consider the promotion of social goals unrelated to the objectives of the federal securities laws, it is authorized and required by NEPA to consider promotion of environmental protection as a factor in exercising its rulemaking authority. See also infra note 687 and accompanying text. 664 See, e.g., letters from Union of Concerned Scientists (May 5, 2015) (‘‘UCS’’); Ceres; Business Roundtable; Global Reporting Initiative (Apr. 14, 2015) (‘‘GRI’’); Carbon Tracker Initiative (Feb. 13, 2015) (‘‘CTI’’); Investor Environmental Health Network (Feb. 11, 2015) (‘‘IEHN’’); Wallace Global Fund (Dec. 1, 2014) (‘‘Wallace Global Fund’’); CFA Institute; SASB; Harrington Investments (Oct. 15, 2014) (‘‘Harrington Investments’’); Interfaith Center on Corporate Responsibility (Sept. 24, 2014) (‘‘ICCR’’); SCSGP; Sustainability Group (Aug. 12, 2014) (‘‘Sustainability Group’’); Corporate Reform Coalition (July 2, 2014) (‘‘Corporate Reform Coalition’’); First Affirmative Financial Network (June 26, 2014) (‘‘First Affirmative Financial Network’’); US SIF 1; Allianz. 665 See, PricewaterhouseCoopers LLP, Sustainability goes mainstream: Insights into investor views, May 2014, available at https:// www.pwc.com/us/en/governance-insights-center/ publications/sustainability-goes-mainstreaminvestor-views.html. See also, e.g., World PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 These topics often are characterized broadly as environmental, social, or governance (‘‘ESG’’) concerns.666 Many commenters noted a growing interest in ESG disclosure among investors 667 and many recommended increased sustainability disclosure requirements.668 Some commenters criticized the primarily voluntary nature of current corporate sustainability reporting and stated their belief that information made available to investors is inconsistent and incomplete.669 Many commenters also sought disclosure of sustainability related risks, and some of these commenters sought related MD&A and trend disclosure.670 One commenter opposed mandatory disclosure of sustainability risks,671 while another opposed disclosure requirements that it described as Federation of Exchanges, Exchange Guidance and Recommendation—October 2015, Oct. 2015, (‘‘WFE Guidance’’) available at https://www.worldexchanges.org/home/index.php/news/worldexchange-news/world-exchanges-agree-enhancedsustainability-guidance. 666 See, e.g., WFE Guidance. 667 See, e.g., US SIF 1 (citing an increase in assets under management by signatories to the Principles for Responsible Investment and the number of institutional investors urging companies to disclose greenhouse gas goals and plans to reduce emissions); Ceres (noting that a ‘‘growing number of investors are working to integrate climate risk into their investment strategies . . . .’’); CFA Institute (noting ‘‘[a] small, albeit growing, constituency of investors has advocated for the inclusion of sustainability information/ disclosures’’). 668 See, e.g., UCS; Ceres; GRI; CTI; IEHN; Wallace Global Fund; Harrington Investments; ICCR; Sustainability Group (concerned with underreporting of material information related to environmental liabilities); US SIF 1; First Affirmative Financial Network Group; Allianz. 669 See, e.g., US SIF 1; Corporate Reform Coalition; letter from Warren G. Lavey, (Nov. 4, 2015). 670 See, e.g., UCS; Ceres (requesting staff scrutiny of and comment on filings made by oil and gas companies on carbon asset risks, stating such risks constitute ‘‘known trends’’); CTI (noting that ‘‘the relevant ‘trend’ is how the increasing threat of unmanageable warming will exert pressure to curb emissions from fossil fuel consumption,’’ with potential disclosure impacts throughout MD&A, including capital expenditure plans and reserve valuations, and seeking quantitative disclosures when reasonably available); IEHN (recommending enhanced trend disclosure of emerging scientific literature that is both relevant to a company’s products and activities and indicative of potential for substantial health or environmental risks, in addition to disclosure of: (i) Potential long-term impact, (ii) the scope of potential exposure, (iii) measures the company is taking to reduce or mitigate these risks, and (iv) relevant benchmarks of liability); ICCR (supportive of risk related requirements relating to climate change); US SIF 1 (affirming its 2009 recommendation to require annual disclosure on a comprehensive set of sustainability indicators (both universal and industry-specific) and seeking interpretive guidance to clarify that short and long-term sustainability risk disclosure is appropriate in MD&A). 671 See SCSGP (stating that sustainability disclosure can be effectively communicated outside of SEC filings). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 addressing ‘‘societal issues unrelated to investor protection’’ in periodic filings.672 One of these commenters acknowledged the importance of sustainability information to a variety of stakeholders but opined that these issues ‘‘are not typically material to an understanding of the company’s financial performance’’ and therefore are not appropriate for inclusion in Exchange Act reports.673 The other commenter raised similar materiality concerns, stating that ‘‘some groups are seeking to use the federal securities laws to address various societal concerns, without giving effect to the bedrock materiality principle.’’ 674 We received several comment letters that specifically mentioned climate change disclosure.675 Many of these commenters expressed concern that disclosures made in response to the Commission’s current rules do not adequately address the risks associated with climate change.676 Some commenters cited specific risks that they believe are not adequately disclosed, such as stranded assets and regulatory risk.677 Other commenters referenced the Commission’s 2010 Interpretive Guidance on Climate Change and stated that registrants are not following that guidance.678 A few commenters suggested that we adopt new line-item disclosure requirements for climate change matters.679 One suggested that we adopt a requirement to disclose anticipated full-cycle costs of future capital expenditures and a requirement to disclose the carbon content of a registrant’s reserves and resources.680 672 See Business Roundtable (suggesting that Commission guidance about when disclosure might be warranted in this area would be more appropriate than expanding the disclosure requirements). 673 See SCSGP (also noting that when these issues are material to a registrant’s financial performance, registrants generally provide disclosure under existing Commission requirements). 674 See Business Roundtable. 675 See, e.g., First Affirmative Financial Network; US SIF 1; ICCR; SASB; Wallace Global Fund; letter from US SIF and US SIF Foundation (Dec. 19, 2014) (‘‘US SIF 2’’); CTI; GRI; Ceres; UCS; Allianz. 676 See, e.g., First Affirmative Financial Network; Wallace Global Fund; Ceres; UCS. 677 See, e.g., Wallace Global Fund (stating that failure to disclose ‘‘stranded assets,’’ which are fossil fuel assets that must stay in the ground because of caps imposed by treaty, law or regulation, may result in a material misrepresentation of a corporation’s balance sheet); Ceres (noting an absence of disclosure regarding material risks to the oil and gas industry due to increased capital expenditures on high-cost projects, regulatory risk, and carbon asset risk); UCS. 678 See, e.g., First Affirmative Financial Network; SASB; US SIF 1. 679 See, e.g., US SIF 1; CTI; Allianz; UCS. 680 See CTI. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Another suggested that we require oil and gas companies to disclose carbon costs alongside the company’s disclosure of proved reserves.681 A third commenter suggested a rule that requires an annual reporting of the risks to the registrant of the effects of climate change, if any.682 We also received many letters recommending the Commission adopt a rule requiring disclosure of political spending.683 2. Discussion In 1975, the Commission considered a variety of ‘‘environmental and social’’ disclosure matters, as well as its own authority and responsibilities to require disclosure under the federal securities laws.684 Following extensive proceedings on these topics, the Commission concluded that it generally is not authorized to consider the promotion of goals unrelated to the objectives of the federal securities laws when promulgating disclosure requirements, although such considerations would be appropriate to further a specific congressional mandate.685 The Commission also noted that disclosure to serve the needs of limited segments of the investing public, even if otherwise desirable, may be inappropriate, because the cost to 681 See Allianz. 682 See UCS. 683 See, e.g., Form Letter Type A; UCS; Ceres; Daniel A. Simon, et al. (Apr. 21, 2015); Business Roundtable; GRI; CTI; IEHN; Wallace Global Fund; CFA Institute; SASB; Harrington Investments; ICCR; SCSGP; Sustainability Group; Agenda Project Action Fund; Corporate Reform Coalition; First Affirmative Financial Network; US SIF 1; Allianz. 684 See 1975 Environmental Disclosure Release, supra, note 663. The Commission instituted public proceedings in response to a court order that required the Commission to ‘‘undertake further rulemaking action to bring the Commission’s corporate disclosure regulations into full compliance with the letter and spirit of NEPA’’ and to ‘‘provide a statement of reasons for the denial of the equal employment portion of Plaintiff’s Rulemaking Petition.’’ Id. at 51657. The order relates to plaintiffs’ 1971 rulemaking petition in which the plaintiffs made specific proposals for new disclosure requirements pertaining to the environment and disclosure about the employment of minorities and women. Regarding the equal employment portion of the petition, the plaintiffs sought to require that the Commission require registrants to provide disclosure of statistics on equal employment practices. The court found that the Commission’s denial of this portion of the plaintiffs’ rulemaking petition failed to comply with the Administrative Procedures Act. See Natural Resources Defense Council. 685 See id. See also, supra, note 61. The Commission was ordered to resolve two overriding factual issues as part of the proceeding, ‘‘the extent of ‘ethical investor’ interest in the type of information which Plaintiffs have requested’’ and ‘‘what avenues of action are available which ethical investors may pursue and which will tend to eliminate corporate practices that are inimical to the environment and equal employment opportunity.’’ See Natural Resources Defense Council at 701. PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 23971 registrants, which must ultimately be borne by their shareholders, would likely outweigh the resulting benefits to most investors.686 In 1975, the Commission also concluded that it would require disclosure relating to social and environmental performance ‘‘only if such information . . . is important to the reasonable investor—material information.’’ 687 While the Commission concluded that its proceedings did not support a specific requirement for all registrants to disclose information describing ‘‘corporate social practices,’’ the Commission noted that in specific cases, some information of this type might be necessary in order to make the statements in a filing not misleading or otherwise complete.688 The current statutory framework for adopting disclosure requirements remains generally consistent with the framework that the Commission considered in 1975.689 However, the Commission has recognized that the task of identifying what information is material to an investment and voting decision is a continuing one in the field of securities regulation.690 The role of sustainability and public policy information in investors’ voting and 686 See 1975 Environmental Disclosure Release at 51666. See also id. at note 26 (‘‘If the Commission were required to promulgate rules by plebiscite at the behest of any member of the public, its functions would be purely ministerial, a result clearly not intended by Congress . . . ’’). 687 See id. at 51660. The Commission’s conclusions in the 1975 proceedings were endorsed by the Sommer Report. The Sommer Report recommended that the Commission ‘‘should require disclosure of matters of social and environmental significance only when the information in question is material to informed investment or corporate suffrage decision-making or required by laws other than the securities laws.’’ Id. at 395. The Sommer Report further expressed the view that the Commission should classify social and environmental information as material ‘‘only when it reflects significantly on the economic and financial performance of the Company.’’ Id. at 326– 327. However, the Sommer Report noted that a minority of the Advisory Committee on Corporate Disclosure believed that disclosure of social and environmental information is material to an investment decision regardless of its economic impact on the financial performance of the company. The minority argued that this kind of information reflects on the quality and character of management, which ‘‘clearly plays an important role in both investment and corporate suffrage decision-making,’’ and urged the Commission to require increased disclosure in the social and environmental area. Id. at 397. 688 See id. at 51656; Exchange Act Rule 12b–20 [17 CFR 240.12b–20]. 689 Since 1996, the Commission also has been statutorily required to consider, in addition to the protection of investors, whether an action will promote efficiency, competition, and capital formation. See Section 2(b) of the Securities Act [15 U.S.C. 77b(b)]; Section 3(f) of the Exchange Act [15 U.S.C. 78c(f)]. See also Section 23(a)(2) of the Exchange Act [15 U.S.C. 78w(a)(2)]. 690 See 1980 Proposed Revisions. E:\FR\FM\22APP3.SGM 22APP3 23972 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 investment decisions may be evolving as some investors are increasingly engaging on certain ESG matters.691 According to one study, investors are more likely to engage registrants on sustainability issues than on financial results or transactions and corporate strategy.692 One observer expressed the view that ESG is not only a public policy issue but also a financial issue, noting a positive correlation between a ‘‘strong ESG record’’ and excellence in operations and management.693 Moreover, this observer specifically noted that regulatory risks posed by climate change are investment issues.694 Recent studies have also found that asset managers increasingly incorporate or have committed to incorporating ESG considerations into their financial analyses.695 691 See Bill Libit and Todd Freier, The Corporate Social Responsibility Report and Effective Stakeholder Engagement, Harvard Law School Forum on Corporate Governance and Financial Regulation, Dec. 28, 2013, available at https:// corpgov.law.harvard.edu/2013/12/28/the-corporatesocial-responsibility-report-and-effectivestakeholder-engagement (discussing increasing stakeholder engagement on ESG issues); Matteo Tonello, Global Trends in Board-Shareholder Engagement, Harvard Law School Forum on Corporate Governance and Financial Regulation, Oct. 25, 2013, available at https:// corpgov.law.harvard.edu/2013/10/25/global-trendsin-board-shareholder-engagement (describing representative shareholder engagement examples that ‘‘indicate that much engagement activity involves executive compensation practices, corporate governance structure, and environmental and social issues’’). 692 See Institutional Shareholder Services for the Investor Responsibility Research Center Institute, Defining Engagement: An Update on the Evolving Relationship Between Shareholders, Directors and Executives, Apr. 10, 2014, (stating this trend in engagement ‘‘may reflect that investors are satisfied with existing levels of disclosure on financials and strategy, and do not feel a need to engage further; or it may reflect that some of the survey respondents were corporate governance and proxy voting specialists, who are more likely to engage on governance or environmental and social matters than on financial matters.’’). See also supra note 691. 693 See BlackRock Investment Institute, The Price of Climate Change, Oct. 2015, at 7, available at https://www.blackrock.com/corporate/en-us/ literature/whitepaper/bii-pricing-climate-risk-us.pdf (indicating that ‘‘ESG factors cannot be divorced from financial analysis. We view a strong ESG record as a mark of operational and management excellence. Companies that score high on ESG measures tend to quickly adapt to changing environmental and social trends, use resources efficiently, have engaged (and, therefore, productive) employees, and face lower risks of regulatory fines or reputational damage.’’). 694 Id. at 2 (indicating that ‘‘[c]limate change risk has arrived as an investment issue. Governments are setting targets to curb greenhouse gas emissions. This may pave the way for policy shifts that we could see ripple across industries. The resulting regulatory risks are becoming key drivers of investment returns.’’) 695 See US SIF Foundation, Unlocking ESG Integration, Sept. 2015, at 7, available at https:// www.ussif.org/files/Publications/ UnlockingESGIntegration.pdf, (stating that VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 In seeking public input on sustainability and public policy disclosures, we recognize that some registrants historically have not considered this information material. Some observers continue to share this view and have expressed concern that sustainability or policy-driven disclosure requirements do not always result in disclosure that a reasonable investor would consider material.696 Some have expressed concerns that policy-driven disclosure requirements represent a shift away from the Commission’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, and that such requirements could risk burdening both registrants and investors with costly disclosure that is not material to any investment or voting decision.697 Similarly, concerns have been expressed that adopting sustainability or policy-driven disclosure requirements may have the goal of altering corporate behavior, rather than producing information that is important to voting and investment decisions.698 Additionally, one observer has noted numerous attempts to use the Commission’s regulatory apparatus to address societal issues.699 As the costs of compiling and disclosing information inclusion of ESG criteria in the financial analysis of surveyed asset managers increased over three times in terms of U.S.-domiciled assets managed (from about $1.4 trillion to about $4.8 trillion) over a two-year period). See also, UNEP Finance Initiative, United Nations Principles for Responsible Investment Report on Progress 2015, available at https:// 2xjmlj8428u1a2k5o34l1m71.wpengine.netdnacdn.com/wp-content/uploads/PRI_Report-onProgress_2015.pdf (stating that approximately 1,000 financial firms with aggregate assets under management of approximately $59 trillion had signed on to the U.N.’s six Principles for Responsible Investment (PRI) as of 2015. Among other things, the signatories to the PRI committed to incorporate ESG issues into their investment analyses and decision making processes, be active owners around these issues, seek appropriate disclosure on ESG issues by companies in which they invest, and collaborate to promulgate the PRI broadly and enhance implementation, while reporting on their own activities). 696 See David M. Lynn, The Dodd-Frank Act’s Specialized Corporate Disclosure: Using the Securities Laws to Address Public Policy Issues, 6 J. Bus. & Tech. L. 327 (Spring 2011) (‘‘Lynn’’); Business Roundtable; SCSGP. 697 See, e.g., Business Roundtable; Lynn. 698 See generally, Cynthia A. Williams, The Securities and Exchange Commission and Corporate Social Transparency, 112 Harv. L. Rev. 1197 at 1297 (Apr. 1999) (describing what the author refers to as the ‘‘Corporate Management Constraint,’’ which is an argument against requiring social disclosure, particularly social disclosure with the explicit or implicit purpose of changing the way registrants are managed, because the Commission has no authority to do so); Lynn; Business Roundtable. 699 See Matt Levine, Climate Change and Sovereign Debt, Bloomberg View (Jan. 25, 2016). PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 about sustainability and public policy issues are borne by the registrant, and ultimately its shareholders, as is all disclosure, we are seeking input on whether these disclosures are important to investors’ voting and investment decisions. 3. Request for Comment 216. Are there specific sustainability or public policy issues are important to informed voting and investment decisions? If so, what are they? If we were to adopt specific disclosure requirements involving sustainability or public policy issues, how could our rules elicit meaningful disclosure on such issues? How could we create a disclosure framework that would be flexible enough to address such issues as they evolve over time? Alternatively, what additional Commission or staff guidance, if any, would be necessary to elicit meaningful disclosure on such issues? 217. Would line-item requirements for disclosure about sustainability or public policy issues cause registrants to disclose information that is not material to investors? Would these disclosures obscure information that is important to an understanding of a registrant’s business and financial condition? Why or why not? 218. Some registrants already provide information about ESG matters in sustainability or corporate social responsibility reports or on their Web sites.700 Corporate sustainability reports may also be available in databases aggregating such reports.701 Why do some registrants choose to provide sustainability information outside of their Commission filings? Is the information provided on company Web sites sufficient to address investor needs? What are the advantages and disadvantages of registrants providing 700 See, e.g., Center for Political Accountability and Zicklin Center for Business Ethics at the Wharton School of the University of Pennsylvania, The 2015 CPA-Zicklin Index of Corporate Political Disclosure and Accountability, Oct. 8, 2015 at 8, available at https://files.politicalaccountability.net/ index/CPA-Zicklin_Index_Final_with_links.pdf; KPMG LLP, Currents of Change: The KPMG Survey of Corporate Responsibility Reporting 2015, Nov. 24, 2015 (‘‘2015 KPMG’’), available at https:// assets.kpmg.com/content/dam/kpmg/pdf/2016/02/ kpmg-international-survey-of-corporateresponsibility-reporting-2015.pdf; Governance & Accountability Institute, Sustainability—what matters?, 2014, available at https://www.gainstitute.com/fileadmin/user_upload/Reports/G_A_ sustainability_-_what_matters_-FULL_REPORT.pdf. 701 See, e.g., CorporateRegister.com for a database of corporate responsibility reports from over 900 companies in the United States and about 8,100 companies internationally, available at https:// www.corporateregister.com; Sustainability Disclosure Database of the Global Reporting Initiative available at https:// database.globalreporting.org. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules such disclosure on their Web sites? How important to investors is integrated reporting,702 as opposed to separate financial and sustainability reporting? If we permitted registrants to use information on their Web sites to satisfy any ESG disclosure requirement, how would this affect the comparability and consistency of the disclosure? 219. In an effort to coordinate ESG disclosures, several organizations have published or are working on sustainability reporting frameworks.703 Currently, some registrants use these frameworks and provide voluntary ESG disclosures.704 If we propose line-item disclosure requirements on sustainability or public policy issues, which, if any, of these frameworks should we consider in developing any additional disclosure requirements? 220. Are there sustainability or public policy issues for which line-item disclosure requirements would be consistent with the Commission’s rulemaking authority and our mission to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation, as described in Section III.A.1 of this release? If so, how could we address the evolving nature of such issues and keep our disclosure requirements current? 221. What, if any, challenges would registrants face in preparing and providing this information? What would be the additional costs of complying with sustainability or public policy lineitem disclosure requirements, including the administrative and compliance costs of preparing and disseminating disclosures, beyond the costs associated with current levels of disclosure? Please quantify costs and expected changes in costs where possible. 222. If we propose line-item disclosure requirements that require disclosure about sustainability or public policy issues, should we scale the disclosure requirements for SRCs or some other category of registrant? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 702 See International Integrated Reporting Council, The International IR Framework, Dec. 2013, available at https://integratedreporting.org/ wp-content/uploads/2015/03/13-12-08-THEINTERNATIONAL-IR-FRAMEWORK-2-1.pdf; Robert G. Eccles and George Serafeim, Corporate and Integrated Reporting: A Functional Perspective (Harvard Business School, Working Paper 14–094 May 5, 2014). 703 See WFE Guidance at 8 (describing sustainability reporting frameworks established by CDP (formerly, the Carbon Disclosure Project), Global Reporting Initiative, the International Integrated Reporting Council, SASB, and the United Nations Global Compact). 704 For example, according to an industry study, about seventy percent of corporate responsibility reporting in the Americas uses the Global Reporting Initiative reporting framework. See 2015 KPMG at 42. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Similarly, should we exempt SRCs or some other category of issuer from any such requirements? 223. In 2010, the Commission published an interpretive release to assist registrants in applying existing disclosure requirements to climate change matters. As part of the Disclosure Effectiveness Initiative, we received a number of comment letters suggesting that current climate changerelated disclosures are insufficient. Are existing disclosure requirements adequate to elicit the information that would permit investors to evaluate material climate change risk? Why or why not? If not, what additional disclosure requirements or guidance would be appropriate to elicit that information? G. Exhibits Exhibits to Commission filings provide detailed information about the registrant that generally is not available in the form itself. Item 601 of Regulation S–K specifies, by form type, the exhibits that registrants must file with Securities Act and Exchange Act forms. The exhibit requirements for Exchange Act forms overlap with many—but not all— of the exhibit requirements for Securities Act forms. Similarly, although there are some differences between the exhibit requirements for Forms 8–K, 10–Q and 10–K, many of the required exhibits are the same. Exhibits required in Exchange Act reports cover such categories as certain transactions,705 corporate organization and governance,706 rights of securities holders,707 matters relating to the financial statements (including 705 E.g., Item 601(b)(2) of Regulation S–K (plan of acquisition, reorganization, arrangement, liquidation or succession) [17 CFR 229.601(b)(2)]. 706 E.g., Items 601(b)(3)(i)–(ii) (articles of incorporation, bylaws); (b)(14) (code of ethics); (b)(20) (documents or statements to security holders); (b)(21) (subsidiaries of the registrant); (b)(22) (published report regarding matters submitted to vote of security holders); (b)(24) (power of attorney); (b)(31) (Exchange Act Rule 13a–14(a)/15d–14(a) certifications) and (b)(32) (Exchange Act Section 1350 certifications) of Regulation S–K [17 CFR 229.601(b)(3)(i)–(ii), (b)(14), (b)(20), (b)(21), (b)(22), (b)(24), (b)(31) and (b)(32)]. 707 E.g., Items 601(b)(4) (instruments defining the rights of security holders) and (b)(9) (voting trust agreement) of Regulation S–K [17 CFR 229.601(b)(4) and (9)]. PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 23973 certifications),708 and material contracts.709 The requirement to file exhibits originated in Schedule A of the Securities Act, which requires registrants to file copies of certain agreements, opinions and governing instruments.710 Over time, the Commission has adopted additional requirements for exhibits as part of different forms under the Securities Act and the Exchange Act.711 In 1980, the Commission standardized and centralized the exhibit requirements by moving them from individual forms to Item 601 in Regulation S–K.712 The exhibit requirements adopted in 1980 remain substantially the same today.713 In 2003, however, the Commission adopted additional exhibit requirements mandated by the Sarbanes-Oxley Act.714 708 E.g., Items 601(b)(15) (letter re unaudited interim financial information); (b)(16) (change in certifying accountant); (b)(18) (change in accounting principles); (b)(31) (Exchange Act Rule 13a–14(a)/ 15d–14(a) certifications) and (b)(32) (Exchange Act Section 1350 certifications) of Regulation S–K [17 CFR 229.601(b)(15), (b)(16), (b)(18), (b)(31) and (b)(32)]. 709 Item 601(b)(10) (material contracts) of Regulation S–K [17 CFR 229.601(b)(10)]. 710 See Securities Act of 1933 Schedule A Paragraphs (28) through (32) [15 U.S.C. 77aa(28)– (32)], which require registrants to file underwriting agreements, opinions of counsel regarding the legality of the offering, material contracts, governing instruments (such as articles of incorporation, bylaws and partnership agreements) and agreements or indentures affecting the offered securities. 711 For instance, in 1971, the Commission adopted a new exhibit requirement for a report on a material change in accounting principles or practices accompanied by a letter from the independent accountant approving or otherwise commenting on such changes. See Section IV.G.6. Similarly, in 1977, the Commission began requiring companies to file as exhibits copies of every contract specifically referred to in the company’s discussion of its reportable industry segments. See infra note 754 and accompanying text. 712 See Amendments Regarding Exhibit Requirements, Release No. 33–6230 (Aug. 27, 1980) [45 FR 58822 (Sept. 5, 1980)] (‘‘1980 Exhibits Adopting Release’’). Prior to 1980, exhibit requirements were included in each registration statement form or periodic report form and many requirements were inconsistent from form to form. The changes were intended to simplify and codify the exhibit requirements. 713 With the adoption of the integrated disclosure system in 1982, the Commission made technical changes to the exhibit requirements and redesignated the requirements from Item 7 to Item 601. See 1982 Integrated Disclosure Adopting Release. 714 See, e.g., Management’s Report on Internal Control over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reporting, Release No. 33–8238 (June 5, 2003) [68 FR 36636 (June 18, 2003)] (adopting Items 601(b)(31) and (b)(32) requiring companies to file the certifications mandated by Sections 302 and 906 respectively of the Sarbanes-Oxley Act as exhibits to certain periodic reports); Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act of 2002, Release No. 33–8177 (Jan. 23, 2003) [68 FR 5110 E:\FR\FM\22APP3.SGM Continued 22APP3 23974 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules In 2009, the Commission adopted rules to require filing of interactive datatagged financial statements as part of its 21st Century Disclosure Initiative.715 More recently, the Commission adopted additional exhibit requirements mandated by the Dodd-Frank Act.716 To the extent that exhibits contain confidential and proprietary information, Commission rules permit registrants to omit this information from their public filings. For Exchange Act filings, registrants may obtain confidential treatment of information under Rule 24b–2. This rule requires registrants seeking confidential treatment to submit an application to the Commission objecting to disclosure of such information along with an analysis of the applicable exemption under FOIA.717 Most applicants rely on the exemption that covers trade secrets and commercial or financial information obtained from a person and privileged or confidential.718 If the Commission grants the application, the registrant may omit the information from its public filings for a limited period of time identified in the application.719 We are seeking input on Item 601 of Regulation S–K to determine whether its requirements continue to provide investors with information important to making informed investment and voting decisions. Consistent with the scope of this release, we are considering only those exhibits required in quarterly and annual reports filed under the Exchange Act, which are identified in the following table.720 While we do not specifically address each exhibit in our discussion, we welcome comments on any of the items listed below.721 Forms 8–K 722 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 (1) Underwriting agreement ......................................................................................................... (2) Plan of acquisition, reorganization, arrangement, liquidation or succession ........................ (3)(i) Articles of incorporation ...................................................................................................... (ii) Bylaws ............................................................................................................................. (4) Instruments defining the rights of security holders, including indentures ............................. (7) Correspondence from an independent accountant regarding non-reliance on a previously issued audit report or completed interim review ...................................................................... (9) Voting trust agreement ........................................................................................................... (10) Material contracts ................................................................................................................. (11) Statement re computation of per share earnings ................................................................ (12) Statements re computation of ratios .................................................................................... (13) Annual report to security holders, Form 10–Q or quarterly report to security holders ....... (14) Code of Ethics ...................................................................................................................... (15) Letter re unaudited interim financial information ................................................................. (16) Letter re change in certifying accountant ............................................................................ (17) Correspondence on departure of director ............................................................................ (18) Letter re change in accounting principles ............................................................................ (19) Report furnished to security holders .................................................................................... (20) Other documents or statements to security holders ............................................................ (21) Subsidiaries of the registrant ............................................................................................... (22) Published report regarding matters submitted to vote of security holders .......................... (23) Consents of experts and counsel ........................................................................................ (24) Power of attorney ................................................................................................................. (31)(i) Rule 13a–14(a)/15d–14(a) Certifications .......................................................................... (ii) Rule 13a–14/15d–14 Certifications ................................................................................. (32) Section 1350 Certifications .................................................................................................. (33) Report on assessment of compliance with servicing criteria for asset-backed issuers ...... (34) Attestation report on assessment of compliance with servicing criteria for asset-backed securities .................................................................................................................................. (35) Servicer compliance statement ............................................................................................ (95) Mine Safety Disclosure Exhibit ............................................................................................ (99) Additional exhibits ................................................................................................................ (100) XBRL-Related Documents ................................................................................................. (101) Interactive Data File ........................................................................................................... (Mar. 31, 2003)] (‘‘Audit Committee Financial Expert and Code of Ethics Adopting Release’’) (adopting Item 601(b)(14), which requires companies to file a copy of any code of ethics that applies to the company’s CEO, CFO and senior accounting personnel with their annual reports, as mandated by Section 406 of the Sarbanes-Oxley Act). 715 See supra note 41. 716 See, e.g., Mine Safety Disclosure Release (adopting Item 601(b)(95) requiring companies that operate coal or other mines to provide information about mine safety required by Item 104 in an exhibit). 717 Exchange Act Rule 24b–2 [17 CFR 240.24b–2]. The rule requires an application containing: An identification of the confidential portion; a statement of the grounds of objection referring to, and containing an analysis of, the applicable VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 10–Q 10–K X X X X X ........................ X X X X ........................ X X X X X ........................ ........................ ........................ ........................ ........................ X ........................ X X ........................ ........................ X ........................ ........................ X X ........................ ........................ ........................ ........................ ........................ ........................ X X ........................ ........................ ........................ X ........................ ........................ X X ........................ ........................ X X X X ........................ X ........................ ........................ X X X X X X ........................ X ........................ X ........................ ........................ X X X X X X X X ........................ ........................ ........................ X X X ........................ ........................ X X X X X X X X X X exemption(s) from disclosure under the Commission’s rules and regulations adopted under FOIA, and a justification of the period of time for which confidential treatment is sought; a written consent to the furnishing of the confidential portion to other government agencies, offices or bodies and to the Congress; and the name of each exchange, if any, with which the material is filed. Id. 718 See FOIA Section 552(b)(4) [5 U.S.C. 552(b)(4)] and Staff Legal Bulletin 1A. 719 Exchange Act Rule 24b–2(b)(2)(ii) [240.24b– 2(b)(2)(ii)]. In interpreting Rule 24b–2, the staff has indicated that the time period for confidential treatment generally will be limited to the duration of the contract, but no more than ten years. See Staff Legal Bulletin 1A. 720 Many of the exhibits addressed in quarterly and annual reports are also required in current reports on Form 8–K. Though not within the scope PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 of this release, the table includes exhibits required in current reports on Form 8–K to provide additional context. 721 As part of its work to develop recommendations for the Commission for potential changes to update or simplify certain disclosure requirements, the staff is separately considering paragraphs (b)(11), (b)(12), (b)(19), (b)(22) and (b)(26) of Item 601. The staff is also separately considering recommendations to aspects of Item 601(b)(25)(ii) and 601(a)(2) as part of this effort. For a description of this project, see Section I. 722 A Form 8–K exhibit is required only if it is relevant to the subject matter reported on the Form 8–K report. For example, if the Form 8–K pertains to the departure of a director, only the exhibit described in paragraph (b)(17) of Item 601 must be filed. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules 1. Request for Comment 224. Should we modify or eliminate any of the exhibit requirements in Item 601? If so, which ones and why? Should we add any new exhibit requirements to Item 601? If so, what requirements should we add and why? 225. Should we revise any of our exhibit requirements to change the presentation or format of the exhibits? 226. Should the Commission consider changes to improve the usefulness of the exhibits? For example, should the exhibits be provided in a tagged or searchable manner? 227. What types of investors or audiences are most likely to value the information that registrants disclose in the exhibits? 228. What is the cost of providing the disclosure required under Item 601, including administrative and compliance costs of preparing and disseminating this disclosure? How would these costs change if we made any of the changes contemplated here? Please provide quantified estimates if possible and include only those costs associated with Item 601. 2. Schedules and Attachments to Exhibits In response to Item 601, registrants generally must file exhibits as complete documents, including any schedules or attachments. These schedules and attachments can be lengthy and sometimes contain proprietary information. The only exception to the requirement to file schedules and attachments applies to a plan of acquisition, reorganization, arrangement, liquidation or succession filed under Item 601(b)(2).723 The rule provides that schedules or similar attachments to these exhibits shall not be filed unless they contain information which is material to an investment decision and has not been disclosed otherwise.724 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter suggested adding a new instruction to Item 601 permitting the omission of schedules to all exhibits required to be filed, unless such schedules contain material information that is not otherwise disclosed in the exhibit or in the filing, as is the case 723 See Item 601(b)(2) of Regulation S–K [17 CFR 229.601(b)(2)]. 724 Id. The exhibit filed must include a list briefly identifying the contents of all omitted schedules along with an agreement to provide a supplemental copy of any omitted schedules to the Commission upon request. Id. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 with current Item 601(b)(2).725 Alternatively, this commenter suggested that we revise Item 601 to permit companies to omit personally identifiable and similar information, such as bank account numbers and home addresses, without having to apply for confidential treatment to protect the information.726 b. Discussion The Commission first permitted registrants to omit schedules and attachments for Item 601(b)(2) exhibits in 1980.727 In revising the exhibit requirement, the Commission stated that many of the schedules received by the staff pursuant to the exhibit requirement were not material for investor information or protection and were unnecessary for Commission review purposes.728 Material contracts filed under Item 601(b)(10) often include schedules that contain information that is not material to investors or that has been disclosed or sufficiently described elsewhere in the exhibit or in the disclosure. Examples of schedules and attachments providing information that may be immaterial include detailed product specifications attached to royalty agreements; implementation plans attached to service agreements; premises descriptions and plots as schedules to real estate leases; and licensing agreements with schedules listing immaterial patents. To the extent these schedules contain confidential and proprietary information, registrants may be permitted to omit such information from the public filing.729 c. Request for Comment 229. Should we continue to allow registrants to omit schedules and attachments for exhibits filed under Item 601(b)(2)? Why? If so, what qualitative or quantitative factors should be considered when determining if omission is appropriate? 230. Should we allow registrants to omit immaterial schedules and attachments from their filed exhibits? If so, should we expand this approach to all exhibits, or should we limit it to material contracts filed under Item 601(b)(10)? Should we provide examples or other guidance on how registrants could evaluate materiality for purposes of including schedules and attachments? If so, what type of guidance would be most useful for 725 See ABA 2. 726 Id. 727 See 1980 Exhibits Adopting Release. id. 729 See supra notes 717, 718 and 719 and accompanying text. 728 See PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 23975 assessing the importance of the information (e.g., quantitative thresholds, qualitative factors)? What would be the potential benefits and challenges associated with such an approach? If registrants omit schedules and attachments based on immateriality, should we require registrants to disclose how they assessed materiality for these purposes? 231. If we allow the omission of immaterial schedules and attachments from all or certain filed exhibits, should we require registrants to include with such exhibits a list briefly identifying the contents of all omitted schedules, together with an agreement to provide a supplemental copy of any omitted schedule to the Commission upon request, similar to the requirement in Item 601(b)(2)? 232. Schedules and attachments to exhibits sometimes contain personally identifiable information (‘‘PII’’), and registrants may request confidential treatment of that information. Division staff generally does not object to the omission of PII from exhibits without a formal confidential treatment request, provided the registrant does not omit any other information from its exhibits. If we retain the requirement for registrants to file schedules and attachments to exhibits, should we codify current staff practice and permit registrants to omit PII without making a formal request under Rule 24b–2 of the Exchange Act? Should we limit such an accommodation to information contained in schedules and attachments to exhibits, or should we expand it to all exhibit filings? 3. Amendments to Exhibits Any amendment or modification to a previously filed exhibit to a Form 10– K or Form 10–Q must be filed as an exhibit to a Form 10–K or Form 10– Q.730 Registrants generally must file such amendments or modifications regardless of the significance of the change.731 As a result, registrants may be required to file a significant number of amendments that are not necessarily material to investors. However, registrants are not required to file amendments or modifications when the previously filed exhibit would not currently be required.732 730 Item 601(a)(4) of Regulation S–K [17 CFR 229.601(a)(4)]. 731 For a discussion of changes to exhibits and Instruction 1 to Item 601, see Section IV.G.4. 732 For example, a previously filed exhibit may no longer be material to a registrant as a result of the registrant’s growth or change in business focus. The Commission revised Item 601 in 1982 to clarify that amendments and modifications must be filed only E:\FR\FM\22APP3.SGM Continued 22APP3 23976 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules For amendments to articles of incorporation or bylaws, Item 601 requires registrants to file a complete copy of the document as amended.733 Item 601 does not include a similar requirement for other exhibits, and registrants typically file amendments to these exhibits without filing a complete, amended and restated version of the agreement. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter suggested revising Item 601(a)(4) to exclude amendments to material contracts that do not affect the economics of such contracts (e.g., technical amendments) from the requirement to file any amendment or modification to a previously filed exhibit.734 b. Discussion mstockstill on DSK4VPTVN1PROD with PROPOSALS3 With adoption of the integrated disclosure system, the Commission consolidated several requirements in Forms 10–Q and 10–K for amendments and modifications to previously filed exhibits.735 The new item required registrants to file as exhibits all amendments or modifications to exhibits that were previously filed with those forms.736 The requirement was moved to paragraph (a)(4) of Item 601 in 1993 and has remained unchanged since.737 Registrants frequently amend agreements, such as credit facilities, licensing agreements, manufacturing agreements and supply agreements, to extend their duration. Registrants also amend credit facilities to increase the amount available for borrowing. Other than amended articles of incorporation or bylaws, multiple amendments to the for currently required exhibits as opposed to previously filed exhibits that are no longer material and required to be filed. See 1982 Integrated Disclosure Adopting Release. 733 Item 601(b)(3) of Regulation S–K [17 CFR 229.601(b)(3)]. If such amendment is being reported on Form 8–K, however, the registrant is required to file only the text of the amendment as a Form 8– K exhibit. In such case, a complete copy of the articles of incorporation or bylaws as amended must be filed as an exhibit to the next Securities Act registration statement or periodic report filed by the registrant to which this exhibit requirement applies. Id. 734 See ABA 2. 735 See 1980 Exhibits Adopting Release. For example, prior to 1980, Form 10–K required registrants to file copies of all amendments or modifications, not previously filed, to all exhibits previously filed, or copies of such exhibits as amended or modified. See, e.g., 1965 Amendments to Form 10–K Adopting Release. 736 Id. 737 See Rulemaking for EDGAR System, Release No. 33–6977 (Feb. 23, 1993) [58 FR 14628 (Mar. 18, 1993)] at note 388. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 same agreement may be dispersed among different periodic reports. c. Request for Comment 233. Should we continue to require registrants to file all amendments or modifications to previously filed exhibits as required under Item 601(a)(4)? Should we instead amend Item 601(a)(4) to exclude immaterial amendments? If so, should we provide guidance to registrants about how to determine whether an amendment is immaterial? Instead of materiality, should we permit registrants to exclude amendments based on a different standard? If so, what standard would be appropriate? 234. Does an amendment-only exhibit provide investors with the information they need to evaluate the impact of the amendment on the registrant? Should we instead require registrants to file a complete, amended and restated agreement each time an exhibit is modified, consistent with the requirement for amendments to articles of incorporation and bylaws? If so, should we require registrants to identify changes in the amended and restated contracts such as by underlining or highlighting the changes? Would complying with such a requirement be more burdensome for agreements than for articles of incorporation or bylaws? If so, why? 4. Changes to Exhibits (Instruction 1 to Item 601) If an exhibit to a registration statement is filed in preliminary form, Instruction 1 to Item 601 provides that registrants are not required to file an amendment to the exhibit if it has been changed only (1) to insert certain information that appears elsewhere in an amendment to the registration statement or a prospectus filed pursuant to Securities Act Rule 424(b), or (2) to correct typographical errors, insert signatures or make other similar immaterial changes.738 No similar 738 Instruction 1 to Item 601 of Regulation S–K [17 CFR 229.601]. The instruction states that if an exhibit to a registration statement (other than an opinion or consent), filed in preliminary form, has been changed only (A) to insert information as to interest, dividend or conversion rates, redemption or conversion prices, purchase or offering prices, underwriters’ or dealers’ commissions, names, addresses or participation of underwriters or similar matters, which information appears elsewhere in an amendment to the registration statement or a prospectus filed pursuant to Rule 424(b) under the Securities Act (230.424(b) of this chapter), or (B) to correct typographical errors, insert signatures or make other similar immaterial changes, then, notwithstanding any contrary requirement of any rule or form, the registrant need not refile such exhibit as so amended. Any such incomplete exhibit may not, however, be incorporated by PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 provision exists for exhibits to Exchange Act reports. Instruction 1 also provides that any such incomplete exhibit may not be incorporated by reference in any subsequent filing under any Act administered by the Commission. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended eliminating the last sentence of Instruction 1 to Item 601, which states that incomplete exhibits already on file that do not reflect the modifications described in the instruction may not be incorporated by reference in any subsequent filing.739 b. Discussion The Commission adopted the predecessor to Instruction 1 of Item 601 in 1954 in connection with new rules designed to simplify the registration procedure for offers involving competitive bidding.740 Those rules provided that, if certain conditions were met, post-effective amendments reflecting the results of the bidding would become effective without the need for a Commission order.741 This provision was intended to avoid the delay and attendant uncertainty that occurred between the filing and effectiveness of post-effective amendments.742 Consistent with this goal, the Commission eliminated a requirement for registrants to refile exhibits solely to insert interest rate, redemption prices and certain other offering-related information.743 The Commission retained this provision as Instruction 1 to Item 601.744 reference in any subsequent filing under any Act administered by the Commission. Id. 739 See ABA 2. 740 See Adoption of Rule 415 Relating to Competitive Bidding Registration Statements, Amendment of Rules 424, 427, 455, 471 and 472 and Rescission of Rule 460, Release No. 33–3494 (Jan. 13, 1954) [not published in the Federal Register] (‘‘1954 Adopting Release’’). 741 See id. At the time, registrants engaged in offerings involving competitive bidding were required to file post-effective amendments to registration statements at the time the bids were opened to reflect the results of the bidding. These post-effective amendments were only effective pursuant to an order from the Commission. 742 See Notice of Proposal to Adopt Rule 415 Relating to Competitive Bidding Registration Statements, To Amend Rules 424, 427, 455, 471 and 472 and to Rescind Rule 460, Release No. 33–3491– Z (Nov. 10, 1953) [not published in the Federal Register]. 743 See 1954 Adopting Release. 744 See 1982 Integrated Disclosure Adopting Release. See also Proposed Rescission of Guides for the Preparation and Filing of Registration Statements and Reports, Release No. 33–6332 (Aug. 6, 1981) [46 FR 41925 (Aug. 18, 1981)] (‘‘Proposed Revision of Regulation S–K (1981)’’) (proposing to incorporate the predecessor to Instruction 1 into the E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules While Instruction 1 is intended to address timing concerns in certain registered offerings, it also affects registrants’ ability to incorporate exhibits by reference to other filings. To the extent a registrant modifies an incomplete exhibit that was filed in preliminary form, as permitted under Instruction 1, the incomplete exhibit already on file may not be incorporated by reference into its Exchange Act reports. Instead, the registrant would be required to file the complete exhibit with an Exchange Act report for the relevant reporting period. c. Request for Comment 235. Should we eliminate Instruction 1? 236. Should we expand the applicability of Instruction 1 to all filings? Should we expand the type of information in clauses (A) and (B) of Instruction 1 to cover additional types of information that, if changed, do not need to be refiled as an amendment to the exhibit? 237. Instruction 1 states that any incomplete exhibit may not be incorporated by reference in any subsequent filing.745 Should we eliminate this limitation? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 5. Material Contracts (Item 601(b)(10)) Item 601(b)(10) of Regulation S–K requires registrants to file material contracts that fall into one of three broad categories: • All contracts not made in the ordinary course of business that are material to the registrant (Item 601(b)(10)(i)); • Contracts made in the ordinary course of business of a type that are specified in the rule (Item 601(b)(10)(ii)); and • Management contracts and compensatory plans in which any director, named executive officer, or other executive officer of the registrant participates (Item 601(b)(10)(iii)).746 Any material contract that is executed or becomes effective during a reporting period must be filed as an exhibit to the instructions to Item 601) and 1981 Proposed Revisions (proposing to delete Rule 472(d), which addressed immaterial changes in exhibits, because its substance was proposed to be included in Item 601). In connection with the adoption of Rule 430A, the Commission amended Instruction 1 to include a reference to prospectus supplements under Rule 424. See Elimination of Certain Pricing Amendments and Revision of Prospectus Filing Procedures, Release No. 33–6714 (May 27, 1987) [52 FR 21252 (June 5, 1987)]. 745 For a discussion of incorporation by reference, see Section V.B. 746 As this release is focused on our business and financial disclosure requirements, we are not addressing Item 601(b)(10)(iii) of Regulation S–K [17 CFR 229.601(b)(10)(iii)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Forms 10–Q or 10–K for the corresponding period.747 a. Contracts Not Made in the Ordinary Course—Item 601(b)(10)(i) Item 601(b)(10)(i) requires registrants to file every contract not made in the ordinary course of business that is material to the registrant and is to be performed in whole or in part at or after the filing of the report, or was entered into not more than two years before such filing.748 Registrants are required to file only those contracts to which the registrant or subsidiary of the registrant is a party or has succeeded to a party by assumption or assignment or in which the registrant or such subsidiary has a beneficial interest. i. Comments Received S–K Study. Two commenters stated that the agreements required to be filed pursuant to Item 601(b)(10)(i) often contain confidential information.749 These commenters also stated that the process of filing the agreements and obtaining confidential treatment is burdensome on registrants and provides information of limited value to investors.750 Disclosure Effectiveness Initiative. None. ii. Discussion In 1964, Congress expanded the information requirements for registration statements filed under Section 12 of the Exchange Act by adding a requirement to include material contracts not made in the ordinary course of business.751 747 Item 601(a)(4) of Regulation S–K [17 CFR 229.601(a)(4) and Instruction 2 to Item 601(b)(10) of Regulation S–K [17 CFR 229.601(b)(10)]. 748 Item 601(b)(10)(i) of Regulation S–K [17 CFR 229.601(b)(10)(i)]. This requirement is virtually identical to paragraph 24 of Schedule A of the Securities Act. [15 U.S.C. 77aa(24)]. 749 See Silicon Valley; M. Liles. 750 Id. 751 See Summary and Interpretation of Amendments to Securities Act of 1933 and Securities Exchange Act of 1934 Contained in the Securities Acts Amendments of 1964, Release No. 34–7425 (Sept. 15, 1964) [29 FR 13455 (Sept. 30, 1964)]. As amended, Section 12(b) required registrants to file material contracts, not made in the ordinary course of business, which are to be executed in whole or in part at or after the filing of the Exchange Act registration statement or which were made not more than two years before such filing. Schedule A includes a similar requirement for Securities Act registration statements. [15 U.S.C. 77aa(24)]. As noted at the time, the amendment to Section 12(b) followed the Commission’s recommendation that registration under both the Exchange Act and the Securities Act be made as similar as possible. See Lee J. Sclar, The Securities Acts Amendments of 1964: Selected Provisions and Legislative Deficiencies, 53 Cal. L. Rev. 1494, 1515 (1965). The two-year requirement was intended as a ‘‘cutoff period’’ so registrants would not have to file PO 00000 Frm 00063 Fmt 4701 Sfmt 4702 23977 Following these Exchange Act amendments, the Commission revised Form 10–K to make the form available for annual reports of all Exchange Act registrants and expanded the form’s disclosure requirements.752 Among other changes, these amendments included a requirement in Form 10–K to file material contracts not made in the ordinary course of business, not previously filed and performed or to be performed at or after the beginning of the fiscal year covered by the report.753 This requirement was similar to the new requirement to file such exhibits with Exchange Act registration statements which, however, required this information for two years prior to filing of the registration statement. In 1977, with the adoption of Regulation S–K, the Commission expanded the exhibit requirements for contracts not made in the ordinary course of business to include those that were material to an understanding of the registrant’s overall business or specifically referred to in the registrant’s discussion of its reportable industry segments.754 In 1980, the Commission eliminated the latter requirement,755 noting that many contracts referred to in the disclosure may not be material to the registrant.756 With this revision, the Commission sought to reduce the number of contracts required to be filed without impairing investor information or protection.757 In 1982, the Commission adopted the current requirements described in Items 601(b)(10)(i) and (ii) with the adoption of the integrated disclosure system.758 all material contracts executed as early as 1932, even though they may have been fully performed years ago. See H.R Rep. No. 88–1418, 83rd Cong., 2nd Sess., 1964. See also Richard M. Phillips and Morgan Shipman, An Analysis of the Securities Acts Amendments of 1964, 1964 Duke L.J. 706, 788–789 (1964). 752 See 1965 Amendments to Form 10–K Adopting Release. 753 Id. Similar to the language in amended Section 12(b) of the Exchange Act, the new requirement called for ‘‘[c]opies of every material contract not made in the ordinary course of business and not previously filed which was performed or to be performed in whole or in part at or after the beginning of the fiscal year covered by the report on this form.’’ Id. at 3433. The Commission adopted additional exhibit requirements with these amendments, which we discuss below in Section IV.G.5.b. 754 See 1977 Regulation S–K Adopting Release. 755 See 1980 Exhibits Adopting Release. 756 See Proposed Amendments Regarding Exhibit Requirements, Release No. 33–6149 (Nov. 16, 1979) [44 FR 67143 (Nov. 23, 1979)] (‘‘Proposed Amendments Regarding Exhibit Requirements Release’’). 757 See 1980 Exhibits Adopting Release. See also Proposed Amendments Regarding Exhibit Requirements Release. 758 See 1982 Integrated Disclosure Adopting Release. See also Proposed Revision of Regulation E:\FR\FM\22APP3.SGM Continued 22APP3 23978 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules In 2004, the Commission adopted Items 1.01 and 1.02 of Form 8–K, which require disclosure when a registrant enters into, amends or terminates an agreement that is material to the registrant and is not made in the ordinary course of business.759 In the proposing release, the Commission sought comment on whether it should use a disclosure threshold that is tied to a financial measure, rather than materiality.760 The Commission ultimately adopted the reporting requirements with a materiality threshold because the standard was ‘‘already familiar to reporting companies,’’ noting that the materiality threshold parallels the materiality threshold for filing this type of agreement under Item 601(b)(10) of Regulation S–K.761 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 iii. Request for Comment 238. Item 601(b)(10)(i) does not include any guidance for determining whether a contract not made in the ordinary course of business is material to a registrant. Should we consider revising the requirement to provide quantitative or other thresholds for determining when a contract is material to the registrant? If so, how should we define these thresholds? Would such a change facilitate registrants’ compliance with this item requirement? Would such a change result in disclosure that is useful to investors? 239. Does ‘‘not made in the ordinary course of business’’ provide a clear standard for agreements covered by the rule? Should a different standard to apply? Should we revise Item 601(b)(10)(i) to define the types of contracts not made in the ordinary course of business that companies are required to file as exhibits? If so, how should we define such contracts? 240. Item 601(b)(10)(i) requires registrants to file material contracts that either (i) are to be performed in whole or in part at or after the filing of the periodic report, or (ii) were entered into not more than two years before such filing. This requirement was enacted in S–K (1981). In connection with these amendments, the Commission revised Item 601(b)(10)(ii)(D) to require that only material leases be filed as exhibits and revised Item 601(b)(10)(iii) regarding management contracts and compensatory plans. 759 See 2004 Form 8–K Adopting Release. See also Items 1.01 and 1.02 of Form 8–K. 760 See 2002 Form 8–K Proposing Release at 42917 (‘‘Because we believe that agreements can be material for reasons other than the monetary amount involved, we propose to require disclosure under this item based on a ‘materiality’ standard and do not propose to tie the disclosure to a financial measure.’’). 761 See 2004 Form 8–K Adopting Release at 15596. See also Instruction 1 to Item 1.01 of Form 8–K. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 the context of requiring material contracts for newly reporting registrants that were entered into within the last two years but may have been fully performed before the period covered by the report. Do such contracts continue to be important to investors? Should we limit subparagraph (ii) to newly reporting registrants? For registrants that are already subject to reporting requirements, should we eliminate subparagraph (ii) and require registrants to file only material contracts that are to be performed in whole or in part at or after the filing of the report? Should we revise Item 601(b)(10)(i) to require all material agreements to be filed regardless of when they were entered into, as long as such agreements remain material to the registrant? Under what circumstances could a contract remain material to a registrant if it has been fully performed in a prior period? b. Certain Contracts Made in the Ordinary Course—Item 601(b)(10)(ii) Contracts made in the ordinary course of business conducted by a registrant and its subsidiaries generally do not need to be filed. Item 601(b)(10)(ii), however, establishes specific exceptions to the general rule and requires certain contracts to be filed even when they ordinarily accompany the kind of business conducted by the registrant and its subsidiaries. The following types of contracts must be filed, except where immaterial in amount or significance: • Any contract to which directors, officers, voting trustees, security holders named in the registration statement or report, or underwriters are parties, other than contracts involving only the purchase or sale of current assets that have a determinable market price, at such market price; 762 • Any contract upon which the registrant’s business is substantially dependent, such as continuing contracts to sell the major part of the registrant’s products or services or to purchase the major part of the registrant’s requirements of goods, services or raw materials or any franchise or license or other agreement to use a patent, formula, trade secret, process or trade name upon which the registrant’s business depends to a material extent; 763 • Any contract calling for the acquisition or sale of any property, plant or equipment for a consideration exceeding fifteen percent of such fixed 762 Item 601(b)(10)(ii)(A) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(A)]. 763 Item 601(b)(10)(ii)(B) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(B)]. PO 00000 Frm 00064 Fmt 4701 Sfmt 4702 assets of the registrant on a consolidated basis; 764 or • Any material lease under which a part of the property described in the filing is held by the registrant.765 i. Comments Received S–K Study. We received letters from two commenters addressing the requirement in Item 601(b)(10)(ii)(B) to file any contract upon which the registrant’s business is substantially dependent, as in the case of a continuing contract to sell the major part of a registrant’s products or services or to purchase the major part of a registrant’s requirements for goods, services or raw materials. Both commenters requested guidance interpreting the phrase ‘‘the major part’’ to mean agreements involving a majority of the products or services sold or purchased.766 Both commenters also noted that the filing threshold for agreements that are ‘‘immaterial in amount or significance’’ as it relates to Item 601(b)(10)(ii)(A) leads to a disproportionate burden on EGCs, which frequently enter into agreements with parties that have a five percent or greater ownership of the registrant.767 These commenters suggested that other disclosure provisions require the filing or disclosure of ‘‘relevant information’’ regarding these related party agreements.768 Disclosure Effectiveness Initiative. One commenter noted that the reference in Item 601(b)(10)(ii)(B) to contracts to sell the major part of a registrant’s products or services is tied neither to a specific quantitative threshold nor to materiality.769 This commenter recommended that the Commission undertake a study to harmonize various qualitative disclosure thresholds in Regulation S–K, such as ‘‘major part’’ in Item 601(b)(10)(ii)(B) and ‘‘major significance’’ in Item 102, to reduce the ambiguity in their application. This commenter also suggested revising Item 601(b)(10)(ii) so that contracts with certain insiders or other parties identified in the item need not be filed if they contain terms no less favorable to the registrant than terms that could have been obtained from unrelated third parties. Another commenter 764 Item 601(b)(10)(ii)(C) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(C)]. 765 Item 601(b)(10)(ii)(D) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(D)]. 766 See Silicon Valley; M. Liles. 767 Id. 768 Id. (referring to Item 404(a) for disclosure of related party agreements, Item 601(b)(4) for agreements establishing the terms of the registrant’s securities, and financial statement footnotes for disclosure about joint venture agreements). 769 See ABA 2. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules recommended eliminating the requirement in Item 601(b)(10)(ii)(D) to file material leases and suggested that disclosure about physical properties usually does not provide investors with meaningful information.770 ii. Discussion—Background and Scope of Item 601(b)(10)(ii) The Commission’s 1965 amendments to Form 10–K included a requirement for registrants to file as exhibits certain specified contracts made in the ordinary course of business.771 The contracts specified in Form 10–K at that time were similar to those identified today in Item 601(b)(10)(ii).772 In addition, Form 10–K included a catch-all requirement to file an exhibit when the ‘‘amount of the contract, or its importance to the business of the registrant and its subsidiaries, [is] material, and the terms and conditions are of a nature of which investors reasonably should be informed.’’ 773 In 1980, the Commission codified in Regulation S–K the exhibit filing requirements, including the filing requirements for material contracts.774 The requirements adopted in 1980 modified the existing requirements and were substantially similar to the current requirements in Item 601(b)(10)(ii)(A)– (D). The Commission modified the requirement to file agreements for the acquisition or sale of ‘‘fixed assets,’’ adopting instead a requirement to file contracts for the acquisition or sale of any ‘‘property, plant or equipment.’’ 770 See Shearman. 1965 Amendments to Form 10–K Adopting Release. 772 See id. The 1965 amendments consisted of the following six categories: ‘‘(1) Directors, officers, promoters, voting trustees, or security holders named in answer to Item 5 [Principal Holders of Voting Securities] are parties thereto except where the contract merely involves purchase or sale of current assets having a determinable market price, at such price; (2) It is of such materiality as to call for specific reference to it in answer to Item 4 [Changes in the Business] or 9 [Interest of Management and Others in Certain Transactions]; (3) The registrant’s business is substantially dependent upon it, as in the case of continuing contracts to sell the major part of registrant’s production in the case of a manufacturing enterprise or to purchase the major part of registrant’s requirements of goods in the case of a distribution enterprise, or licenses to use a patent or formula upon which registrant’s business depends to a material extent; (4) It calls for the acquisition or sale of fixed assets for a consideration exceeding 10 percent of all fixed assets of the registrant and its subsidiaries; (5) It is a lease under which a material amount of property is held by the registrant; or (6) The amount of the contract, or its importance to the business of the registrant and its subsidiaries, are material, and the terms and conditions are of a nature of which investors reasonably should be informed.’’ Id. at 3433. 773 Id. at 3433. 774 See 1980 Exhibits Adopting Release. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 771 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 iii. Request for Comment 241. Should we expand Item 601(b)(10)(ii) to include other types of contracts that, although made in the ordinary course of business, should be filed? 242. Should we revise our overall approach to Item 601(b)(10)(ii) and if so, how? Rather than specifying categories of contracts, is there an alternative approach that would appropriately capture those ordinary course contracts that are important to investors? For example, should we replace the current requirements in Item 601(b)(10)(ii)(A)– (D) with a requirement for registrants to file all ordinary course contracts entered into (i) since the beginning of the last fiscal year, (ii) that exceed a percent of some measure, such as revenue or net income and (iii) where the registrant has a direct or indirect material interest? If we took this approach, how should we establish the relevant time frame and percentage threshold and what measures should we use? What would be the benefits and challenges of such an approach? 243. Do contracts that are required to be filed pursuant to Item 601(b)(10)(ii) contain information that is important to an understanding of the registrant or its business? Are the types of contracts identified in Item 601(b)(10)(ii) sufficiently significant that they should be filed, notwithstanding that they were made in the ordinary course of business? 244. Is ‘‘immaterial in amount or significance’’ a helpful standard by which to determine when a contract need not be filed? How do registrants currently apply this standard? Should we revise the item to provide guidance on the meaning of that phrase? Is it possible for contracts to be material in amount but not in significance? Should we revise the item to exclude only contracts that are immaterial in amount and significance? Would it facilitate compliance if we revised Item 601(b)(10)(ii) to state in the affirmative that registrants must file all material contracts made in the ordinary course of business that fall within one or more of the categories listed? 245. Item 404(a) of Regulation S–K requires disclosure of any related party transaction since the beginning of the registrant’s last fiscal year if the amount involved exceeds $120,000.775 Unlike 775 Item 404(a) of Regulation S–K [17 CFR 229.404(a)]. Registrants must describe any transaction, since the beginning of the registrant’s last fiscal year, or any currently proposed transaction, in which the registrant was or is to be a participant and the amount involved exceeds $120,000, and in which any related person had or will have a direct or indirect material interest. Id. PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 23979 this bright-line disclosure threshold in Item 404(a), Item 601(b)(10)(ii)(A) generally requires registrants to file related party contracts as exhibits unless immaterial in amount or significance. Do the two different disclosure thresholds provide investors with the information they need to evaluate related party contracts? Should we revise Item 601(b)(10)(ii) to require registrants to file as exhibits all contracts involving related party transactions disclosed pursuant to Item 404(a)? What would be the benefits and challenges associated with such a revision? 246. Taken together, Items 601(b)(10)(i) and (ii) require registrants to file material contracts not made in the ordinary course of business as well as certain contracts made in the ordinary course of business that are material to the registrant. Should we revise Item 601(b)(10)(ii) to require registrants simply to file all contracts that are material to an understanding of the registrant or its business, whether or not entered in the ordinary course of business? Are there any contracts currently required to be filed as exhibits under Item 601(b)(10)(ii) that would not be captured by such a principles-based approach? Conversely, would this approach require registrants to file material ordinary course contracts that they are not currently required to file? Would this change enhance the information available to investors? What would be the benefits and challenges of this approach? iv. Discussion—Disclosure Thresholds under Item 601(b)(10)(ii) Qualitative Thresholds. Item 601(b)(10)(ii)(B) requires registrants to file any contract upon which the registrant’s business is substantially dependent. The item provides examples of contracts upon which a registrant may be substantially dependent, such as continuing contracts to sell the major part of a registrant’s products or services or to purchase the major part of a registrant’s requirements of goods, services or raw materials.776 A registrant’s business also may be substantially dependent on any franchise or license or other agreement to use a patent, formula, trade secret, process or trade name upon which the registrant’s business depends to a material extent.777 Since the item’s adoption in 1965, the Commission has not provided registrants with additional guidance about how to determine 776 Item 601(b)(10)(ii)(B) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(B)]. 777 Id. E:\FR\FM\22APP3.SGM 22APP3 23980 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules ‘‘substantial dependence’’ or ‘‘major part,’’ as those terms are used in the exhibits requirements. To enhance consistency and clarity, we are considering whether to quantify ‘‘substantial dependence’’ as used in the item. Possible alternatives include establishing a dollar amount or percentage threshold, similar to the thresholds used in Item 601(b)(10)(ii)(C), as described below. While an objective requirement may provide clarity for registrants in their efforts to comply with the exhibit requirements, this approach could inadvertently exclude material contracts or result in a large number of contracts being filed that contain information that is neither material nor useful for investors. Quantitative Thresholds. Unlike subparagraph (B), which relies on a qualitative threshold, subparagraph (C) provides a quantitative threshold for filing exhibits. Specifically, Item 601(b)(10)(ii)(C) requires registrants to file any contract calling for the acquisition or sale of any property, plant or equipment for a consideration exceeding fifteen percent of such fixed assets of the registrant on a consolidated basis.778 As originally adopted in 1965, this requirement used a threshold of ten percent of all fixed assets of a registrant and its subsidiaries. In 1980, the Commission raised the threshold to fifteen percent,779 consistent with similar requirements on Form S–1 at the time. In doing so, the Commission increased the threshold triggering the filing of such an agreement from consideration exceeding ‘‘10 percent of all fixed assets of the registrant and its subsidiaries’’ to consideration exceeding ‘‘15 percent of such fixed assets of the registrant on a consolidated basis.’’ 780 In the adopting release, the Commission stated that the higher threshold was consistent with the purpose of reducing the burden that exhibit filing requirements impose on registrants ‘‘without materially impairing investor information or protection.’’ 781 In contrast to Item 601(b)(10)(ii)(C), Item 2.01 of 8–K requires a registrant to report the acquisition or disposition of mstockstill on DSK4VPTVN1PROD with PROPOSALS3 778 Item 601(b)(10)(ii)(C) of Regulation S–K [17 CFR 229.601(b)(10)(ii)(C)]. 779 See 1980 Exhibits Adopting Release. 780 See Technical Amendments to Rules, Forms and Schedules; Delegation of Authority to the Director of the Division of Corporation Finance, Release No. 33–6260 (Nov. 13, 1980) [45 FR 76974 (Nov. 21, 1980)]. This release corrected the regulatory text adopted in the 1980 Exhibits Adopting Release, which ‘‘inadvertently chang[ed] the materiality test from a percentage of fixed assets to a percentage of all assets.’’ Id. at 76976. 781 1980 Exhibits Adopting Release at 58823. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 a ‘‘significant amount of assets.’’ 782 Instruction 4 to Item 2.01 provides that an acquisition or disposition shall be deemed to involve a significant amount of assets (i) if the registrant’s and its other subsidiaries’ equity in the net book value of such assets or the amount paid or received for the assets upon such acquisition or disposition exceeded ten percent of the total assets of the registrant and its consolidated subsidiaries; or (ii) if it involved a business that is significant.783 In addition, Form 8–K encompasses any acquisition or disposition, while Item 601(b)(10)(ii)(C) is limited to the acquisition of property, plant or equipment. Accordingly, an acquisition could trigger a disclosure requirement under Item 2.01 of Form 8–K without triggering a requirement to file the related contract under Item 601(b)(10)(ii)(C). When proposing amendments to Form 8–K in 2002, the Commission sought comment on whether to remove the ten percent test from Item 2.01 and replace it with the more general ‘‘materiality’’ test used in Item 1.01 of Form 8–K.784 Although several commenters supported harmonization between the reporting thresholds in Items 1.01 and 2.01, the Commission retained the ten percent test for Item 2.01, stating its intention that Item 1.01 address a different scope of agreements than those that trigger disclosure under Item 2.01. The Commission also indicated it did not believe that the use of two different thresholds will cause undue confusion.785 We are seeking public input on whether the fifteen percent threshold in Item 601(b)(10)(ii)(C) continues to provide investors with information that is important for an understanding of a registrant’s business. We are interested in receiving input on whether a quantitative threshold is useful and, if so, whether fifteen percent of fixed assets is the appropriate measure. We also seek comment on the scope of contracts covered by subparagraph (C) and whether we should broaden the scope to better harmonize the exhibit filing requirements with the Form 8–K 782 A registrant must file a Form 8–K report if it has completed the acquisition or disposition of a significant amount of assets otherwise than in the ordinary course of business. 783 Form 8–K [17 CFR 249.308]. For the definitions of ‘‘business’’ and ‘‘significant,’’ Instruction 4 refers to Rule 11–01(d) and (b), respectively, of Regulation S–X [17 CFR 210.11–01]. 784 See 2002 Form 8–K Proposing Release. The Commission proposed retaining the ten percent threshold in Instruction 4 of Item 2.01 due to ‘‘companies’ familiarity with th[e] test.’’ Id. at 42919. 785 See 2004 Form 8–K Adopting Release. PO 00000 Frm 00066 Fmt 4701 Sfmt 4702 disclosure requirements. In addition, we are seeking public input on whether quantitative thresholds would be appropriate for other types of agreements required to be filed under Item 601(b)(10)(ii). v. Request for Comment 247. Should we adopt additional or different qualitative or quantitative thresholds for determining when contracts identified in Item 601(b)(10)(ii) must be filed as exhibits? If so, what should these qualitative or quantitative thresholds be? Why? 248. Should we revise Item 601(b)(10)(ii)(B) to provide qualitative or quantitative standards for what constitutes ‘‘substantial dependence’’? Should we define the term ‘‘major part’’ in addition to or in lieu of defining ‘‘substantial dependence’’? What factors should we consider in developing definitions or quantitative thresholds? What other alternatives should we consider to clarify which contracts must be filed under Item 601(b)(10)(ii)? 249. How could we design a quantitative threshold that would accommodate the diversity of registrants and business models? What would be the disadvantages of a quantitative threshold? If we used quantitative measures based on registrants’ financial statements, what would be the appropriate measures to use? Alternatively, should we tie the threshold to a registrant’s market capitalization? 250. Should we provide guidance on the phrase ‘‘depends to a material extent’’ in Item 601(b)(10)(ii)(B)? If so, should we adopt a similar approach to the one discussed in the preceding request for comment? Alternatively, should our requirements distinguish franchise or license agreements to use a patent, formula, trade secret, process or trade name from contracts to sell the major part of a registrant’s products or services or to purchase the major part of a registrant’s requirements of goods, services or raw materials? 251. Should we revise Item 601(b)(10)(ii)(C) to either increase or decrease the fifteen percent threshold for exhibits relating to acquisitions of property, plant or equipment? Should the threshold continue to be based on fixed assets? Alternatively, should we eliminate the threshold in favor of a principles-based requirement, such as ‘‘material’’ or ‘‘significant’’ acquisitions of property, plant or equipment? 252. Should Item 601(b)(10)(ii)(C) continue to focus on property, plant and equipment? Should we expand the scope to require registrants to file contracts for the acquisition or E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules disposition of other assets, including intangible assets such as patents, licenses and other intellectual property? If so, should we consider a disclosure threshold consistent with Item 2.01 of Form 8–K? Would a different threshold be more appropriate? 6. Preferability Letter (Item 601(b)(18)) Registrants will, at times, make a voluntary change in accounting principles or practices when two or more generally accepted accounting principles apply. For example, a registrant may choose to switch its inventory valuation from last-in, firstout to first-in, first-out. When such a change occurs, Item 601(b)(18) requires a registrant to file a letter from its independent accountant indicating whether, in the independent accountant’s judgment, the change is preferable under the circumstances.786 No letter is required for changes made in response to a standard adopted by the FASB that creates a new accounting principle, expresses a preference for an accounting principle, or rejects a specific accounting principle.787 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. None. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 b. Discussion The precursor to Item 601(b)(18), adopted in 1971, required registrants to describe and state the reasons for any change in accounting principles or practices that would materially affect the financial statements filed or to be filed for the current year.788 Registrants also were required to file as an exhibit to Form 10–K or Form 10–Q a letter from the independent accountant approving or otherwise commenting on such changes.789 In 1975, the Commission amended Form 10–Q to require the accountant’s letter to state whether the change, in the accountant’s judgment, is preferable.790 Several commenters objected to the requirement, stating that no standards existed for judging preferability among generally accepted accounting principles and that authoritative accounting principles only required 786 Item 601(b)(18) of Regulation S–K [17 CFR 229.601(b)(18)]. Item 601(b)(18) refers to ‘‘independent accountant.’’ We also refer to ‘‘independent accountant,’’ as ‘‘independent auditor’’ in this release. 787 Id. 788 See Notice of Adoption of Amendments to Form 8–K, Form 7–Q, Form 10–Q, Form 10–K and Form N–1Q, Release No. 34–9344 (Sept. 27, 1971) [not published in the Federal Register]. 789 See id. 790 See 1975 Interim Financial Reporting Release. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 management to justify that a change was preferable. The Commission concluded, however, that management’s justification for a change in accounting principle must convince an independent accountant that, in the accountant’s judgment, the new accounting principle is an improvement over alternative principles.791 The requirement for a preferability letter was included in Form 10–K in 1980 when the Commission centralized all exhibit requirements within Regulation S–K.792 While Item 601(b)(18) requires an auditor to articulate the preferability of a change in accounting principle or policy, the nature of the auditors’ statements varies.793 In addition, there is no standard methodology for determining preferability. Since 2000, the number of preferability letters filed in a given year has fluctuated from a high of 108 in 2000 to a low of 57 in 2007.794 In addition to the exhibit requirement of Item 601(b)(18), disclosure about a voluntary change in accounting principles is required under Rule 10– 791 See id. The Commission based its rationale on the Accounting Principles Board Opinion No. 20 (since replaced by Statement of Financial Accounting Standards No. 154 (ASC Topic 250)), which stated that (i) there is a presumption that an accounting principle once adopted should not be changed, (ii) that presumption may be overcome only if the company justifies the use of an alternative acceptable accounting principle on the basis that it is preferable, and (iii) the burden of justifying a change in accounting principle rests with the company proposing the change. See Proposals to Increase Disclosure of Interim Results by Registrants. 792 See 1980 Exhibits Adopting Release. See also supra note 712 and accompanying text. 793 As an example, one auditor’s letter reads: ‘‘There are no authoritative criteria for determining a ‘preferable’ presentation method based on the particular circumstances; however, we conclude that such change in the method of accounting is to an acceptable alternative method which, based on your business judgment to make this change and for the stated reasons, is preferable in your circumstances.’’ Another states: ‘‘Based on our review and discussion, with reliance on management’s business judgment and planning, we concur that the newly adopted method of accounting is preferable in the Company’s circumstances.’’ Another auditor’s letter provides: ‘‘We believe, on the basis of the facts so set forth and other information furnished to us by appropriate officials of the Company, that the accounting change described in your Form 10–Q is to an alternative accounting principle that is preferable under the circumstances.’’ One preferability letter briefly states: ‘‘In our judgment, such change is an alternative accounting principle that is preferable under the circumstances.’’ 794 See Audit Analytics, Preferability Letters: A 15 Year Review, Jan. 2, 2015, available at https:// www.auditanalytics.com/blog/preferability-lettersa-15-year-review. Over the last fifteen years the most common reasons for filing preferability letters have been changes in accounting principles or practices related to: (1) Goodwill Impairment Measurement Date; (2) Inventory Valuation; (3) Expense Recognition; (4) Classification; and (5) Benefits Program. PO 00000 Frm 00067 Fmt 4701 Sfmt 4702 23981 01(b)(6) of Regulation S–X and under U.S. GAAP. In certain instances, Public Company Accounting Oversight Board (‘‘PCAOB’’) Auditing Standards require auditors to address such changes in their opinions. While U.S. GAAP and PCAOB Auditing Standards require consideration of a registrant’s change in accounting principle or practice, they differ from the Commission’s requirements in terms of nature, timing and extent of reporting by the auditor. We are interested in commenters’ views on whether existing disclosure requirements provide investors with sufficient information about a change in accounting principle without the need for registrants to file a preferability letter. Commission Requirements. Rule 10– 01(b)(6) of Regulation S–X requires registrants to (1) state in the notes to the financial statements the date and reasons for any material accounting change and (2) file, in accordance with Item 601(b)(18), a letter from the registrant’s independent accountant as an exhibit to Form 10–Q.795 U.S. GAAP. U.S. GAAP requires disclosure in the notes to the financial statements about the nature of and reason for a change in accounting principle, including an explanation of why the newly adopted principle is preferable.796 Registrants must report the change in accounting principle in the financial statements of both the interim and annual period of the change.797 PCAOB Auditing Standards. PCAOB Auditing Standard No. 6 (‘‘AS No. 6’’) requires auditors to evaluate a change in accounting principle to determine whether, among other things, the registrant ‘‘has justified that the alternative accounting principle is preferable.’’ 798 AU Section 722 795 Rule 10–01(b)(6) of Regulation S–X [17 CFR 210.10–01(b)(6)]. Rule 8–03(b)(5) of Regulation S– X is the equivalent requirement for SRCs. As part of its work to develop recommendations for the Commission for potential changes to update or simplify certain disclosure requirements, the staff is separately considering Rules 8–03(b)(5) and 10– 01(b)(6) of Regulation S–X which require registrants to disclose the date and reasons for any material accounting change. For a description of this project, see Section I. 796 See ASC 250–10–50–1(a). ASC 250–10–45–12 also requires companies to justify the use of an alternative accounting principle on the basis that it is preferable. 797 See ASC 250–10–50–2. 798 AS No. 6, paragraph 7. See also Auditing Standard No. 6—Evaluating Consistency of Financial Statements and Conforming Amendments, PCAOB Release No. 2008–001, Jan. 29, 2008, at note 14, available at https://pcaobus.org/ Rules/Rulemaking/Docket023/PCAOB_Release_ No._2008-001--Evaluating_Consistency.pdf (noting that the language in AS No. 6 was updated ‘‘to be E:\FR\FM\22APP3.SGM Continued 22APP3 23982 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 addresses the review of interim financial statements and requires the auditor to, among other things, make inquiries of management on changes in accounting principles or methods of application. AU 722 does not require the auditor to specifically express a view on the preferability of the change as part of an interim review. The auditor’s opinion on the annual financial statements must discuss the nature of the change in accounting principle if the change has a material effect on the financial statements, but may not necessarily address preferability.799 Under AU 508, the auditor is not required to opine explicitly on the preferability of the change. Rather, if the auditor concludes a registrant has justified that the alternative accounting principle is preferable (as required by AS No. 6 and U.S. GAAP), then it must include an explanatory paragraph in its report identifying the nature of the change, if the change has a material effect on the financial statements.800 If the auditor concludes that the registrant has not justified the preferability of the alternative accounting principle, the auditor should consider the matter a departure from U.S. GAAP and, if the effect of the change in accounting principle is material, issue either a qualified or adverse opinion.801 Consequently, where the change in accounting principle is material, an auditor’s report without a qualified or adverse opinion and identifying the nature of the change is akin to the preferability letter filed under Item 601(b)(18) as both documents convey the auditor’s conclusion that the registrant has justified that the alternative accounting principle is preferable. Unlike a preferability letter filed under Item 601(b)(18), the audit opinion will include an explicit statement as to preferability only when the registrant has not provided a reasonable justification that the alternative accounting principle is preferable.802 Additionally, while Item 601(b)(18) requires registrants to file a preferability letter with the first Form 10–Q following the date of the accounting change, AU 508 requires a statement in consistent with SFAS No. 154’’). The PCAOB adopted AS No. 6, in part, in response to the FASB’s issuance of Statement of Financial Accounting Standards No. 154 (ASC 250). See supra note 791. AS No. 6 requires the auditor to assess whether the company has met its burden of justifying the change in accounting principle as set forth in SFAS No. 154 (ASC 250). 799 See AU 508, Paragraph 17A. 800 See id. 801 See AU 508, Paragraph 17E. 802 See AU 508, Paragraph 52. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 the opinion about this change only in the annual financial statements on Form 10–K. U.S. GAAP requires disclosure about this change in the notes to the interim financial statements.803 We are seeking public input on whether to eliminate the exhibit requirement of Item 601(b)(18) in light of the significant overlap with the accounting requirements under U.S. GAAP and the PCAOB auditing standards. We are also interested in whether requirements in U.S. GAAP and PCAOB auditing standards are sufficient to alert investors to changes in a registrant’s accounting policies or principles. We also seek input on the utility of Item 601(b)(18) given the small number of preferability letters filed and whether the small number of preferability letters reflects decreased utility and importance of this requirement or if, alternatively, these limited occurrences make this disclosure more valuable to investors. c. Request for Comment 253. Given the development of auditing and accounting standards over the past 40 years, including the adoption of more prescriptive standards such as SFAS No. 154 804 and AS No. 6, do preferability letters continue to provide incremental information to investors that is not otherwise available in either the auditor’s opinion on the annual financial statements or in the notes to the interim financial statements? If so, is this incremental information important to investors and how could it be improved? 254. Should we revise Item 601(b)(18) to specify the language that must be included in a preferability letter? Is there any particular language that gives investors more insight into the determination that the change is preferable? In light of the lack of a standard for assessing preferability, do investors receive more information from a preferability letter than from an auditor’s report? Does it depend on the nature of the change in accounting principle? 255. Should we eliminate Item 601(b)(18) in light of the current requirements under U.S. GAAP and the PCAOB’s auditing standards? When a change in accounting principle is material, is an auditor’s report without a qualified or adverse opinion sufficient to convey the independent accountant’s conclusion that the registrant has 803 See supra note 797 and accompanying text. Under U.S. GAAP, companies should, whenever possible, adopt any accounting changes during the first interim period of a fiscal year. See ASC Topic 250–10–45–16. 804 See supra note 791. PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 justified the change to be preferable? Would eliminating the exhibit requirement affect the independent accountant’s analysis of whether an accounting change is preferable? 256. Would it be more appropriate for the independent accountant to indicate in the auditor’s report whether a change in accounting principle is to an alternative principle that in the auditor’s judgment is preferable under the circumstances? 7. Subsidiaries and Legal Entity Identifiers Item 601(b)(21) requires registrants to list all of their subsidiaries, the state or other jurisdiction of incorporation or organization of each, and the names under which such subsidiaries do business.805 The names of particular subsidiaries may be omitted if the unnamed subsidiaries, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary as of the end of the year covered by the report.806 A legal entity identifier (‘‘LEI’’) is a 20-character, alpha-numeric code that connects to key reference information that allows for unique identification of entities engaged in financial transactions. Recently, the Commission has adopted rules requiring disclosure of LEIs in certain circumstances, if available, and in one instance the Commission has mandated use of 805 Item 601(b)(21)(i) of Regulation S–K [17 CFR 229.601(b)(21)(i)]. 806 Item 601(b)(21)(ii) of Regulation S–K [17 CFR 229.601(b)(21)(ii)]. This exception does not apply to banks, insurance companies, savings and loan associations or to any subsidiary subject to regulation by another Federal agency. The term ‘‘significant subsidiary’’ is defined by reference to Rule 1–02(w) of Regulation S–X [17 CFR 210.1–02(w)]. Under that rule, a significant subsidiary means any subsidiary that meets any of the following conditions: (1) The registrant’s and its other subsidiaries’ investments in and advances to the subsidiary exceed ten percent of the total assets of the registrant and its subsidiaries consolidated as of the end of the most recently completed fiscal year (for a proposed combination between entities under common control, this condition is also met when the number of common shares exchanged or to be exchanged by the registrant exceeds ten percent of its total common shares outstanding at the date the combination is initiated); or (2) The registrant’s and its other subsidiaries’ proportionate share of the total assets (after intercompany eliminations) of the subsidiary exceeds ten percent of the total assets of the registrants and its subsidiaries consolidated as of the end of the most recently completed fiscal year; or (3) The registrant’s and its other subsidiaries’ equity in the income from continuing operations before income taxes, extraordinary items and cumulative effect of a change in accounting principle of the subsidiary exclusive of amounts attributable to any noncontrolling interests exceeds ten percent of such income of the registrant and its subsidiaries consolidated for the most recently completed fiscal year. Id. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules LEI.807 LEI disclosure is not required in Exchange Act reports. a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter recommended that we require disclosure of all subsidiaries instead of only significant subsidiaries, asserting that registrants use the Commission’s significance test to hide material information from investors.808 This commenter also recommended requiring disclosure of additional information for each subsidiary, such as profits earned and number of employees, for investors to understand registrants’ structures and their international strategies, on the grounds that this information is necessary to understand a registrant’s corporate structure and tax strategy. Another commenter recommended requiring registrants to disclose each country of operation and the name of each entity domiciled in each country of operation; the number of employees physically working in each country of operation; the total pre-tax gross revenue of each entity in each country of operation; and the total amount of payments made to governments by each entity in each country of operation.809 This commenter stated that investors have an interest in understanding how much of a registrant’s profits are generated from business operations and how much is a function of tax strategies. This commenter added that a registrant’s filings should explain to investors the tax liabilities it incurred for the year, how much it paid, and where. While not addressing Item 601(b)(21) specifically, one commenter recommended revising the test for determining whether a subsidiary is a significant subsidiary by replacing the existing pre-tax income, investment and asset test with a revenue test and a fair value test.810 We received two comment letters addressing LEIs.811 One of these commenters recommended the Commission consider ‘‘a commitment to adopt’’ the LEI endorsed by the G20 as an ‘‘authoritative, unique, and common identifier for entities subject to financial 807 See infra notes 831 to 835 and accompanying mstockstill on DSK4VPTVN1PROD with PROPOSALS3 text. 808 See US SIF 1. AFL–CIO. 810 See ABA 1 (stating that, compared to existing tests, revenue and fair value-based tests are more reliable indicators of the significance of a tested entity to the registrant, easier to calculate and calculated using more consistently measured amounts that are not affected by different bases of accounting). See also supra note 806. 811 See Data Transparency Coalition and letter from TagniFi, LLC (Jan. 27, 2016) (‘‘TagniFi’’). 809 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 regulators, throughout existing forms.’’ 812 This commenter specified that a registrant’s list of subsidiaries would be more useful to investors if the Commission required issuers to disclose each subsidiary’s LEI. The other commenter recommended the Commission move away from ‘‘proprietary identifiers such as the CUSIP and toward an open source identifier such as the Legal Entity Identifier’’ stating this ‘‘will make it easier for investors to connect other datasets with structured data from the Commission.’’ 813 b. Subsidiaries i. Discussion Before the adoption of Regulation S– K, Form 10–K required registrants to disclose a list or diagram of all parents and subsidiaries of the registrant in the text of the annual report.814 In addition, for each entity identified, registrants were required to disclose the percentage of voting securities owned or other bases for control by the immediate parent.815 Registrants were permitted to omit the names of particular subsidiaries if those subsidiaries, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary.816 In 1970, the Commission revised Form 10–K to permit registrants to omit the names of certain consolidated wholly-owned 812 See Data Transparency Coalition (noting that the ‘‘Commission has already proposed requiring the LEI to be included in security-based swap reports where available, but has not yet committed to use the LEI in its corporate disclosure system’’ and that the ‘‘Commission should incorporate commonly-used data fields wherever applicable, starting with the LEI . . .’’). 813 See TagniFi. 814 See, e.g., 1965 Amendments to Form 10–K Adopting Release. Item 1(a) of former 10–K required disclosure of subsidiaries of ‘‘material significance in relation to the total enterprise represented by the registrant and its subsidiaries, in respect of either (1) the investment in and advances to such subsidiary, or (2) the sales or operating revenues of such subsidiary, or (3) the essential nature of the function performed by such subsidiary in the total enterprise represented by the registrant and its subsidiaries.’’ The item also required certain disclosures of omitted subsidiaries such as the number of subsidiaries omitted and the total investment of the registrant in such omitted subsidiaries. Id. 815 This disclosure was required under Item 3 of prior Form 10–K. See 1965 Amendments to Form 10–K Adopting Release. 816 See, e.g., 1965 Amendments to Form 10–K Adopting Release. The item requirement did not define the term ‘‘significant subsidiary.’’ Registrants were also required to indicate (i) subsidiaries for which separate financial statements are filed; (ii) subsidiaries included in the respective consolidated financial statements; (iii) subsidiaries included in the respective group financial statements filed for unconsolidated subsidiaries; and (iv) other subsidiaries, indicating briefly why statements of such subsidiaries are not filed. Id. PO 00000 Frm 00069 Fmt 4701 Sfmt 4702 23983 multiple subsidiaries carrying on the same line of business.817 This exclusion was similar to one recommended in the Wheat Report.818 With the adoption of the integrated disclosure system, the Commission replaced the Form 10–K subsidiary disclosure requirement with a lessdetailed requirement to file as an exhibit a list of subsidiaries and each subsidiary’s jurisdiction of incorporation or organization.819 This change was based on the Sommer Report which recommended that Form 10–K contain only a ‘‘list of all subsidiaries,’’ as opposed to the additional disclosure requirements mentioned above, such as the bases for control of each subsidiary.820 In the adopting release, the Commission also noted that, although a few commenters stated that no such exhibit relating to subsidiaries, in any form, should be required, most commenters did not object to the exhibit requirement if insignificant subsidiaries were not required to be disclosed.821 The Commission agreed with the commenters that listing all subsidiaries would be too burdensome and adopted the exhibit requiring only the names of significant subsidiaries.822 In 1982, the Commission amended the item to allow registrants to incorporate by reference their lists of subsidiaries if an accurate and complete list is contained in a document previously filed with the Commission.823 Disclosure provided under Item 601(b)(21) has decreased in the last several years. Specifically, the average number of subsidiaries reported by 817 See 1970 Revised Form 10–K Adopting Release. Current Item 601(b)(21)(ii) contains substantially the same exception, permitting the omission of consolidated wholly-owned multiple subsidiaries carrying on the same line of business, such as chain stores or small loan companies, provided the name of the immediate parent, the line of business, the number of omitted subsidiaries operating in the United States and the number operating in foreign countries are given. 818 See Wheat Report at Appendix X–3 (recommending that the names of consolidated totally-held subsidiaries may be omitted on a Form 10–K, provided that the number of such subsidiaries shall be given together with an explanation of the basis for omission of names). 819 See 1980 Form 10–K Adopting Release. 820 See 1980 Form 10–K Proposing Release. The Commission also stated that after consideration, it had determined that the value of parent and subsidiary data is not sufficient to warrant its inclusion in Form 10–K itself. In addition, it noted its belief that occasional references to such data may be useful. Accordingly, the Commission proposed a new exhibit requirement rather than including this disclosure in Form 10–K itself. See id. 821 See 1980 Form 10–K Adopting Release. 822 See id. 823 See 1982 Integrated Disclosure Adopting Release. E:\FR\FM\22APP3.SGM 22APP3 23984 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 registrants under Item 601(b)(21) is estimated to have decreased approximately twenty percent in the five years from 2009 to 2014. However, this decrease is roughly equivalent to the increase observed in the previous five years, from 2004 to 2009.824 According to one press report, in recent years certain large registrants have reduced the number of subsidiaries listed pursuant to Item 601(b)(21) by omitting subsidiaries that are not significant.825 While omission of insignificant subsidiaries from the exhibit is permitted under Item 601(b)(21), the report suggested such registrants may be seeking to avoid disclosing subsidiaries located in countries regarded as tax havens at a time when government officials and academics are scrutinizing the use of offshore tax havens.826 We are interested in commenters’ views on the impact of the rule’s exclusion for insignificant subsidiaries. 824 These estimates are based on DERA staff analysis of Item 601(b)(21) data collected using text analysis techniques by academic researchers. The estimates represent approximations and may be affected by, among other things, the limitations of text analysis and sample composition changes over this time frame. The data is available at https:// sites.google.com/site/scottdyreng/Home/data-andcode. For more information about this dataset, see S. Dyreng and B. Lindsey, Using Financial Accounting Data to Examine the Effect of Foreign Operations Located in Tax Havens and Other Countries on U.S. Multinational Firms’ Tax Rates, 47 J. Acct. Res. 1283, 1283–1316 (2009); and S. Dyreng, B. Lindsey and J. Thornock, Exploring the Role Delaware Plays as a Domestic Tax Haven, 108 J. Fin. Econ. 751, 751–772 (2013). 825 See Jessica Holzer, From Google to FedEx: The Incredible Vanishing Subsidiary, The Wall Street Journal, May 22, 2013, available at https://www.wsj. com/articles/SB10001424127887323463704578 497290099032374 (noting the number of subsidiaries disclosed has declined from over 100 subsidiaries to single digits among certain large registrants). 826 Id. See also U.S. PIRG Education Fund and Citizens for Tax Justice, Offshore Shell Games 2015, The Use of Offshore Tax Havens by Fortune 500 Companies, Oct. 2015, available at https://ctj.org/ pdf/offshoreshell2015.pdf (stating that, based on information in Exhibit 21 to Form 10–K, 358 of Fortune 500 companies operated subsidiaries in tax haven jurisdictions at the end of 2014 and noting that ‘‘it is possible that many of the remaining 142 companies simply do not disclose their offshore tax haven subsidiaries’’); and United States Government Accountability Office, International Taxation, Large U.S. Corporations and Federal Contractors with Subsidiaries in Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions, Report to Congressional Requestors, Dec. 2008, available at https://www.gao.gov/assets/290/ 284522.pdf (concluding that 83 of the 100 largest publicly traded U.S. corporations in terms of 2007 revenue reported having subsidiaries in jurisdictions listed as tax havens or financial privacy jurisdictions. Findings were based on information filed in Exhibit 21 to Form 10–K, and the report notes that the findings may be understated because ‘‘the SEC only requires public companies to report significant subsidiaries . . .’’). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 ii. Request for Comment 257. Should we revise Item 601(b)(21) to eliminate the exclusions and require registrants to disclose all subsidiaries? What would be the benefits and challenges associated with this alternative? 258. Should we expand the exhibit requirement to include additional disclosure about the registrant’s subsidiaries? What additional information would be important to investors and why? 259. Should we require registrants to include an organization or corporate structure chart or similar graphic depicting their subsidiaries and their basis of control? How could such a graphic facilitate investors’ understanding of a registrant’s corporate structure? Should we require this chart or graphic as an exhibit or in the text of the annual report? What would be the challenges associated with this approach? 260. For purposes of identifying which subsidiaries a registrant may omit from the exhibit, Item 601(b)(21) relies on the definition of ‘‘significant subsidiary’’ in Rule 1–02(w) of Regulation S–X. Does this definition appropriately exclude subsidiaries that are not important to investors? Does it exclude any subsidiaries that should be included? Should we consider a different definition or test for excluding certain subsidiaries from the exhibit? If so, what factors should we consider? c. Legal Entity Identifiers i. Discussion While there are currently many ways to identify entities, there is no unified global identification system for legal entities across markets and jurisdictions. The LEI is a reference code to uniquely identify a legally distinct entity that engages in a financial transaction.827 It is based on an international standard published by the International Organization for Standardization in June 2012.828 Efforts to expand the use of a universal LEI have progressed significantly over the last few years.829 827 For further information about LEIs, see Frequently Asked Questions: Global Legal Entity Identifier (LEI), Aug. 2012 available at https://www. treasury.gov/initiatives/wsr/ofr/Documents/LEI_ FAQs_August2012_FINAL.pdf. 828 See International Organization for Standardization, Financial Services—Legal Entity Identifier, 2012, Reference No. ISO 17442–2012(E). 829 See, e.g., The Global LEI System and regulatory uses of the LEI, Nov. 5, 2015, available at https://www.leiroc.org/publications/gls/lou_ 20151105-1.pdf (progress report by the Legal Identifier Regulatory Oversight Committee, including an annex listing regulatory actions in the PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 Obtaining an LEI entails both initial registration and annual maintenance fees and is done through local operating utilities such as the Global Market Entity Identifier utility in the United States.830 Fees are not imposed to use or access LEIs, and all of the associated reference data needed to understand, process, and utilize the LEIs is widely and freely available. In recent rulemakings, the Commission has prescribed disclosure of LEI, if available, for parties to certain financial transactions. For example, the Commission recently prescribed disclosure of an obligor’s LEI, if available, with respect to a rating action involving a credit rating of an obligor as an entity.831 In doing so, it stated that use of an LEI can promote accuracy and standardization of NRSRO data and therefore can further the purpose of allowing users of credit ratings to compare the performance of credit ratings by different NRSROs.832 As another example, the Commission recently adopted an LEI disclosure requirement related to credit risk retention for open market collateralized loan obligations (‘‘CLOs’’), if an LEI has been obtained by the obligor, stating that this requirement would allow investors to better track the performance of assets originated by specific originators.833 While these recent United States, the EU countries, and eight other countries which require, request, or allow the use of LEIs). The global LEI system currently has over 419,000 registrations and is growing. See the Global LEI Foundation daily updated ‘‘concatenated file,’’ which includes all LEIs issued globally and related LEI reference data, available at https://www.gleif. org/en/lei-data/gleif-concatenated-file/leidownload# or https://openleis.com. 830 As of December 7, 2015, the cost of obtaining an LEI from the Global Markets Entity Identifier (‘‘GMEI’’) Utility in the United States was $200, plus a $19 per record surcharge for the LEI Central Operating Unit. The annual cost of maintaining an LEI from the GMEI Utility was $100, plus a $19 surcharge for the LEI Central Operating Unit. See https://www.gmeiutility.org/frequentlyAsked Questions.jsp. 831 See Nationally Recognized Statistical Rating Organizations, Release No. 34–72936 (Aug. 27, 2014) [79 FR 55077 (Sept. 15, 2014)] (‘‘2014 NRSRO Amendments Release’’). The Commission revised Exchange Act Rule 17g–7 to require that NRSROs, taking rating action with respect to certain obligors or issuers, disclose the LEI issued by a utility endorsed or otherwise governed by the Global LEI Regulatory Oversight Committee or the Global LEI Foundation of the obligor or issuer, if available, or, if an LEI is not available, the Central Index Key (CIK) number of the obligor or issuer, if available. Id. See also Rule 17g–7(b)(2)(iii)(A) and (iv)(A) [17 CFR 240.17g–7]. 832 See 2014 NRSRO Amendments Release. The Commission also stated that coded identifiers like LEI and CIK will add a level of standardization to the credit rating history data, making for easier electronic querying and processing. Id. 833 See Credit Risk Retention, Release No. 34– 73407 (Oct. 22, 2014) [79 FR 77601 (Dec. 24, 2014)]. Under the final rule’s lead arranger option for open E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules rulemakings have required LEI disclosure only if available, the Commission has mandated use of LEI in the context of security-based swap transactions 834 and has proposed mandatory use of LEI in investment company reporting.835 To the extent that LEIs become more widely used by regulators and the financial industry, they could potentially facilitate investor and Commission use of registrant data by showing networks of control, ownership, liability and risks. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 ii. Request for Comment 261. Should we require registrants to disclose their LEI and the LEIs of their subsidiaries (if available) in the list of subsidiaries filed under Item 601(b)(21)? How would this information benefit investors? Should the industry in which the company operates or the extent to which the company engages in financial market transactions affect whether disclosure of LEIs is required? What would be the costs of requiring disclosure of this information? 262. Should our rules encourage registrants to obtain an LEI? If so, how could we structure our rules, consistent with our authority under the Securities Act and the Exchange Act, to achieve this purpose? For example, should we make obtaining and maintaining an LEI a condition to any of our existing disclosure accommodations or alternatives? Why or why not? If so, should such a condition be limited to certain types of registrants, such as those operating in financial services? For registrants that have not obtained an LEI, will these registrants seek to obtain market CLOs, the sponsor is required to disclose a complete list of every asset held by an open market CLO (or before the CLO’s closing, in a warehouse facility in anticipation of transfer into the CLO at closing). This list requires, among other things, the full legal name, Standard Industrial Classification category code and LEI (if an LEI has been obtained by the obligor) of the obligor of the loan or asset. [24 CFR 267.9]. 834 See Regulation SBSR-Reporting and Dissemination of Security-Based Swap Information, Release No. 34–74244 (Feb. 11, 2015) [80 FR 14563 (Mar. 19, 2015)] (‘‘2015 Regulation SBSR Release’’). 835 In connection with our efforts to modernize reporting and disclosure by registered investment companies, the Commission proposed new Form N–PORT in May of 2015. Form N–PORT would require certain registered investment companies to report information about their monthly portfolio holdings in a structured data format. We proposed inclusion of LEIs in Part A of Form N–PORT and stated that inclusion of this information would facilitate the ability of investors and the Commission to link the data reported on Form N– PORT with data from other filings or sources that is or will be reported elsewhere as LEIs become more widely used by regulators and the financial industry. See Investment Company Reporting Modernization, Release No. 33–9776 (May 20, 2015) [80 FR 33589 (June 12, 2015)] (‘‘2015 Investment Company Release’’) at notes 40–43 and accompanying text. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 an LEI in the future absent any regulatory incentive to do so? In addition to the fees for obtaining and maintaining an LEI, would there be other costs associated with obtaining LEIs? 263. Some registrants may have hundreds or thousands of subsidiaries or affiliates operating globally while other registrants have simple corporate structures. If we required registrants to disclose LEIs (if available) in the list of significant subsidiaries, should we limit the requirement to larger registrants or larger subsidiaries, independent of the industry in which the registrant operates? For example, should we limit the requirement to large accelerated filers or well-known seasoned issuers (WKSIs)? H. Scaled Requirements 1. Categories of Registrants Eligible for Scaled Disclosure Over the years, the Commission has developed a disclosure system that provides regulatory relief in the form of reduced disclosure requirements for certain smaller registrants. Although initially developed to facilitate smaller companies’ access to the capital markets,836 these reduced or scaled disclosure requirements also apply to annual and quarterly reports. Currently, registrants are eligible for scaled disclosure if they qualify as an SRC or an EGC. SRCs are registrants having less than $75 million in public float (i.e., the aggregate market value of the issuer’s outstanding voting and non-voting common equity held by non-affiliates) or, if public float is zero, less than $50 million in annual revenue in the last fiscal year.837 In 2012, Title I of the JOBS Act created a new category of issuer called an ‘‘emerging growth company.’’ Like SRCs, EGCs are eligible for a variety of accommodations, including scaled disclosure requirements.838 A company qualifies as an EGC if it did not complete its first registered sale of common equity securities on or before December 8, 2011 and has total annual gross revenues of less than $1 billion during its most recently completed fiscal year.839 A company retains EGC status until the earliest of the following: 836 See Small Business Initiatives Adopting Release and Form S–18 Release. 837 Item 10(f) of Regulation S–K [17 CFR 229.10(f)]. 838 Public Law 112–106, Secs. 102–104, 126 Stat. 306 (2012). For a discussion of the scaled disclosure accommodations available to SRCs and EGCs, see Section IV.H.2. 839 Public Law 112–106, Sec. 101, 126 Stat. 306 (2012); 15 U.S.C. 77b(a)(19); 15 U.S.C. 78c(a)(80). PO 00000 Frm 00071 Fmt 4701 Sfmt 4702 23985 • The last day of its fiscal year during which its total annual gross revenues are $1 billion or more; • the date it is deemed to be a large accelerated filer under the Commission’s rules; • the date on which it has issued more than $1 billion in non-convertible debt in the previous three years; or • the last day of the fiscal year following the fifth anniversary of the first registered sale of common equity securities of the issuer.840 The Commission has specified other categories of registrants for different purposes. These include: Accelerated filers, with a public float of $75 million or more but less than $700 million; and large accelerated filers, with a public float of $700 million or more.841 A filer with a public float of less than $75 million is a ‘‘non-accelerated filer.’’ 842 These categories determine periodic reporting schedules.843 They also determine the age requirements for financial statements under Regulation S–X 844 and certain requirements for audits of internal control over financial reporting (‘‘ICFR’’) under Item 308 of Regulation S–K.845 In addition, accelerated and large accelerated filers are subject to other disclosure requirements, such as the requirements to disclose their Internet address,846 information about how they make their periodic reports available,847 and a description of any open unresolved staff 840 Id. In addition, the FAST Act amended Securities Act Section 6(e)(1) [15 U.S.C. 77 f(e)(1)] to provide a grace period for EGCs at risk of losing their status as an EGC after the initial filing or confidential submission of their IPO registration statement but before the IPO is completed. Such companies shall continue to be treated as an EGC through the earlier of the consummation of the IPO or one year after they would otherwise cease to be an EGC. See Public Law 114–94, Sec. 71002, 129 Stat. 1312 (2015). 841 Exchange Act Rule 12b–2 [17 CFR 240.12b–2]. Under Rule 12b–2, accelerated filers and large accelerated filers must also have been subject to the requirements of Exchange Act Section 13(a) or 15(d) for at least 12 months and must not be eligible to use the SRC requirements under Regulation S–K for its annual and quarterly reports. Id. See also Revisions to Accelerated Filer Definition and Accelerated Deadlines for Filing Periodic Reports, Release No. 33–8644 (Dec. 21, 2005) [70 FR 76626 (Dec. 27, 2005)] (‘‘2005 Accelerated Filer Revisions Release’’). 842 See 2005 Accelerated Filer Revisions Release. While a ‘‘non-accelerated filer’’ is not defined in Exchange Act Rule 12b–2, it represents a category of filer that, among other things, has a different deadline for filing periodic reports. 843 See 2005 Accelerated Filer Revisions Release. 844 Rule 3–01 of Regulation S–X [17 CFR 210.3– 01]. 845 Item 308 of Regulation S–K [17 CFR 229.308]. 846 Item 101(e)(3) of Regulation S–K [17 CFR 229.101(e)(3)]. 847 Item 101(e)(4) of Regulation S–K [17 CFR 229.101(e)(4)]. E:\FR\FM\22APP3.SGM 22APP3 23986 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules comments on their periodic or current reports.848 The following table summarizes the criteria for determining whether a company qualifies as an EGC, SRC, non- Category of filer Public float 849 to enter status Revenues 850 to enter status EGC ............................... N/A ................................. <$1 billion ......... SRC ............................... Non-Accelerated Filer .... Accelerated Filer ............ <$75 million ................... <$75 million ................... ≥$75 million but <$700 million. ≥$700 million ................. <$50 million 854 N/A ................... N/A ................... Large Accelerated Filer .. a. Comments Received S–K Study. One commenter noted that the $1 billion threshold for EGCs established in the JOBS Act appeared to be arbitrary and opposed any potential Commission guidance broadening the definition of EGCs, because it would unnecessarily increase the risks to investors.859 Two commenters suggested that the Commission should modify Regulation S–K to apply to different classes of EGCs, such as those that reach specified revenue levels lower than $1 billion, or to phase in different requirements after a certain period of time following the IPO.860 Disclosure Effectiveness Initiative. One commenter suggested that overreliance on public float to define SRCs and non-accelerated filers creates 848 Item 1B of Part I of Form 10–K. float is computed as of the last business day of company’s most recently completed second fiscal quarter. Item 10(f) of Regulation S–K [17 CFR 229.10(f)]. 850 Revenues are as reported in a company’s most recently completed fiscal year. [15 U.S.C. 78c(a)(80)]; Exchange Act Rule 12b–2 [17 CFR 240.12b–2]; Item 10(f) of Regulation S–K [17 CFR 229.10(f)]. 851 Ineligibility begins on the last day of the fiscal year in which the fifth anniversary occurs. [15 U.S.C. 78c(a)(80)]. The Division has interpreted the phrase ‘‘first sale of common equity securities’’ under the JOBS Act (‘‘IPO’’ in the table above) not to be limited to a company’s initial primary offering of common equity securities for cash. It could also include offering common equity pursuant to an employee benefit plan on a Form S–8 as well as a selling shareholder’s secondary offering on a resale registration statement. See Jumpstart Our Business Startups Act Frequently Asked Questions, Generally Applicable Questions on Title I of the JOBS Act, Question 2 (Apr. 28, 2012), available at https://www.sec.gov/divisions/corpfin/guidance/ cfjjobsactfaq-title-i-general.htm. 852 Ineligibility begins on the date on which the company has issued more than $1 billion in nonconvertible debt during the previous three year period. [15 U.S.C. 78c(a)(80)]. 853 See supra note 840. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 849 Public VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 N/A ................... • Revenues ≥$1 billion • 5th anniversary of IPO 851. • Non-convertible debt >$1 billion 852. • Float ≥$700 million 853. Float ≥$75 million .......... Float ≥$75 million .......... Float <$75 million or ≥$700 million. Float <$700 million ........ b. Discussion The Commission’s practice of providing disclosure accommodations to smaller companies with less established trading markets dates back to 1979. In providing these accommodations and determining what 854 Revenue test applies only if public float is zero. Item 10(f)(1)(iii) of Regulation S–K [17 CFR 229.10(f)(1)(iii)]. 855 Once a registrant fails to qualify as an SRC, it will remain unqualified unless its public float falls below $50 million as of the last business day of its second fiscal quarter, or if public float is zero, if revenues fall below $40 million during its previous fiscal year. Item 10(f)(2)(iii) of Regulation S–K [17 CFR 229.10(f)(2)(iii)]. 856 Id. 857 Once a registrant becomes an accelerated filer, it will remain an accelerated filer unless it determines at the end of a fiscal year that its public float was less than $50 million as of the last business day of it most recently completed second fiscal quarter. The registrant will not become an accelerated filer again unless it subsequently meets the conditions for initial qualification as an accelerated filer. Rule 12b–2 of the Exchange Act [17 CFR 240.12b–2]. 858 Once a registrant becomes a large accelerated filer, it will remain a large accelerated filer unless it determines at the end of a fiscal year that its public float was less than $500 million as of the last business day of it most recently completed second fiscal quarter. The registrant will not become a large accelerated filer again unless it subsequently meets the conditions for initial qualification as a large accelerated filer. Id. 859 See letter from Council of Institutional Investors (Aug. 9, 2012) (‘‘CII’’). 860 See Silicon Valley and M. Liles. Frm 00072 Fmt 4701 Public float to re-enter status (after exceeding threshold(s)) Criteria to exit status a compliance burden for companies with high valuations that would be considered ‘‘small’’ by any ‘‘reasonable observer.’’ 861 This commenter recommended revising the definition of SRC and non-accelerated filer to include any issuer with public float below $250 million, or annual revenues below $100 million regardless of its public float, to avoid grouping highly valued small companies with little or no revenue with larger corporations. PO 00000 accelerated filer, accelerated filer or large accelerated filer. Sfmt 4702 Revenues to re-enter status (after exceeding threshold(s)) N/A ................................. N/A. <$50 million 855 .............. <$50 million 857 .............. <$500 million but ≥$50 million 858. N/A ................................. <$40 million.856 N/A. N/A. N/A. categories of registrants are eligible for scaled disclosure requirements, the Commission has sought to promote capital formation and reduce compliance costs while maintaining investor protections.862 Our current system of reporting and registration for SRCs is based on Form S–18, which allowed an entity that was not previously a reporting company to raise a limited amount of capital without immediately incurring the full range of disclosure and reporting obligations required of other issuers.863 As part of a larger effort to facilitate capital raising by small businesses and reduce the compliance burdens placed on these companies by the federal securities laws, the Commission created Regulation S–B in 1992 and rescinded 861 See Biotech Industry Organization. e.g., Form S–18 Release; and Small Business Initiatives, Release No. 33–6924 (Mar. 11, 1992) [57 FR 9768 (Mar. 20, 1992)] (‘‘Small Business Initiatives Proposing Release’’). 863 See Small Business Initiatives Adopting Release and Form S–18 Release. Form S–18 was ‘‘in the nature of an experiment’’ for use by certain nonreporting issuers seeking to register certain offerings of less than $5 million. Registrants using Form S– 18 were permitted to provide narrative disclosure somewhat less extensive than Form S–1 and audited financial statements for two fiscal years instead of the three fiscal years required in Form S–1. In addition, and to help reduce the expenses resulting from registration and reporting under the Securities Act and the Exchange Act, the Commission allowed Form S–18 registrants to include this scaled narrative and financial disclosure in their initial Form 10–K. See Form S– 18 Release. See also Section III.A.2.b for a discussion of Form S–18. Notably, while Form S–18 was intended to facilitate a small business’s access to public capital markets, eligibility to use the form was not determined by the size of the issuer. After observing the form’s use, the Commission later expanded the availability of Form S–18. See supra note 78. The offering threshold was raised to $7.5 million in 1983. See Revisions to Optional Form S–18, Release No. 33–6489 (Sept. 23, 1983) [48 FR 45386 (Oct. 5, 1983)]. 862 See, E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Form S–18.864 Regulation S–B was a new integrated disclosure system modeled after Form S–18 and specifically tailored to ‘‘small business issuers,’’ which it defined as registrants with annual revenues of less than $25 million whose voting stock had a public float of less than $25 million. In 2007, the Commission replaced the ‘‘small business issuer’’ definition with the current definition for ‘‘smaller reporting companies,’’ which expanded the universe of registrants eligible for scaled disclosure.865 Unlike the dual eligibility test under Regulation S–B, which required separate calculations using both public float and annual revenues, the 2007 definition, which remains in effect today, eliminated the revenue test for most companies.866 The Commission stated its belief that this would simplify and streamline the definition while expanding the number of companies eligible to qualify. The majority of commenters also supported a revenue test only if a company is unable to calculate public float. Recently, we have received recommendations to revisit some of our registrant categories eligible for scaled disclosure, with particular focus on expanding the SRC definition to include a greater number of registrants.867 In the mstockstill on DSK4VPTVN1PROD with PROPOSALS3 864 See Small Business Initiatives Adopting Release. In addition to the small business integrated disclosure system and forms, the Commission revised Regulation A to, among other things, raise the dollar limit to $5 million in a 12-month period and revised Rule 504 to, among other things, allow for receipt of freely transferable securities and remove the proscription on general solicitation. Id. 865 See SRC Adopting Release. Several of the amendments the Commission adopted in the SRC Adopting Release originated in recommendations made by the Advisory Committee on Smaller Public Companies (ACSPC), which the Commission chartered in 2005 to assess the regulatory system for smaller companies. The ACSPC’s recommendations included establishing a system of scaled securities regulation for ‘‘smaller public companies,’’ which referred to registrants in the lowest six percent of total U.S. equity market capitalizations, and included: ‘‘microcap companies’’ which referred to registrants in the lowest one percent of total U.S. equity market capitalization and would have included registrants with capitalizations below approximately $128 million; and ‘‘smallcap companies,’’ which referred to registrants in the next lowest five percent of total U.S. equity market capitalization and would have included registrants with capitalizations between approximately $128 million and $787 million. See Final Report of the Advisory Committee on Smaller Public Companies to the U.S. Securities and Exchange Commission, Apr. 23, 2006, available at https://www.sec.gov/info/ smallbus/acspc/acspc-finalreport.pdf. 866 See SRC Adopting Release. 867 The Annual SEC Government-Business Forum on Small Business Capital Formation (‘‘Small Business Forum’’) has recommended revising the SRC definition to include a company with a public float of less than $250 million or a company with a public float of less than $700 million with annual revenues of less than $100 million. See e.g., Final Report of the 2014 SEC Government-Business Forum on Small Business Capital Formation, May VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 S–K Study, the staff recommended consideration of the criteria used to determine eligibility for potential further scaling of disclosure requirements and, in particular, whether it would be appropriate to scale for companies other than EGCs. The staff also noted that any determination of which companies should be allowed to scale their disclosures, how companies should migrate to a standard disclosure regime as they mature, and the extent to which disclosure of previously undisclosed information should later be required should reflect the overarching economic principles recommended in the S–K Study. The staff further recommended consideration of the eligibility criteria for SRCs, as well as the criteria for accelerated filers and large accelerated filers.868 We are interested in receiving input on how we should approach the eligibility criteria for using scaled disclosure. The FAST Act requires the Commission to revise Regulation S–K to further scale or eliminate disclosure requirements to reduce the burden on a variety of smaller issuers, including SRCs.869 In response to this mandate, the staff is currently evaluating, among other things, the criteria to qualify as an 2015 (‘‘2014 Forum Report’’), available at https:// www.sec.gov/info/smallbus/gbfor33.pdf. Similarly, the Commission’s Advisory Committee on Small and Emerging Companies (‘‘ACSEC’’) recommended the Commission revise the SRC definition to include companies with a public float of up to $250 million to extend regulatory relief to a broader range of smaller public companies, including, among other things, the exemption from the requirement to provide an auditor attestation of the registrant’s ICFR. Item 308(b) of Regulation S– K [17 CFR 229.308(b)]. Item 308(b) applies to accelerated filers and large accelerated filers, both of which definitions exclude issuers that that are eligible to use the SRC requirements in Regulation S–K. Exchange Act Rule 12b–2 [17 CFR 240.12b– 2]. Because the definitions of accelerated filer and larger accelerated filer specify that they do not include registrants that are eligible to use the requirements for SRCs for their annual and quarterly reports, a change to the threshold for SRCs would extend this exemption even without a corresponding change to the threshold for accelerated filers. The ACSEC also has recommended the Commission revise the definition of ‘‘accelerated filer’’ to include companies with a public float of $250 million or more, but less than $700 million, thereby exempting companies with public float between $75 million and $250 million from the requirement to provide an auditor attestation of the registrant’s ICFR. See e.g., Advisory Committee on Small and Emerging Companies Recommendations about Expanding Simplified Disclosure for Smaller Issuers, Sept. 23, 2015 (‘‘2015 ACSEC Recommendations’’), available at https:// www.sec.gov/info/smallbus/acsec/acsecrecommendations-expanding-simplified-disclosurefor-smaller-issuers.pdf. 868 See S–K Study at 98 and 102–103. For a discussion of the overarching economic principles of the S–K Study, see Section II.C. 869 Public Law 114–94, Sec. 72002(1), 129 Stat. 1312 (2015). PO 00000 Frm 00073 Fmt 4701 Sfmt 4702 23987 SRC, and expects to make recommendations to the Commission. Consequently, we are not addressing the existing criteria in this release. c. Request for Comment 264. In the context of registered offerings, the Commission has determined that certain types of issuers are unsuited for short-form registration or disclosure-related relief.870 These issuers include reporting companies that are not current in their Exchange Act reports, issuers that may raise greater potential for abuse (such as blank check and shell companies) 871 and issuers that have violated the antifraud provisions of the federal securities laws. Are there types of registrants that would meet the current criteria for scaled disclosure but are unsuited for providing such disclosure? If so, which issuers and why? Should we exclude certain types of registrants from the use of scaled disclosure and if so, what should be the criteria (e.g., failure to timely file, subject to enforcement actions for disclosure violations or fraud, being an ‘‘ineligible issuer’’ as defined under Rule 405 of the Securities Act or disqualified under Regulation A or Regulation D) and the time period of exclusion? 265. Should we tie eligibility for scaled disclosure to a certain proportion of companies, such as companies in the lowest one percent of total U.S. market capitalization or the lowest six percent of total U.S. market capitalization, as previously recommended by the ACSPC? 872 266. Should we allow one or more categories of larger companies, such as companies with a longer reporting history or more readily available public information to benefit from scaled disclosure requirements as a means of reducing compliance costs? 267. The benefits of disclosure may be greater for smaller registrants because information asymmetries between investors and managers of smaller companies are typically higher than for larger, more seasoned companies with a large following.873 However, disclosure 870 See Securities Offering Reform Release. id., citing Penny Stock Definition for Purposes of Blank Check Rule, Release No. 33–7024 (Oct. 25, 1993) [58 FR 58099] (the Commission stated that Congress found blank check companies to be common vehicles for fraud and manipulation in the penny stock market, and concluded that the Commission’s disclosure-based regulation and review of such offerings protects investors). 872 See supra note 865. 873 See, e.g., R. Frankel and X. Li, Characteristics of a firm’s information environment and the information asymmetry between insiders and outsiders, 37 J. Acct. Econ. 229, 229–259 (June 871 See E:\FR\FM\22APP3.SGM Continued 22APP3 23988 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules requirements may impose disproportionate costs on smaller registrants, especially if these requirements impose fixed rather than variable costs.874 To what extent are the costs imposed by our disclosure requirements fixed costs that do not scale with the size of a registrant? mstockstill on DSK4VPTVN1PROD with PROPOSALS3 2. Scaled Disclosure Requirements for Eligible Registrants Registrants that qualify as an SRC or EGC are allowed to provide less detailed disclosure about their business operations and financial condition and to limit the number of periods for which disclosure is required.875 An SRC may limit the description of the development of its business under Item 101(h) of Regulation S–K to the last three years rather than the five years required of other registrants. The business description should include the registrant’s form and year of organization, any bankruptcy proceedings, any material reclassification, merger, sale or purchase of assets outside the ordinary course of business and a description of the business. The disclosure required in the description of business for SRCs is less detailed than that required for other reporting companies and does not require information about seasonality, working capital practices, backlog information and certain material government contracts.876 The scaled requirements do, however, call for information not specifically required for other reporting companies, such as the need for government approval of principal products and services.877 SRCs also are required to provide only two years of audited financial statements 878 rather than the three years required of other companies.879 To the 2004). See also, L. Cheng, S. Liao, and H. Zhang, The Commitment Effect versus Information Effect of Disclosure—Evidence from Smaller Reporting Companies, 88 Acct. Rev. 1239, 1239–1263 (2013). 874 Empirical evidence suggests the imposition of additional disclosure requirements in the past has imposed disproportionate costs on smaller registrants relative to larger registrants. See supra note 169. 875 SRCs and EGCs may take advantage of additional scaled disclosure requirements and other accommodations, such as reduced executive compensation disclosure under Item 402(n) through (r) of Regulation S–K [17 CFR 229.402(n) through (r)] that we do not discuss in detail here, as they are beyond the scope of this release. 876 Item 101(c)(1)(v), (vi), (viii) and (ix) of Regulation S–K [17 CFR 229.101(c)(1)]. 877 See, e.g., Item 101(h)(4)(viii) of Regulation S– K [17 CFR 229.101(h)]. 878 Rule 8–02 of Regulation S–X. [17 CFR 210.8– 02]. 879 Article 3 of Regulation S–X requires: Audited balance sheets as of the end of each of the two most recent fiscal years; audited statements of income and cash flows for each of the three fiscal years VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 extent a SRC presents only two years of financial statement information, they also are permitted under Item 303 of Regulation S–K to provide MD&A for only these two years.880 Not all EGCs qualify as SRCs. EGCs are only required to provide two years of audited financial statements in an initial public offering of common equity securities and may limit their MD&A to only those audited periods presented in the financial statements.881 In interpretive guidance, the Division has stated that in any other offering or in an Exchange Act annual report or registration statement, an EGC that is not an SRC is required to provide three years of audited financial statements, except the registrant is not required to include financial statements for any periods prior to the earliest period presented in its initial public offering of common equity securities.882 In preceding the date of the most recent audited balance sheet; and an analysis of changes in stockholders’ equity for each period for which an income statement is required. Rules 3–01, 3–02, and 3–04 of Regulation S–X [17 CFR 210.3–01; 17 CFR 210.3–02; 17 CFR 210.3.04]. 880 Instruction 1 to Item 303(a) of Regulation S– K [17 CFR 229.303(a)]. 881 Public Law 112–106, Sec. 102(b)–(c), 126 Stat. 306 (2012). One study, however, indicated that only fifty-nine percent of EGCs provided the minimum financial statement disclosures required by the JOBS Act and voluntarily provided more disclosure. See Ernst & Young LLP, The JOBS Act: 2015 MidYear Update, (Sept. 2015), available at https:// www.ey.com/Publication/vwLUAssets/JOBSAct_ 2015MidYear_CC0419_16September2015/$FILE/ JOBSAct_2015MidYear_CC0419_ 16September2015.pdf. While the JOBS Act permits EGCs to limit their MD&A to only those audited periods presented in its financial statements, Division staff has provided interpretive guidance that Section 102(c) does not permit an EGC to comply with the SRC provisions of Item 303. An EGC that is not an SRC is therefore required to include the contractual obligations table required by Item 303(a)(5). See Question 41, Jumpstart Our Business Startups Act Frequently Asked Questions, Generally Applicable Questions on Title I of the JOBS Act, (May 3, 2012), available at https:// www.sec.gov/divisions/corpfin/guidance/ cfjjobsactfaq-title-i-general.htm. Additionally, a non-SRC EGC must provide three years of audited financial statements in an Exchange Act registration statement or annual report, and therefore its MD&A in such filing must cover the same three-year period. See Division of Corporation Finance Financial Reporting Manual, Section 10220.1. 882 See Questions 30 and 48, Jumpstart Our Business Startups Act Frequently Asked Questions, Generally Applicable Questions on Title I of the JOBS Act, (May 3, 2012), available at https:// www.sec.gov/divisions/corpfin/guidance/ cfjjobsactfaq-title-i-general.htm. Section 71003 of the FAST Act amended Section 102 of the JOBS Act to allow an EGC that is filing a registration statement (or submitting a draft registration statement for confidential review) under Section 6 of the Securities Act on Form S– 1 or Form F–1 to omit financial information for historical periods otherwise required by Regulation S–X if it reasonably believes the omitted information will not be required in the filing at the time of the contemplated offering, so long as the issuer amends the registration statement prior to PO 00000 Frm 00074 Fmt 4701 Sfmt 4702 addition, EGCs may take advantage of an extended transition period for complying with new or revised financial accounting standards.883 SRCs are not required to provide certain line-item requirements in Regulation S–K, including Item 201(e) (Market price of and dividends on the registrant’s common equity and related stockholder matters—Performance Graph),884 Item 301 (Selected Financial Data),885 Item 302 (Supplementary Financial Data),886 Item 303(a)(5) (contractual obligations table),887 Item 305 (Quantitative and Qualitative Disclosures about Market Risk),888 Item 308(b) (Internal Control over Financial Reporting—auditor’s attestation report) 889 and Item 503(c) (Risk Factors).890 Scaled disclosure requirements under these items differ slightly for EGCs. For example, an EGC is permitted to limit the selected financial data it includes in a registration statement under Item 301 to those periods for which audited financial statements are included in the registration statement. For periodic reports, an EGC is not required to distributing a preliminary prospectus to include all financial information required by Regulation S–X at the time of the amendment. This provision took effect 30 days after the date of enactment of the FAST Act. Section 71003 also directs the Commission to revise the general instructions to Form S–1 and Form F–1 to reflect this selfexecuting change. In addition, Section 84001 of the FAST Act requires the Commission to revise Form S–1 to permit an SRC to incorporate by reference into its registration statement any documents filed by the issuer subsequent to the effective date of the registration statement. Public Law 114–94, Sec. 71003, 129 Stat. 1312 (2015). We recently adopted interim final rules to implement Sections 71003 and 84001 of the FAST Act. See Simplification of Disclosure Requirements for Emerging Growth Companies and Forward Incorporation by Reference on Form S–1 For Smaller Reporting Companies, Release No. 33– 10003 (Jan. 13, 2016) [81 FR 2743 (Jan. 19, 2016)] (‘‘FAST Act Interim Rules Release’’). 883 15 U.S.C. 77g(a)(2)(B). 884 Instruction 6 to Item 201(e) of Regulation S– K [17 CFR 229.201(e)]. 885 Item 301(c) of Regulation S–K [17 CFR 229.301(c)]. 886 Item 302(c) [17 CFR 229.302(c)]. 887 Item 303(d) of Regulation S–K [17 CFR 229.303(d)]. 888 Item 305(e) of Regulation S–K [17 CFR 229.305(e)]. Although SRCs are not required to provide the information required by this item, the adopting release notes that ‘‘if market risk represents a material known risk or uncertainty, [SRCs], like other registrants, will continue to be required to discuss those risks and uncertainties to the extent required by Management’s Discussion and Analysis.’’ See Disclosure of Market Risk Sensitive Instruments Release. 889 Non-accelerated filers, a category that includes SRCs, are not subject to the requirements of Item 308(b) (attestation report of the registered public accounting firm). Item 308(b) of Regulation S–K [17 CFR 229.308(b)]. 890 Item 1A, Part I of Form 10–K and Item 1A, Part II of Form 10–Q. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules provide the selected financial data for any periods earlier than those for which financial statements were presented in the IPO.891 EGCs are also not required to provide auditor attestations of ICFR and, accordingly, are not subject to Item 308(b).892 The following table summarizes the scaled disclosure accommodations available to EGCs and SRCs for periodic Scaled disclosure requirement • 2 years in a Securities Act registration statement for an IPO of common equity. • 3 years in an IPO of debt securities. • 3 years in an annual report or Exchange Act registration statement, unless the company is also an SRC. Standard disclosure requirements apply ......... Description of Business (Item 101) .................... Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters (Item 201). Selected Financial Data (Item 301) .................... Supplementary Financial Data (Item 302) ......... MD&A (Item 303) ............................................... Quantitative and Qualitative Disclosures about Market Risk (Item 305). Extended Transition for Complying with New or Revised Accounting Standards. Internal Control over Financial Reporting (Item 308). Executive Compensation Disclosure (Item 402) mstockstill on DSK4VPTVN1PROD with PROPOSALS3 reports as well as certain other filings.893 Emerging growth company Audited Financial Statements Required ............. 891 Public Law 112–106, Sec. 102(b), 126 Stat. 306 (2012). Title I of the JOBS Act provided EGCs with a variety of scaled disclosure and other accommodations. These provisions were effective upon enactment of the JOBS Act without rulemaking by the Commission. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Standard disclosure requirements apply ......... Not required to present selected financial data for any period prior to the earliest audited period presented in initial registration statement. Not required until after IPO .............................. May limit discussion to those years for which audited financial statements are included. Standard disclosure requirements apply ......... • May elect to defer compliance with new or revised financial accounting standards until a company that is not an ‘‘issuer’’ 894 is required to comply with such standards. • Any decision to forego the extended transition period is irrevocable. • Not required to provide attestation report of the registered public accounting firm. • Not exempt from Item 308(a), but newly public company is not required to comply until it either has filed or has been required to file an annual report for the prior fiscal year. • Permitted to follow requirements for SRCs 895. • Exempt from principal executive officer pay ratio disclosure. 892 Id. at Sec. 103 (amending Section 404(b) of the Sarbanes-Oxley Act [Pub. L. 107–204, Sec. 404(b) 116 Stat. 745 (2002)]). 893 Many of the scaled disclosure accommodations apply to filings other than PO 00000 Frm 00075 Fmt 4701 Sfmt 4702 23989 Smaller reporting company • 2 years. • Development of its business during the most recent three years, including: Æ form and year of organization; Æ bankruptcy proceedings; Æ material reclassification, merger, sale or purchase of assets; and Æ description of the business. • Not required: Æ seasonality; Æ working capital practices; Æ backlog; or Æ government contracts. • Names of principal suppliers. • Royalty agreements or labor contracts. • Need for government approval of principal products and services. • Effect of existing or probable governmental regulations. Not required to provide the stock performance graph. Not required. Not required. • May limit discussion to those years for which audited financial statements are included. • Not required to comply with contractual obligations table requirements in 303(a)(5). Not required, but related disclosure may be required in MD&A. Standard disclosure requirements apply. Non-accelerated filers, a category that includes SRCs, are not required to provide an attestation report of the registered public accounting firm. • 2 years of summary compensation table information, rather than 3. • Limited to principal executive officer, two most highly compensated executive officers and up to two additional individuals no longer serving as executive officers at year end.896 • Not required: Æ compensation discussion and analysis; periodic reports. Some of these filings are identified in the table. Though not within the scope of this release, this information is included here to provide additional context. E:\FR\FM\22APP3.SGM 22APP3 23990 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules Scaled disclosure requirement Emerging growth company Certain Relationships and Related Party Transactions (Item 404). Standard disclosure requirements apply ......... Corporate Governance (Item 407) ..................... Standard disclosure requirements apply ......... Risk Factors (Item 503(c)) .................................. Ratio of Earnings to Fixed Charges (Item 503(d)) 901. Standard disclosure requirements apply ......... Required for same number of years for which it provides selected financial data disclosures 902. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Comments Received 894 An ‘‘issuer’’ is defined in Section 2(a) of the Sarbanes-Oxley Act to mean an issuer whose securities are registered under Exchange Act Section 12, that is required to file reports under Securities Act Section 15(d), or that has filed a registration statement that has not yet become effective and that it has not withdrawn. Public Law 107–204, Sec. 2(a), 116 Stat. 747 (2002). 895 Public Law 112–106, Sec. 102(c), 126 Stat. 306 (2012). 896 Item 402(m)(2) of Regulation S–K [17 CFR 229.402(m)(2)]. Companies that are not SRCs must provide disclosure for the principal executive officer, principal financial officer, three most highly paid executive officers and up to two additional individuals no longer serving as executive officers. Item 402(a)(3) of Regulation S–K [17 CFR 229.402(a)(3)]. 897 Item 404(d) of Regulation S–K [17 CFR 229.404(d)]. 898 Item 407(g)(1) of Regulation S–K [17 CFR 229.407(g)(1)]. 899 Item 407(g)(2) of Regulation S–K [17 CFR 229.407(g)(2)]. 900 Item 1A of Form 10–K [17 CFR 249.310]; Item 1A of Form 10–Q [17 CFR 249.308a]. SRCs also are not required to provide the information required by Item 503(c) of Regulation S–K in Exchange Act registration statements on Form 10 [17 CFR 249.210]. 901 The staff is separately considering Item 503(d) of Regulation S–K in developing recommendations for the Commission for potential changes to update or simplify certain disclosure requirements. For a description of this project, see Section I. 902 See Jumpstart Our Business Startups Act Frequently Asked Questions, Generally Applicable Questions on Title I of the JOBS Act, Question 27 (May 3, 2012), available at https://www.sec.gov/ divisions/corpfin/guidance/cfjjobsactfaq-title-igeneral.htm. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 S–K Study. One commenter encouraged the Commission not to issue guidance or rules to increase the scope of companies eligible for EGC status or to defer further the application of internal control requirements, such as the requirement to provide an auditor attestation report, for EGCs that outgrow their EGC status.904 Two commenters suggested that EGCs should be exempt from Item 305 disclosure.905 These commenters specified that companies that have not yet reached the revenue or market capitalization thresholds that would disqualify them from EGC status are unlikely to face meaningful market risks. These commenters also recommended eliminating the requirement in Item 101(c) to disclose the amount of backlog orders believed to be firm for EGCs, stating the concept of backlog is not a ‘‘meaningful metric’’ for most of these companies. In addition, these commenters noted that the threshold for agreements that are ‘‘immaterial in amount or significance’’ in Item 601(b)(10)(ii)(A) is too low for EGCs, because they often enter into agreements with parties that have a five 903 Item 503(e) of Regulation S–K [17 CFR 229.503(e)]. 904 See CII. 905 See Silicon Valley; M. Liles. PO 00000 Frm 00076 Fmt 4701 Sfmt 4702 Smaller reporting company Æ grants of plan-based awards table; Æ option exercises and stock vested table; Æ change in present value of pension benefits; Æ CEO pay ratio; Æ compensation policies as related to risk management; or Æ pension benefits table. • Description of retirement benefit plans. • Lower threshold to disclose related party transactions. • Not required to disclose procedures for review, approval or ratification of related party transactions. • Additional requirement to disclose certain controlling entities. • Required to disclose related party transactions not only since the beginning of last fiscal year but also for the preceding fiscal year.897 • Not required to disclose whether it has an audit committee financial expert until its second annual report following IPO.898 • Exempt from requirements to disclose compensation committee interlocks and insider participation and to provide a compensation committee report.899 Not required in periodic reports.900 Not required.903 percent or greater ownership of the company.906 Disclosure Effectiveness Initiative. One commenter generally supported the concept of scaled disclosure requirements noting that smaller companies face challenges when preparing annual reports.907 Another commenter expressed concerns with a differential disclosure regime for different sized entities, stating that investors will factor the differences into their price determinations (i.e., they will price the lack of transparency, clarity and comparability in what may be perceived to be lower-quality requirements).908 One commenter recommended that requirements related exclusively to SRCs should be grouped together under separate headings in Regulation S–K.909 b. Discussion In simplifying disclosure requirements for small businesses, we seek to facilitate capital formation without compromising investor protection. Previous Commission efforts in this area have focused on reducing requirements that impede the formation and growth of small businesses and, 906 Id. 907 See UK Financial Report Council. CFA Institute. 909 See Shearman. 908 See E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules given the nature of these smaller companies, the Commission determined are not necessary for the protection of investors.910 The disclosure items formerly required by Form S–18 generally were consistent with the corresponding items in Form S–1. However, Form S–18 required less extensive narrative disclosure and simplified financial statements, consistent with Regulation A. Based on input from public hearings and written comments, the Commission sought to require in Form S–18 only the information that normally would be applicable to those small businesses expected to use the form. Accordingly, the Commission reduced or eliminated requirements that it determined were particularly burdensome to small businesses and tended to elicit information that, in the small business context, was less relevant or less beneficial to investors.911 For example, Form S–18 did not use the description of business requirement from Regulation S–K. Instead, Form S– 18 provided smaller issuers the flexibility to discuss other businessrelated disclosure, such as their dependence on a limited number of customers or suppliers (including suppliers of raw materials or financing) and cyclicality of their industry, only if it would have ‘‘a material impact upon the registrant’s future financial performance.’’ 912 In addition, Form S–18 required two years of audited financial statements prepared in accordance with U.S. GAAP,913 similar in content to those required by Regulation A at the time,914 as opposed to the more detailed requirements in Form S–1. In adopting Form S–18, the Commission stated its belief that the simplified financial statements and schedules would result in costs savings to registrants while providing investors adequate information about these smaller offerings.915 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 910 See, e.g., Form S–18 Release and Small Business Initiatives Proposing Release. 911 See Form S–18 Release. 912 Form S–18 Release at 21570; See also 1977 Regulation S–K Adopting Release. 913 Specifically, Form S–18 required: (1) A consolidated balance sheet as of a date within ninety days prior to the date of filing; and (2) consolidated statements of income, source and application of funds, and other stockholders’ equity for the two fiscal years prior to the date of filing. See Form S–18 Release. 914 Until 2015, Regulation A required financial statements to be prepared in accordance with U.S. GAAP. In 2015, the Commission revised Regulation A to allow Canadian issuers to prepare their financial statements in accordance with either U.S. GAAP or International Financial Reporting Standards. See 2015 Regulation A Release. 915 See Form S–18 Release. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 Under Regulation S–B, the narrative disclosure requirements generally paralleled those in Regulation S–K at the time, except that Regulation S–B incorporated the simplified requirements of Form S–18. The financial information required by Regulation S–B was substantially similar to that required by Form S–18, except that Regulation S–B also addressed interim financial statement requirements.916 In 2007, the Commission eliminated the separate Regulation S–B disclosure requirements and instead provided scaled disclosure requirements in Regulation S–K and Regulation S–X.917 For example, new paragraph (h) to Item 101 of Regulation S–K set forth the alternative disclosure standards for smaller companies that had appeared in Item 101 of Regulation S–B.918 The Commission included an index in Item 10 to identify the Items of Regulation S–K containing scaled disclosure requirements for SRCs.919 In response to comment letters and the recommendation of the ACSPC, the Commission revised the requirements in Regulation S–X to require two years of comparative audited balance sheet data for SRCs, rather than the one year previously required by Regulation S–B.920 The Commission noted that the additional balance sheet data would provide a more meaningful presentation for investors without a significant additional burden on SRCs, because the earlier year data would be readily available for purposes of preparing the otherwise required statements of income, cash flows and changes in stockholders’ equity.921 Unlike Regulation S–B, which required small business issuers to comply with the entire Regulation S–B disclosure regime, the amendments to Regulation S–K adopted in 2007 permitted SRCs to comply selectively with the scaled disclosure requirements on an item-by-item basis.922 The Commission intended the amendments to eliminate redundancies and provide 916 See Small Business Initiatives Adopting Release. See also supra note 913. 917 See SRC Adopting Release. 918 Item 101(h) of Regulation S–K [17 CFR 229.101(h)]. 919 Item 10(f) of Regulation S–K [17 CFR 229.10(f)]. 920 See SRC Adopting Release. 921 See id. 922 Id. Where a disclosure requirement applicable to SRCs was more stringent than the corresponding requirement for other registrants, SRCs were required to comply with the more stringent standard. The SRC Adopting Release identified Item 404 of Regulation S–K as the only instance where the requirements applicable to SRCs could be more stringent than the larger company standard. PO 00000 Frm 00077 Fmt 4701 Sfmt 4702 23991 a more streamlined disclosure system for SRCs.923 In recent years, the Small Business Forum has recommended that the Commission: • Eliminate or significantly reduce the extent of XBRL tagging requirements for SRCs; and • permit SRCs to exclude line itemresponsive disclosures from their periodic reports if such disclosures are not material.924 Similarly, in the last few years, the ACSEC has recommended that the Commission: • exempt SRCs from XBRL tagging requirements; 925 • exempt SRCs from filing immaterial attachments to material contracts; 926 and • when adopting new disclosure rules, consider whether such rules place a disproportionate burden on SRCs in terms of the cost of, and time spent on, compliance with such requirements, and if so, provide for exemptions from or phase-in periods for such new rules for SRCs.927 In 2015, the FAST Act directed the Commission to revise Regulation S–K to further scale or eliminate requirements in order to reduce the burden on EGCs, accelerated filers, SRCs, and other smaller issuers, while still providing all material information to investors.928 Given these recommendations and the recent legislative directive, we are seeking public input on whether we should expand or eliminate any of our scaled disclosure requirements to further ease the compliance burden for smaller registrants and, if so, how we could do so without sacrificing investor protection. c. Request for Comment 268. Are there any disclosure requirements for which scaling is not appropriate? 269. How should we assess whether scaled disclosures are effective at 923 Id. 924 See, e.g., 2014 Forum Report; Final Report of the 2013 SEC Government-Business Forum on Small Business Capital Formation, June 2014, available at https://www.sec.gov/info/smallbus/ gbfor32.pdf; 31st Annual SEC Government-Business Forum on Small Business Capital Formation Final Report, Nov. 15, 2012, available at https:// www.sec.gov/info/smallbus/gbfor31.pdf. 925 See 2015 ACSEC Recommendations; Advisory Committee on Small and Emerging Companies Recommendations Regarding Disclosure and Other Requirements for Smaller Public Companies, Feb. 1, 2013, (‘‘2013 ACSEC Recommendations’’), available at https://www.sec.gov/info/smallbus/acsec/acsecrecommendation-032113-smaller-public-co-ltr.pdf. 926 See 2015 ACSEC Recommendations; 2013 ACSEC Recommendations. 927 See 2013 ACSEC Recommendations. 928 Public Law 114–94, Sec. 72002(1), 129 Stat. 1312 (2015). E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 23992 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules achieving the Commission’s mission of protecting investors, maintaining fair and orderly markets and facilitating capital formation? 270. Are there disclosure requirements that are particularly beneficial for investors in smaller registrants? For example, are there disclosure requirements that elicit information that is not as readily available outside of smaller registrants’ filings although this information might be readily available outside of a filing for larger or more seasoned companies? If so, which requirements and why? Does the information elicited from smaller registrants by these disclosure requirements appropriately consider the costs of these requirements to these smaller registrants? 271. Are there additional item requirements that we should consider scaling for SRCs? Are there any current scaled disclosure requirements that we should scale further or eliminate entirely? 272. Should we allow EGCs to take advantage of the scaled disclosure requirements currently available only to SRCs, such as the less extensive requirements for the description of business set forth in Item 101(h) of Regulation S–K or the elimination of the contractual obligations table available under Item 303(d) of Regulation S–K? 273. Should we reorganize Regulation S–K, as recommended by one commenter,929 to group the requirements related exclusively to SRCs together under separate headings? Why or why not? 274. Should we eliminate or reduce the XBRL tagging requirements for SRCs? What, if any, XBRL tagging should we require of SRCs? 275. Should we permit SRCs to exclude disclosure that would be responsive to specific items in Regulation S–K from their periodic reports if such disclosures are not material? Should we permit SRCs to omit all such disclosure or should we limit this accommodation to specific items in Regulation S–K? 276. What types of investors or audiences would be affected by further scaling? How? 277. Do our scaled disclosure requirements appropriately consider the costs and benefits of these requirements to smaller registrants and investors in these registrants? What savings (or costs avoided) for registrants, including the administrative and compliance costs of preparing and disseminating disclosure, would likely arise from scaling additional item requirements? Please 929 See Shearman. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 provide quantifications of savings and costs avoided where possible. 3. Frequency of Interim Reporting The federal securities laws have required registrants to provide annual reports since 1934.930 In 1955, the Commission adopted rules requiring registrants to file semi-annual reports on Form 9–K.931 In the proposing release for Form 9–K, the Commission stated that ‘‘consideration should be given to requiring reports of certain significant information more frequently than annually.’’ 932 Investors and the securities industry supported the semiannual reporting proposal, while registrants opposed it.933 The Commission has required quarterly reporting since 1970, when it adopted Form 10–Q to replace the semiannual report on Form 9–K.934 However, prior to adopting Form 10–Q, more than seventy percent of public companies produced quarterly reports, partially in response to exchange listing standards.935 As adopted in 1970, Form 930 As enacted, Section 13 of the Exchange Act required listed companies to furnish annual reports, and if the Commission required, quarterly reports. John Hanna, The Securities Exchange Act as Supplementary of the Securities Act, 4 Law & Contemp. Probs. 256, 256–268 (1937). Exchange Act reporting requirements were extended to non-listed registrants with the enactment of Section 12 of the Exchange Act in 1964. See supra note 14. 931 See Semi-Annual Reports, Release No. 34– 5189 (June 23, 1955) [20 FR 4816 (July 7, 1955)]. The Form 9–K was filed once a year, 45 days after the end of the first half the registrant’s fiscal year. The semi-annual report required disclosure with respect to sales and gross revenues, net income before and after taxes, extraordinary and special items, and charges and credits to earned surplus. Form 9–K did not require formal statements of profit and loss or earned surplus and was not required to be certified. 932 Notice of Proposed Rule Making, Semi-Annual Reports, Release No. 34–5129 (Jan. 27, 1955) [20 FR 771 (Feb. 4, 1955)] at 772. 933 See Philip Augar, For Markets There is Such a Thing as Too Much Information, Financial Times, Feb. 1, 2015 (‘‘Augar’’). 934 See Quarterly Reporting Form, Release No. 34–9004 (Oct. 28, 1970) [35 FR 17537 (Nov. 14, 1970)] (‘‘Form 10–Q Adopting Release’’). Form 10– Q was adopted in response to the Wheat Report. See Wheat Report at 357–58 (‘‘More and more publiclyheld corporations are releasing condensed quarterly financial information. Both the New York and American Stock Exchanges require publication of such information by all listed companies, although the standards which they set for such information are minimal . . . The Study carefully examined a significant sample of quarterly financial reports and releases provided by the two exchanges. It was readily apparent . . . that they varied from extremely useful to extremely poor and uninformative . . . It was concluded that a useful advance in disclosure policy could be achieved by developing standards for quarterly financial reporting.’’). 935 See Arthur Kraft et al., Real Effects of Frequent Financial Reporting (Cass Business School, City University London, Working Paper Series No. 26, Aug. 2014) at 2 (‘‘Kraft et al.’’). See also Marty Butler et al., The effect of reporting frequency on PO 00000 Frm 00078 Fmt 4701 Sfmt 4702 10–Q required summarized financial information and profit and loss information in more detail than was required by Form 9–K, including data on earnings per common share. In addition, information on a registrant’s capitalization and stockholders’ equity was also required.936 In 1981, in connection with its integrated disclosure initiatives, the Commission revised Form 10–Q to ‘‘build upon the annual reporting system to ensure meaningful disclosure on a continuous basis by making quarterly reporting a mechanism to update the annual report.’’ 937 The amendments were intended to complement the previously adopted revisions relating to annual reporting, and included the addition of management’s discussion and analysis of interim financial information.938 Other significant additions to Form 10– Q over time have included quantitative and qualitative disclosures about market risk,939 disclosure controls and procedures,940 and risk factors.941 a. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. One commenter suggested that semiannual financial reporting may be sufficient for SRCs that are not listed on a national exchange, noting that scaling the requirement in this way would align the treatment of SRCs with that of comparable companies that are now the timeliness of earnings: The cases of voluntary and mandatory interim reports, 43 J. Acct. Econ. 181, 185 (2007). The New York Stock Exchange began requiring annual reports in 1914, and by 1923, over twentyfive percent of NYSE-listed companies were publishing quarterly reports with another eight percent publishing semi-annual reports. By 1933, over sixty percent of NYSE-listed companies were publishing quarterly reports and twelve percent published semi-annual reports. See James E. Davis, Corporate Disclosure through the Stock Exchanges, Apr. 24, 1999 (unpublished paper) (on file with Harvard Law School and available at https:// cyber.law.harvard.edu/rfi/papers/disclose.pdf). The Form 10–Q proposing release also noted that ‘‘[m]any publicly held companies are releasing condensed quarterly financial information, and the major stock exchange[s] require publication of such information by listed companies.’’ Form 10–Q For Disclosure of Financial Information, Release No. 34–8683 (Sept. 1969) [34 FR 14239 (Sept. 10, 1969)]. 936 See Form 10–Q Adopting Release. 937 See New Interim Financial Information Provisions and Revision of Form 10–Q for Quarterly Reporting, Release No. 33–6288 (Feb. 9, 1981) [46 FR 12480 (Feb. 17, 1981)] (‘‘New Interim Financial Information Release’’) at 12481. 938 Id. 939 See Disclosure of Market Risk Sensitive Instruments Release. 940 See Certification of Disclosure in Companies’ Quarterly and Annual Reports, Release No. 33–8124 (Aug. 29, 2002) [67 FR 57276 (Sept. 9, 2002)]. 941 See Securities Offering Reform Release. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules able to rely on the exemption under Regulation A.942 b. Discussion The Commission adopted quarterly reporting with the purpose of ensuring meaningful disclosure to investors on a continuous basis.943 The Wheat Report concluded that one of the principal omissions in the Exchange Act reporting system was the absence of a quarterly summary of basic financial information prepared using reasonably specific standards.944 The Wheat Report also concluded that ‘‘a regular, quarterly report would be more useful than the current reports on Form 8–K, which were filed irregularly.’’ 945 Accordingly, quarterly reports were intended to provide a mechanism to update the information in an annual report on Form 10–K in a more consistent manner and on a regular basis. The value of quarterly financial reporting has been the subject of debate.946 Opponents of quarterly reporting argue that frequent financial reporting may lead management to focus on short-term results to meet or beat earnings targets rather than on long-term strategies.947 Consequently, some have argued that quarterly reports should be discontinued 948 or made voluntary 949 in the United States.950 942 See mstockstill on DSK4VPTVN1PROD with PROPOSALS3 943 See Ernst & Young 2. New Interim Financial Information Release. 944 See Wheat Report at 332–334. 945 See id. at 332. 946 The debate over quarterly reporting sometimes includes concerns of ‘‘short-termism.’’ The discussion here is not intended to capture all aspects of, or issues raised in, the short-termism debate. For a list of recent publications on short-termism, see Therese Strand, Re-Thinking Short-Termism and the Role of Patient Capital in Europe: Perspectives on the New Shareholder Rights Directive, 22 Colum. J. Eur. L. 1, footnote 26 (2015) at footnote 26. 947 See Kraft et al. 948 See Martin Lipton, Legal & General Calls for End to Quarterly Reporting, Aug. 19, 2015, available at https://www.wlrk.com/webdocs/ wlrknew/AttorneyPubs/WLRK.24734.15.pdf. The author suggests that the Commission should consider the UK’s move toward discontinuing quarterly reporting in pursuing disclosure reform initiatives. He notes that Legal & General Investment Management, a global investment firm with more than £700 billion in assets under its management, contacted the boards of London Stock Exchange’s 350 largest companies to support the discontinuation of quarterly reporting. According to the author, Legal & General emphasized that shortterm reporting ‘‘is not necessarily conducive to building a sustainable business’’ and ‘‘adds little value for companies that are operating in long-term business cycles.’’ See also David Benoit, Time to End Quarterly Reports, Law Firm Says, The Wall Street Journal, Aug. 19, 2015, available at; https:// www.wsj.com/articles/time-to-end-quarterlyreports-law-firm-says-1440025715. 949 See Augar. 950 Other jurisdictions have eliminated quarterly reporting. For example, in the European Union, the VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 On the other hand, some advocates of frequent reporting, typically on a quarterly basis, point out that greater frequency improves the timeliness of earnings and reduces information asymmetry between managers and investors.951 Others are skeptical of the benefits of eliminating quarterly reporting requirements.952 According to one survey of institutional investors, fifty-eight percent of investors preferred to receive information on a quarterly basis to confirm or reframe expectations.953 Some advocates have expressed concern that eliminating quarterly reporting requirements would result in inconsistent reporting intervals across registrants and potentially, from period to period.954 Meanwhile, others argue that delaying a report by a few months would not fix the problems of short-termism.955 The value of quarterly reporting may vary by industry or by the size of the registrant. For example, investors in smaller, capital-intensive technology companies may focus more on requirement for issuers traded on a regulated market to publish financial information more frequently than annual financial reports and semiannual reports was abolished in 2013. See Directive 2013/50/EU of the European Parliament and of the Council, Oct. 22, 2013, available at https://eurlex.europa.eu/legal-content/EN/TXT/ ?uri=CELEX:32013L0050. Following implementation, E.U. member states generally will require only annual and semi-annual reports. However, an E.U. member state may require issuers to publish additional periodic financial information if the requirement does not constitute a significant financial burden and if the required information is proportionate to the factors that contribute to investment decisions. Id. 951 See Kraft et al. 952 See Ronald Barusch, Dealpolitik: Attention CFOs—Don’t Get Your Hopes Up for an End to Quarterly Reporting, The Wall Street Journal Blog, Aug. 20, 2015 (‘‘Barusch’’), available at https:// blogs.wsj.com/moneybeat/2015/08/20/dealpolitikattention-cfos-dont-get-your-hopes-up-for-an-endto-quarterly-reporting (‘‘Eliminating quarterly reporting won’t make investors any less interested in quarterly results. Analysts and professional investors will do their best to figure out what the quarterly would have shown even if companies don’t disclose it themselves.’’). 953 See Ernst & Young, Right team, right story, right price, (2013), available at https://www.ey.com/ Publication/vwLUAssets/Investment_appetite_up_ for_IPOs_among_institutional_investors/$FILE/ Institutional_Investor_Survey.pdf. 954 See, e.g., Barusch (expressing concerns that eliminating the quarterly report requirement could allow public companies to ‘‘provide just what they want the public to know in whatever intervals they choose,’’ whereas the ‘‘current rules require quarterly GAAP-compliant financial information in a standard format’’). 955 See Barry Ritholtz, Wrong Fix for Short-Term Corporate Thinking, Bloomberg, Aug. 20, 2015, available at https://www.bloombergview.com/ articles/2015–08–20/wrong-fix-for-short-termcorporate-thinking; and Mark J. Roe, The Imaginary Problem of Corporate Short-Termism, The Wall Street Journal, Aug. 17, 2015, available at www.wsj.com/articles/the-imaginary-problem-ofcorporate-short-termism-1439853276. PO 00000 Frm 00079 Fmt 4701 Sfmt 4702 23993 significant business or technology developments than on quarterly financial reports.956 Similarly, the costs of more frequent reporting may impose a disproportionate burden on smaller or less capitalized registrants.957 At the same time, smaller registrants may be more volatile and quarterly reporting may provide more timely disclosure of performance issues.958 Additionally, because smaller, capital-intensive companies may need greater or more frequent access to capital markets, more frequent reporting may provide greater investor confidence and a lower cost of capital for these companies.959 c. Request for Comment 278. Do investors, registrants and the markets benefit from quarterly reporting? What are the benefits and costs to investors, registrants and the markets from the current system of quarterly reporting? Should we revise or eliminate our rules requiring quarterly reporting? Why or why not? 279. Should the reporting requirements be different for different types of registrants? Should we consider permitting SRCs to file periodic reports on a less frequent basis, such as semiannually? If so, what disclosures should we require in those reports? 280. Should we allow other categories of registrants to file periodic reports on a less frequent basis, such as semiannually? If so, which categories of registrants should be permitted to file less frequently, and what disclosure should be required? 281. Should we require certain registrants to file periodic reports on a more frequent basis such as monthly? 282. Should we consider reducing the level of disclosure required in the quarterly reports for the first and third quarters? If so, what disclosure should we require in these abbreviated quarterly reports? Should the disclosure requirements for SRCs be the same as those that apply to other categories of registrants? 283. Do quarterly reporting obligations influence the strategic goals and timelines of registrants’ management? Do quarterly reporting 956 See Transcript, Meeting of SEC Advisory Committee on Small and Emerging Companies (Sept. 23, 2015) at 64–65 (noting that some biotechnology companies may not trade on their financial quarterly reporting but rather, may trade on their fundamental clinical development and regulatory events). The ACSEC discussed issues raised by quarterly reporting for small and emerging companies at its September 2015 meeting but did not issue formal recommendations. See id. 957 See id. at 60–61. 958 See id. at 74. 959 See id. at 87–90. E:\FR\FM\22APP3.SGM 22APP3 23994 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 obligations help or hinder long-term decision making by registrants? 284. What types of investors or audiences are most likely to value the information that registrants disclose in quarterly reports? 285. What are the savings (or costs avoided) for registrants, including the administrative and compliance costs of preparing and disseminating disclosure, that would likely arise from revising or eliminating our rules requiring quarterly reporting? Please provide quantifications of savings and costs avoided where possible. V. Presentation and Delivery of Important Information Given the volume, complexity and sophistication of corporate disclosures, the presentation and delivery of information may play a significant role in investors’ ability to access and use important disclosure. The Commission’s own disclosure system creates some fragmentation of information, in both location and time. Registrants provide disclosure on Forms 10–K, 10–Q, and 8– K, which are filed on EDGAR. Registrants also can provide broad, nonexclusionary distribution of information under Regulation FD either on Form 8– K or through press releases, conference calls, or Web sites.960 In addition, registrants may use tools such as crossreferencing and incorporation by reference to reduce repetitive disclosure and present more streamlined information in each filing. As different investors and third parties likely use disclosures in different ways, the benefits of different presentation and delivery approaches may vary. The S–K Study recommended that the staff consider ways to present information that would improve the readability and navigability of disclosure. It also recommended that the staff explore methods to discourage repetition and disclosure of immaterial information.961 Additionally, the FAST Act requires the Commission to issue regulations permitting registrants to submit a summary page in their Form 10–K only if each item on the summary page includes a cross-reference (by electronic link or otherwise) from each item in the summary to the related material in the Form 10–K.962 In light of the S–K Study’s recommendations and the recent FAST Act mandate, we are seeking public input on how our rules can facilitate the 960 See Selective Disclosure and Insider Trading, Release No. 33–7881 (Aug. 15, 2000) [65 FR 51716 (Aug. 24, 2000)] (‘‘Regulation FD Release’’). 961 See S–K Study at 98–99. 962 Public Law 114–94, Sec. 72001, 129 Stat. 1312 (2015). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 readability and navigability of disclosure documents. We are seeking public input on the use of tools such as cross-referencing, incorporation by reference, hyperlinks and registrant Web sites as well as other ways we could change our disclosure requirements to improve the readability and navigability of registrant filings.963 Given the various types of filings and other delivery methods available to registrants, we also are seeking input on where information should be provided directly and in full, and where references to the location of the information may suffice. Additionally, we are interested in whether any required disclosures would be more effective if we required registrants to present them in a specified format, such as a tabular or graphic presentation, to layer the disclosures by means of a summary or overview, or to provide certain information as structured data. A. Cross-Referencing In lieu of presenting duplicative disclosure, our rules generally permit registrants to cross-reference to information in one section of a document to satisfy a disclosure requirement in another section of the document. Several items in Regulation S–K specify that a company may include in its financial statements or related notes a cross-reference to certain information in the non-financial statement disclosure or, conversely, a company may cross-reference from the disclosure to the financial statements or notes thereto.964 In addition to allowing for cross-referencing, Item 303(a)(4) of Regulation S–K requires that the substance of the cross-referenced information be integrated into the discussion to help inform readers of the significance of the information that is omitted from MD&A.965 1. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. Many commenters provided recommendations supporting the use of cross-referencing.966 A few of these 963 Some of the concepts raised in this section, such as incorporation by reference to Securities Act filings, may include filings outside of the scope of this release. 964 See, e.g., Items 101(b) and (d)(2), 202(a)(5), and Instruction 5 to Item 303(a)(4) of Regulation S– K [17 CFR 229.101(b) and (d)(2), 17 CFR 229.202(a)(5), and 17 CFR 229.303(a)(4)]. For a discussion of circumstances where crossreferencing would not be permissible or appropriate, see Section V.A.2.c. 965 Instruction 5 to Item 303(a)(4) of Regulation S– K [17 CFR229.303(a)(4)]. 966 See, e.g., letter from Thomas Amy (June 5, 2014) (‘‘T. Amy’’); CCMC; SCSGP; CFA Institute; PO 00000 Frm 00080 Fmt 4701 Sfmt 4702 commenters recommended clear and precise cross-references to help investors locate important information in the current volume of disclosure.967 Several supported greater use of crossreferencing to eliminate redundancies.968 One of these commenters supported the use of crossreferencing where appropriate to eliminate duplicative information but suggested that any referenced document should be considered ‘‘filed with the SEC’’ for legal and liability purposes.969 One of these commenters supported cross-referencing so long as the level of auditor assurance was not diminished.970 This same commenter noted that many sections within Commission filings are meant to touch on the same topic but from a different perspective and encouraged the Commission to consider not whether those sections should be eliminated, but whether they should be tailored to meet the original disclosure objective. Some commenters suggested that the Commission require or encourage the use of cross-references within filings.971 One of these commenters recommended a new Commission policy on the avoidance of duplication and the use of cross-references.972 This commenter recommended adding instructions to specific Regulation S–K items to encourage the use of cross-references to avoid duplicative disclosure.973 This commenter also recommended that the inclusion of responsive disclosure anywhere in a document should be sufficient to satisfy the disclosure requirement without the need to include Shearman; ABA 2; letter from William J. Klein and Thomas J. Amy (Dec. 12, 2014) (‘‘Klein and Amy 1’’); letter from William J. Klein and Thomas J. Amy (Aug. 31, 2015) (‘‘Klein and Amy 4’’); AFL–CIO. 967 See, e.g., T. Amy; Klein and Amy 1; Klein and Amy 4. 968 See, e.g., ABA 2; CCMC; CFA Institute; Shearman. 969 See AFL–CIO. 970 See CFA Institute. 971 See, e.g., Klein and Amy 1 (recommending that the Commission consider requiring that filers: (1) Make specific cross-references between the line items on their financial statements and the related notes, including the page where the note may be found; and (2) include a detailed table of contents or index for the notes, which would increase the transparency of financial information and make it easier to read and understand); Klein and Amy 4 (reiterating their previous recommendations and recommending that the Commission consider requiring that filers provide specific crossreferences between all discussions of Legal Proceedings that appear in different sections of the report and in the notes to the financial statements); ABA 2; Shearman. 972 See ABA 2. 973 See id. (recommending amendments to Items 101(c)(ix) and 303(a)(1), (4) and (5) to state that ‘‘cross-references should be used to avoid duplicative disclosure’’). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules a cross-reference in each item calling for the information.974 2. Discussion We recognize that an investor may find it easier to access all relevant information in a single location, even if a portion of the information is repeated elsewhere in the document. However, repetitive disclosure may obscure relevant information or render it difficult to evaluate the importance of the information. Below, we consider ways in which cross-references could potentially be used to reduce redundant disclosure and improve the navigability of lengthy documents. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 a. Cross-References to Reduce Repetitive Disclosure Where different disclosure requirements call for the same information in separate parts of the same document, as discussed above, our rules generally allow the registrant to cross-reference to the applicable discussion in another part of the document rather than duplicating the disclosure.975 In some instances, Regulation S–K and U.S. GAAP requirements call for similar but not identical disclosures.976 A registrant, subject to certain conditions, may present all the information required by both requirements in one location, with the second location simply containing a cross-reference back to the first location.977 In this way, the related 974 See id. The one exception recommended was for the financial statements and notes to the financial statements, where cross-references should not be used to satisfy U.S. GAAP requirements. However, where the financial statements and notes to the financial statements include disclosure that is responsive to Regulation S–K items, the commenter recommended that the rules allow an appropriate cross-reference to the relevant financial statement disclosure to satisfy the requirement. 975 See Section V.A. In the Securities Act context, Commission staff has discouraged registrants from repeating disclosure in multiple places in a prospectus, instead encouraging the inclusion of a brief overview to provide context in one section along with a cross-reference to more detailed discussion elsewhere. See also Updated Staff Legal Bulletin No. 7. In addition, Securities Act Rule 421(b), amended at the same time as our Plain English Rules, discourages repeating disclosure in more than one location that lengthens the filing without enhancing the quality of the information. See Note 4 to Rule 421(b) [17 CFR 230.421(b)]; Plain English Disclosure Adopting Release. 976 See, e.g., Item 103 of Regulation S–K (Legal proceedings) [17 CFR 229.103] and ASC Topic 450 (Contingencies); Item 404 of Regulation S–K (Transactions with related persons, promoters and certain control persons) [17 CFR 229.404] and ASC Topic 850 (Related Party Disclosures). The staff is separately considering Item 103 in developing recommendations for potential changes to update or simplify the requirements. For a description of these recommendations, see Section I. 977 In some instances, a cross-reference is effectively prohibited because it would be VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 disclosures may be logically presented together and both requirements met in their separate locations within the filing while avoiding duplicative or partially duplicative disclosure. In seeking input on how registrants can most effectively present and deliver important information, we recognize that information may be relevant to more than one filing or more than one section of a given filing. Registrants often repeat information in response to different item requirements in Form 10– K. For example, disclosure about the registrant’s business appears in the Business section, and parts of that disclosure may be repeated in MD&A, risk factors, and the footnotes to the financial statements. Repetition of this information may be beneficial in certain contexts, such as a registrant with a complex organizational structure or business model. Repetition also may provide users of disclosure with direct access to the information they need in a consistent location, particularly to the extent that different audiences for disclosure focus on different filings or sections of filings. In other instances, such repetition can be distracting. i. Request for Comment 286. Do investors find that crossreferencing within a filing in lieu of repeating the disclosure helps them locate important information? Why or why not? 287. Are there specific items in Regulation S–K that would benefit from greater use of cross-referencing to reduce duplicative disclosure? If so, which items? For these specific items, should we amend the item to specifically encourage use of crossreferences? Alternatively, and as suggested by a commenter,978 should we amend these items to meet the original disclosure objective more effectively? 288. Does cross-referencing negatively affect investors’ ability to use disclosure by creating inconsistency in the location of information across different registrants and different filings? To what extent does cross-referencing introduce challenges with respect to comparative analyses or large-scale automated processing of disclosure? 289. Should we require registrants to provide certain disclosures in the same inconsistent with the disclosure requirement. For example, the table of contractual obligations calls for aggregated information in a single location. A registrant could not satisfy the requirement to provide the data required in the table of contractual obligations with a cross-reference in MD&A to multiple financial statement footnotes. See Item 303(a)(5) of Regulation S–K [17 CFR 229.303(a)(5)]; and Off-Balance Sheet and Contractual Obligations Adopting Release. 978 See CFA Institute. PO 00000 Frm 00081 Fmt 4701 Sfmt 4702 23995 location (e.g., under a specific item of the form) in every filing, rather than permitting cross-referencing? If so, which information should be located consistently and where should that information be located? 290. To what extent does the flexibility to use cross-references reduce compliance and administrative costs to registrants of preparing and disseminating disclosures? Please provide quantifications if possible. b. Cross-References To Navigate Disclosure Cross-references can also assist readers in navigating disclosure where disclosures are not necessarily duplicative but relate to the same topic and may be required in multiple locations throughout a filing.979 For example, a discussion in the business section about how a registrant generates revenue may benefit from a crossreference to the registrant’s revenue recognition policy. Similarly, a risk factor that the registrant may not be able to meet payments on its outstanding debt may benefit from a reference to the debt footnote in the financial statements. Including these crossreferences may help readers obtain a more complete picture by directing them to other similar information that the reader may not have otherwise reviewed. In addition, where registrants include a summary or overview of their filing or part of their filing, as contemplated by the FAST Act,980 cross-references can assist the reader in locating the more detailed disclosure included elsewhere in the filing.981 i. Request for Comment 291. Are there certain items or topics that would benefit from a crossreference to related or more comprehensive disclosure in different parts of the filing? If so, what are those items or topics? 292. Do cross-references that identify related information make the disclosure more or less readable? c. Limitations on Cross-Referencing Registrants’ ability to use crossreferences is not unlimited, as the 979 For a discussion of hyperlinks, see Section V.C. 980 Public Law 114–94, Sec. 72001, 129 Stat. 1312 (2015). 981 See, e.g., H.R. Rep. 114–279, 114th Cong., 1st Sess. 4 (2015) (stating ‘‘[b]ecause the typical 10–K . . . is hundreds of pages long, investors find it difficult to locate important information’’ and that ‘‘a summary page would enable companies to concisely disclose pertinent information . . . [and] would also enable investors to more easily access the most relevant information about a company’’). For a discussion of layered disclosure, see Section V.F. E:\FR\FM\22APP3.SGM 22APP3 23996 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Commission has discouraged crossreferences that render disclosure unclear or incomplete. It also has acknowledged that vague or excessive cross-references can hinder the reader’s ability to locate and understand information.982 Moreover, even specific cross-references may draw the reader away from key information.983 While none of our rules prohibit the use of cross-references, there may be instances where cross-references would not satisfy the requirements or would detract from the readability or completeness of the disclosure. For example, the Commission has stated that its MD&A rules are intended to provide, in one section of a filing, a discussion of all the material impacts on the registrant’s financial condition or results of operations, including those arising from circumstances discussed elsewhere in the filing.984 Cross-referencing is contemplated under auditing standards.985 However, some auditors have expressed concern that cross-referencing from the financial statements to MD&A may confuse users on the auditor’s responsibilities and what information the auditor’s report covers.986 Others have stated that the financial statements and the related notes should stand on their own so they can be audited or reviewed, as applicable.987 982 See Plain English Disclosure, Release No. 33– 7380 (Jan. 14, 1997) [62 FR 3152 (Jan. 21, 1997)]. 983 See U.S. Securities and Exchange Commission, Office of Investor Education and Assistance. A Plain English Handbook: How to Create Clear SEC Disclosure Documents (1998), available at https://www.sec.gov/pdf/handbook.pdf. 984 See 1989 MD&A Interpretive Release. This guidance predated the use of hyperlinking technology. For a discussion of the limitations on hyperlinks to related materials, see Section V.C. 985 AU 508, Paragraph 41 provides: Inadequate disclosure. Information essential for a fair presentation in conformity with generally accepted accounting principles should be set forth in the financial statements (which include the related notes). When such information is set forth elsewhere in a report to shareholders, or in a prospectus, proxy statement, or other similar report, it should be referred to in the financial statements. [Emphasis added] 986 See, e.g., letter from PricewaterhouseCoopers LLP to FASB, Nov. 29, 2012, available at https:// www.fasb.org/cs/BlobServer?blobkey=id& blobnocache=true&blobwhere=1175825243422& blobheader=application%2Fpdf&blobheader name2=Content-Length&blobheadername1= Content-Disposition&blobheadervalue2=621509& blobheadervalue1=filename%3DDISFR.DP.0029. PRICEWATERHOUSECOOPERS_LLP.pdf&blobcol= urldata&blobtable=MungoBlobs (recommending that notes not cross-reference to MD&A as it will not be clear what the audit report covers). 987 See, e.g., Financial Accounting Standards Board and Center for Audit Quality, Financial Statement Disclosure Effectiveness: Forum Observations Summary, Oct. 2012, available at https://www.fasb.org/cs/ContentServer?c= Document_C&pagename=FASB%2FDocument_ C%2FDocumentPage&cid=1176160567809 (‘‘FASB/ VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 In addition, the financial statements are not covered by the PSLRA safe harbor from liability for forward-looking statements. The PSLRA does, however, cover MD&A disclosures.988 While nothing prohibits cross-referencing between the financial statements and, for example, MD&A, forward-looking statements pulled from MD&A into the financial statements could ‘‘lose’’ their PSLRA safe harbor. Accordingly, preparers concerned about forwardlooking information may have a disincentive to include a cross-reference in the financial statements to forwardlooking information elsewhere in the document out of concern that doing so would effectively pull the statements into the financial statements and expose the registrant to liability without the protection of the PSLRA for such statements.989 i. Request for Comment 293. Are there items or topics where cross-references detract from the readability of a filing? Are there items or topics where we should prohibit cross-references and require all related information be presented in a single location? What are these items or topics? 294. Some of the Commission’s guidance limiting the use of crossreferencing pre-date the expanded use of technology that allows registrants to hyperlink to referenced disclosure.990 In light of technological changes that allow hyperlinks, which we discuss below, should we reconsider those rules that seek to provide investors with information in a single location? 295. Should we introduce requirements or guidance for the use of cross-references in order to increase the consistency in location of information across periods and registrants? If so, what requirements or guidance should we consider? CAQ Forum’’) (noting that some participants opposed cross-referencing as a tool to address disclosure overlap between MD&A and notes to financial statements due to concerns related to audit responsibility or because they felt that MD&A and the notes should each stand on their own); letter from PricewaterhouseCoopers LLP to FASB, July 10, 2014, available at https://www.fasb.org/jsp/ FASB/CommentLetter_C/CommentLetterPage&cid= 1218220137090&project_id=2014-200 (expressing concern that disclosures presented outside the audited financial statements prepared in accordance with U.S. GAAP may not be subject to the same degree of scrutiny and assurance). See also ABA 2 (recommending a policy encouraging crossreferencing, except in the financial statements and notes to the financial statements, which should be considered a standalone section). 988 15 U.S.C. 78u–5. See also Off-Balance Sheet and Contractual Obligations Adopting Release. 989 See e.g., FASB/CAQ Forum. 990 See supra note 984. PO 00000 Frm 00082 Fmt 4701 Sfmt 4702 B. Incorporation by Reference Rule 12b–23 of the Exchange Act generally allows a registrant to incorporate by reference information in any part of a registration statement or report in answer, or partial answer, to any other item of a registration statement or report.991 In Form 10–K, registrants may incorporate by reference the information called for by Parts I and II 992 of Form 10–K from the company’s annual report to security holders. Registrants also may incorporate by reference the information required by Part III of Form 10–K from the registrant’s definitive proxy statement or information statement, as applicable.993 The staff has provided interpretive guidance on Rule 12b–23, stating that within the guidelines specified by the rule, a registrant may incorporate by reference into its own Exchange Act documents any information contained in the filed documents of another issuer.994 Rule 12b–23 provides that where material is incorporated by reference: • The material must be clearly identified by page, paragraph, and caption or otherwise; • the filing must state that the specified matter is incorporated by 991 Exchange Act Rule 12b–23 [17 CFR 240.12b– 23]. In addition, Item 10(d) of Regulation S–K provides that where rules, regulations, or instructions to forms permit incorporation by reference, information may be incorporated by reference to the specific document and to the prior filing or submission containing the information. 17 CFR 229.10(d). 992 Subject to some scaled disclosure requirements discussed in Section IV.H above, Parts I and II of Form 10–K generally require the following information: Part I: Business, Risk Factors, Unresolved Staff Comments, Properties, Legal Proceedings, and Mine Safety Disclosures. Part II: Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, Selected Financial Data, MD&A, Quantitative and Qualitative Disclosures about Market Risk, Financial Statements and Supplementary Data, Changes in and Disagreements with Accountants on Accounting and Financial Disclosure, Controls and Procedures, and Other Information. 993 Subject to some scaled disclosure requirements discussed in Section IV.H, Part III of Form 10–K generally requires the following information: Directors, Executive Officers and Corporate Governance; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters; Certain Relationships and Related Transactions and Director Independence; and Principal Accounting Fees and Services. To incorporate Part III information into the Form 10–K, the proxy statement or information statement must be filed not later than 120 days after the end of the fiscal year covered by the Form 10–K See General Instruction G(3) to Form 10–K. 994 See Exchange Act Rules Compliance and Disclosure Interpretations Question 134.01, available at https://www.sec.gov/divisions/corpfin/ guidance/exchangeactrules-interps.htm. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules reference at the particular place in the report where the information is required; and • except in certain circumstances, a copy of any information incorporated by reference or the pertinent pages of the document containing such information must be filed as an exhibit to the report where it is incorporated by reference.995 For exhibits, Rule 12b–32 allows any document or part thereof filed with the Commission to be incorporated by reference as an exhibit to any report filed with the Commission by the registrant or any other person.996 Registrants regularly satisfy exhibit filing requirements by relying on Rule 12b–32 to incorporate exhibits by reference to previously filed reports or registration statements.997 Rule 12b–32 also allows a registrant to meet the exhibit filing requirement of Rule 12b– 23(a)(3) by incorporating by reference as an exhibit the document or portion of the document containing the information incorporated by reference under that rule.998 1. Comments Received S–K Study. None. Disclosure Effectiveness. One commenter suggested that the Commission encourage the use of incorporation by reference by revising Rule 12b–23(a)(3) to eliminate the requirement that copies of the pertinent pages containing incorporated disclosure be filed as an exhibit and ease the navigability of filings by requiring incorporated disclosure to be made accessible via hyperlink in the filed document.999 Another commenter stated that many registrants fail to provide the page, paragraph, citation or other information required by Rule 12b– 23(b), rendering the references less helpful.1000 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 2. Discussion The Commission has a long history of permitting incorporation by reference.1001 Incorporation by reference 995 Exchange Act Rule 12b–23 [17 CFR 240.12b– 23]. Rule 12b–23(a)(3) provides that the following need not be filed as an exhibit: A proxy or information statement incorporated by reference in response to Part III of Form 10–K; a form of prospectus filed pursuant to 17 CFR 230.424(b) incorporated by reference in response to Item 1 of Form 8–A; and information filed on Form 8–K. 996 Rule 12b–32 [17 CFR 240.12b–32]. 997 Item 601(a) of Regulation S–K [17 CFR 229.601(a)]. 998 Rule 12b–23 [17 CFR 240.12b–23(a)(3)]. 999 See ABA 2. 1000 See Klein and Amy 1; Klein and Amy 4. 1001 See Release No. 34–51 (Nov. 27, 1934) [not published in the Federal Register] (adopting the first Exchange Act rule, JB4, allowing registrants to incorporate by reference as an exhibit any document previously or concurrently filed with the VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 was a key component of Form S–3, introduced as part of the integrated disclosure system, based on the efficient market theory.1002 The Commission envisioned that its integrated disclosure system would eliminate duplicative disclosure by allowing registrants to incorporate by reference information filed in Exchange Act reports into Securities Act registration statements.1003 The Commission also acknowledged that incorporation by reference has limitations, as there is no assurance that the mere reference to incorporated information will be meaningful to an investor or potential investor.1004 The Commission initially limited eligibility to incorporate by reference in registration statements to seasoned, exchange-traded companies based on Commission under the Exchange Act); see also Registration and Reporting Rules and Rules of General Application [13 FR 9321 (Dec. 31, 1948)] and 1948 Adoption of Amendments to General Rules and Regulations Release (adopting early versions of Rules 12b–23 and 12b–32). 1002 See 1982 Integrated Disclosure Adopting Release at 11382 (stating that ‘‘Form S–3, in reliance on the efficient market theory, allows maximum use of incorporation by reference of Exchange Act reports and requires the least disclosure to be presented in the prospectus and delivered to investors’’ and that ‘‘[g]enerally, the Form S–3 prospectus will present the same transaction-specific information as will be presented in a Form S–1 . . . The prospectus will not be required to present any information concerning the registrant unless there has been a material change . . . which has not been reported in an Exchange Act filing or the Exchange Act reports incorporated by reference do not reflect certain restated financial statements or other financial information.’’). For a description of the efficient market theory, see supra note 163. 1003 See 1980 Form 10–K Proposing Release. Certain Commission forms allow historical incorporation by reference, meaning a registrant or issuer may incorporate information by reference to previous filings. Examples include Exchange Act Form 8–A, which allows for incorporation by reference of the description of a registrant’s securities if a comparable description is contained in a prior filing. See Instruction to Item 1 of Form 8–A [17 CFR 249.208a]. Certain Securities Act registration statements also permit historical incorporation by reference, such as Form S–3, Form S–4, and Form S–11, which allow incorporation by reference of previous Exchange Act filings into the prospectus. See Item 12(a) of Form S–3 [17 CFR 239.13]; Item 11(a) of Form S–4 [17 CFR 239.25]; Item 29(a) of Form S–11 [17 CFR 239.18]. Certain Securities Act forms allow for forward incorporation by reference by certain issuers, where an issuer is permitted to forward incorporate by reference to Exchange Act reports filed in the future. Examples include Form S–3 and Form S–4. See Item 12(b) of Form S–3 [17 CFR 239.13]; Item 11(b) of Form S–4 [17 CFR 239.25]. In addition, the FAST Act recently directed the Commission to revise Form S–1 to permit SRCs to incorporate by reference to future filings. Public Law 114–94, Sec. 84001, 129 Stat. 1312 (2015); See also FAST Act Interim Rules Release. Given the scope of this release and its focus on Exchange Act periodic reports, the discussion here generally is limited to historical incorporation by reference. 1004 See 1980 Form 10–K Proposing Release. PO 00000 Frm 00083 Fmt 4701 Sfmt 4702 23997 the likelihood that the information in the incorporated filings has been thoroughly analyzed and reflected in the price or rating of the securities offered. For these types of registrants, the Commission concluded that the cost savings to registrants of not having to repeat or refile information disclosed elsewhere outweighed the risk to investors that the stock price does not reflect the omitted information.1005 The integrated disclosure system also gave rise to the current structure of Form 10–K that allows registrants to incorporate Parts I and II from the annual report to shareholders and Part III from the definitive proxy statement.1006 For periodic reports, registrants regularly incorporate by reference the information required by Part III of Form 10–K from their definitive proxy statements. Fewer registrants incorporate Parts I and II of Form 10–K from their annual reports to shareholders.1007 This likely is because many companies have eliminated their separate annual report to shareholders and instead use Form 10–K to satisfy their Rule 14a–3 requirements.1008 For exhibits, registrants often incorporate by reference exhibits from prior filings into their periodic reports. Advancements in technology support greater use of incorporation by reference. In Securities Offering Reform, the Commission expanded the use of incorporation by reference conditioned on the registrant making its incorporated Exchange Act reports and other materials readily accessible on a Web site maintained by or for the 1005 See id. 1980 Form 10–K Adopting Release. Although Form 10–K was amended in 1980 to reflect the current structure, the Commission has allowed some form of incorporation by reference from the annual report to shareholders to satisfy requirements of Form 10–K since 1942. See Amendment to Forms for Registration and Filing Annual Reports [7 FR 10653 (Dec. 22, 1942)] and Release No. 34–3347 [not published in the Federal Register] (Dec. 18, 1942). 1007 Based on data compiled by DERA, in calendar year 2014 approximately two percent of registrants incorporated some portion of the information required in either Part I or Part II of their Form 10–K from their annual report to shareholders, with more registrants incorporating Part II information than Part I information. 1008 Exchange Act Rule 14a-3 [17 CFR 240.14a-3]; see Randi Morrison and Broc Romanek, Annual Report & 10–K Wrap Handbook: Practice Guide & Toolkit, Jul. 2014 (noting that more than fifty percent of companies use a ‘‘10–K wrap’’); Neil Stewart, Designers discuss trends in the latest crop of annual reports, IR Magazine, Jun. 14, 2011, available at https://www.irmagazine.com/articles/ earnings-calls-financial-reporting/18271/directionsannual-reports/ (noting that investors are ‘‘far more likely to [receive] a plain 10K filing or perhaps a 10K-wrap’’ and that ‘‘[t]he traditional annual report may have been all but killed off by the austere 10Kwrap’’). 1006 See E:\FR\FM\22APP3.SGM 22APP3 23998 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules registrant.1009 By conditioning the ability to incorporate by reference on the ready availability of a registrant’s incorporated Exchange Act reports and other materials on its Web site, the Commission sought to provide investors with the ability to obtain the information from those reports and materials at the same time that they would have been able to obtain the information if it were set forth directly in the registration statement.1010 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 3. Request for Comment 296. To what extent does including previously disclosed information along with recent developments in a single self-contained filing facilitate an investor’s understanding of a registrant’s disclosure? Does repeating information that previously has been disclosed hinder an investor’s ability to identify information that has changed since the registrant’s last report? Does providing previously disclosed information along with information that is new or has changed better enable investors to consider the changes in context? If so, should we structure our requirements to elicit disclosure that highlights changes from a registrant’s last report and provides a comprehensive discussion in a single location? 297. Should we expand or limit registrants’ ability to incorporate by reference? Why or why not? Does incorporation by reference make the disclosure more or less readable? 298. Are there particular filings or sections of filings that should remain direct sources of disclosure information, rather than permitting incorporation by reference? If so, what information should be located consistently and in which filings? Which sections of those filings should contain the information? For example, is it more important for an investor to have information included 1009 See General Instruction VII.F. to Form S–1; General Instruction VI.F to Form F–1. 1010 See Securities Offering Reform Release. Issuers may satisfy this condition by including hyperlinks directly to the reports or other materials filed on EDGAR or on another third-party Web site where the reports or other materials are available and access to the reports or other materials is free of charge to the user. See General Instruction VII.F. to Form S–1; General Instruction VI.F to Form F– 1. The Commission noted that this manner of access was similar to those for disclosure of Web site access to an accelerated filer’s Exchange Act reports. See Securities Offering Reform Release. In adopting the requirements for accelerated filers, the Commission noted that, while these reports were already available through the Commission Web site, access through company Web sites was still desirable to encourage the availability of information in a variety of locations and to foster best practices for making that information broadly accessible. See Acceleration of Periodic Report Filing Dates and Disclosure Concerning Web site Access to Reports, Release No. 33–8128 (Sept. 5, 2002) [67 FR 58480 (Sept. 16, 2002)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 directly and in full in a Securities Act registration statement than it is in an Exchange Act filing? 299. Should our requirements to provide historical and recent information within a single selfcontained filing differ for registrants of different sizes, development stages, reporting histories or other factors? 300. Should registrants be permitted to incorporate by reference historical information from prior filings in lieu of presenting prior years’ information in the Form 10–K? If so, when or how frequently should we require registrants to present or refresh their complete core disclosure? Should we limit this approach to certain categories of registrants and, if so, how should we determine which categories would be eligible? 301. Should we expand or limit registrants’ ability to incorporate by reference to exhibits? Why or why not? Does incorporation by reference make it more difficult to locate exhibits? 302. To what extent does the flexibility to use incorporation by reference reduce compliance and administrative costs to registrants of preparing and disseminating disclosures? Please provide quantifications if possible. C. Hyperlinks Under Rule 105 of Regulation S–T, a registrant may include hyperlinks within a filing, such as a table of contents that hyperlinks to specific sections in a filing or a cross-reference that hyperlinks to another part of a filing.1011 Rule 105 also allows registrants to include hyperlinks to exhibits within the same filing or hyperlinks to other Commission filings.1012 However, registrants may not include hyperlinks to information outside the EDGAR system, such as external Web sites.1013 Of the two formats that are generally accepted by the EDGAR system, the text-based American Standard Code for Information Interchange (‘‘ASCII’’) and hypertext markup language (‘‘HTML’’),1014 only the HTML format accommodates hyperlinks. Currently, the vast majority of registrants file in 1011 Rule 105(b) of Regulation S–T [17 CFR 232.105(b)]. 1012 Id. 1013 Rule 105 of Regulation S–T [17 CFR 232.105]. 1014 The EDGAR system also accepts PDF documents, but will not accept PDF documents containing hyperlinks. See, e.g., EDGAR Filer Manual, Vol. I, v. 24 (Dec. 2015) at 3–27. Most PDF documents are considered unofficial copies, and PDF documents are permitted as official filings only in limited circumstances. See Rules 101 and 104 of Regulation S–T [17 CFR 232.101 and 17 CFR 232.104]. PO 00000 Frm 00084 Fmt 4701 Sfmt 4702 HTML format.1015 Many of these registrants include hyperlinks within their filings. If a registrant includes a hyperlink in its filing, whether or not the link is permitted by Commission rules, the information in the linked material is not considered part of the filing for determining compliance with disclosure obligations. However, inclusion of the link will cause the registrant to be subject to the civil liability and antifraud provisions of the federal securities laws for the information contained in the linked material.1016 Similarly, if a registrant hyperlinks to another hyperlink, the registrant will be treated as making all the hyperlinked material its own for liability purposes.1017 1. Comments Received S–K Study. None. Disclosure Effectiveness. Two commenters recommended amending Regulation S–K to specifically encourage use of hyperlinks within a filing.1018 One of these commenters recommended requiring registrants to include a hyperlink to any material that is cross-referenced or incorporated by reference.1019 The other commenter suggested allowing a hyperlink to information posted on a registrant’s Web site to satisfy disclosure requirements.1020 2. Discussion In 2000, the Commission stated that it is appropriate for registrants to assume liability for hyperlinked material as if it were part of the filing, because the use of hyperlinks in filings is voluntary and filers need not hyperlink to material that they do not wish to be understood as having adopted as their own. The Commission cautioned registrants not to use hyperlinks if they are not prepared to accept responsibility for the hyperlinked material.1021 The EDGAR system initially permitted hyperlinks only to different sections within a single document. In 2000, when the Commission expanded the permissibility of hyperlinks to allow hyperlinks to other documents and exhibits filed on EDGAR, the Commission stated that hyperlinks 1015 Based on data compiled by DERA, during calendar year 2015, ASCII represented less than one percent of all Form 10–K filings. 1016 Rule 105(c) of Regulation S–T [17 CFR 232.105(c)]. 1017 See Rulemaking for EDGAR System, Release No. 33–7855 (Apr. 24, 2000) [65 FR 24788 (Apr. 27, 2000)] (‘‘2000 EDGAR Release’’). 1018 See Shearman; ABA 2. 1019 See ABA 2. 1020 See Shearman. 1021 See 2000 EDGAR Release. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules alone should not satisfy the disclosure requirements.1022 The Commission noted that it would not be appropriate for a registrant to use hyperlinks effectively to use incorporation by reference when it is not permitted.1023 In addition, when the form or rule does permit incorporation by reference, the registrant must comply with all of the form or rule requirements for such incorporation by reference.1024 The Commission’s rationale for limiting the use of hyperlinks was that readers might be unable to understand the content of the filing without accessing numerous hyperlinks and that readers would be unable to print the filing as an integrated whole.1025 In 2008, in its guidance on the use of company Web sites, the Commission stated that the inability to print disclosure designed for interactive viewing and not for reading outside the electronic context, is not inherently detrimental to its readability.1026 However, it also noted that certain disclosure would continue to be required in a format convenient for both reading online and printing.1027 Since this 2008 guidance, there has been a significant increase in the use of the Internet as a tool for disseminating information. As of 2014, eighty-seven percent of the U.S. population uses the Internet, up from seventy-four percent in 2008.1028 In addition, recent data shows that most investors, even those who rely on financial advisors, use the Internet to conduct transactions and gather financial information.1029 There 1022 See id. id. (stating that a filer would be permitted to use hyperlinks to optional information for the convenience of the reader, but could not omit information required within the filing by providing it through a hyperlink). 1024 For example, the filing must contain a statement that the document is incorporated by reference, whether or not there is a hyperlink. As another example, Form 10–K may incorporate information from a registrant’s annual report to security holders, so long as the information is filed as an exhibit to the Form 10–K. This exhibit is needed even if the information also is provided by hyperlink. See Section V.B for a discussion of incorporation by reference. 1025 See id. 1026 See 2008 Web site Guidance. 1027 See id. (stating that the Commission did not think it was necessary that information appearing on company Web sites satisfy a printer-friendly standard unless our rules specifically require it, such as the notice and access model, which requires electronically posted proxy materials to be presented in a format convenient for both reading online and printing on paper). For a discussion of disclosure on company Web sites, see Section V.D. 1028 See United Nations, International Telecommunications Union, Percentage of Individuals using the Internet (2015), available at https://www.itu.int/en/ITU-D/Statistics/Documents/ statistics/2015/Individuals_Internet_2000-2014.xls. 1029 See Most Investors Use the Internet for Financial Research, Tools and Transactions; mstockstill on DSK4VPTVN1PROD with PROPOSALS3 1023 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 have also been advancements in the types of technologies that can be used to report and analyze information.1030 In light of these developments, we are interested in learning whether the Commission’s prior concerns about disaggregated disclosure remain relevant. We are seeking public input on whether and how to revise our rules to take advantage of the Internet as a source of information about registrants. 3. Request for Comment 303. Should we consider revising our rules to permit registrants to include external hyperlinks in their filings? Should we consider permitting registrants to include external hyperlinks in their filings to satisfy disclosure obligations? Why or why not? What would be the benefits and challenges of such a requirement? 1031 304. Would increased use of hyperlinks and further disaggregation of company disclosure into multiple filings hinder the quality or readability of disclosure? If so, how? What information, if any, should we require in a single filing or location? 305. Should we require registrants to include hyperlinks with any crossreference to specific information or a specific section within a filing? Why or why not? What would be the benefits and challenges of such a requirement? In particular, what would be the costs or savings in compliance and administrative costs to registrants of required hyperlinks? 306. As suggested by one commenter,1032 should we eliminate the requirement under Rule 12b–23 to attach, as an exhibit, information incorporated by reference from another filing, so long as the registrant includes in the text a hyperlink to the other filing? However, Two-Thirds Prefer to Interact with Advisors in Person, Dec. 17, 2014, available at https://www.johnhancock.com/about/news_ details.php?fn=dec1714-text&yr=2014 (citing John Hancock’s Investor Sentiment Survey and stating that eighty percent of investors have conducted transactions online and fifty-nine percent of investors prefer to use the Internet to research financial products). 1030 See 2015 Investment Company Release; World Economic Forum, Global Agenda Outlook 2013, available at https://www3.weforum.org/docs/ WEF_GAC_GlobalAgendaOutlook_2013.pdf (noting that technologies have evolved and continue to do so, while vast amounts of data are sent and received by billions of interconnected devices). 1031 For a discussion of the use of company Web sites and our requests for comment on permitting registrants to incorporate information from their Web sites by reference in their flings, see Section V.D. 1032 See ABA 2. PO 00000 Frm 00085 Fmt 4701 Sfmt 4702 23999 D. Company Web sites In certain circumstances, our rules and forms either permit or require the use of company Web sites as a means to provide information to investors. Depending on the circumstances, company Web sites may serve as a supplement to material filed or furnished via EDGAR, as an alternative to such materials, or as a stand-alone method of providing information to investors independent of EDGAR.1033 Our rules do not permit a registrant to satisfy disclosure requirements by incorporating by reference to information on registrant Web sites.1034 When a company Web site supplements Commission filings, company information is available both on EDGAR and on the company’s Web site. We have encouraged or required supplemental use of Web sites to make information more broadly accessible. For example, registrants are required to: • Disclose their Web site addresses, if available, in annual reports on Form 10– K and state whether their Exchange Act reports are available on their Web sites; 1035 • make their Exchange Act reports and documents incorporated by reference available on their Web site as a condition to incorporation by reference of previously filed reports into prospectuses filed as part of registration statements on Form S–1 or Form S–11; 1036 1033 See 2008 Web site Guidance. More recently, in April 2013, in connection with an investigation of the use of social media to announce operational metrics, the Commission provided guidance to issuers on how the 2008 Web site Guidance and Regulation FD apply to disclosure made through social media channels. See Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act: Netflix, Inc. and Reed Hastings, Release No. 34–69279 (Apr. 2, 2013), available at https:// www.sec.gov/litigation/investreport/34-69279.htm. 1034 See Item 10(d) of Regulation S–K [17 CFR 229.10(d)] (providing that where rules, regulations or instructions to forms permit, a document may be incorporated by reference to the specific document and to the prior filing or submission in which such document was physically filed or submitted). 1035 Accelerated filers and large accelerated filers are required to disclose this information. Nonaccelerated filers are encouraged to do so. See Item 101(e) of Regulation S–K [17 CFR 229.101(e)]. 1036 See Form S–1, General Instruction VII.F [17 CFR 239.11]; Form S–11, General Instruction H.6 [17 CFR 239.18]. In the adopting release for the Form S–11 amendments, the Commission noted that companies could satisfy the requirement to make filings available on their Web sites by ‘‘including hyperlinks directly to the reports or other materials filed on EDGAR or on another thirdparty Web site where the reports or other materials are made available in the appropriate timeframe and access to the reports or other materials is free of charge to the user.’’ See Revisions to Form S–11 to Permit Historical Incorporation by Reference, Release No. 33–8909, (Apr. 10, 2008) [73 FR 20512 (Apr. 15, 2008)]. E:\FR\FM\22APP3.SGM 22APP3 24000 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules • make their Exchange Act reports and other materials incorporated by reference available on their Web site as a condition for SRCs to forward incorporate by reference into a Form S–1; 1037 • provide their financial statements to the Commission and post them on their corporate Web site, if any, in interactive data format using XBRL;1038 • post on their Web sites, if they maintain one, notice of their intent to delist or deregister their securities as a condition to withdrawing from registration under Section 12(b) of the Exchange Act;1039 and • post on their Web sites, if they maintain one, beneficial ownership reports filed by officers, directors and principal security holders under Section 16(a) of the Exchange Act.1040 In some situations, registrants may satisfy a disclosure requirement either by filing the disclosure on EDGAR or by making it available on the registrant’s Web site, thereby using company Web sites as an alternative to EDGAR.1041 For example, Regulation G requires a registrant that publicly discloses or releases a material non-GAAP financial measure to provide reconciliation to the most directly comparable U.S. GAAP measure. A registrant that releases nonGAAP financial measures orally, telephonically, by webcast, by broadcast, or by similar means may satisfy Regulation G by posting the required reconciliation on its Web site and disclosing the location and availability during the presentation.1042 1037 See FAST Act Interim Rules Release. Rule 405 of Regulation S–T [17 CFR 232.405] and Item 601(b)(101) of Regulation S–K [17 CFR 229.601(b)(101)]. In adopting the interactive data requirements, the Commission stated that requiring the submission and posting of interactive data has the potential to provide advantages for the investing public by making the data more accessible, timely, inexpensive and easier to analyze. See Interactive Data Release. 1039 Exchange Act Rule 12d2–2(c)(2)(iii) [17 CFR 240.12d2–2(c)(2)(ii)]. 1040 See Exchange Act Section 16(a)(4)(C) [15 U.S.C. 78p] and Rule 16a–3(k) [17 CFR 240.16a– 3(k)]. Section 403 of the Sarbanes-Oxley Act [Pub. L. 107–204, Sec. 403 116 Stat. 745 (2002)] amended Section 16(a) of the Exchange Act [15 U.S.C. 78p] to require issuers to file statements of beneficial ownership on Forms 3, 4 and 5 electronically with the Commission and issuers with company Web sites to post change in beneficial ownership reports on their Web sites. The Commission adopted Rule 16a–3(k) to require registrants that maintain a corporate Web site to post on its Web site all Forms 3, 4 and 5 filed with respect to its equity securities by the end of the business day after filing. The Commission noted that ‘‘One objective of the amendments is to encourage availability of this information in a variety of locations, so that it is broadly accessible.’’ See Mandated Electronic Filing and Web site Posting for Forms 3, 4 and 5, Release No. 33–8230 (May 7, 2003) [68 FR 25787 (May 13, 2003)]. 1041 See 2008 Web site Guidance. 1042 See Non-GAAP Measures Release. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 1038 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 In addition, Item 406(c) of Regulation S–K, which requires disclosure of a registrant’s code of ethics, requires the registrant to: File a copy of its code of ethics as an exhibit to its annual report; post the text of its code of ethics on its Web site and disclose in its annual report its Web site address and the fact that it has posted its code of ethics on its Web site; or undertake in its annual report to provide any person a copy of its code of ethics upon request.1043 The Commission originally proposed to require a registrant to file a copy of its code of ethics as an exhibit to its annual report.1044 At adoption, the Commission opted for greater flexibility, citing commenters’ concerns that some codes are extremely lengthy and therefore would be difficult to file electronically on EDGAR and noting that many registrants already post their codes on their Web sites. In addition, our rules require disclosure on either Form 8–K or the registrant’s Web site of any change to or waiver of its code of ethics for its senior financial officers.1045 Only in very limited circumstances do our rules allow a company’s Web site to serve as a standalone method of providing information to investors wholly independent of EDGAR. Rules 12h–6 and 12g3–2(b) permit certain formerly reporting foreign private issuers to use their Web sites to provide information about the company in lieu of Exchange Act registration and reporting requirements. Unlike the examples above, where registrants’ alternative to posting the information on their Web sites is to include it in a Commission filing, these companies are required to include the relevant disclosure on their Web sites. Otherwise, these companies would lose their exemption from registration under Section 12(g) of the Exchange Act. 1. Comments Received S–K Study. None. Disclosure Effectiveness. One commenter recommended that particular focus should be given to adapting disclosure practices to a more technologically-driven marketplace.1046 1043 Item 406(c) of Regulation S–K [17 CFR 229.406(c)]. 1044 See Proposed Rule: Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002, Release No. 33–8138 (Oct. 22, 2002) [67 FR 66208 (Oct. 30, 2002)]. 1045 See Sarbanes-Oxley Act, Section 406(b) [Pub. L. 107–204, Sec. 406(b) 116 Stat. 745 (2002)]. See also Audit Committee Financial Expert and Code of Ethics Adopting Release. A registrant may only use its Web site to disseminate this disclosure if it previously has disclosed in its most recently filed annual report its intention to disclose these events via its Web site and the address of its Web site. 1046 See Lin. PO 00000 Frm 00086 Fmt 4701 Sfmt 4702 Two commenters suggested that registrants be permitted to use their Web sites to satisfy certain disclosure requirements such as those relating to their business, management team, and board.1047 One of these commenters recommended that registrants use their Web site as a repository for basic corporate documents, such as a company’s certificate of incorporation or bylaws.1048 Another commenter opposed the delivery of information using a registrant’s Web site because it would ‘‘raise issues, including liability matters, certifications, preservation of past disclosure, comparability and accessibility that would need to be addressed.’’ 1049 Another commenter stated that ‘‘having some information on a company Web site and other information on EDGAR can cause confusion for investors because they are often unsure where, if anywhere, information will be, and information provided on company Web sites is often difficult to find.’’ 1050 Another commenter acknowledged the potential efficiency to be gained through use of the Internet and electronic delivery, but suggested that, to protect the interests of investors who rely on paper delivery, the Commission should take steps to protect the interests or access of investors who depend on non-electronic access to information.1051 2. Discussion As noted by several commenters, today’s technology provides virtually instant access to information through a variety of sources outside of EDGAR, including company Web sites.1052 The Internet has become a primary source of information for investors. We are seeking public input on whether and the extent to which investors benefit from requiring disclosure in a filing when the information is readily available on the registrant’s Web site. We are also interested in what additional investor protections we should consider in the event we allow registrants to exclude required information from filings when the information is otherwise provided on their Web sites, such as requirements 1047 See CCMC (suggesting companies crossreference their Web sites to satisfy certain disclosure obligations); Shearman (suggesting companies file certain core corporate information both on EDGAR and the company’s Web site). 1048 See Shearman. 1049 See SCSGP. 1050 See letter from the Federal Regulation of Securities Committee, Business Law Section, American Bar Association (Feb. 15, 2016) (‘‘ABA 3’’). 1051 See AFL–CIO. 1052 See, e.g., CCMC; SCSGP; CFA Institute; Shearman; ABA 2. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 for registrants to preserve disclosure provided on their Web site. Currently, investors typically can access registrants’ public filings since 1996 through EDGAR.1053 Investors may request other public filings or records from the Commission.1054 However, information posted on company Web sites may change frequently and may not remain available to investors. Certain of our rules that allow registrants to disseminate information through their Web sites in lieu of including that information in a filing also require the registrant to maintain that information for a designated period of time. For example, registrants posting their code of ethics on their Web site under Item 406(c) are required to make the information accessible for as long as the registrant remains subject to Item 406.1055 Similarly, registrants required to post Exchange Act Section 16(a) filings on their Web sites are required to keep those filings accessible on their Web sites for at least a 12-month period.1056 As another example, while Regulation G does not specify how long a registrant must keep disclosure available on its Web site, the Commission encourages companies to provide ongoing Web site access to this information for at least a 12-month period.1057 For historical information available on company Web sites, the Commission has stated generally that ‘‘the fact that investors can access previously posted materials or statements on a company’s Web site does not in itself mean that such previously posted materials or statements have been reissued or republished for purposes of the antifraud provisions of the federal 1053 Registrants were phased into EDGAR over a three-year period ending May 6, 1996. As of that date, all domestic registrants were required to make their filings on EDGAR, except for filings made in paper because of a hardship exemption. See Rulemaking for EDGAR System, Release No. 33– 7122 (Dec. 19, 1994) [59 FR 67752 (Dec. 30, 1994)]; U.S. Securities and Exchange Commission, Office of Information Technology, Important Information About EDGAR, available at, https://www.sec.gov/ edgar/aboutedgar.htm. 1054 See U.S. Securities and Exchange Commission, Office of Investor Education and Advocacy, Records and Information, available at, https://www.sec.gov/answers/publicdocs.htm. 1055 Instruction 2 to Item 406(c) of Regulation S– K [17 CFR 229.406(c)]. 1056 Exchange Act Rule 16a–3(k) [17 CFR 240.16a3(k)]. In addition, the Commission has stated that the availability of historical issuer information provides investors with more readily accessible information about the issuer and that issuers should be able to maintain historical information on their Web site so that information will remain accessible to the public but will not be considered to be reissued or republished for purposes of the Securities Act. See Securities Offering Reform Release. 1057 See Non-GAAP Measures Release. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 securities laws, that the company has made a new statement, or that the company has created a duty to update the materials or statements.’’ 1058 To help assure that investors understand that the posted materials or statements speak as of a date or period earlier than when the investor may be accessing the posted materials or statements, the Commission has stated that historical or previously posted materials or statements should be: • Separately identified as historical or previously posted materials or statements, including, for example, by dating the posted materials or statements; and • located in a separate section of the Web site containing previously posted materials or statements.1059 In other contexts, the Commission has expressed concerns about whether information disclosed on company Web sites would be adequately preserved for purposes of the reporting and liability provisions under the federal securities laws.1060 Information on company Web sites currently is subject to some but not all Exchange Act liability provisions. Antifraud provisions of the federal securities laws, including Exchange Act Section 10(b) and Rule 10b–5, apply to statements made on a company Web site. If a registrant were to make a false or misleading statement of a material fact on its Web site in connection with the purchase or sale of a security, the registrant could face liability under Section 10(b) and Rule 10b–5. These anti-fraud provisions also apply in certain circumstances to third-party information available via hyperlink on a company Web site that could be attributable to the company, in the same way they would apply to any other statement made by, or attributable to, a company.1061 The reporting provisions of Exchange Act Section 13(a) and Exchange Act Rules 13a–1 and 12b–20 generally do not apply to disclosures on company Web sites. However, if a company fails to satisfy a Web site disclosure option that relieves it of its obligation to file or furnish an Exchange Act report, an 1058 See 2008 Web site Guidance. id. These requirements are consistent with Securities Act Rule 433(e)(2) [17 CFR 230.433(e)(2)] (setting forth conditions under which Web site disclosure will not constitute an offer or a free writing prospectus). 1060 See, e.g., 2014 NRSRO Amendments Release; 2015 Investment Company Release. 1061 15 U.S.C. 78j; 17 CFR 240.10b–5. See 2008 Web site Guidance (citing Use of Electronic Media for Delivery Purposes, Release No. 33–7233 (Oct. 6, 1995) [60 FR 53458 (Oct. 13, 1995)]); Use of Electronic Media, Release No. 33–7856 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)]). 1059 See PO 00000 Frm 00087 Fmt 4701 Sfmt 4702 24001 action could be brought under the Exchange Act reporting provisions based on the company’s failure to file the report.1062 For example, in the event a company fails to make public disclosure of information as required by Regulation FD,1063 that issuer would violate Regulation FD as well as Section 13(a) or Section 15(d) of the Exchange Act.1064 Material incorporated by reference into a filed document is subject to liability under Section 18 of the Exchange Act, which provides a private cause of action for a false or misleading statement of material fact in a filed document.1065 Material appearing solely outside Commission filings, such as on a registrant’s Web site, cannot be incorporated by reference into a registrant’s filings 1066 and would not be subject to Section 18 liability. Liability under Sections 11 and 12(a)(2) of the Securities Act applies to information in Exchange Act filings when it is incorporated by reference in a registration statement or prospectus. Section 11 imposes liability on an issuer for any untrue statement or omission of a material fact in a registration statement. Section 12(a)(2) of the Securities Act imposes similar liability for material misstatements or omissions in a prospectus or oral communication that constitutes an offer. This liability also applies to information incorporated by reference, where permitted, from Exchange Act filings filed after the registration statement. Under our current rules, disclosure provided on a registrant’s Web site rather than in an Exchange Act filing cannot be incorporated by reference into a registration statement or prospectus. Accordingly, it would not be subject to Section 11 liability and would only be subject to Section 12(a)(2) liability to the extent it constitutes an offer. 3. Request for Comment 307. Should we continue to limit the permitted sources of information incorporated by reference to Commission filings, or should we allow registrants to incorporate information from their Web sites? 1062 See 2008 Web site Guidance (citing Exchange Act Section 13(a) [15 U.S.C. 78m] (requiring companies with a class of securities registered under the Exchange Act to file reports prescribed by the Commission) and Exchange Act Rule 13a– 1 [17 CFR 240.13a–1] (requiring such companies to file an annual report with the Commission)). 1063 17 CFR 243.100 et seq. 1064 See Regulation FD Release; Rule 101 of Regulation FD [17 CFR 243.101]; 15 U.S.C. 78m; 15 U.S.C. 78o(d). 1065 15 U.S.C. 78r. 1066 Exchange Act Rule 12b–23 [17 CFR 240.12b– 23]. E:\FR\FM\22APP3.SGM 22APP3 mstockstill on DSK4VPTVN1PROD with PROPOSALS3 24002 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules 308. Are there challenges investors may face in using sources outside registrant filings to obtain information about a registrant? If so, what are these challenges? Would investors seeking information on a registrant’s Web site rather than in its filings require specialized equipment, knowledge or expertise that some investors may not have? What would be the impact on investors who want to receive materials in paper? 1067 What would be the impact on investors or third parties who engage in automated processing or large-scale analysis of disclosure on EDGAR? 309. Would investors seeking information from third-party sources require specialized equipment, knowledge or expertise that some investors may not have? What would be the impact on investors who want to receive materials in paper? What other challenges would this approach pose for investors or for registrants? 310. Do the benefits or challenges of incorporating information by reference differ based on whether the information is incorporated from a company’s Web site or from its filings? 311. If we allow registrants to provide required disclosure by incorporating information by reference to their Web sites, how could registrants limit or delineate the information on their Web sites that is ‘‘filed’’ for liability purposes? What obligation should the registrants have to preserve the material as incorporated or to update the incorporated information? How should it be preserved in the event the registrant exits the reporting system or goes out of business? What would be the impact on the reporting and liability provisions of the federal securities laws if this information is not preserved as required? 312. Are there categories of business or financial information that we should permit registrants to disclose by posting on their Web sites in lieu of including in their periodic reports? 313. Should we permit registrants to meet the requirements of Item 601 of Regulation S–K by incorporating exhibits by reference to documents posted on their Web sites? What would be the benefits and challenges of such an approach? 314. As an alternative to incorporation by reference, should we allow registrants to omit required information from filings when the information is otherwise provided on a 1067 See, e.g., Part I, Item 12(c) of Form S–3 (requiring issuers to state that it will provide a copy of any or all of the information, including Exchange Act reports, that has been incorporated by reference in the prospectus upon request at no cost to the requester). VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 registrant’s Web site? If so, what information would be appropriate and what additional investor protections should we consider? 315. To the extent that information about a registrant is readily available on its Web site, what are the benefits of continuing to require disclosure of the same information in the registrant’s filings? What would be the impact on registrant liability, accuracy of reported information or investor protection generally if we eliminated disclosure requirements for information that investors routinely access from Web sites? 316. Should we consider permitting incorporation by reference from sources other than a registrant’s filings or its Web site? If we allow registrants to provide required disclosure by incorporating information by reference to third-party sources, should we require them to include a hyperlink to that information? Would registrants use such an option? 317. What types of investors or third parties are most likely to value disclosure made available on registrant Web sites? 318. To what extent would permitting registrants to incorporate information from their Web sites enable them to realize cost savings, including savings in the administrative and compliance costs of preparing and disseminating disclosure? Please provide quantifications of expected changes in costs if possible. E. Specific Formatting Requirements The business and financial disclosure requirements in Regulation S–K generally do not specify the precise layout or format for disclosure.1068 In adopting the earliest Exchange Act report forms, the Commission’s emphasis was ‘‘on substance rather than on form,’’ giving companies ‘‘wide latitude in the manner of presenting the required data.’’ 1069 Current Forms 10–K and 10–Q specify that they are not a blank form to be filled in but a guide to be used in preparing the report.1070 1068 This section discusses formatting requirements that call for a standardized visual presentation or layout of disclosure within a registrant’s ASCII or HTML filing. For a discussion of structured disclosures and our requirements for specific data formats to facilitate the extraction of information into standardized formats, see Section V.G. 1069 Release No. 34–66 (Dec. 21, 1934) [not published in the Federal Register]. 1070 See General Instruction C.1 to Form 10–K [17 CFR 249.310]; General Instruction C.1 to Form 10– Q [17 CFR 249.308a]. In addition, Form 10–K cites Exchange Act Rule 12b–20, which requires a company to include, in addition to any information specifically required to be included in a statement or report, any further material information PO 00000 Frm 00088 Fmt 4701 Sfmt 4702 While our general approach allows registrants to use discretion in the overall layout of their disclosure, a few items prescribe the format for disclosure. In some cases, basic formatting requirements may be standardized, such as the prescribed location, order or title of required disclosure. For example, the structure of our periodic reports and related rules require registrants to include the numbers and captions of all items in the relevant form.1071 Some of our more specific requirements seek to elicit standardized information, such as prescribed tables with standardized rows and columns, such as the tabular disclosure of contractual obligations in Item 303(a)(5).1072 1. Comments Received S–K Study. None. Disclosure Effectiveness Initiative. Many commenters provided recommendations on the placement or presentation of registrant disclosure to facilitate identification of current, material information.1073 Two commenters suggested that prior to creating and implementing any new system, the Commission should encourage registrants to experiment with different formats in periodic reports, rather than strictly following the prescribed format of disclosure items in the applicable form.1074 One of these commenters stated that this would support reaching (and effectively communicating with) the broadest possible set of investors.1075 This commenter also suggested that our rules should incorporate the ‘‘growing body of scholarship around user experience’’ to improve the utility of corporate reporting. This commenter specified that some information lends itself well necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. See General Instruction C.3 to Form 10–K [17 CFR 249.310]; Exchange Act Rule 12b–20 [17 CFR 240.12b–20]. 1071 See, e.g., Form 10–K [17 CFR 249.310]; Exchange Act Rule 12b–13 [17 CFR 240.12b–13]. 1072 Item 303(a)(5) of Regulation S–K [17 CFR 229.303(a)(5)]. While outside the scope of this release, Item 402 of Regulation S–K provides another example of prescribed format requirement calling for standardized tables with specified titles, rows, and columns for the disclosure of certain executive compensation information. [17 CFR 229.402]. 1073 See, e.g., AFL–CIO; T. Amy; letter from Robert H. Chambers (June 13, 2014) (‘‘R. Chambers’’); CCMC; SCSGP; SIFMA; CFA Institute; Shearman.; ABA 2; UK Financial Reporting Council; Business Roundtable; Ernst & Young 2; Klein and Amy 3. Several of these commenters proposed various changes to EDGAR technology and related functionality to improve the readability, navigability, and usability of information. 1074 See AFL–CIO; SCSGP. 1075 See AFL–CIO. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules to graphic presentation and that, where possible, reporting companies should use graphics to communicate key trends and practices to investors quickly and clearly. Another commenter suggested that we encourage registrants to base the order, prominence and extent of disclosures presented on the materiality of the matter covered by such disclosures.1076 One commenter recommended a more complete and descriptive table of contents to help investors navigate the current volume of disclosure.1077 One commenter stated that disclosure in ‘‘[p]lain language, clear formatting, no footnotes, no jargon, complete information without having to jump to another site are critical and doable.’’ 1078 Some commenters supported the concept of a ‘‘company profile’’ or ‘‘company tab’’ discussed in the S–K Study.1079 One commenter recommended disclosure in Q&A form for certain common risk factors, with standardized questions for all registrants allowing only for potential responses of ‘‘yes,’’ ‘‘no,’’ or ‘‘NA.’’ 1080 Another commenter provided results of a survey that it conducted showing that a ‘‘substantial majority of respondents (65 percent) indicated that the increased use of tables and charts would be very important to improving financial reporting.’’ 1081 This commenter stated that investors want quantitative tables with entity-specific information appropriately disaggregated and suggested that this information should be supported by ‘‘qualitative explanations that are not littered with boilerplate or generic language.’’ 1082 This commenter further stated that standardization of quantitative disclosures would enhance comparability over time and among firms.1083 Similarly, another commenter recommended that companies consider the use of ‘‘pie charts’’ and ‘‘bar charts’’ to enhance certain disclosure.1084 1076 See Ernst & Young 2. T. Amy. 1078 See letter from Barbara Amsden (Oct. 25, 2015). 1079 See, e.g., CCMC; SCSGP; CFA Institute; Shearman. See also S–K Study at 98 (recommending consideration of a framework based on the nature and frequency of disclosure that would include ‘‘core’’ disclosure or a ‘‘company profile’’ for information that changes infrequently and would be supplemented by periodic filings for information that changes more frequently). 1080 See R. Chambers. 1081 See CFA Institute. See also CFA Report. 1082 Id. 1083 See id. 1084 See Klein and Amy 3 (discussing disclosure of share buyback programs). mstockstill on DSK4VPTVN1PROD with PROPOSALS3 1077 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 2. Discussion A standard layout, format, or style requirement may enhance the comparability of disclosures across periods and across issuers and registrants. Such comparability and consistency may reduce the costs of acquiring information, increase valuation accuracy, and enhance investment efficiency.1085 A standardized presentation may also reduce the ability of registrants to choose presentation formats that could highlight more favorable disclosures and obscure less favorable ones. However, flexibility in the presentation of disclosure may enhance the ability of registrants to tailor disclosure to their individual circumstances and investor bases. Flexibility in presenting disclosure could allow registrants to more effectively communicate the information most critical to understanding their particular company as prescriptive presentation requirements may increase the risk of important information being obscured by less important information. In addition, repetitive disclosure may be due in part to the structure of our Exchange Act forms and related rules, which require registrants to include in their periodic reports the numbers and captions of all items in the relevant form.1086 3. Request for Comment 319. Do current disclosure requirements appropriately consider the need for both standardization and flexibility in presentation? If not, how could we change our requirements? 320. How could we facilitate or encourage better presentation of disclosure by registrants? 321. Would further prescribing the order and format for presenting information in annual or quarterly reports improve readability or increase comparability across registrants? Would such standardized requirements enhance the ability of investors and third parties to use disclosures, including for large-scale processing and analyses, in a more timely and efficient way? 1085 See, e.g., G. DeFranco, S.P. Kothari, and R. Verdi, The Benefits of Financial Statement Comparability, 49 J. Acct. Res. 895, 895–931 (2011); S. Young and Y. Zeng, Accounting Comparability and the Accuracy of Peer-Based Valuations Models, 90 Acct. Rev. 2571, 2571–2602 (2015); C. Chen, D. Collins, T. Kravet, and R. Mergenthaler, Financial Statement Comparability and the Efficiency of Acquisition Decisions (working paper) (Dec. 15, 2015) available at https://papers.ssrn.com/sol3/ papers.cfm?abstract_id=2169082. 1086 See, e.g., Form 10–K; Exchange Act Rule 12b– 13 [17 CFR 240.12b–13]. PO 00000 Frm 00089 Fmt 4701 Sfmt 4702 24003 322. Is there particular information that investors would prefer we require registrants to present in a specific order or in a particular section of the document? If so, which information should be so presented? What would be the advantages or disadvantages of such an approach? 323. Do item numbers and captions improve the clarity, navigability or overall effectiveness of disclosure? Should we revise our rules to reduce or eliminate the requirement to include the item numbers and captions from any of our forms? Why or why not? 324. Should we revise any of our current disclosure rules to require a standardized tabular or graphic presentation rather than, or in addition to, the narrative disclosure we currently require? Which disclosures could be improved by a requirement for tabular or graphic presentation? Would such a presentation improve comparability of disclosure across registrants? Does increased comparability improve transparency or is it otherwise beneficial to investors? What would be the advantages or disadvantages of such an approach? 325. Should we require registrants to present certain disclosures in questionand-answer format? If so, what information would be appropriate for this format? Should we require or permit it for certain types of registrants? 326. Should we permit or require registrants to present certain disclosures in a ‘‘check-the-box’’ presentation, where registrants select the appropriate disclosure from a finite list of options? For example, should we require or permit registrants to indicate by checkbox rather than narrative disclosure portions of the information regarding changes in and disagreements with accountants under Item 304 or management’s conclusions regarding the effectiveness of the registrant’s disclosure controls and procedures under Item 307? What would be the advantages or disadvantages of such an approach? 327. What disclosure requirements, if any, would generate more meaningful disclosure if we modified or eliminated the specific formatting or presentation requirements and permitted greater flexibility in the manner of presentation? 328. How would disclosure costs or other challenges to registrants be affected by any increase in the use of specific formatting or presentation requirements? F. Layered Disclosure In first implementing our integrated disclosure system, the Commission E:\FR\FM\22APP3.SGM 22APP3 24004 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 considered various approaches that might differentiate between institutional investors, professional security analysts and sophisticated individual investors.1087 These approaches included providing investors the option of receiving a simplified annual report containing summary information in lieu of the full, or portions of the, traditional annual report.1088 While the Commission did not adopt such an approach, it has encouraged layered disclosure in several instances. The Wheat Report noted that special efforts should be made to call any unusually speculative elements or risk factors of an offering to the attention of the ordinary investor using an introductory statement.1089 For MD&A, the Commission has suggested registrants use an overview, introduction or other statement of the principal factors, trends or other matters that are covered in more detail elsewhere in the section.1090 The Commission cautioned that an introduction or overview should not be a duplicative layer of disclosure that repeats the more detailed discussion and analysis that follows. Instead, it should present information in a manner that emphasizes the information and analysis that is most important. In offering prospectuses, our rules require summary presentations where the length or complexity of the prospectus makes a summary useful.1091 Similarly, our rules require open-end management investment companies to include key information at the front of their statutory prospectuses in a standardized order to provide investors disclosure that is easier to use and more 1087 See 1980 Form 10–K Adopting Release (‘‘The Commission recognizes that the information content in Form 10–K not only was originally formulated for a specialized use, but that within those groups which have utilized the Form there are different constituencies. Those constituencies which have been the most frequent users of Form 10–K information are institutional investors, professional security analysts and sophisticated individual investors.’’). 1088 See id. The release noted that the potential approach would be based on an ‘‘as yet unproven hypothesis that some users, particularly certain individual investors, either rely on financial advisers and therefore do not use detailed disclosure, or are overwhelmed by the technical nature or volume of presently required disclosure.’’ However, the release also cited studies such as that conducted by Professors Lucia S. Chang and Kenneth S. Most at Florida International University indicating that the typical ‘‘unsophisticated small investor’’ often is quite sophisticated. See Lucia S. Chang and Kenneth S. Most, Financial Statements and Investment Decisions (1979). 1089 See Wheat Report at 32. 1090 See 2003 MD&A Interpretive Release. For a discussion of executive level overviews in MD&A, see Section IV.B.3.b. 1091 See, e.g., Item 503(a) of Regulation S–K [17 CFR 229.503(a)]. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 readily accessible, while retaining the comprehensive quality of the information available elsewhere.1092 1. Comments Received S–K Study. One commenter suggested that the Commission analyze each required disclosure, segregating them by nature and frequency of change to determine the method of filing and delivery.1093 This commenter proposed that basic information (such as the description of the business, risk factors, officers and directors, Web site address) that typically does not significantly change from quarter to quarter, absent a specific transaction or event, should only require updating when something changes. Additionally, the commenter recommended that the information presented in periodic reports be limited to new information specific to the most recent fiscal period (such as MD&A, selected quarterly financial data and executive compensation). Disclosure Effectiveness Initiative. A few commenters addressed layering disclosure and the use of summaries to improve disclosure.1094 One of these commenters stated that an integrated presentation of related information, such as layering information, with summary information presented first and details presented later or longstanding explanatory information that may still be relevant placed separately, perhaps as a schedule to the financial statements, enhances understanding of the relationship between items across financial statements.1095 Another commenter proposed a rule requiring companies to provide an overview describing what happened at the company over the past year and the company’s expectation and concerns about the year to come.1096 This commenter noted that such a rule would not replace the more detailed financial and other business information that allows analysts to populate their models and otherwise scrutinize performance, but would permit management to identify up front what it determines to be the most important information in a way that is both understandable and provides context. One commenter proposed the use of ‘‘tabs’’ to organize information topically (e.g., business, officers and directors, material risks), with information under various tabs to be updated appropriately and supplemented with periodic MD&A 1092 Form N–1A [17 CFR 239.15A]. Ernst & Young 1. 1094 See, e.g., CFA Institute; NYC Bar; SGSCP. 1095 See CFA Institute. See also CFA Report. 1096 See NYC Bar. 1093 See PO 00000 Frm 00090 Fmt 4701 Sfmt 4702 disclosure.1097 This commenter suggested that more effective, navigable documents should eliminate the need for summary disclosure for retail investors without eliminating material information. This commenter further noted that all investors, retail or institutional, should have access to full and fair disclosure.1098 2. Discussion As discussed in Section III.B.2., the informational needs, financial resources, and capacity to analyze disclosure may vary significantly among investors. Highly sophisticated investors may seek a different level or presentation of information than those with fewer financial or analytical resources. For example, some investors may prefer a summary presentation while others may seek detailed data that they can analyze and compare across companies or industries.1099 In addition, a ‘‘layered’’ approach to disclosure that highlights what management believes is the most important information, while still providing detailed data and analysis,1100 may make filings more navigable for all investors. On the other hand, a ‘‘layered’’ approach could introduce challenges for investors or third parties seeking all available disclosure on a particular topic, as they many need to search summary disclosures as well as more detailed disclosures for all data and commentary relevant for their purposes. The FAST Act requires the Commission to issue regulations permitting registrants to submit a summary page in their Form 10–K.1101 We do not address this aspect of layered disclosure here. 3. Request for Comment 329. Other than a summary page, are there other approaches to layering or layered disclosure that we should consider for business and financial information in periodic reports? If so, what are the benefits and challenges of these approaches? G. Structured Disclosures Investors, their financial advisors, and professional analysts use increasingly 1097 See SCSGP. 1098 Id. 1099 See, e.g., Study Regarding Financial Literacy Among Investors, (Aug. 2012) available at https:// www.sec.gov/news/studies/2012/917-financialliteracy-study-part1.pdf (finding that investors favor ‘‘layered’’ disclosure and, wherever possible, the use of a summary document containing key information about an investment product or service). 1100 See, e.g., 2003 MD&A Interpretive Release. 1101 Public Law 114–94, Sec. 72001, 129 Stat. 1312 (2015). E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules complex information and find that structured disclosures facilitate analysis of this information.1102 Some investors seek structured data as it enhances their ability to use technology to process and synthesize information,1103 allowing for more timely and granular analysis of financial information, including comparative 1104 and trend analysis.1105 Structured disclosures include both numeric and narrative-based disclosures that are made machine-readable by having reported disclosure items labeled (tagged) using a markup language, such as eXtensible Markup Language (‘‘XML’’) 1106 or XBRL.1107 Tagging disclosure enables information to be structured, stored, shared, and presented in different systems or platforms.1108 Standardized markup languages, such as XBRL, use standard sets of data element tags for each required reporting element, referred to as taxonomies. Taxonomies provide common definitions that represent agreed-upon information or reporting standards, such as U.S. GAAP for accounting-based Category of registrant Information required to be tagged Reporting companies 1110 ................................. Financial statements, including footnotes and schedules. Financial statements, including footnotes and schedules. Risk/return summaries ..................................... 24005 disclosures.1109 The resulting standardization of financial reporting allows for aggregation, comparison, and large-scale statistical analysis of reported financial and other material information through significantly more automated means than is possible with unstructured formats, such as unstructured HTML or ASCII. Commission rules currently require several categories of registrants to provide certain information in XBRL, including, the following: Language required Method of submission XBRL Filed as exhibit. XBRL Filed as exhibit. XBRL Filed as exhibit. Credit rating history .......................................... XBRL Posted on its Web site, with a link to such location included in an exhibit to its annual Form NRSRO. The Commission requires certain registrants and other filers to provide certain information in XML or other machine-readable format. Asset-backed issuers are required to provide assetlevel disclosures in XML in their registration statements.1114 Forms D, filings required under Regulation A and Regulation Crowdfunding, and Section 16 ownership reports also require all or a part of the information to be filed using XML technology.1115 In addition, beginning in 2016, Regulation SBSR will require security-based swap data repositories to report and publicly disseminate in machine-readable electronic format certain security-based swap transaction information, although 1102 See, e.g., CFA Report (stating that investors do not seek a reduction in data or volume of disclosures, as they can use technology to evaluate the data, but instead seek to identify more effective ways to capture, manage, analyze, present, and deliver financial data); Interactive Data Release (stating that many commenters generally supported the required submission of interactive data). 1103 See Recommendations of the Investor Advisory Committee Regarding the SEC and the Need for the Cost Effective Retrieval of Information by Investors (July 25, 2013) (‘‘IAC Data Tagging Recommendations’’), available at https:// www.sec.gov/spotlight/investor-advisorycommittee-2012/data-tagging-resolution-72513.pdf (recommending that the Commission (i) promote the collection, standardization and retrieval of data filed with the Commission using machine-readable data tagging formats, (ii) take steps to reduce the costs of providing tagged data, especially for smaller issuers and investors and (iii) prioritize revising existing forms to provide for the tagging of data in order to increase transparency with respect to corporate governance). 1104 See Hu 2014 at 620 (noting that greater standardization of information allows for crosscompany comparisons of performance). 1105 See Institute for Corporate Responsibility at George Washington University and the Center for Audit Quality, Initiative on Rethinking Financial Disclosure, Nov. 2014, available at https:// business.gwu.edu/about-us/research/institute-forcorporate-responsibility/research-projects/ rethinking-financial-disclosure (advocating a disclosure platform that allows comparison of information and analysis of a company’s performance trends). 1106 XML is an open source markup language to tag elements of a document. It does not have a defined set of tags, but instead provides a mechanism to define tags and structural relationships between tagged elements. See Norman Walsh, A Technical Introduction to XML (Oct. 1998), available at https://www.xml.com/pub/a/98/ 10/guide0.html?page=2#AEN58. 1107 XBRL is an open source standardized language derived from XML for purposes of tagging business reporting information. Many commercial vendors and open source projects support the XBRL standards with tools and software. See Stephanie Farewell, XBRL International, Inc., XBRL or Customized XML? (Oct. 2010), available at https:// www.xbrl.org/bpboarddocs/ xbrlorcustomizedxml.pdf. 1108 See id. 1109 See, e.g., The Standard for Reporting, available at https://www.xbrl.org/the-standard/ what/the-standard-for-reporting; Financial Statements in XBRL: XBRL designed for Accounts and Financial Statements as well as fixed templates, available at https://www.xbrl.org/thestandard/what/financial-statement-data. 1110 Item 601(b)(101) of Regulation S–K [17 CFR 229.601(b)(101)]; Interactive Data Release. 1111 Exchange Act Rule 13n–11(f)(5) [17 CFR 240.13n–11(f)(5)]. See also 2015 Regulation SBSR Release. 1112 Form N–1A [17 CFR 239.15A]; Rule 405 of Regulation S–T [17 CFR 232.405]. See also Interactive Data for Mutual Fund Risk/Return Summary, Release No. 33–9006 (Feb. 11, 2009) [74 FR 7748 (Feb. 19, 2009)] (‘‘Interactive Data for Mutual Funds Release’’). 1113 Exchange Act Rule 17g–2(d) [17 CFR 240.17g–2(d)]; Form NRSRO [17 CFR 249b.300]. See also Amendments to Rules for Nationally Recognized Statistical Rating Organizations, Release No. 34–59342 (Feb. 2, 2009) [74 FR 6456 (Feb. 9, 2009)] (adopting a public disclosure provision requiring NRSROs to make publicly available on their Web site in XBRL format a random sample of ten percent of the ratings histories of issuer-paid credit ratings and to disclose in Exhibit 1 to Form NRSRO the web address where the XBRL data may be accessed); Amendments to Rules for Nationally Recognized Statistical Rating Organizations, Release No. 34–61050 (Nov. 23, 2009) [74 FR 63831 (Dec. 4, 2009)] (requiring NRSROs to make publicly available on their Web site in XBRL format ratings history information for one hundred percent of their credit ratings initially determined on or after June 26, 2007). 1114 Item 1111(h) of Regulation AB [17 CFR 229.1111(h)]; Rule 11 of Regulation S–T [17 CFR 232.11]. Registrants will be required to comply with the asset-level disclosure requirements beginning in November 2016. See Asset-Backed Securities Disclosure and Registration, Release No. 33–9638 (Sept. 4, 2014) [79 FR 57184 (Sept. 24, 2014)] (‘‘2014 ABS Release’’). 1115 Form D [17 CFR 239.500]; Forms 1–A et seq. [17 CFR 239.90 et seq]; Form C [17 CFR 239.900]; Forms 3, 4, & 5 [17 CFR 249.103–105]. See also Electronic Filing and Revision of Form D, Release No. 33–8891 (Feb. 6, 2008) [73 FR 10592 (Feb. 27, 2008)] (noting that because Form D information consists of relatively simple facts, XML is a sufficient technological solution, and . . . the information tagged in XML [is expected to] be compatible with systems designed for more sophisticated XBRL reporting); 2015 Regulation A Release; Crowdfunding Adopting Release (stating that XML data will enable issuers to provide information in a convenient medium without requiring new technology and will provide the Commission and the public with readily available data about offerings made in reliance on Section 4(a)(6)). Security-based swap data repositories 1111 ...... mstockstill on DSK4VPTVN1PROD with PROPOSALS3 Open-end management investment companies, or mutual funds 1112. Nationally recognized statistical rating organization (NRSRO) 1113. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 PO 00000 Frm 00091 Fmt 4701 Sfmt 4702 E:\FR\FM\22APP3.SGM 22APP3 24006 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules the regulation does not specify a required format.1116 We are seeking public input on the use of structured data and other available standards and technologies that could enhance the quality of disclosure to investors while reducing burdens on registrants. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 1. Comments Received S–K Study. One commenter recommended that the Commission assess the value of XBRL for new registrants and their industries and consider allowing voluntary, rather than mandatory, structuring of data by EGCs.1117 This commenter suggested that this would reduce initial compliance costs for EGCs and allow more time for the market to develop cost-effective XBRL tools, technologies and services. Disclosure Effectiveness Initiative. One commenter encouraged regulators, in light of advances in technology and connectivity and the ever-increasing demand for data, to look to technology to facilitate the capture, management, analysis, presentation, and delivery of information to investors. This commenter also noted that ‘‘technology holds the promise of better (improved quantity and quality of), faster (improved timeliness of), and cheaper (improved access to) information for investors.’’ 1118 Another commenter stated that the ability to download financial tables and other data to better compare companies’ disclosures across industries would appear to be particularly useful.1119 This commenter also noted, however, that the time it takes to prepare the XBRL filing may cause registrants to forego updates to its disclosure in the days prior to filing to allow time for data tagging, and suggested that the Commission explore technological solutions that avoid unnecessary duplication, such as modifying XBRL or using another data tagging system that is more cost and time-efficient.1120 One commenter supported the continued improvement of tagging and coding of financial reporting, noting that investors and regulators alike would benefit greatly from real time access to comparable, searchable and sortable data.1121 By contrast, another 1116 Rule 900(cc) of Regulation SBSR [17 CFR 242.900(cc)]. 1117 See Ernst & Young 1. 1118 See CFA Institute. See also CFA Report. 1119 See ABA 3. 1120 See id. (citing Emily Chasan, Costly Data Go Untapped, The Wall Street Journal, Jan. 22, 2013 (‘‘Chasan’’), available at https://blogs.wsj.com/cfo/ 2013/01/22/costly-data-go-untapped (noting that companies have invested in internal systems that they believe are superior to XBRL)). 1121 See AFL–CIO. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 commenter indicated that XBRL data was not useful.1122 One commenter stated that XBRL data should not require with registration statements if it has been previously filed with a Form 10–K or Form 10–Q.1123 Several commenters, in a jointly submitted letter, provided a number of specific recommendations to enhance and modernize EDGAR, including enhanced functionality associated with structured data.1124 The recommendations included enhancements that would allow the user to save XBRL output more easily in Excel and identify tag extensions used by the registrant. Another commenter provided similar recommendations to modernize EDGAR and improve the Commission’s data tagging framework and concurred with the jointly submitted letter.1125 In addition to longer term improvements, this commenter recommended that the Commission extend XBRL or other data tagging requirements to MD&A and other parts of filings. One commenter recommended that the Commission require complete ‘‘nondimensional’’ financial statements to improve XBRL quality and usage.1126 This commenter also recommended that the Commission consider taking steps to improve the comparability of XBRL data by addressing inconsistencies in XBRL extensions. In addition, this commenter recommended expanding XBRL requirements, such as to earnings releases, MD&A, and proxy statements, and requiring filers to make all ownership-related filings available in an XML structured data format. One commenter encouraged the Commission to transform the current documents-based disclosure system to a system that collects, manages, and disseminates disclosure information as structured data with standardized tags and electronic formats.1127 This commenter argued that such a system would improve accountability to investors, allow public companies eventually to reduce compliance costs by automating reporting tasks, and improve the Commission’s ability to use data analytics to review and evaluate registrants’ submissions. As an initial step, this commenter recommended that the Commission adopt Inline XBRL to eliminate the duplication associated with providing the XBRL exhibit in 1122 See A. Radin (citing Chasan). letter from Fran Sesti (Feb. 1, 2016). 1124 See letter from Center for Audit Quality, et al. (May 29, 2015). 1125 See ABA 3. 1126 See TagniFi. 1127 See Data Transparency Coalition. 1123 See PO 00000 Frm 00092 Fmt 4701 Sfmt 4702 addition to the text-based financial statements, and to ‘‘enforce’’ the quality of XBRL filings.1128 The commenter further recommended that the Commission work with industry groups to set clearer data standards. This commenter also suggested that the higher cost to market participants of absorbing unstructured disclosure results in higher cost of capital to registrants, particularly smaller registrants. 2. Discussion The Commission requires registrants and other filers to provide certain information as structured data to facilitate the analysis and improve the accuracy of that information.1129 When the Commission first adopted rules requiring reporting company registrants to provide financial statement information in XBRL, it cited the potential of structured data to reduce the time required for registrants to prepare their disclosures, to increase the usability of disclosures for investors, and eventually to reduce costs for both registrants and investors, as structured data can help automate regulatory filings and business information processing.1130 By requiring structured data, the Commission has sought to make disclosure easier for investors to access, analyze and compare across reporting periods, registrants, and industries.1131 1128 We are considering whether to amend the current XBRL tagging requirements with respect to the financial statements of registrants to require the use of ‘‘Inline XBRL.’’ Inline XBRL would allow registrants to file the required information and data tags in one document rather than requiring a separate exhibit for the interactive data. Commission rules and the EDGAR system do not currently allow for the use of Inline XBRL. Any such proposal would be subject to public notice and comment as part of a separate rulemaking initiative. In this concept release, we seek comment on the benefits and costs of structured data generally and whether it would be appropriate to extend data tagging requirements to other Commission disclosures. 1129 See, e.g., Rules 401–405 of Regulation S–T [17 CFR 232.401 et seq.]; See also Interactive Data Release; What is Interactive Data and Who’s Using It?, available at https://www.sec.gov/spotlight/xbrl/ what-is-idata.shtml. 1130 See Interactive Data Release (noting that interactive data, unlike static, text-based information, (1) can be dynamically searched and analyzed, facilitating the comparison of financial and business performance across companies, reporting periods, and industries, and (2) allows for the automation of regulatory filings and business information processing, with the potential to increase the speed, accuracy, and usability of financial disclosure and eventually to reduce costs); Interactive Data for Mutual Funds Release (stating the Commission’s intent not only to make risk/ return summary information easier for investors to analyze but also to assist in automating regulatory filings and business information processing). 1131 See Interactive Data Release; Interactive Data for Mutual Funds Release. E:\FR\FM\22APP3.SGM 22APP3 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules mstockstill on DSK4VPTVN1PROD with PROPOSALS3 When registrants provide disclosure items in a standardized data format, investors can more easily search and obtain specific information about registrants, compare common disclosures across registrants, and observe how registrant-specific information changes across reporting periods as the same registrant continues to file in a structured data format.1132 Additionally, data that investors can download, for example, from EDGAR, directly into a spreadsheet or statistical analysis software eliminates the need to enter the information manually, which minimizes the time burden and risk of errors associated with data entry. In adopting Regulation AB requiring asset-level disclosures in XML, the Commission noted that requiring this information in a standardized machinereadable format makes the data transparent and comparable.1133 The Commission stated that it expected that this would lower the cost for investors of accessing, collecting and analyzing information, which would lead to better allocation of capital. In requiring the information in XML rather than XBRL, the Commission noted that the relatively simpler data to be presented in these disclosures, in contrast to the rich complexity of corporate financial disclosures, was well-suited for XML.1134 Our rules requiring registrants to file financial and other information in a structured format require that data to be filed as an exhibit to the filing rather than embedded in the filing itself.1135 In this way, the structured data supplements but does not replace the traditional HTML electronic filing format. Having XBRL and other structured data submitted as a separate exhibit, however, has raised a number of issues regarding the accuracy and usability of the data. First, structured data filed as a separate exhibit does not look like the disclosure in the related HTML document submitted by the registrant unless specially rendered to do so with specialized software.1136 In an effort to make the XBRL data look more like the HTML document, some registrants create custom elements or dimensions 1132 See Concept Release on the U.S. Proxy System, Release No. 34–62495 (July 14, 2010) [75 FR 42982 (July 21, 2010)]. 1133 See 2014 ABS Release. 1134 Id. 1135 See, e.g., Item 601(b)(100) of Regulation S–K [17 CFR 229.601(b)(100)]; Rule 401 of Regulation S– T [17 CFR 232.401]. 1136 See Staff Observations from the Review of Interactive Data Financial Statements (Dec. 13, 2011) (‘‘December 2011 Staff Observations’’), available at https://www.sec.gov/spotlight/xbrl/staffreview-observations-121311.shtml. VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 or otherwise alter their XBRL documents. While our rules permit custom or company-specific element extensions for disclosures for which the standard U.S. GAAP taxonomy does not provide an appropriate element, the Commission and its staff have cautioned against custom elements for minor differences 1137 or solely for formatting,1138 which can inhibit automated parsing processes and potentially create confusion between U.S. GAAP and company specific extension elements. The staff also has found that many registrants create custom axis extensions despite the availability of appropriate standard axis elements in the standard U.S. GAAP taxonomy, further diminishing data quality and impairing comparability across registrants and filings.1139 These and other potentially inappropriate uses of custom elements identified by Commission staff can affect the quality of the data and its potential use.1140 1137 EDGAR Filer Manual, Vol. II, v. 35 (Dec. 2015) at 6–28. 1138 See Regulation S–T Compliance and Disclosure Interpretations, Question 130.08 available at https://www.sec.gov/divisions/corpfin/ guidance/regs-tinterp.htm. See also December 2011 Staff Observations (encouraging registrants to concentrate on the quality of the tagging rather than trying to match the rendering of the XBRL exactly to the HTML filing and advising registrants not to create custom elements or use incorrect dates to achieve specific rendering results). 1139 See Staff Observations of Custom Axis Tags (Mar. 29, 2016) (‘‘2016 Staff Observations’’), available at: https://www.sec.gov/structureddata/ reportspubs/osd_assessment_custom-axistags.html. 1140 See id. See also, Staff Observations of Custom Tag Rates (July 7, 2014) (‘‘2014 Staff Observations’’), available at https://www.sec.gov/dera/reportspubs/ assessment-custom-tag-rates-xbrl.html (in which, for a random sample of filings that staff reviewed, staff observed instances of filers creating custom axis tags unnecessarily when an appropriate standard axis tag existed in the U.S. GAAP taxonomy). An axis tag allows a filer to divide reported elements into different dimensions (e.g., revenue by geographical area, fair value measurement levels, components of total equity (e.g., common, preferred)). In a recent assessment of custom axis extensions use in XBRL exhibits, DERA staff reported that despite the overall decline in the use of custom tags generally, approximately 50% of filers continue to create custom axis tags, with large accelerated filers using custom axis tags more than twice as often as SRCs. DERA staff suggested that a contributing factor may be that SRCs likely have less complex financial disclosures that can be structured primarily using axis options provided by the U.S. GAAP taxonomy. See 2016 Staff Observations. In a previous review of the use of custom tags in general in XBRL exhibits, the staff found a steady decline in custom element use by larger registrants, indicating improvements in the U.S. GAAP taxonomy and registrants’ selections of tags. However, in contrast to the recent findings on axis extensions, the staff found that smaller filers were associated with an average custom tag rate almost 50% greater than that of larger filers. Staff analysis also revealed that some of the perceived quality PO 00000 Frm 00093 Fmt 4701 Sfmt 4702 24007 Second, the redundant process of preparing financial statements and periodic reports in HTML or ASCII and then preparing exhibits in XBRL creates a greater chance of data entry and other errors. Staff identified a number of errors, such as characterization of a number as negative when it is positive, missing amounts and calculations, and other inaccuracies,1141 which may occur more frequently, partially as a result of these redundant processes. Registrants often outsource the structuring of their XBRL reports, thereby adding incremental manual processes and controls to their efforts, which in turn can adversely affect the quality of XBRL-formatted disclosures.1142 Observers also have noted that XBRL data is not required to be audited, resulting in diminished investor confidence in the quality of the data.1143 We continue to explore ways to incorporate structured data. We also continue to explore changes to the Commission’s Web site and the EDGAR system that could enhance the usefulness of structured disclosures. For example, in December 2014, the Commission announced a pilot program under which data that registrants provide in structured formats would be combined and organized into structured data sets and posted for bulk downloads on the Commission’s Web site for use by investors and academics.1144 Concerns have been raised about the costs and time burden associated with structured data requirements. For example, the ACSEC has focused on the costs of structuring disclosures and issues associated with XBRL data are correlated with particular third-party providers of XBRL software and services, which may be, at least in part, due to continued innovation and growth in the market for filer software and services, resulting in offerings of varying functionality and ease of use. See id; 2014 Staff Observations. 1141 See, e.g., December 2011 Staff Observations; Staff Observations From Review of Interactive Data Financial Statements (Jun. 15, 2011), available at https://www.sec.gov/spotlight/xbrl/staff-reviewobservations-061511.shtml. 1142 See Disclosure management: Streamlining the Last Mile, PricewaterhouseCoopers (Mar. 2012), available at https://www.pwc.com/gx/en/xbrl/pdf/ pwc-streamlining-last-mile-report.pdf. 1143 See Trevor S. Harris and Suzanne Morsfield, An Evaluation of the Current State and Future of XBRL and Interactive Data for Investors and Analysts—White Paper Number Three, Columbia Business School Center for Excellence in Accounting and Security Analysis, Dec. 2012, available at https://www8.gsb.columbia.edu/ceasa/ sites/ceasa/files/An%20Evaluation%20of%20the %20Current%20State%20and%20Future%20 of%20XBRL%20and%20Interactive%20Data%20 for%20Investors%20and%20Analysts.pdf. 1144 See SEC Announces Program to Facilitate Analysis of Corporate Financial Data (Dec. 30, 2014), available at https://www.sec.gov/news/ pressrelease/2014-295.html; Financial Statement Data Sets, available at https://www.sec.gov/dera/ data/financial-statement-data-sets.html. E:\FR\FM\22APP3.SGM 22APP3 24008 Federal Register / Vol. 81, No. 78 / Friday, April 22, 2016 / Proposed Rules asserted that the requirements impose a disproportionate burden on smaller registrants in terms of cost and time.1145 As discussed above, both ACSEC and the Small Business Forum have recommended that the Commission exempt SRCs from the requirement to provide financial information in XBRL.1146 In its own structured data recommendation, the Investor Advisory Committee generally supported structured data but acknowledged the costs of data tagging and recommended that the Commission take steps to reduce these costs, particularly for smaller registrants and investors.1147 According to a 2015 AICPA study, however, XBRL filing costs for smaller registrants were lower than initially expected and have been decreasing since the 2009 inception of the Commission’s Structured Data Program.1148 We acknowledge that registrants may incur costs to provide disclosure in structured data format, particularly initial set-up costs. We seek public comment on ways to minimize the costs of providing structured disclosures, particularly over time, while still realizing the intended benefits to investors and other users of such disclosures. 3. Request for Comment 330. How can the quality of structured disclosures be enhanced? 331. Are there changes to the EDGAR system that the Commission should make to render the structured disclosure filed by registrants more useful? 332. Are company-specific custom extensions, such as element or axis extensions, useful to investors or other users of structured disclosures? If so, how might these custom extensions be made more useful for enhancing 2015 ACSEC Recommendations; 2013 ACSEC Recommendations. 1146 See Section IV.H.2.b. 1147 See IAC Data Tagging Recommendations. 1148 See American Institute of CPAs, Research Shows XBRL Filing Costs Lower than Expected (Jan. 2015), available at https://www.aicpa.org/ interestareas/frc/accountingfinancialreporting/xbrl/ pages/xbrlcostsstudy.aspx. mstockstill on DSK4VPTVN1PROD with PROPOSALS3 1145 See VerDate Sep<11>2014 20:05 Apr 21, 2016 Jkt 238001 automated analysis? If not, are there better ways to express disclosures that are unique to a company (e.g., business segment, product line)? 333. Should we require registrants to provide additional disclosures in a structured format? If so, which disclosures? For example, are there categories of information in Parts I and II of Form 10–K or in Form 10–Q that investors would want to receive as structured data? 334. To the extent that we consider additional structured data requirements for disclosure in periodic reports, what level of structured data requirements would be appropriate? For example, should we require registrants to identify sections, sub-sections or topics with ‘‘block text’’ labels, or should we require registrants to structure numeric elements and tables individually? What would be the challenges and costs of such an approach? What would be the benefit? 335. How does the availability of structured data in registrants’ periodic reports affect the timeliness, efficiency, or depth of investors’ review of disclosures? How do the effects of structured disclosure requirements vary across investor types? Are there other methods of structuring disclosures that would make disclosures more accessible or useful? 336. To what extent is the information currently provided in structured disclosures readily available through other sources, such as third-party data aggregators? What are the costs and benefits to investors of obtaining this data from such third parties rather than through the use of structured disclosures filed by registrants? 337. To what extent do investors, analysts, third-party data aggregators, or other market participants rely on structured data provided by registrants in their periodic reports? What specific content in structured disclosures is useful to each of these groups? 338. Are there other ways in which our requirements can improve the accuracy of tagged data? What would be the challenges to registrants posed by such alternatives? PO 00000 Frm 00094 Fmt 4701 Sfmt 9990 339. Are there certain categories of registrant for which we should provide an exemption from some or all structured disclosure requirements, require more limited information to be tagged, or require a different presentation of this information? Why or why not? If so, to which registrants or structured disclosure requirements should such exemptions apply? 340. In requiring structured data, the Commission has sought to make disclosure easier for investors to access, analyze and compare across reporting periods, registrants, and industries.1149 Are there other technologies that could make disclosure easier for investors to access, analyze and compare? If so, how should we incorporate these technologies into our disclosure requirements? VI. Conclusion We are interested in the public’s views on any of the matters discussed in this concept release or on the staff’s Disclosure Effectiveness Initiative. We encourage all interested parties to submit comment on these topics. If possible, please reference the specific question numbers or sections of the release when submitting comments. In addition to investors and registrants, the Commission welcomes comment from other market participants and particularly welcomes statistical, empirical, and other data from commenters that may support their views and/or support or refute the views or issues raised. We also solicit comment on any other aspect of our disclosure requirements in Regulation S–K that commenters believe may be improved upon. Please be as specific as possible in your discussion and analysis of any additional issues. By the Commission. Dated: April 13, 2016. Brent J. Fields, Secretary. [FR Doc. 2016–09056 Filed 4–21–16; 8:45 am] BILLING CODE 8011–01–P 1149 See E:\FR\FM\22APP3.SGM supra notes 1130 to 1131. 22APP3

Agencies

[Federal Register Volume 81, Number 78 (Friday, April 22, 2016)]
[Proposed Rules]
[Pages 23915-24008]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-09056]



[[Page 23915]]

Vol. 81

Friday,

No. 78

April 22, 2016

Part III





Securities and Exchange Commission





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17 CFR Parts 210, 229, 230, et al.





 Business and Financial Disclosure Required by Regulation S-K; Concept 
Release; Proposed Rule

Federal Register / Vol. 81 , No. 78 / Friday, April 22, 2016 / 
Proposed Rules

[[Page 23916]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 229, 230, 232, 239, 240 and 249

[Release No. 33-10064; 34-77599; File No. S7-06-16]
RIN 3235-AL78


Business and Financial Disclosure Required by Regulation S-K

AGENCY: Securities and Exchange Commission.

ACTION: Concept release.

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SUMMARY: The Commission is publishing this concept release to seek 
public comment on modernizing certain business and financial disclosure 
requirements in Regulation S-K. These disclosure requirements serve as 
the foundation for the business and financial disclosure in 
registrants' periodic reports. This concept release is part of an 
initiative by the Division of Corporation Finance to review the 
disclosure requirements applicable to registrants to consider ways to 
improve the requirements for the benefit of investors and registrants.

DATES: Comments should be received on or before July 21, 2016.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (https://www.sec.gov/rules/concept.shtml);
     Send an email to rule-comments@sec.gov. Please include 
File Number S7-06-16 on the subject line; or
     Use the Federal eRulemaking Portal (https://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-06-16. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method of submission. The Commission will post all 
comments on the Commission's Web site (https://www.sec.gov/rules/concept.shtml). Comments also are available for Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street NE., 
Washington, DC 20549, on official business days between the hours of 
10:00 a.m. and 3:00 p.m. All comments received will be posted without 
change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
publicly available.

FOR FURTHER INFORMATION CONTACT: Angie Kim, Special Counsel in the 
Office of Rulemaking, at (202) 551-3430, in the Division of Corporation 
Finance; 100 F Street NE., Washington, DC 20549.

Table of Contents

I. Introduction
II. Relevant History and Background
    A. History of Regulation S-K
    B. Broad Economic Considerations
    C. Prior Regulation S-K Modernization Initiatives and Studies
III. Disclosure Framework
    A. Basis for Our Disclosure Requirements
    1. Statutory Mandates
    2. Commission Responses to Market Developments
    B. Nature of Our Disclosure Requirements
    1. Principles-Based and Prescriptive Disclosure Requirements
    2. Audience for Disclosure
    3. Compliance and Competitive Costs
IV. Information for Investment and Voting Decisions
    A. Core Company Business Information
    1. General Development of Business (Item 101(a)(1))
    2. Narrative Description of Business (Item 101(c))
    3. Technology and Intellectual Property Rights (Item 
101(c)(1)(iv))
    4. Government Contracts and Regulation, Including Environmental 
Laws (Items 101(c)(1)(ix) and (c)(1)(xii))
    5. Number of Employees (Item 101(c)(1)(xiii))
    6. Description of Property (Item 102)
    B. Company Performance, Financial Information and Future 
Prospects
    1. Selected Financial Data (Item 301)
    2. Supplementary Financial Information (Item 302)
    3. Content and Focus of MD&A (Item 303--Generally)
    4. Results of Operations (Item 303(a)(3))
    5. Liquidity and Capital Resources (Item 303(a)(1) and (a)(2))
    6. Off-Balance Sheet Arrangements (Item 303(a)(4))
    7. Contractual Obligations (Item 303(a)(5))
    8. Critical Accounting Estimates
    C. Risk and Risk Management
    1. Risk Factors (Item 503(c))
    2. Quantitative and Qualitative Disclosures About Market Risk 
(Item 305)
    3. Disclosure of Approach to Risk Management and Risk Management 
Process
    4. Consolidating Risk-Related Disclosure
    D. Securities of the Registrant
    1. Related Stockholder Matters--Number of Equity Holders (Item 
201(b))
    2. Description of Capital Stock (Item 202)
    3. Recent Sales of Unregistered Securities (Items 701(a)-(e))
    4. Use of Proceeds From Registered Securities (Item 701(f))
    5. Purchases of Equity Securities by the Issuer and Affiliated 
Purchasers (Item 703)
    E. Industry Guides
    1. Comments Received
    2. Discussion
    3. Request for Comment
    F. Disclosure of Information Relating to Public Policy and 
Sustainability Matters
    1. Comments Received
    2. Discussion
    3. Request for Comment
    G. Exhibits
    1. Request for Comment
    2. Schedules and Attachments to Exhibits
    3. Amendments to Exhibits
    4. Changes to Exhibits (Instruction 1 to Item 601)
    5. Material Contracts (Item 601(b)(10))
    6. Preferability Letter (Item 601(b)(18))
    7. Subsidiaries and Legal Entity Identifiers
    H. Scaled Requirements
    1. Categories of Registrants Eligible for Scaled Disclosure
    2. Scaled Disclosure Requirements for Eligible Registrants
    3. Frequency of Interim Reporting
V. Presentation and Delivery of Important Information
    A. Cross-Referencing
    1. Comments Received
    2. Discussion
    B. Incorporation by Reference
    1. Comments Received
    2. Discussion
    3. Request for Comment
    C. Hyperlinks
    1. Comments Received
    2. Discussion
    3. Request for Comment
    D. Company Web Sites
    1. Comments Received
    2. Discussion
    3. Request for Comment
    E. Specific Formatting Requirements
    1. Comments Received
    2. Discussion
    3. Request for Comment
    F. Layered Disclosure
    1. Comments Received
    2. Discussion
    3. Request for Comment
    G. Structured Disclosures
    1. Comments Received
    2. Discussion
    3. Request for Comment
VI. Conclusion

I. Introduction

    Regulation S-K was adopted to foster uniform and integrated 
disclosure for registration statements under the Securities Act of 1933 
(``Securities Act''), registration statements under the Securities 
Exchange Act of 1934 (``Exchange Act''), and other Exchange Act 
filings, including periodic and current reports.\1\ Over thirty years 
ago, the Commission expanded and reorganized Regulation S-K to be the

[[Page 23917]]

central repository for its non-financial statement disclosure 
requirements.\2\ When adopting the integrated disclosure system, the 
Commission's goals were to reduce the costs to registrants and 
eliminate duplicative disclosures while continuing to provide material 
information.\3\ In this concept release, we revisit the business and 
financial disclosure requirements in Regulation S-K. We seek to assess 
whether they continue to provide the information that investors need to 
make informed investment and voting decisions and whether any of our 
rules have become outdated or unnecessary.
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    \1\ See Item 10(a) of Regulation S-K [17 CFR 229.10].
    \2\ See Adoption of Integrated Disclosure System, Release No. 
33-6383 (Mar. 3, 1982) [47 FR 11380 (Mar. 16, 1982)] (``1982 
Integrated Disclosure Adopting Release'').
    \3\ See id.
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    We focus this release on business and financial disclosures that 
registrants provide in their periodic reports, which are a subset of 
the disclosure requirements in Regulation S-K.\4\ We focus on these 
requirements because many of them have changed little since they were 
first adopted. We are not at this time revisiting other disclosure 
requirements in Regulation S-K, such as executive compensation and 
governance, or the required disclosures for foreign private issuers, 
business development companies, or other categories of registrants. 
Although the specific scope of this concept release is as indicated, we 
welcome and encourage comments on any other disclosure topics not 
specifically addressed in this concept release.
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    \4\ The scope of this release does not include certain 
disclosure requirements for information other than business and 
financial disclosures, such as Subpart 400, which requires 
disclosure about management and certain security holders as well as 
corporate governance matters. We also have not included offering-
specific disclosure requirements under Subpart 500, which generally 
apply to registration statements and prospectuses but not periodic 
reports.
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    This release begins with a discussion of the regulatory history of 
the integrated disclosure system and Regulation S-K as well as an 
overview of prior initiatives to review and modernize our disclosure 
requirements. We then present the framework for our current disclosure 
regime and explore potential alternative approaches. We proceed to 
review the business and financial disclosure requirements that apply to 
periodic reports. We first consider what financial and business 
information should be required and whether any of these requirements 
are appropriate to scale for smaller registrants. We then explore how 
registrants can most effectively present this information to improve 
its usefulness to investors. In this release, we consider input we have 
received from letters submitted in response to disclosure modernization 
efforts \5\ as well as the staff's experience with particular 
disclosure requirements, regulatory history and changes in the 
regulatory and business landscape since the rule's adoption.
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    \5\ See infra notes 9 to 10 and accompanying text.
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    Through this release, we are reviewing and seeking public comment 
on whether our business and financial disclosure requirements continue 
to elicit important information for investors and how registrants can 
most effectively present this information. We are specifically seeking 
comment on:
     Whether, and if so, how specific disclosures are important 
or useful to making investment and voting decisions and whether more, 
less or different information might be needed;
     whether, and if so how, we could revise our current 
requirements to enhance the information provided to investors while 
considering whether the action will promote efficiency, competition, 
and capital formation; \6\
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    \6\ Section 3(f) of the Exchange Act [15 U.S.C. 78c(f)] requires 
that, whenever the Commission is engaged in rulemaking under the 
Exchange Act and is required to consider or determine whether an 
action is necessary or appropriate in the public interest, the 
Commission shall also consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition 
and capital formation. Section 2(b) of the Securities Act [15 U.S.C. 
77b(b)] sets forth this same requirement. See also Section 23(a)(2) 
of the Exchange Act [15 U.S.C. 78w(a)(2)].
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     whether, and if so how, we could revise our requirements 
to enhance the protection of investors;
     whether our current requirements appropriately balance the 
costs of disclosure with the benefits;
     whether, and if so how, we could lower the cost to 
registrants of providing information to investors, including 
considerations such as advancements in technology and communications;
     whether and if so, how we could increase the benefits to 
investors and facilitate investor access to disclosure by modernizing 
the methods used to present, aggregate and disseminate disclosure; and
     any challenges of our current disclosure requirements and 
those that may result from possible regulatory responses explored in 
this release or suggested by commenters.

While we set forth a number of general and specific questions, we 
welcome comments from investors, registrants and other market 
participants on any other concerns related to our disclosure 
requirements. In addition to comments received on this release, we will 
consider any input from investor focus group studies or surveys, the 
Investor Advisory Committee and the Advisory Committee on Small and 
Emerging Companies.

    This concept release is part of a comprehensive evaluation of the 
Commission's disclosure requirements recommended in the staff's Report 
on Review of Disclosure Requirements in Regulation S-K (``S-K Study''), 
which was mandated by Section 108 of the Jumpstart Our Business 
Startups Act (``JOBS Act'').\7\ Based on the S-K Study's recommendation 
and at the request of Commission Chair Mary Jo White,\8\ Commission 
staff initiated a comprehensive evaluation of the type of information 
our rules require registrants to disclose, how this information is 
presented, where and how this information is disclosed and how we can 
leverage technology as part of these efforts (collectively, 
``Disclosure Effectiveness Initiative''). The overall objective of the 
Disclosure Effectiveness Initiative is to improve our disclosure regime 
for both investors and registrants.
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    \7\ Public Law 112-106, Sec. 108, 126 Stat. 306 (2012). Section 
108 of the JOBS Act required the Commission to conduct a review of 
Regulation S-K to determine how such requirements can be updated to 
modernize and simplify the registration process for emerging growth 
companies (``EGCs''). For a further discussion of the S-K Study, see 
Section II.C.
    \8\ See SEC Issues Staff Report on Public Company Disclosure 
(Dec. 20, 2013), available at https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540530982.
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    In connection with the S-K Study \9\ and the subsequent launch of 
the Disclosure Effectiveness Initiative,\10\ we received public 
comments on various topics discussed in this release. Below and 
elsewhere throughout this release, we discuss these comments as further 
context for the topics under consideration. Comments received in 
connection with the Disclosure Effectiveness Initiative that are 
outside the scope of this release are not discussed here. These comment 
letters are being considered as part of the staff's continued 
evaluation of Regulation S-K

[[Page 23918]]

from which the staff expects to make further recommendations to the 
Commission for consideration.
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    \9\ In connection with the S-K Study, we received public 
comments on regulatory initiatives to be undertaken in response to 
the JOBS Act. See Comments on SEC Regulatory Initiatives Under the 
JOBS Act: Title I--Review of Regulation S-K, available at https://www.sec.gov/comments/jobs-title-i/reviewreg-sk/reviewreg-sk.shtml.
     Some of the comments received in connection with the S-K Study 
were specific to EGCs.
    \10\ To facilitate public input on the Disclosure Effectiveness 
Initiative, members of the public were invited to submit comments. 
Public comments we have received to date on the topic of Disclosure 
Effectiveness are available on our Web site. See Comments on 
Disclosure Effectiveness, available at https://www.sec.gov/comments/disclosure-effectiveness/disclosureeffectiveness.shtml.
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    The staff is also working on recommendations for our consideration 
to propose specific revisions to update or simplify certain of our 
business and financial disclosure requirements, as required by the 
recently enacted Fixing America's Surface Transportation Act of 2015 
(``FAST Act'').\11\ Those recommendations relate to specific proposals 
to help address ``duplicative, overlapping, outdated or unnecessary'' 
disclosure and are not specifically addressed in this concept release, 
which seeks to explore both general considerations and specific 
questions that we believe would benefit from further evaluation and 
input before proposing any changes to the related rules.\12\
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    \11\ Public Law 114-94, Sec. 72002, 129 Stat. 1312 (2015).
    \12\ Id.
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II. Relevant History and Background

A. History of Regulation S-K

Regulation S-K
    Enactment of the Securities Act and the Exchange Act resulted in 
the creation of two separate disclosure regimes. These disclosure 
regimes remained distinct for approximately thirty years and often 
resulted in overlapping and duplicative disclosure requirements. 
Regulation S-K reflects the Commission's efforts to harmonize 
disclosure required under both the Securities Act and the Exchange Act 
by creating a single repository for disclosure regulation that applies 
to filings by registrants under both statutes.
    The current integrated disclosure system resulted from a series of 
efforts triggered by a 1964 amendment to the Exchange Act,\13\ which 
added Section 12(g) to the Exchange Act and extended the Exchange Act's 
reporting requirements to companies meeting specified thresholds, 
including those that were not exchange listed.\14\ In light of the 
Exchange Act's broadened reporting requirements, Professor Milton Cohen 
suggested in a seminal 1966 law review article greater coordination 
between the Securities Act and Exchange Act.\15\ He recommended that 
the continuous reporting obligations under the Exchange Act serve as 
the foundation for corporate disclosure while relaxing or eliminating 
overlapping Securities Act disclosure requirements.\16\
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    \13\ See, e.g., Disclosure to Investors--A Reappraisal of 
Federal Administrative Policies under the '33 and '34 Acts, Policy 
Study, Mar. 27, 1969, available at https://www.sechistorical.org/museum/galleries/tbi/gogo_d.php (``Wheat Report'') (stating that one 
of the reasons for a broad re-examination of disclosure policy was 
the 1964 amendment to the Exchange Act). See also infra note 15.
    \14\ 15 U.S.C. 781(g). Congress enacted Section 12(g) of the 
Exchange Act in 1964, which required an issuer to register a class 
of securities under Section 12(g) if the securities were ``held of 
record'' by 500 or more persons and the issuer had total assets 
exceeding $1 million. Prior to the enactment of Section 12(g), the 
Exchange Act reporting requirements were applicable only to listed 
companies. The Commission used its authority under Section 12(h) to 
raise the asset threshold for Section 12(g) registration from $1 
million to $3 million in 1982, $5 million in 1986 and $10 million in 
1996.
    As a result of amendments made by the JOBS Act and the FAST Act, 
Section 12(g)(1) of the Exchange Act now requires an issuer that is 
not a bank, bank holding company, or savings and loan holding 
company to register a class of equity securities if the securities 
are held of record by either (i) 2,000 persons, or (ii) 500 persons 
who are not accredited investors and the issuer has total assets 
exceeding $10 million. Banks, bank holding companies and savings and 
loan holding companies with total assets exceeding $10 million must 
register a class of equity securities if the securities are held of 
record by 2,000 or more persons. Public Law 112-106, Sec. 501, 126 
Stat. 306 (2012) and Public Law 114-94, Sec. 85001, 129 Stat. 1312 
(2015).
    \15\ See Milton H. Cohen, ``Truth in Securities'' Revisited, 79 
Harv. L. Rev. 1340, 1350 (1966) (``With the 1934 Act now extended to 
thousands of additional companies by the 1964 Amendments, the need 
of a reexamination with an eye to coordination of the 1934 Act with 
the earlier one is all the greater'').
    \16\ See id. at 1341-42, stating ``[i]t is my thesis that the 
combined disclosure requirement of these statutes would have been 
quite different if the 1933 and 1934 Acts (the latter as extended in 
1964) had been enacted in opposite order, or had been enacted as a 
single, integrated statute--that is, if the starting point had been 
a statutory scheme of continuous disclosures covering issuers of 
actively traded securities and the question of special disclosures 
in connection with public offerings had been faced in this setting. 
Accordingly, it is my plea that there now be created a new 
coordinated disclosure system having as its basis the continuous 
disclosure system of the 1934 Act and treating ``1933 Act'' 
disclosure needs on this foundation.''
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    Subsequent to the publication of this article, the Commission 
initiated several studies that advanced efforts to integrate the 
Securities Act and Exchange Act disclosure regimes. These efforts 
included the Disclosure Policy Study led by Commissioner Francis Wheat 
\17\ and the report issued by the Advisory Committee on Corporate 
Disclosure led by former Commissioner A. A. Sommer, Jr. (``Sommer 
Report'').\18\ In 1969, the Wheat Report concurred with Cohen's 
proposal for a coordinated disclosure system. It recommended an 
enhanced degree of coordination between the disclosures required by the 
Securities Act and the Exchange Act and formulated specific proposals 
for integrating disclosure between the two Acts.\19\ In 1977, the 
Sommer Report suggested adopting a single, integrated disclosure system 
and recommended developing one coordinated disclosure form.\20\
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    \17\ See supra note 13.
    \18\ See Report of the Advisory Committee on Corporate 
Disclosure to the Securities and Exchange Commission, Cmte. Print 
95-29, House Cmte. On Interstate and Foreign Commerce, 95th Cong., 
1st. Sess (Nov. 3, 1977) available at https://opc-ad-ils/
InmagicGenie/DocumentFolder/
report%20of%20the%20advisory%20committee%20on%20corporate%20disclosur
e%20to%20the%20sec%2011011977.pdf.
    \19\ See generally Wheat Report.
    \20\ See Sommer Report at 420-432.
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    Following the Sommer Report, the Commission adopted the first 
version of Regulation S-K, which included only two disclosure 
requirements--a description of business and a description of 
properties.\21\ While additional disclosure requirements were added in 
1978 and 1980,\22\ Regulation S-K was significantly expanded and 
reorganized in 1982 as the repository for the uniform non-financial 
statement disclosure requirements under both the Securities Act and 
Exchange Act.\23\ With this expansion and reorganization, the 
Commission moved much of the guidance in the prior Industry Guides into 
Regulation S-K and amended the forms and schedules to reference 
requirements in Regulation S-K.\24\
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    \21\ See Adoption of Disclosure Regulation and Amendments of 
Disclosure Forms and Rules, Release No. 33-5893 (Dec. 23, 1977) [42 
FR 65554 (Dec. 30, 1977)] (``1977 Regulation S-K Adopting 
Release'').
    \22\ See S-K Study at 10, footnote 27.
    \23\ See id. at 10, footnote 28.
    \24\ For a discussion of the Industry Guides, see infra notes 
639 to 644 and accompanying text.
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    Many of the disclosure requirements in Regulation S-K originated in 
Schedule A of the Securities Act, which lists 27 items that must be 
disclosed in a registration statement and prospectus.\25\ Section 7 of 
the Securities Act provides that the registration statement shall 
contain the information and be accompanied by the documents specified 
in Schedule A, except the Commission may exercise its rulemaking 
authority to prescribe additional information or may permit prescribed 
information to be omitted as it deems necessary or appropriate in the 
public interest or for the protection of

[[Page 23919]]

investors.\26\ Over the years, the Commission has exercised this 
authority to adopt various registration forms and disclosure 
requirements. While many of the disclosure requirements currently in 
Regulation S-K originated in Schedule A, the Commission has amended 
Regulation S-K numerous times since its adoption.\27\
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    \25\ 15 U.S.C. 77aa. Schedule A requires companies to provide 
information such as: General information about the company, its 
business and capital structure; information about the directors, 
principal officers, promoters and ten percent stockholders and 
remuneration of officers and directors; information about the 
offering; financial statements of the company and of any business to 
be acquired through the proceeds of the issue; and copies of 
agreements made with underwriters, opinions of counsel on legality 
of the issue, material contracts, the company's organizational 
documents and agreements or indentures affecting any securities 
offered.
    \26\ 15 U.S.C. 77g.
    \27\ For a comprehensive discussion of prior revisions to 
Regulation S-K, please see Sections II and III of the S-K Study at 
8-92.
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B. Broad Economic Considerations

    The purpose of corporate disclosure is to provide investors with 
information they need to make informed investment and voting decisions. 
Lowering information asymmetries between managers of companies and 
investors may enhance capital formation and the allocative efficiency 
of the capital markets. In particular, disclosure of information that 
is important for investment and voting decisions may lead to more 
accurate share prices, discourage fraud, heighten monitoring of the 
managers of companies, and increase liquidity. Effective disclosure 
requirements also should increase the integrity of securities markets, 
build investor confidence, and support the provision of capital to the 
market. In addition, such requirements can facilitate the coordination 
of registrants around consistent disclosure standards, increasing the 
efficiency with which investors can process the information.
    There are potential drawbacks associated with disclosure 
requirements. Disclosure can be costly for registrants to produce and 
disseminate, and disclosure of certain sensitive information can result 
in competitive disadvantages. There is also a possibility that high 
levels of immaterial disclosure can obscure important information or 
reduce incentives for certain market participants to trade or create 
markets for securities. The appropriate choice of disclosure 
requirements therefore involves certain tradeoffs. These tradeoffs may 
depend on the nature of the audience for disclosure and the 
characteristics of registrants.
    Markets are composed of a broad spectrum of investors with 
different information needs. Some investors may be highly sophisticated 
and have access to substantial resources to process and interpret data, 
while others may lack sophistication or have fewer resources to process 
and interpret data. Investors also may differ in their reliance on 
disclosure or on third-party analyses of disclosure. The breadth of the 
audience for disclosure may inform choices about what information is 
important to investment and voting decisions and should therefore be 
disclosed. The diversity of the audience for disclosure, and how 
different subsets of this audience access and digest information about 
registrants, will also affect decisions about how best to format and 
disseminate disclosure.
    The trade-off between the benefits and costs of disclosure 
requirements may vary across different types of registrants. For 
example, to the extent that our disclosure requirements impose fixed 
costs, they may impose a disproportionate burden on smaller 
registrants. At the same time, these registrants may have relatively 
simple operations and thus be able to promote an understanding of their 
business and financial condition with less disclosure than larger, more 
complex registrants. Accordingly, it may be appropriate to provide 
disclosure accommodations for certain types of registrants, while 
remaining cognizant of the potential adverse impacts that reduced 
disclosure may have on capital formation and the allocative efficiency 
of the capital markets.
    The benefits associated with disclosing certain items of 
information may be greater in some cases than in others, such as when 
an item of disclosure reflects an important part of one registrant's 
operations but an immaterial part of another's. In this context, it may 
be important to consider various approaches to trigger disclosure where 
it is more likely to be important, rather than in all cases. It may 
also be useful to have disclosure requirements, or guidance in 
fulfilling these requirements, that are specific to certain industries 
or other subsets of registrants. We seek to understand if disclosure 
requirements can be more appropriately tailored to registrants given 
the likely variation across registrants in the benefits and the costs 
of disclosing certain types of information. We discuss specific 
economic considerations in more detail below.

C. Prior Regulation S-K Modernization Initiatives and Studies

    From time to time, the Commission has assessed its disclosure 
requirements. Several of these studies focused on modernizing or 
simplifying disclosure requirements. Other initiatives focused on 
different aspects of the regulatory framework, such as the securities 
offering process or the financial reporting system, but had the effect 
of raising disclosure issues for further consideration or shaping 
current disclosure requirements. The Disclosure Effectiveness 
Initiative builds upon these prior studies and initiatives.
Task Force on Disclosure Simplification
    The Task Force on Disclosure Simplification (``Task Force''), 
comprising staff from across the Commission, was formed in 1995 to 
review regulations affecting capital formation with a view towards 
``streamlining, simplifying, and modernizing the overall regulatory 
scheme without compromising or diminishing important investor 
protections.'' \28\ In its report to the Commission in 1996, the Task 
Force recommended the Commission ``eliminate or modify many rules and 
forms, and simplify several key aspects of securities offerings.'' \29\ 
Based on the Task Force's recommendations, the Commission rescinded 
forty-five rules and six forms and adopted other minor or technical 
rule changes to eliminate unnecessary requirements and to streamline 
the disclosure process.\30\
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    \28\ See Report of the Task Force on Disclosure Simplification, 
available at www.sec.gov/news/studies/smpl.htm (Mar. 5, 1996) 
(``Task Force Report''). To facilitate its review, the Task Force 
met with issuers, investor groups, underwriters, accounting firms, 
law firms and other active participants in the capital markets.
    \29\ See id. stating `` . . . recommendations [of the task 
force] roughly fall into three categories: (1) Weeding out forms and 
regulations that are duplicative of other requirements or have 
outlived their usefulness; (2) Requiring more readable and 
informative disclosure documents; and (3) Reducing the cost of 
securities offerings and increasing access of smaller companies to 
the securities markets.''
    \30\ See Phase One Recommendations of Task Force on Disclosure 
Simplification, Release No. 33-7300 (May 31, 1996) [61 FR 30397 
(June 14, 1996)] (``Phase One Recommendations of Task Force on 
Disclosure Simplification Release''). For example, changes to 
Regulation S-K included eliminating four infrequently used (or 
otherwise already available) items from the list of required 
exhibits in Item 601(b) (opinion regarding discount on capital 
shares, opinion regarding liquidation preference, material foreign 
patents, and information from reports furnished to state insurance 
regulatory authorities).
    See also Phase Two Recommendations of Task Force on Disclosure 
Simplification, Release No. 33-7431 (July 18, 1997) [62 FR 43581 
(Aug. 14, 1997)] (``Phase Two Recommendations of Task Force on 
Disclosure Simplification Release'') (rescinding two forms and one 
rule and amending a number of rules and forms). The Commission 
further implemented certain of the recommendations in the Task Force 
Report relating to accounting disclosure rules that were identified 
as being largely duplicative of U.S. GAAP or other Commission rules.
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    The Task Force also made the following recommendations on 
Regulation S-K:
     Streamline Item 101's description of business disclosure 
by eliminating duplication of quantitative information about business 
segments and foreign operations provided in the financial statements;

[[Page 23920]]

     revise Item 102's description of property disclosure to 
elicit ``more meaningful and material disclosure;'' and
     eliminate Item 103's instruction to replace the $100,000 
standard with a general materiality standard for certain environmental 
legal proceedings to ensure registrants will not be required to 
disclose non-material information.\31\
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    \31\ The Task Force also generally recommended adjusting certain 
dollar thresholds in Regulation S-K and Regulation S-X for inflation 
since the time of their adoption. The Task Force cited, among other 
items, the $50,000 threshold in Item 509 of Regulation S-K (relating 
to disclosure of payments to experts and counsel) [17 CFR 229.509] 
and the $100,000 threshold in Rule 3-11 of Regulation S-X (relating 
to the definition of an inactive registrant) [17 CFR 210.3-11]. See 
Task Force Report.

While the Commission made a number of changes in response to the Task 
Force recommendations, the three items identified above were not 
adopted by the Commission. We revisit some of these issues in the 
questions presented below.
Report of the Advisory Committee on the Capital Formation and 
Regulatory Process
    Also in 1995, the Commission established the Advisory Committee on 
the Capital Formation and Regulatory Processes (``1995 Advisory 
Committee'') to advise on, among other things, the regulatory process 
and disclosure requirements for public offerings. The 1995 Advisory 
Committee's primary recommendation was implementing a system of 
``company registration.'' \32\
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    \32\ Under a ``company registration'' system, a company would, 
on a one-time basis, file a registration statement (deemed effective 
immediately) that includes information similar to that currently 
provided in an initial short-form shelf registration statement. This 
registration statement could then be used for all types of 
securities and all types of offerings. All current and future 
Exchange Act reports would be incorporated by reference into that 
registration statement, and around the time of an offering, 
transactional and updating disclosures would be filed with the 
Commission and incorporated into the registration statement. As part 
of this ``company registration'' system, companies would be required 
to adopt certain disclosure enhancements (and encouraged to adopt 
others) that seek to improve the quality and timeliness of 
disclosure provided to investors and the markets. See Securities Act 
Concepts and Their Effects on Capital Formation, Release No. 33-7314 
(July 25, 1996) [61 FR 40044 (July 31, 1996)] (``Securities Act 
Concept Release'').
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    Noting the Task Force Report, the 1995 Advisory Committee did not 
focus on specific line-item disclosure requirements but suggested 
disclosure enhancements as part of its recommendations for a system of 
``company registration.'' These enhancements included a management 
certification to the Commission for all periodic and current reports, a 
management's report to the audit committee to be filed as an exhibit to 
the Form 10-K, expansion of current reporting obligations on Form 8-K 
and a risk factor disclosure requirement in Form 10-K.\33\
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    \33\ See Report of The Advisory Committee on the Capital 
Formation and Regulatory Processes (July 24, 1996), available at 
https://www.sec.gov/news/studies/capform.htm.
---------------------------------------------------------------------------

    After receiving reports from both the Task Force and the 1995 
Advisory Committee, the Commission issued a concept release on 
regulation of the securities offering process and also sought input on 
the 1995 Advisory Committee's proposed disclosure enhancements.\34\
---------------------------------------------------------------------------

    \34\ See the Securities Act Concept Release. Many of the issues 
raised in the concept release were revisited in the Commission's 
1998 proposal to modernize the securities offering process (known as 
the ``Aircraft Carrier'' release), and in the Commission's 2005 
Securities Offering Reform rulemaking. Some of the proposals from 
the Aircraft Carrier release were later adopted. For example, the 
Aircraft Carrier release recommended inclusion of risk factor 
disclosure in Exchange Act registration statements and annual 
reports. This recommendation was adopted as part of Securities 
Offering Reform. See The Regulation of Securities Offerings, Release 
No. 33-7606A (Nov. 17, 1998) [63 FR 67174 (Dec. 4, 1998)] 
(``Aircraft Carrier Release'') and Securities Offering Reform, 
Release No. 33-8591 (July 19, 2005) [70 FR 44722 (Aug. 3, 2005)] 
(``Securities Offering Reform Release'').
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Plain English
    In 1998, the Commission adopted rules intended to improve the 
readability of prospectuses by promoting clear, concise and 
understandable disclosure (``Plain English Rules'').\35\ These rules 
required registrants to write the cover page, summary and risk factors 
section of prospectuses in plain English \36\ and were extended to 
Exchange Act reports in 2005.\37\
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    \35\ See Plain English Disclosure, Release No. 33-7497 (Jan. 28, 
1998) [63 FR 6370 (Feb. 6, 1998)] (``Plain English Disclosure 
Adopting Release'').
    \36\ Id.
    \37\ See Securities Offering Reform Release. As part of the 
Securities Offering Reform Release, Form 10-K was amended to require 
risk factor disclosure to be written in accordance with the same 
Plain English Rules that apply to risk factor disclosure in 
Securities Act registration statements. See also Part I, Item 1A of 
Form 10-K.
---------------------------------------------------------------------------

Advisory Committee on Improvements to Financial Reporting
    In 2007, the Commission chartered the Advisory Committee on 
Improvements to Financial Reporting (``CIFiR Advisory Committee'') to 
examine the U.S. financial reporting system.\38\ While the CIFiR 
Advisory Committee did not recommend specific changes to Regulation S-
K, several of its suggestions sought to improve the usefulness of 
information in periodic reports.\39\ The Commission adopted some of 
these suggestions, which included updating the Commission's 
interpretive guidance on use of electronic media for disseminating 
information on a registrant's financial performance \40\ and adopting 
rules to require filing of interactive data-tagged financial 
statements.\41\
---------------------------------------------------------------------------

    \38\ The dual goals of the CIFiR Advisory Committee were ``to 
examine the U.S. financial reporting system in order to make 
recommendations intended to increase the usefulness of financial 
information to investors, while reducing the complexity of the 
financial reporting system to investors, preparers, and auditors.'' 
See Final Report of the Advisory Committee on Improvements to 
Financial Reporting to the United States Securities and Exchange 
Commission (Aug. 1, 2008), (``CIFiR Advisory Committee Report''), 
available at https://www.sec.gov/about/offices/oca/acifr/acifr-finalreport.pdf.
    \39\ See CIFiR Advisory Committee Report (stating that 
``[i]ncreasing the usefulness of information in SEC reports'' was 
one of five themes underlying the CIFiR Advisory Committee's 
recommendations).
    \40\ In 2008, the Commission published interpretive guidance on 
the use of company Web sites as a means for companies to communicate 
and provide information to investors in compliance with the federal 
securities laws and, in particular, the Exchange Act. See Commission 
Guidance on the Use of Company Web sites, Release No. 34-58288 (Aug. 
1, 2008) [73 FR 45862 (Aug. 7, 2008)] (``2008 Web site Guidance''). 
When it published the 2008 Web site Guidance, the Commission noted 
that the guidance was prompted, in part, by the CIFiR Advisory 
Committee's efforts.
    \41\ In 2008, the Commission announced the 21st Century 
Disclosure Initiative, with the goal of preparing a plan for future 
action to modernize the Commission's disclosure system. The 
Initiative's report, issued in 2009, recommended a new disclosure 
system in which interactive data would replace plain-text disclosure 
documents while retaining the substantive content and filing 
schedule of the current system. See 21st Century Disclosure 
Initiative: Staff Report, Toward Greater Transparency: Modernizing 
the Securities and Exchange Commission's Disclosure System (Jan. 
2009), available at https://www.sec.gov/spotlight/disclosureinitiative/report.pdf.
    The Commission adopted rules in 2009 requiring companies to 
provide financial statement information in interactive data format 
using the eXtensible Business Reporting Language (``XBRL'') format. 
See Interactive Data to Improve Financial Reporting, Release No. 33-
9002 (Jan. 20, 2009) [74 FR 6776 (Feb. 10, 2009)] (``Interactive 
Data Release''). This adopting release notes the CIFiR Advisory 
Committee's recommendation to require filing of interactive data-
tagged financial statements.
---------------------------------------------------------------------------

JOBS Act Report on Review of Disclosure Requirements in Regulation S-K
    The JOBS Act required the Commission to review Regulation S-K to 
determine how its disclosure requirements can be updated to modernize 
and simplify the registration process for EGCs.\42\ In response to this 
mandate, Commission staff published the S-K Study in December 2013. 
Although the Congressional mandate

[[Page 23921]]

focused on EGCs, the report was intended to facilitate the improvement 
of disclosure requirements applicable to companies at all stages of 
development.\43\
---------------------------------------------------------------------------

    \42\ Public Law 112-106, Sec. 108, 126 Stat. 306 (2012). For a 
discussion of EGCs, including the definition of ``emerging growth 
company,'' see Section IV.H.1.
    \43\ See S-K Study at 4.
---------------------------------------------------------------------------

    The S-K Study recommended a comprehensive review of disclosure 
requirements in the Commission's rules and forms, including Regulations 
S-K and S-X, and identified specific areas for further review.\44\ It 
also recommended the Commission consider the following principles when 
reviewing and evaluating changes to disclosure requirements:
---------------------------------------------------------------------------

    \44\ See id at 92-104. The S-K Study identified four issues for 
further study: (1) Generally, any recommended revisions should 
emphasize a principles-based approach as an overarching component of 
the disclosure framework while preserving the benefits of a rules-
based system; (2) any review of the disclosure requirements should 
evaluate the appropriateness of current scaled disclosure 
requirements and consider whether further scaling is appropriate for 
EGCs or other categories of companies; (3) any review of the 
disclosure requirements should evaluate methods of information 
delivery and presentation, both through EDGAR and other means; and 
(4) any review of disclosure requirements should consider ways to 
present information to improve the readability and navigability of 
disclosure and explore methods for discouraging repetition and 
disclosure of immaterial information. As to this fourth issue, the 
S-K Study suggested reevaluating quantitative thresholds and other 
materiality standards in Regulation S-K as well as reassessing 
requirements for information that is readily accessible, such as 
historical stock price information. Id. at 97-98.
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     Improving and maintaining the informativeness of 
disclosure;
     historical objectives of the rule and their continued or 
recurring relevance;
     whether the required information is available on a non-
discriminatory basis from reliable sources and, if so, any costs or 
benefits from obtaining the information other than from the registrant;
     administrative and compliance costs of the requirements;
     any competitive or economic costs of disclosing 
proprietary information;
     maintenance of the Commission's ability to conduct an 
effective enforcement program and deter fraud; and
     importance of maintaining investor confidence in the 
reliability of registrant information, in order to, among other things, 
encourage capital formation.\45\
---------------------------------------------------------------------------

    \45\ See id. at 94-95.
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FAST Act Disclosure Modernization and Simplification
    Under the FAST Act,\46\ the Commission is required to carry out a 
study to determine how best to modernize and simplify the disclosure 
requirements in Regulation S-K and to propose revisions to those 
requirements.\47\ The FAST Act requires that the study of Regulation S-
K:
---------------------------------------------------------------------------

    \46\ Public Law 114-94, 129 Stat. 1312 (2015).
    \47\ Public Law 114-94, Sec. 72003, 129 Stat. 1312 (2015).
---------------------------------------------------------------------------

     Emphasize a company-by-company approach that allows 
relevant and material information to be disseminated to investors 
without boilerplate language or static requirements while preserving 
completeness and comparability of information across registrants; and
     evaluate methods of information delivery and presentation 
and explore methods for discouraging repetition and the disclosure of 
immaterial information.
In conducting this study, the Commission is required to consult with 
the Investor Advisory Committee and the Advisory Committee on Small and 
Emerging Companies and to issue a report of findings and 
recommendations to Congress.\48\ The FAST Act also requires the 
Commission to revise Regulation S-K to further scale or eliminate 
requirements to reduce the burden on EGCs, accelerated filers, smaller 
reporting companies (``SRCs''), and other smaller issuers, while still 
providing all material information to investors, and to eliminate 
duplicative, overlapping, outdated or superseded provisions.\49\
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    \48\ Id.
    \49\ Public Law 114-94, Sec. 72002, 129 Stat. 1312 (2015). The 
required revisions would not apply to provisions for which the 
Commission determines that further study is necessary to determine 
their efficacy.
---------------------------------------------------------------------------

    Consistent with the S-K Study's recommendations and the FAST Act 
mandates, and in furtherance of the Commission's prior modernization 
studies and initiatives, we seek to evaluate components of our 
disclosure framework and revisit certain of our business and financial 
disclosure requirements to assess whether they continue to provide 
investors with information that is important to making informed 
investment and voting decisions. We also seek to evaluate whether 
current disclosure requirements should be revised to include different 
formats to facilitate the readability and navigability of disclosure, 
which we discuss in Section V of the release.

III. Disclosure Framework

A. Basis for Our Disclosure Requirements

    The Securities Act and the Exchange Act authorize the Commission to 
promulgate rules for registrant disclosure as necessary or appropriate 
in the public interest or for the protection of investors.\50\ The 
Commission has used this authority to require disclosure of information 
it believes is important to investors in both registration statements 
for public offerings and in ongoing reports.
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    \50\ See generally, Sections 7, 10, and 19(a) of the Securities 
Act [15 U.S.C. 77g(a)(10), 77j; and 77s(a)]; and Sections 3(b), 12, 
13, 14, 15(d), and 23(a) of the Exchange Act [15 U.S.C. 78c(b), 78l, 
78m(a), 78n(a), 78o(d), and 78w(a)].
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1. Statutory Mandates
The Securities Act and Exchange Act
    A central goal of the federal securities laws is full and fair 
disclosure.\51\ In enacting these laws, Congress recognized that 
investors must have access to accurate information important to making 
investment and voting decisions in order for the financial markets to 
function effectively. Thus, our disclosure rules are intended not only 
to protect investors but also to facilitate capital formation and 
maintain fair, orderly and efficient capital markets.
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    \51\ See Preamble of the Securities Act (stating it is an Act to 
provide full and fair disclosure of the character of securities sold 
in interstate and foreign commerce and through the mails, and to 
prevent frauds in the sale thereof, and for other purposes.). In 
enacting the mandatory disclosure system under the Exchange Act, 
Congress sought to promote complete and accurate information in the 
secondary trading markets. See S. Rep. No. 73-1455, 73rd Cong., 2nd 
Sess., 1934 at 68 (stating ``[o]ne of the prime concerns of the 
exchanges should be to make available to the public, honest, 
complete, and correct information regarding the securities listed'') 
and H.R. Rep. No. 73-1383, 73rd Cong., 2nd Sess., 1934 at 11 
(stating ``[t]here cannot be honest markets without honest 
publicity. Manipulation and dishonest practices of the market place 
thrive upon mystery and secrecy.'').
---------------------------------------------------------------------------

    Schedule A of the Securities Act sets forth certain items of 
disclosure to be included in registration statements filed in public 
offerings and provides the basis for many of the disclosure 
requirements currently in Regulation S-K. Items in Schedule A are 
largely financial in nature and were intended to help investors assess 
a security's value. According to the House Report that preceded the 
Securities Act:

    The items required to be disclosed . . . are items indispensable 
to any accurate judgment upon the value of a security . . . The type 
of information required to be disclosed is of a character comparable 
to that demanded by competent bankers from their borrowers, and has 
been worked out in light of these and other requirements. They are . 
. . adequate to bring into full glare of publicity those elements of 
real and unreal values which may lie behind a security.\52\

    \52\ H.R Rep. No. 73-85, 73rd Cong., 1st Sess., 1933.
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The Exchange Act requires similar business and financial information to 
be

[[Page 23922]]

disclosed in Exchange Act registration statements and periodic 
reports.\53\
---------------------------------------------------------------------------

    \53\ See Section 12(b)(1)(A) of the Exchange Act [15 U.S.C. 
78l].
---------------------------------------------------------------------------

    In addition to mandating certain disclosure requirements, the 
Securities Act and the Exchange Act grant the Commission authority to 
modify and supplement these requirements as necessary or appropriate to 
implement the purpose of the statutes.\54\ Moreover, whenever it is 
engaged in rulemaking and is required to consider whether the action is 
necessary or appropriate in the public interest, the Commission must 
consider whether the action will promote efficiency, competition, and 
capital formation.\55\
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    \54\ See, e.g., Sections 19(a) and 28 of the Securities Act and 
Sections 3(b), 23(a)(1) and 36(a)(1) of the Exchange Act. [15 U.S.C. 
77s(a), 15 U.S.C. 77z-3] and [15 U.S.C. 78c(b), 15 U.S.C. 78w(a)(1), 
15 U.S.C. 78mm(a)(1)]. Section 19(a) of the Securities Act and 
Section 23(a)(1) of the Exchange Act grant the Commission authority 
to make such rules and regulations as may be necessary to carry out 
the provisions of each title; Section 3(b) of the Exchange Act 
provides that the Commission shall have power to define technical, 
trade, accounting, and other terms used in the Exchange Act, 
consistently with the provisions and purposes of the Exchange Act; 
Section 28 of the Securities Act and Section 36(a)(1) of the 
Exchange Act provide that the Commission may conditionally or 
unconditionally exempt any person, security, or transaction, or any 
class or classes of persons, securities, or transactions, from any 
provision or provisions of each title or of any rule or regulation 
thereunder, to the extent that such exemption is necessary or 
appropriate in the public interest, and is consistent with the 
protection of investors.
    \55\ See, e.g., Section 2(b) of the Securities Act [15 U.S.C. 
77b(b)] and Section 3(f) of the Exchange Act [15 U.S.C. 78c(f)]. See 
also Section 23(a)(2) of the Exchange Act [15 U.S.C. 78w(a)(2)].
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Business and Financial Legislation
    From time to time, Congress has introduced additional disclosure 
requirements through other statutory mandates. Recent mandates have 
focused on corporate responsibility, corporate governance and providing 
enhanced business and financial information to investors. The Sarbanes-
Oxley Act of 2002 (``Sarbanes-Oxley Act'') \56\ mandated numerous 
changes to strengthen the accountability of public companies for their 
financial disclosure and required substantial Commission rulemaking to 
implement its provisions, many of which resulted in additions to 
Regulation S-K.\57\ In 2010, the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act'') \58\ required the 
Commission to adopt an array of disclosure provisions on corporate 
governance, executive compensation and specialized disclosure.\59\
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    \56\ Public Law 107-204, 116 Stat. 745 (2002).
    \57\ See S-K Study at 21-23, footnotes 57-62 and corresponding 
text for a discussion of additions made to Regulation S-K as a 
result of the Sarbanes-Oxley Act.
    \58\ Public Law 111-203, 124 Stat. 1376 (2010).
    \59\ See S-K Study at 28-29, footnotes 73-77 and corresponding 
text for a discussion of provisions in the Dodd-Frank Act that 
impact requirements in Regulation S-K.
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Other Legislation
    In some instances, Congress has mandated disclosure that is not 
necessarily financial in nature. These mandates have ranged from broad 
policy considerations to prescriptive directives. For example, under 
the National Environmental Policy Act of 1969 (``NEPA''),\60\ Congress 
required all federal agencies to include consideration of the 
environment in regulatory action. In response to this mandate, the 
Commission adopted environmental compliance and litigation disclosure 
requirements.\61\ Similarly, Section 1503 of the Dodd-Frank Act 
required registrants to include information about mine safety and 
health in their periodic reports. Although the disclosure requirements 
in Section 1503 were self-executing,\62\ the Act authorized the 
Commission to issue such rules or regulations as necessary for the 
protection of investors and to carry out the purposes of Section 
1503.\63\ To facilitate consistent compliance, the Commission adopted 
rules to codify the statutory disclosure requirements.\64\ More 
recently, the Iran Threat Reduction and Syria Human Rights Act of 2012 
(``ITRSHRA'') requires registrants to disclose certain business 
activities relating to Iran in their periodic reports.\65\
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    \60\ 42 U.S.C. 4321-4347.
    \61\ As a result of NEPA, the Commission issued an interpretive 
release in 1971 alerting companies to potential disclosure 
obligations that could arise from material environmental litigation 
and the material effects of compliance with environmental laws. The 
Commission later adopted more specific disclosure requirements 
relating to these matters and, in 1976, the Commission amended its 
forms to require disclosure of any material estimated capital 
expenditures for environmental control facilities.
    See Disclosures Pertaining to Matters Involving the Environment 
and Civil Rights, Release No. 33-5170 (July 19, 1971) [36 FR 13989 
(July 29, 1971)], Disclosure with Respect to Compliance with 
Environmental Requirements and Other Matters, Release No. 33-5386 
(April 20, 1973) [38 FR 12100 (May 9, 1973)], Disclosure of 
Environmental and Other Socially Significant Matters, Release No. 
33-5569 (Feb. 11, 1975) [40 FR 7013 (Feb. 18, 1975)] (``Notice of 
Public Proceedings on Environmental Disclosure Release''), 
Conclusions and Final Action on Rulemaking Proposals Relating to 
Environmental Disclosure, Release No. 33-5704 (May 6, 1976) [41 FR 
21632 (May 27, 1976)] (``1976 Environmental Release''), Natural 
Resources Defense Council et al., v. SEC, 389 F. Supp. 689 (D.D.C. 
1974) (``Natural Resources Defense Council'').
    \62\ See Section 1503(f) of the Dodd-Frank Act. The disclosure 
requirements took effect 30 days after enactment of the Act.
    \63\ Id. at Section 1503(d)(2).
    \64\ See Mine Safety Disclosure, Release No. 33-9286 (Dec. 21, 
2011) [76 FR 81762 (Dec. 28, 2011)] (``Mine Safety Disclosure 
Release'').
    \65\ Public Law 112-158, 126 Stat. 1214 (2012). Section 219 of 
ITRSHRA amended Section 13 of the Exchange Act to add subsection 
(r). This subsection requires a company that files annual and 
quarterly reports under Section 13(a) of the Exchange Act to provide 
disclosure if, during the reporting period, it or any of its 
affiliates knowingly engaged in certain specified activities 
involving contacts with or support for Iran or other identified 
persons involved in terrorism or the creation of weapons of mass 
destruction. ITRSHRA was self-executing and required no substantive 
rulemaking by the Commission.
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2. Commission Responses to Market Developments
    Our disclosure regime includes requirements that we have adopted in 
response to market developments or advancements in technology. In 
response to the disorderly markets and damage to investors caused by 
the hot issue securities markets between 1967 and 1971, the Commission 
initiated hearings to determine the adequacy of existing disclosure 
requirements \66\ and adopted new disclosure requirements to elicit 
more meaningful information concerning all registrants and to 
communicate more effectively the economic realities of new 
registrants.\67\ Similarly, in 1994 in response to significant and 
sometimes unexpected losses in market risk sensitive instruments due 
to, among other things, changes in interest rates, foreign currency 
exchange rates and commodity prices, the Commission adopted Item 305 
(quantitative and qualitative disclosures about market risk).\68\
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    \66\ Hot issues result when the price of a new issuance of 
securities rises to a substantial premium over the initial offering 
price immediately or soon after the securities are first distributed 
to the public. In 1967-1971, the new issues markets experienced a 
resurgence. See Report of the Securities and Exchange Commission 
Concerning the Hot Issues Markets, August 1984, available at https://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1980/1984_0801_SECHotIssuesT.pdf. Between 1968 and 1970, the 
value of stocks traded on national securities exchanges fell a total 
of $78.8 billion, from $759.5 billion to $680.7 billion. See 
Securities and Exchange Commission, Thirty-Seventh Annual Report, 
appendix Table 5 at 221 (1971) available at https://www.sec.gov/about/annual_report/1971.pdf.
    \67\ See New Ventures, Meaningful Disclosure, Release No. 33-
5395 (June 1, 1973) [38 FR 17202 (June 29, 1973)] (``Hot Issues 
Adopting Release'').
    \68\ See Disclosure of Accounting Policies for Derivative 
Financial Instruments and Derivative Commodity Instruments and 
Disclosure of Quantitative and Qualitative Information about Market 
Risk Inherent in Derivative Financial Instruments, Other Financial 
Instruments and Derivative Commodity Instruments, Release No. 33-
7386 (Jan. 31, 1997) [62 FR 6044 (Feb. 10, 1997)] (``Disclosure of 
Market Risk Sensitive Instruments Release'').
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    Significant advancements in technology have also prompted some of 
our disclosure requirements. The

[[Page 23923]]

Commission's efforts in Securities Offering Reform recognized the 
impact of technology on market demand for more timely corporate 
disclosure and the ability of issuers to capture, process, and 
disseminate this information.\69\ Similarly, modernization of our oil 
and gas rules was intended to update oil and gas disclosure 
requirements to align them with current practices and changes in 
technology.\70\
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    \69\ See Aircraft Carrier Release; Securities Offering Reform 
Release.
    \70\ See Modernization of Oil and Gas Reporting, Release No. 33-
8995 (Dec. 31, 2008) [74 FR 2157 (Jan. 14, 2009)] (``Oil and Gas 
Release'').
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    We are considering changes to our disclosure requirements and 
seeking public input on how our disclosure requirements could be 
improved for the benefit of investors and registrants and whether the 
requirements could be revised to adapt to future changes in market 
conditions and advancements in technology. We also are seeking input on 
the utility of mechanisms such as sunset provisions or temporary rules.
a. Comments Received
    S-K Study. One commenter stated that a sunset provision would 
require the Commission to consider changes in the economic, business 
and regulatory landscape in assessing whether new disclosure 
requirements should be made permanent.\71\ For significant new 
disclosure requirements, this commenter suggested a sunset provision of 
five or ten years and that formal Commission action should be required 
to indefinitely extend or modify any significant new disclosure 
requirement.
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    \71\ See letter from Ernst & Young (Sept. 11, 2012) (``Ernst & 
Young 1'').
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    Disclosure Effectiveness Initiative. We received a few comment 
letters that discussed potential regulatory mechanisms to review and 
update our disclosure requirements.\72\ To determine the continuing 
need for disclosures in light of the then current economic, business 
and regulatory landscape, one commenter suggested a formal, post-
adoption review process for significant new disclosure 
requirements.\73\ This review process, or ``sunset review,'' would 
require formal Commission action to make a new disclosure requirement 
permanent. Another commenter recommended that the Commission develop a 
mechanism to timely update disclosure requirements to address new 
topical issues and to delete existing disclosure when the informational 
value for investors is diminished.\74\ One commenter generally 
recommended sunset rules and finding a means to evaluate user demand 
and disclosure effectiveness for potentially outdated requirements.\75\
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    \72\ See, e.g., letters from the Society of Corporate 
Secretaries and Governance Professionals (Sept.10, 2014) 
(``SCSGP''), Securities Industry and Financial Markets Association 
(Oct. 13, 2014) (``SIFMA''), and letter and articles referenced 
therein from Arthur J. Radin (May 29, 2015) (``A. Radin'').
    \73\ See SCSGP. This commenter also suggested that the staff 
issue ``closing guidance'' when topics on which the staff had 
previously focused are no longer areas of primary concern. The 
commenter cited 2003 MD&A guidance on disclosure of critical 
accounting policies estimates as an example of guidance that could 
be considered closed. See Commission Guidance Regarding Management's 
Discussion and Analysis of Financial Condition and Results of 
Operation, Release No. 33-8350 (Dec. 19, 2003) (``2003 MD&A 
Interpretive Release'') [68 FR 75056 (Dec. 29, 2003)]. This 
commenter stated ``it is not clear that investors are unaware of the 
uncertainties associated with the methods, assumptions and estimates 
underlying a company's critical accounting measurements.''
    \74\ See SIFMA. This commenter did not propose a particular 
mechanism that the Commission should use.
    \75\ See A. Radin.
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b. Discussion
    When adopting disclosure requirements that have departed from 
traditional disclosure concepts, the Commission has historically taken 
an incremental approach to change by first adopting modest revisions 
and then expanding their application after observing and evaluating the 
rules' effectiveness. For example, the initial adoption of simplified 
registration and reporting requirements for smaller businesses on Form 
S-18 were ``in the nature of an experiment'' \76\ and a departure from 
traditional disclosure concepts.\77\ After observing relative, 
widespread acceptance of Form S-18 and the absence of significant 
disclosure or enforcement problems, the Commission expanded the form's 
availability,\78\ and it eventually served as a model for our current 
system of scaled disclosure for SRCs.\79\
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    \76\ See Simplified Registration and Reporting Requirements for 
Small Issuers, Release No. 33-6049 (Apr. 3, 1979) [44 FR 21562 (Apr. 
10, 1979)] (``Form S-18 Release'') at 21564.
    \77\ Id. at 21562 (``The Commission will monitor closely the use 
of Form S-18 for an appropriate period . . .'').
    \78\ See Availability of Simplified Registration Form to Certain 
Mining Companies, Release No. 33-6299 (Mar. 27, 1981) [46 FR 18947 
(Mar. 27, 1981)]. See also Revisions to the Optional Form for the 
Registration of Securities to Be Sold to the Public by the Issuer 
for an Aggregate Cash Price Not To Exceed $5,000,000, Release No. 
33-6406 (June 4, 1982) [47 FR 25126 (June 10, 1982)] (expanding Form 
S-18's availability to non-corporate registrants and registrants 
engaged, or to be engaged, in oil and gas related operations).
    \79\ See Smaller Reporting Company Regulatory Relief and 
Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 FR 934 (Jan. 
4, 2008)] (``SRC Adopting Release''). In adopting the current scaled 
disclosure regime, the Commission stated ``[t]he amendments that we 
are adopting address the need to revisit and adjust the Commission's 
small company policies to reflect changes in our securities markets 
as well as changes to the regulatory landscape since 1992, when the 
Commission first adopted an integrated scaled disclosure system for 
small business in Regulation S-B. The Commission adopted Regulation 
S-B and its associated Forms SB-1 and SB-2 based upon the success of 
Form S-18 . . .''
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    The Commission has, on occasion, adopted temporary rules or rules 
with automatic sunset provisions to better assess the effect of or 
necessity for a particular rule before adopting the rule on a permanent 
basis. For example, Securities Act Rule 415, which permits delayed and 
continuous offerings under certain circumstances, was initially adopted 
on a temporary basis for a period of nine months during which the 
Commission monitored the operation and impact of the new rule.\80\ 
Following public hearings and comment on Rule 415, the Commission 
determined additional experience with the rule was necessary to study 
its operation and impact \81\ and extended the temporary nature of this 
rule.\82\ The Commission permanently adopted Rule 415 following 18 
months of monitoring the operation and impact of the rule.\83\
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    \80\ See 1982 Integrated Disclosure Adopting Release.
    \81\ See Delayed or Continuous Offering and Sale of Securities, 
Release No. 33-6423 (Sept. 2, 1982) [47 FR 39799 (Sept. 10, 1982)].
    \82\ Id. In June 1983, the Commission published the shelf 
registration rule for comment again in order to provide all 
interested parties another opportunity to share their views and 
experience under the Rule before the Commission made its final 
determination. See Delayed or Continuous Offering and Sale of 
Securities, Release No. 33-6470, (June 9. 1983) [48 FR 27768 (June 
17, 1983)].
    \83\ See Shelf Registration, Release No. 33-6499 (Nov. 17, 1983) 
[48 FR 52889 (Nov. 23, 1983)].
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    While the Commission acted to permanently adopt Rule 415, it has 
allowed other temporary rules to expire. The Commission adopted on a 
temporary basis Securities Act Rules 702 and 703. Rule 702 required the 
filing of a Form 701 after sales under Rule 701 exceeded a particular 
threshold. Rule 703 disqualified registrants from relying on the Rule 
701 exemption from registration where the registrant failed to make the 
filing required by Rule 702.\84\ In adopting Rules 702 and 703, the 
Commission noted the importance of monitoring new exemptive provisions 
and stated that it would use Form 701 to ``assess the utility of the 
exemption and, oversee

[[Page 23924]]

any abuses.'' \85\ The Commission did not extend Rules 702 and 703 
based on its belief that the sunset of these rules had not compromised 
investor interests and that their reinstitution of the rules would 
serve little purpose.\86\
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    \84\ See Compensatory Benefit Plans and Contracts, Release No. 
33-6768 (Apr. 14, 1988) [53 FR 12918 (Apr. 20, 1988)] (adopting Rule 
701, an exemption from registration for certain offers and sales 
made pursuant to the terms of compensatory benefit plans or written 
compensation agreements for issuers that are not subject to the 
reporting requirements of Section 13 or 15(d) of the Exchange Act, 
and adopting rules 702 and 703 on a temporary basis of five years).
    \85\ See Regulation D Revisions; Exemption for Certain Employee 
Benefit Plans, Release No. 33-6683 (Jan. 16, 1987) [52 FR 3015 (Jan. 
30, 1987)] at 3021.
    \86\ See Phase One Recommendations of Task Force on Disclosure 
Simplification Release.
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    Even in the absence of a temporary rule or sunset provision, the 
Commission has undertaken efforts to study the effects of new rules or 
amendments. The Commission uses these studies to guide future 
amendments or rulemaking. For example, our staff has examined the 
effects on capital formation through private placements after adoption 
of amendments to Regulation D in accordance with the JOBS Act.\87\ In 
adopting amendments to Rule 506 of Regulation D \88\ to eliminate the 
prohibition against general solicitation for a subset of Rule 506 
offerings, the Commission stated that the staff will monitor 
developments in the market for these offerings.\89\ In addition, in 
connection with recently adopted amendments to Regulation A, an 
exemption from registration for smaller issues of securities, and the 
adoption of Regulation Crowdfunding, a new exemption for smaller 
securities offerings using the Internet through crowdfunding, the 
Commission stated, in each case, that the staff will study and submit a 
report to the Commission on the impact of the regulation on capital 
formation and investor protection.\90\
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    \87\ Scott Bauguess, Rachita Gullapalli, and Vladimir Ivanov, 
Capital Raising in the U.S.: An Analysis of the Market for 
Unregistered Securities Offerings, 2009-2014, Oct. 2015, available 
at https://www.sec.gov/dera/staff-papers/white-papers/unregistered-offering10-2015.pdf.
    \88\ 17 CFR 230.506.
    \89\ See Eliminating the Prohibition Against General 
Solicitation and General Advertising in Rule 506 and Rule 144A 
Offerings, Release No. 33-9415 (July 20. 2013) [78 FR 44771 (July 
24, 2013)].
    \90\ See Amendments to Regulation A, Release No. 33-9741 (Mar. 
25, 2015) [80 FR 21805 (Apr. 20, 2015)] (``2015 Regulation A 
Release''); See Crowdfunding, Release No. 33-9974 (Oct. 30, 2015) 
[80 FR 71387 (Nov. 16, 2015)] (``Crowdfunding Adopting Release''). 
When proposing the crowdfunding rules, the Commission directed the 
staff to develop a work plan to review and monitor use of the 
crowdfunding rules, focusing on the types of issuers using the 
exemption, level of compliance by issuers and intermediaries, and 
whether the exemption is promoting new capital formation while 
providing key protections for investors. See Crowdfunding, Release 
No. 33-9470 (Oct. 23, 2013) [78 FR 66427 (Nov. 5, 2013)].
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    Requiring affirmative Commission action to extend or make permanent 
certain requirements, the utility of which may change over time, could 
require us to more frequently consider the effectiveness of our 
requirements. Alternatively, the Commission could commit to studying 
the impact of certain rule changes on a specified schedule, without 
making the rules temporary or applying automatic sunset provisions. Any 
such review would be in addition to the periodic review currently 
required by the Regulatory Flexibility Act (``RFA''),\91\ under which 
the Commission reviews its rules that have a significant economic 
impact on a substantial number of small entities within ten years of 
their publication as final rules.\92\ These approaches would, however, 
require significant Commission resources and could compete with other 
Commission priorities.
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    \91\ [5 U.S.C. 610(a)].
    \92\ Each year, since 1981, the Commission provides the public 
with notice that these rules are scheduled for review and invites 
public comment on whether the rules should be continued without 
change, or should be amended or rescinded to minimize any 
significant economic impact of the rules upon a substantial number 
of such small entities. As a matter of policy, the Commission 
reviews all final rules that are published for notice and comment to 
assess not only their continued compliance with the RFA, but also to 
assess generally their continued utility. See, e.g., List of Rules 
to be Reviewed Pursuant to the Regulatory Flexibility Act, Release 
No. 33-9965 (Oct. 22, 2015) [80 FR 65973 (Oct. 28, 2015)]. In the 
past, the Commission has received little or no comment on the rules 
that it publishes for review.
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c. Request for Comment
    1. Should the Commission consider including automatic sunset 
provisions in new disclosure requirements? If so, what types of 
disclosure requirements should include these provisions? What factors 
should we consider in identifying them? What would be an appropriate 
length of time for any sunset provisions? Would this length of time 
vary with the nature of the rule in question?
    2. What are the advantages and disadvantages of automatic sunset 
provisions? Would automatic sunset provisions result in unnecessary 
regulatory uncertainty for investors or registrants?
    3. How would the use of automatic sunset provisions affect 
registrants, investors and other users of disclosure? Would 
registrants, investors or other users incur increased costs associated 
with the use of automatic sunset provisions?
    4. Should we consider requiring the staff to study and report to 
the Commission on the impact of new disclosure requirements when 
adopting them, in addition to the review the Commission performs under 
the RFA? For what type of disclosure requirements would such an 
approach be appropriate? What are the advantages and disadvantages of 
such a study and report on a new rule?
    5. Are there other ways our disclosure requirements could be 
revised to adapt more easily to future market changes and technological 
advancements?

B. Nature of Our Disclosure Requirements

    The concept of materiality has been described as ``the 
cornerstone'' of the disclosure system established by the federal 
securities laws.\93\ Schedule A to the Securities Act identifies 
certain categories of information that are generally viewed as material 
to investors.\94\ Those categories are incorporated and expanded upon 
in the categories of information that registrants are required to 
disclose under Regulation S-K.
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    \93\ See Sommer Report at 320.
    \94\ See id. at 324.
---------------------------------------------------------------------------

    In creating and implementing our system of integrated disclosure, 
identification of material information was one of two principal 
objectives. In the 1982 Integrated Disclosure Adopting Release, the 
Commission stated:

    The Commission's program to integrate the disclosure systems has 
focused on two principal objectives: First, a comprehensive 
evaluation of the disclosure policies and procedures under both Acts 
to identify the information which is material to security holders 
and investors in both the distribution process and the trading 
markets . . . and, second, a determination of the circumstances 
under which information should be disseminated to security holders, 
investors and the marketplace.\95\
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    \95\ See 1982 Integrated Disclosure Adopting Release at 11382. 
See also Proposed Comprehensive Revision to System for Registration 
of Securities of Securities Offerings, Rel. No. 33-6235 (Sept. 2, 
1980) [45 FR 63693 (Sept. 25, 1980)] (``1980 Proposed Revisions'') 
at 63694. This proposing release states ``[t]he shape of the 
[Commission's integrated disclosure] program will be influenced by 
the answer to two fundamental questions: (1) What information is 
material to investment decisions in the context of public offerings 
of securities; and (2) Under what circumstances and in what form 
should such material information be disseminated and made available 
by companies making public offerings of securities to the various 
participants in the capital market system? The task of identifying 
what information is material to investment and voting decisions is a 
continuing one in the field of securities regulation.''

    The Commission adopted line-item requirements in Regulation S-K and 
its predecessors to provide investors with specific disclosure within 
broad categories of material information.\96\ Through its disclosure 
requirements, the Commission has adopted different approaches to guide 
registrants in

[[Page 23925]]

evaluating materiality for purposes of disclosure, including in some 
cases using quantitative thresholds to address uncertainty in the 
application of materiality.
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    \96\ See Sommer Report at 324.
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1. Principles-Based and Prescriptive Disclosure Requirements
    Principles-based disclosure requirements. Many of our rules require 
disclosure when information is material to investors.\97\ These rules 
rely on a registrant's management to evaluate the significance of 
information in the context of the registrant's overall business and 
financial circumstances and determine whether disclosure is 
necessary.\98\ The requirements are often referred to as ``principles-
based'' because they articulate a disclosure objective and look to 
management to exercise judgment in satisfying that objective.\99\
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    \97\ On several occasions, the Commission has reiterated that 
its requirements seek disclosure of material information. See, e.g., 
Commission Guidance Regarding Disclosure Related to Climate Change, 
Release No. 33-9106 (Feb. 8, 2010) [75 FR 6290 (Feb. 8, 2010)] 
(``Climate Change Release'') at 6292-6293 (stating ``During the 
1970s and 1980s, materiality standards for disclosure under the 
federal securities laws also were more fully articulated. Those 
standards provide that information is material if there is a 
substantial likelihood that a reasonable investor would consider it 
important in deciding how to vote or make an investment decision, 
or, put another way, if the information would alter the total mix of 
available information.''); Statement of the Commission Regarding 
Disclosure of Year 2000 Issues and Consequences by Public Companies, 
Investment Advisers, Investment Companies, and Municipal Securities 
Issuers, Release No. 33-7558 (Jul. 29, 1998) [63 FR 41394 (Aug. 4, 
1998)] (``Year 2000 Release'') at 41395 (stating ``Our disclosure 
framework requires companies to disclose material information that 
enables investors to make informed investment decisions.''); Timely 
Disclosure of Material Corporate Events, Release No. 33-5092 (Oct. 
15, 1970) [35 FR 16733 (Oct. 29, 1970)] at 16733-16734 
(``Notwithstanding the fact that a company complies with such 
[annual, semi-annual and current] reporting requirements, it still 
has an obligation to make full and prompt announcements of material 
facts regarding the company's financial condition . . . Corporate 
managements are urged to review their policies with respect to 
corporate disclosure and endeavor to set up procedures which will 
insure that prompt disclosure be made of material corporate 
developments . . .''). See also infra note 107.
    \98\ See Sommer Report at 322 (``Although the initial 
materiality determination is management's, this judgment is, of 
course, subject to challenge or question by the Commission or in the 
courts.'').
    \99\ See Study Pursuant to Section 108(d) of the Sarbanes-Oxley 
Act of 2002 on the Adoption of a Principles-Based Accounting System, 
July 2003, available at https://www.sec.gov/news/studies/principlesbasedstand.htm (``Section 108 Study'').
---------------------------------------------------------------------------

    For example, Item 303(a)(2) requires registrants to disclose 
material commitments for capital expenditures, known material trends in 
the registrant's capital resources, and expected material changes in 
the mix and relative cost of such resources.\100\ Similarly, Item 
101(c)(1)(xi) requires registrants to disclose the estimated amount 
spent during each of the last three fiscal years on company-sponsored 
research and development activities, if material.\101\
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    \100\ Item 303(a)(2) of Regulation S-K [17 CFR 229.303(a)(2)].
    \101\ Item 101(c)(1)(xi) of Regulation S-K [17 CFR 
229.101(c)(1)(xi)].
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    Prescriptive disclosure requirements. Some of our rules employ 
objective, quantitative thresholds to identify when disclosure is 
required, or require registrants to disclose information in all cases. 
These requirements are sometimes referred to as ``prescriptive'' or 
``rules-based'' because they rely on bright-line tests rather than 
management's judgment to determine when disclosure is required.
    For example, disclosure requirements specific to environmental 
proceedings in Item 103 enumerate thresholds for disclosure based on a 
percentage of current assets (10%) or a specified dollar amount 
($100,000).\102\ Meeting or exceeding the applicable thresholds 
necessitates disclosure. Similarly, Item 101(c)(1)(i), requires 
registrants to disclose for each of the last three fiscal years the 
amount or percentage of total revenue contributed by any class of 
similar products or services which accounted for ten percent or more of 
consolidated revenue in any of the last three fiscal years or fifteen 
percent or more of consolidated revenue, if total revenue did not 
exceed $50 million during any of such fiscal years.\103\ As another 
example, Item 703 establishes a requirement for registrants to disclose 
all repurchases of equity securities by issuers and affiliated 
purchasers.\104\
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    \102\ Instructions 5.B and 5.C to Item 103 of Regulation S-K [17 
CFR 229.103]. See also infra note 120.
    \103\ Item 101(c)(1)(i) of Regulation S-K [17 CFR 
229.101(c)(1)].
    \104\ Item 703 of Regulation S-K [17 CFR 229.703].
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    Materiality. The concept of materiality is used throughout the 
federal securities laws. The Commission has used a definition of 
materiality since at least 1937. Previously, the Commission defined 
``material,'' when used to qualify a requirement for the furnishing of 
information, as ``those matters as to which an average prudent investor 
ought reasonably to be informed before buying or selling the security 
registered.'' \105\ In 1982, the Commission revised Rule 12b-2, which 
defines ``material'' when used to qualify a requirement for the 
furnishing of information, to adopt the Supreme Court's definition of 
materiality.\106\
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    \105\ Proposed Revisions of Regulation C, Registration and 
Regulation 12B, Registration and Reporting, Release No. 33-6333 
(August 6, 1981) [46 FR 41971 (Aug. 18, 1981)] (``1981 Proposed 
Revisions''). The proposing release notes that, prior to proposing 
this definition, the definition of ``material'' was the same as 
adopted in 1937. This definition provided ``[t]he term `material', 
when used to qualify a requirement for the furnishing of information 
as to any subject, limits the information required to those matters 
as to which an average prudent investor ought reasonably to be 
informed before buying or selling the security registered.'' See, 
e.g., Adoption of Amendments to General Rules and Regulations, 
Release No. 34-4194 (Dec. 17, 1948) [not published in the Federal 
Register] (``1948 Adoption of Amendments to General Rules and 
Regulations Release'').
    \106\ See 1982 Integrated Disclosure Adopting Release. Rule 12b-
2 of the Exchange Act provides that the term ``material,'' when used 
to qualify a requirement for the furnishing of information as to any 
subject, limits the information required to those matters to which 
there is a substantial likelihood that a reasonable investor would 
attach importance in determining whether to buy or sell the 
securities registered. [17 CFR 240.12b-2].
    In addition to the information required to be disclosed, 
Exchange Act Rule 12b-20 requires registrants to disclose such 
further material information, if any, as may be necessary to make 
the required statements, in the light of the circumstances under 
which they are made, not misleading. Rule 12b-20 of the Exchange Act 
[17 CFR 240.12b-20].
---------------------------------------------------------------------------

    The Court has held that information is material if there is a 
substantial likelihood that a reasonable investor would consider the 
information important in deciding how to vote or make an investment 
decision.\107\ The Court further explained that information is material 
if there is a substantial likelihood that disclosure of the omitted 
fact would have been viewed by the reasonable investor as having 
significantly altered the ``total mix'' of information available.\108\
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    \107\ See Basic Inc. v. Levinson, 485 U.S. 224 (1988) (``Basic'' 
or ``Basic v. Levinson'') at 231, quoting TSC Industries, Inc. v. 
Northway, Inc., 426 U.S. 438 (1976) (``TSC Industries'') at 449. In 
TSC Industries, the Supreme Court adopted a standard for materiality 
in connection with proxy statement disclosure under Schedule 14A and 
Rule 14a-9 of the Exchange Act. This standard was supported by the 
Commission. See TSC Industries at footnote 10 (``. . . the SEC's 
view of the proper balance between the need to insure adequate 
disclosure and the need to avoid the adverse consequences of setting 
too low a threshold for civil liability is entitled to consideration 
. . . The standard we adopt is supported by the SEC.''). In Basic, 
the Court reaffirmed this standard of materiality and applied it in 
the Section 10(b) and Rule 10b-5 context. Exchange Act Rule 10b-5(b) 
prohibits any person from making an untrue statement of material 
fact or omitting a material fact necessary to make the statements 
made, in light of the circumstances under which they were made, not 
misleading in connection with the offer or sale of any security. 
Rule 10b-5 of the Exchange Act [17 CFR 240.10b-5].
    \108\ See Matrixx Initiatives, Inc. v. Siracusano, 131 U.S. 1309 
(2011) (``Matrixx Initiatives'') at 1318, quoting TSC Industries at 
449. In Matrixx Initiatives, the Court applied the materiality 
standard, as set forth in TSC Industries and Basic. In articulating 
these standards, the Supreme Court recognized that setting too low 
of a materiality standard for purposes of liability could cause 
management to ``bury shareholders in an avalanche of trivial 
information.'' Id. at 1318, quoting TSC Industries at 448-449.

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[[Page 23926]]

    In proposing to revise Rule 12b-2 to adopt the Court's definition 
of ``material,'' the Commission noted the trend to apply the Court's 
definition in every type of federal securities law violation and 
concluded that the same test would be applied for any purpose under the 
Securities Act and the Exchange Act.\109\ Although some commenters 
recommended retaining the current definition or modifying the proposed 
one, the Commission adopted the definition as proposed because it was 
based on the definition set forth by the Court.\110\
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    \109\ See id.
    \110\ See 1982 Integrated Disclosure Adopting Release.
    Article 1-02(o) of Regulation S-X retains the definition of 
``material'' prior to TSC Industries. In Staff Accounting Bulletin 
No. 99, the staff indicated that it views this definition in 
Regulation S-X to be similar to the definitions of ``material'' in 
Rule 12b-2 of the Exchange Act and Rule 405 of the Securities Act, 
which are consistent with TSC Industries. See footnote 6 of Staff 
Accounting Bulletin No. 99, Release No. SAB 99 (Aug. 12, 1999) [64 
FR 45150 (Aug. 19, 1999)] (``SAB 99''). As with any staff guidance 
referenced in this release, the views of the staff are not rules or 
interpretations of the Commission. The Commission has neither 
approved nor disapproved the views of the staff.
---------------------------------------------------------------------------

    From time to time, the Commission has provided guidance to assist 
management in the types of assessments to make and issues to consider 
in determining whether information is material.\111\ For example, based 
on a review of MD&A disclosure to evaluate the adequacy of disclosure 
practices and identify any common deficiencies, the Commission provided 
interpretive guidance on assessments management should make to 
determine whether disclosure of forward-looking information is required 
under Item 303 of Regulation S-K.\112\ Similarly, in the context of 
determining whether financial statements must be restated, Commission 
staff has expressed the view that materiality determinations cannot be 
reduced to a numerical formula and evaluations of materiality require 
both quantitative and qualitative considerations.\113\
---------------------------------------------------------------------------

    \111\ See, e.g., Climate Change Release (providing guidance as 
to how registrants should evaluate climate change-related issues 
when considering what information to disclose to investors under 
existing disclosure requirements and confirming that, if material, 
registrants should provide climate change-related disclosure); 2003 
MD&A Interpretive Release (providing guidance on MD&A and 
emphasizing that registrants should focus on materiality).
    \112\ See, e.g., Management's Discussion and Analysis of 
Financial Condition and Results of Operations; Certain Investment 
Company Disclosures, Release No. 33-6835 (May 18, 1989) [54 FR 22427 
(May 24, 1989)] (``1989 MD&A Interpretive Release'') (setting forth 
a two-step analysis for disclosure of material forward-looking 
information in MD&A). For a discussion of the Commission's forward-
looking guidance under Item 303 of Regulation S-K and recent court 
of appeals decisions, see Section IV.B.3.c.
    \113\ See SAB 99.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. We received three comment letters that discussed 
principles-based requirements or made recommendations about 
quantitative disclosure thresholds.\114\ Two commenters suggested that 
we move towards a more principles-based disclosure regime in which 
``companies [would be] expected to take the initiative to identify 
material information rather than simply respond to an extensive list of 
potentially relevant line-item disclosure requirements.'' \115\ Another 
commenter stated that it is counterintuitive to define disclosure 
requirements using a ``one-size-fits-all quantitative thresholds.'' 
\116\
---------------------------------------------------------------------------

    \114\ See letters from Fenwick & West LLP, Cooley LLP and Wilson 
Sonsini Goodrich & Rosati, PC (June 19, 2012) (``Silicon Valley''), 
Mike Liles (Apr. 10, 2013) (``M. Liles'') (endorsing the comments 
expressed in the Silicon Valley letter) and Ernst & Young 1.
    \115\ See Silicon Valley and M. Liles.
    \116\ See Ernst & Young 1.
---------------------------------------------------------------------------

    Disclosure Effectiveness Initiative. Several commenters addressed 
whether disclosure requirements should be principles-based or 
prescriptive.\117\ The majority of these commenters supported a 
principles-based system.\118\ Some of these commenters suggested 
revising or eliminating existing prescriptive disclosure 
requirements.\119\ One of these commenters stated that the ``touchstone 
for any disclosure requirement must be materiality as seen through the 
eyes of a reasonable investor'' and suggested reviewing the 
quantitative disclosure thresholds in Items 103 and 404 of Regulation 
S-K \120\ to consider whether they are appropriate.\121\ Another one of 
these commenters suggested amending Item 10 \122\ of Regulation S-K to 
permit registrants to omit information otherwise required by Regulation 
S-K if the information is not material and if the inclusion of the 
information is not necessary to make any required statements not 
materially misleading.\123\ However, this commenter noted that this 
provision should not apply in all instances.\124\ This commenter also 
suggested revisions to some of the quantitative disclosure thresholds 
in Regulation S-K to ``better calibrate'' such requirements \125\ and 
recommended that the Commission determine whether disclosure standards 
other than materiality should be harmonized to ``lessen ambiguity as to 
how these undefined disclosure standards should be applied.'' \126\
---------------------------------------------------------------------------

    \117\ See, e.g., letters from Center for Capital Markets 
Competitiveness, U.S. Chamber of Commerce (July 29, 2014) (``CCMC'') 
(expressing support for a more principles-based approach to 
disclosure); SCSGP (recommending that we eliminate line-item 
disclosure requirements that apply without regard to materiality or 
that contain quantitative disclosure thresholds that do not 
appropriately reflect materiality); Standards & Financial Market 
Integrity Division, CFA Institute (Nov. 12, 2014) (``CFA 
Institute'') (stating that a principles-based system could lead to 
standards that are inconsistently applied); Shearman & Sterling LLP 
(Nov. 26, 2014) (``Shearman'') (stating that a principles-based 
approach would better withstand the pace at which the business 
environment changes); letter from the Federal Regulation of 
Securities Committee, Business Law Section, American Bar Association 
(Mar. 6, 2015) (``ABA 2''); UK Financial Reporting Council (Mar. 10, 
2015) (``UK Financial Reporting Council''); Corporate Governance 
Committee of the Business Roundtable (Apr. 5, 2015) (``Business 
Roundtable''); A. Radin.
    \118\ See, e.g., CCMC; SCSGP; ABA 2; Shearman; UK Financial 
Reporting Council; Business Roundtable.
    \119\ See, e.g., CCMC; SCSGP; Shearman; ABA 2.
    \120\ Item 103 of Regulation S-K requires disclosure of material 
pending legal proceedings. Instruction 2 specifies that no 
information need be given with respect to a proceeding that involves 
primarily a claim for damages if the amount involved, exclusive of 
interest and costs, does not exceed ten percent of current assets of 
the registrant and its subsidiaries on a consolidated basis.
    Instruction 5 to Item 103 requires disclosure of proceedings 
related to federal, state, or local environmental protection laws 
when (i) the proceeding is material to the registrant's business or 
financial condition; (ii) the proceeding involves primarily a claim 
for damages, or involves potential monetary sanctions, capital 
expenditures, deferred charges or charges to income and the amount 
involved, exclusive of interest and costs, exceeds ten percent of 
current assets of the registrant and its subsidiaries on a 
consolidated basis; or (iii) a governmental authority is a party to 
a proceeding involving monetary sanctions, unless the registrant 
believes that the proceeding will result in no monetary sanctions, 
or in monetary sanctions, exclusive of interests and costs, of less 
than $100,000. [17 CFR 229.103].
    Item 404 requires disclosure of transactions with related 
parties where the related party had or will have a direct or 
indirect material interest and the amount involved exceeds $120,000 
or, in the case of SRCs, where the amount involved exceeds the 
lesser of $120,000 or one percent of the average of the SRC's total 
assets at year end for the last two completed fiscal years. [17 CFR 
229.404].
    \121\ See CCMC (noting that quantitative thresholds similar to 
the ones in Item 103 ``may not in fact be set at levels material for 
all, or even most companies'').
    \122\ Item 10 of Regulation S-K contains general requirements on 
the application of Regulation S-K, Commission policies on 
projections and security ratings, incorporation by reference and the 
use of non-GAAP financial measures in Commission filings. [17 CFR 
229.10].
    \123\ See ABA 2.
    \124\ See id. (citing the $120,000 threshold in Item 404 as an 
example of an instance in which the use of a quantitative disclosure 
threshold is appropriate).
    \125\ See id. For example, this commenter suggested increasing 
the quantitative threshold in Instruction 5.C to Item 103 from 
$100,000 to $1,000,000.
    \126\ Id. As an example, this commenter noted that ``major'' is 
used as a standard in Items 101(h)(4)(vi), 102, and 
601(b)(10)(ii)(B).

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[[Page 23927]]

    Two commenters stated that a principles-based approach would 
provide additional flexibility to registrants by allowing them to 
disclose material information based on all relevant facts and 
circumstances.\127\ One commenter, in lieu of creating new item 
requirements, encouraged greater staff guidance through disclosure 
guidance topics or staff bulletins to provide companies with factors to 
consider when making materiality determinations.\128\ One commenter 
stated that using materiality as a guiding principle ``carries with it 
the recognition that what is important to a reasonable investor may 
change over time.'' \129\ Another commenter suggested that accounting 
professionals should readdress the concept of materiality and this 
would help reduce the volume of unnecessary disclosure.\130\
---------------------------------------------------------------------------

    \127\ See SCSGP; Shearman.
    \128\ See SCSGP.
    \129\ See Business Roundtable.
    \130\ See A. Radin.
---------------------------------------------------------------------------

    One commenter opposed a principles-based system, stating such a 
system could result in inconsistent application of the principles-based 
threshold and thus non-comparable information across companies.\131\ 
This commenter also stated that the use of prescriptive disclosure 
requirements does not prevent companies from including additional 
principles-based disclosure if the company would like to do so.\132\
---------------------------------------------------------------------------

    \131\ See CFA Institute (also citing MD&A disclosure during the 
financial crisis as evidence that principles-based reporting 
requirements alone are not sufficient).
    \132\ Id.
---------------------------------------------------------------------------

b. Discussion
    In 2003, the staff prepared a study on the adoption of a 
principles-based accounting system.\133\ Although it did not address 
disclosure requirements under Regulation S-K, many of the study's 
conclusions may be relevant to our general consideration of principles-
based disclosure standards. The study found drawbacks to establishing 
accounting standards on either a rules-based or a principles-based 
approach.\134\ The study noted that principles-only standards may 
present enforcement difficulties because they are, by their nature, 
imprecise.\135\ They can also result in a significant loss of 
comparability among reporting entities. Prescriptive standards, on the 
other hand, can be circumvented more easily by structuring around the 
bright-line requirements of the standard.\136\
---------------------------------------------------------------------------

    \133\ See Section 108 Study. Section 108(d) of the Sarbanes-
Oxley Act directed the Commission to conduct a study on the adoption 
by the United States financial reporting system of a principles-
based accounting system.
    \134\ See Section 108 Study.
    \135\ See id.
    \136\ See id.
---------------------------------------------------------------------------

    In the S-K Study, the staff stated that any recommended revisions 
to Regulation S-K should emphasize a principles-based approach as an 
overarching component of the disclosure framework while preserving the 
benefits of a rules-based system, which affords consistency, 
completeness and comparability across registrants.\137\ In assessing 
this recommendation, we recognize the merits and drawbacks of our 
principles-based and prescriptive disclosure requirements.
---------------------------------------------------------------------------

    \137\ See S-K Study at 98.
---------------------------------------------------------------------------

    Limiting prescriptive disclosure requirements and emphasizing 
principles-based disclosure could improve disclosure by reducing the 
amount of information that may be irrelevant, outdated or immaterial. 
Because prescriptive disclosure requirements may result in disclosure 
that is not necessarily material or important to investors, greater use 
of principles-based disclosure requirements may allow registrants to 
more effectively tailor their disclosure to provide only the 
information about their specific business and financial condition that 
is important to investors. A principles-based approach also may allow 
registrants to readily adapt their disclosure to facts and 
circumstances that may change over time.
    On the other hand, reducing prescriptive disclosure requirements 
and shifting towards more principles-based disclosure requirements may 
limit the comparability, consistency and completeness of disclosure. 
Also, in the absence of clear guidelines for determining when 
information is material, registrants may have difficulty applying 
principles-based disclosure requirements,\138\ and the disclosure 
provided may not give investors sufficient insight into how registrants 
apply different principles-based disclosure thresholds. Potentially 
important information that may be disclosed in response to a 
prescriptive disclosure requirement might not be included in response 
to a principles-based disclosure requirement. In the context of 
accounting standards, some have noted practical challenges associated 
with principles-based standards as ``auditors and accountants may be 
less able to predict how regulators or courts will apply these 
principles in particular contexts.'' \139\ Additionally, the use of 
prescriptive disclosure requirements does not prevent registrants from 
including additional, principles-based disclosures that the registrant 
deems important.
---------------------------------------------------------------------------

    \138\ See Financial Reporting Council, Cutting Clutter, 
available at https://www.frc.org.uk/Our-Work/Publications/FRC-Board/Cutting-Clutter-Combating-clutter-in-annual-report.pdf. In this 
report, the Financial Reporting Council, the United Kingdom's 
independent regulator responsible for corporate governance and 
reporting, refers to a ``threshold'' problem, and lists the many 
words used to describe when disclosure is required. The report 
listed the following descriptors triggering disclosure: Critical, 
essential, fundamental, important, key, main, major, primary, 
principal, and significant. Id. The Financial Reporting Council's 
report pertains to the requirements of companies listed in the 
United Kingdom, but there are similarly several disclosure 
``thresholds'' used in Regulation S-K.
    \139\ See C. Coglianese, E. Keating, M. Michael and T. Healey, 
The Role of Government in Corporate Governance, NYU Journal of Law & 
Business 1: 233-251 (2004).
---------------------------------------------------------------------------

    The Section 108 Study proposed a third alternative for developing 
new accounting standards, which the staff referred to as an 
``objectives-oriented'' approach.\140\ Under this approach, standard 
setters would develop new rules by clearly articulating the accounting 
objective of the standard and providing sufficient detail and structure 
so that the standard can be applied on a consistent basis. The staff 
further recommended that such standards should be based on a 
consistently-applied conceptual framework, minimize exceptions and 
avoid the use of bright-line tests.\141\ We are soliciting comment 
below on whether such an approach might be appropriate for business and 
financial disclosures.
---------------------------------------------------------------------------

    \140\ See Section 108 Study.
    \141\ See id.
---------------------------------------------------------------------------

c. Request for Comment
    6. Should we revise our principles-based rules to use a consistent 
disclosure threshold? If so, should a materiality standard be used or 
should a different standard, such as an ``objectives-oriented'' 
approach or any other approach, be used? If materiality should be used, 
should the current definition be retained? Should we consider a 
different definition of materiality for disclosure purposes? If so, how 
should it be defined?
    7. Should we limit prescriptive disclosure requirements and 
emphasize a principles-based approach? If so, how? How can we most 
effectively balance the benefits of a principles-based approach while 
preserving the benefits of prescriptive requirements?
    8. What are the advantages and disadvantages of a principles-based 
approach? Would a principles-based approach increase the usefulness of 
disclosures? What would be the costs and benefits of such an approach 
for investors and registrants?

[[Page 23928]]

    9. Do registrants find it difficult to apply principles-based 
requirements? Why? If they are uncertain about whether information is 
to be disclosed, do registrants err on the side of including or 
omitting the disclosure? If registrants include disclosure beyond what 
is required, does the additional information obfuscate the information 
that is important to investors? Does it instead provide useful 
information to investors?
    10. Do registrants find quantitative thresholds helpful in 
preparing disclosure? Do such thresholds elicit information that is 
important to investors? Do they require registrants to provide some 
disclosure that investors do not need? To the extent our rules contain 
quantitative thresholds, how should we define them? Are specified 
dollar amounts more or less effective than amounts based on a 
registrant's financial condition, such as a percentage of revenues or 
assets?
    11. Should we develop qualitative thresholds for disclosure? Should 
there be a combination of quantitative and qualitative thresholds?
    12. Do registrants find principles-based disclosure requirements 
helpful in preparing disclosure? Do such requirements elicit 
information that is important to investors?
    13. Would principles-based disclosure affect corporate compliance 
and governance structures? If so, how?
2. Audience for Disclosure
    The Securities Act and the Exchange Act require registrants to 
provide information prescribed by the Commission as necessary or 
appropriate in the public interest or for the protection of 
investors.\142\ The legislative history of the federal securities laws 
speaks broadly to the ``buying public,'' \143\ without addressing 
variation in the needs or sophistication of investors.
---------------------------------------------------------------------------

    \142\ See Section 7(a) of the Securities Act [15 U.S.C. 
77g(a)(1)] and Section 13(a) of the Exchange Act [15 U.S.C. 78m(a)].
    \143\ See H.R. Rep. No. 85, 73d Cong., 1st Sess. 4 (1933) 
(broadly referring to the ``public,'' ``buying public'' or 
``investing public'').
---------------------------------------------------------------------------

    Nearly fifty years ago, the Wheat Report recognized variation among 
the investor audience for disclosure and suggested that the 
Commission's disclosure requirements should strike a ``pragmatic 
balance . . . between the needs of unsophisticated investors and those 
of the knowledgeable student of finance.'' \144\ The Sommer Report also 
recognized the broad spectrum of investors but recommended that the 
Commission should not expect corporate filings ``to be readily 
understandable in total by uninformed investors.'' \145\ Instead, the 
Sommer Report concluded that the Commission's rules should ``emphasize 
disclosure of information useful to reasonably knowledgeable investors 
willing to make the effort needed to study the disclosures, leaving to 
disseminators the development of simplified formats and summaries 
usable by less experienced and less knowledgeable investors.'' \146\
---------------------------------------------------------------------------

    \144\ Wheat Report at 10.
    \145\ Sommer Report at D-9. See also A.A. Sommer Jr,. The U.S. 
SEC Disclosure Study, 1 U. Pa. J. Int'l L. 145, 148 (1978) (``[T]he 
Committee did not believe that the Commission should design a 
variety of formats and degrees of summarization to serve the diverse 
needs of various investors. It is evident that the sophistication 
and knowledge of investors varies broadly, from the small, 
occasional [investor] through the sophisticated portfolio managers. 
The Committee believed that by having the Commission concentrate on 
the needs of sophisticated investors, the needs of other types of 
investors would be adequately served through the many private 
services which collect, synthesize, summarize and comment upon data 
concerning issuers.'').
    \146\ Sommer Report at D-9. The Advisory Committee on Corporate 
Disclosure identified as information disseminators the 
``organizations commonly thought of as the financial press,'' id. at 
163, that ``condense, summarize and disseminate available 
information and thereby assist analysts and investors in obtaining 
investment decision making information in forms suitable to their 
respective needs and abilities to use it.'' Id. at D-5.
---------------------------------------------------------------------------

    When adopting format and content changes to Form 10-K and the 
annual report to security holders as part of integrated disclosure, the 
Commission characterized users of Form 10-K as different from users of 
the annual report to security holders.\147\ Specifically, the 
Commission viewed annual reports to shareholders as readable documents 
designed to be delivered to shareholders \148\ and stated that the 
disclosure requirements in these reports ``evolved in the context of 
shareholders making voting decisions.'' \149\ Meanwhile, the Commission 
noted that Form 10-K was a more technical document,\150\ and the Form 
10-K disclosure was developed for ``investors and other users making 
economic decisions about the company.'' \151\ The Commission further 
noted that the most frequent users of Form 10-K disclosure were 
institutional investors, professional security analysts and 
sophisticated individual investors.
---------------------------------------------------------------------------

    \147\ See Amendments to Annual Report Form, Related Forms, 
Rules, Regulations and Guides; Integration of Securities Act 
Disclosure Systems, Release No. 33-6231, (Sept. 2, 1980) [45 FR 
63630 (Sept. 25, 1980)] (``1980 Form 10-K Adopting Release'').
    \148\ See Proposed Amendments to Annual Report Form; Integration 
of Securities Acts Disclosure Systems, Release No. 33-6176 (Jan. 15, 
1980) [45 FR 5972 (Jan. 24, 1980)] (``1980 Form 10-K Proposing 
Release''). See also 1980 Form 10-K Adopting Release, citing Annual 
Reports--Information Required in Proxy Statement, Release No. 34-
10591 (Jan. 10, 1974) [39 FR 3820 (Jan. 30, 1974)] for the statement 
that ``[t]he annual report to security holders has long been 
recognized as the most effective means of communication between 
management and security holders. Such reports are readable because 
they generally avoid legalistic and technical terminology and 
present information in an understandable, and often innovative, form 
. . . The Commission believes it is in the public interest that all 
security holders be provided with meaningful information regarding 
the business, management, operations and financial position of the 
issuer and that the annual report to security holders is the most 
suitable vehicle presently available for providing this 
information.'' See also Annual Reports, Release No. 34-11079 (Oct. 
31, 1974) [39 FR 40766 (Nov. 20, 1974)] at 40766.
    \149\ 1980 Form 10-K Adopting Release at 63630.
    \150\ See 1980 Form 10-K Proposing Release.
    \151\ 1980 Form 10-K Adopting Release at 63630.
---------------------------------------------------------------------------

    In the adopting release for these changes, the Commission stated 
its belief that focusing primarily on these frequent users is 
appropriate in formulating Form 10-K disclosure requirements, but 
``such a focus would not be appropriate in formulating requirements for 
annual reports to security holders.'' \152\ While the Commission 
acknowledged the benefit of uniformity of certain minimum disclosures 
in the annual report to security holders and the Form 10-K, it stated 
that not all disclosure requirements would be identical between the 
Form 10-K and the annual report to security holders, which potentially 
served different purposes and user constituencies.
---------------------------------------------------------------------------

    \152\ Id.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. Two commenters noted that, in some contexts, customers, 
vendors and competitors of registrants typically understand certain 
disclosures, but that the same information is likely to be less 
meaningful to investors who typically would lack the necessary 
industry-specific knowledge and interest.\153\
---------------------------------------------------------------------------

    \153\ See Silicon Valley and M. Liles.
---------------------------------------------------------------------------

    Disclosure Effectiveness Initiative. Two commenters discussed the 
profile of the investor contemplated by our disclosure requirements and 
the intended audience for public company disclosures.\154\ Both 
commenters recommended that we should assume that investors using 
registrants' disclosures have some level of sophistication. One of 
these commenters suggested that a contributing factor to increased 
disclosure is the current assumption that the typical investor is a 
novice.\155\ The other commenter

[[Page 23929]]

recommended an empirical study of the audience for financial statements 
and a review of who makes investment decisions and how such decisions 
are made.\156\ This commenter stated that sophisticated investors are 
likely the most appropriate audience for Commission filings, as they 
are generally the investors performing detailed analysis and acting as 
price-makers. This commenter also stated that most of these investors 
do not express concern about the volume of disclosure.
---------------------------------------------------------------------------

    \154\ See, e.g., CFA Institute; Shearman.
    \155\ See Shearman (stating ``it seems that disclosure if often 
premised on the assumption that the reasonable investor has little 
or no knowledge of a company's business, its industry or the merits 
or risks associated with its business. We believe that the profile 
of the reasonable investor has devolved to the `neophyte investor' . 
. .'').
    \156\ See CFA Institute.
---------------------------------------------------------------------------

    One commenter suggested that current disclosure is too complicated 
for the everyday person to read and that it should be less duplicative 
and more straightforward.\157\ Another commenter noted the diversity of 
the investor community and that the Commission's mandate is to protect 
all investors.\158\ This commenter acknowledged that some disclosures 
may not be useful to retail investors but may be useful to 
institutional investors or vice versa and that in such circumstances, 
disclosure should still be required. This commenter also stated that 
each segment of the investor community is ``entitled to have access to 
all necessary and relevant information.'' Additionally, this commenter 
noted that broad based disclosure improves transparency and builds 
public trust, confidence and understanding of capital markets.
---------------------------------------------------------------------------

    \157\ See letter from Carrie Devorah (Sept. 25, 2015).
    \158\ See letter from the American Federation of Labor and 
Congress of Industrial Organizations (Nov. 20, 2015) (``AFL-CIO'').
---------------------------------------------------------------------------

b. Discussion
    We recognize the diverse composition and varied informational 
needs, sophistication and financial resources of investors and that 
some investors may obtain their analysis or advice from or through 
third parties who use registrant disclosures. Investors using 
registrant disclosure directly may include both individual investors 
and institutional investors, such as banks, insurance companies, mutual 
funds, exchange traded funds, pension funds, hedge funds and managed 
accounts. These investor types may also use registrant disclosure 
indirectly through professional data aggregators, financial advisors, 
proxy advisors, professional analysts, journalists, and other third 
parties who process and synthesize disclosures for end user investors.
    Different investor types and third parties may focus on different 
filings or items of disclosure.\159\ Accordingly, the audience for 
disclosure is an important consideration in determining the means for 
disclosure, and specifically, in which filings or locations certain 
information should be directly provided and where cross-references, 
hyperlinks or incorporating by reference to information elsewhere is 
appropriate.\160\
---------------------------------------------------------------------------

    \159\ See, e.g., 1980 Form 10-K Adopting Release. See also, 
e.g., M. Drake, D. Roulstone, and J. Thornock, The Determinants and 
Consequences of Information Acquisition via EDGAR, 32 Contemp. Acct. 
Res. 1128, at 1128-1161 (2015) (documenting that, of the 9.8 million 
users who directly searched the EDGAR database from 2008 to 2011, 
86% are infrequent users accessing the database less than three 
times a quarter and generally accessing only one filing, although 
there is a small percentage of users accessing EDGAR at least every 
other trading day).
    \160\ For a further discussion of cross-referencing, 
incorporation by reference and hyperlinks, see Sections V.A., V.B., 
and V.C., respectively.
---------------------------------------------------------------------------

    Similarly, as different investors and third parties use disclosure 
in different ways and seek varying degrees of information, the audience 
for disclosure is also an important consideration in determining what 
information is disclosed. Institutional investors, their financial 
advisors and some third parties often use, and have supported requiring 
complex information and interactive data.\161\ These types of investors 
are likely to use disclosures of large numbers of registrants and 
therefore, may be relatively more interested in standardized disclosure 
formats well-suited for large-scale processing and analysis, including 
machine-readable formats.
---------------------------------------------------------------------------

    \161\ See, e.g., CFA Institute, Financial Reporting Disclosures: 
Investor Perspectives on Transparency, Trust, and Volume, July 2013, 
(``CFA Report''), available at https://www.cfapubs.org/doi/pdf/10.2469/ccb.v2013.n12.1; see also Interactive Data Release at 
footnote 98.
---------------------------------------------------------------------------

    Other investors may seek disclosure that emphasizes, within the 
universe of information that is disclosed, the information and analysis 
that management believes is most important.\162\ To the extent some 
investors rely on market prices to efficiently incorporate all public 
information, rather than relying on disclosures directly, it could be 
argued that disclosures should be tailored to those users most likely 
to actively follow a registrant, transact in the registrant's 
securities and set the market price.\163\ Investors in registrants that 
do not have a public trading market for their securities, however, may 
rely more directly on disclosure to evaluate their investments.
---------------------------------------------------------------------------

    \162\ For a discussion of tailoring disclosure to meet the 
diverse or potentially competing needs of the investor audience, see 
SectionV.F.
    \163\ The efficient market theory suggests that under certain 
assumptions, most investors, when making investment decisions, could 
rely on market prices to incorporate all available information. 
According to this theory, most investors would not need to 
individually examine much of the information in disclosures. See, 
e.g., Stephen J. Choi, Company Registration: Towards a Status-Based 
Antifraud Regime, 64 U. Chi. L. Rev. 567, 569-70 (1997); Eugene F. 
Fama, Efficient Capital Markets: A Review of Theory and Empirical 
Work, 25 J. Fin. 383, 383-417 (1970). The Sommer Report stated that 
the efficient market theory is silent as to the optimum amount of 
information required or whether the optimum should be achieved on a 
mandatory or voluntary basis. The Sommer Report also stated that 
market forces alone are insufficient to cause all material 
information to be disclosed. See Sommer Report at D-6. Other studies 
have noted the limitations of the efficient market theory. See, 
e.g., Robert J. Shiller, From Efficient Markets Theory to Behavioral 
Finance, J. Econ. Persp. 83, 83-104 (2003).
---------------------------------------------------------------------------

c. Request for Comment
    14. Should registrants assume some level of investor sophistication 
in preparing their disclosures? If so, what level or levels of 
sophistication? How should investor sophistication be measured? What 
are the risks or other disadvantages to investors if registrants either 
underestimate or overestimate the level of investor sophistication and 
resources when preparing their disclosures? Does disclosure protect all 
investors if it is tailored to a subset of the investor community?
    15. Should we revise our rules to require disclosure that is 
formatted to provide information to various types of investors in a 
manner that will facilitate their use of disclosure for investment and 
voting decisions?
    16. Commenters have suggested that disclosure should be written for 
a more sophisticated investor than current disclosure appears to 
contemplate,\164\ and that tailoring disclosure to less sophisticated 
investors contributes to excessive disclosure.\165\ Should our 
disclosure requirements be revised to address these views? If so, how 
could we revise our disclosure requirements, and which requirements 
should we revise, to encourage more appropriately targeted disclosure? 
If we revised our disclosure requirements to address these views, would 
there be any harm or costs to investors?
---------------------------------------------------------------------------

    \164\ See CFA Institute.
    \165\ See Shearman.
---------------------------------------------------------------------------

    17. How do investors and other users of disclosure currently access 
and use this information? How does this vary across different subsets 
of the audience for the disclosure?
    18. Should we use investor testing, such as focus groups or 
electronic surveys, to provide input on investors' use of and access to 
disclosure?
    19. To what extent should the reliance of certain investors on 
market prices or third-party analyses, rather than using

[[Page 23930]]

disclosure directly, be a factor in determining the type of investor to 
which disclosures should be targeted?
    20. To what extent should we consider the needs of other market 
participants, such as professional securities analysts and other third 
parties, in revising our disclosure requirements? What would be their 
needs?
3. Compliance and Competitive Costs
    When the Commission is engaged in rulemaking it is statutorily 
required to consider, in addition to the protection of investors, 
whether an action will promote efficiency, competition, and capital 
formation.\166\ Disclosure requirements can help reduce information 
asymmetries from management to investors,\167\ improving the allocative 
efficiency of the capital markets and enhancing capital formation by 
lowering the cost of capital.\168\ Lack of information may affect 
investors' willingness to invest and may decrease the allocative 
efficiency of the capital markets. Thus, requiring an appropriate level 
of disclosure is critical to a well-functioning capital market.
---------------------------------------------------------------------------

    \166\ See supra note 6.
    \167\ See Robert Verrecchia, Essays on Disclosure, 32 J. Acct. 
Econ. 91, 91-180 (2001) (demonstrating that a credible commitment to 
disclosure reduces uncertainty and information asymmetries between a 
firm and its investors or among investors).
    \168\ See, e.g., Richard Lambert, Christian Leuz, and Robert E. 
Verrecchia, Accounting Information, Disclosure, and the Cost of 
Capital, 45 J. Acct. Res. 385, 385-420 (May 2007) ; Luzi Hail and 
Christian Leuz, Cost of Capital Effects and Changes in Growth 
Expectations around U.S. Cross-Listings, 93 J. Fin. Econ. 428, 428-
454 (2009). Lambert, Leuz, and Verrecchia (2007) demonstrate 
theoretically that the quality of accounting information can 
influence the cost of capital. Hail and Leuz (2009) find empirical 
evidence that firms, especially firms from countries with weaker 
institutional structures that cross-list securities on U.S. 
exchanges, experience a decrease in their costs of capital.
---------------------------------------------------------------------------

    Disclosure may also have costs to registrants that could negatively 
affect these factors, although advances in technology and 
communications have the potential to reduce these costs. As disclosure 
costs rise, registrants' costs of capital may increase, which can 
reduce investment, lower the value of a company and impede economic 
growth. Registrants may also choose to exit the Commission's reporting 
system, when eligible, or remain private if the disclosure requirements 
are sufficiently costly.\169\
---------------------------------------------------------------------------

    \169\ See Brian J. Bushee & Christian Leuz, Economic 
Consequences of SEC Disclosure Regulation: Evidence from the OTC 
Bulletin Board, 39 J. Acct. Econ. 233, 233-264 (2005). Bushee and 
Leuz find seventy-six percent of firms trading on the OTC Bulletin 
Board (``OTCBB''), many of which tended to be on average 
significantly smaller by market capitalization, left the market 
after the OTCBB eligibility rule required registrants whose 
securities were quoted on the OTCBB to file updated financial 
reports with the Commission or with their banking or insurance 
regulators.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. One commenter stated its belief that ``certain 
Regulation S-K disclosures impose unnecessary costs while not providing 
concomitant value to investors . . . because the original purposes of 
the disclosure requirements have been achieved or are no longer as 
important.'' \170\ Two commenters stated that potential first-time 
registrants evaluate Exchange Act reporting and compliance costs in 
weighing the costs and benefits of an initial public offering.\171\
---------------------------------------------------------------------------

    \170\ See Ernst & Young 1.
    \171\ See Silicon Valley and M. Liles.
---------------------------------------------------------------------------

    Disclosure Effectiveness Initiative. Some commenters expressed 
general support for changes in disclosure requirements that would 
reduce costs for registrants while still providing needed information 
to investors.\172\ Other commenters, in making specific 
recommendations, acknowledged compliance costs of these recommendations 
\173\ or suggested ways to minimize the cost of such 
recommendations.\174\ One commenter noted the high cost of regulations, 
especially those promulgated by the Commission.\175\
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    \172\ See, e.g., letters from Ernst & Young, dated Nov. 20, 2015 
(``Ernst & Young 2''); letter from the Federal Regulation of 
Securities Committee, Business Law Section, American Bar Association 
(Nov. 14, 2014) (``ABA 1''); ABA 2; Business Roundtable; Arthur 
Mboue (Jun 24, 2015); and the Biotechnology Industry Organization 
(July 14, 2015) (``Biotech Industry Organization'').
    \173\ See, e.g., SCSGP at 14 (acknowledging that seeking repeal 
of requirements only a few years after their enactment would impose 
``an additional layer of costs''); ABA 2 (stating that, in its 
review of specific Regulation S-K items, it considered whether 
certain requirements could be better calibrated to provide investors 
with relevant and useful disclosure while balancing compliance costs 
to companies); letter from Allianz Global Investors (Aug. 13, 2015) 
(``Allianz'') (stating that its goal in requesting certain 
additional environmental data is to improve disclosure while 
minimizing any additional reporting burden) and letter from Data 
Transparency Coalition (Oct. 29, 2015) (``Data Transparency 
Coalition'').
    \174\ See letter from Sustainability Accounting Standards Board 
(Nov. 12, 2014) (``SASB'').
    \175\ See A. Radin.
---------------------------------------------------------------------------

b. Discussion
    We are sensitive to the costs of disclosure, including the 
administrative and compliance costs of preparing and disseminating 
disclosure as well as the potential costs of disclosing sensitive 
information to competitors. While the S-K Study did not specifically 
consider costs to investors, the staff identified economic principles 
that should be given consideration when reviewing and considering 
changes to our disclosure requirements, including: (1) The extent to 
which a given disclosure requirement entails high administrative and 
compliance costs; and (2) the extent to which disclosure of a company's 
proprietary information may have competitive or other economic 
costs.\176\
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    \176\ See S-K Study at 94.
---------------------------------------------------------------------------

    To address the potential negative effects that would result from 
disclosing sensitive information, our rules permit registrants to 
request confidential treatment of proprietary information, if 
disclosure of such information would cause competitive harm to the 
registrant.\177\ The Commission generally does not consider 
confidential treatment to be appropriate for information that is 
necessary for the protection of investors.\178\ If the Commission 
grants a request for confidential treatment, the registrant may redact 
the proprietary information from its public filings.
---------------------------------------------------------------------------

    \177\ Rule 80(b)(4) [17 CFR 200.80(b)(4)] (adopted under the 
Freedom of Information Act [5 U.S.C. 552] (``FOIA'')) (identifying 
as ``nonpublic'' records those that disclose trade secrets and 
commercial or financial information obtained from a person and 
privileged or confidential); Securities Act Rule 406 [17 CFR 
230.406]; Exchange Act Rule 24b-2 [17 CFR 240.24b-2] See also 
National Parks and Conservation Association v. Morton, 547 F.2d 673 
(D.C. Cir. 1974) (holding that information is confidential for 
purposes of FOIA if it is of the type not usually released to the 
public and, if released, would cause substantial competitive harm) 
and National Parks and Conservation Association v. Kleppe, 547 F.2d 
673 (D.C. Cir. 1976) (holding that information is confidential if 
its release is likely to cause substantial competitive harm and that 
actual competitive harm need not be shown).
    \178\ Securities Act Rule 406(b)(2)(iii) [17 CFR 
230.406(b)(2)(iii)]. The staff has provided guidance that, except in 
unusual circumstances, disclosure required by Regulation S-K or any 
other applicable disclosure requirement is not an appropriate 
subject for confidential treatment. See Staff Legal Bulletin 1A, 
Confidential Treatment Requests (July 11, 2001) (``Staff Legal 
Bulletin 1A''), available at https://www.sec.gov/interps/legal/slbcf1r.htm.
---------------------------------------------------------------------------

    The Commission also has addressed the costs of disclosure through 
regulatory relief in the form of scaled disclosure requirements for 
certain smaller registrants. These accommodations are intended to 
promote capital formation and provide relief where the fixed costs of 
compliance may be particularly high relative to the size of the company 
while also considering investor protection.\179\
---------------------------------------------------------------------------

    \179\ See, e.g., SRC Adopting Release at 942 (stating that the 
SRC definition ``is appropriately scaled in that it reduces costs to 
smaller companies caused by unnecessary information requirements, 
consistent with investor protection''); Smaller Reporting Company 
Regulatory Relief and Simplification, Release No. 33-8819 (July 5, 
2007) [72 FR 39670 (July 19, 2007)] at 39678 (stating the 
Commission's objective to ``provide maximum flexibility for [SRCs] 
without disadvantaging investors [by] establishing a baseline of 
required disclosure, [while encouraging SRCs] to determine for 
themselves the proper balance and mix of disclosure . . . given the 
costs of compliance and the market demand for information'').

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[[Page 23931]]

    Throughout this concept release, we seek comment on changes to 
specific disclosure requirements that could reduce costs for 
registrants, while still providing investors with information that is 
important or useful to making informed investment and voting decisions. 
Separately, we address the effectiveness of our scaled disclosure 
requirements.\180\ In addition to those discussions, we are interested 
in public comment on other methods we could consider to reduce costs 
for registrants that would not compromise investors' access to 
important information.
---------------------------------------------------------------------------

    \180\ For a discussion of our scaled disclosure requirements, 
see Section IV.H.
---------------------------------------------------------------------------

c. Request for Comment
    21. Do current disclosure requirements appropriately consider the 
costs and benefits of disclosure to registrants and investors? How 
should the Commission evaluate benefits, such as those arising from 
disclosure, that cannot be easily quantified?
    22. In addition to scaled disclosure and confidential treatment, 
are there other accommodations that we could make to reduce costs for 
registrants while still providing investors with the information that 
is important or useful to making informed investment and voting 
decisions?
    23. Are there other benefits and costs that we should consider when 
evaluating disclosure effectiveness?

IV. Information for Investment and Voting Decisions

A. Core Company Business Information

    Disclosure about a registrant's business lays the groundwork for 
understanding and assessing a company, its operations and financial 
condition. Information about a registrant's industry, business 
environment and other factors affecting the business helps inform 
investment and voting decisions by placing other disclosure in context. 
Schedule A of the Securities Act requires disclosure of the general 
character of the business transacted or to be transacted by the 
registrant. Item 101 of Regulation S-K similarly requires a description 
of a registrant's business. Item 102 requires disclosure about a 
registrant's materially important physical properties. We are reviewing 
the disclosure required by Item 101(a)(1) and (c) \181\ and Item 102 of 
Regulation S-K to determine whether they continue to provide investors 
with the information they need to understand the nature of a 
registrant's business and properties. We are seeking public input on 
whether there are any disclosure requirements that should be eliminated 
or modified and whether we should add any new disclosure requirements 
to these Items.
---------------------------------------------------------------------------

    \181\ The staff is separately considering certain aspects of 
Item 101 in developing recommendations for potential changes to 
update or simplify certain disclosure requirements. For a 
description of this project, see supra Section I.
---------------------------------------------------------------------------

1. General Development of Business (Item 101(a)(1))
    Item 101(a) of Regulation S-K requires a description of the general 
development of the business of the registrant during the past five 
years, or such shorter period as the registrant may have been engaged 
in business.\182\ In describing the general development of the 
business, Item 101(a)(1) requires disclosure such as the following: The 
year in which the registrant was organized and its form of 
organization; the nature and results of any bankruptcy, receivership or 
similar proceedings with respect to the registrant or any of its 
significant subsidiaries; the nature and results of any other material 
reclassification, merger or consolidation of the registrant or any of 
its significant subsidiaries; the acquisition or disposition of any 
material amount of assets otherwise than in the ordinary course of 
business; and any material changes in the mode of conducting the 
business.
---------------------------------------------------------------------------

    \182\ 17 CFR 229.101(a)(1). Item 101(a)(1) states information 
shall be disclosed for earlier periods if material to an 
understanding of the general development of the business.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. One commenter, as part of a 
general recommendation to limit disclosure requirements asking for the 
same or very similar information on multiple occasions, noted 
redundancies between current reports on Form 8-K and annual reports on 
Form 10-K and recommended that redundant disclosure in reports 
subsequent to disclosure in a Form 8-K should not be required.\183\ For 
example, and as noted by this commenter, Items 1.03 (Bankruptcy or 
Receivership) and 2.01 (Completion of Acquisition or Disposition of 
Assets) of Form 8-K require disclosure similar to the disclosure 
required under Item 101(a)(1). This commenter also recommended making a 
distinction under Item 101(a)(1) for new registrants, which may be 
disclosing the general development of their business for the first time 
in a registration statement, and established reporting registrants, 
which would have disclosed such information in a previous filing.
---------------------------------------------------------------------------

    \183\ See CCMC (also noting redundancies between Item 4.01 of 
Form 8-K (Changes in Registrant's Certifying Accountant) and Item 
304 of Regulation S-K (disclosure of changes in and disagreements 
with accountants) and Item 3.02 of Form 8-K (Unregistered Sales of 
Equity Securities) and Item 701 of Regulation S-K (disclosure of 
recent sales of unregistered securities)).
---------------------------------------------------------------------------

b. Discussion
    A requirement to provide a brief outline of the general development 
of the business for the preceding five years was included in the 
earliest forms of registration statements and annual reports.\184\ The 
first version of Regulation S-K adopted in 1977 included Item 101(a)(1) 
as part of the description of business disclosure requirements.\185\ At 
that time, the Commission amended Item 101(c) to delete a requirement 
to discuss specific business changes during the past three fiscal years 
noting ``[a]ny material changes would be described pursuant to 
paragraph (a) of the item.'' \186\
---------------------------------------------------------------------------

    \184\ See, e.g., Item 6 of Form A-2 adopted in 1935, which 
required registrants to outline briefly ``the general development of 
the business for the preceding five years.'' See Release No. 33-276 
(Jan. 14, 1935) [not published in the Federal Register]. 
Additionally, Item 5 of Form A-1, adopted in 1933, required 
registrants to briefly describe the length of time the registrant 
had been engaged in its business. See Release No. 33-5 (July 6, 
1933) [not published in the Federal Register]. See also S-K Study at 
32, footnote 88.
    \185\ See 1977 Regulation S-K Adopting Release.
    \186\ Id. at 65553. (``The disclosure requirement relating to 
descriptions of products or services has also been amended to delete 
the requirement that changes in the kinds of products produced or 
services rendered or in the markets or methods of distribution 
during the past three fiscal years be discussed. Any material 
changes would be required to be described pursuant to paragraph (a) 
of the item.'').
---------------------------------------------------------------------------

    Business developments and other disclosure called for by Item 
101(a)(1) are often reflected elsewhere in the filing, such as in the 
financial statements or MD&A. Additionally, in 2004, the Commission 
expanded the number of reportable events on Form 8-K to include items 
that may result in disclosure that overlaps with the requirements of 
Item 101(a)(1), such as disclosure of entry into a material definitive 
agreement, including business combination agreements.\187\
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    \187\ See Additional Form 8-K Disclosure Requirements and 
Acceleration of Filing Date, Release No. 33-8400 (Mar. 16, 2004) [69 
FR 15594 (Mar. 25, 2004)] (``2004 Form 8-K Adopting Release'').
---------------------------------------------------------------------------

c. Request for Comment
    24. Does the current requirement in Item 101(a)(1) to describe the 
general development of a registrant's business during the past five 
years provide useful disclosure that is not available either elsewhere 
in the current filing (e.g., MD&A or the notes to the financial

[[Page 23932]]

statements) or in any prior filing, including current reports on Form 
8-K? Should we require additional or more specific information under 
Item 101(a)(1) and, if so, what type of information and why?
    25. How could we improve Item 101(a)(1)? For example, is the five-
year time frame for this disclosure appropriate? Would a shorter or 
longer time frame be more appropriate? If so, what time frame would be 
appropriate and why?
    26. Does this disclosure continue to be useful for registrants with 
a reporting history? Once a registrant has disclosed this information 
in a registration statement should we allow registrants to omit this 
disclosure from subsequent periodic reports unless material changes 
occur? Alternatively, should we require registrants to describe its 
business as currently conducted as well as any material changes that 
have occurred in the last five years?
    27. Should we revise Item 101(a)(1) to require disclosure of a 
registrant's business strategy? Would investors find such a disclosure 
important or useful? If so, should this requirement be included in a 
registrant's MD&A? Should we define ``business strategy''? If so, how?
    28. Should we permit a summary disclosure of the general 
development of a registrant's business in all filings except the 
initial filing? For example, should we require a more detailed 
discussion of a registrant's business in the initial filing, and in 
subsequent filings only require a summary of the registrant's business 
along with a discussion of material changes in the business as 
previously disclosed in the registrant's Form 10-K? Alternatively, 
should we require a more detailed discussion of a registrant's business 
on a periodic basis, such as every three years, and a summary 
disclosure in other years? Should any such requirement be conditioned 
on timely reporting or some other consideration?
    29. What types of investors or audiences are most likely to value 
the information required by Item 101(a)(1)?
    30. What is the cost of providing the disclosure required by Item 
101(a), including the administrative and compliance costs of preparing 
and disseminating this disclosure? How would these costs change if we 
made any of the changes contemplated here? Please provide quantified 
estimates where possible and include only those costs associated with 
providing disclosure under Item 101(a).
2. Narrative Description of Business (Item 101(c))
    While Item 101(a) requires disclosure of the general development of 
the business, Item 101(c) requires a narrative description of a 
registrant's business and identifies thirteen specific items that must 
be disclosed: \188\
---------------------------------------------------------------------------

    \188\ 17 CFR 229.101(c). Item 101(c)(1) specifies that, to the 
extent material to an understanding of the registrant's business 
taken as a whole, the description of each segment must include the 
information specified in subsections (i) through (x). Information in 
subsections (xi) to (xiii) is required to be discussed for the 
registrant's business in general; where material, the segments to 
which these matters are significant also must be identified.

    (i) principal products produced and services rendered;
    (ii) new products or segments;
    (iii) sources and availability of raw materials;
    (iv) intellectual property;
    (v) seasonality of the business;
    (vi) working capital practices;
    (vii) dependence on certain customers;
    (viii) dollar amount of backlog orders believed to be firm;
    (ix) business subject to renegotiation or termination of 
government contracts;
    (x) competitive conditions;
    (xi) company-sponsored research and development activities;
    (xii) compliance with environmental laws; and
    (xiii) number of employees.
a. Comments Received
    S-K Study. Two commenters recommended eliminating the requirement 
in Item 101(c) to disclose the amount of backlog orders believed to be 
firm for EGCs, stating the concept of backlog is not a ``meaningful 
metric'' for most of these companies.\189\ These commenters stated that 
eliminating this requirement for EGCs would not ``compromise the 
delivery of meaningful disclosure to investors.'' These commenters also 
raised the question of whether the concept of backlog (or for 
businesses other than industrials, some other measure of committed 
revenue that is not yet reflected in the financial statements) would be 
addressed more appropriately in MD&A. Another commenter recommended 
eliminating disclosure requirements that no longer apply due to market 
or other changes and noted backlog as an example.\190\ This commenter 
recommended eliminating this requirement for all registrants, not only 
EGCs, or moving this requirement to MD&A.
---------------------------------------------------------------------------

    \189\ See Silicon Valley and M. Liles. Item 101(c)(1)(viii) 
requires disclosure of the dollar amount of backlog orders believed 
to be firm, as of a recent date and as of a comparable date in the 
preceding fiscal year, together with an indication of the portion 
thereof not reasonably expected to be filled within the current 
fiscal year, and seasonal or other material aspects of the backlog.
    \190\ See Ernst & Young 1.
---------------------------------------------------------------------------

    Disclosure Effectiveness Initiative. One commenter stated that many 
of the subsections of Item 101(c) would be more appropriately addressed 
elsewhere in the filing, stating that when such information is material 
to a registrant, investors would be better served by having the 
registrant address that information in its MD&A or risk factors.\191\
---------------------------------------------------------------------------

    \191\ See SCSGP (stating that the following subsections of Item 
101 would be more useful if included in MD&A: backlog 
((c)(1)(viii)), working capital practices ((c)(1)(vi)), sources and 
availability of raw materials ((c)(1)(iii)), dependence on certain 
customers ((c)(1)(vii)), competitive conditions ((c)(1)(x)), 
compliance with environmental laws ((c)(1)(xii)) and risks attendant 
to foreign operations ((d)(3))).
---------------------------------------------------------------------------

b. Discussion
    Consistent with Schedule A of the Securities Act, the earliest 
forms of registration statements and annual reports required a brief 
outline of the general character of the business done and intended to 
be done by a registrant.\192\ Many of the disclosure requirements that 
currently appear in Item 101(c) were adopted in 1973 following 
investigation of the hot issues markets.\193\ The adopting release 
notes that, in making investment decisions, venture capitalists and 
underwriters typically obtain specific information from companies about 
their competitive position and the methods of competition in their 
respective industries, and accordingly, the new requirements were 
expected to provide similar information to the investing public.\194\ 
At the same time, the Commission also added requirements for the 
disclosure of the amount of backlog orders, the sources and 
availability of raw materials essential to the business, the number of 
employees and working capital practices.\195\
---------------------------------------------------------------------------

    \192\ See, e.g., Item 5 of Form A-2 adopted in 1935, which 
required registrants to outline briefly ``the general character of 
the business done and intended to be done by the registrant and its 
subsidiaries.'' See Release No. 33-276 (Jan. 14, 1935) [not 
published in the Federal Register]. Additionally, Items 3 through 5 
of Form A-1, adopted in 1933, required registrants to briefly 
describe the ``character of business done or intended to be done,'' 
disclose a list of states where the issuer owned property and was 
qualified to do business, and the length of time the registrant had 
been engaged in its business. See Release No. 33-5 (July 6, 1933) 
[not published in the Federal Register]. See also S-K Study at 32, 
footnote 88.
    \193\ See Hot Issues Adopting Release. See also Hot Issues; 
Meaningful Disclosure, Release No. 33-5274 (July 26, 1972) [37 FR 
16005 (Aug. 9, 1972)].
    \194\ See Hot Issues Adopting Release.
    \195\ See id.
---------------------------------------------------------------------------

    In the S-K Study, the staff recommended reviewing the description 
of business for continuing relevance in

[[Page 23933]]

light of changes that have occurred in the way businesses operate, 
which may make other disclosures relevant that are not expressly 
addressed under current requirements.\196\ As an example, the S-K Study 
noted that requirements could be more specific as to additional 
disclosure that would be necessary where a business relies heavily on 
intellectual property owned by a third party or relies on a service 
agreement with third parties to perform necessary business 
functions.\197\
---------------------------------------------------------------------------

    \196\ See S-K Study at 99-100.
    \197\ Below, and in other parts of this release, we discuss 
other areas where our requirements could be revised to reflect 
changes in the way businesses operate.
---------------------------------------------------------------------------

c. Request for Comment
    31. Do the disclosure requirements in Item 101(c) continue to 
provide useful information to investors? How could we improve Item 
101(c)'s requirements?
    32. How could we update Item 101(c) to better reflect changes in 
the way businesses operate? Are there particular categories or types of 
registrants for which these disclosure requirements are more or less 
relevant?
    33. Are there additional line-item disclosure requirements about a 
registrant's business that would improve the quality and consistency of 
disclosure? Are there any categories of information that certain 
registrants voluntarily provide, and are not required to disclose under 
Item 101(c), that we should include in Item 101(c)? \198\ What would be 
the benefits and challenges of requiring disclosure of additional 
categories of information?
---------------------------------------------------------------------------

    \198\ For example, the staff has observed that many registrants 
provide disclosure about the regulatory environment in which their 
business operates although no specific line-item disclosure 
requirement for this exists.
---------------------------------------------------------------------------

    34. Currently, some registrants include in their business section a 
general description of their industry. Should industry disclosure be a 
separate requirement? If so, would this requirement be more useful to 
investors in the business section or in MD&A?
    35. Should we require additional specific disclosure relevant to 
particular industries, such as manufacturing or technology companies? 
If so, which industries and why? What are the benefits and challenges 
of requiring industry-specific disclosure? \199\
---------------------------------------------------------------------------

    \199\ For a discussion of industry-specific disclosures, see 
Section IV.E.
---------------------------------------------------------------------------

    36. What is the impact on disclosure of listing the thirteen item 
requirements in Item 101(c)? In practice, do registrants view Item 
101(c) as a checklist? Do the prescriptive items result in disclosure 
of information that is not important by some registrants?
    37. Should we require Item 101(c) disclosure only in the initial 
filing with follow-up disclosure of any material changes for subsequent 
years? Should any such requirement be conditioned on timely reporting 
or some other consideration? Should the requirements differ for 
registration statements and periodic reports?
    38. Is there any information currently disclosed in the description 
of business that should be presented in a different context such as 
MD&A or risk factors? Why?
    39. In some circumstances, disclosure is required under Item 
101(c)(1) if material. The item specifies that, to the extent material 
to an understanding of the registrant's business taken as a whole, the 
description of each segment shall include the information in (c)(1)(i) 
through (x) and that matters in (c)(1)(xi) through (xiii) shall be 
discussed for the registrant's business in general; where material, the 
segments to which these matters are significant shall be identified. 
Additionally, some sub-items of Item 101(c)(1) require disclosure if 
material, such as (c)(1)(ii) and (c)(1)(ix),\200\ while others do 
not.\201\ Should we require disclosure of all line items in Item 101(c) 
in all circumstances, regardless of materiality? Why or why not? 
Alternatively, would a principles-based approach to disclosure about a 
registrant's business and operations allow flexibility to disclose 
information that is important to investors? If so, how should such a 
disclosure requirement be structured? What factors should we consider 
in developing such a requirement?
---------------------------------------------------------------------------

    \200\ For example, Item 101(c)(1)(ii) requires a description of 
the status of a product or segment (e.g., whether in the planning 
stage, whether prototypes exist, the degree to which product design 
has progressed or whether further engineering is necessary), if 
there has been a public announcement of, or if the registrant 
otherwise has made public information about, a new product or 
segment that would require the investment of a material amount of 
the assets of the registrant or that otherwise is material. In 
addition, Item 101(c)(1)(ix) requires a description of any material 
portion of the business that may be subject to renegotiation of 
profits or termination of contracts or subcontracts at the election 
of the Government.
    \201\ For example, Item 101(c)(1)(xiii) requires disclosure of 
the number of persons employed by the registrant.
---------------------------------------------------------------------------

    40. What types of investors or audiences are most likely to value 
the information required by Item 101(c)? Would an alternative format or 
presentation of the information improve the value of such disclosure to 
a particular type of investor or audience? If so, what type of format 
or presentation?
    41. What is the cost of providing the disclosure required by Item 
101(c), including the administrative and compliance costs of preparing 
and disseminating this disclosure? How would these costs change if we 
made any of the changes contemplated here? Please provide quantified 
estimates where possible and include only those costs associated with 
providing disclosure under Item 101(c).
3. Technology and Intellectual Property Rights (Item 101(c)(1)(iv))
    Item 101(c)(1)(iv) requires disclosure of the importance to the 
segment and the duration and effect of all patents, trademarks, 
licenses, franchises and concessions held.\202\
---------------------------------------------------------------------------

    \202\ 17 CFR 229.101(c)(1)(iv).
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. None
    Disclosure Effectiveness Initiative. None.
b. Discussion
    A broad range of industries benefit from intellectual property, 
both directly and indirectly,\203\ and intellectual property has become 
increasingly important to business performance.\204\ Certain industries 
produce or use significant amounts of intellectual property or rely 
more heavily on these rights.\205\ Accordingly, certain registrants 
provide detailed disclosure in response to Item 101(c)(1)(iv), and 
disclosure varies among registrants and across industries.
---------------------------------------------------------------------------

    \203\ See Economics and Statistics Administration and United 
States Patent and Trademark Office, Intellectual Property and the 
U.S. Economy: Industries in Focus (March 2012) at iv, available at 
https://www.uspto.gov/sites/default/files/news/publications/IP_Report_March_2012.pdf (``Intellectual Property and the U.S. 
Economy'').
    \204\ See, e.g., Kelvin W. Willoughby, What impact does 
intellectual property have on the business performance of technology 
firms?, Int. J. Intellectual Property Management, Vol. 6, No. 4 
(2013).
    \205\ See Intellectual Property and the U.S. Economy. This 
report identifies seventy-five industries as ``IP-intensive.'' In 
this report, patents, trademarks and copyrights were the categories 
of intellectual property assessed. The methodology for designating 
each of these subcategories as ``IP-intensive'' is outlined further 
in this report. For patent intensive industries, the report utilized 
the North American Industry Classification System (NAICS) codes and 
identified, as the four most patent-intensive industries, those 
industries classified in computer and electronic product 
manufacturing (NAICS 334). This three-digit NAICS industry includes 
computer and peripheral equipment; communications equipment; other 
computer and electronic products; semiconductor and other electronic 
components; and navigational, measuring, electro-medical, and 
control instruments.
---------------------------------------------------------------------------

    In the biotechnology and pharmaceutical industries, registrants 
that provide detailed patent disclosure often disclose the jurisdiction 
in which the patent was filed, year of expiration, type of patent 
(e.g., composition of

[[Page 23934]]

matter, method of use, method of delivery or method of manufacturing), 
products or technologies to which the patent relates and how the patent 
was acquired (e.g., licensed from another entity or owned and filed by 
the registrant). Some registrants in these industries aggregate patent 
disclosure by groups of patents, potentially making disclosure about 
individual material patents difficult to discern. As registrants in the 
biotechnology and pharmaceutical industries regularly sell one or a few 
patented products that generate substantial revenue, disclosure of 
``patent cliffs,'' \206\ which often result in material adverse 
financial effects, may be required in the risk factors section or MD&A.
---------------------------------------------------------------------------

    \206\ The term ``patent cliff'' as used in the biotechnology and 
pharmaceutical industry refers to a future loss of patent protection 
and consequential loss of revenue. These potential future losses are 
known to registrants far in advance of their onset. When they occur, 
they often precipitate material adverse financial effects. See, 
e.g., Andrew Jack, Pharma tries to avoid falling off `patent cliff,' 
Financial Times, May 6, 2012 and Cliffhanger, Economist, Dec. 3, 
2011. See also Ed Silverman, Big Pharma Faces Some Big Patent 
Losses, but Pipelines are Improving, Wall St. J.: L. Blog, available 
at https://blogs.wsj.com/pharmalot/2015/02/09/big-pharma-faces-some-big-patent-losses-but-pipelines-are-improving/.
---------------------------------------------------------------------------

    In the information technologies and services industry, registrants 
protect their intellectual property through the use of patents, 
trademarks, copyrights, trade secrets, licenses and confidentiality 
agreements.\207\ Registrants with large portfolios of intellectual 
property often disclose that their products, services and technologies 
are not dependent on any specific patent, trademark, copyright, trade 
secret or license. As a result, these registrants often provide only 
high-level discussions of their intellectual property portfolios, which 
include general statements of a registrant's development, use and 
protection of its intellectual property. Registrants with smaller 
intellectual property portfolios tend to provide slightly more detailed 
discussions, including, for example, disclosure of their total number 
of issued patents, a range of years during which those patents expire 
and their total number of pending patent applications.
---------------------------------------------------------------------------

    \207\ See Bruce Abramson, Promoting Innovation in the Software 
Industry: A First Principles Approach to Intellectual Property 
Reform, 8 B.U. J. Sci. & Tech. L. 75 (2002) (discussing the software 
industry's use of intellectual property law).
---------------------------------------------------------------------------

    In general, registrants in the information technologies and 
services industry use copyrights to protect against the unauthorized 
copying of software programs \208\ and trade secrets to protect 
proprietary and confidential information that derives its value from 
continued secrecy.\209\ Since Item 101(c)(1)(iv) does not require 
disclosure about copyrights or trade secrets, registrants currently 
make disclosure about such matters voluntarily.
---------------------------------------------------------------------------

    \208\ See Dennis S. Karjala, Copyright Protection of Operating 
Software, Copyright Misuse, and Antitrust, 9 Cornell J.L. & Pub. 
Pol'y 161, 172 (1999) (discussing the dependence of software 
technology companies on copyright).
    \209\ See Raymond T. Nimmer & Patricia Ann Krauthaus, Software 
Copyright: Sliding Scales and Abstracted Expression, 32 Hous. L. 
Rev. 317, 325 (1995) (distinguishing between the software industry's 
use of trade secret law, patent law and copyright law).
---------------------------------------------------------------------------

c. Request for Comment
    42. Should we retain the current scope of Item 101(c)(1)(iv), which 
requires disclosure of a registrant's patents, trademarks, licenses, 
franchises and concessions? Should we expand the rule to include other 
types of intellectual property, such as copyrights? Should we remove 
the individual categories and instead require disclosure of 
``intellectual property''? If so, should we define that term and what 
should it encompass?
    43. What, if any, additional information about a registrant's 
reliance on or use of technology and related intellectual property 
rights should we require and why? Should we revise Item 101(c)(1)(iv) 
to require more detailed intellectual property disclosure, similar to 
the disclosure currently provided by some biotechnology and 
pharmaceutical registrants? If so, should we require such detailed 
disclosures for all or only some of a registrant's intellectual 
property, such as those that are material to the business?
    44. For registrants with large intellectual property portfolios, 
does aggregate disclosure of the total number of patents, trademarks 
and copyrights and a range of expiration dates provide investors with 
sufficient information? If not, what additional information do 
investors need about a company's portfolio of intellectual property? 
Would tabular disclosure or an alternate format or presentation of a 
registrant's intellectual property portfolio make the information more 
useful to investors? What would be the benefits and challenges of 
requiring disclosure of this information in this format?
    45. Should we limit these disclosure requirements to registrants in 
particular industries? If so, which industries should we specify and 
why? Is disclosure about a registrant's intellectual property most 
useful in the context of the description of business, disclosure about 
trends and developments affecting results of operations, or in a 
discussion of risk and risk management?
    46. What are the competitive costs of disclosure under Item 
101(c)(1)(iv)?
4. Government Contracts and Regulation, Including Environmental Laws 
(Items 101(c)(1)(ix) and (c)(1)(xii))
    Item 101(c)(1)(ix) requires disclosure of any material portion of a 
business that may be subject to renegotiation of profits or termination 
of contracts or subcontracts at the election of the government.\210\ 
Item 101(c)(1)(xii) requires disclosure of the material effects of 
compliance with environmental laws on the capital expenditures, 
earnings and competitive position of the registrant and its 
subsidiaries, as well as any material estimated capital expenditures 
for the remainder of the fiscal year, the succeeding fiscal year, and 
such future periods that the registrant deems material.\211\ There is 
no separate line-item requirement to discuss government regulation that 
may be material to a registrant's business.
---------------------------------------------------------------------------

    \210\ 17 CFR 229.101(c)(1)(ix).
    \211\ 17 CFR 229.101(c)(1)(xii).
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. One commenter suggested 
including an instruction to Item 101(c)(1)(ix) to specify that, to the 
extent disclosure responsive to this item is included in the notes to 
the financial statements, cross-references should be used to avoid 
duplicative disclosure.\212\ Another commenter stated that registrants 
in the pharmaceutical industry noted that high levels of regulatory 
disclosure and other issues common to all pharmaceutical registrants 
have become commonplace and have detracted from meaningful 
disclosure.\213\ Two commenters sought

[[Page 23935]]

increased disclosure of a registrant's corporate structure and tax 
strategy.\214\ One of these commenters recommended specific disclosures 
such as a list of each country of operation and the name of each entity 
of the issuer group domiciled in each country of operation and the 
total pre-tax gross revenues of each member of the issuer group in each 
country of operation.\215\
---------------------------------------------------------------------------

    \212\ See ABA 2.
    U.S. government contracts generally contain provisions that 
enable the contract to be terminated, in whole or in part, without 
prior notice, at the government's convenience (due to lack of 
funding or for other reasons) or for default based on performance. 
ASC 912-275-50-1 requires footnote disclosure of renegotiation 
uncertainties, their significance, and renegotiation discussions 
relating to the current year. In addition, ASC 912-275-50-6 states 
that if there are indications that a contract termination may occur 
and the termination would have a material effect on the contractor's 
operations, disclosure of the circumstances and the potential 
effects shall be made in the notes to financial statements. The 
staff has observed that, rather than provide duplicative disclosure, 
some government contractors cross-reference their discussion of the 
government's right to terminate a contract under Item 101(c)(1)(ix) 
to either their accounting policy disclosure for revenue recognition 
in the critical accounting estimates disclosure in MD&A or to their 
significant accounting policies in the notes to the financial 
statements.
    \213\ See Shearman.
    \214\ See letter from US SIF and US SIF Foundation (Sept. 18, 
2014) (``US SIF 1'') (stating that a lack of information about a 
registrant's subsidiaries ``prevent investors from accurately 
assessing corporate tax structure and tax strategy and the attendant 
contingent liabilities, as well as exposures to political risks in 
these countries''), and AFL-CIO (``Even minor changes to US or 
foreign tax policy could lead to major changes in the issuer's 
financial performance.'').
    \215\ See AFL-CIO.
---------------------------------------------------------------------------

b. Government Contracts (Item 101(c)(1)(ix))
i. Discussion
    Business contracts with agencies of the U.S. government and the 
various laws and regulations relating to procurement and performance of 
U.S. government contracts impose terms and rights that are different 
from those typically found in commercial contracts. In a 1972 Notice to 
Registrants, the Commission noted that government contracts are subject 
to renegotiation of profit and to termination for the convenience of 
the government.\216\ At any given time in the performance of a 
government contract, an estimate of its profitability is often subject 
not only to additional costs to be incurred but also to the outcome of 
future negotiations or possible claims relating to costs already 
incurred.\217\
---------------------------------------------------------------------------

    \216\ See Defense and Other Long Term Contracts; Prompt and 
Accurate Disclosure of Information, Release No. 33-5263 (June 22, 
1972) [37 FR 21464 (Oct. 11, 1972)].
    \217\ Id.
---------------------------------------------------------------------------

    Registrants with U.S. government contracts tend to disclose that 
the funding of these contracts is subject to the availability of 
Congressional appropriations and that, as a result, long-term 
government contracts are partially funded initially with additional 
funds committed only as Congress makes further appropriations. These 
registrants disclose that they may be required to maintain security 
clearances for facilities and personnel in order to protect classified 
information. Additionally, these registrants state that they may be 
subject to routine government audits and investigations, and any 
deficiencies or illegal activities identified during the audits or 
investigations may result in the forfeiture or suspension of payments 
and civil or criminal penalties.
ii. Request for Comment
    47. Is disclosure about government contracts important to 
investors? Why? Is there any additional information about a 
registrant's contracts with the government that would be important to 
investors?
    48. Rather than focusing specifically on government contracts, 
should we require registrants to briefly describe all material 
contracts? Would such a requirement elicit disclosure not otherwise 
provided in MD&A or the description of business?
c. Compliance with Environmental Laws (Item 101(c)(1)(xii))
i. Discussion
    Pursuant to NEPA, which mandated consideration of the environment 
in regulatory action, the Commission adopted Item 101(c)(1)(xii) in 
1973 to require disclosure of the material effects compliance with 
federal, state and local environmental laws may have on the capital 
expenditures, earnings and competitive position of the registrant.\218\ 
Subsequent litigation concerning both the denial of a rulemaking 
petition and adoption of the 1973 environmental disclosure requirements 
resulted in the Commission initiating public proceedings in 1975 
primarily to elicit comments on whether the provisions of NEPA required 
further rulemaking.\219\ As a result of these proceedings, the 
Commission in 1976 amended the requirements to specifically require 
disclosure of any material estimated capital expenditures for 
environmental control facilities for the remainder of the registrant's 
current and succeeding fiscal years, and for any further periods that 
are deemed material.\220\
---------------------------------------------------------------------------

    \218\ See supra note 61.
    \219\ See Notice of Public Proceedings on Environmental 
Disclosure Release.
    \220\ See 1976 Environmental Release.
---------------------------------------------------------------------------

ii. Request for Comment
    49. Should we increase or reduce the environmental disclosure 
required by Item 101(c)(1)(xii)? Why? What kind of information should 
we add to or remove from this requirement?
    50. Is disclosure about the material effects that compliance with 
provisions regulating the discharge of materials into the environment, 
or otherwise relating to the protection of the environment, may have 
upon a registrant's capital expenditures, earnings and competitive 
position important to investors? If so, should we require registrants 
to present this disclosure in a specific format? Would this disclosure 
be more appropriate in MD&A or the business section?
    51. Should we require specific disclosure about the material 
effects that other regulations may have on a registrant's capital 
expenditures, earnings and competitive position? If so, are there 
specific laws and regulations that our rules should cover?
d. Government Regulation
i. Discussion
    Although not referenced in Item 101, many registrants discuss 
government regulations relevant to their business.\221\ Healthcare and 
insurance providers regularly disclose the registrant's collection, use 
and protection of individually-identifiable information and its 
compliance with the Health Insurance Portability and Accountability Act 
of 1996,\222\ as well as the impact of the Patient Protection and 
Affordable Care Act \223\ on its business. Biotechnology or medical 
device companies often disclose the status of and process for FDA 
approval of significant new drugs or medical devices. Public utilities 
typically discuss regulation by various federal, state and local 
authorities and include information about state ratemaking procedures, 
which determine the rates utilities charge and the return on invested 
capital they earn.
---------------------------------------------------------------------------

    \221\ However, the disclosure requirements applicable to SRCs do 
require some of this information, to the extent material. Item 
101(h)(4)(viii) requires disclosure of the need for any government 
approval of principal products or services. If government approval 
is necessary and the SRC has not yet received that approval, SRCs 
are required to discuss the status of the approval within the 
government approval process. The staff has observed that 
biotechnology or medical device companies that are not SRCs also 
provide this disclosure. Additionally, Item 101(h)(4)(ix) requires 
disclosure of the effect of existing or probable governmental 
regulations on the business. For a discussion of scaled disclosure 
requirements, see Section IV.H.2.
    \222\ Public Law 104-191, 110 Stat. 1936 (1996).
    \223\ Public Law 111-148, 124 Stat. 119 (2010).
---------------------------------------------------------------------------

    Registrants in the financial services industry regularly describe 
federal and state regulation as well as supervision by the Federal 
Reserve Board, while registrants with a material amount of U.S. 
government contracts disclose the laws and regulations for government 
contracts. Registrants with tax strategies involving foreign 
jurisdictions typically disclose that they are subject to income taxes 
in both the U.S. and numerous foreign jurisdictions, and that future 
changes to U.S. and non-U.S. tax law could adversely affect their 
anticipated financial position and results. Some disclose the impact on 
their business of tax treaties between the U.S. and one or more foreign 
jurisdictions.

[[Page 23936]]

ii. Request for Comment
    52. Given that many registrants provide disclosure of material 
government regulations without a specific line-item requirement, are 
the current disclosure requirements sufficient? Would a specific 
requirement seeking this disclosure provide additional information that 
is important to investors? If so, what specific information and level 
of detail should we require and why? What would be the costs of 
requiring disclosure of this information?
    53. Foreign regulations, including foreign tax rates and treaties, 
may have a material impact on a registrant's operations. Should we 
specifically require registrants to describe foreign regulations that 
affect their business? If so, what specific information and level of 
detail should we require? How would any additional information inform 
investment and voting decisions? Would there be challenges for 
registrants to provide such disclosure?
5. Number of Employees (Item 101(c)(1)(xiii))
    Item 101(c)(1)(xiii) requires disclosure of the number of persons 
employed by the registrant. The Division of Corporation Finance 
(``Division'') has provided interpretive guidance on this requirement 
stating that, in industries where the general practice is to hire 
independent contractors rather than employees, companies should 
disclose the number of persons retained as independent contractors as 
well as the number of regular employees.\224\
---------------------------------------------------------------------------

    \224\ See Regulation S-K Compliance and Disclosure 
Interpretations Question 203.01, available at https://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. One commenter suggested 
requiring disclosure of the number of employees for each of a 
registrant's subsidiaries along with other information about the 
subsidiaries, to provide investors with the information necessary to 
understand the structure of the registrant and its international 
strategy.\225\ This commenter stated that disclosure of a subsidiary in 
a known tax haven with ``zero employees and billions in profits, for 
example, would signal to investors the use of a particularly aggressive 
and potentially risky strategy to hide profits from regulators.''
---------------------------------------------------------------------------

    \225\ See US SIF 1.
---------------------------------------------------------------------------

b. Discussion
    The number of persons employed by the registrant can help investors 
assess the size and scale of a registrant's operations. Changes in the 
number or type of persons employed can also be indicative of trends or 
shifts in a registrant's operations. Disclosure of the number of 
employees varies among registrants. Some registrants distinguish 
between the number of full-time and part-time employees, and others 
specify the number of employees in each department or division. 
Registrants with large numbers of employees often disclose the 
approximate number of employees and discuss their employees' membership 
in a union or similar organization. Other registrants characterize the 
state of their employee relations and disclose whether their employees 
are covered by a collective bargaining agreement or represented by a 
labor union.
c. Request for Comment
    54. Does disclosure of the number of persons employed by the 
registrant help investors assess the size, scale and viability of a 
registrant's operations and any trends or shifts in operations? Is this 
disclosure important to investors and why? Is there any additional 
information about employees that would be important to investors? If 
so, what information?
    55. For new registrants filing a registration statement that have 
not had revenue from operations during each of the preceding three 
fiscal years, Item 101(a)(2)(iii) requires disclosure of any 
anticipated material changes in the number of employees in the various 
departments such as research and development, production, sales or 
administration.\226\ Is this information useful to investors? Should we 
include a similar requirement for all registrants in periodic and 
current reports? Should this requirement be in addition to or in lieu 
of the current requirement to disclose the number of employees?
---------------------------------------------------------------------------

    \226\ Item 101(a)(2) applies to registrants filing a 
registration statement on Form S-1 or Form 10 that are not subject 
to Sections 13(a) or 15(d) of the Exchange Act and have not received 
revenue from operations during each of the three fiscal years 
immediately before the filing of such registration statement.
---------------------------------------------------------------------------

    56. Should we require registrants to distinguish among their total 
number of persons employed, such as by distinguishing between:
     Full-time and part-time or seasonal employees;
     Employees and independent contractors; or
     Domestic and foreign employees?
    Why or why not?
    57. Rather than requiring registrants to disclose the number of 
employees or independent contractors, should we require or permit 
registrants to provide a range? Why? Should we allow for different 
ranges based on the size of the registrant? Would reporting a range 
rather than a specific number reduce the costs of producing this 
disclosure?
    58. Should we require disclosure of additional information about a 
registrant's employees or employment practices? What would be the 
challenges of requiring disclosure of any additional information, and 
what would be the benefits to investors?
    59. As outsourcing and subcontracting have become more prevalent in 
the last few decades,\227\ what, if any, additional information about a 
registrant's outsourcing or subcontracting arrangements should we 
require? Would this information be most useful in the context of the 
description of the registrant's business, disclosure about trends and 
developments affecting results of operations, or in a discussion of 
risk and risk management? What would be the challenges of requiring 
disclosure of this information?
---------------------------------------------------------------------------

    \227\ See, e.g., Deloitte, Deloitte's 2014 Global Outsourcing 
and Insourcing Survey (2014), available at https://www2.deloitte.com/content/dam/Deloitte/us/Documents/strategy/us-2014-global-outsourcing-insourcing-survey-report-123114.pdf (noting a 
significant rise in offshoring in the last two decades but also a 
small but growing reversal where companies that had previously 
offshored functions are bringing them back to their home country); 
Here, there and everywhere, Economist, Jan. 19, 2013 (discussing 
offshoring trends in the last several decades, but also noting such 
trends are ``maturing, tailing off and to some extent being 
reversed'').
---------------------------------------------------------------------------

6. Description of Property (Item 102)
    Item 102 of Regulation S-K requires disclosure of the location and 
general character of the principal plants, mines and other materially 
important physical properties of the registrant and its subsidiaries. 
Item 102 also requires registrants to identify the segments, as 
reported in the financial statements, that use the properties 
described. Instruction 1 states that registrants must disclose such 
information as reasonably will inform investors as to the suitability, 
adequacy, productive capacity and extent of utilization of the 
facilities by the registrant.\228\ Instruction 2 provides that, in 
determining whether properties should be described, registrants should 
take into account both quantitative and qualitative factors.\229\
---------------------------------------------------------------------------

    \228\ Detailed descriptions of the physical characteristics of 
individual properties or legal descriptions by metes and bounds are 
not required. See Instruction 1 to Item 102.
    \229\ Disclosure specific to the mining industry in Item 102--
Instructions 3, 5 and 7 refer to the mining industry--is outside of 
the scope of this release. Commission staff is undertaking a 
separate review of disclosure requirements for mining activities. 
Instructions 4, 6 and 8 apply to the oil and gas industry. 
Disclosure specific to the oil and gas industry was considered in 
2008 and is also outside of the scope of this release. See Oil and 
Gas Release. Instruction 9 applies to the real estate industry. For 
a general discussion of Industry Guides, see Section IV.E.

---------------------------------------------------------------------------

[[Page 23937]]

a. Comments Received
    S-K Study. One commenter recommended that property disclosure 
should not be required for entities where physical plant or properties 
are not a significant element of enterprise value.\230\
---------------------------------------------------------------------------

    \230\ See Ernst & Young 1.
---------------------------------------------------------------------------

    Disclosure Effectiveness Initiative. Two commenters noted that if 
material to a registrant's business, MD&A would require a discussion of 
the importance of a property or facility and, in these instances, Item 
102 may result in immaterial or duplicative disclosure.\231\ One 
commenter recommended eliminating Item 102 disclosure, stating that 
disclosure of physical properties does not, in most cases, provide 
investors meaningful information, particularly for registrants not 
engaged in manufacturing.\232\ Another commenter cautioned against 
disclosing only material properties and eliminating requirements to 
list locations, capacity and ownership.\233\ This commenter stated that 
investors need a complete understanding of the scope of a registrant's 
operations and assets in order to evaluate the scope of its risks and 
opportunities. One commenter noted different triggers for disclosure in 
Item 102 such as the item's reference to ``materially'' important 
physical properties and ``major'' encumbrance. This commenter 
recommended a Commission study to determine whether these varied 
formulations should be harmonized to lessen ambiguity on their 
application.\234\
---------------------------------------------------------------------------

    \231\ See CCMC; SCSGP.
    \232\ See Shearman.
    \233\ See US SIF 1.
    \234\ See ABA 2.
---------------------------------------------------------------------------

b. Discussion
    Since 1935, we have required disclosure similar to that required 
under Item 102.\235\ The predecessor to Item 102 called for a brief 
description of the general character and location of ``principal plants 
and other important units'' of the registrant and its subsidiaries and, 
for property not held in fee, a description of how the property was 
held.\236\ In 1977, a similar requirement was one of two original 
requirements in Regulation S-K and additionally, required registrants 
to identify the segments that use the properties described.\237\
---------------------------------------------------------------------------

    \235\ See Release No. 33-276 (January 14, 1935) [not published 
in the Federal Register].
    \236\ Id.
    \237\ See 1977 Regulation S-K Adopting Release.
---------------------------------------------------------------------------

    In 1996, the Task Force on Disclosure Simplification recommended 
the Commission revise Item 102 to more effectively elicit disclosure of 
material facts about a registrant's principal properties, rather than 
lists of properties and their immaterial characteristics.\238\ The S-K 
Study recommended reviewing Item 102 for continuing relevance given 
that many businesses no longer require or depend on physical 
locations.\239\ For businesses that do have material properties, the S-
K Study suggested refocusing disclosure on the significance of the 
property to the business and any trends or uncertainties in connection 
with that property, rather than requiring a list of locations, capacity 
and ownership.\240\
---------------------------------------------------------------------------

    \238\ See Task Force Report.
    \239\ See S-K Study at 99-100.
    \240\ See id.
---------------------------------------------------------------------------

    In response to Item 102, registrants typically disclose information 
about their headquarters such as the location, size and whether they 
own or lease the property, as well as information about other 
properties material to the business. In addition to this disclosure, 
some registrants cross-reference to the discussion in the notes to the 
financial statements such as to the note on purchase and lease 
commitments or to the note on property, plant and equipment.
    Registrants in certain industries may provide more specific 
disclosures. For example, registrants with retail stores often disclose 
the number of their stores, location, size and lease termination dates. 
Registrants in the hotel and lodging industry tend to disclose the 
location and number of rooms at each of their properties. Some 
registrants with casino operations disclose the number of table games 
and slot machines at each location. Registrants in the restaurant 
industry tend to disclose the number of their restaurants, location and 
whether they are registrant-operated or franchisee-operated stores. In 
the paper mill or paper production industry, registrants typically 
provide tabular disclosure for facilities including their geographic 
location and related products or use. By contrast, some registrants, 
such as those that provide services or information technology, may not 
have material physical properties and tend to disclose information 
about their corporate headquarters, office space and other facilities.
c. Request for Comment
    60. Should we retain or eliminate Item 102? Why or why not? How 
could Item 102 be improved?
    61. Would any additional disclosure about a registrant's properties 
be important to investors? If so, what additional disclosure would be 
important? What would be the challenges to registrants of requiring 
disclosure of any such additional information, and what would be the 
benefits to investors?
    62. For registrants that may not have material physical properties, 
is the disclosure that registrants typically provide about their 
corporate headquarters, office space and other facilities important to 
investors?
    63. Should we require property disclosure only for registrants in 
certain industries? If so, how should we identify these industries?
    64. Should the disclosure requirements focus instead on the risks 
to a registrant's business resulting from the availability and cost of 
properties it needs for its operations?
    65. What types of investors or audiences are most likely to value 
the information required by Item 102?
    66. What is the cost of providing the disclosure required by Item 
102, including the administrative and compliance costs of preparing and 
disseminating this disclosure? How would these costs change if we made 
any of the changes contemplated here? Please provide quantified 
estimates where possible and include only those costs associated with 
providing disclosure under Item 102.

B. Company Performance, Financial Information and Future Prospects

    Financial information is essential to understanding a registrant's 
performance, financial condition and future prospects. The Commission 
has long recognized the need for a narrative explanation of the 
financial statements, as a numerical presentation and accompanying 
footnotes alone may be insufficient for an investor to assess the 
quality of the earnings and the likelihood that past performance is 
indicative of future performance.\241\
---------------------------------------------------------------------------

    \241\ See, e.g., 1989 MD&A Interpretive Release.
---------------------------------------------------------------------------

    Regulation S-X requires companies to provide annual and quarterly 
financial statements,\242\ while several items in Regulation S-K 
require additional disclosure about a registrant's financial condition 
and results of operations:
---------------------------------------------------------------------------

    \242\ Articles 3, 8 and 10 of Regulation S-X [17 CFR 210.3, 
210.8 and 210.10].
---------------------------------------------------------------------------

     Item 301 requires disclosure of selected financial data;

[[Page 23938]]

     Item 302(a) requires disclosure of selected quarterly 
financial data; \243\ and
---------------------------------------------------------------------------

    \243\ The staff is separately considering Item 302(b), which 
requires certain disclosures of oil and gas activities, as part of 
its work to develop recommendations for the Commission for potential 
changes to update or simplify certain disclosure requirements. For a 
description of this project, see Section I.
---------------------------------------------------------------------------

     Item 303 requires disclosure of management's discussion 
and analysis of financial condition and results of operations.
    We are reviewing these disclosure requirements to determine whether 
they continue to provide investors with information that is important 
to evaluating a registrant's performance, financial condition and 
prospects for the future and what, if any, aspects of the disclosure 
requirements are duplicative. We are seeking public input on whether we 
should consider any new disclosure requirements and whether we should 
eliminate or modify any existing disclosure requirement related to such 
matters.
1. Selected Financial Data (Item 301)
    Item 301 requires registrants to disclose selected financial data 
that highlight significant trends in the registrant's financial 
condition and results of operations.\244\ Disclosure must be provided 
in comparative columnar form for each of the registrant's last five 
fiscal years and any additional fiscal years necessary to keep the 
information from being misleading. Instruction 2 to Item 301 lists 
specific items that must be included, subject to appropriate variation 
to conform to the nature of the registrant's business, and provides 
that registrants may include additional items they believe would 
enhance an understanding of and would highlight other trends in their 
financial condition and results of operations.\245\ Registrants must 
include selected financial data in their annual reports but this is not 
a requirement for quarterly reports.
---------------------------------------------------------------------------

    \244\ Item 301 of Regulation S-K [17 CFR 229.301].
    \245\ Instruction 2 to Item 301 of Regulation S-K lists the 
following items that must be included in the table of financial 
data: net sales or operating revenues; income (loss) from continuing 
operations; income (loss) from continuing operations per common 
share; total assets; long-term obligations and redeemable preferred 
stock (including long-term debt, capital leases, and redeemable 
preferred stock); and cash dividends declared per common share.
---------------------------------------------------------------------------

a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. Two commenters suggested 
eliminating Item 301.\246\ One of these commenters noted that readers 
can discern trends from a registrant's financial statements and 
MD&A,\247\ while the other commenter stated the information required by 
this item can be readily obtained from sources other than Commission 
filings.\248\
---------------------------------------------------------------------------

    \246\ See Shearman; SCSGP.
    \247\ See Shearman.
    \248\ See SCSGP.
---------------------------------------------------------------------------

    Two commenters suggested revising Item 301 to allow registrants to 
omit the earliest two of the last five fiscal years where the 
information cannot be provided without unreasonable cost or 
expense.\249\ One of these commenters suggested limiting the required 
disclosure to the last three fiscal years, unless all five years are 
necessary to illustrate a material trend in the registrant's 
business.\250\ The other commenter also noted challenges to registrants 
in recasting annual periods prior to those presented in the financial 
statements to reflect a retrospective accounting change and suggested 
allowing registrants to present a retrospective accounting change only 
for the periods presented in the financial statements if the earlier 
periods cannot be recast without unreasonable effort and cost.\251\ To 
inform investors why this information is unavailable, this commenter 
suggested ``clear disclosure about the unreasonable effort'' that would 
be required to recast these earliest periods.\252\
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    \249\ See ABA 2 (stating this accommodation should be allowed 
where the information is unavailable or not obtainable without 
unreasonable cost or expense as long as information (qualitative 
and, if reasonably available without unreasonable cost or expense, 
quantitative) about a material trend is otherwise provided for such 
two fiscal years) and Ernst & Young 2 (noting Item 3.A of Form 20-F 
provides this accommodation for foreign private issuers and that 
EGCs are also allowed a similar accommodation).
    \250\ See ABA 2.
    \251\ See Ernst & Young 2.
    \252\ Id.
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b. Five-Year Trend Data (Instruction 1)
i. Discussion
    Item 301 is intended to provide selected financial data in a 
convenient and readable format that highlights significant trends in 
the registrant's financial condition and results of operations.\253\ In 
adopting this requirement, the Commission stated that Item 301 was 
relevant primarily where it related to trends in the registrant's 
continuing operations.\254\ When adopted, this item replaced a previous 
requirement that called for a summary of operations.\255\
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    \253\ Instruction 1 to Item 301 [17 CFR 229.301]. See also 1980 
Form 10-K Adopting Release.
    \254\ See 1980 Form 10-K Adopting Release. See also 1980 Form 
10-K Proposing Release.
    \255\ See 1980 Form 10-K Adopting Release. While the item in its 
current form was not adopted until 1980, the concept of providing a 
five-year presentation of certain significant line items was 
suggested as early as 1967. See Wheat Report at 338-39 (recommending 
that the Commission require registrants to provide a five-year 
earnings summary annually).
    In October 1970, the Commission expanded Form 10-K to include 
``Item 2--Summary of Operations,'' which required registrants to 
furnish in comparative columnar form a five-year summary of 
operations and any additional fiscal years necessary to keep the 
summary from being misleading. See Annual Reports by Certain 
Companies Having Registered Securities, Release No. 34-9000 (Oct. 
21, 1970) [35 FR 16919 (Nov. 3, 1970)] (``1970 Revised Form 10-K 
Adopting Release'').
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    Most of the items required by Item 301 are also required in the 
annual financial statements. Unlike the financial statements required 
in a Form 10-K, however, Item 301 information covers each of the 
registrant's last five fiscal years. Accordingly, Item 301 disclosure 
for items such as net sales and income or loss from continuing 
operations in the income statement \256\ and total assets and 
redeemable preferred stock in the balance sheets,\257\ overlaps with 
disclosure in the financial statements for the most recent three and 
two years, respectively.\258\
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    \256\ Rule 5-03 of Regulation S-X [17 CFR 210.5-03].
    \257\ Rule 5-02 of Regulation S-X [17 CFR 210.5-02].
    \258\ SRCs are not subject to the requirements of Item 301. Item 
301(c) of Regulation S-K [17 CFR 229.301(c)].
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    Earlier years required to be disclosed under Item 301 are typically 
available in prior annual reports. When the precursor to Item 301 was 
adopted in 1970, prior annual reports were not readily accessible.\259\ 
Today, these reports can be readily accessed through EDGAR and other 
public sources, including company Web sites.
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    \259\ Before adopting the precursor to Item 301, the Commission 
implemented a microfiche system in 1968 that supplemented its hard 
copy reproduction service and was intended to ``facilitate wider, 
more economical and more rapid distribution'' of Exchange Act 
reports. See Wheat Report at 313.
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    Despite some overlap with current and prior financial statements, 
Item 301 disclosure can provide information that might not be available 
to investors for all five years. Specifically, retrospective changes to 
the annual financial statements would typically be reflected in the 
selected financial data table across all five years instead of the 
three years covered in the financial statements.\260\ For example, a 
registrant that retrospectively revises its annual financial statements 
to reflect discontinued operations typically may need to consider 
whether it should adjust years four and five in its selected financial 
data table in addition to the three most recent years covered in the 
annual audited financial statements.

[[Page 23939]]

Item 301 disclosure reflecting the discontinued operations for these 
earlier two years would not be available in either the current or prior 
financial statements.
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    \260\ See Division of Corporation Finance Financial Reporting 
Manual, Section 1610.1.
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ii. Request for Comment
    67. Is the Item 301 disclosure that is not otherwise available or 
readily accessible important to investors? Are there benefits to having 
the five-year information in one table?
    68. Should we retain, modify or eliminate Item 301? Why? Does it 
achieve the goal of highlighting significant trends in a registrant's 
financial condition and results of operation? Does it also achieve the 
goal of providing selected financial data in a convenient and readable 
format? How would the elimination of Item 301 affect investors? Would 
elimination of this requirement increase costs to investors because 
they would then need to obtain this information from prior filings?
    69. If we retain Item 301, should we modify this requirement and, 
if so, how? Should we modify the item to require additional disclosure 
and, if so, what additional disclosure would be important to investors 
and why?
    70. Instruction 1 to Item 303(a) specifies that, where trend 
information is relevant, reference to the five-year selected financial 
data pursuant to Item 301 may be necessary.\261\ Despite this 
instruction, registrants generally do not discuss or analyze trends 
outside the three-year timeframe of Item 303. Does selected financial 
data effectively highlight significant trends that are not described 
elsewhere? If so, is five years an appropriate period or should we 
modify the number of fiscal years required to be included in the 
selected financial data? If selected financial data does not 
effectively highlight significant trends that are not described 
elsewhere, how could we modify our requirements to best achieve the 
objective of highlighting significant trends in registrants' financial 
condition and results of continuing operations?
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    \261\ Instruction 1 to Item 303(a) of Regulation S-K [17 CFR 
229.303(a)].
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    71. EGCs are not required to present selected financial data for 
any period prior to the earliest audited period presented in connection 
with its first effective registration statement.\262\ Should we revise 
Item 301 to provide a similar accommodation for all registrants? Why or 
why not?
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    \262\ Public Law 112-106, Sec. 102, 126 Stat. 306 (2012).
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    72. Should we require Item 301 disclosure for the full five years 
only in certain instances such as when a registrant revises its annual 
financial statements or if information on the earliest two of the last 
five years is available without unreasonable cost or expense?
    73. Currently, Item 301 disclosure is required in comparative 
columnar form. If we continued to require this disclosure, should we 
consider other presentation or format requirements?
    74. What types of investors or audiences are most likely to value 
the information required by Item 301?
    75. What is the cost of providing the disclosure required by Item 
301, including the administrative and compliance costs of preparing and 
disseminating this disclosure? How would these costs change if we made 
any of the changes contemplated here? Please provide quantified 
estimates where possible and include only those costs associated with 
providing disclosure under Item 301.
c. Items Included in Selected Financial Data (Instruction 2)
i. Discussion
    When proposing the requirement for selected financial data, the 
Commission sought to strike a reasonable balance between specified 
content and a flexible approach that permits registrants to select the 
data that best indicates performance.\263\ The Commission noted that 
commenters requested increased flexibility in the form and content of 
this disclosure in response to an advanced notice of proposed 
rulemaking.\264\ Accordingly, while Instruction 2 to Item 301, as 
adopted, contains prescriptive requirements, such as disclosure of 
total assets and income (loss) from continuing operations, it also 
permits registrants the flexibility to include additional items they 
believe would enhance an understanding of and would highlight other 
trends in their financial condition and results of operations.\265\
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    \263\ See 1980 Form 10-K Proposing Release.
    \264\ See 1980 Form 10-K Proposing Release; see also Annual 
Report Form, Release No. 34-15068 (Aug. 16, 1978) [43 FR 37460 (Aug. 
23, 1978)].
    \265\ Instruction 2 to Item 301 of Regulation S-K [17 CFR 
229.301].
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    For registrants that provide additional items in their selected 
financial data, disclosure varies. Financial institutions commonly 
provide additional metrics that may include return on average assets 
and capital ratios. Registrants in the telecommunications industry may 
include the number of subscribers while retailers may include the 
number of stores or average store size. While such information is not 
required under U.S. GAAP, it is not considered a ``non-GAAP financial 
measure'' such that reconciliation under Item 10(e) of Regulation S-K 
would be required.\266\ Additionally, some registrants include non-GAAP 
financial measures in their Item 301 disclosures.
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    \266\ Item 10(e)(4) states that, for purposes of paragraph (e), 
non-GAAP financial measures exclude operating and other statistical 
measures; and ratios or statistical measures calculated using 
exclusively one or both of (i) financial measures calculated in 
accordance with GAAP, and (ii) operating measures or other measures 
that are not non-GAAP financial measures. [17 CFR 229.10(e)(4)]. See 
also Conditions for Use of Non-GAAP Financial Measures, Release No. 
33-8176 (Jan. 22, 2003) [68 FR 4819 (Jan. 30, 2003)] (``Non-GAAP 
Measures Release'') (stating that operating and other statistical 
measures such as unit sales, numbers of employees, numbers of 
subscribers, or numbers of advertisers are not non-GAAP financial 
measures).
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ii. Request for Comment
    76. Does Instruction 2 provide a reasonable balance between 
specified content and a flexible approach that permits registrants to 
select the data that best indicates performance? Why or why not? If 
not, how should we modify Instruction 2? For example, should we modify 
Instruction 2 to be more prescriptive or provide for a more flexible 
approach? If a flexible approach should be used, should we require 
registrants to disclose their reasons for the items it included?
    77. Should we require auditor involvement (e.g., audit, review or 
specified procedures) for this disclosure, and if so, what should the 
nature of the involvement be? What would be the benefits and costs to 
registrants and to investors?
    78. What is the impact of listing specific items of disclosure in 
Instruction 2? Do registrants view the items listed in Instruction 2 as 
a checklist? Should additional items be considered?
2. Supplementary Financial Information (Item 302)
    Item 302(a)(1) requires certain registrants to disclose quarterly 
financial data of selected operating results \267\ and Item 302(a)(2) 
requires

[[Page 23940]]

disclosure of variances in these results from amounts previously 
reported.\268\ Registrants must provide quarterly information for each 
full quarter within the two most recent fiscal years and any subsequent 
period for which financial statements are included or required by 
Article 3 of Regulation S-X. Under Item 302(a)(3), registrants must 
describe the effect of any disposals of segments of a business and 
extraordinary, unusual or infrequently occurring items recognized in 
each quarter, as well as the aggregate effect and the nature of year-
end or other adjustments that are material to the results of that 
quarter.\269\ If a registrant's financial statements have been reported 
on by an accountant, Item 302(a)(4) requires that accountant to follow 
appropriate professional standards and procedures regarding the data 
required by Item 302(a).\270\
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    \267\ Item 302(a)(1) of Regulation S-K [17 CFR 229.302(a)(1)]. 
Item 302(a)(1) specifies disclosure of net sales, gross profit (net 
sales less costs and expenses associated directly with or allocated 
to products sold or services rendered), income (loss) before 
extraordinary items and cumulative effect of a change in accounting, 
per share data based upon such income (loss), net income (loss) and 
net income (loss) attributable to the registrant, for each full 
quarter within the two most recent fiscal years and any subsequent 
interim period for which financial statements are included or are 
required to be included by Article 3 of Regulation S-X.
    The staff is separately considering Item 302(b), which requires 
certain disclosures of oil and gas activities, as part of its work 
to develop recommendations for the Commission for potential changes 
to update or simplify certain disclosure requirements. For a 
description of this project, see Section 0.
    \268\ Item 302(a)(2) of Regulation S-K [17 CFR 229.302(a)(2)]. 
When disclosure in Item 302(a) varies from amounts previously 
reported on the Form 10-Q filed for any quarter, such as if a 
combination between entities under common control occurs or where an 
error is corrected, the registrant must disclose a reconciliation of 
the amounts given with those previously reported and describe the 
reason for the difference.
    \269\ Item 302(a)(3) of Regulation S-K [17 CFR 229.302(a)(3)]. 
The requirement applies to items recognized in each full quarter 
within the two most recent fiscal years and any subsequent interim 
period for which financial statements are included or are required 
to be included.
    \270\ Item 302(a)(4) of Regulation S-K [17 CFR 229.302(a)(4)].
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a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. One commenter recommended 
eliminating Item 302(a)(1), stating that this disclosure has been 
previously reported.\271\
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    \271\ See letter from Gregg L. Nelson, VP Accounting Policy & 
Financial Reporting, IBM Corporation (Aug. 7, 2014) (``IBM'').
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b. Discussion
    A few years after adopting Form 10-Q, in 1974, the Commission noted 
that quarterly data was still being ``reported on an extremely 
abbreviated basis and annual financial statements [had] generally been 
presented without regard for or disclosure of trends occurring within a 
year.'' \272\ To help remedy this information deficiency, the 
Commission adopted the precursor to Item 302(a), Rule 3-16(t) of 
Regulation S-X. This rule required, for certain registrants, disclosure 
of selected quarterly financial data in the notes to the annual 
financial statements.\273\
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    \272\ See Interim Financial Data; Proposals to Increase 
Disclosure, Release No. 34-11142 (Dec. 19, 1974) [40 FR 1079 (Jan. 
6, 1975)] (``Proposals to Increase Disclosure of Interim Results by 
Registrants'') at 1080.
    \273\ See Interim Financial Reporting: Increased Disclosures, 
Release No. 33-5611 (Sept. 10, 1975) [40 FR 46107 (Oct. 6, 1975)] 
(``1975 Interim Financial Reporting Release''). Rule 3-16(t) of 
Regulation S-X required disclosure in a note to the financial 
statements of net sales, gross profit, income before extraordinary 
items and cumulative effect of a change in accounting, per share 
data based upon such income, net income for each full quarter within 
the two most recent fiscal years and any subsequent interim period 
for which income statements are presented. It also required 
registrants to describe the effect of any disposals of segments of a 
business and extraordinary, unusual or infrequently occurring items 
recognized in each quarter, as well as the aggregate effect and the 
nature of year-end or other adjustments which are material to the 
results of that quarter. Furthermore, it required a reconciliation 
of amounts previously reported on Form 10-Q to the quarterly data 
included in the note to financial statements if the amounts differ. 
See id.
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    The Commission recognized that numerous commenters opposed the 
requirements, suggesting that interim results are materially affected 
by random events and that including such data in annual financial 
statements would lend them an appearance of reliability that could be 
misleading.\274\ The Commission nevertheless adopted the disclosure 
requirement, stating its belief that this disclosure would ``materially 
assist investors in understanding the pattern of corporate activities 
throughout a fiscal period'' by disclosing trends over segments of time 
that are sufficiently short to reflect business turning points.\275\ By 
contrast, the Commission stated that annual periods ``may obscure such 
turning points and may reflect a pattern of stability and growth which 
is not consistent with business reality.'' \276\ The Commission also 
noted that quarterly data would reflect seasonal patterns. Recognizing 
the costs of providing quarterly data, the Commission provided an 
exemption for smaller registrants and registrants whose shares were not 
actively traded.\277\ Because the selected quarterly financial data was 
unaudited, and recognizing that information contained within the 
financial statements should be audited, the Commission moved the 
requirement to Regulation S-K in 1980.\278\
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    \274\ Id.
    \275\ Id. at 46107.
    \276\ Id. at 46108.
    \277\ See id. at 46107 (``The Commission believes that the 
greatest investor need for these data exists in the case of such 
companies whose activities are most closely followed by analysts and 
investors. Accordingly, registrants whose shares are not actively 
traded or whose size is below certain limits have been exempted from 
this rule at the present time.'').
    See also Audit Committee Disclosure, Release No. 34-42266 (Dec. 
22, 1999) [64 FR 73389 (Dec. 30, 1999)] (summarizing the 
requirements for application of Item 302(a) that had been in effect 
since 1980). The requirements only applied to registrants who met 
certain tests, including but not limited to: (1) Two of the three 
following requirements: (a) Shares outstanding have a market value 
of at least $2.5 million; (b) the minimum bid price is at least $5 
per share; or (c) the registrant has at least $2.5 million of 
capital, surplus, and undivided profits; and (2) the registrant and 
its subsidiaries: (a) Have had net income after taxes but before 
extraordinary items and the cumulative effect of a change in 
accounting of at least $250,000 for each of the last three fiscal 
years; or (b) had total assets of at least $200 million for the last 
fiscal year end. See id.
    \278\ See General Revision of Regulation S-X, Release No. 33-
6233 (Sept. 2, 1980) [45 FR 63660 (Sept. 25, 1980)]. See also 
General Revision of Regulation S-X, Release No. 33-6178 (Jan. 15, 
1980) [45 FR 5943 (Jan. 24, 1980)] at 5945 (``Based upon the premise 
that information contained within the financial statements should be 
audited, the proposed rules would remove from [Regulation] S-X the 
requirement relating to unaudited information concerning selected 
quarterly financial data and place this requirement under Regulation 
S-K.'').
---------------------------------------------------------------------------

    While most of the disclosure required by Item 302(a) is required in 
prior quarterly reports, Item 302(a)(1) also requires a separate 
presentation of certain items for a registrant's fourth quarter, which 
is not otherwise required. Although there is no similar requirement for 
disclosing the fourth fiscal quarter, U.S. GAAP typically allows 
investors to infer fourth quarter data by requiring disclosure of 
disposals of components of an entity and unusual or infrequently 
occurring items recognized in the fourth quarter.\279\
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    \279\ ASC 270-10-50-2 requires the disclosure of certain 
information if interim data and disclosures are not separately 
reported for the fourth quarter. This information includes 
``disposals of components of an entity and unusual, or infrequently 
occurring items recognized in the fourth quarter, as well as the 
aggregate effect of year-end adjustments that are material to the 
results of that quarter.''
---------------------------------------------------------------------------

    Additionally, as Item 302(a)(2) requires disclosure of variances in 
results from amounts previously reported for the two most recent fiscal 
years, the effect of a retrospective change in any quarter for which a 
Form 10-Q was filed in the more recent of the two fiscal years will be 
disclosed in the selected quarterly data. Absent Item 302(a)(2), this 
variance would not be disclosed until the following year in the 
corresponding fiscal quarter in which the retrospective change 
occurred. Disclosure in the Form 10-Q for this corresponding fiscal 
quarter would not include the effects of this change in the earliest of 
the two years presented in the Form 10-K, as this Form 10-Q would be 
limited to the current and prior-year interim periods.
c. Request for Comment
    79. Should we retain or eliminate Item 302(a)? Why? If we retain 
Item

[[Page 23941]]

302(a), should we modify the item and, if so, how? For example, should 
we modify the item to require additional disclosure and, if so, what 
additional disclosure would be important to investors and why?
    80. Is fourth quarter information, which is required under Item 
302(a) but not in the annual financial statements, important to 
investors? Do the other instances where disclosure required by Item 
302(a) is not duplicative of previously provided disclosure merit 
retaining the item? Why or why not?
    81. The disclosure required by Item 302(a) was originally intended 
to help investors understand the pattern of corporate activities 
throughout a fiscal period by disclosing trends over segments of time 
that are sufficiently short to reflect business turning points.\280\ 
Does this objective remain important today? If so, does the item 
achieve this objective? If the item does not achieve this objective, 
how could we modify it to do so?
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    \280\ See Interim Reporting Amendments Release.
---------------------------------------------------------------------------

    82. Should we require auditor involvement (e.g., audit, review or 
specified procedures) on the reliability of the disclosure, and if so, 
what should the nature of the involvement be? What would be the 
benefits and costs to registrants and to investors?
    83. Item 302(a) disclosure is commonly provided either as an 
unaudited note to the financial statements in Form 10-K \281\ or 
separately outside of the financial statements. To the extent a 
registrant's Item 302(a) disclosure is provided in the notes to the 
financial statements, it must be tagged as XBRL data. Registrants' 
financial statements and footnotes presented in quarterly reports must 
also be tagged in XBRL.\282\ Given some of Item 302(a) disclosure is 
available in prior quarterly reports and also tagged in XBRL, do 
investors use the disclosure required by Item 302(a)?
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    \281\ This may be due to the fact that the requirements to 
provide annual financial statements and Item 302 disclosure are both 
in Item 8(a) of Form 10-K [17 CFR 249.310].
    \282\ Rule 405 of Regulation S-T [17 CFR 232.405]. See also 
Interactive Data Release.
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    84. What types of investors or audiences are most likely to value 
the information required by Item 302?
    85. What is the cost of providing the disclosure required by Item 
302, including the administrative and compliance costs of preparing and 
disseminating this disclosure? How would these costs change if we made 
any of the changes contemplated here? Please provide quantified 
estimates where possible and include only those costs associated with 
providing disclosure under Item 302.
    86. Would costs to investors increase if Item 302 was eliminated 
and if so, how?
    87. What are the benefits of providing the disclosure required by 
Item 302? How could the benefits change if we made any of the changes 
contemplated here? Please provide quantified or qualitative estimates 
where possible relating to disclosure under Item 302.
3. Content and Focus of MD&A (Item 303--Generally)
    Item 303 of Regulation S-K requires disclosure of information 
relevant to assessing a registrant's financial condition, changes in 
financial condition and results of operations.\283\ Item 303(a) 
contains three core components that registrants must analyze in their 
MD&A disclosures: Liquidity, capital resources, and results of 
operations.\284\ Item 303(a) also requires disclosure of off-balance 
sheet arrangements and contractual obligations.\285\
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    \283\ Instruction 2 to Item 303(a) of Regulation S-K [17 CFR 
229.303(a)].
    \284\ Item 303(a)(1), (a)(2) and (a)(3) of Regulation S-K [17 
CFR 229.303(a)(1), (a)(2) and (a)(3)].
    \285\ Item 303(a)(4) and (a)(5) of Regulation S-K [17 CFR 
229.303(a)(4) and (a)(5)].
    See also Disclosure in Management's Discussion and Analysis 
About Off-Balance Sheet Arrangements and Aggregate Contractual 
Obligations, Release No. 33-8182 (Jan. 28, 2003) [68 FR 5982 (Feb. 
5, 2003)] (``Off-Balance Sheet and Contractual Obligations Adopting 
Release'').
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    Overall, these MD&A requirements are intended to satisfy three 
principal objectives:
     Provide a narrative explanation of a registrant's 
financial statements that enables investors to see the registrant 
through the eyes of management;
     enhance the overall financial disclosure and provide the 
context within which financial information should be analyzed; and
     provide information about the quality of, and potential 
variability of, a registrant's earnings and cash flow, so investors can 
ascertain the likelihood that past performance is indicative of future 
performance.\286\
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    \286\ See 2003 MD&A Interpretive Release.
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    The Commission has provided substantial guidance in the past 
intended to improve the quality of MD&A disclosures.\287\ Much of this 
guidance has focused on the following topics:
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    \287\ See, e.g., Commission Guidance on Presentation of 
Liquidity and Capital Resources Disclosures in Management's 
Discussion and Analysis, Release No. 33-9144 (Sept. 17, 2010) [75 FR 
59894 (Sept. 28, 2010)] (``2010 Liquidity and Capital Resources 
Interpretive Release''); 2003 MD&A Interpretive Release; Commission 
Statement About Management's Discussion and Analysis of Financial 
Condition and Results of Operations, Release No. 33-8056 (Jan. 22, 
2002) [67 FR 3746 (Jan. 25, 2002)] (``2002 Commission Statement 
about MD&A''); 1989 MD&A Interpretive Release.
---------------------------------------------------------------------------

     Quality and focus of analysis;
     forward-looking information; and
     use of key performance indicators.\288\

    \288\ See generally 2003 MD&A Interpretive Release (addressing 
each of these topics throughout).

To help achieve the principal objectives of MD&A, and before evaluating 
specific subsections of Item 303(a), we seek public input on these 
topics and how we could improve the overall quality of MD&A disclosure.
a. Comments Received
    S-K Study. None.
    Disclosure Effectiveness Initiative. One commenter stated that MD&A 
requirements are too principles-based.\289\ Another commenter stated 
that MD&A's principles-based approach results in disclosure that is 
``among the most meaningful disclosure contained in periodic reports.'' 
\290\ Another commenter recommended reexamining MD&A to, among other 
things, reinforce the guiding principle of materiality so that MD&A is 
more useful for investors.\291\ One commenter recommended, in addition 
to MD&A, adopting a rule requiring registrants to provide an overview 
of their performance in the most recent year as well as expectations 
and con