What You Need to Know Now About Regulation S-K Modernization

EPISODE 47: DHG's Greg Faucette and Jennifer George discuss how the SEC seeks to modernize disclosures by taking a look at new regulations for S-K.



[00:00:09] JL: Welcome to today’s edition of DHG’s GrowthCast. I’m your host, John Locke. At DHG, our strength relies on our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser-focused on company goals. In this ever-changing world, DHG’s GrowthCast provides insights and thought-provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace.

Thanks for joining us as we discuss tomorrow's needs today.

[00:00:42] ANNOUNCER: The views and concepts expressed by today's panelists are their own and not those of Dixon Hughes Goodman LLP. Always consult the advice of your legal and financial professional before taking any action.


[00:00:58] JL: Welcome to today’s GrowthCast, focusing on what you need to know for this year’s 10-K reporting season. I am joined today by Jennifer George, a partner in DHG’s Professional Standards Group and Greg Faucette, a relatively new partner in the Professional Practice Group, both focusing their work on SEC related issues. Welcome, Jennifer and Greg. Thanks for being here today.

[00:01:22] JG: Thank you, John. It’s great to be back here with you.

[00:01:26] GF: John, thank you. IT’s great to be joining this podcast series for the first time.

[00:01:31] JL: Yeah. Greg, I know you’re new to the firm, so we are excited to have you with DHG and excited to learn from you today. But we’ve got a lot to talk about, so let’s just get on to today’s business. The Securities and Exchange Commission has been pretty active in rulemaking this year, at least the rumor has it. Jennifer what has been the reason behind this?

[00:01:51] JG: Well, there’s a couple things. Under Chairman Jay Clayton, who we know will be leaving the commission shortly and some of his recent predecessors, the SEC’s been working to improve information and disclosures available to investors outside the financial statements, right? So a good bit of that has really resulted from studies or rulemaking mandated by the Dodd-Frank Act, as well as the FAST Act of 2015. Each of those legislative acts had required to certain actions on the part of the SEC, with some of those focused on improving information that’s available to investors.

[00:02:27] GF: That’s right, Jennifer. Legislative acts have for a very long time forced the SEC to embark on rulemaking. Just think back those who’ve been around for a while of what came out of the Sarbanes-Oxley Act back in the early 2000. A lot of action prodded by legislation, but the staff has long focused on improving the information available just as part of its mission.

[00:02:52] JL: Well today, we are really here to talk specifically about recent rule changes affecting all public companies that will begin and ready to prepare and file their 10-Ks for 2020.

[00:03:03] JG: Yeah, John. There are really two rules we want to talk about today. One of those rules was effective this past November 9th. So company’s filings with due dates after that date, such as companies with a September 30th year end may have already started to implement this. But then there’s a second one that we don’t have an effective date for because it’s really based on the publication in the Federal Register, which has not happened yet. The final rule was released by the SEC on November 19, but since it hasn’t been published in the Federal Register yet, we don’t have an effective date on it.

[00:03:39] JL: Greg, what rules are we talking about here?

[00:03:43] GF: Well John, the SEC has creatively titled these rules Modernization of Regulation S-K Items 101, 103 And 105. That’s the first one Jennifer referenced. The second one was Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information. They didn’t give us the numbers for those but those are 301, 302, 303. Two rules focused on the same sections of the 10-K if you will, the stuff outside of the financial statements and footnotes.

[00:04:17] JL: Okay. Well, lots of numbers there, so can you translate that for us?

[00:04:21] GF: Sure. Items 101, 103, 105 kind of what’s called the business section. 101 is the description of the business, 103 are the legal proceedings they may be facing and 105 are  the risk factors they want to highlight to investors. We get into the MDA in the others, Section 301 is selected financial data. People may think of it as the five-year table. 302 is the supplementary financial information, often around quarterly disclosures and item 303 is itself, management’s discussion and analysis or as here us refer to it as MD&A.

[00:04:57] JL: Okay. Well, all right, Jennifer. Now, Greg explained those very well, but there seems like a lot of rule sections that changed. Are there any general themes with the changes that you can share?

[00:05:10] JG: Yes, absolutely. One of the broad themes were seen is the introduction of a more principles-based focus for these disclosures. Now, the staff is very interested in companies being thoughtful around their disclosures and making them meaningful and company-specific rather than kind of the broad or boilerplate disclosures we’ve seen. This is management’s chance to tell their story about their company. In the amended rules for the MD&A, the guidance now states that “A discussion and analysis that meets these requirements is expected to better allow investors to view the registrant from management’s perspective.”

Really, the MD&A is allowing an investor to see a company through management’s eyes and really is perhaps one of the ultimate expressions of the principles-based approach in these disclosures.

[00:06:02] JL: So now, Greg, this idea of improving disclosures is frequently associated with a reduction of disclosure. And SEC did note the rules were intended to simplify compliance for registrants. Now, did they achieve this?

[00:06:18] GF: John, I think they did in large part they removed some things and we’ll talk a little bit more about it. But the fiver-year table, the off-balance sheet arrangements, disclosures, the tabular presentation of contractual obligations, those have been removed but replaced with words that require the registrant to talk about those things in a more narrative fashion. The helped a little bit. but they gave us some more things to think about in terms of how we’re communicating and what we can communicate to fit kind of the facts and circumstances for each individual registrant.

[00:06:50] JL: Jennifer, let’s start getting to some of these details. Perhaps we just walk through the sections in their order.

[00:06:58] JG: Sure. In fact, the first rule addresses the first three items and the second rule addresses the second three items. If we start with Item 101, as Greg mentioned, that’s a discussion of the registrant’s business and it’s really a very factual section of the filing and it required a discussion of events and strategies over the last five years for most registrants. Three if you’re a smaller reporting company. But the staff removed that prescribed period and replaced it with a principles-based requirement to cover only the information material to an understanding of the general developments of the company.

What this rule allows a registrant to really only focus on changes in its business since the last complete update as long as they put a blink in there that’s provided to that most recent filing with the complete update. It really allows that kind of just repeat and carrying forward. Now, the old rules had 12 items that were previously prescribed by Item 101, which still included in rules. They were just much more detailed before, like naming a greater than 10% customer or disclosing the dollar amount of backlog.

Now, they’ve kind of have those items, but they’re a little bit broader terms and they’re described in the disclosure that this should be included as they are material, but not really limited to just this. Really, registrants have a chance to really think about each one of those and go through those and figure out what they want to include.

[00:08:31] JL: Great. Greg, anything in this Item 101 description of the business you want to highlight?

[00:08:36] GF: Yeah, let me touch on an easy one and a tougher one. The easy one, as companies have always had to disclose their relevant environmental regulations, how they interact with environmental regulations, and that’s been expanded to governmental regulations, including environmental regulation. That’s a little easier to get your arms around some more things there. But here’s where the staff puts kind of a more perplexing new disclosure around human capital resources. Now, they’ve always had to disclose the number of people employed, but this goes well beyond that. They’re asking management the kind of share the measures or the objectives that the registrant focuses on as it manages its business. Think about things that are quantitative or qualitative as to how they manage the business using human capital resources.

Things like recruiting, retention, inclusiveness and diversity could factor into that. It’s causing lots of folks to the think a little bit. Jennifer, you and I both attended virtually at least the AICPA’s SEC conference this year and I expected to hear a good bit about that, but really didn’t hear too much.

[00:09:46] JG: Yeah. I really thought that was surprising. I mean, it really just emphasized the fact that a company only needs to disclose the HR related issues that are material to the company and that they should be specific to the company. But it was interesting, one of the panels, the corporate financial reporting folks. One of them noted that they provide already a lot of discussion around diversity and inclusion in their reporting outside of their SEC filings. But there were really going to be a little more challenge as to what the brand is “material” by including it in the S-K disclosures.

[00:10:21] GF: Yeah. If you look at some of the 10-Ks that have already been filed because this rule is effective, those with 9/30-year ends. Some had two sentences before, now they have three sentences. Some had a paragraph but have added a second. Disney has about three-fourths a page and Starbucks, who we all kind of think of in terms of societal focus and whatnot, they have a page and a half. There’s a diversity out there in terms of how companies are complying. I know companies are really going to need to think about that this year.

[00:10:50] JL: Well, Greg, wrap us up on this business section. There were two last items you mentioned. Legal proceedings and risk factors. The legal proceedings, there’s a lot of discussion and 10-K is about litigation that may be out there against the company. Oftentimes has been disclosed in different places and oftentimes repetitive. So what the SEC said is now, “Hey, let’s do some cross-referencing. Let’s not give them the same words in different places several times. Let’s just say it once and then cross-reference.”

[00:11:21] JG: Yeah. I think, Greg, this is really consistent with the SEC allowing more cross-referencing within and between documents given what technology can do today. I mean, in this case, they explicitly acknowledge that you can cross reference from the financial statement footnotes but you can never cross-reference into the financial statement footnotes, only from. I think this really has to do with the level of work performed by the auditors, meaning the financial statements are covered by the auditor’s opinion and the MDA is not.

[00:11:56] GF: John, back to your point. The last two items. The last item is around risk factors. It’s a section that companies are very familiar with. An investor sees a lot of pages about things that could be a challenge to the company. It’s been there for a while. The SEC’s kind of made some changes there to once again focus everybody on the items that are most relevant and very company-specific. They asked that companies, if you talk about something that’s kind of a generic thing, it gets moved to the back of that presentation. As you focus on those risk factors that are most important to investors, prioritize them, use subheadings to help organize them. And importantly, if it’s too long and they gave us some measure of too long. If your pages run more than 15 pages of risk factors, then you need to give a summary that’s no longer than two pages at the beginning. focusing on those real key factors, risk factors that make the registrant investments speculative or risky.

I’ve heard people asked the staff, “Hey, wait a minute. How about that old college trick? We used to change the font and change the margin often to make our papers longer. But if we want to make it shorter, can we widen the margins? Can we reduce the font?” And the staff would say, “Well, if you want to. but there are actually rules for EDGARizing documents that will dictate margins and font size.” That tool may only help you or that trick may only help you so much,

[00:13:25] JL: Not surprising that they would clamp down on that as well. Thanks for that., Greg. Now, moving into the items from the most recent rule, Jennifer. What’s changed there?

[00:13:34] JG: Well, this section has several examples of the trade-offs between the old rules-based items and any new principles-based disclosures. We see that very quickly in two of the sections. The updates to Item 301 on the selected financial data and 302 on the supplementary information. The update to the selected financial information is easy described. It’s been eliminated. That item had been around since the time that one needed to keep all their old paper copies of 10-Ks to look back at, and the SEC registrants start putting a table.

Now, with the Internet, that information is available at the touch of a button or at the very least, a few keystrokes. So, recall every time a new major standard came out with transition provisions to be reflected somehow in the three years of financial statements in the filing, somebody always ask the SEC staff the question, “What about the other years in the five-year table?” The staff always had to deal with those questions, so maybe this one is a little bit of a benefit to the SEC staff as well.

[00:14:40] JL: Yeah. Jennifer, the concept of your second item, Item 302, supplementary information may not immediately come to mind to the audience as they may not have that topic listed in their 10-Ks. But the information is there, correct?

[00:14:57] JG: Yeah, that’s right. This item is why companies usually have an unaudited footnote, showing tiers of data from their quarters in the footnote. That specific requirement for eight quarters has now been eliminated, but it was replaced with a principle-based requirement that recognizes that information on material retrospective changes to quarters can be improved, but should still remain timelier than it would be if the case that the rule was eliminated. For example, having to wait until a subsequent forum 10-Q next year.

As a result of one or more retrospective changes to the statements of comprehensive income, which importantly starts with net income within the two most recent years are deemed material individually or in the aggregate. And the registrant discloses the reasons for the material change and for each affected quarterly period and the fourth quarter in the affected period, summarized information related to the statements of comprehensive income and EPS must be reflected in those changes. Keep in mind that effective quarter can be either a single quarter or more if those effects of the retrospective change continue to effect subsequent quarters through the year after the change.

[00:16:14] JL: Okay. Jump ball here. We are about to move in the MD&A and Item 303 or Reg S-K. What are the broader conceptual items with these amendments?

[00:16:28] JG: The amendment completely superseded the existing requirements and instructions for MD&A and Item 303. So instead of doing the usual insert text and showing deletions, it was just so pervasive with the changes and reorganizing that area that they really just re-did the area. Now, the overall intention is to emphasize the discussion on material matters and not just reciting of dollar percentage changes. It really also embraces the significant concepts from the SEC’s interpretive release from back in 2003, which was the commission’s guidance regarding management’s discussion and analysis of financial condition and results of operations. Or you may have heard referred to as the financial reporting release FR-72.

Now, this whole section starts off with a 303(a) that states the overall objective is really to incorporate much of the guidance and perspective previously provided in the instructions to 303 and FR-72. Instead of the original FR-72 that was issued by the commission have, it has that same feel but now it’s got the effect of a real rule. Also, the disclosures into Item 303(b), now they emphasize the need to provide MD&A, the underlying reasons in qualitative and quantitative terms for again material changes within the financial statements. This is really consistent with the staff’s long-standing efforts in SEC comment letters.

[00:18:02] GF: Jennifer, I would just add that we see words in the new MD&A rules that says it’s there to better allow investors to view the registrant for management’s perspective. That’s as close as you’re going to get to a regulator using those words we typically hear, allowing somebody to see the company through management’s eyes. Again, just baking more of that principle-based thought into the new rules.

[00:18:24] JL: Greg, give us some of the SEC’s particular focus points. What makes this more principles-based?

[00:18:32] GF: Yeah, John. We’re still going to look at period-on-period, changes in terms of operations, liquidity, balance sheet items. We’re likely still to talk about it from the perspective of a business segment. Although the staff has added product lines as a cut one may think about talking about an MD&A. We’re going to look at material cash requirements, but they used to focus on those for capital investments. Now it’s just material cash commitments, so it’s a little broader. The results of operations, they’ve actually fixed a little flaw in the rule that required you to only disclose increases. Everybody’s been doing increases and decreases, that’s now formalized.

The discussion requirement to talk about the effects of inflation and price changes the last three years, that’s kind of been eliminated because it’s considered something you would need to disclose any way under the more principle-based focus.

[00:19:23] JG: Yeah. Another example of something both eliminated and replaced, the explicit requirement around off-balance sheet arrangements which required a separate caption and was a product of the rulemaking under Sarbanes-Oxley. It’s been eliminated as changes in gap disclosures over time kind of created an overlap there. Similarly, the contractual obligations table as part of the rulemaking in 202, well, it’s been eliminated and is not considered to provide any meaningful incremental information in light of some of the other changes that they’re now making to the MD&A rule.

[00:19:57] JL: Greg, anything else that you would add in the MD&A?

[00:20:01] GF: Yeah, this isn’t new but we now formally have the critical accounting estimates, which were kind of part of the commission’s interpretation back in the FR-72. They are now a formal part of the rule. You can see the real focus on them wanting companies to disclose what talks about the uncertainty of an estimate. Not necessarily the accounting policy, why is it uncertain, what are the impact of assumptions, what relevant periods do we have to think about in terms of sensitivity of these amounts to assumptions?

And the [Inaudible 00:20:35] has been intentional about some of their words. They want you to talk about information that’s reasonably available so you don’t need to generate endless possibilities. You likely have what you need based on the math that you did for the 10-K and focus on relevant periods. Meaning they didn’t dictate it over a year, or a quarter or whatnot. It’s a relevant period that makes sense in the companies’ particular facts and circumstances.

[00:20:57] JG: Yeah. I feel like some of these disclosures are going to draw some additional scrutiny from the SEC court reviewers, just given the nature of the commentary in the SEC adopting release. The release really emphasizes several points, including that these disclosures should not mere the registrant significant accounting policies, it rather focuses on enhancing the discussion and analysis of measurement uncertainty. Companies should make sure that they’re really calling out some of those significant accounting policies that have these material estimates that have a significant level of estimation uncertainty and think about organizing them in some logical order of magnitude or risk, and then ensuring that they’re discussing the nature of the uncertainty and likely sensitivity to these key assumptions, rather than just regurgitating their policy.

[00:21:44] JL: All right. Well, Greg, share with us the final little gift from the SEC in these rules. There may be something a company finds as a more meaningful option in preparing this quarterly MD&A.

[00:21:57] GF: Sure, John. Companies have always disclosed quarter-to-date comparison to a previous quarter-to-date, and then the year-to-date to the previous year-to-date period. The year-to-date thing is still the same, but the quarter has some flexibility. A company can choose to compare this current quarter to the same quarter in the last year or they can now compare this current quarter to the previous immediately preceding quarter if that makes more sense for them. If you do that, you either got to drop in some data that you’re going to be comparing it to or giving them a link likely to your previous 10-Q. And you can kind of change your perspective from period to period if you want to. But in a period you change from the immediate previous quarter to the prior year quarter or vice versa, you got to run both discussions and that MD&A as you’re changing your approach. A gift allows companies maybe to think of what’s the more meaningful discussion of their business for investors.

[00:22:53] JL: This has been great information. So any thoughts as we wrap up today, Jennifer?

[00:22:59] JG: Yeah. I just want to make one more comment about the effective dates. So we’ve got the first rule that around the business section items that are already effective now, but we’ve got the second rules released in November and they are not effective yet. Those are rules around the selected financial data, the supplemental financial data and the MD&A. As of this conversation, we’re still waiting for them to be published in the Federal Register. Once they are effective, people can early adopt, but they just have to remember, you have to adopt an entire section so you can adopt Item 303 on MD&A, but you can’t pick and choose within 303. Such as eliminating the things that they’re allowing to be eliminated, but having to add the new things that they’re saying required. Just be aware of that.

[00:23:47] GF: Jennifer, I think that’s a great advice. I will just kind of add on. The staff is saying these are principles-based, this is a real kind of clean sheet piece of paper moment for registrant, so they’re encouraged to think about what’s the best thing to communicate about your specific company to the investors that they need to know. So kind of keep that in mind as you’re doing a little bit of rewrites of these sections of MD&A and the other areas of the 10-K.

[00:24:13] JG: I think that’s a great conclusion, Greg.

[00:24:17] JL: Well, Jennifer, Greg, my thanks to you both for your insights today. I’d tell you, there is just wonderful information here for companies as they head into reporting season. So thank you for sharing this great information today with us.

End of Episode

[00:24:33] JL: Thank you for joining us today on DHG’s GrowthCast episode with Jennifer George and Greg Faucette, and our discussion 10-K reporting issues. I’m your host, John Locke, and I look forward to reconnecting with you soon on another edition of DHG GrowthCast.

About DHG's GrowthCast

At DHG, our strength lies in our technical knowledge, our industry intelligence and our future focus. We understand business needs and are laser focused on company goals. In this ever-changing world, DHG’s Growthcast, provides insights and thought -provoking conversations on topics and trends that address growth opportunities and challenges in the current and future marketplace. Join us in discussing tomorrow’s needs today.

Disclaimer: The views and concepts expressed by today’s guests are their own and not those of Dixon Hughes Goodman LLP. Always consult with your legal and financial professional before taking any action.


Gary Greer
Co-Managing Partner, DHG Assurance
Scott Berte
Co-Managing Partner, DHG Assurance
Greg Faucette
Professional Practice Partner


© Dixon Hughes Goodman LLP. All rights reserved.
DHG is registered in the U.S. Patent and Trademark Office to Dixon Hughes Goodman LLP.