Securities and Exchange Commission (SEC) Regulation S-K changes will require CFOs to rethink their risk disclosure, regulatory specialists say.

The changes, approved August 26, are the first in over 30 years to S-K. They include amendments to Item 101 ("Description of Business"), Item 103 ("Legal Proceedings") and Item 105 ("Risk Factors").

Moving the emphasis of disclosures from prescriptive to principles-based, the revisions can reduce compliance costs by eliminating the need to report non-material information.

Howard Scheck, once chief accountant for the SEC's enforcement division, said the changes will require issuers to engage in "fresh thinking" about how they craft their disclosures to best describe their business, legal and risk factors.

"Previously, these areas may have been considered largely boilerplate, and the drafting each year rote," he said. "Now, in light of the new principles-based rules, CFOs will need to get comfortable with the flexibility they will have, while still providing investors with material information." 

Broader thinking

Scheck, now a forensic accountant at StoneTurn, a management consulting firm, is advising public company CFOs to lead their company's efforts to update their risk assessments, and coordinate with the general counsel and COO to address all regulatory areas.

CFOs and CEOs will also need to evaluate disclosure controls and procedures to ensure material information is disclosed and 302 certifications are accurate, he said.

Scheck predicts the SEC will put out FAQs on human capital as registrants attempt to determine what they should disclose concerning any relevant measures or objectives focused on business management.

Ronald Mueller, an SEC disclosure and regulatory matters specialist at law firm Gibson Dunn, said the changes will push public company CFOs into an important role in helping their companies think more broadly about what aspects of their business are material and should be disclosed in order for investors to understand the business as a whole.

CFOs also must help reassess which risk factors are truly potentially material to the company and investors, Mueller added. 

Enforcement impact

While companies won't be subjected to dot-the-"i"s and cross-the-"t"s requirements of earlier prescriptive disclosures, Mueller said, it's unclear whether the vaguer principles requirement will make it easier for them to defend against SEC enforcement actions and lawsuits by private parties.

"It could have the opposite effect," he said. "Both sides will have the burden of attempting to demonstrate that any gap in the disclosure was or was not material to investors at the time the disclosures were made. For companies, that could be difficult to document and demonstrate." 

SEC and plaintiffs' lawyers will continue having the benefit of second-guessing disclosures in hindsight, he added. 

In unveiling the changes, SEC Chairman Jay Clayton said human capital disclosures are a major focus of the package.

Before, the regulator only required the disclosure of the number of employees at a point in time, which the lawyer said can be a terribly complicated determination for some companies with a wide range of worker relationships.

Now, the rules will require disclosures to focus on the resources, measures, and objectives used in managing the company, and are material to a holistic understanding of the business. 

"What specific information rises to that level will vary widely from company to company," Mueller wrote in an alert to Gibson Dunn clients.

The increased regulatory reliance on principles-based standards could prove to be a double-edged sword. "On the one hand, registrants will have greater license to adapt their disclosures to reflect their particular business model and operations," he said. "That's increasingly important in an innovative and dynamic economy where many aspects of companies' operations defy simple classifications."

On the other hand, the changes could open the door for companies to misjudge what information is material.

The principles-based regime could also lead to SEC staffers using different criteria to determine if Regulation S-K disclosure requirements have been met.

A National Association of Corporate Directors blog post said the changes will make it harder for directors to be sued.

"Such cases against directors will have a harder time succeeding now that companies are no longer required to list everything but the proverbial kitchen sink when describing their businesses, their liability exposures, and their risks," NACD Chief Knowledge Officer Emeritus Alexandra Lajoux wrote.