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Publicly traded companies must disclose certain legal proceedings and risk factors in registration statements and in annual and quarterly reports. These disclosures significantly help investors in assessing the financial integrity of a publicly traded company; formulating a disclosure precisely is critical to compliance, while at the same time accurately capturing the nature and extent of the potential risks. This article summarizes this Securities and Exchange Commission (SEC) proposed rule, which is intended to modernize the Regulation S-K obligations, particularly as they relate to environmental disclosures, and discusses the unique challenges these reporting obligations impose on the chemical industry.
Background
For many years, the SEC required companies to make certain disclosures in the form of reporting obligations intended to enable investors to make informed judgments about the financial integrity of a company. Unsurprisingly, the disclosure requirements relate to a variety of topics, including the materiality of certain claims in pending legal proceedings, the general development of the business, and the disclosure of certain risk factors. Over the years, the standards of materiality have changed, as well as the SEC’s views about how best to define the scope of information that would enable investors to assess the companies they choose to support. The proposal reflects, in part, the SEC’s commitment to update the rules to keep current with contemporary disclosure requirements and to modernize the disclosure requirements to reflect current materiality standards.
Proposed Rule
A key element of the proposal is SEC’s adherence to a non-prescriptive, and what SEC describes as a “principles-based” approach to disclosure and its commitment to ensure flexibility in adapting to fast-changing circumstances and a reporting environment that has altered radically from when the rules were first adopted more than 30 years ago. Item 103 generally applies to “legal proceedings” and compels disclosure of litigation deemed “material,” which generally is anything other than ordinary. Instruction 5 to the item defines an environmental penalty of $100,000 or more as not being ordinary. The proposal would change this materiality standard to $300,000. The SEC requested comment on whether it should adopt a higher threshold or adopt an inflation adjustment factor (as many government penalty assessment programs include) to account for increases occasioned by the passage of time.
Item 101 addresses description of business matters. Under current regulations, companies must disclose estimated capital expenditures for the current and succeeding fiscal years (and beyond if the registrant deems material) for environmental control facilities if they are material. In keeping with the SEC’s principles-based approach, the proposed rule would eliminate the need to disclose the succeeding fiscal year and leave to the discretion of the registrant whether expenditures during that time frame are material.
Also, in keeping with a principles-based approach, the SEC’s proposal doesn’t explicitly address climate risk reporting. Instead, the registrant is to use its judgment as to whether climate information is material. (For an initiative to ease climate change reporting to non-governmental organizations (NGOs), see “Easier Disclosures to NGOs Near.”)
Discussion
These days, SEC filings are routinely scrutinized by a broad range of stakeholders —shareholders, investors, competitors, NGOs, the federal government, state governments, whistle-blowers, facility neighbors, labor unions, area residents and more. As noted above, crafting the precise language of disclosures deemed to be material as they relate to environmental matters is exceedingly important. Similarly, the decision-making process used to identify the scope of disclosures subject to reporting under the SEC S-K rules is also critically important and must be aligned with the SEC rules and internally consistent with other internal corporate standards for defining materiality.
The proposal’s principles-based approach is good news and would appear to provide much needed flexibility to registrants in discharging their reporting obligations. That said, such an approach imposes a higher standard on registrants to ensure their reporting obligations are internally aligned and principle-based, meaning the disclosures should be rooted in a core set of principles that apply across the board. In other words, a registrant should carefully consider what is deemed material for SEC purposes and align that materiality standard with disclosure requirements that apply under other authorities, especially in the environmental area. Federal reporting obligations that come to mind include Toxic Substances Control Act Section 8(e) and Federal Insecticide, Fungicide and Rodenticide Act (FIFRA) Section 6(a)(2), which require disclosure of adverse effects under the circumstances set forth in the reporting rules.
