Disclosure Categories

• Author: Stephanie Tsacoumis
• Profession: Recognized securities law practitioner and professor at Georgetown Law Center
• Pages: 77-235

77

Chapter4

Disclosure Categories

Disclosure Regime Generally

Principles- Based Versus Prescriptive Regulation

SEC disclosure regulations combine a principles- based approach with

prescriptive requirements, all generally embodied in Regulation S-K,

which governs nonnancial disclosure, and Regulation S-X, which

governs nancial disclosure. Many SEC rules require disclosure when

information is “material” to investors. These principles- based rules rely

on management to assess the signicance of the specied information

in light of the company’s overall business and nancial circumstances.

Disclosure of related- party transactions is one example of a principles-

based disclosure; public companies must disclose transactions “in

which a related person had or will have a direct or indirect material

interest.” As another example, one Regulation S-K provision requires

disclosure of “material commitments for capital expenditures.”

Principles-Based Disclosure

“Under a principles- based approach, one starts with laying out the key

objectives of good reporting in the subject area, and then provides guid-

ance explaining the objective and relating it to some common examples.”

—Robert Herz, Former Chairman, Federal

Accounting Standards Board

78 What Must Public Companies Disclose?

Other SEC rules contain objective, quantitative thresholds to

identify when disclosure is required. One Regulation S-K provi-

sion, for instance, calls for disclosure of environmental proceedings

involving a claim for damages or monetary sanctions in excess of

10% of current assets of the company.

Categories of Material Information

In developing and implementing its system of disclosure, the SEC

focused on identifying categories of material information. Because

Schedule A to the 33 Act identies certain categories of information

that generally are viewed as material to investors, the SEC incorpo-

rated and expanded these categories in Regulation S-K. These cat-

egories are now reected in the Regulation S-K specic line- item

requirements.

Business Operations

Consistent with Schedule A of the 33 Act, a key SEC disclosure

requirement addresses the character of the business done and

intended to be done by the company. Public companies have sig-

nicant exibility in presenting their business- related disclosure to

“showcase” their operations, provided that the disclosure is balanced

and fairly described.

Fair and Balanced Disclosure:

Customer Testimonials

Disclosure must be balanced: Glowing testimonials of prominent customers

may present an unbalanced view of the company, the results produced by

the company’s products, and the signicance of the customer. Such dis-

closure often implies that the testimonials represent typical customers and

typical results. In some instances, depending on the facts, staff may request

counterbalancing information, which may include negative feedback, as an

example.

Chapter4■ Disclosure Categories 79

(continued)

Disclosure must be fair: References to prominent customers also may create

misleading impressions about a company’s typical or representative cus-

tomer and about the size and quality of a company’s customer base. To put

customer testimonials into context, staff may ask for additional disclosure,

such as the total number of customers, whether sales to prominent cus-

tomers are signicant or immaterial, and whether the prominent customers

comprise a representative sample with respect to products and volume or

amounts of purchases.

Business Description

Regulation S-K calls for disclosure about the company’s business,

including a description of the general development of the busi-

ness during the prior ve years. The business done and intended

to be done by the company must be described in narrative form,

with a focus on the company’s “dominant segment or each report-

able segment.” The narrative should address the following spe-

cic items:

• principal or “material” products produced and services

rendered;

• new products or segments;

• sources and availability of raw materials;

• intellectual property;

• seasonality of the business;

• working capital practices;

• dependence on certain customers;

• dollar amount of backlog orders believed to be rm;

• business subject to renegotiation or termination of govern-

ment contracts;

• competitive conditions;

• compliance with environmental laws; and

• number of employees.