On Dec. 27, 2017, Morningstar submitted a comment letter in response to the Security and Exchange Commission’s proposed changes to Regulation S-K. Our policy research team writes comment letters to federal agencies in response to their proposed rules when we believe we can offer feedback and advice that improves investors’ experiences.
Proposed changes to Regulation S-K
Regulation S-K arose from the U.S. Securities Act of 1933. It governs many of the disclosures that companies must make, which investors and analysts rely on to make investment decisions.
Many of these disclosure forms—such as S-1, 8-K, or 10-K—will be familiar to investors and anyone who has researched a company’s financial data. These disclosures are essential to creating and maintaining a transparent market in which investors are well-informed about a company’s balance sheet, risks, and prospects for the future.
In general, the proposed changes show that the SEC is looking to modernize and improve the disclosures that Regulation S-K governs. For example, the SEC has proposed removing the requirement to disclose information that has over time proven to be unnecessary, duplicative, or immaterial. The commission has also demonstrated that it wants to increase the use of structured, machine-readable data.
These two particular proposed changes improve the experience of individual investors, and we conveyed our strong support for them in our comment letter to the SEC. Individual investors and analysts save time by not having to comb through disclosures that are unnecessary and do not serve to help them make informed investment decisions. Investors and analysts also benefit from the increased use of structured and machine-readable data, which ensures that disclosures are processed quicker and more accurately.
Our recommendations to the SEC on Regulation S-K
We also recommended ways the SEC could improve investor experiences through other changes to the regulation. First, we suggested that the commission encourage all companies that file disclosures under Regulation S-K to obtain legal entity identifiers, or LEIs. Requiring companies to obtain and disclose LEIs can help analysts better assess a company’s risk exposure by quickly and reliably identifying transaction counterparties. This can, in turn, help investors make more informed decisions about where to invest their money.
We also recommended that the SEC remove the risk factors given as examples when companies are disclosing the potential risks affecting their business. At first glance, this seems like an odd recommendation. However, many companies don’t disclose meaningful risk factors. Instead, they use generic phrasing that describes risks that are common to all investments. Or, some companies view the list of examples as exhaustive, and do not fully disclose other risks.
We think that removing these examples can force companies to more critically evaluate their risks and potentially provide more meaningful responses. Investors benefit when companies disclose more meaningful risk factors, rather than simply disclosing generic risks common to all securities.
Judging by the proposed modifications to Regulation S-K, the SEC is looking to modernize the process that companies use to disclose information and make these disclosures more relevant to investors. Public comments on these changes were due Jan. 2. While there’s no standardized timeline for the final rule, the SEC first will consider the feedback it’s received and then craft a final rule that formalizes the changes to Regulation S-K.