Sweeping changes may be afoot for the Securities and Exchange Commission's disclosure and reporting regime, but some are wondering if overhauling disclosure could actually bring more work and higher costs for reporting companies.
The agency is taking a comprehensive look at ways to streamline requirements, modernize the filing process, and reduce redundancy. It is a long-overdue, long demanded overhaul of reporting requirements. But some lawyers and disclosure experts are warning: “be careful what you wish for.”
There are fears that a comprehensive review could unintentionally put a greater compliance burden on companies, at least in the short term. By eliminating some of the specific rules and reporting requirements and moving to an approach based more on principles—the argument goes—companies may think they need to actually provide more information to satisfy non-specific requirements.
“Any time you have a proposal that starts out with a premise of making things more streamlined, and then diverges into something more thought-provoking and intensive in terms of analysis, you have to stop and ask where the simplification comes in,” says Brian Lynch, a partner at the law firm Drinker Biddle & Reath. “There is the potential it could become more time consuming.”
Others say the move to embark on a comprehensive review will take years, delaying efforts to foster capital formation by reducing the disclosure burden on emerging growth companies, which was the original intent of the push for disclosure review contained in the JOBS Act. The short-term costs to adjust to a radically different disclosure system could also be extensive, some lawyers caution.
Lynch is skeptical that much-needed reforms will ever see the light of day. But if they do, he warns, there is a danger that “less means more.” “It is hard to be optimistic about fundamentally positive disclosure reforms being implemented as contemplated. Long-shots like 14 seeds in the NCAA basketball tournament and the S-K Study are a lot of fun to root for, but they rarely, if ever, succeed,” Lynch says.
With the JOBS Act, Congress required the SEC to “comprehensively analyze” the rules underpinning its disclosure system, review disclosure requirements for Regulation S-K non-financial disclosures, consider how to modernize and simplify those requirements, and reduce the costs and burdens for emerging growth companies (EGCs), which are public companies with total annual gross revenues under $1 billion.
In December, the SEC issued a report to Congress laying out how it will approach the task. It will not only focus on EGCs, but undertake an across-the-board review of all disclosure requirements, including executive compensation, corporate governance, and risk factors. The report also promises a thorough review of the systems for filing financial statements and disclosures, including a review of Regulation S-X, which governs the content of financial statements in SEC filings.
One direction the SEC may take, according to the report, is to emphasize principles in the disclosure framework, similar to the current rules and guidance for Management Discussion and Analysis disclosure. In theory, it would allow companies to take a more narrative approach, providing latitude to focus on what their investors find material and actionable.
A principles-based approach may sound good on paper, but could present greater disclosure challenges and burdens for issuers, Lynch fears. It would expand disclosure requirements and affect existing descriptions of material properties or asset classes. If a principles-based approach is advanced through new rulemaking initiatives, the SEC must concurrently reduce existing prescriptive, line-item disclosure requirements, he says. Failure to do so “may produce neither overall disclosure simplification for issuers nor a reduction in issuer costs and burdens.”
Added complexity would be even more burdensome when layered atop Dodd-Frank and Sarbanes-Oxley disclosure obligations. “You are adding an additional area of MD&A-like analytics,” Lynch says. “That would seem to make for a lengthier disclosure and preparation unless something gives in the process.”
No Quick Fix Here
Another concern is that the broad review will unnecessarily delay the JOBS Act's efforts to spur capital markets and benefit emerging growth companies.
The JOBS Act didn't limit the SEC to just reviewing disclosure demands for EGCs, explains Stacy Kanter, a partner with the law firm Skadden, Arps, Slate, Meagher & Flom. Nevertheless, the comprehensive approach “could, and probably will, delay any kind of streamlining or scaling of the disclosure requirements for EGCs,” she says.
“Long-shots like 14 seeds in the NCAA basketball tournament and the S-K Study are a lot of fun to root for, but they rarely, if ever, succeed.”
—Brian Lynch,
Partner,
Drinker Biddle & Reath
Changes to the current disclosure regime could also prove costly, at least initially, for companies forced to rethink and reconfigure their internal approaches. That would be especially true for large organizations with mature compliance programs.
“It could be similar to when the SEC introduced new executive compensation rules a few years ago,” Kanter says. “There was a lot of getting up to speed as everyone had to figure out how to deal with those new rules. Any kind of change in disclosure—unless it is just a lessening, which I don't think is going to happen here—is going to have some cost for companies as they ramp up to comply.”
Tougher on Small Companies
A disclosure overhaul could also be disproportionately difficult on smaller companies, the exact group it was intended to help. Traditionally, large companies are fairly efficient when it comes to filings and absorb the cost and manpower needs more than their smaller peers, says Georgia Quinn, a senior associate with the law firm Seyfarth Shaw and a JOBS Act specialist. That could change.
“For the largest corporations to prepare a 10-K or offering document it can be relatively inexpensive because they already have the material generated, it just needs cutting and pasting it into the right format,” she says. “It's astounding that we live in a world where it is cheaper for the largest, most complicated companies in the world to prepare their materials than it is for a small business owner with a cookie company.”
Changing disclosure expectations will lead to the compliance equivalent of growing pains. “That's what legal changes do, they add huge amounts of cost to everyone involved,” Quinn says. “If anything, it could be a bit of an equalization of the playing field.”
What Could Work?
This is not the first time the SEC has tackled its disclosure regime. In 1998, there was the so-called “Aircraft Carrier Release,” a comprehensive review with a nickname reflecting the size and scale of the task at hand. It went nowhere. In several recent speeches, however, SEC Chairman Mary Jo White has emphasized that the current review is a priority.
POSSIBLE NEXT STEPS
The following, an excerpt from the Securities and Exchange Commission's “Report on Review of Disclosure Requirements in Regulation S-K,” details where the disclosure overhaul may go next and the criteria underlying the review.
The following economic principles should be given consideration when reviewing and considering changes to disclosure requirements:
Improving and maintaining the informativeness of disclosure to existing security holders, potential investors and the marketplace, which is particularly relevant to emerging growth companies that need capital to invest in their businesses.
The historical objectives of a given rule should be considered, including a consideration of any specific disclosure gaps, mandated policy objectives or other conditions sought to be addressed by a given requirement's adoption, whether disclosure requirements.
The extent to which a given disclosure requirement entails high administrative and compliance costs, especially for emerging growth companies.
The extent to which disclosure of a company's proprietary information may have competitive or other economic costs, which may be particularly relevant to emerging growth companies.
After considering the information gathered in connection with the preparation of this report, the staff recommends the development of a plan to systematically review the disclosure requirements in the Commission's rules and forms, including Regulation S-K and Regulation S-X, and the related rules concerning the presentation and delivery of information to investors and the marketplace. The review should also include disclosure requirements developed through interpretations in Commission releases, and staff interpretations and guidance.
Source: SEC.
Lynch suggests that Congress shift focus from mid-term election and step in to further expedite the review and provide relief for EGCs.
“The easiest thing they could do is say to the SEC, ‘we appreciate the fact that you have inventoried a lot of these things, but we would really like you to just focus on the aspects that involve an offering process,” he says. Legislators should also place a greater focus on smaller reporting companies as “they need the simplification just as much, if not more, than EGCs.”
Because the SEC is also looking to encourage new ways to report company information, leveraging the internet and new technology, additional safe harbors will be necessary to protect companies, Lynch says. “If they really are intending to do something with delivery and formatting, they should give the companies explicit protection,” he suggests.
The SEC is also going to bring more experts into the process, he adds. The goal of harmonizing Regulation S-K and Regulation S-X will require additional input and buy-in from other constituencies, including the Financial Accounting Standards Board and others in the accounting world.
Meaningful Streamlining
Still, there are many who are willing to risk the harmful effects of disclosure reform if it means truly streamlining the process. “When you look at a 10-K now it is about 800 pages,” Quinn says. “It is ridiculous to think that anybody is actually going to be able to sit down and digest it. They are not serving their intended purpose, to shine sunlight on companies. If the SEC could get these documents pared down to something that is actually useful to investors, it would be such a win. It would help the big companies, and the little companies, and the investors.”
“The discussed disclosure reforms would be a step in the right direction,” says Tom Lin, a professor at Temple University's Beasley School of Law who researches securities disclosure. “It is widely understood that securities disclosures can be more investor friendly given modern advances in information technology. The disclosure system, while imperfect, has worked well in many ways. The task of the SEC is likely not a radical overhaul of the disclosure system, but constructive changes to make it work better for firms and investors.”
“We have to start somewhere,” agrees Tom Quaadman, vice president of the U.S. Chamber of Commerce's Center for Capital Markets Competitiveness. “The JOBS Act review is updating outdated regulatory requirements that the SEC never moved on, and those efforts should not preclude other efforts to overhaul other, larger corporate disclosures.”
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