New Ideas on Corporate Disclosure

A consensus is beginning to emerge that the Securities and Exchange Commission should scrap its 20-year-old system of electronically filed periodic reports—although nobody knows just what new system should be built to haul the SEC into the 21st century.

The Commission held a roundtable last week to discuss its 21st Century Disclosure Initiative, an idea hatched before the credit crisis swept all other regulatory priorities to the back burner. Still, the SEC assembled a panel of notables Oct. 8 to push the matter forward, and talk centered on how to abandon the existing EDGAR filing system in favor of one designed around XBRL technology.

Chia

Whatever new system the SEC comes up with should be “something people want to use,” said Doug Chia, assistant corporate secretary at Johnson & Johnson. Urging the SEC to look at the systems companies are using for their internal reporting, Chia noted, “They don’t use EDGAR.”

Bill Lutz, emeritus professor at Rutgers University and a “plain English expert” who is leading the SEC program, says an XBRL-based system will allow investors to “find the data they want with a minimum of key strokes, and to slice and dice and manipulate it to get the information they want in a format they want.”

Lutz

Lutz’s team is supposed to develop a plan for moving to a new system by the end of the year; the SEC expects to create an advisory committee early next year to make recommendations for implementing it. So far the project has been christened “IDEA” for Interactive Data Electronic Applications, but it isn’t much more than a clever name and a dream right now.

While IDEA is new, the desire to revamp the disclosure system isn’t. John White, director of the SEC Division of Corporation Finance, noted that it was conceived several years ago as “Project Alpha” by his predecessor Alan Beller, now a partner at the law firm Cleary Gottlieb Steen & Hamilton. (Beller also participated in the forum last week.)

The SEC proposed a rule in May to mandate the use of XBRL technology in financial reports, with the largest 500 public companies starting to file in XBRL as soon as next spring. SEC Chairman Christopher Cox, who has tirelessly championed XBRL during his tenure, has said repeatedly that he wants a final rule in place by year-end. The comment period on the XBRL proposal ended Aug. 1, but a proposed final rule has yet to appear.

“We’re going to give investors … easy, quick access to the same high-quality information they have today.”

— Bill Lutz,

Emeritus Professor,

Rutgers University

Two XBRL-themed approaches emerged during the discussion. Lutz described one as the “company file system,” where companies would file their disclosure information online in a structured format like XBRL. He likened it to setting up an online shopping account with Amazon.com: Users enter basic information such as their name, address, and phone number one time only, and then re-enter it only when changes are necessary.

Companies would file mandated information regularly, as they do now, but would do so online rather than via the SEC’s multitude of forms. “Evergreen” information would only need to be reaffirmed, rather than reloaded into the filing system every single time. A user interface built on the needs of investors would make the information easily accessible and wouldn’t preclude people from using third-party software.

“We’re going to give investors … easy, quick access to the same high-quality information they have today,” Lutz said.

Grundfest

Another approach, proposed by Beller and Stanford University Law Professor and former SEC Commissioner Joseph Grundfest, would turn the current requirements of Regulation S-K into an online questionnaire. Companies would respond to the questions using pull-down menus and checklists. All pull-down menus would include a blank text field for registrants to provide additional information “in the event they’re concerned a response doesn’t fully capture the subtly of their position,” Grundfest said.

“The SEC could implement the approach by taking all of the Reg S-K requirements that exist today … and get the same information extracted in a form we believe is cheaper, easier, and better for the companies filing and for users,” he said.

Both approaches would require companies to update their information on the same schedule they use today under Forms 10-K, 10-Q, and 8-K.

Treading Carefully

Steven Bochner, a partner with the law firm Wilson Sonsini Goodrich & Rosati, said he supported Lutz’s approach, because it would allow companies to “reduce replication, improve their processes, and focus on the core information, rather than the repetitive processes that exist today in filings that call for the same kinds of information.”

Bochner

But Bochner urged the SEC to keep the current system of periodic reports, rather than adopting a system of continuous, real-time disclosure. Others agreed.

A BETTER WAY?

Below is an excerpt of a plan from Alan Beller and Joseph Grundfest to improve the SEC's system of corporate disclosure.

The current forms-based structure calls for filing complete documents that

provide all the information required by specific forms according to a schedule defined by

Commission rules. The system operates on the assumption that those documents are

prepared, studied, and archived on paper. In today’s world companies assemble data,

including in databases, that capture the salient information. Disclosure documents on

paper-based forms are then prepared based on that information. Investors and

intermediaries then analyze Commission filings in what is in effect an effort to

reconstruct the databases and other information that are the starting point of the

disclosure process. The interposition of the paper-based filing of forms, even if

executed electronically through EDGAR, thus introduces a wasteful inefficiency in the

information flow from filers to investors and to the Commission.

A more efficient process would promote a “direct to database” design that would

make it easier and cheaper for registrants to provide the necessary information and for

users to analyze the information provided by registrants. An online questionnaire is, we

suggest, the most efficient means of achieving this objective.

Although the proposed on-line questionnaire can take many different forms, we

presently conceptualize the questionnaire as being composed of a combination of binary

(yes/no) responses, pull-down menus, numeric fields, and textual responses. Information

corresponding to current 10-K disclosure requirements would be updated annually;

information corresponding to current 10-Q disclosure requirements would be updated

quarterly; and information corresponding to that now required by Form 8-K would be

updated on the occurrence of specified events. Information required by Schedule 14A

would be updated as of each proxy solicitation relating to a similar matter put to shareholder vote. (Of course, implementing this new disclosure structure would provide

an important opportunity for the Commission and the staff of the Division of Corporation Finance to consider revisions to the substantive disclosure requirements and modify them as appropriate to improve the quality of disclosure.)

Further, once the questionnaire is initially completed, filers would be required to

update only those items that have changed since the last reporting period. The need to

repeat unchanged information—a pervasive and wasteful aspect of the current disclosure

regime—is thus eliminated.

Source

Beller & Grundfest: on Online Questionnaires vs. Form Filings (August 2008).

“The rhythm that’s developed around the periodic system … has considerable substantive importance to it and contributes to the reliability of the disclosure that the SEC gets in ways we should be very careful about disregarding or discarding,” Beller said.

For example, he noted, procedures have developed around the current system for audit or audit review, review by disclosure committees and senior executives, and for CEO and CFO certifications. “To move to something that requires [companies] to disclose whatever’s material whenever it happens, I understand the appeal of that, but I think it raises serious issues of reliability,” Beller said.

Chia, however, warned that an electronic filing system could lead investors or other users of financial statements to push companies for real-time disclosure. “As much as we have good intentions of moving to a system that’s completely electronic … once you move there, the pressure is going to be on to move to an evergreen filing system,” he said. “Someone’s going to say, ‘We’re in an electronic age; there’s no reason that companies can’t make real time disclosure.’”

Chia said issuers would probably resist the move for that very reason. “Unless you relax the liability standard for the evergreen disclosures, people are going to be extremely hesitant to move in that direction,” he said.

Likewise, Grundfest said that while a real-time disclosure system “in concept sounds wonderful, in practice, it’s hellaciously difficult to implement.”

“It’s important we move forward in a way that preserves a periodic reporting requirement that reasonably balances the interests of the reporting community with those of the investor community,” he said.

Meanwhile, Beller noted, while the SEC can revamp the delivery system with the disclosure rules as they currently exist, “This is also an opportunity to look at the rules.” Beller said the SEC “ought to look at substance as well as how it’s going to get delivered.”

Beller suggested the SEC could revisit differences and similarities between Form 8-K and Regulation S-K, and streamline the two. Such a chore would be “easy,” he said, “but nonetheless, would be a real improvement for the people who have to write this stuff and for the people who have to read it.”

The harder question, he said, “is how you get more transparent, high-quality material information to investors. I think it’s worth looking at S-K and the other disclosure rules with that question in mind.”

The SEC is accepting public input on the roundtable comments until Oct. 22.