SEC Adds Comprehensive Disclosure Review to Its Plate

The Securities and Exchange Commission filed its study of all required disclosures and filings last month, and while it didn't offer any concrete solutions, the study could open the door to something companies have demanded for years: comprehensive disclosure reform.  

The report, required by Congress through the JOBS Act, included a comprehensive analysis of Regulation S-K, which establishes public company filing requirements, with an eye toward finding ways to ease the burden on emerging growth companies by modernizing and simplifying the registration process. Rather than offer specific reforms for emerging growth companies in the report, however, the SEC decided to take a delayed, yet more ambitious, approach and offered a future broader review of its entire disclosure regime.

“The staff believes that a comprehensive inventory of the Commission's disclosure regulations that identifies the origin and purpose of existing disclosure requirements and sets forth the history of updates to those requirements is an essential first step in formulating recommendations with respect to modernizing and simplifying disclosure,” the report says. It adds that a “comprehensive approach,” rather than a targeted one, may require a longer-term effort, but “would be able to achieve the dual goals of streamlining requirements for companies, including emerging growth companies, and focusing on useful and material information for investors.”

SEC Chairman Mary Jo White and Commissioner Daniel Gallagher have recently raised concerns about “information overload,” where too much disclosure data can confuse, rather than empower investors. In a December speech, Gallagher said, “disclosure reform is a must for the Commission.”

“What may be missing in this longstanding discussion is a practical sense of where to begin,” he added. “There's an old adage: how do you eat an elephant? One bite at a time. But in tackling the topic of disclosure reform, what piece of the elephant do we take a bite of first?”

The report doesn't suggest where to start nibbling—that will come later. In a statement, White said she has directed SEC staff to develop “specific recommendations for updating the rules that dictate what a company must disclose in its filings.”

“The ultimate objective is for the Commission to improve the disclosure regime for both companies and investors,” she said, encouraging public feedback as an important part of that process.

The report says the review should address four key issues:

Revisions should emphasize a principles-based approach to the disclosure framework to address “increasing layers of static requirements,” while preserving the benefits of a rules-based system with consistency and comparability of information across registrants.

The appropriateness of scaled disclosure requirements should be considered.

The review should evaluate methods of information delivery and presentation.  It could explore a possible filing and delivery framework based on the nature and frequency of the disclosures, including a “core” disclosure or “company profile” filing with information that changes infrequently, periodic and current disclosure filings with information that changes from period to period, and transactional filings that have information relating to specific offerings or shareholder solicitations.

The evaluation should consider ways to present information that would improve the readability and navigability of disclosure documents and discourage repetitive disclosure of immaterial information. The review could explore whether technology could be used to make disclosure documents easier to prepare and easier to use.

In the study's conclusions, the SEC says that a comprehensive approach will take longer but provide a better solution than identifying a few changes to make right away. “They are not going to have short-term solutions or an ad-hoc approach, of ‘let's fix this rule here and this rule there.' The really want to take a holistic approach and evaluate all the rules together, which for a lot of years never happened,” says Bruce Czachor, a partner with the law firm Duane Morris. “There was always a set of rules that would come out, such as Regulation D in the early 1980s, then something else would come out 10 years later that conflicted with the others and you had to go and ask for relief.”

The report provides a rich review of current disclosure practices, and a modest, but promising preview of potential changes to those practices in the near future, says Tom Lin, a professor at Temple University's Beasley School of Law who researches financial disclosures. “The discussion about improving presentation and delivery via new information technology is particularly promising given the advances in information technology and market practices since the last round of changes to Regulation S-K.”

Changes to Disclosure Methods, Too

The SEC says it will also review the broader system for presenting and filing company reports. Czachor is hopeful that the SEC will carefully evaluate its EDGAR electronic filing system as part of the review. Back in the 1990s, the Commission passed on having a top tech company develop it, opting instead to award contracts to smaller firms, and the final product, he says, “has never been user friendly.” By comparison, with the Canadian equivalent, SEDAR, “you can print in Microsoft Word, you can file from your desktop, and you don't have to go through this crazy coding and have to hire somebody to do it.”

“There is no reason I can think of why you shouldn't just be able to file from your desktop with an appropriate security code without having to go to someone like RR Donnelley or hire somebody who does this,” he says.

“There's an old adage: how do you eat an elephant? One bite at a time. But in tackling the topic of disclosure reform, what piece of elephant do we take a bite of first?”

—Daniel Gallagher,

Commissioner,

SEC

The SEC Website should also be more user-friendly and improve its search function, he says. “I go to the SEC site when I want to verify a rule, but otherwise I hardly ever go to it because it is just too cumbersome,” Czachor says.

Those concerns were not ignored in the report, which says that “any review of the disclosure requirements should include an evaluation of methods of information delivery and presentation, both through the EDGAR system and other means.”

Reform Won't Be Easy

Streamlining all these regulations may be easier said than done, as new requirements keep emerging, many of them mandates of Congress. Major disclosure additions in the Dodd-Frank Act include reporting on the use of “conflict minerals” from the Congo, itemizing government payments for extraction rights by mining and energy companies, and a whole slate of executive compensation revelations.

Czachor points to the legislative demand to allow equity crowdfunding as typical of new disclosure demands.

“The way Congress wrote it, the SEC's hands are tied, with investor certifications and requirements for audited financials when raising over half-a-million dollars,” he says. “I don't know what lawyer would advise his client to use that platform as opposed to just doing an old-fashioned private placement. The joke among practitioners is that if we ever see one of these done, that lawyer could probably get sued for malpractice. Why would you do that?”

A starting point, in Czachor's eyes, is to zero in on redundancies, where the same basic company information and risk factors pop up in multiple places.

A COMPREHENSIVE REVIEW

The following, from the Securities and Exchange Commission's “Review of Disclosure Requirements in Regulation S-K,” summarizes the Commission's intended approach for streamlining disclosure requirements:

In light of the number and breadth of prior initiatives to review the Commission's disclosure requirements summarized in this report, and the detailed inventory of Regulation S-K illustrating the range of topics covered by the disclosure requirements, the staff has identified two possible approaches (a comprehensive approach and a targeted approach) for further work to develop particular recommendations for revised disclosure requirements for all registrants, including emerging growth companies.

Although a comprehensive approach would likely be a longer-term project involving significant staff resources across the Commission, the staff believes that a comprehensive approach would be able to achieve the dual goals of streamlining requirements for companies, including emerging growth companies, and focusing on useful and material information for investors.

Accordingly, the staff recommends that a comprehensive approach should be used to review and revise the disclosure requirements.

Source: SEC.

He would also like the SEC to look at Regulation G and requirements for how companies treat non-GAAP financial information.

“That's been a constant struggle,” he says. “They tried to make accommodations to the market to say you could have non-GAAP financial metrics, which usually comes up in a debt offering, but you have to have all this reconciliation back to a GAAP number. There is a whole lot of disclosure to get you there, but nobody cares. We are doing all this work to satisfy an SEC rule that the investors truly do not care about.”    

The SEC isn't alone is looking to ease disclosure confusion and burden. A survey released this past summer by the Financial Accounting Standards Board saw respondents rank improving disclosure requirements as the most important project it should undertake. The SEC report directs its Office of the Chief Accountant to coordinate with FASB on this effort.

Hans Hoogervorst, chairman of the International Accounting Standards Board, also flagged the importance of taking a fresh look at what's required in annual reports during a speech last year. “For many companies, the size of their annual report is ballooning,” he said. “The amount of useful information contained within those disclosures has not necessarily been increasing at the same rate. The risk is that annual reports become simply compliance documents, rather than instruments of communication.”

Behavioral issues underlie some of that problem, Hoogervorst said. “Many preparers will err on the side of caution and throw everything into the disclosures,” he said. “They do not want to risk being asked by the regulator to restate their financials. After all, no CFO has ever been sacked for producing voluminous disclosures, while restatements may be career-limiting. Moreover, excessive disclosures can even be very handy for burying unpleasant, yet very relevant information. And sometimes it's just easier to follow a checklist, rather than put in the effort to make the information more helpful and understandable.”