SEC Disclosure Reform: Welcome, but Not Easy

For as long as there have been disclosure requirements, companies have complained that some elements of reporting cost too much, are too difficult to assemble, or offer a poor or confusing view into the true nature of the company.

Meanwhile, investors and analysts argue that they aren't always as useful or timely as they could be.

To address these concerns, the Securities and Exchange Commission is about to embark on its latest attempt to review all aspects of corporate reporting with an eye toward streamlining some reporting, eliminating unnecessary disclosure, and making others more useful. And while most companies welcome any effort to simplify disclosures, many observers are skeptical that the review will lead to any significant disclosure reform.

Speaking last month before the National Association of Corporate Directors, SEC Chairman Mary Jo White fretted about “information overload.” The current slate of disclosure requirements, she said, may be too much for investors to digest, not as useful or timely as it could be, and too costly for companies.

White addressed the numerous calls over the years for disclosure reform, most recently the scaling back of disclosure regimes demanded of emerging growth companies under the JOBS Act. The legislation requires the SEC to “comprehensively analyze” the rules underpinning its disclosure regime and consider how to modernize and simplify them, in particular to reduce the costs and burdens for emerging growth companies, defined as those with less than $1 billion in revenue that have been public for less than five years. The staff of the Division of Corporation Finance is currently finalizing this report.

White's remarks were a “step in the right direction,” says Tom Lin, a professor at Temple University's Beasley School of Law who researches securities disclosure. “Both corporations and investors generally believe that disclosure could be better and more helpful.”

Among the questions White raised during her speech:

Has “risk factors” disclosure in securities offering documents and annual reports become unwieldy?

Where is there duplication and is that such a bad thing?

Do line item disclosures make the most sense or could a principles-based approach work?

Would investors benefit from disclosures that are tailored to specific industries?

Are the current timeframes in SEC rules and forms appropriate? Would shorter timeframes impose an undue burden on companies?

How should new technology and social media be handled?

White also floated the idea of improving the SEC's Website and EDGAR filing system. The Commission may explore implementing a “core document” or “company profile” process where information changes infrequently, she said. Companies would be required to update those core filings with information about securities offerings, financial statements, and significant events.

Satisfying both corporations and investors will be a difficult balancing act for the SEC, say corporate reporting experts. “Investors are generally in favor of new rules that make their life easier and make the markets work better,” Lin says. That being said, he suspects not many average investors sit down and read all of a company's SEC filings. Nonetheless, having the information disclosed means that more sophisticated players see it and it gets priced into the stock, “which is beneficial for everybody.”

The Risk of a Meteorite Strike

The often voluminous “risk factors” companies are required to disclose to investors are a prime area for reform, suggests Lyle Roberts, a partner at the law firm Cooley whose practice focuses on securities litigation and regulation.

“If you open up any 10-K you will see 20 pages of risk factors, ranging from specific things about the company to the threat that our monetary system collapses,” he says. “There is this inherent tension between having to list out that a meteorite could hit our main factory and giving investors information they really need.”

Over time, risk factor disclosure has become more extensive, not necessarily because of SEC requirements, but also because of legal advice from lawyers assisting with the preparation of filings. “It is fair to ask whether there is more there than is really needed,” said White.

“You disclose all these things to cover yourself. Companies are putting them in more for liability protection than informative purposes.”

—Tom Lin,

Professor,

Temple University

Annual reports issued by European-listed companies contain far fewer risk factors and discuss them in plainer language, says Roberts. “They are shockingly different,” he says. “You are getting a lot of the same financial information and the same kind of outlook stuff, but the biggest difference is the risk factors.”

Lin describes the current approach to risk factors as akin to “low-cost insurance.” “You disclose all these things to cover yourself,” he says. “Companies are putting them in more for liability protection than informative purposes.”

Some worry that asking companies to pare back risk factors and use plain English to describe them could increase the threat of litigation. “It is all well and good for the SEC to suggest there is too much risk disclosure and we should cut back in some way, but unless you are curbing the private plaintiffs bar and their ability to go after you for misrepresentations in your filings, well, then the incentive still exists for companies to put all that in,” Roberts says.

Principles vs. Rules

White also signaled that the SEC might be inclined to move toward a more principles-based approach, rather than line-by-line disclosure demands. Additionally, requirements could be better tailored for specific industries.

Another suggestion she had, to better embrace technology and social media, could have pitfalls. “There is some tension for corporations between wanting to get the information out there on a timely basis and making sure that they don't run afoul of securities fraud rules,” Lin says, citing Regulation Fair Disclosure concerns. Although the SEC has encouraged company information to be distributed via social media, it has also made it clear that Reg FD's demands that information be widely disseminated, not just parceled off to a favored group, will be closely watched.

It is important for the SEC to better leverage advancing information technology to make disclosure more useful for all market participants, Lin says. Ideally, this should be done in a way that encourages investors to do “comparison shopping” by comparing different risks among companies and their balance sheets.

The Future of Disclosure?

The following is a selection from remarks made by Securities and Exchange Commission Chair Chairman Mary Jo White before the National Association of Corporate Directors on Oct. 14. During her speech, she spoke of ways the SEC may reconsider its longstanding disclosure regime.

Consider the lengthy “Risk Factors” disclosure in a few offering documents and annual reports. In 1995, Congress enacted the Private Securities Litigation Reform Act that, among other things, addressed the concern that companies were often subject to securities fraud claims any time they made optimistic statements about the future that did not come true. The PSLRA, in essence, offered liability protection to companies by establishing a safe harbor provision for so-called forward-looking statements – statements about everything from projection of revenues, income, earnings per share, and dividends, to name a few.

The safe harbors encouraged companies to share more “soft” information with investors, provided that they also included cautionary language that explained the important factors that could cause actual results to differ materially from what the company was saying. For example, a company could say that it believed that revenues could increase over the course of the following year, and couple that statement with factors that could impact the likelihood of that increase, such as actions by competitors or various market events.

Before 1995, risk factor disclosure was typically only provided in offering documents for higher-risk companies or securities. Over time, this cautionary language became more and more extensive, not necessarily because of a change in the SEC requirements for risk factor disclosure (although it is now required in the 10-K) but, at least in part, because of legal advice from attorneys assisting with the preparation of filings.

It may be difficult or unwise to significantly walk those disclosures back, but it is fair to ask whether there is more there than is really needed. And, if this is not the result of an SEC or Congressional mandate, then it is worth asking what might be done if companies strive to reduce the length of these provisions on their own?

Source: SEC.

“Right now, the average investor has to print that information out and lay it all side-by-side,” he says. “I suspect the average Joe and Jane isn't doing that.”

No Let-Up in Rulemaking

One big hurdle for anyone desiring streamlined disclosure demands: Congress.

While legislators were happy to ease disclosure demands for emerging growth companies with the JOBS Act, it is far more common to see it mandate new rules. For example, the Dodd-Frank Act prompted the SEC to create a whole new disclosure process, Form SD, used to report the vetting of “conflict minerals” in the supply chain and payments to governments by oil and gas companies for extraction rights. These disclosures are more about human rights and social issues than financial matters.

“In the past, you didn't have a lot of congressional involvement in what companies should disclose, but clearly, in the wake of SOX and Dodd-Frank, it is a lot more interested in those issues now,” Roberts says. “That adds another big player you have to deal with.”

“The SEC can say it wants to streamline things, but Congress keeps adding to the list and there is nothing [the SEC] can do about it,” he warns. “The SEC is trying to make policy, but has this loud uncle off in the corner yelling out requirements. I understand their frustration.”

Lin similarly cautions that disclosure reform won't happen quickly or easily. “Folks who want to see significant reform done in the next year or so need to realize it is going to take more time than that,” he says. “You have a lot of stakeholders with different views and they will all have to be heard by the SEC.”

There is reason to be optimistic, however. “We've seen that the SEC was not shy about relaxing and amending some of their traditional disclosure practices for emerging growth companies, Lin says. “So, it's hard, but not impossible.”