The Securities and Exchange Commission is telling companies that, when it comes to disclosure, less is more.
Even with no specific rules in the works, the SEC is nudging companies to do what they can to curtail excessive or unnecessary disclosures. Accounting experts agree it's possible to trim some information from financial reports, and not a bad idea, but potentially difficult to do.
At a recent national regulatory conference of the American Institute of Certified Public Accountants, various members of the SEC staff said companies need to rethink their disclosures, especially those that are immaterial. “What we're really looking for is clear, effective disclosure,” said Nili Shah, deputy chief accountant at the SEC. Staff remarks came only a few weeks after SEC Chairman Mary Jo White devoted an entire speech to pondering whether investors are inundated with too much information and what the SEC can do to address the problem.
While White offered no firm plan, SEC officials urged companies to take action even in the absence of any specific rules or guidance. Dan Murdock, deputy chief accountant at the SEC, called on companies to do what they can, “right now, in this reporting season,” to reduce disclosures in the body of the financial statements and in the footnotes. “There are a lot of things that I'd suggest people are putting in that are clearly immaterial,” he said. “It begins with the registrant taking a hard look at the footnotes and saying: Does this information need to be in here? Does it make a clearer, more transparent message to investors using the financial statements?”
Disclosure experts say they see measures companies can take on their own to reduce disclosures, although they acknowledge companies aren't eager to do so for several reasons. “It's easy to say, but it's hard to do,” says Bob Laux, senior director of financial accounting and reporting at Microsoft. “It takes everyone in the supply chain to improve disclosures. I don't think it's easy for companies to try to do things to disclosures [on their own]. There is fear of the SEC commenting on it—somewhat valid fears.”
Mark Scoles, a partner at Grant Thornton, says it's probably not realistic that calendar year companies will take action this late in the year to rethink disclosures for 2013 reporting. “Not a lot of companies are going to take that up in January or February, but once they are through the crunch, it's a good time to take a look at it,” he says. “Stepping back and taking a look at disclosures is probably a good exercise for most companies.”
Companies can look at simplifying their disclosures from a number of different angles, experts say, such as reducing redundancies, removing information that's truly immaterial, and reducing legalese and industry jargon in favor of plain English. Each approach is possible, but comes with its own challenges.
“There are a lot of things that I'd suggest people are putting in that are clearly immaterial. It begins with the registrant taking a hard look at the footnotes and saying: Does this information need to be in here?”
—Dan Murdock,
Deputy Chief Accountant,
SEC
SEC staff focused most of their attention on disclosures of immaterial information, highlighting stock-based compensation as an example. Kathy Collins, a senior accountant at the SEC who focuses on disclosure, said some companies are putting in too much unfocused information. “To some extent, we agree that the disclosures are too lengthy,” she said. The idea behind the disclosure requirements is not to provide the entire history of company events, but to focus on important information, she said. “Our general view is if it's taking you more than a couple of pages to provide this information, you're probably getting it wrong.”
Better Safe Than Sorry
Removing immaterial information, however, is a disclosure improvement that may be tough to tackle. “In theory, many feel once you put a disclosure in, it's safe to keep it in,” says Neri Bukspan, a partner with EY. “If you take it out, people are going to ask you about it, so the safer thing is to leave it in.”
Scoles agreed it's a tricky process to remove disclosures because that requires a materiality assessment to support removal, complete with controls over the process and an auditor's assessment of it. “It many cases, it's easier to leave it in,” he says.
DISCLOSURE OVERLOAD
Below is an excerpt on SEC Chairman Mary Jo White's speech on disclosure.
Today, companies are required to disclose—and include in reports filed with us—a whole host of different types of information, including:
How they operate their business now and how they intend to do so in the future, and in some cases, how they did it before.
How much money they made over the last few years, as well as in the current year and how that might change in the future.
Specific details about large shareholders.
The money they have borrowed, repaid, will borrow and will repay.
A description of the background and experience of the officers and directors of the company, how much they are paid and why.
Over the years, the list has grown and become more and more specific and more and more detailed, not all of which has been a result of our rules or guidance we have provided.
I am not suggesting that investors do not and have not benefited from each of the types of information that I just described. Certainly, much if not all of that kind of information may or could be relevant and necessary for investors, even if as some insist most investors do not take advantage of it.
Information Overload
But, I am raising the question here and internally at the SEC as to whether investors need and are optimally served by the detailed and lengthy disclosures about all of the topics that companies currently provide in the reports they are required to prepare and file with us.
When disclosure gets to be “too much” or strays from its core purpose, it could lead to what some have called “information overload”—a phenomenon in which ever-increasing amounts of disclosure make it difficult for an investor to wade through the volume of information she receives to ferret out the information that is most relevant.
The Supreme Court addressed this overload concern over 35 years ago in TSC Industries when it considered, in the context of a proxy statement for a merger, what should constitute a “material” misstatement or omission under the federal securities laws. In reaching its conclusion, it rejected the view that a fact is “material” if an investor “might” find it important. As explained by Justice Marshall, writing for the Court: “[M]anagement's fear of exposing itself to substantial liability may cause it simply to bury the shareholders in an avalanche of trivial information—a result that is hardly conducive to informed decision making.” Instead, the Court held that a fact is “material” if “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”
Not too long before the TSC ruling, the Commission confronted a similar issue and held public hearings on what topics should be required in corporate disclosures. In the course of those hearings, it received suggestions of over 100 topics—a “bewildering array of special causes”—ranging from charitable contributions to “good things a company has done.” Expressing the view that disclosure should generally be tethered to the concept of materiality, the Commission decided against requiring disclosure of the identified matters, noting that “as a practical matter, it is impossible to provide every item of information that might be of interest to some investor in making investment and voting decisions.”
We must continuously consider whether information overload is occurring as rules proliferate and as we contemplate what should and should not be required to be disclosed going forward.
Source: SEC.
Hoyt Stastney, a partner at law firm Quarles & Brady, says another approach to consider is reducing redundancies by using more cross-referencing. “It's a real struggle when you look at what's contained in the financial statements and what's repeated in the rest of the document,” he says. Typically, the financial team advocates for disclosures that must be contained in the financial statements, while the legal and operating teams drive disclosures that belong in management discussion and analysis. There's often overlap to the point of exact duplication, he says, but at some companies neither group is willing to consent to cross-referencing.
“Some forward-thinking companies have done some work in this area, and there's some tension but you can definitely resolve it and put out a shorter document,” he says. He points to a handful of areas where redundancies are thickest, such as discussion of credit agreements, liquidity issues, contractual obligations, and equity plans. Many of those issues rose to prominence in the financial crisis, compelling lengthy disclosures in both footnotes and MD&A, he says, but many companies are now reluctant to cross-reference or reduce those disclosures.
Bukspan says he also sees a great deal of redundancy around critical or significant accounting policies, litigation exposure, financial instruments, segment disclosures, environmental issues, and general descriptions of the business. He agreed companies have some leeway under existing rules to do more cross-referencing, especially with technological advances that make it easy to do. However, he acknowledges there are limits, depending on whether certain disclosures are explicitly required in certain locations.
Also an advocate for more plain English, Bukspan says companies could make a big improvement in financial statements by viewing them not just as a statutory requirement, but also as a communications vehicle. “There are many, many areas that are burdened by what I would call overly complex professional jargon,” he says. Companies could improve their stead with investors by taking greater care to communicate with them more clearly through better disclosures, he says, and they might also shorten the time required for reviewing financial statements.
The Financial Accounting Standards Board is further down the path than the SEC on reconsidering disclosures and currently has a project under way to improve disclosure effectiveness. The board is hopeful that focusing on improving the effectiveness of disclosure will naturally lead to reduced volume at the same time. FASB is performing a field study to determine how entities exercise discretion over what they disclose.
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