Stop us if you’ve heard this before: The Securities and Exchange Commission is attempting a comprehensive overhaul of its disclosure regime.
Mary Jo White is only the latest in a long line of SEC chairmen who have tried disclosure reform. All have failed. Now, however, even as agency critics lament its slow pace of rulemaking, this may be one area where White might actually succeed.
Speaking at the SEC’s Advisory Committee on Small and Emerging Companies in late September, White announced that pieces of the ongoing disclosure effectiveness review (a requirement of the JOBS Act) are quickly falling into place.
“The staff in the Division of Corporation Finance continues to be hard at work on our initiative to enhance the effectiveness of the public company disclosure regime for investors and companies,” White said. “The staff’s review is focused initially on the business and financial disclosures required in companies’ periodic reports, and I expect that the Commission will publish the first product from this initiative very soon.”
Early results of that effort have already emerged. On Sept. 28, the SEC announced a 60-day public comment period on the effectiveness of financial disclosure requirements in Regulation S-X. The request for comment, part of the disclosure effectiveness initiative, focuses on financial disclosures companies must file with the agency about acquired businesses, affiliated entities, and guarantors and issuers of guaranteed securities.
The Advisory Committee on Small and Emerging Companies also advanced another piece of the disclosure reform puzzle, forwarding its recommendations to the full Commission in late September.
Under current SEC rules, “smaller reporting companies” have a public float of less than $75 million in common equity, or if unable to calculate the public float, less than $50 million in annual revenues. Similarly, a company is considered a non-accelerated filer if it has a public float of less than $75 million as of the last day of the most recently completed second fiscal quarter. The advisory committee recommends revising the definitions to include companies with a public float of up to $250 million—meaning that many non-accelerated filers would drop to be smaller reporting companies, with less disclosure burden. This move would be in tandem with other recommendations, among them exemptions from the pay ratio rule, auditor attestation requirements, and furnishing a Compensation Discussion & Analysis.
The advisory committee also said the SEC should revise its rules to provide smaller reporting companies with the same disclosure accommodations available to emerging growth companies, defined by Congress as having less than $1 billion in annual revenue. These include exemptions from the requirement to conduct shareholder advisory votes on executive pay and permission to file only two years of audited financial results rather than three.
The committee also recommends an exemption from the auditor attestation requirement of Section 404(b) of the Sarbanes-Oxley Act, plus an exemption from filing statements tagged in XBRL, for companies with a float between $75 million and $250 million.
And Other Opinions
Recent public comments related to the disclosure review include numerous other ideas the SEC and its staff may consider as the effort moves forward.
In an Oct. 7 letter, Henry Hu, a law professor at the University of Texas at Austin and a former head of risk research at the SEC, urged the Commission to address the “parallel disclosure universe” that has emerged as the Federal Reserve and other bank regulators push financial institutions to make more public disclosures.
“The longstanding exclusivity of the Commission is gone,” he wrote. “Unlike the Commission’s system, the bank regulator public disclosure system is not directed at the interests of investors and market efficiency, but instead is directed at the well-being of the bank entities themselves and the reduction of systemic risk … Having two sets of regulators with widely divergent ends and full authority over the same informational territory is ultimately unsustainable.”
“While U.S. companies do not, as of yet, have the option of discontinuing quarterly reporting—though they do have discretion to decline giving quarterly earnings guidance—the SEC should keep [this] in mind in pursuing disclosure reform initiatives.”
Martin Lipton, Founding Partner, Wachtell, Lipton, Rosen & Katz
Hu urged better coordination between the two regulatory realms. “Some ‘soft’ form of boundary setting, slicing risk along quantitative/qualitative lines in the context of public disclosures in the case of dually regulated entities, could be considered,” he said.
Cartier Esham, executive vice president for the Biotechnology Industry Organization, a trade group that represents more than 1,100 biotech companies, urged consideration of how disclosure affects capital formation. She called on the SEC to “move away from its existing reliance on public float to determine a company’s compliance obligations” by defining any issuer with annual revenues below $100 million as a smaller reporting company and a non-accelerated filer, regardless of how the market values their stock.
“The high cost of biotech research coupled with strong investor interest in life-saving medical advancements means that growing biotechs often have a high public float despite their simple corporate structure and lack of product revenue,” she wrote. “The dependence on public float as a marker for size begs the question: What does a pre-revenue biotech company with a public float of $400 million truly have in common with a $400 million widget-maker?”
Rep. James Langevin (D-R.I.) wrote of the need to update the SEC’s cyber-security disclosure guidance for publicly traded companies. The Commission should consider directing issuers to disclose in Form 10-K reports a clear description of their current state of conformity to industry best practices; the plan and schedule for achieving full conformity; and how often the CEO, CFO, and directors are briefed on cyber-security incidents.
DISCLOSURE AND CAPITAL FORMATION
The following are recommendations made by the SEC’s Advisory Committee on Small and Emerging Companies for consideration by the full Commission.
The committee recommends that:
1. The Commission revise the definition of "smaller reporting company" to include companies with a public float of up to $250 million. This will afford the following accommodations to a broader range of smaller public companies:
a. exemption from pay ratio rule;
b. exemption from auditor attestation requirement; and
c. exemption from providing a Compensation Discussion & Analysis.
2. The Commission revise its rules to provide smaller reporting companies with the same disclosure accommodations that are available to emerging growth companies. These include:
a. exemption from the requirement to conduct shareholder advisory votes on executive compensation and on the frequency of such votes;
b. exemption from rules requiring mandatory audit firm rotation;
c. exemption from pay versus performance disclosure; and
d. allowing compliance with new accounting standards on the date that private companies are required to comply.
3. The Commission revise the definition of "accelerated filer" to include companies with a public float of $250 million or more, but less than $700 million. As a result of such revision, the requirement to provide an auditor attestation report under Section 404(b) of the Sarbanes Oxley Act would no longer apply to companies with public float between $75 million and $250 million.
4. The Commission exempt smaller reporting companies from XBRL tagging.
5. The Commission exempt smaller reporting companies from filing immaterial attachments to material contracts.
The Business Roundtable, an association of CEOs, had both conceptual and specific recommendations.
For the latter, John Hayes, former CEO of the Ball Corp. and chairman of the group’s corporate governance committee, wrote that “a significant factor giving rise to duplicative disclosures in filings is the overlap between SEC and Financial Accounting Standards Board requirements.”
The SEC, he said, should explore ways to enhance cooperation and coordination with FASB, “not only in formulating standards but also in shaping the extensive guidance related to financial reporting.”
“There are a number of instances, particularly between FASB’s requirements for financial statement footnotes and the SEC’s requirements in Regulations S-X and S-K as they pertain to Management Discussion and Analysis, where the disclosure requirements and guidance may be duplicative or outdated,” he wrote. “More robust coordination also could help in seeing that the financial statement footnotes are not used for expanded disclosures about forward-looking information.”
Earlier this month the Business Roundtable also published a position paper urging the SEC and Congress to return to traditional materiality standards for public company disclosures, rather than obfuscating this data with social concerns such as the conflict minerals rule.
“Investors also receive information that is irrelevant and distracting to their investment and voting decisions,” the group wrote. “Policymakers should maintain the materiality standard for determining what information public companies must disclose to investors. The time-tested standard is proven effective in protecting investors and helping them make informed investment and voting decisions.”
One idea the SEC is unlikely to incorporate into its forthcoming recommendations: doing away with quarterly reports in favor of annual or semi-annual filings. That push is underway in Britain as an antidote to “short-termism,” and trial balloons have been floated by such diverse figures as Hillary Clinton, a Democrat, and former SEC Commissioner Daniel Gallagher, a Republican.
Another high-profile proponent is Martin Lipton, founding partner of the law firm Wachtell, Lipton, Rosen & Katz. “While U.S. companies do not, as of yet, have the option of discontinuing quarterly reporting—though they do have discretion to decline giving quarterly earnings guidance—the SEC should keep [this] in mind in pursuing disclosure reform initiatives and otherwise acting to promote, rather than undermine, the ability of companies to pursue long-term strategies,” he says.