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New Ideas on Disclosure Reform

Robert Herz | February 18, 2015

More than a year ago, the staff of the Securities and Exchange Commission released the results of a study mandated by the Jumpstart Our Business Startups Act (JOBS Act) on simplifying and modernizing disclosure requirements for “emerging growth companies.” The study recommended a more comprehensive review of the disclosure regime for all SEC registrants, not just emerging growth companies.

Since then, various senior SEC officials, including Chair Mary Jo White, have spoken publicly about this project, and various groups within the SEC have begun reviewing current disclosures rule and regulations. For example, each of the Assistant Director offices in the Division of Corporation Finance is reviewing specific disclosures in Regulation S-K, including each of the SEC Industry Guides. The Office of the Chief Accountant is reviewing the Regulation S-X requirements for filing separate financial statements of acquired businesses, equity investees, and guarantors, and the Office of the Chief Counsel is reviewing the Form 8-K requirements. Also, the staff is encouraging input from stakeholders through the Disclosure Effectiveness spotlight page on the SEC website.

This all seems like a good start to an important effort to improve, simplify, and modernize the SEC’s disclosure regime. I’m also mindful, however, of the rather checkered history over the past 20 years of various previous attempts by the SEC at broad reforms of its disclosure system—that ultimately did not result in significant simplification or modernization of the regime.

But maybe, just maybe, this time broader reforms are achievable.

I say that because I believe the December 2013 SEC report highlighted some overarching themes that would prove useful in guiding the current disclosure reform initiatives. These include a preference for principles-based disclosure requirements grounded in materiality, as opposed to detailed, specific line item requirements; and recognition of the need to eliminate outdated disclosure requirements and to reduce repetitive and redundant disclosures within SEC documents.

The idea of replacing the current periodic reporting system with a model where registrants maintain an “evergreen” file of standing information on the company, and then file real-time updates as events and circumstances arise, has been

mentioned. While this is not a new idea, advances in technology would seem to make this more possible now than in the past. And in that regard, the SEC through the XBRL filing program and other recent efforts aimed at improving its understanding and use of reporting technologies, may now be able to better assess the potential role of technology in modernizing, improving, and simplifying the disclosure system. These all seem like worthwhile avenues for the SEC staff to explore.  

We will have many challenges ahead in overhauling the current SEC reporting system. It will require careful analysis, thoughtful input from stakeholders, potential pilot testing of new approaches, and sustained leadership and perseverance by the Commission of the kind that didn’t seem to be present in prior efforts at meaningful disclosure reform.

Any project as large and complex as disclosure reform will have many devils in the details. Various groups have already given the SEC many interesting and constructive recommendations on potential changes to specific disclosure requirements. Along those lines, then, I offer my own high-level comments and suggestions regarding the disclosure reform initiative.

First, to improve the overall flow and organization of information in SEC filings, I support further evaluation of the idea to replace our current model of registration statements and periodic reports with one where registrants would prepare and maintain a file of standing data on the company and file timely updates as material events and circumstances arise.

Thus, for example, companies would first prepare the standing file. That would include (as currently required) current and comparative financial statements, and current governance and executive compensation information—all to be submitted upon filing for an initial public offering or otherwise initially registering with the SEC. Then would come the timely updated financial statements, governance and compensation information, and information on other material events along the lines of the current Form 8-K requirements. The information in these filings would update the company’s standing file.

As far as the flow, organization, and content of information in filings, I offer a few suggestions.

Framing the Discussion

First, if the SEC wants to develop a more principles-based approach to disclosure than exists now, while also enhancing the overall readability, understandability, and usefulness of documents filed with the Commission, it should look carefully at the International Integrated Reporting Framework released by the International Integrated Reporting Council in 2013 and actual examples of corporate reports using that framework.

The framework, developed by a coalition of international bodies and stakeholders in corporate reporting, applies principles and concepts that are focused on bringing greater cohesion and efficiency to the reporting process and to improving the relevance of financial and other material corporate information communicated to investors and other providers of financial capital. It was developed through extensive consultation and pilot testing by 140 businesses and investors from many countries, including U.S. companies and investors. While a good deal of the information contained in integrated reports is currently required in one or more SEC filings, in my view the IIRC Framework provides a potentially better way to organize and “integrate” the communication of material information relating to a reporting company’s environment, the risks and opportunities it faces, its strategy and business models, how it is governed, its current performance and prospects, and overall how it creates value over various time horizons.

Some of the information in integrated reports goes beyond what is currently contained in most SEC filings, including information on key non-financial performance indicators and value drivers. One example: data on environmental, social, and governance matters addressed by the U.S.-based Sustainability Accounting Standards Board, in its ongoing work to develop voluntary industry-based standards for reporting material ESG information in SEC filings.

Adopting an integrated reporting framework and incorporating more systematic reporting of information on material non-financial performance information and value drivers would be a significant (albeit challenging) step forward in improving and modernizing the SEC reporting regime. It could also help reduce the extent of repetitive and redundant information in SEC documents. Elimination of redundant information between the financial statements and other parts of filings will require the SEC staff to work closely with the Financial Accounting Standards Board and (in the case of filings by foreign registrants) with the International Accounting Standards Board. In that regard, both FASB and IASB have ongoing projects aimed at improving the effectiveness of disclosures in financial statements.     

Finally, as I have done in prior columns, I would encourage the SEC staff to continue to explore how the power of modern reporting technologies can be brought to bear on modernizing, simplifying, and improving the reporting of information in SEC filings and the accessibility and use of this information by investors and other stakeholders in the reporting system.                                                                     

We will have many challenges ahead in overhauling the current SEC reporting system. It will require careful analysis, thoughtful input from stakeholders, potential pilot testing of new approaches, and sustained leadership and perseverance by the Commission of the kind that didn’t seem to be present in prior efforts at meaningful disclosure reform.

In discussing this topic with interested parties, some are understandably skeptical about the chances of meaningful change, saying words to the effect that “it will get lawyered to death.” But some lawyers are encouraging real reform. For example, in a letter dated Sept. 3, 2014, to Keith Higgins, director of the SEC Division of Corporation Finance, the Committee on Financial Reporting of the Bar of the City of New York suggested the SEC add a simple rule to its existing disclosure requirements that would state: “Provide an overview describing what happened at the company over the past year, and your expectations and concerns about the year to come.”

The letter adds, “That’s it. No definitions. No detailed disclosure requirements. No boxes to be checked. Just a rule that calls upon companies to describe what’s going on.” Bravo!

Moreover, as Alan Beller, an eminent securities lawyer, stated in various speeches about a decade ago when he headed the SEC Division of Corporation Finance, “Disclosure is too important to be left solely to lawyers.” From the public statements of current SEC officials, I sense a willingness and genuine desire for meaningful disclosure reform. Time will tell whether that enthusiasm will be sustained.