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How Congress Is Misusing the Reporting System

Scott Taub | September 25, 2012

The closest thing The Securities and Exchange Commission has to an official motto is former Chairman William Douglas's decree: “We are the investor's advocate.”

Anyone with financial knowledge can quickly identify the target audience of SEC filings to be investors, and would describe the goal of those filings as providing information to investors to help them make better decisions. Of course, the reporting requirements are intended to balance the cost of assembling that information with its benefit to investors.

These ideas are generally well-known and widely accepted, but not by the United States Congress. I have criticized Congress before, in particular over the rollback of internal control reporting requirements that was shoehorned into the Dodd-Frank Act, apparently based on cost-benefit concerns. But some other recent Congressional actions suggest that Congress is unaware of the purpose of SEC reporting entirely—or, more likely, just ignores it when it proves inconvenient.

The SEC finalized rules implementing two more provisions of Dodd-Frank in August. The first requires public companies to disclose their use of so-called “conflict minerals” that originated in the Democratic Republic of the Congo or an adjoining country. According to Dodd-Frank, the reason behind the rules is “… the sense of Congress that the exploitation and trade of conflict minerals originating in the Democratic Republic of the Congo is helping to finance conflict characterized by extreme levels of violence in the eastern Democratic Republic of the Congo, particularly sexual- and gender-based violence, and contributing to an emergency humanitarian situation therein, warranting …” additional disclosures.

I have no reason to doubt the “sense of Congress” that these payments are contributing to the heinous actions described, but the line from that concern to the new disclosure requirements is not at all straight. The SEC's release accompanying the rule notes that “… we understand Congress's main purpose to have been to attempt to inhibit the ability of armed groups in the Covered Countries to fund their activities by exploiting the trade in conflict minerals.” A noble purpose to be sure, but why are public company reporting requirements the right tool to use for this?

The second Dodd-Frank related rule recently finalized requires public companies involved in resource extraction—mostly mining, oil, and gas companies—to disclose certain payments made to U.S. or foreign governments. The SEC release notes that Congress enacted this section of the Dodd-Frank Act to increase the transparency of payments made by resource extraction companies to governments “…to help empower citizens of those resource-rich countries to hold their governments accountable for the wealth generated by those resources.”  

I'm all for holding governments accountable—heck, that's what this very column is about. But again, somebody needs to explain to me why SEC filing requirements are the right place for this stuff.

Why does anybody think that the SEC has the expertise necessary to write effective rules for the disclosure of payments related to conflict minerals or payments made to governments? The SEC deals with investors and markets, not foreign policy.

Is funding of violence only wrong for publicly-traded companies? Isn't the wealth being provided to governments that sell mineral rights just the same if the payments come from private companies? And if the payments are leading to violence, why not stop the payments, instead of just requiring their disclosure by certain companies?  Also, why does anybody think that the SEC has the expertise necessary to write effective rules for the disclosure of payments related to conflict minerals or payments made to governments? The SEC deals with investors and markets, not foreign policy.

Sure, one could simply say, as I'm sure many in Congress have rationalized, that these problems are important enough to confront in any way possible, and since the public company reporting framework already exists, it's easier to just slip it in there instead of setting up something new. The disclosure will be incomplete and inefficient, but, hey, at least we are doing something, right? And even if these disclosures aren't investor-focused, they don't take away any other information, and it's certainly possible that some investors will be interested—some comment letters to the conflict mineral proposal did suggest that investors would be interested.

But these disclosures dilute the purpose of SEC filings. By adding to the cost of being a public company to address an issue that is unrelated to being a public company, these requirements put up an artificial barrier to going public. By forcing the SEC to spend time and effort in areas where it has no expertise, these requirements make it harder for the SEC to actually perform its core mission of protecting investors. And finally, by adding to public filings information not based on investor needs, these requirements make investors slog through information mostly unrelated to their investment decisions to get to the information they want.

Worst of all, the misuse of SEC filings for these purposes, even if it doesn't necessarily harm investors, encourages misuses that do harm investors, like the misnamed Jumpstart Our Business Startups Act.

Less Disclosure

As much as I dislike shoehorning disclosures for conflict mineral and extractive industry government payments into the public company reporting requirements, they pale in comparison to the absolute abuses of public company reporting brought about by the JOBS Act.  Much has been written questioning whether it will promote job growth and if Congress actually believes it will promote job growth, as opposed to just rewarding Wall Street for ruining the economy five years ago. But even if I presume that Congress believes that the JOBS Act provisions related to financial reports will promote job growth, I can see that those provisions make a mockery of the intent of SEC reporting.

The JOBS Act allows a large swath of companies seeking to go public to do so with two years of audited financial statements instead of three, lets them adopt new accounting standards on the schedule applied to private companies instead of public companies, and exempts them from being required to report even unaudited information for periods before the required audited information. It also allows such companies to skip certain compensation disclosures and auditor reports on internal controls. All of these easier reporting requirements can continue for up to five years after the company goes public.

So Congress decided to take information away from the public markets in an attempt to create jobs. Even if that is the genuine purpose of the provisions, it's a travesty. Deliberately harming the investing public in order to allow companies to grow faster completely rewrites the purpose of SEC reports. It's a pretty cynical bet by Congress that says we can increase the amount of capital available by allowing companies to get it from less informed investors. If the private-equity entities, after significant due diligence, haven't been willing to finance these companies despite lots of available capital, the only way the JOBS Act works is if less informed people are willing to put their money where more informed people are not.

Congress has explicitly decided to trade investor protection for job-creation, and is forcing the SEC, the investor-protection agency, to write the rules to implement it. Again, that's time away from the SEC's core mission. And again, investors have their source of information co-opted for other purposes.

How Do You Feel?

I suspect that many corporate interests agree with my complaints about the conflict mineral and extraction industry payment disclosures. But those same interests are likely to see the JOBS Act reporting reductions as a boon to business with little or no cost to the American people.

Investors, on the other hand, are more likely to agree with me on the evils of reduced reporting requirements for the terribly-misnamed “Emerging Growth Companies,” but probably did not speak up to try to get the conflict mineral and extraction industry payment disclosures out of public reports.

Too often, we applaud Congress for ignoring principle when the result furthers our own views and interests, while criticizing the same violations of principle when they harm us.  

The purpose of SEC filings and public company financial reporting is providing information to investors. Congress should stop using the system for other purposes. To do so will undoubtedly erode the strength of our markets while addressing the other purposes in a diluted manner at best. It's bad enough that the tax code is routinely used for purposes other than to fairly finance government. Let's not have financial reporting continually misused as well. After all, it wasn't much more than 15 years ago that accounting standards were deliberately written to encourage loan securitization. That didn't work out so well.