Amid discussion about reforms to the Securities and Exchange Commission’s disclosure regime, perhaps no idea is as controversial as the rethinking of how frequently companies must disclose financial information.
While it may seem a cornerstone of public filings, quarterly 10-Q financial statements have only been an SEC requirement since 1970. There is now a push to turn back the clock, with concerns that a standard reporting timetable encourages short-term thinking by investors and company management. Adding a twist to the argument, regulators in the United Kingdom stopped mandating that companies provide quarterly financial reports to investors, a decision meant to alleviate an unnecessary regulatory burden that, at least in popular opinion, failed to provide useful or meaningful information.
For the most part, discussions about moving quarterly reporting in the U.S. to a biannual requirement have been high-level and academic. Nevertheless, there are recent indications that the proposal is, at the very least, earning serious consideration.
During a Jan. 21 speech in London, Keith Higgins, director of the SEC’s Division of Corporation Finance, tiptoed into the debate over interim reporting. “The need for such re-examination may be especially appropriate for smaller reporting companies because of the burdens associated with providing financial statements every three months,” he said.
Leading the charge for change is Martin Lipton, a founding partner of 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 consider “disclosure reform initiatives and otherwise acting to promote, rather than undermine, the ability of companies to pursue long-term strategies,” he wrote in a memo last year.
Democratic Presidential Candidate Hillary Clinton has also incorporated the concept into campaign talking points that decry corporate “short-termism.” In a recent speech, she criticized “quarterly capitalism.”
“Today’s marketplace focuses too much on the short term, like second-to-second financial trading, and quarterly earnings reports, and too little on long-term investments,” she said.
Critics, however, see no need to tinker with what has been a successful disclosure model. Among them are Robert Pozen, a senior lecturer at MIT’s Sloan School of Management, and Mark Roe, a professor at Harvard Law School.
“While U.S. companies do not, as of yet, have the option of discontinuing quarterly reporting, [the SEC should consider] disclosure reform initiatives and otherwise acting to promote, rather than undermine, the ability of companies to pursue long-term strategies.”
Martin Lipton, Founding Partner, Wachtell, Lipton, Rosen & Katz
“With semiannual reporting, actual earnings will more frequently drift further away from management’s projections, giving companies more reason to smooth earnings semi-annually,” they recently wrote. “Worse, with companies going dark for six months, the gap between inside information and public information will widen—increasing the temptation for insider trading.”
Eliminating quarterly reporting “would deprive investors and analysts of much-needed information in a fast-moving economy, and it would do little to push companies into better long-term investments,” they added. “Streamlined quarterly filings, dovetailed with today’s typical earnings release, would be less expensive and time consuming, while providing investors with more focused disclosure of important company information.”
In September, members of the SEC’s Advisory Committee on Small and Emerging Companies jumped into the fray, discussing interim reporting but stopping short of a recommendation.
“I would agree that short-termism is a problem, but I think that the quarterly reporting cycle is an enabler of it,” said Dan Chace, lead portfolio manager of the Wasatch Micro Cap Fund. “It is not the cause of it…we have talked in the past about reducing the amount of disclosure that goes along with it and making it easier, but I like getting the financials every quarter.”
“There are a lot of companies who do not permit trading by insiders except during certain windows, which open upon filing of quarterly financials and then close maybe 10 days later,” warned Sara Hanks, CEO of CrowdCheck. “One of the things we should just bear in mind is that, to the extent we did away with the Q's and had only semiannual, you would be permitting those insiders only to trade during much narrow windows during the year.”
MUCH ADO ABOUT DISCLOSURE
The following is an excerpt from a Jan. 21 speech by Keith Higgins, director of the Securities and Exchange Commission’s Division of Corporation Finance.
I would like to make a few remarks about interim reporting. The United Kingdom has stopped mandating that companies provide quarterly financial reports to investors. Lately, some commentators have asked the Commission to re-think the need for quarterly reporting by U.S. issuers, which has been a staple of the U.S. regulatory system since 1970, advocating that this frequency leads to short-term thinking by investors and company management.
These commentators note that financial reporting that focuses on short-term performance is not conducive to building sustainable businesses because it steers management to focus on short-term goals and performance. Other commentators oppose a change in this area arguing that replacing quarterly with semi-annual reporting will not induce management to make longer-term business decisions and will increase the temptation for insider trading.
The need for such re-examination may be especially appropriate for smaller reporting companies because of the burdens associated with providing financial statements every three months.
This focus on interim reporting is not new. In April 2004, one of my predecessors, Alan Beller, addressed this subject in his speech about Regulation in a Global Environment in Berlin, Germany, expressing then some skepticism about the arguments in favor of semi-annual reporting. Members of the SEC Advisory Committee on Small and Emerging Companies discussed the pros and cons of discontinuing quarterly reporting at length during the Committee’s meeting on September 23, 2015. Although this discussion has not resulted in a formal recommendation to the Commission, the debates and research in this subject area are likely to continue in the future.
Source: Keith Higgins, SEC
She also urged booth committee members and SEC commissioners to keep in mind that smaller companies “are a little more volatile on a quarterly basis, and, therefore, the Q's do play a role in giving an early warning system to something that could be going on.”
Of course, there will also be foot-stomping from those who benefit from more frequent reporting. “Part of me that says this will never have a chance of going anywhere because the PCAOB, the lawyers, and others are going to be lining to say, ‘No, no, no, no, no, no.’ Now, come on. We are here to help you. We are here to save you,’” said Christine Jacobs, co-chairman of the committee. “I think there is an awful lot lined up against this idea because there are whole industries set up to keep us on that quarterly schedule," she said, adding that she also questioned the effect less-frequent reporting would have on market liquidity.
There are certainly pros and cons that must be considered when it comes to quarterly reporting, says Anna Pinedo, a partner at law firm Morrison Foerster.
Already some are reacting. The New York Stock Exchange recently sent notice to its listed companies that it plans a rule change to require that foreign private issuers file quarterly results, no matter what the U.K. may demand. “They feel presenting the quarterly reports is important because analysts expect and investors, particularly large institutional investors, expect to hear those results,” Pinedo says.
It is also interesting to see that, in Europe, companies are considering the concept of loyalty shares, rewarding long-term shareholders by giving them additional stock or voting rights,” she says. When Ferrari issued an American IPO last summer, it became the first company to bring the concept here. Investors who buy in to the IPO would qualify to join the loyalty program in three years, a perk that gives them two votes for every share they hold at annual meeting.
“It does seem to suggest that maybe we should be heading in the direction of finding ways to reward long-term shareholders, whether it is through the model of the loyalty shares, super voting rights for investors who hold for more than a certain period of time as the carrot, or whether its not requiring companies to report on a quarterly basis,” Pinedo said. “I do think it is time for something to happen, I’m not sure what the right mix of tools and incentives is, but all of them should be under consideration.”