If the Securities and Exchange Commission has learned anything from past unsuccessful attempts to overhaul its disclosure regime it is this: build consensus. That approach manifested with a recent Concept Release seeking public comment on nearly 350 questions regarding the Commission’s Regulation S-K review.
At last week’s Compliance Week 2016 conference in Washington D.C., Karen Garnett, associate director of disclosure operations for the SEC’s Division of Corporate Finance, headlined a panel discussion on the process thus far. Joining her were Aaron Briggs, executive counsel for corporate, securities and finance at GE; and Tom Lin, a professor at Temple University’s Beasley School of Law who studies disclosure and its evolution.
Over thirty years ago, the Commission expanded and reorganized Regulation S-K to be the central repository for non-financial statement disclosure requirements. The recent release is part of the Commission’s ongoing Disclosure Effectiveness Initiative, a review of the requirements, presentation, and delivery of disclosures. The effort was mandated by the JOBS Act and nudged forward by the recent FAST Act, which mandated that the SEC “determine how best to modernize and simplify such requirements in a manner that reduces the costs and burdens on issuers while still providing all material information.”
Discussions sparked by the Concept Release include considerations of both content and delivery, Garnett said.
“The Commission is really seeking to understand how do investors get information,” she explained. “Do they look at the SEC filings? Do they look to other sources to understand the companies they are investing in?”
“The Commission is really seeking to understand how do investors get information.Do they look at the SEC filings? Do they look to other sources to understand the companies they are investing in?”
Karen Garnett, Associate Direcor of Disclosure Operations, SEC Division of Corporate Finance
A self-described focus of Lin’s studies is the effect of new technology on financial regulation and “researching what the SECs bedrock principle of full disclosure means in a marketplace where most of the investment decisions are being made by smart machines in a marketplace where the investor population is more diverse than ever.”
“How can we begin to reimagine and recreate the current disclosure regime for a new marketplace where there are so many types of ‘reasonable investors’?” he asked. “Much of what is contained in the concept release represents steps in the right direction.”
Lin said he will watch closely to see how both the Commission and business world come together and leverage new technology in ways that make it easier for investors to protect themselves, while balancing cost considerations to make it easier for smaller companies to raise capital.
Briggs elaborated upon moves by GE in recent years to tackle disclosure improvements on its own. Among the efforts was a 2007 overhaul on proxy materials. It carved away “legalese” and focused on plain English, “being conversational and authentic.” The document included an initial, 60- to 80-page summary of that year’s most critical information. Investors could begin with that summary or “dive as deep into the details as they wanted in the back of the document,” Briggs said.
More recent efforts have focused on “layered disclosure” and creating a more easily skimmed document without sacrificing full content. “These documents are traditionally just pages and pages of paragraphs that go on and on without a heading or bullet points,” Briggs said. “We added in a lot of active, descriptive headings so you can go through the document in 10 minutes to get the gist of what our story is, and then delve into the details however and whenever you want.”
Spurred and supported by GE’s board and senior management, efforts turned to a 10-K overhaul and crafting more visual earnings releases for the past two years.
“It is amazing how much quicker you can understand the information being presented when you are not trying to read through a dense paragraph,” Briggs said, adding that the new 10-K is more forward looking. “When you think of traditional 10-Ks, they are usually more backward-looking, reporting on the last year or past three years. What investors want to see, based on our conversations with them, is much more forward-looking: Where is the business headed and how are we going to get there?”
As for risk factors, GE leadership decided to offer a summary in the 10-K of its four most critical risks for investors on an enterprise-wide basis. “You really need to distill the information down to help investors focus on what really matters and what management thinks matters,” Briggs said. The back of the document includes a 10-K cross-referencing index to further improve navigability.
Garnett discussed the debates fielded by the SEC on improving risk factor disclosures. One of the ideas the Concept Release raises is combining discussions of risk and risk management, “so the current disclosure requirements only speak to material risks.”
Such a discussion is usually found elsewhere in the filing, but integration of this sort is not required. Garnett concedes, however, that this move may not solve “the kitchen sink problem” of companies spewing forth any risks they can think of, no matter how likely or relevant they may be.
“Another question we raise in the Concept Release is whether investors are really bothered by having lengthy risk factor disclosures,” she says. “It is certainly a cost for companies in providing lengthy disclosures, but the comments we received prior to issuing the Concept Release suggest that investors would prefer more, not less disclosure.”
Another question: Should management be required to either rank risk factors or assign some sort of probability to them? Lin agreed with the goal of improving the quality of risk disclosures, even if quality reductions are harder to come by. While companies understand the need to inform investors, the disclosures have become “a cheap form of insurance.”
“They can provide lots of coverage for themselves by disclosing all these risks, so that if a stock should tank for some reason they can say, ‘Look, you were informed about this risk that manifested.’ The danger in doing that is you end up having lengthy, boilerplate language that is not specific to the firm or helpful to investors,” Lin said.
HOW TO COMMENT
Below is information on how to comment on the SEC’s Concept Release.
Comments should be received on orbefore [Insert date 90 days after publication in the Federal Register].
Comments may be submitted by any of thefollowing methods:
Use the Commission’s Internet comment form (http://www.sec.gov/rules/concept.shtml);
Send an e-mail to email@example.com. Please include File Number S7-06-16 on the subject line; or
Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.
Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.
Allsubmissions should refer to File Number S7-06-16. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method of submission. The Commission will post all comments on the Commission’s website (http://www.sec.gov/rules/concept.shtml). Comments also are available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street, NE, Washington, DC 20549, on official business days between the hours of 10:00 am and 3:00 pm. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make publicly available.
Lin’s suggestion is that companies both rank risk and make it easier for all investors to track them over time. “If risk profiles change from year to year there is no easy way to see those changes,” he said. Hedge funds and institutional investors have software that can automatically do multi-year comparisons for them, but the average investor doesn’t have that. If there is some way, via coding, to highlight changes that would be a small, yet powerful step in the right direction.”
Lin pointed out that, risk disclosures aside, the average Fortune 500 company’s annual report has ballooned from about 16 pages on average in 1950 to 180 pages today. “I know business has become more complicated, I’m just not sure it is 10 times more complicated,” he said.
Briggs suggests that more companies show investors a related breakdown of board committee responsibilities that also maps risk mitigation to other corporate functions.
“The idea is to provide information in a more easily digestible form, but then making sure investors are getting a complete picture and not just the highlight reel,” Garnett said.
As for sustainability reporting, the growing number of organizations calling for sustainability reporting could mean reporting on 100 different metrics and “that’s not without cost,” Briggs said. GE’s approach, which includes a separate sustainability repot and integrated reporting document, is to “focus on the governance framework and give you a snapshot of what we think are 15 or so critical sustainability measures for the company.”
The SEC understands the push by some investors to change corporate behavior by “pushing very hard for increased sustainability disclosure requirements,” Garnett said. A goal is to determine what particular sustainability issues that would be material to investors and narrow down detailed, industry-specific reporting frameworks.
Another debate prompted by the Concept Release: having a principles-based or prescriptive approach to disclosure rules.
The answer, realistically, will be a combination of both. On one hand, a principles-based approach provides the most flexibility and enables companies to focus their disclosures on the information that is most relevant to investors; that contrasts with the improved comparability line item provided for by disclosures.
“You can’t just have pure rules and pure line item disclosure items for a regulatory regime that oversees hundreds of thousands of companies and industries,” Lin said.
Briggs asked: “How do you write rules for a $250 billion company, as well as a $50 million company on a line item basis?”
“One of the dangers with the line item rules is that they become stale over time and would need to be redone,” he added. “That being said, one hybrid approach might be similar to what the SEC did in the proxy with narrative discussion of compensation. It is principles-based, but they give you some examples of the types of things they expect to see in your disclosures. At least it gives some sort of a framework.”
“If there is concern that a principles-based approach is not eliciting sufficiently detailed disclosures, maybe the answer lies in more staff guidance as opposed to more rigid rulemaking to elicit that disclosure,” Garnett said.
What’s next? Garnett stressed that current work falls into what is a first phase of the initiative. It will be followed by a second effort that will address what wasn’t included in the current Concept Release, most notably disclosure requirements that relate to governance and executive compensation. A modernization of longstanding, and long-unchanged, industry-based financial reporting guides is also likely.
The SEC is also considering ways to address overlapping disclosure requirements with GAAP and Financial Accounting Standards Board accounting standards. “We are looking at areas where we can maybe reduce some of that overlap and duplication and also looking, very technically, at whether there are requirements that are simply outdated,” Garnett said.
Also on the horizon: SEC Chair Mary Jo White has asked for the creation of a new committee to look at how new and emerging technology may lead to improvements in how disclosure data is delivered to investors.