Congress has demanded—and many associated with the Securities and Exchange Commission agree—that the burdensome and complex disclosure regime for companies and their offered securities must be fixed.
In many ways, demands to streamline regulatory disclosures found in the JOBS Act and FAST Act had corporate interests at heart. Fewer disclosures—or at least modernized ones stripped of redundancy and busy work—would certainly be less burdensome and costly for filers.
Investor advocates, among them Sen. Elizabeth Warren (D-Mass.) have balked at the suggestion that there is “investor overload” or that “less is more” when it comes to disclosures. Politics aside, one thing is made abundantly clear by academic research: Financial literacy is lacking and investors deserve to have disclosures that are meaningful and easily comprehended.
It was with investors’ needs in mind that the SEC held an “Evidence Summit” on March 10. Organized by the Office of Investor Advocate, the event provided a forum to “discuss strategies for raising retail investors’ understanding of key investment characteristics such as fees, risks, returns, and conflicts of interest.”
Among the panels: “How can the SEC’s disclosure regime facilitate disclosure in the most effective manner for a wide variety of users?” The goal is a lofty one, experts warned.
Financial literacy is substandard among most of the public, they said. In large numbers, mutual fund investors don’t understand such concepts as buy and hold, asset mix, and compounded interest. Balancing risk profiles with performance goals is nearly unheard of amongst the general populace. Fees? Who even pays attention to them any more?
Rick Larrick, a professor at Duke University’s Fuqua School of Business, Duke University, compared problems deciphering financial data to comprehending the complexities of nutritional labeling.
“We don’t want to overwhelm people with cereal box information,” he said, expressing a need to “translate information that is otherwise obscure to something they care about.”
John Kozup, associate professor of marketing and business law at Villanova University added to the analogy. A health-conscious consumer may be well aware that trans fats are unhealthy. But how much is too much? Is three grams per serving high or low?
Without a comparison baseline, food labeling is nearly meaningless. That is also the case with financial disclosures and investment prospectuses.
“We are a 15-second sound bite, 140-character culture,” Kozup said. “We are exposed to 3,000 messages a day and, in the midst of all this clutter, we expect people to attend to disclosure. It is a heavy lift.”
“Even assuming that consumers are motivated to process disclosure information, do they have the ability?” he asked, lamenting “woefully inadequate financial literacy” and a widespread habit of “thinking we know more than we really do.”
Amid this backdrop, Kozup stressed the importance of financial advisers. “We’ve lost a generation to financial illiteracy. The financial adviser is important. Some will need somebody to hold their hand through the process. Having advisers integrated with FinTech and sound disclosure is going to result in a fully informed consumer.”
“With this new tool, we can gain better insights into the potential benefits to investors from proposed rule changes, and we will be able to help identify the best options amongst competing policy choices.”
Rick Fleming, Investor Advocate
“People want to be told what to do,” Kozup added. “At the end of the day, when faced with confusing information, steer them in the right direction, or beat them over the head with it, but people want to be told what to do.”
The myth of the reasonable investor
The SEC’s disclosure regime is challenged by its reliance on the idealistic concept of a “reasonable investor,” says Tom Lin, Associate Professor of Law, Temple University Beasley School of Law.
“The SEC’s disclosure regime is a profoundly optimistic one. At its heart is the premise that there is an ideal reader for disclosure, called a reasonable investor, a rational human being of average wealth and sophistication able to process financial information into a narrative for funds and entities of all types in the marketplace,” he said. “This convenient fiction obscures a larger more complex truth about a diverse investor population and disclosure.”
Real investors, Lin reminds, are incredibly diverse. “They are financiers and farmers, retirees and new workers, homemakers and fund managers, public employees and private … humans and, more and more, AI programs,” he said. “Yet, for all their diversity, securities regulation often treats them monolithically for the purposes of disclosure.”
This, he said, has led to a “regulatory mismatch” and “in reality, most real investors do not behave like the theoretical reasonable investors.”
“Real investors do not have perfect rationality,” he added. “They often do not have, or ignore, disclosures. To the extent they read them, they cannot process the information properly.”
The SEC should “start with a better recognition of the diverse investor population,” Lin said. “While perfect investor protection is a noble, but elusive goal, better investor protection is certainly achievable. An improved smarter disclosure framework that better accounts for the realities of a diverse investor population in a high-tech marketplace would be a step in the right direction.”
BRING ON THE HTML
The following is from a fact sheet detailing new Securities and Exchange Commission’s rules intended to ease investor access to exhibits in company filings.
The amendments require registrants that file registration statements or reports subject to the exhibit requirements under Item 601 of Regulation S-K, or that file Forms F-10 or 20-F, to include a hyperlink to each exhibit listed in the exhibit index of these filings, and to submit such registration statements and reports on EDGAR in HyperText Markup Language (HTML) format.
Registrants will be required to include a hyperlink to each exhibit identified in the exhibit index, unless the exhibit is filed in paper pursuant to a temporary or continuing hardship exemption under Rules 201 or 202 of Regulation S-T, or pursuant to Rule 311 of Regulation S-T.
This requirement will apply to the forms for which exhibits are required under Item 601 of Regulation S-K as well as Forms F-10 and 20-F. The final rules, however, will exclude exhibits that are filed with Form ABS-EE and exhibits filed in the eXtensive Business Reporting language (XBRL).
Registrants will be required to file in HTML format the registration statements and reports subject to the exhibit filing requirements under Item 601 of Regulation S-K, as well as Forms F-10 and 20-F, because the text-based American Standard Code for Information Interchange (ASCII) format cannot support functional hyperlinks. While the affected registration statements and reports will be required to be filed in HTML, registrants may continue to file in ASCII any schedules or forms that are not subject to the exhibit filing requirements under Item 601, such as proxy statements, or other documents included with a filing, such as an exhibit.
The final rules will provide a longer compliance date for non-accelerated filers and smaller reporting companies and for certain filings on Form 10-D. Under the final rules:
Non-accelerated filers and smaller reporting companies that submit filings in ASCII will not have to comply with the final rules until Sept. 1, 2018.
The compliance date for any Form 10-D filing that will require a hyperlink to an exhibit filed with Form ABS-EE will be delayed until SEC staff completes programming changes to EDGAR that will allow registrants to include the Form 10-D and Form ABS-EE in a single submission so that the required exhibit hyperlinks can be created at the time the Form 10-D is filed.
The SEC will publish a notice in the Federal Register and on the SEC website announcing the compliance date for those Form 10-D filings.
The use of XBRL (eXtensible Business Reporting Language) requirements will make it easier to provide user-friendly interactive disclosure interfaces, Lin added.
That last recommendation is exactly what the SEC is building toward.
Welcome to the machine
Earlier this month, the Commission adopted a requirement for registrants to include hyperlinks to the exhibits in their filings.
New amendments require registrants that file registration statements or reports subject to the exhibit requirements under Item 601 of Regulation S-K, or that file Forms F-10 or 20-F, to include a hyperlink to each exhibit listed in the exhibit index of these filings, and to submit registration statements and reports on EDGAR HTML format.
“This is a simple, yet profound, change,” SEC Acting Chairman Michael Piwowar said. “Currently, an investor seeking a company’s articles of incorporation, for example, might have to trawl manually through exhibit indices and dozens of archived filings.”
The effort, he said, “will bring the Commission further into the 21st Century by harnessing technology to improve the manner in which investors can access public company disclosure.”
The main reason for the hyperlinking requirement is a practical one. “It will make it easy for someone trying to find a company’s articles of incorporation, tax opinion, material contract, underwriting agreement or other exhibit,” Piwowar said. Currently, an investor trying to locate and access an exhibit that the registrant has incorporated by reference from a filing that it may have filed years earlier must check the exhibit index and search through the registrant’s previous filings to find and review the exhibit of interest. The search process can be cumbersome and time-consuming.
“Unfortunately, our document-driven, text-based disclosure system is increasingly obsolete in an age of big data, cloud computing, and machine learning,” Commissioner Kara Stein said before the March 1 vote.
The Commission also proposed a rule that, if adopted, would require the use of inline XBRL for financial statement information and mutual fund risk/return summary information.
Currently, this information is submitted as a separate interactive data file via the EDGAR system. “Not only would this rule improve the accessibility of disclosures, but it would also take advantage of developments in XBRL technology to reduce both regulatory costs and burdens,” Piwowar said.
“The recommendation continues our efforts to modernize reporting and to improve the accessibility of disclosures to the public,” he added. “The recommendation also reflects the Commission’s effort to use developments in XBRL technology to lower regulatory burdens and costs.”
For example, machine readable XBRL data allows investors and other market participants, including data service providers, to build comprehensive datasets and use analytical tools that include financial information from all covered filers.
The Commission also approved a requirement that foreign private issuers preparing their financial statements in accordance with IFRS, as issued by the IASB, submit their financial statements in XBRL format. Implementation is subject to a phase-in schedule, with an initial voluntary period followed by mandatory compliance for fiscal periods ending on or after Dec. 15, 2017.
If we are the investors’ advocate, we must continually ensure that we are in touch with the modern investor,” Stein said. “We must understand how today’s investors interact with our increasingly complex markets. We need to continuously strive to conduct outreach and use technology in order to identify gaps in investor protection, which may include, for example, gaps in investor financial literacy. In order to foster informed engagement by all investors, we need data, research, and analysis.”