Better disclosure doesn’t necessarily mean less disclosure, but the Securities and Exchange Commission has still sent a fresh reminder to companies that trying to prune back their annual financial statements is a good idea.
In remarks at an American Institute of Certified Public Accountants national conference, Cicely LaMothe, an associate director in the SEC Division of Corporation Finance, offered some tips on what companies can do now (ahead of any potential SEC rulemaking) to make disclosures easier to digest. Some of her suggestions: Use cross-references to reduce word count; don’t react to SEC comments with an automatic addition of text; and don’t assume the SEC will object if you trim your disclosures.
Acknowledging that companies might face audit issues if they cross-reference information inside financial statements with other information outside the scope of the audit, LaMothe encouraged companies to give it a try. “We are aware there are some registrants that seem to have navigated those challenges in practice,” she said.
That applies especially to the significant duplication the SEC sees in the statement of significant accounting policies and the discussion of critical accounting estimates in Management Discussion and Analysis, LaMothe said. To illustrate the redundancy, she said the staff analyzed both disclosures in one large filing and found more than 3,000 words that were identical across the two pronouncements.
“My view of disclosure effectiveness has changed even in the last few years. My initial reaction as a preparer is to just get rid of pages. But as I delve into what’s the premise of the compliance document I’m preparing here, it’s to protect investors and to really explain to prospective shareholders what my business is about.”
DawnDee Hankel, Controller, Intel
“Only one sentence was different,” she said. “That’s not what was intended.”
CorpFIn Director Keith Higgins reminded companies to consider the purpose of a disclosure to help them hone it. “The purpose of the critical accounting estimates disclosure is to tell investors what it is about the estimates embedded in the financial statements that makes them highly uncertain or subject to change,” he said.
LaMothe conceded that the SEC’s review and comment process may have contributed to over-disclosure over time. “We’re going to have to be diligent in avoiding comments where we’re instructing companies to add disclosures on pages 4, 30, and 167,” she said. “We recognize we’re going to have to take a look at our process as well.”
The SEC is in the midst of a comprehensive process to reconsider financial statement disclosure requirements, seeking ways to assure disclosures are more effective in helping investors understand the underlying economics of a given company. DawnDee Hankel, controller for external reporting at Intel, had some perspective for the SEC to consider. “My view of disclosure effectiveness has changed even in the last few years,” she said. “My initial reaction as a preparer is to just get rid of pages. But as I delve into what’s the premise of the compliance document I’m preparing here, it’s to protect investors and to really explain to prospective shareholders what my business is about.”
Getting to the Good Stuff
Hankel said Intel undertook an effort to reduce the page count of its annual filing, but the process morphed into how to make the message more succinct, she said. In the front half—the portion not subject to audit—the company typically relied on a recitation of its product releases to fulfill its disclosure requirements, she said, and that’s not an uncommon strategy. She and her team worked with the audit committee and legal department on how to recast the front section, to make it more focused and provide good information to readers of financial statements.
SAMPLING OF COMMENTS
Below are some of the comments the SEC has received on disclosure effectiveness.
Specifically, we respectfully request that you provide: (1) An update as to the status of, and a timeline for, the SEC’s overall industry guide review, and in particular Guide 7. (2) An update as to the status of, and a timeline for, any outreach you have done or plan on doing to the mining industry and other stakeholders, including investors, to get their thoughts on what would be helpful disclosure with respect to the mining industry? (3) An update as to the status of, and a timeline for, when you hope to provide the revised industry guides to the public.
—Sens. Dean Heller (R-NV), Mike Crapo (R-ID), Jon Tester (D-Mont.)
We support the SEC’s initiative on disclosure effectiveness and are hopeful that it will lead to meaningful changes that will benefit both investors and preparers. If the Commission is looking for a few “quickhitters” in terms of reducing redundant information in the Form 10-K, we would recommend the following: (1) Eliminate the prior year in review requirement in the Management Discussion and Analysis. For example, in the 2013 10-K, the requirement to include an analysis of 2012 versus 2011 performance. This information is presented in detail and available in the prior year 10-K; (2) Eliminate the 2-yr quarterly information table, including the stock price information. Similar to the item above, this information has been previously reported and is available for investors.
—Gregg Nelson, VP Accounting Policy Financial Reporting, IBM Corp.
We agree that a comprehensive disclosure review is appropriate as we believe that there are significant gaps in current disclosure practices, and certainly some reporting processes and requirements need to be updated to reflect the rapid technological and marketplace changes since the last review.
However, the agency should prioritize ongoing rulemaking duties, particularly the long-delayed implementation of new corporate governance rules as required under Dodd-Frank, as this implementation would significantly reduce disclosure deficiencies. We believe that these rules should be made a priority, and that the Dodd-Frank Act should be taken into consideration when mandating any revision to disclosure rules. Some of the rules mandated by the act seem to be in danger of going by the wayside, including new required disclosures concerning executive compensation—a rule we believe is crucial to our evaluation of appropriate corporate governance and management.
We are also concerned that comments made as part of the initial report are focused on cutting back on disclosure requirements to the benefit of issuers. While there are certainly many opportunities to streamline reporting and eliminating duplication and nonmaterial information, we hope that the review is truly focused on the effectiveness of disclosure and the needs of investors.
—Holly Testa, Director, Shareowner Advocacy
We believe that the Division should conduct its review in the context of three key developments that we believe affect disclosure effectiveness most significantly: (1) Availability of Information. The internet has put vast amounts of information at investors’ fingertips. A multitude of reputable organizations publish for free information which can, and does, serve to educate investors about economic trends, companies, and the industries in which they operation; (2) Instantaneous Communications. Advances in communications technology have made the dissemination of news nearly instantaneous and constant. Annual, quarterly, and current reports on Form 8-K are only one source of information about an issuer in today’s communications environment; (3) Institutionalization of Stock Ownership. Institutional investors held 67% of equities in 2010. These investment managers are highly sophisticated, and the type of information that they use in making investment decisions differs in many ways from information issuers provide in response to Regulation S-K and periodic reports.
—Shearman & Sterling
“With the back half of the document, we had significant discussion with our auditors, and we didn’t make significant inroads there,” she said. In that portion of the filing, disclosures are driven by rule requirements, but pay little heed to materiality, she said.
Hankel lamented that Intel gives seven pages of pension footnote disclosures, when that costs is only 4 percent of net income. Meanwhile, she said, “I give about one half of a page of combined R&D, inventory, and fixed asset disclosure. Half a page. That’s my entire business.” She believes rulemaking focused on the latest crisis of the day has heaped on disclosure requirements that make it difficult for companies to focus on what’s material.
If preparers were able to convince auditors to let them curtail disclosure of matters clearly immaterial, that would lead to new internal controls over disclosures to monitor and evaluate when an item should become material and need to be disclosed, Hankel said. So preparers give in to the audit pressure and disclose more rather than less. “It’s not worth the debate and the monitoring,” she said.
Brian Lane, a partner at law firm Gibson, Dunn & Crutcher and a former CorpFin director, said some companies provide model disclosures in MD&A meant to explain the business to investors. Liquor company Brown-Forman’s latest Form 10-Q, at a slim 30 pages, is “fascinating,” he said. The company provides introductions and executive summaries using bullet points and graphics that tell the story of its overall performance, broken out by brand and geographic area. “When do you ever see something like that?” he asked. “You don’t, so hats off to Brown-Forman.”
Energy company AES provides an entire section in its latest filing on the company’s strategy, Lane said, as does toy maker Mattel. “It says this is what the company really cares about, and this is how we’re going to grow the business and what we’re going to focus on,” he said. General Electric provides an interesting feature, Lane said, in its use of bullet points to explain its recent financial highlights and significant developments. “When you want to create readability, bullet lists are king,” he said.
Mark Kronforst, chief accountant in CorpFin at the SEC, said the SEC’s efforts to examine disclosures and make them more effective is in its early stages. The staff is working on a concept release but has not said when it will be issued. So far, the staff is getting some varied feedback.
“Different types of investors want different things,” he said. “Some want it to be principles-based, some don’t. I’m not sure we’re going to put our finger on the scale and say, ‘Here’s what disclosure effectiveness is. Our role is to at least identify some broad alternatives. I don’t know where this is going to lead.”