How to improve, modernize and—perhaps—simplify the Securities and Exchange Commission’s disclosure regime has long been the Holy Grail of securities law. Corporate filings, many bemoan, have become bloated and nearly impenetrable for the average investor, forcing them to wade through voluminous documents filled with lawyer-pleasing redundancies and an everything-but-the-kitchen-sink approach to financial information and risk factors.
Attempts at reform have come and gone over the years with only occasional and limited success. Now, however, one of the most ambitious efforts is yet gaining traction. On April 13, the SEC voted to publish a Concept Release seeking public comment on nearly 350 questions about modernizing disclosures required under Regulation S-K. Over thirty years ago, the Commission expanded and reorganized Reg S-K to be the central repository for non-financial statement disclosure requirements.
The concept release is part of the SEC’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.”
In announcing the Concept Release, SEC Chairman Mary Jo White explained that it “explores how the Commission could improve the readability and navigability of company disclosures,” inviting comment on various formats used to present information, such as tables and structured data, as well as different tools used to deliver disclosure, including cross-referencing, incorporation by reference, hyperlinks, and company websites.
Among the discussions sparked by the release: taking a principles-based versus prescriptive, rules-based approach; the appropriateness of scaled disclosure requirements and further concessions to emerging growth companies (with less than $1 billion in annual revenue) or other categories of companies; the methods of information delivery and presentation; and ways to present information to improve readability and navigability, while discouraging repetition and immaterial information. Mixed into the broad topics are discussions of other “line-item” disclosures, such as reporting on environmental or social justice matters.
A core dilemma throughout any such effort, and one the Concept Release addresses, is to answer the difficult question of who disclosures are intended for. On one side are institutional investors and savvy Wall Street pros who want all the data they can glean; the other audience includes retail investors who may be befuddled by the current array of filings.
“You can’t please everybody, and the Concept Release appropriately asks who we should be writing these for,” says Anna Pinedo, a partner at law firm Morrison Foerster. “Are these for the financial analyst community, or for the average retail investor? At what level should one pitch the disclosures? When we are trying to put together an IPO registration statement or something along those lines, we give a lot of thought to that question and it is difficult to strike the right balance.”
“At what level should one pitch the disclosures? When we are trying to put together an IPO registration statement or something along those lines, we give a lot of thought to that question and it is difficult to strike the right balance.”
Anna Pinedo, Partner, Morrison Foerster
The dilemma is especially daunting for companies based on proprietary technology, such as life sciences companies, where their intellectual property is relatively complex and “it is difficult to not get the science wrong and make mistakes when attempting to reduce things to plain English, or gloss over details that would be important in terms of a scientist or research analyst reading it,” she says. “It is an important question, but I’m not sure there is a great answer for it.”
Pinedo is encouraged by the Concept Release in that is shows the SEC is serious in its efforts to help companies avoid unnecessary repetition and is “encouraging them to avoid including risk factors just for the sake of including them and adding ones that are common to every company.”
“Executives and boards of directors, obviously, face a lot of scrutiny and are always concerned about cutting back disclosures and whether eliminating some exposes the company in any way to potential litigation risks,” she says.
The SEC’s effort also looks at how disclosures are organized. Pinedo sees great value in potentially putting all risk disclosures in one place. “It makes complete sense,” she says. “Why do we have risk factors and then, separately, market risks way back in the Management Discussion and Analysis?”
The debate over having a principles-based or prescriptive approach to revising disclosure rules may tilt to the former, but is nevertheless one of the more challenging discussions. “Lawyers are our own worst enemy in that we always ask for principles-based disclosure because we want to be able to work with clients and let them decide, and advise them on, what is material or not material,” Pinedo says. “But then when we get principles-based disclosure we are the first to raise our hands and say we need more guidance.”
“By and large, most of the disclosure rules are principles-based,” says Danielle Carbone a partner with law firm Reed Smith and head of the firm’s Capital Markets Group. “If you look at MD&A it is really principles-based in that they ask, ‘If material please disclose this.’ My sense is that there are certain things that are susceptible to having threshold disclosure or a prescriptive disclosure but, by and large, having a principles-based set of rules allows issuers the flexibility to disclose what is important to them and material to their company, which is very different if you look at the range of registrants.”
A disclosure regime that stresses a principles-based approach could factor into the call to reduce the regulatory burden on smaller reporting companies. “It allows for flexibility and allows you to recognize differences between Apple and a small registrant that has just done an IPO,” Carbone says.
CONCEPT RELEASE HIGHLIGHTS
The following is from a fact sheet released by the Securities and Exchange Commission.
The concept release requests comment on the business and financial disclosure required in periodic reports filed by companies. It covers:
The Commission’s framework for company disclosure, including the nature of the disclosure requirements, statutory mandates, and the audience for disclosure
Existing and potential disclosure requirements, including principles-based and line-item disclosure requirements in Regulation S-K, industry-specific disclosure, information relating to public policy and sustainability matters, and scaled disclosure requirements
Alternative methods of presenting disclosure that could improve readability and investor access to information.
For each of these topics, the concept release would consider the regulatory history, public input received, the administrative and compliance costs of disclosure requirements, and present specific questions for public comment.
The Commission’s framework for company disclosure derives from the Securities Act of 1933 and the Securities Exchange Act of 1934. The Commission first introduced its current system of integrated disclosure in 1977; in which a centralized set of rules apply to both registered public offerings and periodic reports. Regulation S-K is the central repository for the Commission’s rules covering the business and financial information outside the financial statements that companies must provide in their filings.
The concept release will be published on the Commission’s website and in the Federal Register. The comment period will remain open for 90 days.
Source: Securities and Exchange Commission
The release makes a similar case. “Limiting prescriptive disclosure requirements and emphasizing principles-based disclosure could improve disclosure by reducing the amount of information that may be irrelevant, outdated, or immaterial,” it says. “Greater use of principles-based disclosure requirements may allow registrants to more effectively tailor their disclosure to provide only the information about their specific business and financial condition that is important to investors.”
On the other hand, “reducing prescriptive disclosure requirements and shifting toward more principles-based disclosure requirements may limit the comparability, consistency, and completeness of disclosure,” it cautions. “In the context of accounting standards, some have noted practical challenges associated with principles-based standards, as auditors and accountants may be less able to predict how regulators or courts will apply these principles in particular contexts.”
Among the hundreds of questions posed in the concept release:
Should we revise our rules to require registrants to provide an executive-level overview?
Are there new rules that we should consider that would result in more meaningful analysis in MD&A?
Should we require auditor involvement regarding the reliability of MD&A disclosure?
Should we consider different disclosure requirements for financial institutions versus non-financial institutions?
Should we require additional disclosure of off-balance sheet arrangements that occurred during a reporting period?
How could we modify our rules to require or encourage registrants to describe risks with greater specificity and context?
Would line-item requirements for disclosure about sustainability or public policy issues cause registrants to disclose information that is not material to investors?
Should we allow one or more categories of larger companies, such as companies with a longer reporting history or more readily available public information to benefit from scaled disclosure requirements as a means of reducing compliance costs?
Should we eliminate or reduce the XBRL tagging requirements for smaller reporting companies?
Do investors, registrants, and the markets benefit from quarterly reporting?
Should we consider permitting smaller reporting companies to file periodic reports on a less frequent basis, such as semi-annually?
Should we require certain registrants to file periodic reports on a more frequent basis, such as monthly?
Should we consider reducing the level of disclosure required in the quarterly reports for the first and third quarters?
Although the concept release is indeed comprehensive, there were omissions. It focuses on business and financial disclosures that registrants provide in their periodic reports. Other disclosure requirements, such as executive compensation and governance, or the required disclosures for foreign private issuers, business development companies, or other categories of registrants, may come at a future date. SEC staff is also continuing to develop recommendations to update and enhance its industry guides, in particular, Guide 3 and Guide 7, which cover disclosures in the banking and mining industries.
As for the Commissioners who approved the Concept Release, they also have thoughts on where it should be supplemented.
Commissioner Kara Stein asks if there should “be changes to our rules to address abuses in the presentation of supplemental non-GAAP disclosure, which may be misleading to investors?” Another topic for future discussion: “How should a modernized disclosure regime address communication to investors about diversity and inclusion measures?”