Why Wait for SEC? The DIY Disclosure Review

The Securities and Exchange Commission is in the middle of a highly anticipated review of its disclosure regime, intended to improve the effectiveness of securities filings, streamline bloat, remove redundancies, and modernize the whole process.

“In the middle” being the operative phrase there—nobody knows when a final proposal might land on the internet. The review was required as part of the JOBS Act of 2012, and it is only the latest of many efforts to review the SEC disclosure regime in the last 20 years. All of those plans ultimately fizzled out.

Rather than wait for the results of this disclosure review, can companies take their own steps to reduce repetition and eliminate outdated or immaterial information? Yes, now securities experts aren’t the only ones who suggest companies take unilateral action; the SEC is in favor of it too.

Keith Higgins, director of the Division of Corporation Finance, has used multiple public appearances to encourage companies’ own disclosure reviews. “In recent years, some companies made significant changes to the presentation of their proxy statements to enhance the disclosure for investors,” he said in an October 2014 speech. “We want to encourage companies to make similar strides with their periodic reports, experiment with the presentation, reduce duplication, and eliminate stale information that is both outdated and not required.”

Governance Committees

The starting point for an internal disclosure review is to bring all key stakeholders to the table.

One approach is the creation of a governance committee that can “centralize a company’s thinking about disclosures,” a recent report by EY suggests.  Disclosure committees are not necessarily board-level committees, but often include senior executives. Typical candidates are the corporate controller, chief accounting officer, and general counsel, among others.

The SEC has not mandated what procedures are required for companies to follow to review their disclosures, “but they do recommend that they have some type of a governance body in the organization and that typically manifests as a disclosure committee,” says Matt Posta, a partner and leader of EY’s accounting policy and governance group.

“Most filings are the accumulation of content that has just been repeated over and over again. Companies haven’t really taken a step back to cut away the underbrush of repetition and unnecessary content.”
Matt Posta, Partner, EY

Although barely 40 percent of companies with disclosure committees coordinate those efforts with the board’s audit committee, that should be considered as a standard, Posta says.

Reduce Repetition

A constant complaint about disclosure documents is the bloat they have taken on over the years. Concerns raised by legal counsel and auditors, plus the basic desire to mimic what your peers are doing, has prioritized liability protection above all else.

“Most filings are the accumulation of content that has just been repeated over and over again,” Posta says. “Companies haven’t really taken a step back to cut away the underbrush of repetition and unnecessary content.”

Higgins also stressed the need to reduce redundancy. “Think twice before repeating something,” he said, using the example of companies that include disclosure from their significant accounting policies footnote in the Management Discussion and Analysis (MD&A). “The purpose of the discussion of critical accounting estimates is to educate the reader about the aspects of the particular accounting policy that are the most uncertain and subject to possible revision, not to repeat how the accounting policy works,” he said.

Risk Factors

The required recitation of risk factors is another area prime for pruning. Over the years that part of the Form 10-K has been larded with boilerplate rather than risks that are company-specific.

“There are a lot of overly broad risk factors that aren’t company-specific in disclosures, and they are nothing more than filler,” says Lori Zyskowski, a partner with the law firm Gibson Dunn & Crutcher and former in-house legal counsel at General Electric.

Rethinking this section might include organizing risk factors by likelihood and magnitude, and using bullet points for general risks that don’t warrant a full narrative. Items can be grouped into appropriate categories, such as those related to operations, technology, the economy, and legal or regulatory factors.

Materiality

Assessing what is or isn’t material information is a difficult decision. Companies draw on definitions provided in Supreme Court cases and Financial Accounting Standards Board guidelines, but those standards can leave room for interpretation.

BEFORE AND AFTER

The following, from a report by auditing and consulting firm EY entitled “Disclosure Effectiveness: What Companies Can Do Now,” illustrates how the treatment of company data can be improved to be more concise and offer investors greater clarity.
Existing Disclosure:

Year ended December 31, 2013, compared to year ended December 31, 2012
Revenues
Total revenues increased by approximately $65 million, or 19%, to $415 million during the year ended December 31, 2013 as compared to $350 million for the year ended December 31, 2012. The revenue growth results from the acquisition of ABC, Inc. in the US which  contributed $35 million during the year, and increased sales of customers primarily as a result of significant focus on selling new products. Excluding the ABC, Inc. acquisition, North America revenue increased $29 million to $285 million in 2013 from $256 million in 2012 due to the increased sales of our new routing and switch products. Revenue in Europe increased from $94 million in 2012 to $95 million in 2013 due to a slight increase in data center equipment sales offset by the unfavorable effects of foreign currency.
Year ended December 31, 2012, compared to year ended December 31, 2011
Revenues
Total revenues increased by approximately $15 million, or 4%, to $350 million during the year ended December 31, 2012, as compared to $335 million for the year ended December 31, 2011. The revenue growth is primarily attributed to increased sales volume from our routing and switch products. North America revenue increased $21 million to $256 million in 2012 from $235 million in 2011 due to stronger demand for our networking, router and switch products. Revenue in Europe declined from $100 million in 2011 to $94 million in 2012 due to lower sales of data center equipment as a result of intense competition and the unfavorable effects of foreign currency.
Alternative Enhanced Disclosure:

Total revenue changes are due to:

North America revenues in 2013 rose by $35 million, or 14%, due to the ABC, Inc. acquisition and by $29 million, or 11%, due to organic growth related primarily to sales of our new routing and switch products. Increases in 2012 were due to stronger demand for our networking, router and switch products.

Europe revenues were relatively flat in 2013 as the slight increase in data center product sales was offset by unfavorable foreign currency effects. Decreases in 2012 resulted from lower volumes of 3%, primarily in data center products, resulting from increased competition. The remaining change was due to unfavorable foreign currency effects.
Source: EY.

“When the disclosure committee gets together they should look critically at whether an item crosses the threshold of materiality,” Posta says. “What we find now is a knee-jerk reaction to disclose as much as possible because there is fear of liability. By having cross-functional folks at the table, they can come to a better analysis to determine whether or not to make a specific disclosure.”

Think Like a Writer

Many 10-Ks and other disclosures feel like a book “written by different authors,” says Neri Bukspan, a partner in EY’s financial accounting advisory services group. In large part that’s because they are, with sections created by various corporate fiefdoms. His suggestion is to focus on the presentation of the document and ensure a “plain English” approach.

A particular focus should be placed on the readability of MD&A disclosures, which should be made as succinct and relevant as possible. Provide not only required disclosure, but also an analysis that explains management’s view of the significance and implications of that information, he suggests.

Layering is a strategy that may help, where disclosure sections emphasize the most important information first and relegate less important data to a summary if needed. The use of summaries, bullet points, and charts and graphs can provide a more concise, and logically structured, approach to data. Cross-referencing to other parts of the document can help provide additional information as needed, without cluttering the narrative.

“If you have to describe market share in five continents by products, you can do it in 10 paragraphs or one pie chart,” Bukspan says. “To the extent you have to have all the salient information, and make it searchable [by the SEC’s EDGAR system], there is nothing to preclude you from having graphs and tables.”

“Study the analyst presentations that Investor Relations groups produce each quarter,” Zyskowski says. “Look at how they use charts and graphs. Information presented through charts and summaries is more easily digested by investors. You don’t need to repeat the information in narrative form, just describe the most significant trends.”

Even advocates of internal disclosure reviews admit the process must proceed with caution. “It is easier said than done,” says David Mittelman, a partner with the law firm Reed Smith. “The regulatory pendulum swings between complexity and clarity, and public companies are usually caught in the middle. There’s always been a tension between the concept of full disclosure and the reality of disclosure overload.” When the SEC talks about simplification it usually refers to fewer forms and eliminating specific disclosure requirements; “companies can’t just decide which disclosure items are outdated, even though some of them are,” he warns.

“Companies will always have a reluctance to take disclosure out, but I think people feel somewhat emboldened by what SEC staff has been saying and that there won’t necessarily be dire consequences if they explore options,” says David Lynn, a partner at Morrison and Foerster and former chief counsel of the SEC’s Division of Corporation Finance.

His one caution: Don’t assume that past and future SEC guidance on the matter is one-size-fits-all. “Just because staff issues a comment to somebody else doesn’t mean it applies to you,” he says. “Don’t go making changes just because you saw a summary of an SEC comment letter somewhere.”