Let’s just say that no one at the meeting of the SEC’s Advisory Committee on Small and Emerging Companies yesterday morning had anything nice to say about the SEC’s current disclosure regime, no matter where they sat –as a reporting company, as a banker, as an investor. Particularly dyspeptic – and understandably so — were those representing companies that just exceeded the threshold to qualify as smaller reporting companies but had been public too long to qualify as Emerging Growth Companies. What will any of this mean for the SEC’s “disclosure effectiveness” project?
SEC representatives at the meeting discussed the scope of the “disclosure effectiveness” project, which is focused on three areas: Reg S-K, Reg S-X and how companies provide information, including EDGAR. In the project, the SEC hopes to balance the compliance and cost burdens on companies with the need to provide effective disclosure for investors. With regard to Reg S-K, they are considering whether the principles-based requirements deliver the needed disclosure and whether the prescriptive requirements include appropriate thresholds. The are also considering whether the scaled disclosure requirements lead to appropriate disclosure and whether the types of eligible issuers should be differently “scoped.” In connection with Reg S-X, the project is looking at elimination of redundancies and the need for financial statements of entities other than the registrant. They are also looking at EDGAR modernization (a 10-year project) and making filings easier to access in the shorter term.
Among participants who were not SEC representatives, there were many stories of the doubling and tripling of the length of disclosure over time. Officers at companies that would have qualified as EGCs but for the timing of their IPOs were, not surprisingly, highly critical of the enormous disparity between the obligations of companies that went public on or prior to December 8, 2011 and those going public thereafter. Moreover, they contended, the costs of compliance affected them disproportionately relative to much larger companies that can satisfy their compliance obligations with in-house staff. Corporate governance requirements for smaller companies also came under attack: one CEO seemed to question whether all of the sturm und drang over internal controls really made sense for smaller companies that aren’t likely to have the impact of Enron. (Prediction: I don’t think I’d be going out on a ledge to predict that the staff will propose to raise the threshold for smaller reporting company status substantially above the current $75 million public float, but whether it reaches the $1 billion annual revenue cap applicable to EGCs remains to be seen.) Investment bankers present at the meeting complained about information overload – e.g., who needs a stock price graph? Moreover, institutional investors (who, BTW, agreed about the lack of utility of the stock price graph) observed that the information that is contained in SEC filings is just not the kind of information that is of interest to them. From their perspective, the business section doesn’t get specific enough about how the company intends to increase value and the MD&A is too vague to be useful. What’s more, they complained, companies treat their filings as compliance documents and prepare them as check-the-box exercises. (I’ll let you fill in the blank as to whose fault they think that is.) Fortunately, bankers and investors are resourceful types that find other sources for the information they want, such as meetings, presentations and press releases. The only person defending the disclosure system was the lawyer who reminded the group that the disclosure system has to present a baseline of information and safety net to support the further discussions in various meetings and talks. Moreover, he said, disclosure documents are primarily historic, and analysts and investors want to know what the future holds. Some meeting participants also recognized that companies want to minimize the risk of litigation and receipt of regulatory comments. One investor indicated that she appreciated the benefits of say on pay and wanted to know when the SEC was going to require say on lobbyists?
There’s not much question that the length of filings has increased dramatically. As reported in this CFO Journal post, the average 10-K grew to about 42,000 words in 2013, compared to about 30,000 words in 2000, and some companies have had to add staff to comply with the increased disclosure requirements. But do investors benefit from the additional information? Some commentators cited in the article maintain that these voluminous 10-Ks are functioning as “data dumps” designed to hide the “most relevant” information. But many companies have had to increase their disclosures, the article suggests, because of the increase in international operations and related risk exposures, as well as increased use of sophisticated derivatives and hedging strategies.
Although retail investors may not be cover-to-cover readers, what about institutional investors? The article notes that institutional holders own about two-thirds of all stock in the U.S. Notably, some of those investors do not particularly welcome “simplification” of disclosure, fearing that it may just mask an effort to “avoid publishing unflattering information.” Some institutions maintain that they would like more detail in some areas, such as expenses and lines of business. And some disdain the lengthy risk factors, intended to, among other things, protect the company in the event of litigation. This article from the WSJ reports that “[i]nstitutional investors and analysts are much more likely to search filings for specific information they need than to read them cover-to-cover these days, leading to some debate about U.S. regulators’ plans to make disclosures in corporate securities filings more effective….The way people use information disclosed in corporate filings is changing. Investors and analysts ‘aren’t necessarily printing them [filings] out and reading them,’ [according to a representative of the CFA Institute]….. Analysts tend to focus on comparing year-over-year changes in filings and are more likely to retrieve financial numbers from earnings releases and market data providers….” In addition, the representative observed, investors prefer individualized disclosure rather than boilerplate, which she characterized as “legally-motivated details that vary little between companies.” Institutions and analysts attribute fear of securities litigation as a principal cause of the dearth of information necessary to perform fundamental analysis. One analyst indicated that he finds more useful information at events such as investor day presentations by management. Nevertheless, despite the burden of wading through complex and voluminous disclosure, institutional investors cited in the article prefer to avoid the omissions that may result from “simplification.” According to one analyst at a major institutional holder: “There are ways we can make disclosure more effective….But I’m not interested in seeing less disclosure.”
Given the multiplicity of views and consumers of information, one conclusion drawn by a participant at the Committee meeting was that the likelihood of much significant change resulting from the disclosure effectiveness project was not very great, and that, at most, we might see some elimination of redundancy and small changes around the edges. We’ll have to wait to see if he was right.