Yesterday, SEC Chair Jay Clayton announced that the SEC will be holding a roundtable this summer to discuss “the impact of short-termism on our capital markets and whether our reporting system, or other aspects of our regulations, should be modified to address these concerns…. The SEC staff roundtable will seek to explore the causes of short-termism and to facilitate conversations on what market-based initiatives and regulatory changes could foster a longer-term performance perspective in American companies.” In his statement, Clayton observed that, in light of increases in life expectancy, together with the greater responsibility of “Main Street investors” for their own retirements—largely as a result of the shift from the security of company pensions to 401(k)s and IRAs—the needs of these investors have changed: “Main Street investors are more than ever focused on long-term results.” However, from time to time, they also “need liquidity. In other words, at some point, long-term investors do become sellers. The SEC’s disclosure rules should reflect and foster these needs—long-term perspective and liquidity when needed.” To that end, the goal of the roundtable is not just to discuss the problems associated with short-termism, but also to promote “further dialogue on the causes of and potential solutions to the issue.”
Much has been written about the problems associated with the prevalence of short-term thinking in corporate America. As noted in a post from The Harvard Law School Forum on Corporate Governance and Financial Regulation, an academic study revealed that “three quarters of senior American corporate officials would not make an investment that would benefit a company over the long run if it would derail even one quarterly earnings report.” (See this PubCo post and this article in The Atlantic.) There are, of course, many points of view with regard to the causes of short-termism, with blame attributed to, among other things, executive compensation (see this PubCo post and this PubCo post), pressure from Wall Street to increase quarterly results (see this PubCo post), traders’ compensation (see The Atlantic), the “legal underpinnings” of capital markets regulation and the business model and prevailing culture of the investment management industry (see this PubCo post), caselaw regarding directors’ fiduciary duties (see this PubCo post), and, perhaps most significant, hedge-fund activism (see this PubCo post).
You might recall that, in December 2018, SEC posted a “request for comment soliciting input on the nature, content, and timing of earnings releases and quarterly reports made by reporting companies.” In particular, as Clayton noted in his statement, the request highlighted questions regarding “mandated quarterly reporting and the prevalence of optional quarterly guidance. The request also asked for comments on whether and how our reporting system may be causing companies to disproportionally focus their time and resources on short-term results.” (See this PubCo post.) For a discussion of whether a shift to semiannual reporting would really affect short-termism, see this PubCo post.
The request for comment included a number of thoughtful questions, including questions generally focused around these broad topics:
- “The nature and timing of disclosures that reporting companies must provide in their quarterly Form 10-Q reports, including when the Form 10-Q disclosure requirements overlap with the disclosures such companies voluntarily provide to the public in earnings releases furnished on Form 8-K.” U.S. companies often issue earnings releases, but there is substantial variation in the items and methods of presentation, and some of the information, such as earnings guidance, does not appear in the Form 10-Q. The SEC asks a number of questions about the uses of the quarterly release and Form 10-Q, including whether there are benefits to investors and other market participants from having two sources of historical quarterly financial information, when only one is required. When much of the information is disclosed in the earnings release, “is the Form 10-Q still useful?” Does confusion arise from the two versions of the disclosure? If the frequency of reporting were reduced, how would a semiannual reporting model affect the use of earnings releases?
- “How the Commission can promote efficiency in periodic reporting by reducing unnecessary duplication in the information that reporting companies disclose and how any such changes could affect capital formation, while enhancing, or at a minimum maintaining, appropriate investor protection.” The SEC seeks ways to simplify the process for investors, who must evaluate and compare the 10-Q and the earnings release, while maintaining or enhancing the investor protection inherent in the disclosure and reducing company time and costs. For example, should there be a Supplemental Approach, under which earnings releases would be used “to satisfy the core disclosure requirements” of Form 10-Q? Under this Supplemental Approach, “a company would use its Form 10-Q to supplement a Form 8-K earnings release with additional material information required by the Form 10-Q not already presented in the Form 8-K or alternatively incorporate by reference disclosure from the Form 8-K earnings release into its Form 10-Q.” Alternatively, how would a reduction in frequency of reporting affect the cost of capital or contractual requirements to provide reports on a quarterly basis? What about the impact on other users, such as investment advisors?
- “Whether Commission rules should allow reporting companies, or certain classes of reporting companies, flexibility as to the frequency of their periodic reporting.” The SEC has been looking at issues related to the frequency of interim reporting in connection with an earlier Concept Release, but is continuing to consider the issue and is requesting additional input on reporting frequency and alternate approaches. Ideally, alternatives should “appropriately address the informational needs of investors while reducing the costs and other burdens on registrants who provide that information.” One possibility might be a flexible reporting frequency model that would be selected based on the needs of the company and its investors. Should it apply only to certain classes, such as smaller companies or companies in certain industries? How would that model affect accounting and auditing?
- “How the existing periodic reporting system, earnings releases, and earnings guidance (either standing alone or in combination with other factors) may affect corporate decision making and strategic thinking, including whether these factors foster an inefficient outlook among reporting companies and market participants by focusing on short-term results.” For example, the Request suggests, there has been encouragement by some market participants to move away from earnings guidance and “instead put more focus in Form 10-Qs on demonstrating progress made against the company’s long-term strategic plan.” (The reference here may be to the WSJ op-ed by investor Warren Buffett and JPMorgan CEO Jamie Dimon urging companies to move away from quarterly guidance. Their contention was that it’s not quarterly reporting that creates “an unhealthy focus on short-term profits at the expense of long-term strategy, growth and sustainability,” it’s quarterly guidance.) Does the practice of providing quarterly forward-looking earnings guidance create short-termism and negatively affect the ability of companies to focus on long-term results? ( See this PubCo post to read about the defense of quarterly reporting from the Council of Institutional Investors).
Although the agenda is still in development, Clayton suggested the following potential topics:
- “The role, if any, that short-termism plays in the declining number of public companies. In particular, examining how the pressure on public companies to take a short-term focus in our markets may discourage private companies from going public could provide valuable insight into how to make our public markets more attractive and increase investment options for Main Street investors.
- “Our ability to reduce burdens for companies while facilitating better disclosure for long-term Main Street investors. For example, I am interested in exploring whether the information typically included by companies in earnings releases could be allowed to satisfy certain quarterly reporting obligations and whether there are ways that quarterly disclosures could be streamlined. This is particularly the case in the first fiscal quarter when the quarterly report often comes closely on the heels of the annual report.
- “The potential for certain categories of reporting companies, such as smaller reporting companies, to be given flexibility to determine the frequency of their periodic reporting.
- “Market practices that could be oriented to encourage longer-term thinking and investment at public companies. For example, it would be informative to explore the extent to which certain activist practices, such as “empty voting” (e.g., acquiring voting rights over shares but having little or no economic interest in the shares), are factors that drive short-term focus.”
According to this article in the WSJ, if a change from quarterly reporting to semiannual reporting were actually implemented, smaller companies could experience significant cost savings, but large companies—not so much. While it may be debatable whether a shift from quarterly to semiannual reporting would have any real effect on short-termism, there’s not much question, the article asserts, that it would save time and costs, at least for some companies. The article maintains, however, that
“size matters. The anticipated cost savings would benefit smaller public companies, but the change probably wouldn’t make a substantial difference for larger firms….Accelerated and large accelerated filers—companies that have earlier deadlines to file annual reports with regulators—paid audit fees of $541 per $1 million of revenue to their independent auditors in 2016, the latest full-year data available. By contrast, smaller reporting companies that recorded revenue in 2016, a group of 1,554 firms, paid $3,345 per $1 million in revenue, according to an analysis from consulting firm Audit Analytics conducted for The Wall Street Journal. The disparity reflects the fixed costs involved in performing annual audit and review work, as well as the economies of scale that can make large companies more efficient. For smaller companies, absolute costs matter more because they represent a greater share of potential profit.”