The U.S. Securities and Exchange Commission has embarked on a far-reaching review of its public company disclosure requirements. In a concept release issued on April 13, the SEC invited comments on how it could modernize Regulation S-K, the body of rules that spells out the business and financial information that SEC-reporting companies must disclose in annual and quarterly filings. The concept release is part of the SEC’s Disclosure Effectiveness Initiative, which is exploring ways to make disclosure more useful to investors. The comment period runs until July 21, 2016.
The release covers an array of issues and possible reforms and includes 340 questions, many with multiple subparts. The discussion is divided into three broad topics–
- The SEC’s current disclosure framework and potential alternative approaches.
- The specific business and financial disclosures that companies are required to include in periodic reports.
- How companies can most effectively present required information to investors.
The release focuses on the periodic disclosure requirements that apply to U.S. companies and does not include foreign private issuer disclosure. However, any changes to the SEC’s disclosure regime would likely be applied to both domestic and foreign reporting companies.
The scope of the issues raised makes clear that the SEC is open to re-thinking the foundations on which its disclosure system rests. For example–
- Principles v. rules. The release asks how the SEC should strike a balance between principles-based disclosure and prescriptive disclosure rules. That is, to what extent should companies be asked to disclose information only if it is material to the company and to what extent should particular disclosures be required, regardless of company-specific materiality? In this context, the SEC also asks whether its longstanding materiality test – whether there is a substantial likelihood that a reasonable investor would attach importance to particular information in deciding whether to buy or sell the security – should be retained or replaced with a different standard.
- Risk factors. Periodic reports must disclose the most significant investment risks, and filings often contain a lengthy list of generic risks which, if they were to occur, could adversely affect the company. The release asks how risk factor disclosure could be improved and raises such possibilities as requiring the company to discuss the probability of occurrence and the effect of each risk; requiring the “top ten” risks to be identified and listed in order; and discouraging the listing of risks that are not specific to the company.
- The future of MD&A. The Management Discussion and Analysis requirement is intended to provide a narrative explanation of the financial statements that enables investors to see the company “through the eyes of management”. The release asks how MD&A disclosure could be improved, including whether the SEC should require an “executive-level overview” or auditor involvement regarding the reliability of MD&A.
- Environmental and social responsibility disclosure. Traditionally, the SEC has declined to require disclosures regarding environmental and social responsibility matters, except to the extent that the information is required by statute or is material to a particular company. The release notes that this type of information is becoming more important in voting and investment decisions and invites comment on whether environmental or social responsibility disclosures should be mandatory.
- Scaled disclosure. The timing and content of reporting currently varies with company size, with different requirements applicable to emerging growth companies, smaller reporting companies, non-accelerated filers, accelerated filers, and larger accelerated filers. The release asks whether the criteria for scaling should be changed and whether other types of companies should be eligible – for example, whether the nature or frequency of large company reporting could be reduced because there is more publicly available information regarding these companies.
- Reporting frequency. Critics believe that quarterly reporting encourages management to focus on short-term results rather than on long-term strategies. The concept release raises the possibility of abolishing quarterly reports for some companies, and conversely of requiring some companies to file periodic reports “on a more frequent basis such as monthly.”
- Improving readability. The release asks for comment on how reports could be made more reader-friendly. Possibilities include greater (or lesser) use of cross-referencing, incorporation by reference, and hyperlinks, including permitting hyperlinks to external websites. The release also discusses the use of layered disclosure, in which disclosures are presented in summary form with a more detailed discussion also available.
Some of the ideas in the concept release – such as mandatory environmental and social reporting – could increase the cost and complexity of complying with the SEC’s disclosure rules. Other ideas, such as scaled disclosure, could have the opposite effect. Accordingly, companies that file reports with the SEC – both domestic and foreign – should consider submitting comments, individually or through industry associations. Because of the SEC’s obligation to weigh costs and benefits as part of its rulemaking, company views concerning compliance costs and burdens are particularly likely to receive attention.