CalPERS raises concerns over MD&A reform plans

CalPERS has voiced concerns that SEC disclosure reforms would leave investors lacking key information – and raise particular challenges given the impact of Covid-19 on companies. 

The SEC in January proposed amendments designed, in its words, to ‘modernize, simplify and enhance’ certain financial disclosure requirements under Regulation SK. ‘The proposed amendments would eliminate duplicative disclosures and modernize and enhance management’s discussion and analysis [MD&A] disclosures for the benefit of investors, while simplifying compliance efforts for companies,’ officials wrote. The proposals are part of a broader assessment of SEC disclosure requirements.

Specifically, the commission proposed eliminating Item 301 of Regulation SK, which covers selected financial data, and Item 302, which covers supplementary financial data. It also proposed amending Item 303 on MD&A by, among other things:

• Replacing Item 303(a)(4) on off-balance-sheet arrangements with a principles-based instruction to prompt registrants to discuss such arrangements in the broader context of MD&A
• Eliminating Item 303(a)(5) on the tabular disclosure of contractual obligations
• Revising the interim MD&A requirement in Item 303(b) to offer flexibility by allowing companies to compare their most recently completed quarter with either the corresponding quarter of the previous year, as is currently required, or with the immediately preceding quarter.

In a recent comment letter, CalPERS CEO Marcie Frost urges the SEC to abandon the project, or at least implement it only once the coronavirus pandemic and its impact have passed.

‘Under the current macroeconomic environment resulting from the Covid-19 crisis, we are disappointed that the commission is considering eliminating the disclosure of basic information upon which investors rely,’ she writes. ‘The middle of the worst economic crisis in a decade is not an appropriate time to limit transparency and access to information put in place in response to previous economic crises.’

Frost does not see benefits to investors arising from the planned changes, arguing that they would make it more difficult, if not impossible, for investors to get essential information and could lead to existing information becoming less available, reliable and comparable. ‘[T]he expressed rationale for removing much-needed information seems thin,’ she writes. ‘The commission has not provided sufficient and relevant economic analysis, nor has it quantified the negative impact on investors, generally or by categories.’

The proposed changes would make it harder and increase costs for CalPERS to fulfill its fiduciary responsibilities to its beneficiaries, ‘dramatically’ affecting its investment process and consumption of essential information, adds Frost.

She writes: ‘The Covid-19 crisis will likely highlight numerous supply chain, demand, human capital and other important risks for investors. Many of these risks are now threatening entire companies, and few, if any, were meaningfully shared with investors.

‘This is a problem we would like addressed, but the proposed rule makes this problem worse because it hides off-balance-sheet items and contractual obligations, while eliminating the need to report anything because of the new materiality construction.’

Frost outlines a series of questions she says the SEC needs to address, including:

• How would the loss of specific, comparable information affect investors’ ability to analyze and compare investments?
• How would investors replace the missing information, if at all?
• What would the impact be on investment returns across different asset classes?
• How would the loss of information and lack of comparability impact different types of investors – for example, longer-term holders as compared to short-term investors?
• What would be the impact on overall investment in different asset classes and for corporate governance purposes?   

There is no existing system to allow investors to replicate the eliminated data for all companies, and the SEC’s proposal release does not explain where investors would find reliable and comparable information, according to Frost: ‘Further, the analysis in the release does not consider what it means to have thousands of investors attempting to replicate information that can be easily and continuously provided by registrants and, as noted earlier, nearly impossible for investors to replicate the data for some registrants.’