Concept release on Regulation S-K asks for comments on various disclosure issues, including use of technology to make information more digestible
Last week, the SEC approved the concept release for Regulation S-K, which sets guidelines and requirements for companies’ financial disclosures. This 341-page document focuses on the business and financial disclosures other than those related to executive pay and financial statements that companies make in their quarterly or annual reports. It is the latest step in the SEC’s ongoing effort to advance its disclosure effectiveness project.
A key issue in that project is whether the SEC’s approach to financial reporting should be more principles-based or prescriptive. A principles-based system lets senior management of each company exercise their judgment about whether information is material enough to be disclosed, where the rules-based system is seen by some as restrictive by assuming that the same things are material across all companies. A key drawback to a principles-based standard, the SEC has said, is that it makes it harder to compare companies’ business and financial disclosures.
In the concept release, the SEC introduced a third alternative – an objectives-oriented approach – that was originally proposed by a study of Section 108 of the Sarbanes-Oxley Act, which directed the Commission to conduct a study on the adoption of a principles-based accounting system. ‘Under this approach, standard setters would develop new rules by clearly articulating the accounting objective of the standard and providing sufficient detail and structure so that the standard can be applied on a consistent basis. The staff further recommended that such standards should be based on a consistently applied conceptual framework, minimize exceptions and avoid the use of bright-line tests.’ The SEC said it’s soliciting comments on whether this approach might be appropriate for business and financial reporting.
Questions have been raised in the US as to whether or not quarterly reporting works adversely to investors by encouraging a short-term outlook among management, so the release solicits public input, even as to whether quarterly reporting is appropriate for all companies, says Lloyd Harmetz, a capital markets partner at Morrison & Foerster, who works mainly with financial institutions on their capital raises and in developing financial products.
Harmetz says he likes the tenor of the SEC’s concept release. ‘The tone is generally fairly constructive – are investors receiving the information they need, in a way that they can digest? Are the risks that are material or most important to smaller investors properly being conveyed in a way they can understand? Or do the current SEC rules have the unintended consequence of making it hard for investors to find the information that they would really find material?’
He believes the SEC is very open to discussion on that point and genuinely wants to hear from public companies, their lawyers, and both retail and institutional investors what’s good and not so good about the current disclosure rules and how they can be improved.
The SEC also seems intent on revising disclosure rules in a way that makes the best use of technology that could simplify the way financial information is presented, including avoiding repetition and enhancing comparability among issuers. The Commission said that under the Fixing America’s Surface Transportation (FAST) Act, which Congress adopted in December, it is ‘required to carry out a study to determine how best to modernize and simplify disclosure requirements in Regulation S-K and to propose revisions to those requirements.’
‘There are a variety of interesting concepts here that technology makes possible, such as electronic hyperlinking within a document and to company websites,’ Harmetz says. ‘One of the more interesting developments would be to see SEC encourage issuers to use these technologies in a way that makes information easier to digest, particularly by less sophisticated investors.’
Although the focus of the concept release is on materiality, there were signals at an open meeting on the concept release on April 13 that certain commissioners, if not the entire commission, are willing to consider whether more information related to companies’ environmental, social and governance practices also belongs in their periodic filings.
In a statement at the open meeting, Commissioner Kara Stein cited the ‘need to acknowledge that investors in 2016 may have fundamentally different views about what information is important to them compared to investors 30 years ago,’ adding that social concerns that may figure into an investor’s investment calculus in 2016 may not have been material to an investor in1982.
‘Today, investors make their decisions based on an array of information, which goes beyond mere profit and loss. Many believe that the era of sustainability or impact investing has arrived,’ Stein said. ‘Sustainability disclosure differentiates companies and it may foster investor confidence, trust, and employee loyalty. More importantly for investors, companies that adopt certain environmental, social, and corporate governance or ESG measures may perform better than those that do not. Yet our current disclosure regime, and the current concept release, do not specifically address many of these ESG topics.’
Stein went on to ask whether a modernized disclosure regime should address communication to investors about diversity and inclusion measures companies are taking, as well as whether specific disclosure requirements should be added to enhance transparency for investors regarding the extent to which companies are good corporate citizens and are socially responsible.
In contrast, Commissioner Michael Piwowar emphasized the traditional – and arguably more narrow – view of materiality, which he called an objective legal standard rather than a subjective political one. ‘While certain shareholders may have their own particular pet interests, the reasonable investor standard prevents an individual investor from hijacking corporate resources to serve their own specific agenda,’ Piwowar said.
