Friday, February 21, 2014

More on Less Complexity in Financial Reporting

Want simpler financial reporting? If you believe the SEC’s public statements, reduction in complexity may be on the way.

Edith Orenstein has posted the following in the FEI Financial Reporting Blog. Here is her full post:

One recent development at the SEC that ties into FASB’s “combating complexity” goal cited further above, is that noted by SEC Chairman Mary Jo White concurrent December 20, 2013 issuance of the SEC staff report, Report on Review of Disclosure Requirements in Regulation S-K. The report was conducted by the SEC as requested by Congress under the JOBS Act.

Importantly, as noted in the SEC's press release, White stated:

“This report [on Reg S-K] provides a framework for disclosure reform. As a next step, I have directed the staff to develop specific recommendations for updating the rules that dictate what a company must disclose in its filings. We will seek input from companies about how we can make our disclosure rules work better for them and will solicit the views of investors about what type of information they want and how it can best be presented. The ultimate objective is for the Commission to improve the disclosure regime for both companies and investors.”

Keith Higgins, Director of the SEC’s Division of Corporation Finance stated:
“Updating our rules is only one step – albeit an important one – in improving company disclosures. For their part, companies should examine how they can improve the quality and effectiveness of their disclosures and how our rules can be improved to facilitate clear and effective communications to investors. Better disclosure benefits everyone in the marketplace, and we plan to work with companies and investors to achieve this common goal.”

The press release also noted that:

“The SEC’s Office of the Chief Accountant will coordinate with the Financial Accounting Standards Board to identify ways to improve the effectiveness of disclosures in corporate financial statements and to minimize duplication with other existing disclosure requirements.”

Chairman White led up to this initiative in remarks given at the NACD’s annual conference in November, 2013, as we noted in this post, SEC’s White Calls for ‘A Meaningful Review of Disclosure Requirements.’ 

Commissioner Dan Gallagher also focused on the need for disclosure reform in a speech at the 2nd Annual Institute for Corporate Counsel on December 6, 2013, excerpted below:

“We can’t foster capital formation in fair and efficient capital markets through private investment unless the critically important information about public companies is routinely and reliably made available to investors. We need to take seriously however, the question whether there can be too much disclosure. Justice Louis Brandeis famously stated that sunshine is the best disinfectant. As my friend and former colleague Troy Paredes pointed out some years ago, though, it is possible to create conditions in which investors are 'blinded by the light.' That is to say that from an investor's standpoint, excessive illumination by too much disclosure can have the same effect as obfuscation - it becomes difficult or impossible to discern what really matters ...”

“I often hear from investors that disclosure documents are lengthy, turgid, and internally repetitive. In their present state, they are, in other words, not efficient mechanisms for transmitting the most critically important information to investors — especially not to ordinary, individual investors. They are not the sort of documents most people are likely to read, even if doing so is in their financial self-interest. For that reason, today’s disclosure documents raise questions of what their purpose actually is and whether they are meeting it.”

“Here, it seems to me, we must acknowledge a dilemma. The good we have done in shaping a detailed disclosure regime to assist and protect investors has, in fact, led to some potential but, I submit, avoidable harm. Corporate disclosure filings didn’t naturally evolve into their present convoluted state. Rather, the rules that require periodic corporate reporting and the detailed instructions that implement them, as well as the staff interpretations and guidance that supplement those rules and instructions, have been the principal forces shaping modern corporate disclosure filings.”

“But other, external forces have played a role as well, most notably the risk of litigation -- much of it absolutely frivolous and solely for the benefit of plaintiffs’ lawyers, not investors. The failure to disclose anticipatorily is often enough to prompt a shareholder lawsuit based on the assertion of a material omission. It is rational, in other words, for those who prepare corporate disclosure documents to prepare for the worst, thus perversely prioritizing the need to avoid the penalties that accompany claims of insufficient disclosure, it seems, over rendering the required disclosure in a manner intelligible to the average investor. In sum, the Commission has cause for self-examination where the question of the utility and lucidity of corporate disclosures arises.”

“And in that process we cannot ignore the impact of excessive and frivolous litigation.”

“Here, we come to a fundamental fork in the road. Should we jump in with both feet to begin a comprehensive review and possible overhal of SEC-imposed disclosure requirements under the securities laws, or should we take a more targeted approach, favoring smaller steps towards our ultimate reforming goals? Ordinarily, I would argue for a comprehensive approach to the solution of almost any problem. Where securities regulation is concerned, we often find that actions we take in one area have unforeseen and unintended effects in others.”

“However, disclosure reform may be the exception. Although I've publicly called on multiple occasions for a holistic, comprehensive review of market structure issues, I believe, on balance, that with disclosure reform it is better to start addressing discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched. On this point, I was very pleased to see the recent remarks by Chair White (citing NACD speech). I hope and expect that, under her stewardship, the Commission will begin to make real headway on disclosure reform. I am genuinely enthusiastic about the prospect of solving some of the real-world problems that have become obvious to all who focus on this area. In short, it’s time to get practical and time to get started.”

Inquiring minds may ask: why have I not put “disclosure reform” as the highest priority item for 2014 as relates to the SEC, instead of “Enforcement”? Well, it’s not just because “Disclosure Reform” is two words, and “Enforcement” is one. I truly believe that with so much messaging from the highest levels of the SEC of a “get tough” attitude that we will see some illustrations of that attitude. We have seen that messaging from the Chairman, the Director of Enforcement, and in speeches from the Office of the Chief Accountant, and although preparers and auditors may prefer to see “disclosure reform” I believe that is a longer term project, and that in the shorter term, specifically 2014, attention should be paid to dotting the I’s and crossing the t’s as well as the big picture, substance over form, etc. with an eye toward Enforcement.

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