As the Securities and Exchange Commission seeks input on how it should modernize regulations governing public company disclosures, lawyers say the review provides a fresh opportunity to trim one-size-fits-all rules that have been accumulating for decades, but some doubt that the process will generate bold changes.
Under mandate from Congress, the SEC is seeking feedback on limited plans to revise Regulation S-K, a centralized set of rules that describe what companies should include in most business and financial disclosures. While the framework of S-K has generally held up well, revisiting it is timely considering the growth in regulation since the last big update in 1982, lawyers say.
“Over the years, we’ve had quite a buildup of new rules being implemented,” Gibson Dunn partner Glenn Pollner said. “Things are added; it is very rare that things come out. It’s an opportunity to clean things up. There is so much information overload.”
The SEC issued a 341-page concept release last week detailing the scope of its review, and it will accept comments for 90 days after the document is published in the Federal Register.
The report invites input on a broad range of topics regarding what companies divulge in their periodic reports, asking questions such as how duplicative requirements can be eliminated to ease costs on issuers, how to improve the readability of documents, and to what extent the language of disclosures should factor in an investor’s sophistication.
The release also seeks comments on potentially controversial ideas, like whether companies should disclose more information about their environmental policies and their political spending, and whether quarterly filing requirements should be eased for certain companies in favor of longer intervals.
The SEC launched its review in connection with the agency’s “disclosure effectiveness initiative” that followed congressional passage of the Jumpstart Our Business Startups Act of 2012, or JOBS Act. The landmark law eased regulations on companies — especially smaller issuers — seeking to raise capital, and urged the SEC to update and modernize its disclosure requirements.
Congress also last December called on the SEC — through a highway bill called the FAST Act that included a JOBS Act revision — to recommend duplicative disclosures that can be eliminated, and the lawmakers pushed for more of a “company-by-company” approach that is less boilerplate.
The agency’s current mandate to trim its rules contrasts sharply with the mood a decade ago, when the agency enacted many regulations at the urging of Congress — like those mandated by Sarbanes-Oxley Act of 2002 — after the collapse of Enron and other public company accounting scandals.
Kirkland & Ellis LLP partner Dennis Myers said he expects the current review to result in incremental changes, given the SEC tends to be wary of dismantling historical disclosure obligations. At the same time, the agency will likely be careful not to propose changes that result in more disclosure.
“Certainly, the tenor of the both JOBS Act and the FAST Act is to cut down, not add,” Myers said. “I think they will be very leery of adding.”
But lawyers say one area of the SEC’s concept release that could result in additional disclosure is a section that asks whether companies should include more information about their policies on climate change and other social and political issues.
The SEC notes that some investors factor those policies into their decision making, but it has steered clear of requiring such disclosures in the past on grounds that such information, while interesting, is not material to most investors.
“It’s not a core materiality issue,” Shearman & Sterling LLP partner Richard Alsop said. “Maybe there are some businesses where it’s relevant to their continued operations, but for most it’s a social aspect of a business. It does not have a direct impact on their financial performance. I think a lot of companies are going to want to weigh in on that and try to limit anything that is overly complicated.”
Attorneys say companies will likely find important a section that asks whether the SEC should shift its overarching approach toward “principles-based” disclosure in which a company has flexibility in explaining how it meets a disclosure objective. That’s in contrast with a “prescriptive-based,” or rules-based, approach that requires all companies to answer a uniform set of questions regardless of their size and industry.
The idea behind a principles-based approach is that companies can tailor their disclosures to better reflect their specific circumstances, making them more material to investors. But the SEC notes that the prescriptive-based system preserves consistency and makes comparisons easier among filings. The current regime combines both models.
Alsop said a move toward principles-based disclosure could benefit issuers by enabling them to focus on more material information, such as their business strategy, industry context and specific market challenges faced by that company.
“There is an opportunity here for companies to help craft disclosure requirements and presentation methods that will be more meaningful and effective than they have been in the past,” Alsop said.
Another area likely to generate debate is the SEC’s invitation for input on “risk factors,” a section of quarterly and annual documents where companies disclose why investing in their securities can lose money. The SEC says in its release that its five broad principles explaining what kinds of risks companies should disclose haven’t changed since 1964. Some worry that the risk-related disclosures, which consume large space in documents, have become unwieldy.
“That is an area ripe for change,” Reed Smith LLP partner Danielle Carbone said, adding that it would be beneficial to “refocus companies on what is important rather than having a very lengthy list of risk factors, many of which that could apply to every company that is an SEC registrant.”
The flip side is that companies might be reluctant to disclose fewer risks given the highly litigious nature of securities law, where investors often file suits following massive stock drops. Lawyers say companies often err on the side of disclosing more than enough so they can comfortably issue forward-looking statements without fear of being sued.
“Given the litigation climate, many people feel they are better served by being more conservative and more inclusive in drafting the risk factors rather than less inclusive,” Pollner said.
In terms of cutting back paperwork, the SEC also asks whether scaled disclosure requirements — such as those that apply to emerging growth companies, a category established by the JOBS Act generally defined as having less than $1 billion in revenue — should be applied more broadly.
The same section asks whether current quarterly filing requirements be reduced to semiannual, at least for smaller companies that have less ability to pay for frequent filings. Some critics of quarterly reporting also say it fosters a short-term focus on company management at the expense of long-term priorities that take longer to affect earnings.
Whatever the merits, attorneys don’t expect the issue to gain traction considering modern demands for real-time information.
“The U.S. markets and analysts are so used to quarterly reporting that I think it would be a tough sell even if they allowed it,” Alsop said.
Though the scope of the SEC's review is vast, the agency isn't examining the entirety of S-K. The regulation's segments on executive compensation, corporate governance and registration statements are not being addressed, though Chairwoman Mary Jo White said the SEC may seek comment on those items in the future.
Regulation S-K also does not cover company financial statements, which are governed by a companion set of rules known as Regulation S-X that is being reviewed separately. The SEC hasn't said when and if it will propose revised rules, though Carbone said given the size of the review, an extension of the 90-day comment period is possible.
When all is done, Myers said it's likely that S-K could slim down. He noted the segment of Regulation S-K that requires companies to include five years of selected financial data that highlight significant trends invites reconsideration.
Much of that information is available elsewhere and in other filings, and could be revised in the spirit of burdening companies and investors with less paperwork. But he doesn’t expect a rewriting of S-K.
“I really don’t see any major systemic changes off of this," Myers said. "There will be some refinements.”
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