Will disclosure reform favor corporations or investors? Experts weigh in.

Stakeholders in the reporting community have strong and diverse opinions on the subject of disclosure reform.  We asked five leading experts to weigh in.

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Vintage question > Critics such as Senator Elizabeth Warren have argued that the SEC disclosure effectiveness initiative is designed only to make things easier for filers (especially large corporates), not to help investors or actually improve disclosure of financials. Where do you think the SEC’s priorities lie – more with filers, or more with investors?

Anna Pinedo > The SEC’s priorities lie with protecting investors while continuing to promote capital formation. The SEC was not intended to discharge a political mandate and should not be politicized.

Robert Herz > First of all, the SEC’s initiative was actually mandated – it came out of the JOBS act. In a broader context, the SEC mission relates to both investor protection and to the efficiency and effectiveness of our capital markets and overall capital formation. It’s not just investor protection – that’s a very important part of it, and disclosure an important part of that – but it’s not the only component. When I served as chairman of the Financial Accounting Standards Board, we issued disclosure standards as well as accounting rules, and the first place you start is, “What do investors want and need?” At the same time, you also have to look at the cost effectiveness of rule changes. So, you try to get input from both sides, as well as from other knowledgeable stakeholders, and look at costs and benefits intensively.

I would hope that is the approach taken by the SEC in this whole endeavor.

I would say that what they’ve come up with so far is quite promising. Whether it will go anywhere is another question. One of the problems with the SEC is that the half-life of a chairman, a chief accountant, and other key people is two to four years at most, and then somebody else comes in. The question is whether it can be sustained or not.

v-redthe-irwhitepaperFor example, they had a very big similar reform effort in the 1990s and it didn’t get very far. I think most stakeholders in the reporting system, including a number of knowledgeable investors and analysts, agree that it is time to modernize and get rid of outdated requirements, put things in better context, and broaden some of the information that gets included. I think the time is right for that.

Dan Hanson > Transparency is a good thing for investors. But looking at where we are today, the information overload can be more obfuscating than helpful. There’s still a securities industry classification code for buggy-whip manufacturers, for instance, so there is room to take stock of where we are today. That is the counterpoint to Senator Warren’s argument: less sometimes is more, as long as it’s focused on the material issues. And you balance that with the fact that there is clearly a role for protection and a disclosure framework.

The other point I would make is that without the heavy hand of government intervention or required disclosure, there is a natural market-driven motivation that can be very positive. If you let the markets work, they tend to reward high-caliber business models and candid, credible management teams. In an ideal situation, you get really high-quality managements that are transparent about their business practices, and both the markets and their customers like it. They want to do business with them. I think you can foster a race-to-the-top environment using market forces.

So I think it’s a balance of having protections for investors, but also knowing ultimately that the onus is on management to report in a forthright way. And that’s really no different from the traditional financial reporting framework. In fact, I would make the analogy that under traditional GAAP and financial statements accounting, there is plenty of room for issuers to use conservative or aggressive assumptions and still have credible GAAP audited results. There is room for judgement, and so the market is reliant on management teams to take to heart the idea of providing transparency to the capital markets, because they know that they can be rewarded with a lower cost of capital.

Broc Romanek > Overall I am a fan of Senator Warren, but I think she is misguided here. For one thing, SEC Chair Mary Jo White, to whom she addressed her letter, is on the way out, so I think the letter was really aimed at the next SEC chair. But ultimately, I don’t think the Senator clearly understands the disclosure effectiveness project. She says that it seems like it is aimed at making things easier for companies; the way I read what the SEC has put out is that they’re asking the right questions.

The SEC’s mission has always been investor protection – although the commissioners, admittedly, have become partisan, which they were not a decade ago. There clearly are some commissioners that I’d say are more pro- business than pro-investor. There’s no reason why someone can’t be both, but in some cases they are more one than the other. At the end of the day, I think the SEC recognizes that while this project may result in some slight reduction of duplicative disclosures, the end product will illicit many new disclosures, and so the net result will actually be more information, not less. I don’t think the SEC has been telegraphing any other message than that.

OUR EXPERTS:

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Erik Bradbury > To those who are upset with the SEC’s review of their disclosure policies, I would say that the SEC has always been in the business of reviewing its disclosure requirements. Perhaps not to this extent before, but it’s unreasonable to think that the SEC should never review its disclosure regime and ask whether the existing rules should be modified. An approach that only ever adds to disclosure but doesn’t question whether existing disclosures remain necessary or whether they’re outdated or should be modified is a flawed system, because it only makes disclosure even more voluminous and inaccessible.

One of the questions asked in the SEC release is who the audience should be for disclosure, and I think this is really vital to unlocking the point of view that you’re hearing from different constituents. Our point of view is that commission rules should emphasize disclosure of information useful to a reasonably knowledgeable investor – in other words, investors who are willing to make the effort needed to study disclosures, leaving to disseminators the development of simplified formats and summaries useful for less experienced and less knowledgeable investors.

The key question here is: Who is a reasonably knowledgeable investor? I think that is an important question that needs to be answered, and that helps to understand why our point of view is what it is. We believe that we need to expand the scope of who is captured in that definition of “reasonably knowledgeable investor” by making our financial reports more broadly accessible.

We had a conference at Pace University earlier this year and one of the highlights was our keynote speaker, General Electric CFO Jeff Bornstein. His presentation emphasizes what I’m trying to say here in a very profound way. GE looked at its investors and discovered that around 60% were institutional investors, but they still had 40% who were retail investors. And when they looked at how they produced their financial information, they realized that it would be very hard for 40% of their investors to understand their business in a meaningful way given how they were putting together their reports.

And the proof is in the pudding here. In 2012, if you look at the first 15 days of their 10-K being released, they had approximately 100 downloads of the document. Then they started making disclosure improvements and added an “Integrated Summary Report,” which essentially takes all the key components from their financial reports and puts it into a summarized format. After they made these improvement efforts, in 2015 they had 2,700 downloads of their report within the first 15 days, and in 2016 they had 8,700 downloads of the 10-K report. That speaks volumes to what we believe is the key to the effort here.

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