SEC Asks Disclosure Reform Questions

The Securities and Exchange Commission is asking for opinions about the quarterly reporting system again, the latest volley in what could be a contentious debate in 2019 about corporate disclosure.

The request for comment, published Tuesday, runs 31 pages long. It asks whether some disclosures in the Form 10-Q quarterly report could be abolished if they’re already disclosed in a company earnings release; whether certain classes of companies could get away with semiannual reporting only; how other financial reporting rules might need to change if they’re based on the idea of quarterly reports; and much more.

Interested parties can submit comments starting today, and they should. Changes to quarterly reporting could have a dramatic effect on financial analysts, investors, corporate accountants preparing financial statements, audit firms that review financial data, and even executives’ business decisions that might be based on how Wall Street will judge financial results.

SEC chairman Jay Clayton is walking a tightrope here. President Trump nominated Clayton with one overriding objective: reduce securities regulation so that more businesses can go public on U.S. markets. By that logic, alleviating the burdens of quarterly corporate reporting would be part of the plan. On the other hand, the rhythm of quarterly reporting and the Form 10-Q has been around since 1970, and powerful constituencies have built their livelihoods premised on getting more information, not less.

As Clayton put it in a statement Tuesday:

There is an ongoing debate regarding the effects of mandated quarterly reports and the prevalence of optional quarterly guidance. Our markets thirst for high-quality, timely information regarding company performance and material corporate events.  We recognize the importance of this information to well-functioning and fair capital markets. We also recognize the need for companies and investors to plan for the long term. Our rules should reflect these realities.

To complicate matters, Clayton also has President Trump in the background, always liable to blurt out something on Twitter that might make Clayton’s job that much more difficult. Remember, one reason Clayton revived semiannual reporting is because Trump did exactly that last August, sending the SEC scrambling to put out a statement that um, yeah sure, we were totally planning to revisit that issue.

Disclosure Point 1: Investor Protection

One principal question for the SEC should be: if the agency does relax rules for quarterly reporting, and allow companies to rely on disclosures published in an earnings release, how does the SEC continue to protect investors from the risk of false or inaccurate statements?

For example, earnings releases are furnished to the SEC rather than filed, which means the company faces less liability for material misstatement in an earnings release. And while audit firms review disclosures in the 10-Q, they don’t need to examine disclosures in the earnings release at all.

So if the SEC lets companies shift more disclosure from the 10-Q to the earnings release, that exposes investors to more risk — unless the SEC also ladles more regulation onto the earnings release, to provide more assurance that those disclosures are as accurate as what you’d find in the 10-Q.

Would the SEC actually do that? I dunno, but the SEC’s request for comment does ask whether statements in an earnings release should be filed or audited; and what information investors find most useful in either document, that therefore needs the most assurance.

So corporate disclosure executives might want to ponder a world where the earnings release replaces the 10-Q filing (yay!) but those disclosures might also be subject to auditor review or more liability (boo!). What would that change mean for your own internal processes and controls to gather those disclosures? Would it mean any practical change at all?

Disclosure Point 2: Investor Behavior

Second, the SEC talks about providing information and protection to “investors” — as if investors are one monolithic group, all behaving the same way. That’s not in step with reality. Several types of investors use corporate disclosures in different ways, and our disclosure regime needs to respect that reality if it’s going to serve its purpose.

That is, most retail investors don’t read 10-Q disclosures at all. They just put a portion of their earnings into a mutual fund or 401(k) account, make a few broad choices about where that money should be invested, and forget about it. So when disclosure critics complain, “We spend all this time preparing stuff nobody actually reads!” they’re not entirely wrong.

Alas, those critics are still wrong where it counts: with the small group of institutional investors and financial analysts who do use all those disclosures in the 10-Q. Essentially, one small group of expert investors uses that information on behalf of the retail investors who set it and forget it with their 401(k) contributions.

Those 10-Q disclosures, onerous though they may be to the corporate filer, empower the professional investors to make decisions that affect the welfare of the retail investor — and judging from the stock market over the last 35 years, generally that relationship has benefitted both groups.

Will the SEC take those nuances of investor behavior under consideration? Again, I dunno. But that is how the investor world works.

And the Disclosure-Industrial Complex

Financial reporting and audit executives also need to assess everything else that might need to change to make a reduced disclosure regime possible. The SEC acknowledges that this is an issue; some audit standards are based on the assumption of quarterly reporting, some accounting standards are, and lots of other less formal financial practices are, too.

All of those practices might need revision if the SEC moves ahead with reducing disclosure duties in the 10-Q. For example, the SEC also asks about companies issuing earnings guidance, and how much the pressure to meet guidance drives short-term focus at the expense of long-term corporate viability. The SEC even asks whether something as radical as filing earnings guidance (so liability attaches) should be considered.

Ponder those secondary consequences. That’s where a change in SEC policy might affect internal policies and procedures, internal controls, and lord knows what else.

Anyone involved in corporate disclosure, disclosure controls, investor relations, financial processes, preparing financial statements — you’re going to need to ponder those secondary consequences. That’s where a change in SEC policy might affect internal policies and procedures, internal controls, pay practices, compensation structures, audit experiences, and lord knows what else.

We don’t know when the SEC might propose specific plans for reduced quarterly reporting requirements, and other countries already have similar regimes; the idea has some merit, if applied in the right way.

Still, the more extreme ideas (supported by the U.S. Chamber of Commerce, for example) would be a huge change. Even if the SEC spends most of 2019 dickering over the details, follow the discussion.

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