Thank you for that kind introduction, and thank you for having me at this most timely discussion on the future of financial reporting.
I’ve been thinking a lot about the future of reporting these days — both financial reporting and reporting of all of the other stuff investors care about — and I’d like to spend my time talking with you about what I see for the future of the Commission’s disclosure system.
Before I begin, let me give the necessary disclaimer.
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed here are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues on the staff of the Commission. That standard admonition is particularly relevant to the 21st Century Disclosure Initiative, which I have led for the past seven months, because our mandate was to challenge the orthodoxy of the Commission and think outside the box. Our study is now complete, our work is done, and today we delivered our report to the Commissioners and the SEC staff for their consideration.
But this event isn’t timely just because I’ve been spending a lot of time thinking about the future of financial reporting. It’s timely because I believe that limited access to that information for investors may have been a contributing factor to the recent market turmoil. In many cases, even sophisticated investors took positions in financial instruments without understanding their structure or the risks associated with their underlying assets. Investors who purchased shares in institutions holding some of these assets, at least initially, may have had no idea about the risks embedded in these transactions. It would not have averted this crisis, but improved transparency would have surely blunted some of the pain we are suffering.
To be sure, companies and other issuers supply the markets with a host of information and data. But at some point this data can get lost because there’s simply too much of it, and investors can’t make sense of what they see. Think of trying to analyze an asset-backed security described in a mere 15,000 or even 750,000 pages. Who has the time, the patience, or the expertise to read and understand such documents?
This is even more the case in markets such as ours where transactions move at the speed of light — literally, when you think of transactions made over the internet — and decisions are made in a nanosecond.
This is no minor problem . . . and it’s not a new one either. What we’re talking about this evening is information, and providing the information investors want in a way that they can really use it.
So, what is information? [SLIDE 2] Like all really good definitions, this one is simple, elegant, and profound. [SLIDE 3] (This is the definition formulated by Claude Shannon and Warren Weaver in their 1949 ground-breaking monograph, The Mathematical Theory of Communication.)
Look at this 1913 London Underground map. [SLIDE 4] Anything that doesn’t reduce uncertainty is “noise,” and there’s a lot of “noise” here. For the traveler who wants to know how to get from point A to point B, the noise is deafening.
The 1932 Underground map [SLIDE 5] removed some of the noise.
Over the years, more and more noise was eliminated until we get today’s familiar Underground map. [SLIDE 6]
How do I get from Piccadilly Circus to Elephant and Castle? With this map I can quickly and easily find the information I want, which is which lines to take, where to transfer, and how much the fare is. I don’t care about the exact route the trains will take, the precise flow of the Thames, or where Hyde Park is located.
And then there’s the New York subway map. [SLIDE 7] There’s more noise here than information. I would like to make sure this doesn’t happen again.
My concerns over the lack of transparency and accessibility of information as a contributor to today’s market stress make all the more relevant the results of a study recently completed by the Commission’s Office of Investor Education and Assistance. Last spring, OIEA commissioned a study of the usefulness of SEC-mandated company and fund disclosures for investors. The survey asked 1,000 investors about their use of disclosure information from proxy statements, fund prospectuses, and operating and investment company annual reports. The results are really quite revealing.
First, the majority of people were at least somewhat satisfied with all of the disclosure documents filed with the Commission, and they recognized that the data contained in those documents is important and helpful. But the survey tells us that a majority of those investors surveyed never actually read the various reports. Instead, they gather that information from other sources.
One reason they don’t read reports filed with the Commission is that they are filled with legal, accounting, and technical jargon, and they’re long and wordy. Investors voiced concerns like: “I’d have to take a week’s vacation to read this,” or “Several years ago I tried to read them. There is so much minutia in most of it and yeah, it’s in the English language, but trying to make heads-or-tails of it, I finally gave up!” So one part of the problem is that the time and expertise required to extract relevant information from company reports can make it too burdensome for all but the professional investor to use those reports.
It’s a problem of accessibility. Investors are getting buried in an avalanche and need a way to dig out.
Many of these concerns are not new to the Commission or to the public. And so for many years the Commission has adopted new regulations and technology to improve the usefulness of company reports. The move to the EDGAR filing system in the early 1990s was targeted at improving the flow of information from companies to investors. The Plain English rules in 1998 were part of an effort to make that information more readable and understandable.
The Commission’s recent adoption of new rules to allow for summary prospectus materials to be delivered to investors should respond to a particular research finding: that 64% of investors who receive mutual fund prospectuses rarely read them.
The Federal Advisory Committee on Improvements to Financial Reporting’s creation, and the recommendations that it made a few months ago, are targeted at making financial disclosures simpler, timelier, and of higher quality. A key recommendation centers on application of XBRL to public company financial statements. The Commission has now adopted a rule requiring just that.
Each of these efforts has been important and has produced or will produce very valuable and tangible benefits for investors. But I believe that these approaches are reactive, not proactive. They have dealt with specific problems. This process of identifying problems and finding resolution will continue as long as we have markets and investors.
But I would like investors, issuers, and the Commission to look forward to a day that avoids even new problems, not just those revealed by the latest scandal or market crash. For this reason, I believe that the Commission needs to fundamentally re-think the way that it collects, analyzes, and disseminates disclosure information so that investors, institutional and individual alike, have better access to high quality information. Such a system would enable investors to make better decisions. It would also enable a future Commission to more effectively discharge the mission of this great agency.
The Commission has already taken the first few steps. In August, the Commission rolled out the new technology platform that will replace EDGAR. IDEA, the Interactive Data Electronic Applications system, will support all of the Commission’s technological needs, including new enforcement tools, new financial tracking systems, new investor tools, and, eventually, a modernized disclosure system. That’s where I come in.
In June I was hired to develop a high-level plan for modernizing disclosure. After working these past months with a team of Commission staffers, I have prepared a report for the commission’s consideration that proposes a modernized disclosure system that uses IDEA as its platform, fully exploits interactive data, is organized around “company files,” and stores disclosure data in an enterprise-wide data warehouse.
Allow me to give a brief preview of the report that I have submitted to the Commission and that will be made public tomorrow. In it, I explain how this coordinated approach to fundamentally re-thinking disclosure will lead to better access to high quality information for all investors. And more importantly, how it will help you better communicate with your investors without adding cost or duplication.
Today, companies file information with the Commission in forms that have usually been formatted by a financial printer and uploaded into EDGAR. In many cases, the companies take financial data from highly automated and trustworthy internal systems and transcribe that data so that it can satisfy EDGAR’s filing requirements, introducing the possibility of human error, or worse, fraud. [SLIDES 8 and 9]
After much back and forth between the company, its lawyers and accountants, and the financial printers, and after proofing and reproofing, converting and reverse converting, disclosure forms get filed on EDGAR.
Once loaded into EDGAR, those forms are then downloaded or fed to financial intermediaries, sometimes called infomediaries, who data mine the forms to pull out discrete pieces of information. Again, this laborious process can cost money, time, and accuracy. These infomediaries then slice, dice, and repackage that information and sell it to still other infomediaries such as analysts, advisors, brokers, or independent outlets like Internet finance web sites.
Meanwhile, back at the company, IR professionals often go to work to cut and slice these very same reports so that they can give investors the information they want on the company’s website.
This current process, centered on EDGAR, has worked sufficiently for years, but it’s inefficient, at best. Data jumps through many hoops to get filed with the Commission, and particularly with small companies, the filing process can be costly. Ultimately, shareholders bear those costs. The process can also introduce errors that, if uncorrected, can be compounded as data is aggregated and transmitted. It’s a process, by the way, that was created in the 1930s when typewriters, paper, and snail mail were the only options to communicate with investors, and it has only been upgraded incrementally.
Because these documents are long, stuffed with information, and complicated, investors seeking comparative information between companies, or specific information about the risks associated with investing in a single company or fund, have to wade through pages and pages of form after form to get the information they’re after. That might explain the heavy reliance on advisors, brokers, and stock sorting web sites.
In fact, here’s the process that one must go through today to get at company information on EDGAR. [SLIDES 10 to 18]
There has to be a better way, and I think the disclosure system I propose in my report goes a long way to resolving these issues. It would allow us to find a way to get investors faster access to higher quality information. It would serve to drive down costs for filers while improving the quality of the information they file by leveraging technology. And the Commission’s lawyers, economists, and accountants would enjoy these same advantages, leading to better regulation and enforcement.
As I noted a moment ago, my final report proposing this high-level plan will be available at SEC.GOV.
My basic recommendation is for the SEC to move from its current reliance on lengthy disclosure documents that lock important investor information in long, static forms to an interactive filing system that calls for filing specific disclosure data in response to regulatory reporting obligations. Filings would be made in interactive format, using a universal language, and would reside on an enterprise-wide database that holds individually-accessible but related information. A mouthful, I know. But what it means for you is really pretty simple.
My report calls for a company file system where companies would file basic information just once, and then add to that information when required by statute or rule. No more 245-page annual reports, unless, of course, an investor wanted to print a copy.
For example, when an operating company needs to file its annual report, it wouldn’t re-enter unchanged information like the description of business, the location of headquarters, or the shares outstanding. That is, unless that information changed, and then the company would simply update it. But in the main, only new information would be supplied to file an annual report — things like the financials and the MD&A. Filers could render the whole collection of data — the old stuff and the new — do all their legal checks, audits, proofing, and officer certifications, and then hit send. [SLIDES 19 to 22] My report gives a little more detail, but the basic premise is that familiar reports — Ks and Qs, proxies and prospectuses — would be available just like today. They would just get filed differently. And the database would store historical information and maintain audit trails so everyone knows who filed what when, and for what purpose.
Some companies might choose to submit their filings directly into an SEC web-based portal. Others might upload files to the system, or use software that interfaces with the SEC system directly. Still others might use a financial printer. In any event, redundancies would fall away, and manual filing and proofing errors should be minor and few.
Because all of the filed disclosure information would be tagged using either XBRL or some other common language, investors would be able to get at that data immediately, and would be able to do targeted searches, sorts, and comparisons. This would help investors find important disclosure information even if it’s buried deep in a long form. Instead, an investor seeking to understand what growth management is forecasting for the next year will be able to pull up the most recent MD&A discussion with a few key strokes. Or maybe that investor would want to look at what’s new in management’s forecast: a redline against last year’s filing would be a snap.
Likewise, investor relations professionals could plug the interactive disclosure materials right into the tools on their company’s investors’ page the minute they’re filed. Time and transcription errors would drop, and investor relations professionals could spend their time working directly with investors rather than pulling disclosure data out of one form and putting it in another.
Were the SEC to build this new system and reorganize its disclosure rules to make the system work, it could look hard at what specific disclosures are required in its various reporting rules and try to find ways to elicit more clear and comparable statements. And redundancies and duplication would fall away.
Investors would find at SEC.gov an intuitive and easy to use company page. Maybe something like this: [SLIDES 23 and 24]
Imagine being able to type a few words to learn how exposed your mutual fund is to investment risk in Asia, or how much a financial institution you’re thinking about taking a position in deals in structured products tied to sub-prime loans? This will be possible if the rules better capture the kind of information investors want, and in a format they can use.
And infomediaries will benefit too. Here’s how I envision the new disclosure system seamlessly moving data from company to Commission to user. [SLIDE 25] As you can see, the data doesn’t need to be reformatted, mined, or scrubbed to be useful in investor models or tools.
Users could continue to obtain feeds from IDEA, just as they do from EDGAR, but they could scrap mining through forms to pull out information that plugs into their analysis software. Instead, the data would already be structured and could feed right into their systems. The costs — both financially and those from human transcription and delay errors — would go down dramatically. Investors big and small would be able to gather better information faster, whether relying on the SEC’s website, analysts, advisors, or free sites.
As I said at the beginning of my remarks, my report will be made public tomorrow. It lays out a high-level plan for modernizing disclosure that expands upon the Commission’s XBRL work and looks to using technology to help investors navigate their way through the ocean of investment information they receive every day. Hopefully, investor relations web pages and third-party investment tools would become even more helpful, and maybe we would even reinvigorate independent analysis, particularly covering smaller issuers. The possibilities are truly endless. We would have a system that eliminates noise and delivers information, and helps you find how to get from Piccadilly Circus to Elephant and Castle quickly and easily.
I hope you’ll take a look at the report and join the discussion on how to make disclosure information more accessible and easier to use. Thank you again for your time.
I’d be happy to take any questions.
Slide presentation (PDF)