Oct. 3, 2014
Thank you for your kind introduction and for inviting me to participate in this discussion on securities disclosure. The topic is certainly a timely one. Before I begin, I need to provide the standard disclaimer that my remarks are my own views and do not necessarily reflect the views of the Commission or any of my colleagues on the staff of the Commission.1
I am delighted to be here today, and I am particularly pleased that the topic of this year´s symposium is securities disclosure. Full and fair disclosure has been a central goal of the U.S. securities laws for over 80 years. And given the complexity of modern companies, the need for such disclosure has probably never been greater.
I plan to talk with you today about the Division´s review of our disclosure requirements and share some thoughts on the future of disclosure. In particular, how can our rules ensure that companies provide transparent, material information that today´s investors will find useful? And at the same time, can this information be prepared and provided to investors in a manner that is less burdensome for companies?
Before turning to the future of disclosure, I´d like to turn the clock back to the dawn of the federal securities laws. With all the eminent securities scholars we have with us today, I am quite certain that we could spend hours examining in minute detail the differences between our markets prior to 1933 and those that exist today. Yet, as former Chairman Arthur Levitt once said, none of those differences would have developed in the absence of one dominating innovation — disclosure.2
In December 2013, the staff published a detailed report that traces the history of our disclosure requirements.3 It recounted how two separate disclosure regimes emerged after the enactment of the ´33 Act and the ´34 Act, which often resulted in overlapping and duplicative requirements. A 1966 article, "Truth in Securities" Revisited, suggested that the continuous reporting obligations under the ´34 Act should serve as the foundation for corporate disclosure.4 This seminal article was the intellectual touchstone for the integrated corporate disclosure regime that exists today.
Many of our existing disclosure requirements can be traced back to Schedule A of the Securities Act. The same holds true for the specialized registration statements that the Commission has developed over the years. Schedule A, however, contains a fairly short list of disclosure requirements and — as you may expect from a provision of the Securities Act — many of the requirements relate to the offering of securities. One is tempted to call it a rather tiny acorn from which a robust disclosure regime has now grown.
Regulation S-K, which is a key part of the integrated disclosure regime, came to life in 1977. The first version of Regulation S-K included only two disclosure requirements — a description of business and a description of properties. Over time, new disclosure requirements were added to Regulation S-K, and now it is the repository for the non-financial statement disclosure requirements under the Securities Act and the Exchange Act.5
Now, back to where we are today. In a speech in April, I announced the Division´s Disclosure Effectiveness agenda.6 Our goal is to recommend to the Commission rule changes — principally to Regulation S-K and Regulation S-X — to update and modernize specific disclosure requirements, to eliminate duplicative disclosures and to continue to provide material information. I want to reiterate that reducing the volume of disclosure is not our objective — we want to put better disclosure into the hands of investors. Although we believe that these efforts can reduce the costs and burdens on companies, updating the requirements may very well result in additional disclosures.
The starting point for shaping company disclosure is remembering its purpose — that is, to provide investors the information they need to make informed investment and voting decisions. As such, our Disclosure Effectiveness initiative is keenly focused on ensuring that companies continue to provide information that is relevant to the investment and voting decisions of today´s investors.
So who are the twenty-first century investors?
According to a 2013 survey, approximately 14 percent of all Americans directly held individual stocks, and nearly half of all Americans owned individual stocks or held interests in stocks through mutual funds, retirement accounts or other managed assets.7 Before the financial crisis, this percentage was even higher, reaching a peak of 53 percent.8
Add to that a shifting retirement paradigm. We know that people are living and working longer. The average life expectancy in the United States is 78.7 years old, compared to 63 in 1933.9 When coupled with the movement away from defined-benefit pension plans to 401(k) plans and defined contribution plans, today´s investor is increasingly relying on investments in securities for his or her retirement.
Another shift is the increase in stock ownership by institutional investors, which manage savings on behalf of smaller investors. Institutional investors held approximately 5% of U.S. equities when the Securities Act was adopted.10 Fast forward to the present and institutional investors, such as pension funds, mutual funds and insurance companies, account for approximately 67% of the ownership of equity securities.
Knowing that the audience can be diverse — from a retail investor with a 401(k) plan to a Ph.D. portfolio manager at a mutual fund with billions of dollars of assets under management — is not terribly useful when deciphering for whom disclosure should be written. Former Chairman Elisse Walter always referred affectionately to her Aunt Millie and thought that companies should have Aunt Millie in mind when crafting their disclosures. Critics of that approach express concern that — with apologies to Aunt Millie — writing disclosure for the masses is not the answer. Rather, we ought to make sure that sophisticated securities analysts on both the buy and the sell side have the information that they need to determine whether a company´s stock is trading at the right price. The efficient market hypothesis would then tell us that all investors — retail and institutional — will benefit from those efforts.
If the goal of disclosure is to put material information into the hands of investors, it seems axiomatic that what is material — and therefore what must be disclosed — must be viewed through the eyes of the reasonable investor. After all, the reasonable investor is a bedrock concept in federal securities regulation.11
And although the reasonable investor is a useful standard for liability purposes, our disclosure system does not specify that companies provide only material information. In fact, the Commission has rulemaking authority to require the disclosure of information "necessary to carry out the provisions" of the federal securities laws.12 The Commission also can prescribe rules "as...necessary or appropriate in the public interest or for the protection of investors."13 And, there are certainly discrete line item requirements — such as the number of employees or the number of shares repurchased on a monthly basis irrespective of the dollar amount — that individually may not be material to investment or voting decisions, but over the years the Commission has determined are relevant disclosures for investors.
This brings us to a key question — what information do today´s investors need to help them make informed decisions? It is imperative that investors´ perspectives are represented as we shape the future of disclosure. To seek their views, we are, among other things, working closely with our new Office of the Investor Advocate and soliciting input from the Commission´s Investor Advisory Committee, among other initiatives.
We also recognize that for investors with voracious appetites for information the need for company disclosures can be boundless. This is where balance comes into play. In assessing potential revisions to the disclosure regime, we also must consider the compliance costs for companies and the potential impact on efficiency, competition and capital formation.
Now, I´ll switch gears to the companies that are charged with preparing the disclosures. Last year, more than 9,100 reporting companies filed annual reports with the Commission. Given the diverse nature of these companies, the Division will consider whether one-size-fits-all disclosure requirements are practical for companies or beneficial for investors.
For over 35 years, the Commission has permitted smaller companies to provide simplified disclosure and reporting. In 2007, the Commission revised the scaled disclosure system and expanded the number of small reporting companies that are eligible to use it.14 But some have questioned whether $75 million in public float is the appropriate threshold for smaller reporting companies. For example, one group has advocated for a threshold of up to $250 million in public float.15 Another suggestion was to expand smaller reporting companies to public companies with less than $100 million in annual gross revenue and less than $700 million in public float.16 These are worthwhile questions to consider and we are doing so with, of course, help from our colleagues in the Division of Economic and Risk Analysis.
We also are mindful of the changing company landscape. Over the years, the staff of the Commission has provided guidance to companies in specialized industries, including oil and gas, mining and bank holding companies.17 But what distinguishes the industries that have guides to those — such as biotechnology, telecommunications or social-media — that do not? At the very least, however, we need to modernize the current set of Industry Guides — whether as separate guides or as codifications in Regulation S-K — to reflect the current reality in the industries.
Another area the Division is considering is reducing redundancy in company filings, which could translate into cost savings for issuers and better disclosure for investors. We are cognizant that overlapping disclosure requirements in Regulation S-K and GAAP may be a source of repetition in filings. As examples, some have pointed out that the SEC and the Financial Accounting Standards Board ("FASB") require similar information to be disclosed about legal proceedings, off-balance sheet arrangements, market risk sensitive derivative instruments and share repurchases. The staff is meeting regularly with FASB representatives to discuss joint efforts to reduce the amount of overlap, and we look forward to continued coordination.
But, I want to emphasize that disclosure effectiveness is not just about our rules. In recent years, some companies made significant changes to the presentation of their proxy statements to enhance the disclosure for investors. We want to encourage companies to make similar strides with their periodic reports — experiment with the presentation, reduce duplication and eliminate stale information that is both outdated and not required. If companies have ideas to improve their disclosures and want to talk with us about them, although we won´t pre-clear specific disclosures we are certainly happy to discuss potential changes.
Turning to think about the disclosure framework more generally, the Division is considering whether our recommendations should focus on a more principles-based approach. Taking this approach may provide a company with more flexibility to provide disclosures that it believes are material to investors.
Many have noted that "[o]f all of our disclosure rules, MD&A may be the most principles-based."18 This does not mean, however, that it is not ripe for re-examination as part of our Disclosure Effectiveness initiative. For example, the Commission has previously recognized that period-to-period comparisons in MD&A can include an unnecessary amount of duplicative disclosures.19 Some have suggested that MD&A could be more useful to investors if it focused on the most recently completed fiscal period and the comparison to the prior year. If the third year of comparative information is not repeated in MD&A, would investors have sufficient information to evaluate material trends and analyze the company´s performance? Or would this mask trends that might otherwise be apparent? Of course, our principles-based disclosure system requires the disclosure of "known trends and uncertainties" so companies should include this disclosure when applicable.
There also are individual line items that are required in the Business description — such as working capital practices, backlog and seasonality — that seem to fit more appropriately in the MD&A. Might it be sufficient for the rules governing business descriptions to require simply that companies "describe the material aspects of the business?" I think all of us would have some discomfort with such an open-ended requirement. On the other hand, once line-item disclosure requirements are added to the disclosure regime, where do you draw the line? An important element in the Disclosure Effectiveness initiative will be striking the right balance between principles-based requirements and line-item disclosures that inform investor decision-making.
Finally, a discussion about disclosure would not be complete without mentioning the role that technology can play in how investors access company information. Many people in today´s world can´t imagine getting their news by sitting down and reading the daily paper from cover to cover. We need to think similarly about company disclosure.
When EDGAR was implemented almost two decades ago, it represented a significant transformation to the disclosure system. It provided an electronic library of paper-based forms and made information accessible to investors almost instantaneously. By now, we´ve all grown accustomed to EDGAR, and the basic layout of the forms has changed very little in recent years. Change is often difficult, but in this increasingly paperless society — should the disclosure regime continue to be based on forms that are filed periodically? To answer this question, we´ll need input from market participants about the delivery and presentation of disclosure.
Let´s consider the "company file" approach, which is an alternative that is gaining traction. Under this system, perhaps in lieu of filing a periodic report, companies would be required to update information on the same time schedule as currently required for filings. The company page on sec.gov might display tabs such as "Business information," "Financial information," "Governance information," "Executive Compensation," and "Exhibits" instead of a chronological list of filings. And, instead of the response to Item 101 of Regulation S-K being included in a Form 10-K, it would appear as a block of structured data under the "Business information" tab on sec.gov. This is just one example, and I´ll pose a few other questions:
As we consider alternatives for how companies prepare and file their disclosures, we must be mindful of the disciplined process that has developed around the periodic reporting system — such as audits, officer certifications and disclosure controls and procedures. These processes have substantive importance and contribute to the reliability of company disclosures. We also need to recognize that there may be instances where it may be desirable for investors to have all of the relevant information available in one place at the same time.
This is a dynamic time to be at the Commission. Although the Division has quite a full agenda with our mandated rulemakings under the Dodd-Frank Act and the JOBS Act, we recognize that the time is ripe for reviewing the disclosure regime to make it work better both for investors and companies.
The Division is committed to the Disclosure Effectiveness initiative, and I am confident that market participants will continue to provide observations to inform our understanding. Since we have the benefit of scholars in the audience today, I encourage you to submit research about company disclosure to us at disclosure@sec.gov. I assure you that we greatly appreciate all interest and input.
Thank you for your attention. I look forward to answering your questions in the time that we have remaining.
1 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 herein are those of the author and do not necessarily reflect the views of the Commission or of the author´s colleagues upon the staff of the Commission.
2 See Arthur Levitt,I added those Investor Education: Disclosure for the 1990s (November 1, 1995), available at: http://www.sec.gov/news/speech/speecharchive/1995/spch063.txt.
3 See "Report on Review of Disclosure Requirements in Regulation S-K" (Dec. 2013), available at: http://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.
4 See Milton H. Cohen, "Truth in Securities" Revisited, 79 Harv. L. Rev. 1340 (1966).
5 See supra note 3.
6 Keith F. Higgins, Disclosure Effectiveness: Remarks before the American Bar Association Business Law Section Spring Meeting (April 11, 2014), available at: http://www.sec.gov/News/Speech/Detail/Speech/1370541479332.
7 See Board of Governors of the Federal Reserve System, Changes in U.S. Family Finances from 2010 to 2013: Evidence from the Survey of Consumer Finances (September 5, 2014).
8 Id.
9 See Organization for Economic Cooperation and Development, Health at a Glance 2013: OECD Indicators, available at http://www.oecd.org/els/health-systems/Health-at-a-Glance-2013.pdf; See also Andrew Noymer, Raw Data for Life Expectancy in the U.S.A. (1900-1998), available at: http://demog.berkeley.edu/~andrew/1918/figure2.html.
10 See Marshall E. Blume and Donald B. Keim, Working Paper, Institutional Investors and Stock Market Liquidity: Trends and Relationships, The Wharton School, University of Pennsylvania (Aug. 21, 2012), available at: http://www.wharton.upenn.edu/jacobslevycenter/files/14.12.keim.pdf.
11 See TSC Industries v. Northway, 426 U.S. 438 (1976).
12 15 U.S.C. 77s(a).
13 15 U.S.C. 77g.
14 See Smaller Reporting Company Regulatory Relief and Simplification, Release No. 33-8876 (Dec. 19, 2007) [73 Fed. Reg. 934], available at: http://www.sec.gov/rules/final/2007/33-8876.pdf.
15 See Recommendations of the U.S. Securities and Exchange Commission Advisory Committee on Small and Emerging Companies (Feb. 1, 2013), available at: https://www.sec.gov/info/smallbus/acsec/acsec-recommendation-032113-smaller-public-co-ltr.pdf.
16 See SEC Government-Business Forum on Small Business Capital Formation, Final Report (Nov. 15, 2012), available at: http://www.sec.gov/info/smallbus/gbfor31.pdf.
17 See Industry Guides, available at: http://www.sec.gov/about/forms/industryguides.pdf.
18 See Cynthia A. Glassman, Remarks before the Tenth Annual Corporate Counsel Institute: Priorities and Concerns at the SEC (March 9, 2006), available at: http://www.sec.gov/news/speech/spch030906cag.htm; See also John W. White, The Principles Matter: Options Disclosure (September 11, 2006), available at: http://www.sec.gov/news/speech/2006/spch091106jww.htm#foot4.
19 See Commission Guidance Regarding Management´s Discussion and Analysis of Financial Condition and Results of Operations, Release No. 33-8350 (December 19, 2003), available at: http://www.sec.gov/rules/interp/33-8350.htm.