On August 17, 2018, the US Securities and Exchange Commission (SEC) amended certain disclosure requirements that it determined to be redundant, duplicative, overlapping, outdated or superseded in light of other SEC disclosure requirements, US GAAP or changes in the information environment. Our Legal Update highlights several key amendments, discusses related practical considerations for companies and provides a table listing the SEC rules, regulations and forms impacted.
Many recent press articles lamenting “short-termism” in corporate America blame research analysts for focusing on quarterly earnings. In a recent paper titled, “Analyst Coverage and the Quality of Corporate Investment Decisions” authors Thomas To, Marco A. Navone and Eliza Wu demonstrate a causal connection between analyst coverage and good investment decisions. The authors assess the impact of financial analyst coverage on corporate investments by evaluating corporate total factor productivity (or efficiency gains) for US listed companies from 1991 to 2013. Their “information hypothesis” postulates that analyst coverage delivers information about companies to the market and may therefore provide those companies with access to funding that permits companies to make capital expenditures and other investments. Also, as a result of analysts monitoring companies and revealing negative information and assessments to the market, it ensures that company management’s will undertake the most productive projects. In this latter case, analysts effectively serve as monitors prompting companies to improve capital allocation efficiency. The study also shows that a reduction in analyst coverage reduces capital expenditures and institutional monitoring. In this light, perhaps the claims that analysts contribute to short-termism should be reevaluated.
Even before the Trump tweet, discussions regarding interim reporting requirements for U.S. public companies had been ongoing for several years. In fact, going back to 2015, the Securities and Exchange Commission’s Advisory Committee on Small and Emerging Companies considered the advantages and disadvantages associated with discontinuing quarterly reporting. In 2016, the Director of the Commission’s Division of Corporation Finance addressed the issue in a speech in Europe, noting that, “The United Kingdom has stopped mandating that companies provide quarterly financial reports to investors. Lately, some commentators have asked the Commission to re-think the need for quarterly reporting by U.S. issuers, which has been a staple of the U.S. regulatory system since 1970, advocating that this frequency leads to short-term thinking by investors and company management. These commentators note that financial reporting that focuses on short-term performance is not conducive to building sustainable businesses because it steers management to focus on short-term goals and performance.” Flash forward a few years, and Title XXII Section 2201 of the JOBS Act 3.0 requires that the Securities and Exchange Commission conduct an analysis regarding the costs and benefits of quarterly reporting on Form 10-Q, especially for emerging growth companies. This provision may have been influenced by a report published by various trade groups, including SIFMA, about which we recently blogged. In that trade group report, a recommendation is made that emerging growth companies be given the option to issue a press release with their quarterly results rather than be required to file a quarterly report on Form 10-Q. The trade group report states that quarterly reports have become longer and more detailed, and therefore producing such reports has become more expensive. In the trade group report, the focus was on costs and reporting burdens.
At the same time, the debate relating to quarterly earnings guidance has been reinvigorated. Some have argued that quarterly reporting distracts managers from focusing on long-term goals and observe that public companies are all too concerned with short-term gains at the expense of long-term investments. The same commentators have focused in particular on the potential detrimental effects of providing quarterly earnings guidance. Perhaps these concerns are overstated. It seems that over time, fewer and fewer companies continue to provide quarterly earnings guidance. According to a recent study, approximately one-third of public companies issue quarterly earnings guidance. Nonetheless, in a piece titled “Short-Termism is Harming the Economy,” Jamie Dimon and Warren Buffett joined the Business Roundtable in calling for companies to refrain from giving quarterly guidance. The National Association of Corporate Directors and the National Investor Relations Institute joined in the call to eliminate earnings guidance. However, the Business Roundtable report does not advocate terminating the filing of quarterly reports on Form 10-Q. Regardless of whether quarterly reports on Form 10-Q are mandated or not, it would still be the case that companies would report quarterly results. The two issues—quarterly filings and quarterly guidance—appear to have been conflated making it more difficult to parse the real issues.
The Securities and Exchange Commission has adopted amendments requiring the use of the Inline eXtensible Business Reporting Language (XBRL) format for the submission of operating company financial statement information and fund risk/return summary information. The amendments become effective 30 days after publication in the Federal Register (likely by the middle of August 2018) but provide a phased-in compliance period. Our Legal Update summarizes the new requirements and offers timing and other practical considerations.
The Securities and Exchange Commission’s Chief Accountant, Wesley Bricker, addressed attendees at a conference of the Institute of Management Accountants. Mr. Bricker commented on the global nature of the capital markets. He noted that “American investors are investing directly in the securities of foreign private issuers and companies based outside the United States and registered in non-U.S. jurisdictions. At the end of 2016, U.S. investors had invested $9.9 trillion (of which U.S. mutual funds had invested over $4.3 trillion, and U.S. pension funds had invested over $1.3 trillion) in equity and debt securities listed in non-U.S. jurisdictions.” In light of the interconnectedness of global markets, Mr. Bricker emphasized the importance of collaboration among organizations involved in financial reporting and the significance of promoting high-quality financial reporting. Mr. Bricker commented on the importance of internal control over financial reporting, as well as on the role of preparers of financial reports. Mr. Bricker also noted the role of auditors as gatekeepers. He also touched on the role of the PCAOB and the role of audit committees. Mr. Bricker outlined a number of questions that audit committee members ought to pose to a company’s external auditors, including the following:
- In an audit of the financial statements, was the external auditor able to rely on a company’s internal control over financial reporting?
- If not, which of the business processes included the internal controls on which the auditor did not (or could not) place reliance? What were the factors that prevented reliance?
- Were any significant deficiencies or material weaknesses identified (and communicated in writing)?
- How did management consider that feedback in preparing the financial statements, including in its period-end closing processes?
Mr. Bricker noted that communications between the audit committee members, the auditors and management regarding financial reporting and internal control over financial reporting should be candid. The full text of his remarks is available here.
Today, the House Financial Services Committee advanced six bills for House consideration, including H.R. 5054, H.R. 5756, and H.R. 5877.
H.R. 5054, the Small Company Disclosure Simplification Act of 2018, which was introduced by Representative David Kustoff (R-TN), the “Small Company Disclosure Simplification Act of 2018” provides a voluntary exemption for emerging growth companies and other smaller companies from the requirements to use Extensible Business Reporting Language (xBRL) for financial statements and other periodic reporting. The bill passed 32-23.
H.R. 5756, to require the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals, which was introduced by Representative Sean Duffy (R-WI), H.R. 5756 requires the Securities and Exchange Commission to adjust certain resubmission thresholds for shareholder proposals. The bill passed 34-22.
H.R. 5877, the Main Street Growth Act, which was introduced by Representative Tom Emmer (R-MN), the “Main Street Growth Act” amends the Securities Exchange Act of 1934 to allow for the registration of venture exchanges to provide a venue which will allow qualifying companies one venue in which their securities can trade. The bill passed 56-0.
The Center for Audit Quality (CAQ) recently published “Non-GAAP Measures: A Roadmap for Audit Committees” (CAQ Roadmap), which examines themes that emerged from a series of 2017 roundtables hosted by CAQ with various stakeholders. The CAQ publication notes that audit committees have an important responsibility to oversee the financial reporting process and external audit.
The CAQ report notes that the audit committee can act as a bridge between management and investors, assess management’s reasons for presenting non-GAAP measures and evaluate the sufficiency of related disclosures. It adds that the audit committee can determine whether the measures present a fair and balanced view of company performance. CAQ lays out a three-fold roadmap for audit committee members: (1) identify key discussion topics with management, counsel and external auditors, (2) understand the external auditor’s role regarding non-GAAP measures and (3) adopt leading practices to support the presentation of high-quality non-GAAP measures. With respect to item (1), CAQ suggests that audit committee members consider topics for dialogue including: asking management whether it has internal guidelines for determining how non-GAAP measures are generated, calculated and presented; seeking the perspective of counsel on non-GAAP measures; asking the company to benchmark such measures to those of its peers; and finding out what disclosure controls and procedures are in place. With respect to item (2), while external auditors do not audit non-GAAP measures as part of their financial statement or ICFR audits, audit committees and management may consider external auditors as a resource when evaluating such measures and may ask them to perform certain procedures, such as testing controls related to the preparation and use of such measures in light of management’s polices, and to report such results to them. Last, the audit committee and management should consider adopting best practices, such as subjecting non-GAAP measures to robust disclosure controls, and adopting guidelines to follow when preparing and presenting non-GAAP measures to stakeholders.