That paragon of disclosure, the Securities and Exchange Commission, has come to the conclusion that too much information can ultimately mean less information. As such, it is seeking public comment on proposals to allow firms to issue abbreviated financial statements in their annual reports and other documents, such as prospectuses and proxy statements.
To be fair to the SEC, it hasn’t done an about-turn on its disclosure policy. If implemented after the comment period (ending October 10), the proposals would ensure that full financial statements would continue to be filed with the Commission – and have to be provided by the company, upon request, to any investor within five days. Companies would have to make it clear in their annual reports that the financial statements were in abbreviated form and that the full versions were available without charge.
Prompted by academic concern over the issue, the SEC’s belief is that the growing complexity and volume of financial information has made the annual report and other documents less readable and comprehensible to investors. And it has also put a significant printing and distribution cost burden on public companies. ‘Proponents of annual report simplification believe that streamlined annual reports will allow registrants both to communicate more effectively with shareholders by being able to highlight key financial items and to reduce the costs of preparing and delivering the annual report,’ says the SEC executive summary on the proposals. It continues by asserting the view that a large segment of a company’s shareholders does not review or analyse the detailed information in the notes to the financial statements.
By cutting out some of the financial footnotes from the annual report the theory is that the information will actually become more accessible to the everyday investor. Indeed, at the launch of the proposals back in June, Commission chairman Arthur Levitt cited the example of one major corporation which would have its financial statements reduced from 43 pages to 13 by omitting the relevant footnotes. Those investors that want the full works will just have to put a little bit more effort into getting hold of them.
Meredith Cross, deputy director of the SEC’s corporation finance division, stresses that the Commission is not saying to investors: you can’t understand this, so you’re not going to get it. ‘It’s not intended that way at all,’ says Cross. ‘We’re asking investors if they use this particular information. It’s part of the SEC’s commitment to increase the readability of disclosure. We want more plain English. The proposals are specifically aimed at shortening the statements and making them less daunting.’
So what does the SEC want in and – more importantly – what does it want out? The abbreviated financial statements would be limited to those addressing specified matters, including accounting policies, comparability, explanatory language in the accountant’s report, contingencies, loan defaults and related party transactions.
The Commission’s release does not directly discuss what footnotes would be left out of financial statements if the proposals were implemented, but it does list the major types of disclosures that would typically be omitted in an appendix.
These include information on long-term obligations; use of derivatives and hedging activities; employee stock ownership plans; pension plans; currency translations; and stock options. The latter has been proposed for exclusion before the Financial Accounting Standards Board has released its final decision on what information to include in footnotes on this subject.
Readers of this magazine will recall that the footnotes disclosure on stock options was adopted by the FASB last year after it dropped a proposal to make companies take a charge against their earnings. It appears that the SEC is now suggesting that stock options do not require the wide level of disclosure originally envisaged when the FASB backed down.
But the SEC’s proposals do not stop there. The Commission is proposing that executive and director compensation disclosures that appear in proxy statements should be streamlined and consolidated (see The Great Pay Debate, page 29). And along with the release on abbreviated financial statements, the Commission is sending out a questionnaire to investors soliciting comment on its main proposals as well as a whole string of other areas designed to streamline disclosure further. During the comment period, it is also holding focus groups with investors to elicit their opinion on abbreviated financial statements by looking at examples in mocked-up form.
The questionnaire looks at a whole slew of issues which the Commission considers pertinent to the current debate on disclosure. Part of that debate is being driven by the wealth of information becoming available to investors by electronic means. ‘One question we’re asking is whether we need to be regulating how companies communicate with their shareholders in annual reports,’ says Cross at the SEC.
Wrapped up in that introspective look at its own role, the Commission touches upon the possibility of some fairly radical departures from the norm within the questionnaire. Summary annual reports crop up as a possible option for the future, despite being widely criticised back in the late 1980s for a lack of information provision. And the Commission wants to know just where its boundaries should lie: ‘Should the SEC continue to require that companies send shareholders annual reports?’ muses the section on annual reports. ‘Would you like to continue to get financial and other information from companies in paper even if you get it electronically?’ asks the online information section. The Commission is seeking opinion on the streamlining of information across the board.
Responses to the SEC’s proposals have been mixed. Patrick McGurn at the Investor Responsibility Research Center (IRRC) in Washington says that he hasn’t heard a lot of ‘squawking’ from institutional investors on the proposals. ‘There hasn’t been a great degree of heat on the issue to date,’ says McGurn. ‘Whether that’s down to apathy or simply because it’s the vacation season I don’t know. The comment period is still open.’ IRRC has come out with its guns blazing in some respects though: ‘While less may be more in some cases, nothing is nothing,’ it said with regard to the SEC’s moves in its newsletter in early July. ‘Many firms have already decided to cut mailings of quarterly reports; given the choice, many might scrap the annual report as well.’
Those are fears echoed by several others in the investor community. Alyssa Machold, deputy director at the Council of Institutional Investors, says that she welcomes the spirit of the SEC’s proposals; but she is concerned that they may be distorted by some unscrupulous companies if they are implemented.
‘Our members have a great interest in seeing all the information possible and seeing it in a clear, straight-forward manner,’ says Machold. ‘To the extent that these changes may bring this about we are supportive of the SEC’s efforts. However, we are aware that changes made with the best of intentions may have additional consequences. Our experiences with some corporations have led us to believe that if you give an inch they will take a mile.’
Machold’s concerns are backed-up by comments from the investors themselves. In the latest edition of Full Disclosure, an annual survey of fund managers in the UK and the US conducted by management consultants Shelley Taylor & Associates, one investor notes: ‘I don’t like the abbreviated annual reports that some companies are moving to. It is important to have everything in one document in a standard format.’
Shelley Taylor says that this is a theme which crops up time and again in the research. ‘My impression is that investors want more useful annual reports rather than more condensed versions. We’ve seen little concern from investors about the size of the document or whether it includes information for other audiences.’ Taylor adds that it’s not the amount of information which causes concern for investors in the survey, it is whether that information is clearly set out in an easily accessible form.
Do not be put off, though. There are many investors and companies which also recognise the need for a streamlining of information in annual reports and other disclosure documents. And the corporates are not only motivated by a desire to cut costs. There is a real recognition that private investors, in particular, often do not look at the detailed information in the financial footnotes and can find the excess of information daunting in their appraisal of their investments.
There is also a high level of support for the SEC’s initiative from some quarters where it would not normally be expected. Addison Design Company in New York gains a lot of business from the annual report market, but chairman David Stewart does not believe that the Commission’s proposals present any threat to his business – in fact, he positively welcomes them.
‘These are very encouraging moves,’ says Stewart. ‘The SEC is doing things the right way by soliciting the views of investors first. We expect that the better companies will do more and more innovative things, whether that means updating web sites daily or releasing investor magazines quarterly. More companies will want to communicate better when the prescribed manner of communication is left up to them. Some companies will inevitably give less information, but the market will seek its revenge.’
