Monday, July 25, 2016

SIFMA urges principles, priorities for SEC’s disclosure reforms

By Mark S. Nelson, J.D.

The Securities Industry and Financial Markets Association said it wants the SEC to focus its efforts to reform Regulation S-K on the development of principles-based rules, the primacy of materiality, and to avoid creating new liability risks for registrants. SIFMA offered its views on the Commission’s Regulation S-K Concept Release as the time for public comments drew to a close.

Reform of Regulation S-K has long been on the minds of regulators (SEC disclosure effectiveness initiative) and practitioners, but recent Congressional mandates in both the Jumpstart Our Business Startups (JOBS) Act (Section 108) (SEC report) and the Fixing America’s Surface Transportation (FAST) Act (Sections 72002 and 72003) (SEC proposal) have returned the issue to the fore. Much of the debate has centered on how to prune outmoded disclosure rules and re-cast the remaining ones to help companies deliver more effective disclosures to investors, especially given the varied ways modern technology may allow investors to consume this information.

Principles, materiality. According to SIFMA, the SEC’s disclosure regime has become increasingly prescriptive in character after having started with a more principles-based approach. SIFMA said this evolution, which even permeates some staff guidance, has led to “boilerplate” disclosures that emphasize “quantity over quality.” SIFMA would prefer that the Commission mull whether any new rules should be prescriptive and to adopt principles-based rules if a prescriptive approach would lack “significant benefit.” The industry group also urged the Commission to substitute principles-based rules for existing prescriptive ones, and to mull clarifying the meaning of rules that have morphed from their original principles-based formulation into more prescriptive edicts (SIFMA suggested the management’s discussion and analysis or MD&A as an example).

SIFMA also said the Commission should continue to employ the Northway and Basic formulations of materiality (Cf. Staff Accounting Bulletin No. 99). In this context, SIFMA welcomed a statement by SEC Chair Mary Jo White that “information overload” can occur when disclosures become extensive or fail to live up to their intended purposes. But some in Congress, including Sen. Elizabeth Warren (D-Mass), have cautioned the SEC about depriving investors of needed information about companies. Yet for SIFMA the issue is often one of scale and it urged the SEC to avoid adopting rules for all registrants that would be inapt for many of them.

Consolidated MD&A, liability risks. The Commission’s concept release asked a number of questions about the utility of the MD&A required by Item 303 of Regulation S-K. That provision emphasizes disclosures about liquidity, capital resources, results of operations, and off-balance sheet arrangements. According to SIFMA, the Commission should consolidate the myriad guidance it has published over the years on Item 303 compliance into a single resource because doing so would help provide streamlined disclosures to investors, ease burdens on companies, and increase the likelihood of compliance.

Elsewhere, SIFMA urged the Commission to replace the existing two-step test for disclosures of known trends in the MD&A context with a probability/magnitude test derived from Supreme Court precedent regarding the definition of materiality. The Commission explained the two-step test in a 1989 release discussing forward-looking information contained in the MD&A. SIFMA further observed that the Commission has conceived of multiple possible standards in this setting and cautioned against adopting an “reasonably possible” test (as opposed to “reasonably likely”) because companies may flood investors with needless disclosures in an effort to deal with increased liability risks.

SIFMA also warned that giving auditors expanded duties over MD&A disclosures may not justify the related burdens on companies. For example, SIFMA said management’s view could be marginalized and the resulting disclosures might trend towards boilerplate. SIFMA noted that auditors already review “other information” (such as MD&A) for disclosures that are “materially inconsistent” with the company’s financial statements (See, AU Section 550, reorganized as AS 2710).