Thursday, October 06, 2016

Advisory committee considers disclosure, diversity, capital issues affecting small companies

By Amy Leisinger, J.D.

The SEC’s Advisory Committee on Small and Emerging Companies met to discuss the impact of Regulation S‑K disclosure requirements and issues concerning corporate board diversity on smaller companies and to begin formulating potential recommendations for the Commission. The committee also heard from the Division of Trading and Markets on the tick-size pilot and treatment of capital “finders” and the Division of Corporation Finance regarding ongoing outreach efforts for smaller companies about raising capital generally.

Disclosure. Several committee members noted that disclosure rules, particularly Regulation S-K, cover a large amount of information but suggested that, while transparency is important, regulators need to consider what levels of disclosure will actually allow, or even encourage, small companies to succeed. The primary focus must be on determining what information is material and ensuring that the material information is disclosed. For example, in most cases, comprehensive disclosure about business structure is not as crucial for small companies, one member noted. The question ultimately comes down to which individual or entity will be the end consumer of the information provided and, as such, a more principles-based approach to disclosure may be appropriate for small and emerging entities. The starting point should be asking whether the disclosure provides data to assist in informed investment decision-making, one member said.

The committee also considered whether the SEC should require companies to disclose costs associated with compliance efforts. This information may be more useful to the agency than anecdotal industry comments in evaluating the true burdens of regulation and would bring to light potential disproportionate burdens imposed on small companies. However, one member noted, fixing regulations may not fix cost issues; some businesses have an incentive to spend time interpreting and assessing application of disclosure requirements.

Diversity. National Association of Corporate Directors board member Cari Dominguez offered a primer on diversity issues in public company boards and suggested that boards cannot fulfill their responsibilities without reflecting the composition of stakeholders and customers. While most agree that increasing board diversity is an important goal, she explained, progress in the U.S. has been slow in comparison with other countries. Other nations have called on boards to establish and measure diversity and set specific targets, and many foreign companies have implemented voluntary measures to increase diversity and limit director tenure. Leaders of large U.S. companies are more likely to discuss these issues; more than half of the small-cap companies polled stated that their boards did not discuss gender, racial, ethnic, or age diversity in the past year, Dominguez said. She urged all boards to get diversity on their discussion agendas and figure out ways to expand their pools of potential board candidates.

Some committee members cited a lack of knowledge concerning where to find qualified director candidates who would provide diversity and noted that the most competent individuals are often already overburdened with board services at other companies. Further, they cautioned that mandating diversity or enforcing quotas could have a negative impact on optimal board composition and highlighted the fact that the market will eventually address disparities in board diversity.

Others agreed that proscribed standards are not the answer but suggested that disclosure of director characteristics may be the best way to address the matter, particularly with regard to any unconscious biases that may be looming within a company. Market forces will eventually balance out boards, but that could take years, they noted. To speed up the process, it is necessary to show that diversification adds value, members concluded.

Capital formation. The committee closed its meeting with a discussion of outreach initiatives for smaller companies regarding capital-raising activities. Entrepreneurs need to know about the various approaches to capital formation and their requirements and limitations, members said, and the Division of Corporation Finance has made great strides in conducting local seminars for small business owners. However, the committee found, more can and should be done, both in terms of additional locations and enhanced information for investors and lawyers who assist small business owners. The committee acknowledged the limits on SEC staff in terms of actually providing advice on the propriety of any approach in a specific case but did suggest that efforts be made to better organize the educational information that is available and ensure access for all entrepreneurs.