SEC Revisits Reporting Requirements (Round 2)

TL;DR: The SEC released on 13 April 2016 a concept paper to obtain public comments on business and financial reporting. As a member of the investing public, I am thus commenting. My first round of comments are here.

Disclosure of Government Contracts

47. Is disclosure about government contracts important to investors? Why? Is there any additional information about a registrant’s contracts with the government that would be important to investors?

48. Rather than focusing specifically on government contracts, should we require registrants to briefly describe all material contracts? Would such a requirement elicit disclosure not otherwise provided in MD&A or the description of business?

My take: Government contracts are important, and more so in extractives, finance, utilities, technology, aerospace and defense, and infrastructure. Disclosure of these contracts, arguably regardless of value, helps investors gauge a company’s exposure to political and corruption risks. Oil and gas companies are particularly vulnerable to both risks, and a high level of exposure can have significant impacts on a company’s assets and potential revenues. Financial companies can be dragged into corruption scandals in state-owned corporations. In addition to government contracts, all material contracts would be useful to know also to determine exposure to counter-party risks in the financial and non-financial sense.

Government Regulations

Foreign regulations, including foreign tax rates and treaties, may have a material impact on a registrant’s operations. Should we specifically require registrants to describe foreign regulations that affect their business? If so, what specific information and level of detail should we require? How would any additional information inform investment and voting decisions? Would there be challenges for registrants to provide such disclosure?

My take: Because many US companies are generating significant revenues from foreign operations, foreign regulations and their impact on the business is material information to investors. Tech companies for instance, are facing increased regulatory pressures relating to privacy, which may have long-term implications on these companies’ ability to operate in Europe. It is strange that an investor reads this in the news but is not explained in the 10-K.

Number of Employees

54. Does disclosure of the number of persons employed by the registrant help investors assess the size, scale and viability of a registrant’s operations and any trends or shifts in operations? Is this disclosure important to investors and why? Is there any additional information about employees that would be important to investors? If so, what information?

(Skipping 55, as I have no comment on it)

56. Should we require registrants to distinguish among their total number of persons employed, such as by distinguishing between: • full-time and part-time or seasonal employees; • employees and independent contractors; or • domestic and foreign employees? Why or why not?

57. Rather than requiring registrants to disclose the number of employees or independent contractors, should we require or permit registrants to provide a range? Why? Should we allow for different ranges based on the size of the registrant? Would reporting a range rather than a specific number reduce the costs of producing this disclosure?

58. Should we require disclosure of additional information about a registrant’s employees or employment practices? What would be the challenges of requiring disclosure of any additional information, and what would be the benefits to investors?

My take: Human capital is an important component of a business and one that is not adequately addressed in regulatory filings. As pointed out by one of the comments in the concept paper, disclosing the number of employees, location and type, as well as employment practices helps investors understand tax implications as well as vulnerability to labor issues and changes in labor laws.

Disclosure of Information Relating to Public Policy and Sustainability Matters

216. Are there specific sustainability or public policy issues are important to informed voting and investment decisions? If so, what are they? If we were to adopt specific disclosure requirements involving sustainability or public policy issues, how could our rules elicit meaningful disclosure on such issues? How could we create a disclosure framework that would be flexible enough to address such issues as they evolve over time? Alternatively, what additional Commission or staff guidance, if any, would be necessary to elicit meaningful disclosure on such issues?

217. Would line-item requirements for disclosure about sustainability or public policy issues cause registrants to disclose information that is not material to investors? Would these disclosures obscure information that is important to an understanding of a registrant’s business and financial condition? Why or why not?

218. Some registrants already provide information about ESG matters in sustainability or corporate social responsibility reports or on their websites. Corporate sustainability reports may also be available in databases aggregating such reports. Why do some registrants choose to provide sustainability information outside of their Commission filings? Is the information provided on company websites sufficient to address investor needs? What are the advantages and disadvantages of registrants providing such disclosure on their websites? How important to investors is integrated reporting, as opposed to separate financial and sustainability reporting? If we permitted registrants to use information on their websites to satisfy any ESG disclosure requirement, how would this affect the comparability and consistency of the disclosure?

219. In an effort to coordinate ESG disclosures, several organizations have published or are working on sustainability reporting frameworks. Currently, some registrants use these frameworks and provide voluntary ESG disclosures.  If we propose line-item disclosure requirements on sustainability or public policy issues, which, if any, of these frameworks should we consider in developing any additional disclosure requirements?  Are there sustainability or public policy issues for which line-item disclosure requirements would be consistent with the Commission’s rulemaking authority and our mission to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation, as described in Section III.A.1 of this release? If so, how could we address the evolving nature of such issues and keep our disclosure requirements current?

My take: The SEC’s coverage of sustainability metrics is a huge development for ESG reporting because integrating sustainability metrics in regulatory filings confirms the materiality of ESG issues. Requiring prescriptive reporting on some quantifiable metrics (i.e carbon emissions) will further improve the quality of ESG data while allowing comparability. Reporting on such metrics should, however, be in contextual form and should include trends, rather than reporting absolute numbers in isolation. But because not all sustainability metrics are quantifiable, disclosures should be combination of quantitative and qualitative. And both investors and companies are better served disclosing metrics that are material to the company and their shareholders.  A prescriptive reporting standard for all sustainability metrices may not work because the business impact of sustainability issues  vary from company to company.

Nonetheless, disclosing through regulatory filings also removes the spin from most CSR reporting. CSR reports tend to double up as marketing tools and highlight “nice to have” initiatives, rather than issues that pose risks to the company. CSR reports like to showcase philanthropy and employee volunteerism, which, while important, do not have a clear business impact. CSR reports tend to focus on the good story, conveniently omitting controversial issues that raise a company’s risk profile. The SEC’s 2010 advisory note to integrate climate change reporting in 10-Ks was a strong start but can certainly be improved upon because sustainability has expanded to much more than environmental issues.

Disclosing sustainability metrics to regulators ultimately provides investors a comprehensive and holistic view of a company, one that is shaped by looking at both financial and non-financial aspects of the business. This can only mean better informed investors who are better equipped to make reasonable decisions.

Risk Factors

145. How could we improve risk factor disclosure? For example, should we revise our rules to require that each risk factor be accompanied by a specific discussion of how the registrant is addressing the risk?

146. Should we require registrants to discuss the probability of occurrence and the effect on performance for each risk factor? If so, how could we modify our disclosure requirements to best provide this information to investors? For example, should we require registrants to describe their assessment of risks?

147. How could we modify our rules to require or encourage registrants to describe risks with greater specificity and context? For example, should we require registrants to disclose the specific facts and circumstances that make a given risk material to the registrant? How should we balance investors’ need for detailed disclosure with the requirement to provide risk factor disclosure that is “clear and concise”? Should we revise our rules to require registrants to present their risk factors in order of management’s perception of the magnitude of the risk or by order of importance to management? Are there other ways we could improve the organization of registrants’ risk factors disclosure? How would this help investors navigate the disclosure?

148. What, if anything, detracts from an investor’s ability to gain important information from a registrant’s risk factor disclosure? Do lengthy risk factor disclosures hinder an investor’s ability to understand the most significant risks?

149. How could we revise our rules to discourage registrants from providing risk factor disclosure that is not specific to the registrant but instead describes risks that are common to an industry or to registrants in general? Alternatively, are generic risk factors important to investors?

150. Should we specify generic risks that registrants are not required to disclose, and if so, how should we identify those risks? Are there other ways that we could help registrants focus their disclosure on material risks?

151. Should we retain or eliminate the examples provided in Item 503(c)? Should we revise our requirements to include additional or different examples? Would deleting these examples encourage registrants to focus on their own risk identification process?

152. Should we require registrants to identify and disclose in order their ten most significant risk factors without limiting the total number of risk factors disclosed?

My take:  Risk factors is the first section I tend to read when I open a 10-K and I have read enough to be able to recite verbatim that regulation poses a risk to every business in the planet. This is to say that the Risk Factors section has become so boilerplate that it no longer provides meaningful insights into what the company considers as real risks to its business. Yet, where there is a semblance of a discussion of risk, there is no substantive discussion of the process by which a company determined its risk factors year after year, the determination of key risks, how it is addressing its risks, and how much progress it has made in mitigating its risks.  So on the questions relating to specificity, risk prioritization, and the probability of occurrence, the answer is a resounding yes. On the question of length, I say drop the lawyer and hire a writer.



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