US Chamber Calls for Streamlined Corp Disclosures but Investors Wary of Less Information
The US Chamber of Commerce recently issued a report, Corporate Disclosure Effectiveness: Ensuring a Balanced System that Informs and Protects Investors and Facilitates Capital Formation. The report proposes two sets of recommendations for the Securities and Exchange Commission (SEC) — one to be accomplished in the short term and the other in the long term — to streamline corporate disclosures and make them more effective.
As we have seen with other reports and articles on corporate disclosures, the discussion of disclosure effectiveness soon turns into one of “disclosure overload.” The report states:
Information overload strikes a blow to the effectiveness of the disclosure regime that the SEC administers. The essential problem is that investors become inundated with information that is not useful, making it difficult to identify important information about a business. In some instances, investors simply ignore long, dense documents altogether as they find much of the information unhelpful or too time-consuming to go through.
We agree with some of the report’s recommendations, such as the call for eliminating repetitive information, including legal proceedings, i.e. information pertaining to litigation issues that appears in different parts of the annual report, sometimes verbatim, or outdated requirements that don’t take into account the advances in technology. One such example: the requirement to display a graph showing the company’s stock price performance over a period of time.
We, however, disagree with the report’s heavy focus on reduction of information. Investors are voracious consumers of information. As we demonstrate in the CFA Institute publication Financial Reporting Disclosures: Investor Perspectives on Transparency, Trust, and Volume, investors do not seek a reduction in data or volume of disclosures because they have the ability to utilize technology to evaluate the data. Instead they seek more effective disclosures. Our publication offers definitive recommendations on how to achieve such effectiveness. Instead the Chamber report’s emphasis appears to be on quantity rather than quality. We illustrate the point by highlighting a couple of examples.
On changes that might require more study and could take place in the long term, the Chamber report recommends reassessing the compensation discussion and analysis (CD&A) section of a company’s annual filing.
Although CD&A was intended to illuminate a company’s executive compensation practices and philosophy, the discussion at most companies has instead resulted in a narrative that is dense and laden with technical jargon and immaterial information. CD&A can be impenetrable, even for sophisticated investors. The length of CD&A alone — a 20-page narrative is not uncommon and it has been known to run on for over 40 pages at some companies — can obscure what is material.
We agree that the CD&A section should be reassessed. But the issue has less to do with length than the fact that it is largely a wasted opportunity for issuers burying in legal boilerplate any real insight on compensation strategy. Investors want management and the board to provide their assessments of strategies, but without the legalese that obscures true insight. Accordingly, in a 2009 CFA Institute member survey, 74% of respondents told us that they regularly use compensation practices and/or pay level information in the investment decision-making process. However, in a later survey of more than 2,300 CFA Institute members, only 20% of respondents said that US company CD&A disclosures are both transparent and understandable. Given that the current format for CD&A disclosure does not serve investor needs, CFA Institute convened both issuers and investors to develop a CD&A template reflecting compensation disclosure best practices that allow issuers to tell their story while assuring that investors have access to meaningful information.
Similarly, the Chamber report discusses risk disclosures, stating the following:
The SEC’s requirements for the disclosure of risk have expanded in a piecemeal fashion over many decades. Companies are required to discuss risks to the business under various items of Regulation S-K, including, among others, Item 101 (Description of Business), Item 103 (Legal Proceedings), Item 303 (MD&A), Item 305 (Quantitative and Qualitative Disclosures About Market Risk), and Item 503 (Risk Factors).
The report recommends considering consolidating requirements relating to risk factors, legal proceedings, and other quantitative and qualitative information about risk and risk management into a single requirement as this “would reduce redundancy and articulate for investors a valuable holistic view of risk through the eyes of management.”
Again, we believe the emphasis should be on effectiveness rather than just eliminating redundancy. Investors believe the 2008 financial crisis — and the ensuing five years of economic uneasiness — plainly revealed the insufficiency of disclosures, particularly those around risk management and especially in the case of financial institutions. We, therefore, welcome more complete disclosure around the risks that companies confront and their strategies for mitigating them, as well as more insight on the risk governance process. That includes better disclosure of the board’s role and capabilities on risk management.
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