On April 11, 2014, Keith F. Higgins, Director of the U.S. Securities and Exchange Commission’s (SEC) Division of Corporation Finance, gave a speech before the ABA Business Law Section discussing the new Disclosure Project that is being led by the Division of Corporation Finance. In an effort to improve disclosure in SEC filings, the project will involve reviewing specific sections of Regulation S-K and Regulation S-X. The goal, according to Director Higgins, is to determine if the disclosure requirements can be updated (1) to reduce the costs and burdens on companies while continuing to provide material information and (2) to eliminate duplicative disclosures. At the same time, the SEC is trying to determine if there is information not currently required to be disclosed that should be.
Ways to Improve Disclosure Effectiveness
At one point, Director Higgins observed that in addition to SEC updates to Regulations S-K and S-X, companies and their representatives can help improve what Director Higgins referred to as “the focus and navigability” of disclosure documents. Specifically, he recommended that companies improve their SEC filings by (1) reducing repetition, (2) focusing their disclosure and (3) eliminating outdated information.
Director Higgins recommended that companies reduce repetition by thinking twice before repeating something. As an example, he noted that many companies take their significant accounting policies footnote and repeat it verbatim in their MD&A discussions of critical accounting estimates. “If there were ever a place in a report that cried out for a cross reference,” Director Higgins remarked, “this is near the top of the list.” Additionally, he questioned whether the SEC’s MD&A guidance on critical accounting estimates even requires a recitation of the accounting principle itself.
While recognizing that companies have come to view the risk factors sections as an insurance policy, Director Higgins emphasized that the risk factors section is one that could be written better—less generically and more tailored. More precisely, Director Higgins said that the risk factors section should explain how the risks would affect the company if the risks actually came to pass. Director Higgins acknowledged the tendency for companies to simply follow what other companies have done or to include disclosures because a client alert says that it is a “hot button” issue for the staff. However, according to Director Higgins, the first question should be “does this issue apply to the company?” If not, then it should not be included.
Eliminating Outdated Information
Finally, Director Higgins recommended that companies and their representatives regularly evaluate their disclosures to determine whether they are material to investors. If disclosures are not material and are not otherwise required, then companies can take them out. Even if something was included in a prior filing in response to a staff comment, Director Higgins said that it is “perfectly all right to remove disclosure when it is immaterial or outdated.” Director Higgins assured the audience that “[a] staff comment is not carved in stone and enshrined for time immemorial in each filing going forward.”
Director Higgins, of course, was speaking for himself and prefaced his remarks with the customary disclaimer that his views did not necessarily reflect those of the SEC. But even if the SEC shares Director Higgins’ views regarding disclosure, companies must also consider the potential for private litigation. Indeed, Director Higgins acknowledged that courts have not been uniform in their interpretation of what constitutes “meaningful cautionary statements” for purposes of the Private Securities Litigation Reform Act safe harbor. Thus, companies have little incentive to limit the number of risk factors or trim excessive disclosure. Director Higgins also recognized that “materiality is not an easily applied litmus test.” Without a clearly defined metric for materiality, rational companies will continue to err on the side of disclosure, even at the risk of inundating investors with too much information. Even Director Higgins pointed out that disclosure overload for one person may not be enough disclosure for another. So, unless the securities laws are amended or regulations are issued to provide more meaningful safe harbors, companies may not be so eager to respond to Director Higgins’ call to action.