September 8, 2008

21st Century Disclosure: Grundfest and Beller Weigh In with “Evergreen” Questionnaire

Back when the SEC announced its new “21st Century Disclosure Initiative” at the end of June, Chairman Cox credited former SEC Commissioner Joe Grundfest and former Corp Fin Director Alan Beller with originating the idea (which was named “Project Alpha” back in the day). Now, Joe and Alan have published a brief 8-page summary of their model for reinventing the SEC’s disclosure system (they plan to expand it into a more extensive article later).

With a somewhat dramatic flourish, Grundfest and Beller suggest that the SEC should abandon “all vestiges of the world of paper-based filings” in favor of a Web-based questionnaire. This questionnaire would replace the forms-based filing framework that currently exists (and could be accomplished without any legislative action or change to liability standards). Here is a summary of their summary:

– On-line questionnaire would be comprised of a combination of yes/no responses, pull-down menus, predefined fields and narrative responses; many of the questions would require “free form” narrative disclosure (e.g. MD&A).

– Going forward, companies would only need to update any items that have changed since the last reporting period – there would no longer be a need to repeat unchanged information.

– When a change occurs, this would be highlighted – so period-to-period comparisons would be possible.

– All exhibits would be centralized in a single location.

– Companies wouldn’t need to file their questionnaire responses directly with the SEC – rather they would post the responses either on an SEC website or on their own websites, with a ‘hash’ that authenticates the document as well as the date and time of posting.

The notion of “company-based disclosure” rather than periodic or current reporting is not a new one. It’s been battered around for quite a while. But with the Web facilitating things, it’s exciting to see that the SEC is seriously considering such a radical change. The SEC will be holding its first roundtable on the “21st Century Disclosure Initiative” in October.

My Ten Cents: “21st Century Disclosure Initiative”

Here are a few of my thoughts on the general notion of reforming the periodic/current reporting regime (note these do not relate to the Grundfest/Beller model specifically):

1. Don’t Overpromise Savings – Whatever ideas are floated to change the reporting regime, don’t sell it as a cost-saver. Even if you cut out the financial printers, etc., there will be new vendors that will have to be paid. And the time that lawyers haggle over language will continue to exist in bountiful numbers.

2. Don’t Underestimate Technological Challenges – If my memory serves, some of these ideas were kicked around back in the mid-90s when I was at the SEC. One hurdle that continued to pose insurmountable problems was how to enable companies to avoid filing all of their disclosure with the SEC. One of these concerns was security – can companies (or their vendors) post information on their own websites in a manner that couldn’t be hacked? Another type of example – Dominic Jones recently wrote about a possible tech snafu with the SEC’s XBRL proposal.

3. The Tricky Issue of Duty to Update – If a new regime requires companies to post their disclosure on their IR web pages rather than in the form of a Form 10-K and Form 10-Q, consider what investors will expect? Even if the SEC adopts rules clearly stating that this disclosure is not subject to a duty to update except on a quarterly basis (or more frequently for Form 8-K-like items), investors won’t necessarily know – or care – about that – particularly retail investors. They will be expecting the information they read on a company’s site to be current.

4. Cut to the Chase for Investors – This point really is the bottom line. If the SEC is gonna bother to rework their reporting regime, I think the focus should first be on delivering the type of information that investors covet most – i.e. forward-looking information, what is the company’s strategy going-forward, how is employee morale, a sense of what management is really like, do the directors really kick the tires, etc.

In other words, only a few discrete pieces of Reg S-K have been updated since the movement to integrated disclosure thirty years ago. Why not focus on whether the required information is still material in this day and age and whether the information is what investors truly want, rather than keep tinkering around with how the information gets delivered?

These are really tough issues to parse and have been tackled before. But this should be the starting point for the discussion and debate. I fear that the SEC may focus on “form” rather than “substance”…

– Broc Romanek