February 15, 2018

Should We Lose the 10-Qs?

In recent years, some prominent governance commentators have advocated that the SEC follow the lead of EU & UK regulators and eliminate mandated quarterly reporting.  A recent study published in the March issue of “The Accounting Review” says that there’s empirical data supporting the idea that the SEC should “lose the 10-Qs.”  Here’s an excerpt from a recent American Accounting Association press release on the article:

With regulatory reform a high priority for the Trump administration, a new study focuses on one possible target – and it’s a fat one – the half-century-old SEC rule mandating the filing of quarterly financial reports by public companies.

The EU and UK no longer require quarterly financials, and the question of whether the SEC should follow suit has evoked heated debate. While there has been plenty of theorizing about the subject, what has been absent until now is large-scale evidence of the advantages less frequent reporting offers to companies and their shareholders. The research challenge: How to compare the effect of reporting frequency when all U.S. companies have to file quarterly.

Now a study in “The Accounting Review,” published by the American Accounting Association, finds a way around this problem by analyzing evidence from periods when reporting-frequency mandates changed in the U.S., permitting before-and-after comparisons to be made.

While acknowledging that, yes, there may very well be advantages in increased reporting frequency – such as lower cost of capital and more information for investors – the study concludes, crucially, that shorter reporting intervals engender “managerial myopia” which finds expression in a “statistically and economically significant decline in investments” along with “a subsequent decline in operating efficiency and sales growth.”

Therefore, “our evidence…supports the recent decision by the EU and the UK to abandon requiring quarterly reporting for listed companies with an apparent intent to preventing short-termism and promoting long-term investments,” write the study’s authors, Rahul Vashishtha and Mohan Venkatachalam of Duke University’s Fuqua School of Business and Arthur G. Kraft of the Cass Business School of City University London.

The study says that prior to the reporting mandates, firms that reported results at longer intervals had greater annual sales, annual sales growth and return on assets than firms that reported more frequently. By contrast, in the period three to five years post-mandate, sales and sales growth were about the same for the two groups, while the difference in return on assets narrowed significantly.

Of course, one of the truisms of corporate governance research seems to be that for every study that says “white,” there’s another that says “black.” This MarketWatch article from last year suggests that the issue of reporting frequency is no exception.

DOJ’s New Policy Restricting Use of Agency Guidance

Late last year, Attorney General Sessions issued a memo announcing his intention to curb the practice of “rulemaking by guidance.” This King & Spalding memo says that the DOJ has acted to implement the AG’s directive. Here’s an excerpt summarizing the new policy:

On January 25, 2018, Associate Attorney General Rachel Brand issued a memorandum significantly restricting Department of Justice civil litigating units’ use of executive agency guidance documents in affirmative civil enforcement actions. The Brand Memo outlines new policies for cases in which an executive agency previously issued relevant non-binding guidance, including:

– Reinforcing the long-standing principle that guidance documents are just that—recommendations for regulated industries;

– Emphasizing that guidance does not bind regulated parties or create new legal obligations beyond the scope of existing statutes and regulations;

– Precluding the Department from “effectively convert[ing] agency guidance into binding rules”; and

– Preventing Department lawyers from using noncompliance with guidance to establish violations of law.

The Brand Memo’s potential impact is very broad, and it will influence any DOJ investigation that relies heavily on regulatory agencies’ non-binding interpretive guidance, but the King & Spalding memo suggests that it may have a particularly significant impact in the life sciences sector – where DOJ attorneys have long leveraged guidance from the DHS’s Office of the Inspector General and the FDA to support the government’s claims.

Nasdaq Proposes Changes to Shareholder Approval Rule

This Morrison & Foerster blog highlights a recent Nasdaq proposal that would tinker with the rules governing when listed companies would have to go to their shareholders for approval of new stock issuances. Here’s an excerpt summarizing the proposed changes:

The proposal would, among other things:

– Amend the measure of “market value” in connection with assessing whether a transaction is being completed at a discount from the closing bid price to the lower of: the closing price as reflected by Nasdaq, or the average closing price of the common stock for the five trading days preceding the definitive agreement date;
– Refer to the above price as the “Minimum Price,” and existing references to “book value” and “market value” used in Rule 5635(d) will be eliminated; and
– Eliminate the references to “book value” for purposes of the shareholder vote requirement.

For some Nasdaq companies, this is kind of a big deal. Currently, listed companies need shareholders to sign off on any financing transaction (other than a public offering) that would result in the issuance of 20% or more of their outstanding shares at a price less than the greater of book or market.

Changing the rules to eliminate the reference to book value and shake out some of the effects of market volatility will enhance companies’ ability to raise private money quickly – and doesn’t seem to do violence to shareholders’ interests either.

John Jenkins