Despite the current volume of non-financial information required under Regulation S-K, institutional investors are calling for more disclosure.
The burden of compiling the volume of non-financial information required under Regulation S-K often falls on the shoulders of the person responsible for compiling the financial information – the CFO – and the burden could be set to increase following the responses to a concept paper issued by the SEC in April.
Already the burden is a significant one. According to a survey conducted in March this year by software vendor CCH Tagetik, the non-financial information required under Regulation S-K (the “narrative”) accounts for 50% or more of the content in nearly half of financial reports – in some cases, the survey found, there is more than double the volume of non-financial information as there is financial information.
Typically, the narrative consists of an explanation of the results, a management and discussion analysis, and notes to the accounts. Whereas this level of narrative could be considered material non-financial information, institutional investors are calling for much more disclosure – so much more that concerns are being raised the volume of non-financial information that may be required under Regulation S-K could cause smaller investors an “information overload”.
CII Wants More Non-Financial Information Required under Regulation S-K
The SEC received more than 26,000 responses to the concept paper – among the bulk of them were letters calling for details to be disclosed about companies´ foreign subsidiaries and their sustainability plans – with many demanding that companies disclose their “human capital”. Brandon Rees, deputy director of the AFL-CIO’s Office of Investment, commented “Some two-thirds of the value of U.S. corporations comes from intangibles, and much of this comes from the employees, but if it’s not measured it’s not managed.”
Rees would like to see the disclosure of employee safety and health information, race and gender workforce composition, and employee turnover and retention rates; and Ken Bertsch, executive director of the Council of Institutional Investors (CII) agrees. Bertsch told CFO.com “employees constitute one of the primary drivers of value in companies, and companies don’t have to disclose much about them.” Bertsch would also like to see reasons for a change of auditor and much tougher controls on non-GAAP reporting.
When addressed with the question that his members could suffer from “information overload”, Bertsch replied: “We just have not heard from our members that there’s huge concern about the volume of disclosures, other than that they’d like to see a better organized 10-K and that the proxy statement is too long.” However, Robyn Bew, director of strategic content development at the National Association of Corporate Directors, disagrees. She feels that enforcing a higher volume of non-financial information required under Regulation S-K could have a negative effect on smaller investors.
Bew said: “One of the things that we hear from investors is that an unintended consequence of mandatory disclosure rules is more boilerplate. Everybody wants disclosures to be more effective, but that can mean different things to different people. Larger investors can say ‘Give it all to us and we’ll figure out what we want,’ while smaller investors don’t have the resources to do that kind of data mining.” Bew concludes it would be more useful if companies and boards could do more of their own thinking without regulation.
Likely No Drastic Changes in the Near Future
The trend in financial reporting is for companies to err on the side of caution and burden SEC filings with disclosures that are not material. However, this may be an unnecessary overreaction to investor demands. In recent years the SEC has aligned its definition of what it considers necessary “material information” closer to that of the Supreme Court. Currently, financial and non-financial information is considered “material”:
“When used to qualify a requirement for the furnishing of information as to any subject, [materiality] limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered.”
Disclosure for the sake of disclosure can shift investor focus away from information that is actually material to company operations. Fortunately for CFOs who would rather see disclosures streamlined and the burden of narrative reporting eased, the SEC does not look as if it is going to act quickly on the calls for more non-financial information required under Regulation S-K.
The SEC is still attempting to fine-tune its Disclosure Effectiveness Initiative and, if the calls to disclose more non-financial information required under Regulation S-K are acted on by the SEC, this could undo the good work already accomplished by the Initiative and negatively impact investors by obscuring relevant information in company filings.