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To restore investor confidence, the SEC is asking companies to file more financial information -- and quicker. But some worry that faster isn't better.
Jennifer Caplan, CFO.com | US
October 9, 2002
When it comes to filing financial reports, will faster be better?
The Securities and Exchange Commission seems to think so. To give investors more to go on than pro forma earnings statements at the end of a quarter, the SEC will require publicly traded companies to speed up their 10-K and 10-Q filings. On top of that, thanks to a host of new and proposed regulatory requirements, corporations will likely have to include a whole lot more detail in their financial statements.
What's not entirely clear, however, is whether more reporting plus shorter deadlines equals better information. The tighter deadlines "would strain resources and could decrease the quality of reports by increasing the likelihood of errors and omissions," wrote Robert Davis, Dell Computer's vice president of corporate planning and reporting, when the SEC was considering the tighter deadlines it would eventually invoke.
In a similar vein, Ronald Samford, CFO of Hibernia Corp, a financial services holding company, wrote: "We want to be thoughtful, not hurried. We need to focus on quality, not an illusion of speed that increases the risk that financial reports may be inaccurate, incomplete or even misleading."
Indeed, the SEC's announcement in early September that beginning in 2004, companies with more than $75 million in market value will be required to file 10-Qs and 10-Ks in record time has generated strong opposition from companies, auditors, and business groups. (The SEC received 302 letters objecting to its initial proposal.)
As of next year, public companies will have to file 10-Qs within 40 days after the end of the quarter. That deadline will fall to 35 days in 2004. Annual reports must be filed within 75 days in 2003, and within 60 days beginning the following year.
That will slash the reporting time a tad. Previously, companies had 45 days after the end of a quarter to file 10-Qs and 90 days to file 10-Ks. According to a Deloitte & Touche study, it takes a Fortune 500 company about 44 days after a quarter's end to file a 10-Q, and 81 days to file a 10-K. In short, time was already tight.
To meet the new requirements, companies will likely have to boost spending to improve IT systems, hire new personnel, and shoulder higher auditing and legal fees. Although costs are likely to vary significantly across firms, some will pay a hefty price. One company responding to the Deloitte study, for example, said that modifications to its financial reporting system alone could easily exceed $1 million.
No Big Whoop
Some observers think the added expenses won't amount to all that much, however. David Fondrie, vice president of equity research at Heartland Advisors, a mutual fund company based in Milwaukee, maintains that the excessive-cost argument against faster filing is a hollow one. He notes, "A well-run company should be able to get its financials out in time if people are doing their jobs correctly."
But late filers do stand to assume a heavy load in added paperwork. The penalty for failure to comply — the loss of eligibility to use short-form registration statements for at least one year — is burdensome. "That alone is a pretty powerful incentive to get things done on time," says David Copenhafer, director of EDGAR services at Bowne & Co., a corporate reporting and mutual fund printing company.
Companies not swift enough in their reporting would have to swap the short S-3 form for the lengthy S-1 variety. That would amount to hundreds of pages of added disclosure, Copenhafer explains. "The difference in document size is huge and could cost hundreds of thousands of dollars in legal fees and additional expenses," notes Copenhafer. What's more, investors may treat failure to comply as a negative signal and punish companies that don't file on time.
Still, it might indeed have been high time for SEC to update its filing requirements, which were last adjusted in 1970. In its final rule release letter issued on September 5, the commission argued that advances in technology over the last 30 years have allowed companies to crunch the numbers and produce better reports more quickly. Technology boosts have also "increased the market's demand for more timely corporate disclosure," said the commission.
But finance chiefs contend that more-complicated accounting standards and disclosure rules have made it harder and more time-consuming to prepare the reports. "We believe that [increased complexity] more than offsets the advances in communications and technology," said Hibernia's Samford in a letter to the SEC.
Indeed, those reporting requirements are likely only to increase over time. The SEC recently voted unanimously to require corporate filers to explain how they apply critical accounting policies in the MD&A section of their financial statements, for example. The new rule would require managers to include an Application of Critical Accounting Policies section in annual reports, registration statements, and proxy and information statements.
Since Enron's collapse, of course, the feds have proposed and invoked a slew of rules governing such things as off-balance-sheet transactions and stock option treatment. What's more, the requirement under the Sarbanes-Oxley Act that CFOs and CEOs certify company financials is likely to pack even more bustle into the tighter filing deadlines. Jeff Naylor, CFO of Big Lots, a closeout merchandise retailer, reckons that certification alone will add at least two to three extra days to his company's filing process.
The politicians and regulators apparently haven't given much thought to matching up the new requirements with the time needed to comply with them, contend executives. Issuing hard-and-fast deadlines before finalizing new accounting and disclosure regulations still in the pipeline is premature. Says Naylor: "I wish the SEC had determined the specifics around the standards and disclosures they wanted first, and then figured a reasonable time frame for compliance."
The Pitt Stops Here
Following the recent flurry of accounting and reporting abuses, however, the SEC was in no mood to be accommodating. Still, some insist that the commission's push for tighter deadlines is merely a politically motivated overreaction to a few scandals. "There's a lot of knee-jerk reaction going on right now," says Naylor of Big Lots.
To be fair, the SEC priority of getting more reliable information to investors preceded the scandals. Just a few months after being named SEC commissioner in August 2001, Harvey Pitt derided the growing practice of issuing pro forma results and called for a revamping of the financial reporting system. The proposed changes included speedier filing. "Pitt came into the commission…convinced that faster filing was a priority and that it could work," recalls Beth Young, director of special projects at The Corporate Library, a corporate governance research organization.
Requiring speedier filing is a reasonable response by regulators to piecemeal financial reporting, critics contend. By issuing information selectively, "companies in large part brought this on themselves," says Young. Before the SEC's actions, managers typically put out earnings releases two to three weeks after the close of the quarter, leaving a gap of about 24 to 30 days before the 10-Q was issued.
During that time, investors had to base their decisions mainly on unaudited, non-GAAP earnings information. Some corporations even omitted balance sheets, leaving investors largely in the dark to piece the financial puzzle together.
Pro-forma has indeed been the order of the day. In an exclusive CFO.com/KPMG survey released last November, 82 percent of 196 finance managers said their companies report some kind of non-GAAP (that is, pro forma) earnings in press releases. And according to a survey conducted by the National Investor Relations Institute (NIRI) last year, 133 of the 233 companies sampled, or 57 percent, reported pro forma information prominently (or at least gave it equal importance to GAAP measures if those were shown). At the same time, of the 133 companies reporting pro forma results, only four did not include GAAP earnings-per-share results.
Reporting non-GAAP earnings has provided corporations with more than a little flexibility. "Many companies were issuing pro forma earnings statements to essentially make up whatever they wanted," acknowledges Stephen Melvin, CFO of The Princeton Review, a standardized-test preparation company.
Narrowing the time gap between the issuance of earnings press releases and that of 10-Qs and 10-Ks has thus been high on the SEC's to-do list. "While quarterly and annual reports generally reflect historical information, a lengthy delay before that information becomes available makes the information less valuable to investors," said the SEC. "Earnings announcements themselves are generally less complete in their disclosure than quarterly or annual reports."
Step by Step
The commission also contends that, once companies release earnings statements, they've already done the bulk of the work needed to prepare quarterly and annual reports. Executives retort that producing management's discussion and analysis (MD&A) and footnote disclosures requires an additional layer of time-consuming work. That process, they stress, involves many steps and relies on outside information, including competitive market trends, for example.
Generating MD&As and footnotes is "much more time-consuming than just producing basic financial statements," say Hibernia's Samford. Robert Reilly, a managing director at Willamette Management Associates, a business valuation firm, agrees: "That's a whole other level of work, that requires multiple steps across departments and takes much longer."
Speeding up the reporting process, companies argue, would put undue burdens on those involved in it, compromise accuracy, and ultimately hurt investors. According to Deloitte and Touche, it takes an average Fortune 500 company 3 to 6 days to collect the raw data for a 10-Q, and 18 to 22 days to put out an earnings announcement. It then takes between 14 and 30 days to prepare the MD&A and footnote disclosures. Then follow two more weeks — for reviews by senior management, auditors, and audit committees and boards, as well as for conversion of the reports into EDGAR format — before the 10-Q can be filed with the SEC.
Managers also worry that the quality of the both the internal and external audit processes could suffer if filing is rushed. "We are concerned that shortening the filing due dates may serve to undermine [the audit committee's] ability to fulfill its role," the law firm Sherman & Sterling wrote to the SEC.
Indeed, it may also make it harder for companies to recruit qualified people to sit on audit committees if tighter deadlines put excessive pressure on the role. Another worry is that audit firms might find themselves stretched to the limit and giving preference to their largest customers.
Beyond all the worries about the toll the new rules on corporations is a more fundamental one: How much will faster reporting help restore investor confidence?
Not unexpectedly, institutional investors, who stand to benefit most because of their analytical capabilities, have largely welcomed the SEC's move. "The availability of more in-depth disclosure will allow us to make better investment decisions faster," says Fondrie, the mutual fund executive.
Faster filing, however, isn't likely to mean all that much to smaller investors. Robert Shiller, a professor at Yale's School of Management and best-selling author of Irrational Exuberance, is skeptical of the impact the new rules will have on investor confidence. "This will just make the information a bit more up to date, but probably won't break the consciousness threshold of most investors," he says.