Advice for New SEC Chair: Keep It Simple

Elisse Walter needs to keep regulatory disclosure uncomplicated to help small and mid-size public companies drive prosperity.
Edwin L. Miller Jr. and Howard E. BerkenblitDecember 13, 2012

The incoming Securities and Exchange Commission Chair Elisse Walter has a unique opportunity to implement a mandate suggested by the recent Jumpstart Our Business Startups (JOBS) Act—namely to simplify the voluminous maze of regulatory disclosure requirements that currently overwhelm the most material information about public companies.

After all, when President Obama signed the JOBS Act into law in April, he recognized that companies seeking access to capital “should not be hindered by unnecessary or overly burdensome regulations.” Among other conditions, the act called for the SEC to review Regulation S-K disclosure requirements for emerging growth companies raising money from investors and determine how those rules can be updated and simplified.

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Walter is replacing Mary Schapiro, who steps down today after four years as SEC chair. The new chair can make a difference in the way both public and private companies are regulated and, more importantly, in the flow of information conveyed to investors as they make their investment decisions.  This is not the time for the SEC to make cuts in the rules here and there. Reducing a thousand pages of regulations to 900 pages will not help. 

Instead, the new SEC chair needs to champion a top-to-bottom review of those regulations to make sure they are simple and effective for small and emerging growth companies and that the companies have the ability to produce transparent disclosure documents. A focus on small companies is crucial since they create the most jobs in our economy.

We recognize that the SEC’s mission is to protect investors. But it can do so in a way that does not place such a burden on emerging growth companies that it stymies the ambitions of dynamic firms that can help our economy prosper. 

With each new scandal or political hot button, rules are added. Yet few are ever removed. Current SEC rules have become a quagmire of reactive actions that has accumulated over many years, leaving companies with an ever increasing burden of disclosure rules. It’s hard to tell investors your story when someone else is preparing the outline.

That’s essentially the situation for entrepreneurs trying to raise capital to foster their companies’ growth in the current regulatory thicket. They are seriously inhibited by the time, expense, and risk of complying with complex regulations, many of which force disclosure that is irrelevant for small companies. 

Walter, as well as the permanent successor that President Obama might still appoint, should launch a start-from-scratch, complete review of the current plethora of SEC regulations, one that focuses on the issues that are truly “material” to investors rather than belated attempts at avoiding the latest scandal du jour.  

During the past 20 years, as a result of violations of corporate securities laws, poor executive ethics, and Wall Street scandals, critics have demanded greater transparency for investors. But as former SEC Chairman Arthur Levitt said in 1999, “our passion for full disclosure has created fact-bloating reports and prospectuses that are redundant.” Thirteen years later, those materials have only become more overstuffed and opaque.

Ernst & Young produced a study in June, for example, that tracked the annual report sizes of 20 recognized companies from 1992 through 2011. During those 19 years, the average volume of pages under Management’s Discussion and Analysis (MD&A) grew by 400%, to 48 pages in comparison to the 12 found in a similar study of 25 companies. During the same time, the average number of notes to the financial statements increased 406%, to 69 pages from 17.

When voting on new regulations, the chair should ask whether the rule adds materially to the mix of data needed for an investor to make an informed purchasing decision or is merely swamping the investor in excessive, irrelevant information. Twenty pages of bloated risk-factor language, for example, are not only tedious to read, if anyone reads them at all. More seriously, they may disguise the real risks to investors. The more bloat, the greater the opportunity to “bury” the important stuff.

Increasingly, companies raising capital are also being required to produce reactive information related to social concerns, as opposed to material investment information. Examples include significant increases in required disclosures of executive compensation and climate change, with more threatened in areas like cyber security and political spending. At the behest of Congress in August, and not at the SEC’s own initiative, the SEC adopted rules requiring all public companies to annually evaluate their supply chain and sourcing information regarding “conflict minerals,” and potentially file related reports and audits with the SEC.

Such social goals are without a doubt noble. But they come at a cost that significantly inhibits the growth of the economy and the creation of jobs. The SEC has estimated an initial cost of $3 billion to $4 billion to implement the conflict minerals rules, amounting to an average of $500,000 per affected issuer. 

Not only are those rules an absurd burden on the economy, but they’re unlikely to have a significant impact on the illegal acts in West Africa that they are supposed to deter. What’s more, is it beneficial to investors to have thousands of companies that pay their executives fairly suffer through dozens of pages of incomprehensible compensation disclosure regulations in order to produce dozens of pages of incomprehensible compensation disclosures?

Even if these regulations have marginal benefit, they entail financial and human resources compliance costs.  Business groups have recently been successful in overturning rules for which the SEC did not adequately weigh the burdens of compliance against the benefits.  To properly regulate, the SEC must consider the practical ramifications of its regulatory actions. 

The impact of regulations falls differently on different companies. Yet regulations, with few exceptions, are made equally applicable to giants like Apple and the newest, smallest public company. There has been progress in alleviating the burden of SEC regulations on small companies, but the changes just chip away at the margins. 

To undertake an overhaul this challenging, the new SEC chair must make sure the proper resources are allocated for a dedicated team or task force. Some advice: Find the necessary resources to get it done, or get the private sector to do most of it.

Howard E. Berkenblit is a partner in the Boston office of the law firm of Sullivan & Worcester and leader of the firm’s securities and corporate governance practice group. Edwin L. Miller Jr. is also a partner at Sullivan & Worcester and has practiced corporate and securities law for more than 35 years.

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