Tuesday, June 28, 2016
SEC Chair Mary Jo White yesterday presented the keynote address, for the International Corporate Governance Network Annual Conference, "Focusing the Lens of Disclosure to Set the Path Forward on Board Diversity, Non-GAAP, and Sustainability." The full speech is available here.
In reading the speech, I found that I was talking to myself at various spots (I do that from time to time), so I thought I'd turn those thoughts into an annotated version of the speech. In the excerpt below, I have added my comments in brackets and italics. These are my initial thoughts to the speech, and I will continue to think these ideas through to see if my impression evolves. Overall, as is often the case with financial and other regulation, I found myself agreeing with many of the goals, but questioning whether the proposed methods were the right way to achieve the goals. Here's my initial take:
The Role of the SEC in Corporate Governance
Dictating corporate governance practices in the United States is generally outside the scope of the SEC’s regulatory authority. [As it should be.] And there is no national uniform code of governance for public companies as there is in many other countries. [Nor should there be.] Rather, in the United States, corporate governance is, with some exceptions, the domain of each of our fifty states under their corporate law, which tends to accord shareholders relatively limited rights over corporate management and governance. [True, but that “tends” to be the case because that is, as Prof. Bainbridge notes, how shareholders tend to (and usually should) want it.]
The SEC has an impact on corporate governance through its disclosure powers – requiring public companies to provide investors with the information they need to make informed investment and voting decisions. [True as to the goal, less clear on the execution.] The SEC thus does not decide who may sit on a corporate board, but our rules do require disclosure about those who serve or are nominated to serve as directors and, importantly, why they were selected to serve. [True, and execution here is probably tied closer to the intended purpose.]
In some cases, legislation is passed that specifically provides both substantive requirements and disclosure requirements intended to bring about substantive change. For example, under the Sarbanes-Oxley Act, directors who are members of an audit committee of public companies listed on national exchanges must be independent and, if at least one member is not a “financial expert,” companies must disclose that fact and say why. [True, and I would have chosen this example, too, as it is one of less objectionable parts of Sarbanes-Oxley, in my view.] In a similar vein, although the SEC cannot set the form or amount of pay of corporate executives [Despite some who would very much like that], our rules have long required detailed disclosure about executive compensation. The Dodd-Frank Act enacted in 2010 also empowered the SEC and other financial regulators to establish permissible parameters for incentive compensation at certain financial institutions to avoid incentivizing the kind of excessive risk-taking associated with the financial crisis. [Efforts that probably could have been more effectively targeted through other rules.] A joint agency rule proposal to do that is now out for public comment.
* * * *
Diversity on boards, and in organizations more generally, is very important to me and I have not shied away from expressing my strong views on the topic. As a former member of a public company board and its audit committee, I have seen first-hand what the research is telling us – boards with diverse members function better and are correlated with better company performance. This is precisely why investors have – and should have – an interest in diversity disclosure about board members and nominees. [I agree with Chairperson White, and as to the goals and think this should be a critical focus of public companies. I am less sure of the SEC’s role in it beyond advocating for it.]
. . . .
My view is that the SEC has a responsibility to ensure that our disclosure rules are serving their intended purpose of meaningfully informing investors. [As should be done with all rules, I would think.] This rule does not and it should be changed. [I am less sure on that.] Our lens of board diversity disclosure needs to be re-focused in order to better serve and inform investors. [I agree “our” collective lens needs to improve, and companies need to do more work on this front. I don’t know that I think the SEC is the right place for it, but I absolutely agree there should be a greater commitment to making these changes. My sense is that too many companies use prior board service, for example, a requirement. That’s a pretty strong limit to the pool of potential board members, and I am not sure other SEC rules are facilitating a company taking risks on new people, which is a mistake.]
* * * *
Non-GAAP Financial Measures
. . . .
In too many cases, the non-GAAP information, which is meant to supplement the GAAP information, has become the key message to investors, crowding out and effectively supplanting the GAAP presentation. Jim Schnurr, our Chief Accountant, Mark Kronforst, our Chief Accountant in the Division of Corporation Finance and I, along with other members of the staff, have spoken out frequently about our concerns to raise the awareness of boards, management and investors. And last month, the staff issued guidance addressing a number of troublesome practices which can make non-GAAP disclosures misleading: the lack of equal or greater prominence for GAAP measures; exclusion of normal, recurring cash operating expenses; individually tailored non-GAAP revenues; lack of consistency; cherry-picking; and the use of cash per share data. I strongly urge companies to carefully consider this guidance and revisit their approach to non-GAAP disclosures. [I agree companies can do better in this area, and I support calling on them to do so.] I also urge again, as I did last December, that appropriate controls be considered and that audit committees carefully oversee their company’s use of non-GAAP measures and disclosures. [Again, I am all for asking audit committees to do their jobs.]
We are watching this space very closely and are poised to act through the filing review process, enforcement and further rulemaking if necessary to achieve the optimal disclosures for investors and the markets. [Okay, though I rather like using existing rules and punishing those who aren’t following them before adding more rules that may or may not be enforced.]
The third and final item on your agenda that I will cover today is sustainability reporting – obviously, a topic of great importance, interest and complexity.
I will start with the baseline. Our rules and guidance are clear that, to the extent issues about sustainability are material to a company’s financial condition or results of operations, they must be disclosed. [And that is the appropriate limit.] But deciding whether such disclosures are triggered in a particular context is often easier said than done when trying to calibrate materiality to phenomena that have a longer term horizon than most other financial metrics do. [Okay, but that’s true about changes in technology and in other areas, too.] And measuring whether and how a company will sustain its performance in a changing global physical and legal environment, which is itself uncertain, is not an easy undertaking. [Right, which is why disclosure is helpful, but can only be so effective. Both companies and consumers have to make some decisions without full information.]
To begin with, sustainability encompasses a very broad range of topics that may relate to a company’s risk profile, trends or uncertainties that could affect financial performance. [Agreed.] These could include climate change, resource scarcity, corporate social responsibility, and good corporate citizenship. The importance of such issues can also vary significantly by industry and company. [True, which suggests risk profile is the better assessment tool, rather than one specifically linked to “sustainability.”]
. . . .
Currently, disclosure of sustainability information under SEC rules is being addressed by a combination of our materiality-based approach to disclosure, guidance on certain issues, and shareholder engagement on a range of sustainability topics, whether through direct dialogue with management or our Rule 14a-8 shareholder proposal process. [Again, this seems right to me. Climate risk and sustainability concerns for investors are tied to these issues. Beyond this, it is a policy questions for someone other than the SEC.] Although we are seeing increased disclosure and engagement on sustainability matters, we are taking a more focused look at such disclosures, particularly related to climate change, in our annual filings reviews. [I want to know where a company stands on climate change concerns as it affects their business. Is the company insurer likely raise rates? Is the company getting concerns from insurers or other sources that could impact performance? Has the company responded or ignored the risk? Has the company accounted for regulatory risk? These are questions that I think need to be answered like other business risks. Otherwise, sustainability and climate concerns are policies for other arenas.]