In yet another one of his early morning messages, late last week President Donald Trump stirred up a squall by suggesting in a tweet that the SEC should study doing away with quarterly reporting requirements in favor of a system of semi-annual reports. The suggestion fits within the larger debate about whether or not reporting companies have an excessively short-term focus and the related but separate debate about whether regulatory requirements impose excessive costs on businesses. The idea of eliminating quarterly reporting raises a number of important issues, and may raise some important questions for the D&O insurance industry as well.
President Trump’s August 17, 2018 Tweet
In a tweet on August 17, Mr. Trump reported that he had consulted “some of the world’s top business leaders” on ways to create jobs and make business even better. One suggestion he reports receiving is to “Stop quarterly reporting & go to a six month system.” Trump said that the changes would “allow greater flexibility & save money.” The President said he had asked the Securities and Exchange Commission to study the change.
The Wall Street Journal reported that the business leaders President Trump consulted included outgoing PepsiCo CE Indra Nooyi, whom he consulted in a meeting with corporate executives at Mr. Trump’s golf course in Bedminster, N.J. earlier this month.
In a statement issued also issued on Friday, SEC Chair Jay Clayton noted that “encouraging long-term investment in our country” is a key consideration for American companies. He said that that the SEC has recently implemented “a variety of regulatory changes that encourage long-term capital formation.” He noted that the SEC’s Division of Corporation Finance “continues to study public company reporting requirements, including the frequency of reporting,” and he welcomed input from companies, investors and other market participants.”
The Background on Eliminating Quarterly Reporting
The idea of eliminating quarterly reporting is not new. As I noted at the time, in August 2015, prominent New York attorney Martin Lipton caused quite a stir by calling for the end of quarterly reporting. Lipton’s suggestion drew a variety of response, including expressions of concern from former Treasury Secretary Lawrence Summers, who observed in a Financial Times article that “skepticism about whether all horizons should be lengthened is appropriate.”
These ideas have been circulating in the U.S. since at least 2013, when the E.U. amended its transparency directive to eliminate the quarterly reporting requirement for small and medium-sized issuer companies.
More recently, a number of business leaders and commentators have been calling for steps to encourage businesses to take a longer term approach. For example, in a June 6, 2018 op-ed article in the Wall Street Journal, Berkshire Hathaway Chairman Warren Buffett and J.P. Morgan Chase CEO Jamie Dimon called for companies to move away from providing quarterly earning guidance. The article accompanied the June 7, 2018 release by the Business Roundtable supporting the call for a move away from short-term guidance.
Investors’ Concerns
Eliminating short-term guidance is, however, a different proposal than eliminating quarterly reporting. Although President Trump’s suggestion for eliminating quarterly reporting immediately drew words of support, there were other voices raising concerns. For example, the Council of Institutional Investors issued a statement last Friday expressing their view that public companies should continue to report quarterly on their financial performance, noting that “Investors need timely, accurate financial information to make informed investment decisions.” Other commentators hailed the proposed change, in particular noting the possible costs savings, particularly for smaller companies.
Discussion
I come to this topic with a bias left over from the excesses of the Internet stock bubble in the dot com era. I recall all too well how pressure on many companies, particularly in the tech sector, to make their quarterly numbers led to excesses such as channel stuffing, invented quarterly reporting criteria that told the story management wanted to tell, and hockey stick quarter-ends.
Along with the potentially distorting effects that a short-term focus can produce, there is no question that frequent reporting requirements come with administrative costs. Indeed, that is the primary reason that the EU eliminating quarterly reporting for smaller and medium-sized companies in 2013.
There are, however, a number of other considerations that do need to be taken into account. The concerns of institutional investors, who of course want more information rather than less, should be taken into account. In that regard, we should all be aware that in the life cycle of a smaller company, particularly a start-up, six months can be a very long time. The likelihood of an eventful life for a reporting company explains why some countries, such as Australia and Canada, have gone in favor of a continuous reporting requirement, rather than a periodic reporting requirement.
I expect that we will continue to hear about these issues in the months ahead and that there will be a robust debate. Whether or not quarterly reporting is the most important issue facing U.S. businesses now may be a matter of debate, but I think the President’s promotion of these issues, along with the support for these kinds of changes in certain sectors of the U.S. business community, ensures that there will be robust discussion and possibly even changes to a quarterly reporting regime that has been in place since 1970.
These issues may have important implications for the D&O insurance community as well. For example, if short-termism drives corporate management into an exaggerated focus on short term results, then taking steps to reduce the short-term focus – even eliminating quarterly reporting requirements — could help reduce the likelihood of events and activities that can lead to claims against corporate directors and officers.
As welcome as it might for changes that could reduce the possibility of D&O claims, all of the possible effects of eliminating quarterly reporting should be taken into account. For example, lengthening the time between reports could introduce a longer time cycle within which material information about a company has not been disclosed. Among the pitfalls this could create is a greater likelihood of allegations of insider trading, as company executives try to trade in the personal holdings of company stock between longer reporting dates. The possibility of the accumulation of undisclosed material information during the longer reporting cycle could introduce an increased risk of Reg. F-D requirements. In addition, a longer reporting cycle increases the possibility that companies’ share prices are misaligned with the company’s fundamentals, creating the possibility for share price shocks when companies do report results on a longer time frame.
From my perspective, in terms of eliminating liability risks, the more promising suggestion, rather than eliminating quarterly reporting altogether, is eliminating quarterly guidance, as Messrs. Buffet and Dimon proposed. Changes along these lines would go a long way to eliminate short-term pressures to “make your numbers” and reduce the pressures on company managers that can lead to excesses and accounting maneuvers.
To be sure, advocates of eliminating quarterly reporting have the added argument of cost savings for smaller companies. If changes to quarterly reporting in reliance on arguments of cost savings, the question of whether or not and to what eliminating quarterly reporting would eliminate costs should be carefully studied. If the cost savings would be substantial, then the case for eliminating quarterly reporting is more justified. If the costs are less or uncertain, the case for eliminating quarterly reporting is weaker, particularly given the investors’ interests in more rather than less disclosure.
The study of this question should also look at which companies realize cost savings; it may well be that the costs savings are most pronounced for smaller companies, and would have less effect for larger companies with far-flung operations where quarterly reporting requirements contribute relatively little to the companies’ overall costs.
Indeed, memories from that era suggest that this is an issue in which D&O insurers have a stake. If short-termism drives corporate management into an exaggerated focus on short term results, then steps – such as Marty Lipton’s proposal to do away with quarterly reporting – could help reduce the likelihood of events and activities that can lead to claims against corporate directors and officers.