As U.S. regulators consider whether it’s possible to make companies’ financial disclosures clearer, most companies are going ahead and making changes to their financial statements without waiting for regulators to act.
The documents that companies have to file with the Securities and Exchange Commission, such as the annual 10-K and quarterly 10-Q filings and the proxy statement, have grown longer and more convoluted as companies have responded to wave after wave of accounting regulations. The SEC is taking a look at such filings after Chairwoman Mary Jo White announced a disclosure effectiveness initiative last year. But a recent survey by the Financial Executives Research Foundation (FERF) and Ernst & Young found that 74% of the companies that responded already are taking steps to improve their financial reporting.
The survey of 120 finance, accounting, and financial reporting executives shows the most popular targets for such improvements are companies’ 10-Qs and 10-Ks, both of which were cited by 75% of respondents. Just about a quarter said they have made improvements to their earnings releases or proxy statements.
Neri Bukspan, Americas disclosure leader at EY, said that trend reflects a number of factors, including companies’ perception that the current state of their disclosures is “subpar” and there is room for self-improvement, the SEC’s push on this topic, and the changes that have occurred in technology and the way people share information.
In addition, the Enron debacle, coupled with the financial crisis of 2008, sparked “a decade of massive accounting and disclosure changes that resulted in a massive amount of accountese and legalese introduced to reports,” Bukspan said. “When you read it, it doesn’t hang well together.”
He also cited companies’ evolving relationship with their shareholders: “The dialogue with investors on various points now has become much more robust, and disclosure improvements became part of that.”
Larger companies are more likely to be making changes than smaller companies, he said. “They were kind of blazing the trail for others. It makes much more sense in the context of their market expectations, their scale.”
Alana Griffin, a partner at the law firm King & Spalding, said companies’ efforts to make their financial filings clearer reflects the much broader audience that now uses such filings.
In the past, while larger shareholders read financial statement filings, very few small shareholders did so, Griffin said. Today, with the Internet making filings readily available, “Widow Brown in Des Moines is calling and asking questions about your 10-K,” she said. A public company’s employees, and other companies with which it does business, are other groups that are more likely to read financial filings today than in the past, Griffin said.
The financial filings have also become “more closely intertwined” with related documents like earnings press releases and investor presentations, Griffin said. “I don’t think you’ll see documents filed with the SEC ever get to the same type of approach as a press release or investor deck, but they look a lot different than they used to.”
And companies have the same goals for all the different information they provide, she said: “Make things clearer, make them more usable, make it easier for investors or regulators to find the information that you think tells your story.”
Eliminating Redundancy in Financial Disclosures
One company that has made changes in its financial disclosures is American Express Co. At the annual Financial Executives International (FEI) annual Current Financial Reporting Issues Conference in November, David Cornish, senior vice president and deputy controller for business advisory and governance at American Express, said the process of improving his company’s financial statements had three aspects: eliminating redundancy in disclosures, replacing words with charts, and reassessing footnotes that had accumulated over the years.
“What was relevant five years ago may not be relevant today,” he said of footnotes.
Changes were discussed beforehand with the company’s investor relations group, auditors, and counsel, but the various interested parties didn’t take much convincing, Cornish said. “The 10-K and Q grow every year, and the talk internally is how to simplify and cut down statements.
“Don’t start small, start big,” Cornish advised the conferenc-goers, adding that companies might even be able to change something that had been added in response to an SEC comment letter.
Disclosure Reforms Driven from the Top
According to the survey, the push to fine-tune financial disclosures often originates with senior executives. More than half (53%) of those surveyed cited the influence of the company’s management team as the main reason for making changes in disclosures, with another 27% citing the management team as one of the major reasons.
Jan R. Hauser, controller, chief accounting officer, and vice president at General Electric Co., said at the FEI conference that GE made changes to its 2014 10-K after the new CFO took a critical look at the 2013 filing. Hauser said GE’s reworking of its proxy, which had met with a good response, was another factor in the decision to work on the 10-K.
GE’s changes included adding a section at the front of the report explaining the $148.6 billion company and its seven different business units. Hauser noted that such an explanation might not be necessary at smaller companies.
The changes resulted in a shorter document. “When you tell it as a story, you start seeing redundancies,” Hauser said. She noted that the company did not eliminate any information that had been in the 10-K, only redundancies.
Benefits of Revamping Financial Filings
Companies surveyed by FERF and EY said the benefits of revamping their financial filings include a meaningful improvement in their financial communication, which was cited by 56%, and meaningful process efficiencies, cited by 32%.
In fact, more than a third of the respondents said improving their financial statements saved them time, or will save them time next year, with 30% citing a savings of one to three days in the time it takes to prepare financial statements, while another 9% expect to save even more time.
“It takes more time to create the efficiencies in the first place,” said EY’s Bukspan, pictured at left. “You need to step back and think, ‘What is redundant, what can be condensed to a chart, where can I use a graphic, and more holistically how our disclosures can be better presented and communicated.’”
But once the changes have been made, they can facilitate other improvements to related processes.
Bukspan cited a financial report that has to be read by many of a company’s executives. “To the extent that you have excess verbiage or it’s simply hard to read, after 15 minutes you need a cup of coffee,” he said, while a clearer report can mean “significant time savings” for those in the company who must review it.
Eliminating redundancies also saves readers time. “Even if you write the same thing twice, you have to read it twice just to be sure nothing accretive is in it,” Bukspan said. He added that financial disclosures often repeat the same information about litigation and risks in more than one location.
“The little things can add up quite interestingly for many, many companies,” he said.
Determining Materiality for Financial Filings
The survey pointed to materiality—whether a topic is important enough to include in filings—as one of the big challenges for companies making changes to their filings.
King & Spalding’s Griffin noted that what’s material evolves constantly and cited the example of financial institutions and regulatory risk. “I don’t think 10 years ago regulatory risk would have been something the average investor thought was material or would have cared about,” she said. “Today it is a very high priority.”
Carrie Ratliff, a partner-elect at King & Spalding, said cyber risk is another area whose importance has grown as more companies have suffered data breaches. “Ten years ago you didn’t see any of that disclosure and today’s it’s material to a lot of companies.”
As an aid to deciding which issues are material, Griffin suggested that companies keep lists of questions they’ve been asked by investors or regulators, a practice she compared to benchmarking.
“The focus is on listening to your investors when you’re out on the road, looking to the questions you get from local press or other sources,” she said. “Every question on its own is not specifically something you need to address, but it’s a good way to look for recurring themes. You may discover there’s a topic you haven’t addressed, or you have addressed but from the questions you’re getting, you haven’t clearly conveyed the impact of that topic on the company.”