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Statement on Amendments to Registered Debt Disclosure Rules

March 2, 2020

Audited financial statements provide a fundamental investor protection for registered securities offerings. The final rules we are adopting today will expand the circumstances in which issuers of registered debt securities offerings that are guaranteed or collateralized by affiliates may skip the requirement to provide audited financial statements for those affiliates, and instead provide an alternative form of disclosure.[1] Further, these rules reduce the amount of alternative disclosure that companies must provide and give management greater flexibility to determine the content of that disclosure.[2] Finally, the rules let companies provide these reduced disclosures outside of financial statements, such that they will not be subject to the assurances of an auditor.[3] Thus, the final rules will result in less disclosure for investors, and disclosure that is less detailed, less comparable, and less reliable. While I am appreciative of the work of the staff on these rules, I cannot support them.

Today’s rules form part of the Commission’s Disclosure Effectiveness Initiative under which the Commission is reviewing Regulations S-K and S-X for ways to improve the disclosure regime.[4] It makes sense to take a comprehensive look at disclosure requirements and seek ways to improve them for investors and for businesses. But careful scrutiny of successive rulemakings under the umbrella of the initiative reveals there are certain unexamined, unproven, and, in some instances, downright implausible assumptions undergirding these efforts. These assumptions are evident in today’s rulemaking.

As an initial matter, it’s important to note that we have not identified a problem or issue in this market that we seek to address. Indeed, the release provides data showing an increase in registered debt offerings in recent years.[5] As to the specific subset of registered debt offerings affected by these rules, we apparently do not have data on their number or volume. Thus, we cannot make a fair assessment of whether we are wise to expend our time and resources in this area, much less whether we have taken the right approach.

More importantly, today’s release, as with certain other proposals and rules under the Disclosure Effectiveness Initiative,[6] rests on a kind of “regulatory intuition” in two areas. First, it assumes, without evidence or data, that less disclosure and greater reliance on materiality judgments by management will yield better disclosure for investors. In fact, there is evidence of risk associated with relying too heavily on management’s materiality judgments,[7] but we do not weigh, nor even adequately recognize, that risk.

We might at least take comfort that we are on the right track if investors—among the stated beneficiaries of our actions—had asked for, or even supported after the fact, the proposed reduced disclosures and protections. But they have not.[8]

As a number of commenters on this rulemaking observed, we should be chiefly concerned with the views of investors on disclosure.[9] They are, after all, the end users of the information. Nevertheless, we substitute our own judgment about what disclosure is best for investors in place of what they have actually told us they want.[10] For example, at the proposing stage for today’s rule, investors expressed concerns that we were permitting the alternative disclosure that is allowed by these rules in lieu of subsidiary financial statements to occur outside of the financial statement footnotes.[11] Their concern was that such disclosure is not audited. The proposal at least contemplated requiring the alternative disclosure to be made in financial statement footnotes in some subsequent periodic reporting by the parent companies. The final rule, however, abandons this approach, permitting the alternative disclosure to occur outside of the financial statements at the time of registration and in all subsequent periodic reporting, swinging even further in the direction that troubled investors. 

The second product of regulatory intuition in the release is the assumption that if we reduce certain disclosures and protections, thereby potentially reducing the attendant costs to issuers, the result will be an increase in the number of registered debt offerings affected by these rules. Again, we have not supported this hypothesis, but rather rely on a broad intuition that reducing burdens on issuers will increase the number of public offerings.[12]

From there we proceed full circle to this implausible assertion:  that reduced disclosure will actually result in increased transparency. The release states that “[t]he proposed amendments were intended to benefit investors by… improving transparency in the market to the extent more offerings are registered.” [13] That is a tough case to make, and we have not done so in the release. Moreover, it ignores the effect of these changes on retail investors. Retail investors’ holdings are concentrated in the public markets, and thus transparency for them is largely reduced by these rules changes. 

I am concerned that we are not consistently taking a balanced approach to rulemakings under the Disclosure Effectiveness Initiative. It is important to listen to, and carefully balance, the concerns of both registrants and investors when considering regulations that affect them both directly. We also should not rely too heavily on regulatory intuition, but should gather and analyze relevant data, and carefully weigh competing considerations accordingly. These rules, unfortunately, do not adequately consider investor concerns, nor are they sufficiently grounded in economic data and analysis. I therefore respectfully dissent.     


[1] Rule 3-10 of Regulation S-X requires financial statements to be filed for all issuers and guarantors of securities that are registered or being registered, but provides exceptions where (1) a parent company offers its own securities that its subsidiary guarantees; or (2) a subsidiary offers securities that its parent company guarantees. Specifically, under the applicable exceptions, a parent company can provide certain alternative disclosures about the subsidiary (whether it is the issuer or guarantor) in lieu of providing the subsidiary’s financial statements where (1) the subsidiary is 100 percent-owned by the parent; and (2) the guarantee is full and unconditional. The new rule loosens both of those conditions. Rule 3-16 requires an issuer to provide separate financial statements for each affiliate whose securities constitute a substantial portion of the collateral for any class of registered securities as if the affiliate were a separate registrant. The new rule replaces the requirement to provide the financial statements of the affiliate with a requirement that an issuer provide certain alternative disclosures about the affiliate.

[2] Under Rule 3-10, where the conditions of the exception are met, the parent company is generally required to provide alternative disclosure in place of the subsidiary’s financial statements in the form of consolidating financial information about the subsidiary, which includes all major captions of the balance sheet, income statement, and cash flow statement that Article 10 of Regulation S-X requires to be shown separately in interim financial statements. The final rule will require only supplemental financial information, which includes certain select balance sheet and income statement line items, and additional information if the company considers it material. It also permits the supplemental information of the parent and subsidiary to be presented on a combined basis and for a reduced number of periods. Under Rule 3-16, an issuer has to provide audited financial statements for each issuer whose securities constitute a substantial portion of the collateral for any class of registered securities. The final rule will require only supplemental financial information and additional information if the company considers it material, which may be presented on a combined basis.

[3] The final rules reduce the amount of audited disclosure required in two respects. First, Rule 3-10 requires audited annual financial statements for all issuers and guarantors of registered debt securities, except where an affiliate issuer or guarantor is 100 percent-owned by the parent issuer or guarantor and the guarantee is full and unconditional. The final rule loosens both requirements for the exception, thereby expanding the circumstances in which issuers and guarantors may omit audited financial statements. Similarly, Rule 3-16 requires a registrant to provide audited annual financial statements for each affiliate whose securities constitute a substantial portion of the collateral for any class of registered securities. The new rule will permit the provision of supplemental financial information instead, thereby expanding the circumstances in which companies may omit audited financial statements. Second, Rule 3-10 requires the alternative disclosure that is permitted in lieu of financial statements to be provided in the footnotes of the consolidated financial statements and therefore be subject to audit. The final rules permit the alternative disclosure to be provided outside of the financial statements, and thus not be subject to audit.

[4] See Spotlight on Disclosure Effectiveness,

[5] See Financial Disclosures about Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities, Final Rule, Rel. No. 33-10762, n.9 (Mar. 2, 2020) [Adopting Release].

[6] See, e.g., Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, Proposed Rule, Rel. No. 33-10750 (Jan 30, 2020) (proposing to remove a requirement for disclosure of specific off-balance sheet arrangements with a more principles-based approach, and stating “[w]e believe this could result in more effective discussion of the impact of these arrangement.”) (emphasis added); Modernization of Regulation S-K Items 101, 103, and 105, Proposed Rule, Rel. No. 33-10668 (Aug. 8, 2019) (proposing a shift to more principles-based approach to the description of business and risk factors disclosure requirements, and stating“[w]e believe this approach would elicit more relevant disclosures about these items”) (emphasis added).

[7] See Andrew A. Acito, Jeffrey J. Burks, and W. Bruce Johnson, The Materiality of Accounting Errors: Evidence from SEC Comment Letters, 36.2 Contemp. Acct. Res. 839, 862 (2019) (studying managers’ responses to SEC inquiries about the materiality of accounting errors and finding that managers are inconsistent in their application of certain qualitative considerations and may omit certain qualitative considerations from their analysis that weigh in favor of an error’s materiality); see also Preeti Choudhary, Kenneth J. Merkley, and Katherine Schipper, Auditors’ Quantitative Materiality Judgments: Properties and Implications for Financial Reporting Reliability, (June 28, 2019), (finding, among other things, that auditors vary widely in how they measure and assess materiality).

[8] There were two investor comment letters on this rulemaking, from groups representing investors with a total of nearly $8 trillion in assets. See Letter from Council of Institutional Investors (CII) (Nov. 26, 2018) and Letter from The Credit Roundtable (CRT) (Sept. 28, 2018). These groups singled out three provisions in the proposal of concern to them. CII and the CRT both opposed the provision of this rule that would eliminate Rule 3-10’s continuous reporting obligation for the parent company for the life of the guaranteed security. CII also opposed the proposal to permit alternative disclosure outside of the parent company’s financial statements and the proposal to eliminate the requirement that foreign private issuers reconcile the financial information in the alternative disclosure to U.S. GAAP. Nevertheless, we are adopting these provisions over investor objections. In support of this approach, we cite letters from the issuer community. See Adopting Release at nn.241, 319.

[9] See e.g., Letter from Deloitte & Touche LLP (Nov. 27, 2018) (“We believe that investors and other financial statement users are best positioned to provide input on the most meaningful level of detail regarding obligor group information.”); Letter from Grant Thornton LLP (Nov. 13, 2018) (“We recommend that the Commission consider input from investors in making their determination related to location of proposed disclosures.”).

[10] We also saw this in the proposal to update Regulation S-K Items 101, 103 and 105 which favors the principles-based approach preferred by issuers, rather than balancing the use of principles with line item disclosure as advocated by investors. See Modernization of Regulation S-K Items 101, 103, and 105, Proposed Rule, Rel. No. 33-10668, nn.16-17 (Aug. 8, 2019) (evidencing a clear division of views between investors and issuers). The same was true for the proposal to update MD&A and other Regulation S-K items which proposed to eliminate line-item disclosure requirements, including tabular disclosure of selected financial data, separately-captioned off-balance sheet arrangements, and tabular disclosure of known contractual obligations, despite investor comments advocating retaining those items. See Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, Proposed Rule, Rel. No. 33-10750, nn.35-37, 180-82, 196 (Jan 30, 2020) (evidencing investor preference for retaining these disclosure items). We saw this again in the proposal regarding the disclosure of payments by resource extraction issuers, which proposed a highly-aggregated form of disclosure of payment information as requested by some issuers, despite the clear preference of investors for more granular payment-level disclosure. See Disclosure of Payments by Resource Extraction Issuers, Proposed Rule, Rel. No. 34-87783, n.173 (Dec. 18, 2019) (acknowledging that the proposed definition of “project,” which permits highly aggregated disclosure of payment information, is similar to the definition advocated for by some issuers).   

[11] See Letter from CII (Nov. 26, 2018).

[12] This particular untested hypothesis animates a number of recent rules and proposals. See, e.g., Amendments to the Accelerated Filer and Large Accelerated Filer Definitions, Proposed Rules, Rel. No. 34-85814 (May 9, 2019) (asserting that exempting more companies from the requirement that auditors attest to management’s assessment of the effectiveness of the issuer’s internal control over financial reporting “may be a positive factor in the decision of additional companies to register their offering or a class of their securities”); Smaller Reporting Company Definition, Final Rules, Rel. No. 33-10513 (June 28, 2018) (asserting that making smaller reporting company status—and the corresponding reduced disclosure requirements—available to more registrants “could encourage capital formation because companies that may have been hesitant to go public may choose to do so if they face reduced disclosure requirements.”) I note that this assumption would support the removal of virtually any disclosure or other investor protection afforded in the public markets. Moreover, it fails to take into account other factors relevant to issuer decisions to register public offerings. See, e.g., Letter from Shearman & Sterling (Sept. 18, 2018) (“We are skeptical about the prospect that the proposed revisions will bring high-yield issuers that have migrated to the ‘Rule 144A for life’ market back to the registered market to a meaningful extent. It is our impression that for high-yield debt securities the growth in the size and depth of the Rule 144A for life market has largely eliminated the historical pricing benefits of registered issuance.”).

[13] See Adopting Release at 10.

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