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Statement on Amendments to Smaller Reporting Company Definition

June 28, 2018

I would like to join Chairman Clayton in thanking the staff for their hard work on this release. I also would like to note that this will be our last open meeting with Commissioner Piwowar. Over the last five years, Commissioner Piwowar and I have worked on a number of important rulemakings. I believe many of these rulemakings were thoughtful and productive steps that will withstand the test of time. Some that come to mind include amendments to the securities transaction settlement cycle, or T+2, and the transaction fee pilot for NMS stocks. And, today, we will vote on final rules relating to Inline XBRL requirements. These rulemakings are reflective of the collaborative spirit in which I believe Commissioner Piwowar and I have worked. And I think, as a result, the rules have been better for it. With that, I want to thank Commissioner Piwowar for his leadership and for his dedication to protecting investors, facilitating capital formation, and making our markets more fair and resilient. And I wish him good luck and success in his future endeavors.

Today, the Commission is being asked to adopt amendments to the definition of “smaller reporting company.” These amendments would expand the number of companies that could qualify as smaller reporting companies under the Commission’s rules. In fact, our staff estimates that approximately 966 companies will be newly eligible to qualify as smaller reporting companies if the rules are adopted.[1] This means that approximately 966 newly eligible companies will be allowed to provide investors with less disclosure than what other public companies must provide. These companies would qualify for what is commonly called “scaled disclosure”—or, as I like to call it, “disclosure lite.”

You might be asking yourself: Why does this arcane area of the securities laws matter? It matters because today’s recommendation is based largely on the premise that the final rules will “promote capital formation and reduce compliance costs.”[2] Based on the data we have, I am not confident that we will accomplish this goal.

Reducing compliance costs may be a benefit, but at what cost? Reducing disclosure may ultimately lead to greater indirect costs to smaller companies, such as a higher cost of capital. Such tensions between disclosure and costs are relatively common. Indeed, many of us will remember the macaroni and cheese debate from a few years ago. Many consumers became worried about the artificial dyes used to give boxed macaroni and cheese its golden color. One such dye was listed as “yellow #5” in the ingredient list on the back of the macaroni and cheese boxes.[3] Manufacturers could have removed these dyes from their products, but many manufacturers used them to save on production costs.[4] Another option would have been to allow manufacturers to remove the ingredient information from the back of the macaroni and cheese boxes. This would have perhaps maintained cost savings for many of these manufacturers. But it wouldn’t have helped a parent understand whether his or her preferred brand of macaroni and cheese still contained yellow #5. In addition, it wouldn’t have helped the parent decide whether he or she should buy the brand and feed it to his or her child. And what if, in the absence of this information, consumers just decided to stop buying boxes of macaroni and cheese that contained yellow #5 or to insist on paying less for each box? Would the reduction in production costs to the manufacturer actually have been worth the reduction in sales? The same tradeoff is true here.

* * * * *

Today’s rules would amend the definition of “smaller reporting company,” in part, to include companies with a public float[5] of less than $250 million.[6] This is a $175 million increase from the current $75 million threshold today. The release states that this number came from recommendations made by the SEC Advisory Committee on Small and Emerging Companies and the SEC Government-Business Forum on Small Business Capital Formation. However, the release does not clearly state why the Commission agrees with these recommendations. Instead, it points rather flatly to the fact that the percentage of companies that would qualify as smaller reporting companies under the final rules mirrors the percentage of companies that qualified as smaller reporting companies when the definition was first adopted in 2007. While this may be true, I am unclear if this alone provides us with a sufficient basis for a shift in our disclosure regime. Notably, the Commission adopted the original threshold in recognition of then-existing rules that used a $75 million public float metric to distinguish smaller companies.[7]

To be sure, I am not suggesting that the $250 million threshold is inappropriate, to the extent the threshold should be adjusted. I’m simply saying that before we adopt rules that reduce disclosure to investors, we should be certain that any threshold increase is the smallest possible increment needed to achieve the desired outcome. Looking at our economic analysis, it is unclear that this is in fact the case.[8]

So what should the threshold be? I’m not sure myself. The purported reason for increasing the smaller reporting company threshold, after all, is to promote capital formation and reduce costs. I am not certain, however, that expanding the number of companies that are eligible to provide reduced disclosure by the magnitude we are contemplating today would successfully accomplish either goal.

It simply has not been conclusively shown that so-called “high regulatory costs” and “burdensome SEC rules” actually discourage companies from accessing the public markets.[9] On the other hand, what has been demonstrated is that there are additional, indirect costs to companies as a result of reduced disclosure. That is, it may be more expensive for companies to obtain capital from investors when they provide reduced disclosure. Some scholars have shown that investors apply a discount to share prices of companies who engage in an initial public offering with reduced disclosure.[10] Others have found that more disclosure actually results in a lower market cost of capital[11] and increased trading in a company’s shares. So, scaled disclosure actually may have the effect of discouraging capital formation. Some companies seem to be cognizant of this, and are voluntarily providing more disclosure.[12] In addition to the costs of reduced disclosure to companies, reduced disclosure also imposes costs on investors. In this regard, I am also not certain that removing disclosure in this manner is a good thing for retail investors in particular.[13] What’s more, our economists don’t appear to be entirely sure either.[14] Simply put, our rules should be data-driven, and it is not clear to me that these rules are.[15]

Speaking of data-driven policy, I’d like to briefly discuss the part of the release directing the staff to make further recommendations. In particular, the release states that “the Chairman has directed the staff to formulate recommendations to the Commission for possible additional changes to reduce the number of registrants that our rules define as accelerated filers.” In other words, the staff is being asked to prepare a recommendation that, among other things, could exempt companies with public floats above $75 million but below $250 million from the requirement to comply with section 404(b) of the Sarbanes-Oxley Act.

Section 404(b) requires a registered public accounting firm to attest to, and report on, management’s assessment of the effectiveness of a company’s internal control structure and procedures for financial reporting. Created as one of the responses to accounting frauds at firms like Enron and WorldCom, section 404(b) provides an independent check of management’s assessment of a company’s ability to accurately report financial information to investors.[16] This is why section 404(b) is considered to be such a critically important investor protection measure. And the larger and more complicated a company gets, the more important it can be.

Indeed, the data bears this out. In 2011, our staff published a study that recommended that section 404(b) continue to apply to companies with public floats between $75 million and $250 million.[17] Of note, our staff found no specific evidence that any potential savings from exempting these companies from section 404(b) would justify the loss of investor protections. Rather, our staff found that companies that were subject to section 404(b) generally had a lower rate of financial statement errors than those that were not.[18] Our staff is not alone, as the literature is replete with data suggesting that section 404(b) increases investor confidence,[19] may lower a company’s cost of capital,[20] including for smaller companies,[21] and that any costs associated with section 404(b) have declined over the years.[22] And chief financial officers appear to agree, too, with 85% believing that the internal control over financial reporting audit function has helped their companies.[23]

So, why is the staff embarking on a road that could exempt these companies from section 404(b)? The reason appears to be to provide a recommendation that would promote capital formation. It is true that some commenters believe that companies with a public float above $75 million but below $250 million should be exempt, but it is also true that many commenters do not. Given the range of opinions on this point, it probably would make more sense for the Commission to simply publish a concept release, instead of a proposal, to help fully inform our understanding of this issue before moving forward.

* * * * *

While I have my doubts about the efficacy of reduced disclosure, in the end, I am willing to support today’s recommendation because these final rules allow smaller companies to make a choice. In other words, a company that may qualify as a smaller reporting company is not required to provide reduced disclosure. In many ways, I see this as a pilot program. That is why I asked that there be a commitment that the staff review, and report back to the Commission on, the implementation of the final rules. The staff’s review would help the Commission better understand the impact of reduced disclosure and, in particular, whether it is actually increasing or decreasing the cost of capital for smaller companies.[24]

Unfortunately, the final rules do not provide this commitment. Rather, the release notes that some companies could face higher costs of capital in addition to reduced liquidity for their securities, but it does not conclusively quantify these effects.[25] Nor does the release adequately justify how these rules, and the particular thresholds chosen, will encourage capital formation in light of the mixed data.[26] Instead, it states that companies can more or less determine this for themselves before opting into the regime. I think a report by the Commission’s staff on the strengths and weaknesses of reduced disclosure would provide valuable information to these smaller companies and to investors who may not be able to employ economists to analyze the impact themselves. While the final rules do not provide a report, I am hopeful that the staff will review the impact of these rules nonetheless. The Commission owes it to investors, as well as smaller companies, to help them determine the consequences of these changes. In addition, having these facts in hand will help the Commission make policy choices based on real-world data going forward.

Finally, I would like take a step back and touch upon one final matter. As we move forward, the Commission should be mindful when issuing rules that would remove disclosure. Information and transparency are what fuels our markets and makes them the gold standard for the world. In this regard, any decrease in information and transparency may actually do more harm than good, not only to investors, but to our markets as a whole.

Thank you.

[1] See Amendments to Smaller Reporting Company Definition (“Adopting Release”), at section IV.B.2.

[2] Adopting Release, supra note 1, at section I.

[3] See, e.g., Parvati Shallow, “Kraft removing artificial dyes, preservatives from Mac & Cheese,” CBS News (Apr. 20, 2015), available at

[4] See Barbara Woolsey, “If it’s so easy to replace artificial food ingredients, why don’t more companies do it?,” Thrillist Health (Apr. 25, 2016), available at; see also Johanna Blythman, “Inside the food industry: the surprising truth about what you eat,” The Guardian (Feb. 21, 2015), available at

[5] Public float is computed by multiplying the aggregate worldwide number of shares of a company’s voting and non-voting common equity held by non-affiliates by the price at which the common equity was last sold, or the average of the bid and asked prices of common equity, in the principal market for the common equity. See Item 10(f)(1)(i) of Regulation S-K; rule 405 of Regulation C; rule 12b-2 under the Exchange Act.

[6] The rules also amend the definition of “smaller reporting company” to include companies that have annual revenues of less than $100 million in the previous year and either no public float or a public float of less than $700 million.

[7] Smaller Reporting Company Regulatory Relief and Simplification, Exchange Act Rel. No. 56013 (Jul. 5, 2007) [72 FR 39670 (Jul. 19, 2007)], at section II.A.1.a., available at

[8] For example, it appears that most of the estimated 779 companies with a public float between $75 million and $250 million have public floats closer to $75 million than they are to $250 million. Therefore, it is unclear to me why the rule increases the threshold to $250 million and not to a threshold nearer to where most of these additional companies fall.

[9] See, e.g., John C. Coffee, Jr., “Legislative Proposals to Help Fuel Capital and Growth On Main Street” or “The Irrepressible Myth That SEC Overregulation Has Chilled IPOs,” Hearings Before the Subcommittee on Capital Markets, Securities, and Investment of the Committee on Financial Services of the United States House of Representatives (May 23, 2018), available at

[10] The effects of implementing scaled disclosure under the Jumpstart Our Business Startups Act are informative in this regard. See, e.g., Daniel J. Taylor, “The Lemons Problem: How Less Disclosure Affects Risk Perceptions,” Knowledge@Wharton (Jun. 23, 2015) (“The Lemons Problem”), available at (“What we find is that the discount [to the IPO offering price] that investors apply to firms that are taking advantage of these reduced disclosure regulations is about an 8% discount.”).

[11] See, e.g., Yan Li & Holly Yang, Disclosure an the Cost of Equity Capital: An Analysis at the Market Level (Nov. 2012), available at

[12] See Jennifer Francis, Dhananjay Nanda & Per Olsson, Voluntary Disclosure, Earnings Quality, and Cost of Capital (May 2007), available at

[13] See, e.g., The Lemons Problem, supra note 10 (“Relative to the sophisticated investors, we think that they’re actually worse off—because the sophisticated investors can make up for any lack in public information by collecting private information, whereas unsophisticated investors can’t go out there and collect private information. They may or may not even realize that the amount of public disclosure that the firm is providing has shrunk.”); see also Mary E. Barth, Wayne R. Landsman & Daniel J. Taylor, The JOBS Act and Information Uncertainty in IPO Firms (Jan. 2017); Letter from CFA Institute (Aug. 30, 2016) (“CFA Letter”), available at (“In particular, we believe that allowing different sized entities to use different disclosure regimes will signal to investors that the entities lack comparable quality. That will occur, however, only if investors are aware of the difference in reporting requirements.”).

[14] See, e.g., Adopting Release, supra note 1, at sections IV.B.3.b. and IV.B.3.d. (citing a study that suggests otherwise with respect to share liquidity, noting that “[t]he effect of scaled disclosures on share turnover ratio is negative but statistically insignificant” and “Taken together, our empirical analysis suggests that, for most of the newly eligible [smaller reporting companies] under the final rules, scaled disclosures may generate a modest, but statistically significant, amount of cost savings in terms of the reduction in compliance costs, a modest, but statistically significant, deterioration in some of the proxies used to assess the overall quality of information environment, and a muted effect on the growth of the registrant’s capital investments, investments in [research and development], and assets.”)

[15] Even if an increased threshold is proven necessary, the Commission should be mindful to tailor which disclosures should be scaled and which should not. For example, some disclosures may be more meaningful to investors the larger the company is. See CFA Letter, supra note 13 (“[W]e also recognize that certain types of information that are affected by the current scaled disclosure requirements are arguably more important than others. For example, we believe that requiring SRCs to provide the pension benefits table and a disclosure of compensation policies and practices related to risk management (both of which can be deleted under scaled disclosure) are more vital than certain other disclosures. Thus, in keeping with the Commission’s intent to simpl[ify] disclosure and to ease burdens on SRCs, we think it would be helpful to conduct an overall review of the scaled disclosure framework with an eye to retaining items of information important to investors and research analysts, while deleting those items that require repetitive information.”).

[16] See Mitchell Franklin, Sarbanes-Oxley Section 404: A Historical Analysis, 16 J. Acct. & Fin. 56 (2016).

[17] Study and Recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 for Issuers with Public Float between $75 and $250 Million (Apr. 2011), available at

[18] The Commission acknowledged these findings when we proposed today’s rules. See Amendments to Smaller Reporting Company Definition, Exchange Act Rel. No. 78168 (Jun. 27, 2016) [81 FR 43130 (Jul. 1, 2016)], at section II.C., available at

[19] See, e.g., U.S. Government Accountability Office, Internal Controls: SEC Should Consider Requiring Companies to Disclose Whether They Obtained an Auditor Attestation (Jul. 2013) (“GAO Report”), available at

[20] See, e.g., Cory A. Cassell, Linda Myers & Jian Zhou, The Effect of Voluntary Internal Control Audits on the Cost of Capital (Jun. 1, 2013), available at

[21] See, e.g., Sheryl-Ann K. Stephen & Pieter J. de Jong, The Impact of the Sarbanes-Oxley Act (SOX) on the Cost of Equity Capital of S&P Firms, 13 J. Applied Bus. & Econ. 102 (2012).

[22] See, e.g., GAO Report, supra note 19.

[23] Center for Audit Quality, CAQ Pulse Poll: CFO Perspectives on the Sarbanes-Oxley Act (May 2017), available at

[24] The staff’s review and report that I asked for could have, for example, included (i) an assessment of whether the final rules are effectively promoting capital formation and reducing costs for smaller reporting companies; and (ii) quantifiable data supporting the assessment, including, but not limited to, data relating to (a) the distribution of companies by each trigger (public float and revenue), (b) industry break down and (c) the number of companies that qualify as smaller reporting companies but do not utilize the regime.

[25] See supra note 14 and accompanying text.

[26] See supra notes 7–15 and accompanying text.

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