SEC Disclosure Matters

The SEC recently issued a long concept release seeking public comment on ways to modernize Regulation S-K, the set of disclosure requirements used both for Securities Act registration statements like Form S-1 and Exchange Act reports like Form 10-K. (As a side note, the term “concept release” invariably brings to my mind concept albums by bands like Pink Floyd.) Given my (self-imposed) limit on the length of my blog posts, I will confine my discussion of the release for now to just one point: the SEC’s solicitation of comment on the suggestion that companies provide, in the Risk Factors section, estimated probabilities of the relevant event occurring and the magnitude of the effect on the company if it does occur.

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The SEC’s Discussion of Risk FactorsRead More »

I try to keep the topics of most of my blog posts broad and of interest to most of my clients. This one, however, is a bit of an exception and will only be relevant to (1) public companies, who (2) are classified as smaller reporting companies, and (3) need to use Form S-1, rather than short Form S-3, for their resale registration statements. In most cases, in other words, we are talking about public companies whose shares are not listed on a national securities exchange.

If you’re still with me after that narrowing of scope, there is some good news from Congress, which in December passed, and the President signed, the FAST Act. The SEC issued a short summary of the provisions relating to the securities laws that were included in the statute. One of the provisions described here is headed Small Company Simple Registration, and as noted in the description, it requires further SEC rulemaking before it becomes effective.

When an issuer files a registration statement on Form S-3, if eligible, the main reason it is usually shorter than an equivalent Form S-1 is that the filing “incorporates by reference” the issuer’s past Exchange Act filings (e.g., Forms 10-K and 10-Q). So, instead of containing financial statements, for example, the form simply says that certain Exchange Act filings already made (which themselves contain those financial statements) are deemed to be included in this Form S-3. (The SEC now permits some incorporation by reference of past filings into Form S-1, under limited circumstances.)

The new provision of the FAST Act deals not with incorporation of past filings, but with the obligation to update a prospectus after the registration statement is declared effective. Form S-3 has always permitted so-called forward incorporation by reference, meaning that Exchange Act filings made after the Form S-3 is declared effective are automatically deemed to update the prospectus, without further action. As a result of the FAST Act provision, the same will be true for Form S-1, and forward incorporation of reference will be permitted. This eliminates a huge logistical burden on small public companies that can’t use Form S-3, who until now had to make duplicative prospectus supplement filings to update their Form S-1 prospectus after each Exchange Act filing they made. The drafters of the provision understood that no practical purpose was served by requiring issuers to incur the cost of these additional filings, since all interested parties know to consult the most current Exchange Act filings for current information.

The SEC this week approved the pay ratio rules, required under the Dodd-Frank Act. Details can be found in the SEC’s adopting release and press release. The rules require disclosure by public companies of the ratio of the compensation of its CEO to the median compensation of its employees. My topic today is not the finer points of the rules, which are not really relevant to my practice – the “smaller reporting companies” that I represent are exempt from the disclosure requirements – but on the policy underlying the rules.

There is no debate over the fact that, over the past few decades, the average pay ratio has gotten far larger, i.e., top executives now receive far more in compensation than the average employee, as compared to the state of affairs during the 1950s and 1960s. If you accept that executive compensation is out of whack, as I do (though that is in part a political judgment), the question becomes the best way to address it. By introducing the pay ratio disclosure concept, the drafters of Dodd-Frank adopt the Justice Brandeis view that “sunlight is the best disinfectant,” that disclosure of the pay gap will embarrass companies and lead stakeholders to push them toward fairer pay structures.

However, although I wouldn’t say I’m in favor of opacity and non-disclosure, it’s fair to question whether requiring this disclosure will have the desired effect. Greater public dissemination of compensation information has not resulted in reduction of compensation; quite the opposite. The publication of law firm profit figures by the American Lawyer magazine has fueled the sense among partners that there are greener pastures elsewhere, leading to high guaranteed pay packages. Agents for free agent athletes cherry pick examples of other highly paid players – and everyone now knows what they’re paid – to negotiate higher pay for their clients. And getting back to public companies, the SEC has for years required detailed compensation disclosure for senior executives, and the result has not been embarrassment and retrenchment, but the hiring of compensation consultants that use the public data to justify ever more generous pay packages. Walmart shareholders are already well aware that the CEO is paid far more generously than a median worker; calculation and disclosure of the ratio will have no impact on their willingness to vote in favor of “say on pay” proposals or to retain directors who approve generous pay packages.