Trump Eyes Reforms to Corporate Earnings Reports

At half past seven on the morning of Friday, August 17, that rarest of phenomena graced the Internet: a sober, judicious, policy-oriented, presidential tweet. For a fleeting instant, there it was, tucked between ritual denunciations of former CIA director John Brennan, New York governor Andrew Cuomo, the D.C. local government, and “Senator” Richard Blumenthal (quotation marks in original). Behold! A message calling upon the Securities and Exchange Commission (SEC) to revisit its rules on quarterly securities disclosure:

This tweet represents — albeit in only 279 characters — perhaps the most extensive comments from the Oval Office on securities regulation since the Executive Order on Core Principles for Regulating the United States Financial System was issued on February 3, 2017.

To understand the significance of the president’s tweet requires a little knowledge of how securities markets operate. Under our securities laws, a publicly traded company is required to disclose information about its business, financial condition, and results of operations on an ongoing basis. This information is presented in both qualitative and quantitative formats. A typical disclosure document discusses the various risks besetting a company and includes management’s discussion and analysis of the company’s current financial statements. As I have discussed at greater length elsewhere, the theory underlying these required disclosures is that an informed investor is a protected investor. You might say that the SEC’s unofficial motto is: “Caveat investor.”

The basic structure and timing of our securities-reporting regime were established by SEC rules made in 1934, 1955, and 1970, although to some extent these rules simply formalized longstanding practices that had been in place in some companies since before the establishment of the SEC. Currently — to elide reams of technical detail — domestic companies are required to file quarterly reports after their first, second, and third financial quarters; audited annual reports at the end of the year; and occasional reports upon the occurrence of certain material events that may be of interest to investors. After being scoured by lawyers and accountants, each of these reports is filed electronically on the SEC’s EDGAR system and made available online to the investing public.

There is no more magic to reporting financial information quarterly than there is to holding biannual federal elections or quadrennial Olympics. The choice of a three-month interval is more or less arbitrary. Nevertheless, over the decades, quarterly reporting has become the common time signature of our financial markets: Each annual measure has precisely four quarterly beats. The sections of the securities-industry orchestra — issuers of securities, investment banks, professional and individual investors, analysts, regulators, academics, financial journalists — each take their cues from the steady ostinato of mandatory disclosures. In general, quarterly reporting has not been a subject of debate.

Recently, however, a growing chorus has suggested that quarterly reporting may do more harm than good. Preparing quarterly reports is costly in terms of both management time and treasure, the argument goes. Thus, reducing the frequency of such disclosures would allow companies to devote resources to more productive uses. Critics of the current system — including, apparently, the “top business leaders” who spoke with the president — also hold that an unintended byproduct of quarterly reporting is the “short-term-ism” that plagues corporate America. Rather than pursue the long-term interests of shareholders, detractors say, managers of U.S. public companies are too narrowly focused on meeting or exceeding quarterly earnings-per-share projections and other ephemeral objectives. A precipitous drop in stock price usually awaits a company that misses its target by a few cents per share. This tendency is only magnified by the financial media’s fascination with whether or not a company will “beat the Street.” A move to reporting every six months rather than every three, it is thought, might alleviate some of the short-term pressures on boards of directors.

There is an appealing plausibility to the claim that requiring a company to show its progress every three months promotes corporate myopia. There are, however, reasonable counterarguments. Some, including many investor advocates and activist investors, accept that short-term-ism is a grave malady but dispute whether quarterly reporting is its proper cause. As noted, many public companies issue quarterly earnings-per-share targets. Management often discusses these targets on scheduled conference calls with investors and analysts. Neither these calls nor the earnings targets themselves are required by any law of Congress or rule of the SEC. Indeed, even if the SEC were to abolish quarterly reporting entirely or give companies the flexibility to report at a lesser frequency, these practices might well continue out of companies’ deference to investor expectations. If companies have decided to play Wall Street’s game by releasing self-imposed earnings targets, skeptics argue, there is not much that Congress or the SEC can — or even should — do about it.

Weighing the costs and benefits of quarterly reporting is ultimately an empirical question, and the president is to be praised, mirabile dictu, for the measured tone of his tweet. Note that he called only for the SEC to “study” the issue rather than demanding a hasty adoption of half-year reporting. Other countries have either considered or adopted rules removing the requirement of quarterly reporting, potentially placing U.S. issuers on poor footing relative to their foreign competitors. For example, last year, it was reported that fully a fifth of the companies included in London’s FTSE 100 index had taken advantage of regulatory easing and abandoned quarterly reporting over an eleven-month period. A careful study of the available evidence by the SEC’s Division of Economic and Risk Analysis — and perhaps even a multi-year pilot study — seems appropriate, as the president suggests.

Early indications from the SEC have been guardedly positive. Jay Clayton, a political independent and Trump’s choice to serve as chairman of the politically balanced five-man SEC, responded to the president’s tweet almost immediately with a public statement praising the president for “highlight[ing] a key consideration for American companies and, importantly, American investors and their families — encouraging long-term investment in our country.” The statement further said that the “SEC’s Division of Corporation Finance continues to study public company reporting requirements, including the frequency of reporting.” (Until July 7, 2018, I served as a senior counsel to Republican SEC commissioner Michael S. Piwowar but played no role in the agency’s response or deliberations.)

If adopted by the SEC, a move from quarterly reporting to half-year reporting would constitute one of the more dramatic structural reforms of disclosure practice in recent memory. Given the agency’s swift response, one wishes that the president would tweet about other hotly contested securities-law issues, such as the mandatory arbitration of shareholder claims or reducing the burden of internal controls audits under the Sarbanes-Oxley Act. Over the past year, the SEC has been extremely — some might say, excessively — deliberate in advancing reforms to promote capital formation. It is likely that the agency will remain so as it studies the effects of quarterly reporting. While the outcome of the SEC’s study of quarterly reporting likely lies in the distant future, it is encouraging that President Trump and Chairman Clayton have taken an interest in disclosure reform. The securities industry — not to mention the Forgotten Investor — hopes for more of the same.

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