Even though the SEC did not have an open meeting to consider its new proposal to amend Rules 3-10 and 3-16 of Reg S-X (see this PubCo post), Commissioner Kara Stein decided nonetheless to release a public statement about the proposal. While she voted in favor of issuing the proposal, she had some serious reservations.  

The proposed amendments to Rules 3-10 and 3-16 are designed to streamline the financial disclosure rules related to registered debt offerings that involve guaranteed or collateralized securities, by providing “investors with material information given the specific facts and circumstances, make the disclosures easier to understand, and reduce the costs and burdens to registrants.” Rule 3-10 addresses when a filing must include financial statements for a subsidiary that issues securities guaranteed by the parent or for a subsidiary that guarantees the parent’s securities.  Rule 3-16 addresses when an affiliate’s financial statements are required if the affiliate’s securities are used to collateralize the registrant’s debt securities.

Stein looked favorably on the amendments to the rules related to guaranteed debt that were adopted by the SEC in 2000; these proposed new amendments—not so much. In Stein’s view, the 2000 amendments, which permitted companies to provide a reduced level of financial information, effectively reflected her central concern “that a full understanding of a guarantor’s financial situation is necessary for an informed investment decision” and “balance[d] the burden on issuers and guarantors to disclose required information fully with the investor’s need for information.”

She was not so confident, however, that the same balance was retained in this new proposal. In particular, she rejected the idea that “some of the current required disclosures ‘require unnecessary detail, thereby shifting investor focus away’ from important information. Reducing the information provided to investors on the basis that such information may be too much for investors to handle is a precarious road to walk down.” She was even more concerned about the “slippery slope” of allowing material information to be presented outside of the financial statements—and therefore removed from the rigors of the audit—to provide “increased flexibility” and accelerate capital raising. She feared that that slope

“might inadvertently result in threatening the strength and credibility of the bedrock of our markets—high quality financial reporting….For years, investors have struggled to understand financial statements with alternative metrics that do not conform to agreed-upon standards, such as U.S. GAAP or IFRS, as supplements to their audited financial reports. In view of this, why is the Commission embarking down this path? The release states that it is intended to save costs, but does not provide adequate data in support. To move away from investor and market accountability, without having a full understanding of the reasons behind doing so, is troubling. Indeed, this type of argument can support the removal of virtually any single footnote currently required in the financial statements.”

Stein also expressed concern about “the release’s endorsement of private market disclosure practices as ‘best practices’ for the public market. This too is a slippery slope.”  There are significant differences between the two markets, she said, and the SEC has long recognized that the differences in the types of investors (retail v. sophisticated) that are allowed to participate in the two markets necessitates different levels of transparency and risk: to “look at the disclosure that is provided to a sophisticated investor and say that the same disclosure is sufficient for a retail investor simply does not make sense and runs contrary to the federal securities laws more broadly.”

Nevertheless, she welcomed the opportunity for the public to express its views on these important concerns: “In particular, should companies have a choice to take certain information out of audited footnotes and present it elsewhere in order to go to market faster? How does this benefit the investor? What are the costs?” She hoped that, with public input, the SEC will “construct rules that could, ultimately, strike the right balance.”


Posted by Cydney Posner