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SEC Hosts 21st Century Disclosure Initiative Roundtable

The SEC recently hosted a roundtable under its 21st Century Disclosure Initiative to examine ways to improve transparency and disclosure. In opening remarks, SEC Chairman Christopher Cox noted that investors' right to reliable information about the securities that trade in the public markets has never been more urgent. Cox also called on Congress to give the SEC and the CFTC the authority to issue antifraud rules for the over-the-counter credit default swaps market. No government agency has authority over this $58 trillion market, he said, which poses a risk to the financial system given the complete lack of information about who is exposed to whom.

Cox reviewed the actions that the SEC has taken in recent weeks to address the ongoing credit crisis. He reported that the staff has over 50 pending law enforcement investigations related to subprime mortgages. The Division of Enforcement has begun a nationwide investigation of potential fraud by issuers of securities in financial institutions, he said, and is looking into the manipulation of securities, abusive short selling and the intentional spreading of false information.

Cox said that Congress must address the regulatory gap with respect to OTC credit default swaps. The legislation should require trade and position reporting by dealers in OTC credit default swaps, position reporting by market participants with significant positions and basic recordkeeping. The failure to act is inexcusable given the costs of other regulatory gaps in the past few months, according to Cox.

The 21st Century Disclosure Initiative should help investors better understand the complex financial instruments in today's markets. The roundtable featured two panels. One panel focused on the market's use of disclosure information and the SEC's disclosure system. The other panel addressed ways to modernize the SEC's disclosure system, including a company file system in which core company information is provided in a central file and updated to reflect new developments.

Alfred Berkeley with XBRL U.S. believes that the ease of use will determine whether the disclosure system gets used. He pointed to a 2,003 page document related to a complex mortgage security product and said that no one reads it other than the sell side. If the data is tagged, it could transform the understanding of the buy side, in his view. Data tagging will revolutionize the ability of credit agencies and other users to drill down and determine the value and the price of the security, he said.

David Copenhafer, a former director of EDGAR services for Bowne & Co., Inc., suggested that the SEC make more sense out of its form types. For instance, he said there are nine variants of Form S-3, many of which are replications. He suggested that one form type would suffice with references to the applicable rule.

Joseph Grundfest, a law professor at Stanford University and a former SEC commissioner, outlined a proposed questionnaire-based approach that he developed with Alan Beller, a partner with Cleary Gottlieb Steen & Hamilton LLP and former director of the SEC's Division of Corporation Finance. The questionnaire is similar to the company filing approach, he said. Companies would have a legal obligation to update the questionnaire on the same schedule as current periodic filings, but the forms would no longer be needed.

The questionnaire is not a substitute for XBRL, according to Grundfest. Filers would amend their responses whenever the information in the questionnaire has changed. The system will tag any changes to bring them to investors' attention. Grundfest said the questionnaire could be implemented without any changes to the current statutory structure. The system would be cheaper for filers once it is in place. It would track current Regulation S-K disclosure.

Grundfest echoed Cox's concerns about credit default swaps and pointed to the Gramm-Leach-Bliley Act amendments which specifically prohibit the SEC from issuing rules governing swap agreements. He recommended that the SEC, in cooperation with the Federal Reserve Board and the Treasury, pay no attention to that prohibition and write the rules and regulations that should be in place. The regulators can then ask OTC credit default swap market participants to voluntarily comply. In the current environment, Grundfest predicted that all of them would agree to do so. Congressional action will not come any time soon, he explained, but markets need clarity and transparency.

White observed that the SEC's last effort involving a voluntary program, the consolidated supervised entity program, did not turn out very well. The program was ended on September 26, 2008. In announcing the termination of the program, Cox advised that the past six months have made clear that voluntary regulation does not work.

Beller agreed that the SEC could pursue a response to the credit default swaps market without rulemaking and suggested Management's Discussion and Analysis as the best tool in the SEC's arsenal. He pointed to the staff's recent use of "Dear CFO" letters to gain better disclosure on fair value measurements as an example. Recent events have highlighted the reemergence of the importance of credit and liquidity, he said. He urged the SEC to think about seeking more information about credit concentration and liquidity under the rubric of MD&A.

Steven Bochner, a partner with Wilson Sonsini Goodrich & Rosati, said he is a fan of moving to a company file system with a core filing that is supplemented with periodic reports. Investors would have one place to go for information. He and Beller agreed that the rhythm of the periodic reporting system which is linked to audit reviews, disclosure committees, CEO and CFO certifications, could be kept.

Beller said that changing to a company file system could be done within the current rules, and would also provide an opportunity to look at all of the rules. He urged the SEC to look at the "very low hanging fruit" such as any inconsistencies among the rules. He urged the SEC to review Regulation S-K to see how it can get more transparent, high quality information to investors. He also reminded panelists of the need to be aware of the global markets. U.S. market capitalization is now 30-odd percent, he said, and 10 years from now it will probably be less. The SEC does not need an international delivery system, but it must be aware of what is going on globally, he said.