This chapter presents the results of the review in the area of disclosure of periodic financial information and ad-hoc information. It takes stock of the criteria and mechanisms that may motivate and allow flexibility and proportionality in the implementation of rules and regulations relating to the area across the 39 jurisdictions that responded the survey used for the review. It also includes a case study of the U.S. corporate governance framework in the area submitted by the staff of the U.S. Securities and Exchange Commission.
Flexibility and Proportionality in Corporate Governance
Corporate Governance
Chapter 7. Disclosure of periodic financial information and ad-hoc information
Abstract
Introduction
Regulations: background and context
Disclosure regulations are an important policy tool for securities regulators. In most jurisdictions, companies are subject to three types of disclosure requirements. Firstly, when a company wants to offer its securities to the public, the company is required to disclose information – in particular with regard to its financial status – prior to public offerings. Secondly, the company is subject to periodic disclosure – at least on an annual basis – as long as its securities are held by the public. Thirdly, the Principles support timely disclosure – i.e., ad-hoc disclosure – of all material developments that arise between regular reports.
Disclosure regulations can also be categorised depending on whether they are mandatory or not. Mandatory disclosure regulation is generally stipulated in company law, securities law and listing requirements1. On the other hand, voluntary disclosure regulation is often stipulated in corporate governance code that adopts “comply or explain” approach. As pointed out in the G20/OECD Principles, companies often make voluntary disclosure that goes beyond minimum disclosure requirements in response to market demand.
The key objective of disclosure regulations is to provide shareholders and potential investors with information necessary for their decision making. Shareholders and potential investors require access to regular, reliable and comparable information in sufficient detail for them to assess the stewardship of management, and make informed decisions about the valuation, ownership and voting of shares. Insufficient or unclear information may hamper the ability of the markets to function, increase the cost of capital and result in a poor allocation of resources.
It has been pointed out that policy makers tend to make extensive use of disclosure-based techniques in the area of financial market regulation.2 Some may believe that securities regulation is motivated by the assumption that more information is better than less3. Another reason may be that disclosure is a less burdensome regulatory tool, in the sense that extending its scope or content does not usually entail any direct government expenditure. This tendency of policy makers explains the need for adopting flexibility and proportionality mechanisms in disclosure regulations so as not to place an undue burden on companies.
Issues and trends
The OECD’s survey has found that the United States and some European stock markets today have between 30 to 40 percent fewer publicly traded companies than they had at the turn of the century4. This decline is to a large part explained by a structural decline in the number of initial public offerings. In particular, as pointed out in the OECD Equity Markets Review: Asia 2017[4], IPOs by smaller companies (below USD 50 million) have declined in the European Union and the United States during the last ten years.5
Partly in response to this decline in IPOs, scaled disclosure for smaller companies has been adopted in some jurisdictions. For example, in the United States, the Jumpstart Our Business Start-ups (JOBS) Act provides scaled disclosure provisions for emerging growth companies, including permitting them to include only two years of audited financial statements in the registration statement for an IPO of common equity securities. In Japan, the Financial Instruments and Exchange Act was amended to exempt smaller companies – for three years after listing – from the obligation of having their internal control reports audited by a Certified Public Accountant.6
Another important trend in the area of disclosure regulations is that some have criticised quarterly disclosure requirements. “The Kay Review of UK Equity Markets and Long-term Decision Making”[7] published in July 2012 recommends to reduce the pressures for short-term decision making that arise from excessively frequent reporting of financial and investment performance, including quarterly reporting by companies. In its response to the Kay Review[8], the UK government supported the recommendation with a view to reducing the regulatory burden of reporting for companies and addressing concerns that rigid quarterly reporting requirements may be promoting a short-term focus by companies, investors and market intermediaries.
In 2013, the EU Transparency Directive[9] was amended and the requirement to publish interim management statements was abolished based on the idea that “the obligations to publish interim management statements or quarterly financial reports represent an important burden for many small and medium-sized issuers whose securities are admitted to trading on regulated markets, without being necessary for investor protection. Those obligations also encourage short-term performance and discourage long-term investment”.
The view of the G20/OECD Principles
The G20/OECD Principles devote an entire chapter to disclosure and transparency. The outcome advocated by the chapter is transparency which is central to (i) shareholders ability to exercise their ownership rights on an informed basis; (ii) market integrity; and (iii) the accountability of the company to its shareholders. The chapter specifies the type of material information which should be disclosed, how and to whom this information should be communicated and the processes by which confidence in the quality of the information can be ensured.
The G20/OECD Principles emphasise the importance of a strong disclosure regime that promotes real transparency since it is a pivotal feature of market-based monitoring of companies and is central to shareholders’ ability to exercise their rights on an informed basis. The G20/OECD Principles state that a strong disclosure regime can help to attract capital and maintain confidence in the capital markets, while weak disclosure and non-transparent practices can contribute to unethical behaviour and to a loss of market integrity at great cost, not just to the company and its shareholders but also to the economy as a whole.
With regard to periodic disclosure, the G20/OECD Principles point out that public disclosure is typically required, at a minimum, on an annual basis though some jurisdictions require periodic disclosure on a semi-annual or quarterly basis, or even more frequently in the case of material developments affecting the company. The G20/OECD Principles also support timely disclosure of all material developments that arise between regular reports.
It is worth noting that the G20/OECD Principles state that disclosure requirements are not expected to place unreasonable administrative or cost burdens on enterprises. This may be one of the reasons why most jurisdictions apply flexibility and proportionality mechanisms when designing disclosure regulations.
Flexibility and proportionality for disclosure of periodic financial information
The key objective of disclosure regulations is to provide shareholders and potential investors with sufficient information so that they can make well-informed decision. At the same time, as mentioned in the G20/OECD Principles cited above, disclosure regulations should be designed so as not to place an undue burden on companies. Thus, disclosure regulation is an area where policy makers can make use of flexibility and proportionality mechanisms in order to strike a right balance between those two objectives.
One way to achieve this goal is to use flexibility and proportionality mechanisms in a way that relaxes disclosure requirements for certain types of companies (e.g. small companies). When relaxing disclosure requirements, policy makers typically choose either to exempt companies from disclosure itself (e.g. when companies offer its securities to a limited number of investors), to reduce the frequency of reporting (e.g. exemption from quarterly reporting) or to exempt companies from disclosing certain items or documents (e.g. small companies are exempt from disclosing its internal control system), among others.
Another way is to use flexibility and proportionality mechanisms in a way that strengthens disclosure requirements for certain types of companies (e.g. large companies or companies with complex risk factors). When strengthening disclosure requirements, policy makers usually increase the frequency of reporting (e.g. opt-in for quarterly reporting) or oblige companies to disclose additional items or documents.
The following section presents the main results from the survey responses as to how these are implemented.
Survey results
Out of the 39 jurisdictions included in the survey, 32 jurisdictions reported at least one criteria or optional mechanism that allow for flexibility and proportionality with respect to disclosure of periodic financial information and ad-hoc information (Figure 7.1.). Seven jurisdictions report that they are not using any flexibility and proportionality criteria or optional mechanism in the area of the disclosure of periodic financial information and ad-hoc information.
Figure 7.1. Jurisdictions with at least one criteria or optional mechanism in the areas of regulation
Source: OECD Survey.
Figure 7.2. Overall use of criteria across all areas of regulation
Source: OECD Survey.
Figure 7.3. Use of criteria for disclosure of information across jurisdictions
Source: OECD Survey.
As described in the main chapter of this thematic review, among all the criteria that jurisdictions employ to promote flexibility and proportionality in their corporate governance frameworks, the criterion of listing/publicly trading and the criterion of size are by far the most used when considering all areas of practice. This is also the case in the area of disclosure of periodic financial information and ad-hoc information (Figure 7.2.). Figure 7.3 shows the frequency and distribution among different types of criteria that jurisdictions have reported.
The use of listing/publicly traded as criteria for flexibility and proportionality
Listing/publicly traded is used in the area of the disclosure of periodic financial information and ad-hoc information by all but 13 jurisdictions and is present in the corporate governance framework in several dimensions, with the listing level being the most common policy consideration (Figure 7.4.).7
Most jurisdictions report that they use listing/publicly traded as a criterion in the sense that non-listed companies are not subject to the same disclosure regulations as listed companies. Typical example of additional requirements for listed companies is that they are required to file a financial report more frequently than annually. This is the case in Australia; Denmark; Finland; Italy; Japan; Korea; Latvia; Lithuania; Malaysia; Portugal; Saudi Arabia; Singapore; Spain; and Switzerland, among others.
Figure 7.4. Use of the listing/publicly traded criterion for disclosure of information
Source: OECD Survey.
Some jurisdictions differentiate between listing levels. For example, in Italy, listed companies belonging to the STAR segment – the market segment comprising medium-sized companies which comply with enhanced disclosure and governance requirements – are required to publish interim reports. In Japan, companies listed on either MOTHERS segment or JASDAQ segment – the market segment comprising mainly start-up companies – are required to comply with only five General Principles of the Corporate Governance Code and are not required to comply with detailed Principles of the Code including those on disclosure and transparency. In Malaysia, listed companies in the LEAP Market – the market segment which aims to facilitate fund raising and growth of SMEs – are not required to have their own website or issue an annual report.
Whether the company lists only debt instruments or not (debt only listing) is also a relevant consideration used to introduce flexibility and proportionality by a number of jurisdictions. This is the case in Denmark, Finland, Singapore, Sweden, Switzerland and Turkey.
For example, in Singapore, issuers which only have a debt listing need only to disclose certain information relevant to debt holders, such as immediate announcements on the redemption or cancellation of debt securities8 and details of any interest payments to be made. In Switzerland, the listing rules require semi-annual financial reporting, while the Additional Rules for the listing of bonds exempt debt-only issuers from this requirement for semi-annual financial reporting.
Other dimensions of the listing/publicly traded criterion used include a consideration for trading in ATPs. This is the case in Finland, Italy, Spain and Sweden. Cross listings are also considered, and for example Singapore exempts listed companies on SGX from its periodic financial information provisions if those companies’ home exchange is from a developed jurisdiction and those companies comply with their home exchange’s regulations.
The use of size as criterion for flexibility and proportionality
As shown in Figure 7.5., size also appears to be an important criterion used in the disclosure of periodic financial information and ad-hoc information. Seventeen jurisdictions report using it in different dimensions.
The size criterion is often used to introduce flexibility and proportionality for SMEs, using the dimensions of size of assets (eight jurisdictions), size of revenues (eight jurisdictions) and size of workforce (nine jurisdictions) as the most common policy considerations to define a company as small or medium. Some jurisdictions use a multiple test and require two or more positive answers to consider a company as a SME. For example, in Belgium, Finland and Germany, the test involves a 2-out-of-3 analysis depending on size of workforce, size of turnover, and size of balance sheet.
Once SMEs are identified based on the dimensions mentioned above, usually scaled disclosure regulations are applied to them. For example, in Belgium, drawing up a management report is not applicable to small companies. In Finland, the obligation to publish principles concerning the diversity of the board of directors and the supervisory board in the Corporate Governance Statement is not applied to SMEs. In Germany, small companies only have to draw up abridged balance sheets showing only certain items and they are also exempt from certain disclosure requirements in the notes to the financial statement. In Ireland, micro companies and small companies may file abridged financial statements and qualify for the audit exemption. In Israel, small companies are exempt from certain regulatory requirements including the ISOX regime9 and Galai Report.10
Figure 7.5. Use of the size criterion for disclosure of information
Source: OECD Survey.
Some jurisdictions define large companies and impose tighter regulations on them. For example, in Japan, Companies Act defines a large company as a company of which amount of the stated capital on the balance sheet is 500 million JPY or more, or a company of which total sum of the amounts in the liabilities section of the balance sheet is 20 billion JPY or more. These large companies11 must prepare consolidated financial statements. In Singapore, listed companies with a market capitalisation of more than 75 million SGD are required to issue quarterly financial statements.
The use of legal form as criterion for flexibility and proportionality
Seven jurisdictions (Australia, Belgium, Germany, Ireland, Lithuania, Mexico and the UK) use the criterion of the legal form to introduce flexibility and proportionality in this area of regulation. In Australia, a disclosing entity12 and public company13 are required to file an annual report, while a proprietary company is required to file an annual report when it is a large proprietary company. In Germany, only certain stock corporations, partnerships limited by shares and European Corporations have to include a corporate governance statement in their management report.
In the UK, while Limited Liability Partnerships14 (LLPs) are subject to very similar registration and filing requirements to those applicable to limited companies, the Limited Liability Partnerships Act 2000 does not regulate the internal management of the LLP. Consequently, their financial reporting requirements are similar but remain subject to a discrete set of regulations that reflect their structure. Another significant legal entity in the UK is the Community Interest Company (CIC).15 CICs are required to have a higher duty of transparency than private companies and are subject to additional legislation/regulation. As part of the CIC regulations, these entities are required to report on their activities and impact for previous 12 months to check if they have been providing community benefit.
The use of ownership/control structure as criterion for flexibility and proportionality
The ownership/control structure criterion is used less often for the disclosure of periodic financial information and ad-hoc information. Four jurisdictions report using it (Figure 7.6.). For example, in Ireland, a subsidiary is allowed to file the consolidated financial statements of its parent company.
Figure 7.6. Use of the ownership/control structure criterion for disclosure of information
Source: OECD Survey.
The use of accounting standards as criterion for flexibility and proportionality
Four jurisdictions (Denmark, Germany, the UK and the US) use the criterion of accounting standards to introduce flexibility and proportionality in this area of regulation. For example, in Denmark, if a company has chosen to use the International Financial Reporting Standards (IFRS) even though it is not forced to do so, then the company can opt for preparing interim financial statements as well, but it is not obliged to do so. In Germany, a parent company that prepares and publishes a consolidated financial statement in accordance with the IFRS is exempt from many national disclosure requirements stipulated in the German Commercial Code.
The use of maturity of firm as criterion for flexibility and proportionality
Two jurisdictions (Israel and the US) use the criterion of maturity of firm to introduce flexibility and proportionality in this area of regulation. For example, in Israel, a company that offers its securities to the public for the first time is required to provide comparative numbers in the financial report for the last two years (rather than three) for a period of five years (rather than three) while in the US, an emerging growth company will lose accommodations available to it on the last day of the fiscal year following the fifth anniversary that it first sold equity securities.
The use of opt-in and opt-out mechanisms
Opt-in and opt-out mechanisms are used for the regulation of the disclosure of periodic financial information and ad-hoc information by 12 jurisdictions (Figure 7.7.).
Figure 7.7. Use of opt-in and/or opt-out mechanisms for disclosure of information
Source: OECD Survey.
A typical way of using opt-in mechanisms is to allow listed companies to opt-in more frequent reporting. For example, in Italy and Spain, listed companies are subject to half-year reporting, while they can opt-in on interim reporting on a quarterly basis. In Latvia, listed companies are allowed to disclose either a shortened version of three- and nine-months financial report or expand it to a full report.
Opt-out mechanisms are used in five jurisdictions. In Germany, companies are entitled to omit certain disclosures in the notes to the financial statements under special circumstances, for example where the disclosure of that information would be seriously prejudicial to the company.
The use of sectoral criteria for flexibility and proportionality
An analysis of the results per sector of activity reveals that flexibility and proportionality criteria for the disclosure of periodic financial information and ad-hoc information are used in a majority of jurisdictions (28), with a varying degree of scope (Figure 7.8.). Most jurisdictions that present flexible sectoral regulations report having special regimes for the financial sector and for their State-owned companies.
Figure 7.8. Use of flexibility and proportionality in different sectors for disclosure of information
Source: OECD Survey.
Case study: United States
Overview
The U.S. capital markets are the deepest and most liquid in the world. U.S. and non-U.S. businesses access these global markets by offering and selling securities in transactions that are registered with the U.S. Securities and Exchange Commission (Commission or SEC) and in transactions that are exempt from the federal securities laws’ registration requirements. Companies that register transactions with the Commission, choose to list their securities on a national securities exchange, or become subject to the Commission’s other jurisdictional requirements are subject to the ongoing disclosure requirements of the federal securities laws.
Compared to other capital markets, U.S. markets have a relatively high degree of dispersed share ownership.16 Many other jurisdictions tend to have more concentrated ownership with a controlling shareholder or group.17
U.S. corporate governance framework
In the United States, corporate governance requirements generally are within the purview of the states and, for companies listed on national securities exchanges, those national securities exchanges. Each of the 50 states comprising the United States as well as the District of Columbia have statutes that provide for the formation of corporate entities and the terms of governance among shareholders, the board of directors, and management. State corporate law consists of both the statutory provisions and judicial decisions interpreting those provisions. Those judicial decisions, which comprise each state’s “common law,” have established several key components of the U.S. corporate governance framework.
With respect to any specific U.S. company, the law of the particular state in which it is established and relevant judicial decisions of that state will provide the requirements for the entity’s corporate governance. The majority of companies incorporated in the United States that are listed on U.S. exchanges have elected to incorporate in Delaware, and Delaware corporate law statutes and related jurisprudence are well-developed and followed closely by a number of other states.
The U.S. federal securities regulatory system is based on the principle of full and fair disclosure to investors by companies. Because this regulatory system is not based on merit regulation, the federal securities laws do not prescribe how a company structures itself or its transactions. Rather, the federal securities laws are based on the premise that investors should have the material information necessary to make informed investment decisions. The Commission is charged with protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation. Although state law provides the primary corporate governance framework, certain corporate governance matters are governed by the federal securities laws through a combination of federal statutes and the SEC’s rules and regulations. For companies listed on national securities exchanges, corporate governance requirements also are within the purview of the national securities exchanges.
While the corporate governance framework in the United States is based on the various sources described above, this case study will discuss the periodic and current disclosure requirements under the U.S. federal securities laws.
Legal and regulatory framework for periodic and current disclosure requirements
This principle of full and fair disclosure applies to offers and sales of securities, the listing and registration of classes of securities, and periodic and ongoing reporting under the U.S. federal securities laws. Companies that are subject to the ongoing reporting requirements of the Securities Exchange Act of 1934 (Exchange Act) are required to file annual, quarterly, and current reports with the Commission among other reporting requirements. Generally, a company may become subject to the ongoing reporting requirements by raising capital in a transaction registered under the Securities Act, listing its securities on a national securities exchange, or when the company has a class of equity securities that is held of record by more than 2 000 persons or 500 non-accredited investors and the company has more than $10 million in total assets.18
Under the federal securities laws, the disclosure requirements for companies that are subject to the Exchange Act’s periodic and current reporting requirements differ based on the company’s status as a domestic company or foreign private issuer,19 an emerging growth company,20 a smaller reporting company,21 or whether the company is a large accelerated filer,22 an accelerated filer,23 or a non-accelerated filer.24 Companies are subject to different regulatory requirements depending on their status as one type of company versus another. The baseline regulatory requirements of the federal securities laws generally presume the company status to be a domestic company that is not an emerging growth company or a smaller reporting company. Different regulatory requirements also apply to companies that rely on an exemption from registration to offer and sell securities under Regulation A (offerings up to $50 million per year by U.S. and Canadian companies) or Regulation Crowdfunding (certain crowdfunded offerings of up to $1.07 million per year by U.S. companies).
Companies that are subject to the baseline requirements are required to file an annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K. The disclosure requirements for these reports are located in the forms, Regulation S-K for the non-financial disclosure requirements, and Regulation S-X for the financial disclosure requirements. These companies are required to comply with U.S. generally accepted accounting principles. The Commission recognizes the financial accounting and reporting standards of the Financial Accounting Standards Board as generally accepted for the purposes of the federal securities laws.25
In addition to specific line-item disclosure requirements, a prospectus, registration statement, and periodic and current reports must include “such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.”26 To help assure that companies disclose material information to investors in connection with a registered public offering of securities and in ongoing reports, the federal securities laws provide for the liability of certain parties if the documents “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.”27
The Commission enforces the federal securities laws by investigating and bringing civil enforcement actions against individuals and companies for violations of the securities laws. In some cases, the federal securities laws are subject to both public and private enforcement. The Commission’s Division of Corporation Finance (Division) selectively reviews periodic reports of each reporting company at least once every three years and the Division reviews many companies more frequently. The Division also selectively reviews transactional filings.
The federal securities laws take into consideration proportionality and flexibility as they relate to smaller issuers, foreign private issuers, and companies that offer and sell securities based on exemptions from registration. These requirements are balanced with the Commission’s mission of protecting investors.
The disclosure requirements for companies that are subject to the Exchange Act’s periodic and ongoing reporting requirements can differ based on the company’s status. The following describes the regulatory requirements for companies outside of the baseline to highlight the principles of flexibility and proportionality present in the U.S. regulatory framework.
Flexibility and proportionality in the U.S. federal regulatory framework
Emerging growth company
In 2012, the Jumpstart Our Business Startups Act (JOBS Act) was enacted to “increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies.”28 The JOBS Act created a new category of issuer called an emerging growth company.29 If a company qualifies as an emerging growth company, it may comply with scaled disclosure requirements in its IPO and subsequent periodic reports. An emerging growth company is a company that has total annual gross revenues of less than $1.07 billion30 during its most recently completed fiscal year. By identifying itself as an emerging growth company in its prospectus or in other forms, the issuer’s disclosure informs investors that the issuer is eligible to use the scaled disclosure requirements permitted for those issuers. Under the JOBS Act provisions, this scaled disclosure includes:
permitting the issuer to provide two years of audited financial statements for an IPO of common equity securities instead of the baseline of three years of audited financial statements;
requiring the issuer to provide selected financial data only for the periods it included in the registration statement for the IPO and for subsequent periods in documents it files after its IPO whereas others issuers are required to provide five years of such data unless they have been in existence for fewer than five years;
complying with reduced executive compensation disclosure requirements permitting the issuer to omit a Compensation Discussion & Analysis section (CD&A) and not subjecting the issuer to the requirement to conduct the shareholder advisory votes;
exempting the issuer from the requirement under Section 404(b) of the Sarbanes-Oxley Act for auditor attestation of internal controls over financial reporting; and
permitting the issuer not to comply with new or revised accounting pronouncements until the date that a private company would be required to comply.
Under the regulatory relief provided by the JOBS Act, there are provisions:
allowing the issuer not to comply with any rule the Public Company Accounting Oversight Board (PCAOB) issues with respect to mandatory audit firm rotation or the auditor reporting model; and
that provide that any new PCAOB auditing standard will not apply to the issuer unless the SEC finds it necessary and appropriate in the public interest, after considering the protection of investors, and the promotion of efficiency, competition, and capital formation.
These scaled disclosure requirements and other regulatory relief apply as long as the issuer is an emerging growth company. An issuer will no longer qualify as an emerging growth company on the earliest of:
the last day of the fiscal year following the fifth anniversary that it first sold equity securities;
the last day of the fiscal year in which its total annual gross revenues are $1.07 billion or more;
the date on which it becomes a large accelerated filer; or
the date on which it has issued more than $1 billion in non-convertible debt in the previous three years31.
Smaller reporting company
The SEC has adopted scaled disclosure requirements for smaller reporting companies. Smaller reporting companies generally are companies that have a public equity float of less than $250 million or, the annual revenues of the company are less than $100 million and either it had no public float or a public float of less than $700 million.32 The scaled disclosure requirements permit smaller reporting companies to:
include less extensive narrative disclosure than required of other reporting companies, particularly in the description of executive compensation, which does not require smaller reporting companies to provide CD&A; and
provide audited financial statements for two fiscal years, in contrast to other reporting companies, which must provide audited financial statements for three fiscal years.
In addition, smaller reporting companies that are non-accelerated filers are exempt from the requirement to provide an auditor attestation of internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act.
Different due dates for periodic reports based on public float
The SEC has different due dates for filing annual and quarterly reports depending on, among other things, the public float of a company. The due dates for a company’s annual report and quarterly reports vary depending on its filer status as a large accelerated filer, an accelerated filer, a non-accelerated filer, or a foreign private issuer. Large accelerated filers, accelerated filers, and all other U.S. filers must file annual reports within 60, 75, and 90 days, respectively, of the fiscal year-end covered by the report. Foreign private issuers must file annual reports on Form 20-F within four months of the fiscal year-end covered by the report.
Large accelerated filers and accelerated filers must file a quarterly report within 40 days after the end of the fiscal quarter covered by the report. All other domestic filers must file within 45 days after the end of the fiscal quarter covered by the report. Foreign private issuers are not required to file quarterly reports.
Foreign private issuer
The SEC has a separate disclosure regime specifically tailored to foreign private issuers. While this regime largely elicits equivalent disclosures in connection with public offerings of securities and annual reports as for U.S. companies, the SEC’s disclosure system for foreign private issuers contains targeted disclosure accommodations that promote participation by foreign private issuers in the U.S. public capital markets in a manner consistent with investor protection.
In general, foreign private issuers must provide financial statements prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) or which contain reconciliation to U.S. GAAP. Foreign private issuers also may provide financial statements prepared in accordance with IFRS, as issued by the International Accounting Standards Board (IASB), without a reconciliation to U.S. GAAP. Some of the specific disclosure requirements for foreign private issuers that differ from those for U.S. issuers are:
foreign private issuers are exempt from the requirements to file proxy or information statements under the Exchange Act;
foreign private issuers’ securities are exempt from Section 16 of the Exchange Act;
foreign private issuers are not subject to the Exchange Act requirements to file quarterly reports on Form 10-Q and current reports on Form 8-K. Instead, foreign private issuers must furnish certain information on Form 6-K;33
foreign private issuers are not subject to Regulation FD, which prohibits selective disclosure of material non-public information;
foreign private issuers are permitted to follow home country requirements for disclosure of executive compensation;
foreign private issuers are required to provide in their annual reports a concise summary of any significant ways in which its corporate governance practices differ from those followed by domestic companies under the listing standards of the exchange; and
eligible Canadian foreign private issuers may file reports under the multijurisdictional disclosure system and satisfy certain securities registration and reporting requirements of the Commission by providing disclosure documents prepared in accordance with the requirements of Canadian securities regulatory authorities.
Exempt offerings
In addition to registering the offer and sale of securities, companies may offer and sell securities under an exemption from the Securities Act registration requirements34. The offering exemptions described below require issuers to provide some level of financial and non-financial information to investors about the offering and, in some case, on an ongoing basis.
Regulation A
The JOBS Act amended the small issues exemption under the Securities Act. The Commission implemented the provision by expanding the exemption into two tiers: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period.35
Companies that rely on Regulation A to offer and sell securities are required to provide financial and non-financial disclosure in offering materials. This disclosure is based on the specific requirements of the offering tier that an issuer elects to follow when conducting a Regulation A offering. This information is scaled as compared to companies that engage in registered offerings.
With the exception of securities that will be listed on a national securities exchange upon qualification, purchasers in Tier 2 offerings must either be accredited investors or be subject to limitations on their investment. Tier 2 issuers that list their securities on an exchange become subject to the Exchange Act reporting requirements. Tier 2 issuers are not subject to state securities law registration and qualification requirements. This may lead to a more simplified review process and reduce the costs associated with the offering.
Regulation A is available to companies organized in and with their principal place of business in the United States or Canada. This exemption is not available to companies that have ongoing Exchange Act reporting obligations.36 Bad actor disqualification provisions prohibit the issuer, directors, executive officers, more than 20% beneficial owners, promoters, and persons compensated for soliciting investors from engaging in a Regulation A offering if they were subject to certain disqualifying events.
Under Regulation A, the ongoing reporting regime varies according to type of offering. Tier-1 issuers are not required to engage in any ongoing reporting other than disclosure about sales in offerings and to update certain issuer information by electronically filing a Form 1-Z exit report with the Commission not later than 30 calendar days after termination or completion of an offering. Tier 2 issuers are required to file electronically their annual, semi-annual, and current reports.
The annual report on Form 1-K provides scaled disclosure requirements for non-financial information and financial information. A company is required to provide scaled information about its business; directors and executive officers; executive compensation; beneficial ownership of voting securities held by executive officers, directors, and owners of more than 10% of any class of the issuer’s voting stock; and related party transactions. A company also is required to provide two years of audited financial statements and a management’s discussion of the company’s liquidity, capital resources, and results of operations for those periods.
The annual report is due within 120 calendar days from the issuer’s fiscal year end. Unlike reporting companies, issuers of securities under Regulation A are not required to file quarterly reports. They are required to file semi-annual reports, which are due 90 calendar days after the end of the first six months of the issuer’s fiscal year. The due dates are longer than those for reporting issuers. The current report also includes fewer item requirements than the current report for reporting issuers. The requirement to file current reports is based on a fundamental change standard as opposed to a materiality standard. Current reports are due within four business days after the occurrence of a triggering event.
Regulation A financial statement requirements
Tier 1 and Tier 2 issuers are required to file balance sheets and other required financial statements as of the two most recently completed fiscal year ends (or for such shorter time that they have been in existence) for offerings of securities. This is in contrast to the three-year requirement for issuers in registered offerings that are not emerging growth companies.
Issuers in Tier 1 offerings are not required to file audited financial statements, unless the issuer already has audited financial statements available, while issuers in Tier 2 offerings are required to file audited financial statements.
Financial statements for U.S.-domiciled issuers are required to be prepared in accordance with U.S. GAAP, while Canadian issuers may prepare financial statements in accordance with either U.S. GAAP or IFRS as issued by the IASB.
Additionally, consistent with the treatment of emerging growth companies under the JOBS Act, Regulation A issuers, where applicable, may delay the implementation of new accounting standards to the extent such standards provide for delayed implementation by non-public business entities.
Regulation crowdfunding
In 2015, the SEC adopted Regulation Crowdfunding to implement the requirements of the JOBS Act.37 Regulation Crowdfunding is an exemption from the Securities Act registration requirements and permits non-reporting companies to raise up to $1.07 million38 in a 12-month period by offering securities on the Internet through crowdfunding. These crowdfunding transactions must be conducted through a registered intermediary that complies with SEC requirements. The rules provide limitations on the amount that individual investors may invest in all crowdfunding issuers in a 12-month period. Securities purchased in a Regulation Crowdfunding offering generally may not be resold for one year.
Disqualification rules prohibit bad actors from participating in these offerings as a director, officer, 20% or more beneficial owner of the company’s voting equity securities, promoter, or solicitor if they have been involved in disqualifying events. Only issuers incorporated in the United States and its territories may rely on Regulation Crowdfunding. Reporting companies may not use the Regulation Crowdfunding exemption.
Regulation Crowdfunding requires companies that rely on these rules to file annual information with the Commission and the rules provide scaled disclosure requirements.39 The Commission adopted separate reporting forms for companies that engage in crowdfunding offerings. These companies are required to provide an annual report on Form C-AR. The annual report is due no later than 120 days after the end of the fiscal year. The disclosure forms permit both scaled financial and non-financial disclosures.
The financial statements requirements in the offering document are based on the amount of securities offered and sold in reliance on Regulation Crowdfunding within the preceding 12-month period:
For issuers offering $107 00040 or less: Financial statements of the issuer and certain information from the issuer’s federal income tax returns, both certified by the principal executive officer. If, however, financial statements of the issuer are available that have either been reviewed or audited by a public accountant that is independent of the issuer, the issuer must provide those financial statements instead and will not need to include the information reported on the federal income tax returns or the certification of the principal executive officer.
Issuers offering more than $107 000 but not more than $535 000: Financial statements reviewed by a public accountant that is independent of the issuer. If, however, financial statements of the issuer are available that have been audited by a public accountant that is independent of the issuer, the issuer must provide those financial statements instead and will not need to include the reviewed financial statements.
Issuers offering more than $535 000:
For first-time Regulation Crowdfunding issuers: Financial statements reviewed by a public accountant that is independent of the issuer, unless financial statements of the issuer are available that have been audited by an independent auditor.
For issuers that have previously sold securities in reliance on Regulation Crowdfunding: Financial statements audited by a public accountant that is independent of the issuer.
The financial statements must cover the shorter of the two most recently completed fiscal years or the period since the company’s inception. Companies are required to provide certified comparable financial disclosure in their annual reports, but such disclosure does not have to be reviewed or audited.
Regulation Crowdfunding also provides scaled disclosure requirements for narrative, non-financial disclosures. These scaled disclosure requirements apply to all disclosure about the company, risk factors, use of proceeds, legal proceedings, related party transactions, and its officers, directors, and more than 20% beneficial owners. For example, the disclosure of related party transactions in Regulation Crowdfunding is based on the size of the offering that an issuer is conducting. Similarly, the beneficial ownership disclosure requirements apply to more than 20% beneficial owners as compared to the more than 5% beneficial ownership disclosure requirements for companies that have sold securities in transactions registered under the Securities Act or registered their equity securities under the Exchange Act.
Conclusions
As shown in the survey results, many jurisdictions use flexibility and proportionality mechanisms in the area of disclosure of periodic financial information and ad-hoc information, mainly to reduce the reporting burden for smaller companies and thereby promoting their access to capital. In designing these mechanisms, jurisdictions are mindful of not impairing the key objective of disclosure regulations, i.e., to provide shareholders and potential investors with sufficient information so that they can make well-informed decisions.
The case study illustrates that the United States has adopted numerous measures that provide for flexibility and proportionality as it relates to the reporting of periodic and current financial and non-financial information. The case study demonstrates that there are different ways to adopt flexibility and proportionality into corporate governance frameworks. The framework in the United States has developed over many years and is complemented by both public and private enforcement actions and the SEC staff’s selective review of certain types of company filings.
References
Ferrarini, G. and Ottolia, A. (2013), “Corporate Disclosure as a Transaction Cost: The Case of SMEs”,.
Kay, J. (2012), “The Kay Review of UK Equity Markets and Long-term Decision Making”, http://www.gov.uk/government/uploads/system/uploads/attachment_data/file/253454/bis-12-917-kay-review-of-equity-markets-final-report.pdf.
OECD (2015), G20/OECD Principles of Corporate Governance, OECD Publishing, Paris, https://doi.org/10.1787/9789264236882-en.
OECD (2017), “OECD Corporate Governance Factbook 2017”, http://www.oecd.org/daf/ca/Corporate-Governance-Factbook.pdf.
Paredes, T. (2003), “Blinded by the Light: Information Overload and Its Consequences for Securities Regulation”, https://openscholarship.wustl.edu/cgi/viewcontent.cgi?article=1287&context=law_lawreview.
UK Department for Business Innovation & Skills (2012), “Ensuring Equity Markets Support Long-Term Growth: The Government Response to the Kay Review”, http://www.gov.uk/government/uploads/system/uploads/attachment_data/file/253457/bis-12-1188-equity-markets-support-growth-response-to-kay-review.pdf.
Notes
← 1. This survey focuses mainly on the mandatory elements of the corporate governance framework, typically comprising company law, securities law and listing requirements.
← 2. See Enriques and Gilotta (2014), 2[1].
← 3. See also Paredes (2003), 418[2].
← 4. See Çelik and Isaksson (2017)[3].
← 5. Ferrarini and Ottolia (2013)[5] pointed out that “Corporate governance reforms over the last decade, with their emphasis on financial information and related controls, have significantly increased the direct and indirect costs of disclosure. As a result, they are often held responsible for slowing down the pace of SMEs’ recourse to capital markets and determining a dramatic fall in the number of IPOs in recent years”.
← 6. See Report by the Financial System Council (2013)[6].
← 7. It should be noted that in the United States, non-reporting companies – rather than non-listed companies – may use the Regulation Crowdfunding exemption. Please refer to the case study of the United States for the details.
← 8. Immediate announcements on the redemption or cancellation of debt securities are required when every five percent of the total amount of those securities is redeemed or cancelled.
← 9. The ISOX regime is an implementation of an Israeli version of the SOX. The regulations require reporting entities to attach (1) a management representation letter regarding the accuracy of the reports and information contained therein; (2) a management report regarding the effectiveness of internal control system over financial reporting and disclosure; and (3) an independent auditor’s opinion regarding the effectiveness of internal controls.
← 10. In Galai Report, companies are required to describe their exposure to financial risks and the way companies deal with such risks.
← 11. Limited to those required to submit an annual securities report under the Financial Instruments and Exchange Act.
← 12. A company whose securities are listed and/or held by 100 or more persons.
← 13. A company that has more than 50 non-employee shareholders and/or engages in activity requiring disclosure to investors.
← 14. A Limited Liability Partnership (LLP) is a UK specific legal form with similarities to both a partnership and a limited company. LLPs were formed under the Limited Liability Partnership Act 2000.
← 15. CICs were formed by the Community Interest Companies Regulations 2005 (“The CIC 2005 Regulations”). Under the Act, a company which is to become, or be formed as, a community interest company must satisfy the “community interest test”.
← 16. OECD Corporate Governance Factbook (2017)(2)].
← 17. Id.
← 18. Companies that have registered a class of equity securities under the Exchange Act or as a result of meeting the jurisdictional thresholds based on asset size and the number of record holders are required to file proxy or information statements for annual shareholder meetings among other matters. Greater than 5% holders of a company’s class of equity securities are subject to beneficial ownership reporting requirements. Officers, directors, and greater than 10% holders of a company’s class of equity securities are subject to the Section 16 reporting regime. These disclosure requirements are beyond the scope of this case study. This case study will focus on the periodic and current disclosure requirements under the Exchange Act and under certain exemptions from registration.
← 19. A foreign company is defined as a “foreign private issuer” unless: i) more than 50% of its outstanding voting securities are held of record (directly or indirectly) by residents of the United States; and ii) any one of the following is true: a) the majority of its executive officers or directors are U.S. citizens or residents; b) more than 50% of the issuer’s assets are located in the United States; or c) the issuer’s business is administered principally in the United States.
← 20. See discussion of emerging growth company status and requirements below.
← 21. See discussion of smaller reporting company status and requirements below.
← 22. A large accelerated filer is an issuer that: i) had aggregate worldwide public float of $700 million or more, as of the last business day of its most recently completed second fiscal quarter; ii) has been subject to the periodic and current reporting requirements of the Exchange Act for a period of at least twelve calendar months; and iii) has filed at least one annual report.
← 23. An accelerated filer is an issuer that: i) had aggregate worldwide public float of $75 million or more and less than $700 million, as of the last business day of its most recently completed second fiscal quarter; ii) has been subject to the periodic and current reporting requirements of the Exchange Act for a period of at least twelve calendar months; and iii) has filed at least one annual report.
← 24. A non-accelerated filer is an issuer that is neither an accelerated filer nor large accelerated filer.
← 25. See Commission Statement of Policy Reaffirming the Status of the FASB as a Designated Private-Sector Standard Setter, SEC Release No. 33-8221 (Apr. 25, 2003), available at www.sec.gov/rules/policy/33-8221.htm.
← 26. Rule 408 of Regulation C and Rule 12b-20 under the Exchange Act.
← 27. Section 11(a); cf. Section 12(a)(2) of the Securities Act and Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5.
← 28. Pub. L. No. 112-106, 126 Stat. 306 (2012).
← 29. Emerging growth companies are permitted to make confidential submissions of draft registration statements for initial public offerings (IPOs). They also are subject to less restricted communications to certain sophisticated investors before and after filing a registration statement. In 2015, the Fixing America’s Surface Transportation Act extended additional relief to emerging growth companies (Pub. L. No. 114-94 (2015)). This relief permitted companies to file publicly with the SEC 15 days before commencing a road show or seeking effectiveness for their IPO, which shortened the public filing requirement to 15 days from the 21 days required under the JOBS Act. It also permitted emerging growth companies to omit financial information from their confidential draft submissions if that information would not be required at the time of the offering. SEC staff subsequently permitted all companies (not only emerging growth companies) to submit draft registration statements for non-public review by the SEC staff for IPOs and initial listings and for the first year after the IPO or initial listing. Since the 1980s, SEC staff has afforded foreign private issuers the ability to make non-public submissions for their first registration statements. The SEC also accepts non-public submissions of initial draft offering statements under Regulation A.
← 30. The JOBS Act requires the Commission to adjust this amount for inflation every five years.
← 31. See Section 2(a)(19) of the Securities Act and Section 3(a)(80) of the Exchange Act.
← 32. In 2018, the Commission adopted amendments that increased the financial thresholds in the smaller reporting company definition. See Amendments to Smaller Reporting Company Definition, SEC Adopting Release 33-10513 (Jun. 28, 2018), available at www.sec.gov/rules/final/2018/33-10513.pdf.
← 33. The information and documents furnished on Form 6-K are not deemed to be “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of Section 18.
← 34. These companies may or may not be subject to the Exchange Act ongoing reporting requirements, depending on the circumstances.
← 35. See Amendments to Regulation A, SEC Adopting Release No. 33-9741 (Mar. 25, 2015), available at www.sec.gov/rules/final/2015/33-9741.pdf.
← 36. The Economic Growth, Regulatory Relief, and Consumer Protection Act requires the Commission to amend Regulation A to allow reporting companies to use Regulation A. Pub. L. No. 115-174 (May 29, 2018).
← 37. See Crowdfunding, SEC Adopting Release No. 33-9974 (Oct. 30, 2015), available at www.sec.gov/rules/final/2015/33-9974.pdf.
← 38. The Commission adjusts this amount for inflation every five years.
← 39. The securities that companies issue in reliance on the securities-based crowdfunding exemption are conditionally exempted from the record holder count under Exchange Act Section 12(g), subject to being current in their ongoing annual reports and compliance with other conditions.
← 40. The Commission is required to adjust the offering amounts described in this paragraph for inflation every five years.