Smaller Companies’ Frustration with XBRL Heard in Congress
On January 14, 2015, the House of Representatives passed H.R. 37, a bill that would exempt 60% of public companies from the SEC mandate to file XBRL-formatted financial statements. [1] As H.R. 37 wends through the Senate, and on to the President, this article looks at how XBRL enables the investing public to make informed decisions, but how it may hamper smaller companies trying to grow via access to the public markets. It raises the question of how the differing needs of these constituencies will frame securities regulation in the coming years, particularly as smaller companies continue to be spotlighted in Washington as agents of the post-2008 economic recovery, due to their role as job creators.
Background
The SEC began to require XBRL in 2009 as a means of enhancing investors’ access to public issuers’ financial statements. [2] Financial statements are arguably the most important source of information people use to make investment decisions. Yet during the mid-2000’s, the SEC identified a perceived flaw in required disclosures: static, text-based financials were difficult to analyze without sophisticated tools. [3] The SEC believed this reduced their transparency, particularly to ordinary investors vis-à-vis institutional investors. [4] It undermined the SEC’s goal to promote efficient and transparent capital markets. [5]
Interactive data provided a solution. Financial information in eXtensive Business Reporting Language (“XBRL”)– an interactive data format– was easy to search, extract, aggregate and compare. It could be downloaded to spreadsheets using widely available software. These elements provided benefits to investors, and in 2009, the SEC released a rule public issuers to include XBRL-formatted financial statements as exhibits to certain periodic filings on EDGAR and on their corporate websites. [6]
The Impact of XBRL on Smaller Public Issuers
In the years since implementation of the XBRL requirement, compliance challenges for smaller companies have come to light. This has led to questions about whether the cost-benefit of XBRL makes sense with regard to smaller issuers. It has sparked conversation among issuers, and now in Congress, about whether a second look should be given to the one-size-fits-all aspect of the XBRL rule.
Smaller companies face distinct challenges. One study shows proper handling of technical aspects of XBRL preparation is a top concern among companies, who are wary that formatting issues will result in SEC comment letters. [7] Smaller companies may be less prepared than larger issuers to bear costs associated with addressing such letters. They may be less able to pay rush premiums to modify or finalize XBRL files by deadlines. [8] And they may be more burdened by the prospect of liability for errors in the final disclosures, even as they are less able to develop the education and training resources to prepare XBRL files in-house. [9] For these reasons, while larger issuers have gained comfort and confidence with XBRL during the last few years, smaller issuers tend to struggle. [10]
The SEC’s transparency argument in favor of XBRL applies differently to smaller issuers. There is a view that smaller companies’ financial statements are not complex enough to justify the cost of XBRL filings on the basis of transparency: their simplicity makes the statements sufficiently clear and useful in static form to suit the public interest. This does not apply across the board. But it may be something to consider when viewing XBRL as a one-size-fits-all solution to providing useful financial statements to investors.
Finally, smaller issuers may be more impacted by misunderstandings related to the XBRL provision in Rule 144’s current public information requirement. Rule 144 is a safe harbor through which investors sell un-registered shares in the public market, subject to conditions. [11] They can generally sell stock in reporting companies after holding it for six months, as long as the issuer has posted required XBRL on its website and EDGAR for the past year. [12] (After one year, only former shell companies have a continuing XBRL requirement under Rule 144, and this is limited to filing XBRL on EDGAR). [13] Issuers commonly post PDF’s or links to public filings on their websites, under the mistaken belief that these satisfy the requirement. But improper or incomplete XBRL forecloses investors from selling after six months; it re-directs them to a one-year minimum hold—and a completely different investment risk proposition. [14] The perceived change in investment risk can be more material for investors in smaller issuers, due to the fact that these issuers’ stock price is typically more volatile. For this reason, smaller issuers’ relationships with investors can be more strained when a Rule 144-sale delay occurs.
Smaller companies’ experiences with XBRL compliance are unique, due to their particular needs and vulnerabilities. Yet their concerns were not excluded by oversight, from the SEC’s analysis of XBRL during the rule’s drafting. The SEC has no obligation to look at a new rule’s impact on smaller businesses. Whether this should continue to be the case is a question that has become ever more relevant in Congress, for reasons described in the next section.
The Politics of XBRL
Legislators in Washington have incorporated the XBRL debate into a larger conversation about the important role of small businesses as agents of the continuing post-2008 economic recovery. H.R. 37’s full name is the “Promoting Job Creation and Reducing Small Business Burdens Act.” Its directive is to place job creation as the top priority from which regulatory policy flows. The method is to strip away regulations from small businesses, freeing their resources so they expand their businesses and ultimately hire more employees. Transparency in the markets is a secondary, if not a tertiary, concern under this rubric.
Congressman Robert Hurt (R-Virginia) authored the bill’s XBRL exemption, available to issuers with revenues under $250 million. His press release after the House victory explains, “[H.R. 37] offers a practical step forward to ensure that our regulatory structure does not disproportionately burden smaller companies and dis-incentivize start-ups from accessing the public markets… [S]mall companies will now be able focus on innovating, expanding, and creating jobs.” [15]
The Congressman expressed a need for a “laser-focus” [16] on enacting policies that spur job creation to catalyze the economic recovery. The idea of a “laser-focus” seems to anticipate detractors who say the monetary cost of XBRL, which hovers around $10,000 annually for most public companies, [17] is not burdensome enough to merit exempting anyone from the requirement. Under the logic of the bill, that argument holds little weight. Every saving for a smaller company could theoretically enable it to expand and create jobs. The logic of H.R.37 allows lawmakers to view all regulations on small businesses as suspect.
Conclusion
The success of H.R. 37 so far illustrates the current prominence of smaller issuers, as they have been characterized as agents of the post-2008 economic recovery. This role has allowed them to distinguish themselves as a constituency apart from the investing public or the large company. When the SEC designed the XBRL requirement, it focused on the investor’s perspective and did not distinguish smaller public issuers. This was in accordance with the SEC’s existing obligations. It remains to be seen whether the political tide will result in smaller issuers’ concerns becoming part of the SEC’s rulemaking process, even as their concerns are highlighted in legislation.
[1] Tammy Whitehouse; “House Passes XBRL Exemption as Survey Reveals Costs;” Compliance Week, January 15, 2015. http://www.complianceweek.com/blogs/accounting-auditing-update/houses-passes-xbrl-exemption-as-survey-reveals-costs#.VMfsCP7F8ko
[2] Securities and Exchange Commission, “Interactive Data to Improve Financial Reporting,” p. 7. SEC Release #33-9002 (January 30, 2009)(Final Rule).
[3] Id., at p. 7
[4] Id., at p.7
[5] Id., at p.6
[6] Securities and Exchange Commission, “Interactive Data to Improve Financial Reporting.” SEC Release #33-9002 (January 30, 2009)(Final Rule).
[7] William M. Sinnett; “SEC Reporting and the Impact of XBRL: 2013 Survey.” Financial Executives Research Foundation. Page 1, 11-12. https://www.secprofessionals.org/sites/default/files/2013%20FERF%20Final%20Report.pdf
[8] Id.
[9] Id.
[10] Id., at p.1
[11] 17 CFR 230.144
[12] 17 CFR 230.144(c)
[13] Phone call with Special Counsel, U.S. Securities and Exchange Commission, Michael Reedich on January 30, 2015.
[14] 17 CFR 230.144(b)(1)
[15] “LEGISLATIVE UPDATE: Hurt’s Bill to Encourage Small Public Company Growth Passes in the House,” January 14, 2015. http://hurt.house.gov/index.cfm/press-releases?ID=B3DB3AA9-FDAD-41A1-908B-A3FA295BC372
[16] Id.
[17] “Research Shows XBRL Filing Costs Lower than Expected.” http://www.aicpa.org/interestareas/frc/accountingfinancialreporting/xbrl/pages/xbrlcostsstudy.aspx
The information in this article is for general, educational purposes only and should not be taken as specific legal advice.
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