Reregulation Gone Wild?

CFOs and treasurers are unhappy with an SEC proposed rule change that would require “quantitative and qualitative” disclosures about short-term borrowings in the Management’s Discussion and Analysis (MD&A) section of periodic financial statements. And that’s just for starters.

Everyone knows that the SEC is trying to close the door on the types of big bank shenanigans that sparked the financial crisis of 2008-09. Who can forget Lehman’s Repo 105 parlor games? But the effort is spilling over onto nonfinancial corporations in, perhaps, unintended ways. According to Michael Gallanis, who runs the corporate consulting practice at Treasury Strategies, Inc., “This is part of the financial fallout of the past 24 months. The SEC wants added transparency over how corporations manage their liquidity and their short-term borrowing practices.” On its face, that’s a noble intent: Give investors the information they need to evaluate how well a company is being managed. “But some treasurers think this SEC proposal is overkill. They worry that the SEC will impose a ‘one-size-fits-all’ disclosure requirement. And that could have the opposite effect of what is intended and needed.”

The proposal touches a number of areas. Let’s look at few of the most troublesome ones (condensed below in the form of questions that the SEC developed for feedback). The response shown under each question comes from the comment letter sent to the SEC by the Financial Reporting Committee of the Institute of Management Accountants (IMA):

Question from the SEC:

Should registrants that are not financial companies be required to provide the maximum daily amount of short-term borrowings, rather than permitting them to provide the maximum month-end amount? Do registrants that are not financial companies have systems to track and calculate this information on a daily basis? What are the burdens and costs of requiring companies engaged in nonfinancial businesses to meet that requirement? Should registrants that are not financial companies be required to disclose each month-end amount rather than the maximum? Should registrants also be required to provide the minimum month-end (or, daily, for financial companies) amount outstanding? What are the burdens and costs of requiring companies to meet those requirements?

IMA Response: We do not believe a discussion of the maximum amount during the period is necessary unless it materially differs from average and/or period-end balances. We also do not believe that disclosing minimum month-end or daily balances will add value to an investor’s analysis.

Question from the SEC:

Should we require year-to-date information in addition to quarterly information for interim periods? Would year-to-date information be useful to investors? Describe in detail the costs and benefits of providing year-to-date information in this context.

IMA Response: No, we believe year-to-date information is not relevant. Liquidity is not managed with year-to-date information.

There are many more issues you can find swirling through the official comments letters on the SEC Web site. But two that are really bothering CFOs are summed up below.

First, the SEC might force companies to follow a prescribed narrative when explaining their short-term borrowings and working capital management. “That would be unfortunate,” says Gallanis. “Some companies are heavily dependent on short-term funding. But most are not in the situation of being exposed to failure [risk] due to an inability to access short-term working capital.” More often than not, he adds, short-term debt is not material, in the legal sense of the word. “Companies are saying to the SEC: ‘Don’t make this so rigid. Some of us assess our borrowing strategies monthly. Others do so quarterly. It depends what kind of business you’re in.’”

Finally, we come to the SEC’s notion of a uniform leverage ratio. According to Gallanis, “The concept would force everyone [nonfinancial corporations] to calculate that ratio in exactly the same way. That’s problematic.” At present, we all know it would be silly to try to compare companies’ working capital management metrics without adjusting for industry-specific dynamics. Why this move? Gallanis is as stymied as I am. “Institutional investors already capture industry-specific leverage ratios that make sense.” Forcing a uniform ratio would lead companies to provide bare-bones disclosures — just enough to squeak by. And that would be less useful than what they now share with shareholders.

The IMA, for its part, has this to say: “We do not believe the Commission should extend the requirement to disclose leverage ratios to companies that are not bank holding companies. We do not believe those disclosures will be meaningful to investors. As indicated in the Proposed Rule, analysts and other users have developed their own models and ratios to use in assessing a company’s financial health. Because there is not a consensus between analysts and users on how all companies should calculate a leverage ratio, we do not believe the Commission mandating a particular approach will change the process that analysts and users engage in to assess a company’s financial health.