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Mar 27, 2019

CII backs quarterly reporting, but not guidance

Historical performance information, not speculation, is useful to investors, group says

The Council of Institutional Investors (CII) has given its support to the existing quarterly reporting model – but has voiced concern that quarterly guidance can lead to short-termism and ‘making the numbers.’

US domestic issuers must file quarterly reports on Form 10Q. That is a system that benefits investors, companies and other market participants, according to CII. ‘[T]he requirement to report historical earnings on a quarterly basis is a key element of the timely and accurate information flow that underpins the quality and efficiency of our capital markets,’ CII general counsel Jeffrey Mahoney writes in a recent letter to the SEC.

‘The requirement helps ensure important information is promptly and transparently provided to the marketplace, allowing investors to assess concrete progress against strategic goals.’

CII filed its letter in response to an SEC request for feedback on the ‘nature, content and timing’ of earnings releases and quarterly reports made by reporting companies. The SEC in December sought industry input on how it can ‘reduce burdens on reporting companies associated with quarterly reporting while maintaining – and in some cases enhancing – disclosure effectiveness and investor protections,’ officials wrote in a statement.

The commission also asked for comment on how the existing periodic reporting system, earnings releases and earnings guidance, alone or in combination with other factors, may foster an ‘overly short-term focus’ by managers and other market participants. US President Donald Trump in August asked the regulator to study the possibility of allowing US companies to report on a semi-annual basis.

CII does not believe that requiring quarterly reporting leads company management to focus on short-term results to the detriment of long-term performance. But it has concerns about releasing quarterly guidance.

‘The notion that quarterly reporting encourages short-term thinking is, in our view, outdated and generally not supported by empirical evidence,’ Mahoney writes. ‘If the commission wants to encourage long-term-decision making by public company management the focus should be on discouraging quarterly forecasted earnings guidance rather than quarterly financial reporting.’

Less frequent reporting of actual performance would likely lead to greater share price volatility – and more intense investor focus on short-term share price fluctuations – as investors would have greater windows to guess how the company is doing, according to CII.

On the other hand, forward-looking guidance, which by definition is predictive and speculative, is very different from reporting on what has already taken place, Mahoney writes, adding: ‘From discussions we have had with various market participants, we think there is considerable confusion on this distinction.’

CII generally supports companies deciding against providing quarterly earnings guidance, as ‘such guidance can cause undue focus on short-term profits at the expense of long-term strategy and investment. More specifically, we believe quarterly earnings guidance can incentivize companies to unduly focus on making the numbers at the expense of the long-term interests of the company and its long-term shareowners,’ Mahoney writes.

That said, CII believes it would be useful for the SEC to clearly require companies to pass on their earnings guidance to the agency if they do produce it, so that management can be held accountable for its accuracy. ‘[W]e think that in cases where companies and executives provide guidance, not only on earnings but also on other elements of future performance, it is critical that the SEC continue to use its authority to challenge misleading information,’ Mahoney writes. 

CII further argues that the Form 10Q report should not be replaced by an earnings release. Investors’ reliance on the information required by the form is enhanced by requirements that increase the quality and usefulness of the information and encourage discipline and accountability of the company’s reporting practices, it says. Those requirements include: 

  • The independent auditor’s review and report on the company’s quarterly financial information
  • The CEO and CFO certifications accompanying the Form 10Q
  • Filing rather than furnishing the Form 10Q to the SEC, which imposes enhanced civil liability on management for false or misleading statements contained in the quarterly reports
  • Data tagging.

Among other commenters responding to the SEC, attorneys at Sullivan & Cromwell said the commission should avoid imposing additional rigid regulatory restrictions on quarterly earnings disclosure practices. Partners Robert Buckholz and Robert Downes noted that there are many considerations issuers take into account when deciding the timing, content and format of quarterly earnings disclosures.

‘Subject to appropriate guardrails – currently provided by the line-item requirements and filing deadlines of Form 10Q, as supplemented by Rule 12b-20 – we think reporting companies are best positioned to make those choices for themselves, and that it would be a mistake for the commission to seek to promote convergence in practice, under the auspices of uniformity or in an effort to reduce unnecessary duplication,’ they wrote.