July 24, 1974
Page 24880
CORPORATE CONCENTRATION
Mr. MUSKIE. Mr. President, over the last 3 months, the Subcommittee on Budgeting, Management, and Expenditures, under the able leadership of Senator METCALF, has been conducting hearings into the concentration of ownership of major U.S. corporations in the hands of a very few large institutional investors. The hearings have been held jointly with the Subcommittee on Intergovernmental Relations, which I chair.
These hearings were sparked by a report of the Subcommittee issued last December, entitled "Disclosure of Corporate Ownership. Among the major findings of this study was that current procedures for disclosing corporate ownership data, and particularly data relating to voting power, are highly inadequate, and frequently misleading.
The report gives us a singularly thorough look at the ways in which information about corporate ownership is hidden from public view – not illegally or deliberately – but in accord with generally accepted methods of accounting and reporting. The result of such practices – such as the use of street name accounts in place of actual names to identify ownership – is information which too often gives no hint of the patterns of ownership of a particular corporation, or of the degree to which ownership of that corporation is concentrated in a very few hands.
Because of the importance of this report, I am pleased to draw the attention of my colleagues to some well deserved praise for it, from A. A. Sommer, Commissioner of the Securities and Exchange Commission.
In remarks prepared for delivery before a postgraduate course on Federal securities law in California earlier this month, Commissioner Sommer has presented a most thoughtful and persuasive case for the need for more complete disclosure of a number of aspects of corporate activities. With justified compliments for Senator METCALF, Mr. Sommer made the following point:
Senator Metcalf's concern about the concentration of the ownership of major corporations in large financial institutions is strongly reminiscent of concerns that have been expressed in this country for well over a century about concentration of wealth. It may well be that the dangers of this concentration are more pronounced now than ever before, particularly in view of the emergence of huge funds of capital and pension funds, charitable foundations, investment companies and other mechanisms for grouped investments. It seems to me that some of the criticisms which Senator Metcalf and his staff have spoken about concerning present disclosure practices are well justified.
One of the major recommendations of the subcommittees' study was fuller disclosure concerning the business affiliations of officers and directors of publicly held companies. Commissioner Sommer proposes a substantial expansion of this recommendation – that "all occupations and directorships of directors, officers and substantial shareholders of an issuer be publicly disclosed in the annual report."
For those concerned with issues of corporate disclosure and accountability, Commissioner Sommer's remarks are important reading. I ask unanimous consent that they be printed in the RECORD.
There being no objection, the material was ordered to be printed in the RECORD, as follows:
REPORT ON ANNUAL REPORTS
(By A. A. Sommer, Jr., Commissioner, Securities and Exchange Commission)
By now you have undoutedly been amply reminded that you are attending this course in the midst of the weeks during which the Securities and Exchange Commission began its existence 40 years ago. Any fair rendering of the last 40 years' history of securities regulation would, I think, as did such a rendering by Felix Belair, Jr. in The New York Times a week ago Sunday, give the
Securities and Exchange Commission fairly high marks in protecting investors, assuring the integrity of securities markets, and in general advancing the reliability of information available to investors. Like any human organization, the Commission has had times of greatness, times of trouble, times of torpor, and, in the minds of some at least, times of hyper-activism.
However, while engaging in a bit of self-adulation during this memorable period, I find it helpful to reflect upon not only what has been done, but what has been left undone, despite earnest desires and enormous efforts. I have been recently reading the doctoral thesis of Professor Robert Chatov who presently teaches at The New York State University at Buffalo. This thesis, impressive both in length and quality, discusses in considerable detail the accounting profession since its advent on the American economic scene, but more particularly the relationships which have existed since 1933 between that profession and the Securities and Exchange Commission.
So much that was said during the early period of the Commission's existence – the mid-30's and shortly thereafter – is remarkably contemporary in the tone and content. There was then, as there is now, a harsh suspicion in many quarters that the Commission wishes to pre-empt the establishment of accounting principles and auditing standards; there was concern that the professionalism of the accounting profession would be diluted unless there was preserved to it the opportunity for "flexibility" and judgment, with the establishment of unitary accounting principles as a foe to the preservation of these characteristics. So many of the issues seem so similar, the rhetoric so familiar. Ha, how slowly do times change.
On a broader scale, the arguments concerning the value of proposed extensions of disclosure continue unabated, the usefulness of disclosure practices continues to be questioned. Contrast, if you will, the statement of Judge Weinstein in Feit v. Leasco with that of then Chairman of the SEC, James M. Landis, uttered in 1935. Here is Judge Weinstein:
"In at least some instances, what has developed in lieu of the open disclosure envisioned by Congress is a literary art form calculated to communicate as little of the essential information as possible while exuding an air of total candor. In the face of such obfuscatory tactics the common or even the moderately well informed investor is almost as much at the mercy of the issuer as was his pre-SEC parent. He cannot by reading the prospectus discern the merit of the offering."
And here is James M. Landis 36 years before:
"Perhaps the most common complaint against the operation of the Securities Act centers about the length and complexity of the prospectus that under the law must precede or accompany the sale of a registered security ... A different problem presents itself, however, with reference to the mass of investors, some of whom still believe that surplus is cash in the bank and that balance sheet valuations are readily convertible into money. A great question remains of how to simplify for them a thing that is naturally intricate and how to do it without running the danger of misleading them by the very fact of enforced simplicity."
Thirty-nine years later we are still concerned with the problem of conveying the information available to issuers in a meaningful, comprehensive, adequate fashion to the smaller investor.
During the 40 years of the Commission's existence ideas to accomplish this have ranged from provisions for simplistic graphs and charts through to total abandonment of the individual investors in favor of the professionals. It has been suggested that, in effect, prospectuses and other documents should be in words little advanced beyond baby talk; on the other hand, Homer Kripke in referring to the "myth of the informed layman" has suggsted that disclosure documents should reflect a realization that only a professional can understand them and they should be frankly designed for his use. It has been suggested that documents be in two or more parts, with one part a simplified version directed to the average investor, and other parts of substantially greater complexity for use by the professionals and sophisticated investors (how ideas do endure: in 1935, precisely what Chairman Landis suggested with respect to prospectuses and in 1969 it was precisely what the Disclosure Study recommended with respect to certain proxy statements and in somewhat attenuated form with respect to prospectuses) Recently the Commission developed the concept of "differential disclosure," a technique which would result in greater details in the financial statements in the Form 10-K filed with the Commission, with only summarization of such additional data included in the financial statements in the annual report to shareholders.
Amid these recurring re-examinations, it is sometimes possible to discern real progress. I would suggest that one area in which this has been accomplished is the approach of the Commission to the annual report to shareholders.
Historically, the Commission, while developing an increasingly sophisticated system of disclosure in connection with distributions and in connection with filings with it, has treated the annual report to shareholders with extreme tentativeness and even deference. It has been unsure of its power to directly affect the contents of the annual report; this misgiving is amply reflected in statements of Professor Louis Loss, the Reporter of the American Law Institute's Federal Securities Code project, where he has said that one of the primary purposes of the codification effort is to give the Commission direct power over the content of annual reports to shareholders.
The Commission has been hesitant to churn up the one fertile patch in which a company, and particularly its chief executive officer, can speak uninhibitedly to its shareholders of past triumphs and disappointments, the promise of future glories and the wonders of the present without having his every word parsed by a gaggle of lawyers and sliced thin by Washington bureaucrats.
The Commission has, in my estimation, been too sensitive to charges that regulation of the contents of the annual report to shareholders would be an unwarranted intrusion upon freedom of speech for management; to some extent the Commission's hesitancy is probably a reflection of the notion, somewhat naive I think, that the mandated disclosures in filings with the Commission would offset exaggerations or inadequacies in annual reports in the market place.
At one time, namely 1942, the Commission did propose to extend its controls over the annual reports rather directly. Under a proposal then considered by the Commission, the annual report would have had to be filed with the Commission in advance of its use; either it or the proxy statement would have had to include extensive modifications in the Commission's power over proxy statements as a result of intense pressures brought on Congress and the Commission. An examination of the legislative history pertaining to this matter indicates that there was indeed no misgiving expressed on the part of the Congress or the Commission with regard to the assertion of direct power over annual reports; as a matter of fact, it is apparent from examining the dialog between Chairman Purcell and members of the House Committee on Interstate and Foreign Commerce that the Committee members found it very difficult to differentiate between the Form 10-K filed with the Commission and the annual report furnished to shareholders.
To the extent that the Commission has in the past exerted power over the annual report, it has done so in two ways: one, by referring such power from its power to regulate proxy solicitations (Section 14 (a) of the 1934 Act), and second, through that ubiquitous creature Rule 10b-5.
All of the present requirements promulgated by the Commission with respect to the annual report are contained in one rule under Section 14 (a) : Rule 14a-3 (and its correlative, Rule 14c-3). Under this rule, as it is presently constituted, anyone who solicits proxies pursuant to Section 14 of the 1934 Act is required to furnish either before or concurrently with a conforming proxy statement an annual report containing specified information (these provisions also relate to statements required under Section 14(c) when proxies are not solicited). This information must include comparative columnar form financial statements for the last two fiscal years prepared on a consistent basis, including balance sheets and income statements. These financial statements must conform to those that are in the Form 10-K filed by the issuer unless there is set forth in the annual report "any differences ... from the principles of consolidation or other accounting principles or practices, or methods of applying the accounting principles or practices ... which have a material effect on the financial position or results of operation of the issuer." There is permitted the omission from the statements in the annual report of some details and the condensation of some information within parameters that are further specified in other rules.
These financial statements, at least for the last fiscal year, must be certified by independent public or certified public accountants, with certain rare exceptions; it is now proposed that the financial statements for both years must be certified.
For a company which is subject to the proxy rules for the first time, the annual report must contain such information about the business done by the issuer and its subsidiaries during the fiscal year as will, in the opinion of the management, indicate the general nature and scope of the business of the issuer and its subsidiaries.
Seven copies of the annual report must be mailed to the Commission "solely for its information," and such reports are not regarded as "filed" for liability purposes under the 1934 Act – but note, this does not remove them from the scope of Rule 10b-5.
The rule very specifically provides that "Subject to the foregoing requirements with respect to financial statements, the annual report to security holders may be in any form deemed suitable by management."
Obviously these requirements are restrained, limited, conservative.
The other means by which the annual report has become subject to federal requirements is through Rule 10b-5. There has been litigation, and causes of action have been found to exist, as a consequence of alleged omissions from or misstatements in annual reports, and I would say without much hesitation at this time that virtually all counsel are fully convinced that, given the broad interpretations by courts of the scope of Rule 10b-5, any material misstatement in an annual report or any omission from it of a material fact necessary to make the statements included in it not misleading may give rise to a rule 10b-5 cause of action. As you well know, courts have held that a defendant in a Rule 10b-5 action need not be a purchaser or seller of securities to be held liable; the requirement that a violation be "in connection with the purchase or sale of a security" is satisfied by the simple existence of a trading market with public dissemination of information that may be relied upon by those purchasing or selling securities in the market or which may impact the price of securities in that market.
I think the diffidence and hesitancy of the Commission with regard to the annual report are now disappearing and there is considerably more willingness on the part of the staff and the Commission to entertain a broader interpretation of the Commission's powers in this area. In the latter part of 1972, Chairman William J. Casey appointed an Advisory Committee on Industrial Issuers to review the disclosure practices and policies of the Commission and make recommendations with regard to their change and augmentation. I was a member of the committee. Among the members of the committee, consisting not only of lawyers, but representatives of the industrial community, the securities business and other government agencies, there was precious little concern with whether the Commission had the power to intrude itself into the contents of the annual report. It was, I think, unanimously recognized that the annual report was perhaps the single most effective medium through which corporate information was disseminated to the investment community and that as such it should be more fully utilized and should be made more reliable. Thus, the committee recommended a number of changes in the annual report, mostly increasing the information contained in it, many of which recommendations have now been incorporated by the Commission in proposed amendments to Rules 14a-3 and 14c-3.
One of the most significant changes suggested by that committee, which has been incorporated in the proposed revision of Rules 14a-3 and 14c-3, would be a requirement that "... no chart, schedule, 'financial highlights' section, graph, figure or similar material of a financial nature contained anywhere in the report shall present the results of operations or other material financial information for two or more periods, in a light either less or more favorable than the financial statements included in the report."
This is an effort to eliminate the practice, not uncommon during the financial orgy of the late 60's, when a company's financial statements would be prepared with a relative degree of conservatism and in accordance with generally accepted accounting principles, but other information in the annual report would present the same basic data in a far more favorable light and in many instances blatantly inconsistently with the information in the certified financial statements – and always, I should add, more dramatically and compellingly than the manner of presentation of the financial statements.
The proposed amendments of Rules 14a-3 and 14c-3 would significantly expand the quantum of information contained in the annual report; much of this information now in the Form 10-K would be simply repeated in the annual report. These are the additional items that would be required in the annual report:
1. A summary of operations covering a five-year period substantially in the form required by Item 2 of Form 10-K.
2. Textual information which will, in the opinion of management, indicate the nature and scope of the liquidity and working capital requirements of the issuer. Matters that should be considered include peak seasonal demand for working capital, availability and cost of credit, policies associated with the extension of credit to customers, purchase commitments related to inventories, policies followed as to the magnitude of inventory to be maintained, and future financing requirements and plans. This requirement and others like it are important. They require that management furnish not only raw information and bare facts to shareholders and the investment community, but that in addition management interpret this information in a meaningful way to assist the ordinary investor in understanding it. Too frequently I think management has had the attitude that their sole responsibility to shareholders was to give them raw data concerning the company; if the shareholders were sophisticated enough to understand it, well and good; if they were not, then that was their misfortune unless they sought professional assistance. This provision is intended to create at least a possibility that ordinary shareholders will be able to understand the financial situation of the company, will be able to understand when a company is heading into a liquidity crisis, will be able to understand when a company may be on the threshold of financial need, the satisfaction of which may pose significant peril.
3. Information about the business done by the issuer and its subsidiaries during the fiscal year such as will in the opinion of the management indicate the general nature and scope of the business of the issuer and the subsidiaries. This obviously is found in most annual reports; however, the formalization of it may have the effect of causing management to pay closer attention to the manner in which it renders this vital information. In addition, it would be required that the "line of business" reporting data contained in the Form 10-K be also reported in the annual report to shareholders. This requirement, it should be noted, reflects not only the recommendation of the Advisory Committee referred to earlier, but that of the Financial Executives Institute in 1971 and of the American Institute of Certified Public Accountants at about that time.
4. The name, principal occupation or employment and the name and principal business of any organization in which each director and each executive officer of the corporation is employed. As I will note in a moment, this information, already required in the Form 10-K and proxy statements, is not enough in the eyes of many people and should be expanded further.
5. Information about the principal market in which the securities of any class entitled to vote at the meeting are traded, and the high and low sales prices (or in applicable classes, the range of bid and asked quotations) for each quarterly period within the most recent two years, information about dividends paid on such securities during such two years, and a statement of the issuer's. dividend policy with respect to such securities. I think this is extremely important additional information. Granted any shareholder with enough interest would be able to go back and reconstruct these figures, but why should that burden be placed upon him?
Historically, both in terms of time and emphases, the annual report has been more peculiarly the domain of the stock exchanges, and particularly the New York Stock Exchange, than it has been of the Securities and Exchange Commission. For many years, the New York Stock Exchange has had as a part of its listing agreement a requirement that a company with securities listed on the Exchange furnish to its shareholders an annual statement containing certain specified information. Recently, the Exchange published its "White Paper" entitled "Recommendations and Comments on Financial Reporting to Shareholders and Related Matters." In this, the Exchange, without making it a matter of rule, set forth in fairly strong language the types of information which should properly be included in the annual reports of listed companies. In many instances these proposals also would simply repeat in the annual report information already required in the Form 10-F; in other instances the proposals go beyond that.
Here is some of the data which the Exchange suggests should be in an annual report :
1. information concerning liquidity;
2. information concerning lines of business;
3. explanation of the differences between book and taxable income;
4. details of the computation of earnings per share:
5: five-year summary of earnings;
6. information with respect to conflicts of interest between the corporation and officers and directors; and
7. a discussion of the reasons for material changes in the factors affecting the results of operations of the current year as compared with the preceding year.
The Exchange suggests that it might be useful for companies to set aside a section of the annual report for supplemental financial data. This is a resurrection of an idea which has been suggested frequently in the past – that perhaps both worlds – the one, consisting of the freely written, uncensored, colorful, lively aspects of the annual report, the other, the structured exactness of filed documents with the Commission – can be served by having an annual report consisting of two parts, each reflecting one world. The commission has not mandated such a segmentation in annual reports and it has certainly not prohibited it. It has, as a matter of fact, on occasions recognized that companies might wish to follow this course. It may well be that mandated detailed information can be segregated from the more "glamorous" parts of the annual report.
However, in the course of doing this issuers should be careful that they do not mislead investors with regard to the importance of information required by the Commission or relegate it by type-size or placement to such an extent that no investor might reasonably be expected to familiarize himself with it.
One of the reasons why the annual report is so attractive a vehicle in the disclosure scheme lies in the belief that people do read it. In the course of using it as a vehicle for the effective communication of important information, it must not become so overburdened, so lengthy, so suffused with detail that it loses the one characteristic which it has above all other corporate documents, namely, readability and readership.
With that caution in mind, I approach suggestions of additional information to be included in the annual report with some diffidence. However, I think there is good evidence that there have emerged additional areas of investor concern about which larger amounts of information should be widely circulated.
One of these is the problem of the independence of the public accountant. I am thoroughly convinced that if hope there be for the restoration of belief in corporate integrity, it lies in the integrity, the independence and the professional capacity of the accounting profession.
Consequently, I feel that we should avail ourselves of every means at our disposal to shore up that independence and give the accountants every opportunity to perform their professional work in a manner that is in the public interest. At the present time, Item 12 of Form 8-K requires the disclosure of information concerning changes in a registrant's certifying accountant. The item requires that, in the case of such a change, the registrant must furnish to the Commission a letter stating whether within the 18 months preceding the engagement there were any disagreements between the registrant and the former principal accountant on any matter of accounting principles or practices, financial statement disclosure or auditing procedure, "... which disagreements if not resolved to the satisfaction of the former accountant would have caused him to make reference in connection with his opinion to the subject matter of the disagreement." In addition, the registrant must ask the former accountant to furnish a letter to the Commission stating whether he agrees with the statement contained n the letter of the registrant and, if not, the basis for the disagreement. We are in the process of re-examining these provisions. Many have suggested that perhaps they are too loose, that they lend themselves to evasion, that there is a normal human reluctance to hang out dirty linen which prevents the requirement of such disclosure having the effect intended.
Professor Douglas Hawes of the Vanderbilt Law School has recently suggested that information concerning change of accountants should be incorporated in the proxy statement furnished to shareholders. I heartily endorse this proposal (and would suggest, because of its readership, that perhaps the information might be included in the annual report). It seems to me that there is little information which can be made available to shareholders which is more important than information concerning disputes that have developed between the independent auditor and the management. It seems to me that the threat of more widespread dissemination of this information will lead to greater management willingness to prepare financial statements in the manner which will meet auditor approval. If there has been a change of auditors in circumstances in which there was a dispute between management and the auditors, then surely the shareholders should know this when they are called upon to vote for management and for the selection of auditors, a practice which is commonplace now. Beyond that, it seems to me that not only should disagreements eventuating in a change of auditors be disclosed, but when such a change occurs the company should have to disclose whether during, say, the three preceding years the disappearing auditor had qualified its opinion and what the nature of the qualification was.
Auditors, as a consequence in some measure of the deluge of litigation to which they are being subjected, are quicker now than before to qualify an opinion and in a significant number of cases a qualification is followed in fairly short order by dismissal. Shareholders should be alerted to this sequence of events through the means best afforded to bringing it to their attention, the annual report.
Senator Metcalf of Montana is the Chairman of the Senate Subcommittee on Budgeting, Management and Expenditures which, together with Senator Muskie's Subcommittee on Intergovernmental Relations, has been conducting extensive hearings following publication of an outstanding report dealing with the problems of disclosure of corporate ownership. Senator Metcalf's concern about the concentration of the ownership of major corporations in large financial institutions is strongly reminiscent of concerns that have been expressed in this country for well over a century about concentration of wealth. It may well be that the dangers of this concentration are more pronounced now than ever before, particularly in view of the emergence of huge funds of capital in pension funds, charitable foundations, investment companies and other mechanisms for grouped investments. It seems to me that some of the criticisms which Senator Metcalf and his staff have spoken about concerning present disclosure practices are well justified. In the case of the Commission, our statutory mandates relate principally to disclosures pertaining to "beneficial" and "record" ownership – see, for instance, Schedule A to the Securities Act of 1933 and Section 12(b) of the Securities Exchange Act of 1934; totally absent from these disclosure standards in the statutes are requirements with regard to disclosure with regard to "beneficial" (as we presently understand it) and "record" ownership without having any notion whatsoever as to the location of voting power in a corporation.
It is the voting power upon which the Subcommittees have concentrated and with good reason. Because of the statutes under which it works, the Commission is severely handicapped in gaining information concerning voting power, even though many recognize the desirability of more disclosure concerning such matters. At the present time the staff is exploring the extent to which it can mandate disclosure of this information and the extent to which we should require public disclosure of it. It seems to me that to the fullest extent feasible, without creating a body of misleading information, the Commission should require the disclosure in annual reports or in proxy statements of all material information concerning holdings of large amounts of voting power. It may be that legislation will be required to clarify and fill out the power of the Commission to compel this disclosure. Meanwhile, it is heartening that some institutional holders, notably the First National City Bank of New York, are publishing their holdings and the extent to which they have voting rights with respect to them.
It has been suggested that the threshold of disclosure be reduced from the common and conventional ten percent or five percent to a level of one percent. I have some concern as to whether the disclosure of all those who have possession of one percent or more of the voting power of a corporation would really add significantly to the useful fund of knowledge without unduly burdening the annual report or the proxy statement. However, again I think that this is a matter which should be explored. I react similarly to the proposal by the Subcommittees that the 30 largest holders of voting power in all publicly-held corporations be disclosed. In many instances I can conceive that this information would be extremely useful and extremely helpful; however, in others I think it would contribute very little to investors' protection. Again, though, this is a subject that deserves careful study.
The Subcommittees have also proposed fuller disclosure about the business affiliations of officers and directors of publicly held companies. As indicated, Form 10-K requires that the principal occupation of officers and directors be disclosed and there have been proposals that this information be included in the annual report. However, it seems to me that the requirements with respect to this information might be further extended to require that each officer, director and substantial shareholder disclose the identity of all corporations and other business enterprises in which he has an interest as officer, director or substantial shareholder. Many of the matters which might be disclosed under such a standard are already required to be disclosed under present conflict of interest disclosure provisions; however, in many instances these requirements may not flush out the full extent to which a director may have interests that would be relevant to shareholders of a corporation in assessing his competence, his dedication to the company, and his ability to serve effectively as a director. I would strongly endorse the idea that all occupations and directorships of directors, officers and substantial shareholders of an issuer be publicly disclosed in the annual report.
There is the temptation to use the annual report as a means of social control; for instance, the suggestion has been made that the annual report should contain more extensive detailed information with regard to the environmental and employment practices and violations of a corporation. It frequently seems that many look to disclosure less as a means of assisting an investor in making an intelligent investment decision than as a means of promoting social policies established by other branches of the government. I do not mean to demean the worthwhileness of such other efforts. However, I think it is important that if the annual report is to be the primary means through which the average investor secures useful investment information about an issuer, it should remain as unencumbered, as direct, as simple as we can possibly make it so that it may effectively serve that purpose. If it becomes another prospectus, if it becomes prolix and extended, if it becomes weighted with legalisms, then we will have lost the last opportunity to make information conveyance to average investors a meaningful and useful process.
In this connection, it seems to me that one of the most constructive proposals that has been made during the recent round of suggestions for change is the one contained in the proposed amendments of Rules 14a-3 and 14c-3, as well as in the New York Stock Exchange White Paper, to the effect that provisions be made for any shareholder to secure without cost a copy of the corporation's Form 10-K. The need for this is demonstrated by the fact that there have been too many instances in which the annual report contents vary significantly – and invariably in the direction of less meaningful disclosure – from those in the Form 10-K. Surveys have repeatedly found, for instance, that disclosures with respect to lines of business are often stated less accurately and candidly in the annual report. In a recent issue of Forbes a writer compared the disclosures in the Franklin National annual report with those in its 10-K and discovered rather shocking omissions from the annual report.
Of all the proposals contained in the proposed amendments to Rules 14a-3 and 14c3, I am told by the Division of Corporation Finance that this is the one that has drawn the most objections.
Principally, these objections are on the ground that this would burden a corporation with an unwarranted and unnecessary cost. The experience of companies which have made the 10-K available without cost to shareholders has invariably been that the number of shareholders requesting the documents has been very few. Thus, if, say, one percent of the shareholders requested the document, then a corporation with 30,000 shareholders would have to furnish 300 copies. Inasmuch as typically in publicly-held companies Forms 10-K are produced in substantial quantity for circulation internally and to lenders and investment bankers and others anyway, it would seem to me that the additional cost of reproducing a relatively small number of copies would be insignificant and that the only significant additional charges would be mailing and personnel to respond to the requests. It may well be that the Commission should permit the omission of certain financial schedules unless they are paid for by the requesting party. If that is done, it seems to me unlikely that the cost of mailing 10-K's to requesting shareholders would be more than $1 to $2 a copy. If the experience of other companies is truly indicative, and if that cost estimate is a realistic one, then it seems to me that that is a very small price to pay to more fully inform shareholders and other members of the investing community.
Should we take another step to give the annual report integrity by requiring that it be filed prior to use? I do not think so. I can readily appreciate and sympathize with the concern that has been expressed by issuers that such a requirement would lead to all the frustration, delays, prolixity, verbal obtuseness that attend 1933 Act prospectuses. The very reason why the annual report is a better medium for informing shareholders than the proxy statement derives, frankly, from those characteristics which it has acquired as a consequence of the public relations arts. People are far more likely to spend time with a document that has a fetching cover, is printed on glossy paper, is replete with multi-color illustrations, is punctuated with easily understood charts and graphs, and is written in good English style with colorful adjectives and compelling verbs. If these qualities are lost, then the annual report will lose much of that which gives it its potential as a vehicle for fuller and better communication. I must candidly confess the Commission's staff has not historically appeared to have much tolerance of the P.R. arts and I would fear for the annual report's vitality if it came under our scalpel.
In addition to changes that relate specifically to the contents of annual reports there are other changes pending or made which will impact those contents, particularly in the accounting area.
The Commission is steadily expanding the information which must be in financial statements filed as part of Form 10-K. These changes have required or will require more information concerning compensating balance arrangements, costs of borrowing, deferred taxes, accounting policies and the like. While this additional information must be set forth in extenso in the financial statements of the Form 10-K, the Commission does expect that it will be summarized adequately in the financials in the annual report.
This incidentally is the "differential disclosure" concept about which there has been some controversy. This is an effort by the Commission to avoid deluging the ordinary investor with a mass of unmanageable information and detail while making it available to the professional and the sophisticated investor who can use it intelligently. The thought is that the detail is available to everyone but that actually putting it in documents such as annual reports which are intended for widespread distribution may really result in poorer rather than better disclosure. Nonetheless, the combination of adequate summarization in connection with the financial statements contained in the annual report and the availability of the Form 10-K upon request of a shareholder should assure that no one is being discriminated against as a consequence of "differential disclosure."
In one area it is impossible to effectively legislate – and that is in candor. When the Commission and the New York Stock Exchange are finished writing their new prescriptions for the contents of annual reports, they still can be misleading – in some cases culpably so, in others not so culpably – if management does not choose to level with its shareholders and with the investment community. If the hard facts mandated for inclusion in the annual report are inundated in fluffy meringue, then the annual report will serve its purpose little better than it has done historically.
There must, above everything else, be a realization on the part of management that candor, forthrightness, honesty and directness with the investment community are essential to public acceptance of a corporation's securities. When suspicion exists that a corporaiton has not been forthright, has not been honest, has not been candid, then the price paid in the market place, not only by it, but by its shareholders as well, can be simply devastating.
The annual report and the requirements for informational content cannot be static; rather it must constantly reflect what is important to investors. In other days, environmental problems were of little consequence to investors; now to many they are a meaningful measure of a corporation and its management. Thus the contents of the report must constantly adapt to the necessities of the time. Unfortunately, we know precious little of the information which actually goes into an investor's decision, hence many of our conclusions about what should be in an annual report must reflect conjecture and surmise. This limitation of knowledge however, should not prevent intelligent judgments about what investors need to know, and when we make that judgment, we must then determine how they can best be given the information they need.
With its hesitancies now gone, with its legal authority better recognized, the Commission is now moving toward making the annual report a more effective means of informing the markets about issuers. This need not be done at the cost of that which is good in the annual report; it need not be done at the expense of the opportunity of corporate officials to comment on the past and the future; it need not be done at the expense of all the public relations techniques which enliven most annual reports. But the annual report must become a more reliable, a fuller, a more candid statement of information important to the average investor – and along with it it will also become more useful to the professional and the sophisticated investor.
I think fairness demands that we recognize the extent to which annual reports are doing a better job than before. In examining them through the years it is apparent that many issuers are striving more conscientiously to make them fair, accurate, meaningful, useful and even candid, and certainly if one contrasts them with the practices of a generation ago the change is immense. But I think there is room for improvement. The continuation of greater Commission attention, greater recognition by management of the financial as well as legal penalties for fudging and the demands of investors are going to result in that improvement.