The SEC Approves the Use of Differential Reporting

Article excerpt

The SEC Approves The Use Of Differential Reporting

On January 20, 1987, the Securities and Exchange Commission (SEC) ruled that companies whose securities are publicly traded on US security markets may henceforth produce an annual report in whatever form they wish or even dispense with the annual report completely. All companies to which the ruling applies must, however, continue to file all required financial information with the SEC and take the necessary steps to ensure that this information is available to shareholders.

The significance of this ruling is that it drew attention to the fact that there was no requirement that companies whose securities are publicly traded must report to their shareholders through the traditional annual report, and, by doing so, it cleared the way for differential reporting. In this sense, differential reporting refers to reporting in a different manner to satisfy the various informational needs of shareholders as well to provide investors and financial intermediaries with information for investment decision-making purposes. Financial reporting may, therefore, be expected to undergo considerable change over the next decade.

In retrospect, it is obvious that it was only a matter of time before a ruling of this nature was made. This is because since 1980, as a result of the SEC's integrated reporting system that was intended to be cost effective and encourage the provision of more information, the financial information included in Form 10-K and in the annual reports for shareholders became virtually identical. Companies could, therefore, satisfy the financial reporting requirements of Form 10-K (i.e., management's discussion and analysis of financial conditions and results of operations, the audited financial statements, etc.) by attaching their annual reports thereto and referring readers to the required information.

The SEC, in recognizing the importance and broad implications of this ruling, made the exchange of letters between itself and General Motors on the topic a matter of public record.(1) The ruling was given informally in a letter from the SEC's Director of Corporate Finance, Linda C. Quinn, replying to a requiest by General Motors Corporation that it be allowed to include summarized financial statements in place of the usual audited financial statements in what they referred to as their "glossy" annual reports to shareholders. The conditions on which the ruling was made were that General Motors would include the financial information required by the SEC in Form 10-K and as an appendix to the proxy statement for the election of directors mailed annually to shareholders. In addition, the full audited financial statements would be released with the earnings press release, Form 10-K would be filed with the SEC at or prior to the release of the annual report, and both the annual report and appendix to the proxy statement would inform shareholders that the Form 10-K was available to them on request. The summarized financial statements would also be supported by a suitable report of the auditors.

HOW DID THIS COME ABOUT?

Financial reporting in the US is controlled by the SEC. It was formed by the Securities Exchange Act in 1934 as part of the economic "new deal" of the government of Franklin D. Roosevelt to restore the confidence of the American investing public in securities markets at the height of the "great depression" of the 1930's. Its purpose was to control the various stock exchanges and other securities markets in the US and to administer the Securities Act of 1933, which prescribed certain reporting requirements for those companies whose securities were publicly traded. The 1934 Act also conferred upon the SEC the authority to specify the disclosure requirements of companies whose securities were publicly traded. The significance of this move for financial reporting was that an authoritative body having control over the public trading of corporate securities on US securities markets had been established with the primary responsibility of satisfying investor informational needs. …