Ex-SEC leaders challenge Cox’s interactive data initiative

TWO influential US Securities and Exchange Commission (SEC) alumni have raised concerns that broadening the use of eXtensible Business Reporting Language (XBRL) to non-financial information will increase disclosure costs, raise difficult legal liability issues, and create burdens on companies that are “formidable in the extreme.”

Former SEC commissioner and Stanford Law School professor Joseph Grundfest, and the former director of the SEC’s corporation finance division, Alan Beller, now a partner with Cleary Gottlieb Steen & Hamilton LLP in New York, are calling on the legal community and regulators to join them in “open discussion, debate, and commentary” about the future of the US disclosure system.

In a summary paper published on the Web on the same day that SEC chairman Christopher Cox announced that work had begun on a new database that will make extensive use of XBRL and interactive data, Beller and Grundfest say they have a better approach, one that will limit the use of XBRL and introduce a single web-based questionnaire in place of the myriad forms the SEC currently uses.

“Superior to XBRL tagging”

The SEC chairman has also said he favors scrapping the SEC’s form-based system, but he has thrown his weight behind the global XBRL interactive data standard. Cox recently launched a 21st Century Disclosure Initiative to radically rethink how the SEC collects and publishes information. He has credited Grundfest and Beller as being the inspiration for that project.

Now Beller and Grundfest say they will build their own “mock” database to demonstrate the benefits of their questionnaire-driven concept. Rather than use only XBRL tagging, they are proposing to replace almost all  prescribed SEC forms with a web-based questionnaire that companies would update on a schedule set by the SEC.

They argue that while XBRL and interactive data approaches are well suited to financial statements and fixed-format disclosures, their questionnaire-driven approach is “superior to XBRL tagging of information for other forms of disclosure,” such as narrative information in annual reports and proxy statements.

Says the paper, which is dated Aug. 4 but was published on the SSRN website on Aug. 19: “The tagging and taxonomy requirements under XBRL for the more free-form non-financial disclosure may be formidable in the extreme. In addition, simply adding XBRL tagging to the current form-based architecture continues to require the preparation and filing of repetitive information. This feature of the XBRL approach is not problematic for financial disclosure because those disclosures almost always differ for each financial period.

“We are also concerned that extending XBRL to non-financial disclosure would add to the cost of the disclosure system, could raise difficult issues regarding the legal liability that might arise in the event of a contested XBRL tag, and would fail to provide for the flexibility inherent in the questionnaire driven approach.”

XBRL taxonomies for non-financial info already exist

Proponents of XBRL take the position that any kind of corporate information is amenable to being tagged. Taxonomies have already been developed by various groups for Management’s Discussion and Analysis, proxy statements, executive compensation and even social and environmental reporting.

At last week’s press conference to discuss the SEC’s new Interactive Data Electronic Applications (IDEA) database, Cox said: “It’s important to keep in mind that data tagging that makes information interactive isn’t just about numbers. It’s about words, too, or it could be about pictures, graphs, anything that you like can be tagged this way.”

In their paper, Beller and Grundfest say they heartily endorse the commission’s 21st Century initiative but they present a very different framework for achieving its goals than the SEC has proposed.

“A more efficient process would promote a ‘direct to database’ design that would make it easier and cheaper for registrants to provide the necessary information and for users to analyze the information provided by registrants. An online questionnaire is, we suggest, the most efficient means of achieving this objective,” they write.

“Although the proposed on-line questionnaire can take many different forms, we presently conceptualize the questionnaire as being composed of a combination of binary (yes/no) responses, pull-down menus, numeric fields, and textual responses. Information corresponding to current 10-K disclosure requirements would be updated annually; information corresponding to current 10-Q disclosure requirements would be updated quarterly; and information corresponding to that now required by Form 8-K would be updated on the occurrence of specified events.”

Companies would only update those parts of the questionnaire that are relevant, and investors would be able to easily identify changed information. They describe this as an “evergreen incrementally updated disclosure database.”

Adds the paper: “Ideally, the databases generated by this online disclosure regime would include audit trails that allow easy identification of the date and content of any modification, thereby allowing users easily to reconstruct any filer’s disclosure history as to any disclosure item. It would then, for example, be easy to track the history of changes in any filer’s description of its own business, risk factors, or any other disclosure item.”

Beller and Grundfest say companies would not have to file their information directly with the SEC, but could post responses either on an SEC website or on their own websites, “with a ‘hash” that authenticates the document as well as the date and time of posting. The act of posting on either of these sites, together with the relevant hash, could then constitute filing.”

Project Alpha Beller’s brainchild

In a speech in June, Cox credited Beller and Grundfest as being the instigators of the 21st Century Initiative, which was code named “Project Alpha” by Beller when he was still at the commission. However, Cox has appointed plain language guru and disclosure expert Bill Lutz to oversee a dedicated team at the SEC to prepare a blueprint that will be presented to a federal advisory committee in 2009.

Grundfest’s most recent work for the SEC was as a member of the Advisory Committee on Improvements to Financial Reporting. Beller has been credited as the architect of the e-proxy rule, which has led to a 73% decline in retail shareholder voting during the first year of implementation.

In their paper, Grundfest and Beller call on other lawyers and regulators to join in their effort to create a web-based disclosure questionnaire. They plan to publish a more detailed article and develop a mock system.

The paper ends with the following call to action: “The experience of the online community in developing open source code and wikis is, we believe, salient though alien to the legal community and to the administrative process. This preliminary description of an on-line questionnaire-driven disclosure regime is intended to provoke among securities lawyers and regulators the sort of open discussion, debate, and commentary that is the norm in the internet community and that can help build a more efficient disclosure regime that reduces costs for filers while improving the quality of information available to investors.”

Personally, I think Beller and Grundfest present an interesting concept, but they underestimate the flexibility and global benefits of XBRL, including integrated translation into up to 40 languages. In fact, their questionnaire could output XBRL data from the information that companies enter.

I don’t see the point of outputting some other parochial format that isolates companies in the US from what is happening everywhere else in the world.

Chairman Cox announced last week that the 21st Century initiative group will host a roundtable discussion on October 8th. A list of participants for the event has not been announced.

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