The SEC's entire corporate-disclosure operation is based on the written document. That's a huge problem, says this watchdog.
Wall Street movie villain Gordon Gekko executed trades on a cellphone larger than his head. Today's traders can execute thousands of trades ina second on their iPhones. One might assume that the Securities and Exchange Commission has kept up, enforcing its rules with state-of-the-art software, algorithms, and computers.
The SEC's entire corporate-disclosure operation is based on the written document. For the most part, the agency collects financial information as documents, not as searchable data.
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Like many U.S. regulators, the SEC hasn't kept pace with technological evolution. As a result, the firms it's charged with overseeing are getting away with shady practices, investors are being denied easy access to key information, and, our economy is being put at risk.
To understand why the SEC's low-tech disclosure system poses such a threat, consider the 2008 financial crisis. As the Treasury Department's financial research director, Richard Berner, pointed out recently, "when Lehman Brothers failed six years ago, its counterparties could not assess their total exposures to Lehman. Financial regulators were also in the dark."
The reason? Accessible data on Lehman just wasn't available -- not even to the SEC. Lehman had complied with relevant reporting requirements, but that information was trapped within thousands of documents, with no way to search across the whole. This lack of accessibility fueled a crisis that nearly toppled our financial system.
Six years later, and the SEC has yet to implement the data-collection reforms that its own experts agree are needed.
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Since 2009, the agency has required publicly traded companies to submit a version of each financial statement in a standardized "open data" format, alongside the regular-old document version.
Open data enables regulators, analysts, and investors to crunch the information electronically instead of sifting through endless individual documents.
Unfortunately, officials aren't applying the same quality standards to these open-data filings as they apply to the old-fashioned document versions. So firms are effectively allowed to file quarterly statements that are incomplete, incomprehensible, or downright inaccurate. In effect, much of the SEC's most important financial data is of little use.
A 2012 study co-authored by Columbia Business School's Trevor Harris found that less than 10 percent of investors had made use of the SEC's open data. "If companies don't deliver something of high quality, why should investors use it?" Harris asks.
Plain-text financial statements still rule the day at the SEC. Agency attorneys and accountants frequently rely on documents rather than data and have to manually check the math. Disclosure via voluminous documents often serves to obstruct, rather than facilitate, serious investigation.
As the SEC's own advisors in the investment community have complained, since the "vast majority" of the agency's public information is "not currently machine readable, it is difficult to retrieve, analyze and compare."
Some lawmakers, including Patrick McHenry (R-NC) and Carolyn Maloney (D-NY), have been pressuring the SEC to expand its use of open data.
However, others are taking steps that would actually make this problem worse. In January, the House voted to exempt companies with annual revenues below $250 million from the SEC's open-data filing requirements. These firms would only have to file their financial statements as plain-text documents.
Supporters of the bill say it will ratchet back unnecessary regulatory burdens on small businesses. But by setting the threshold at $250 million, this bill exempts 60 percent of public firms. Most can't be considered "small" by any stretch of the imagination. If enacted, the bill would further degrade the SEC's already-lagging disclosure system.
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The SEC must bring its disclosure system into the 21st century. Open-data filings should have to meet high quality standards. The document option should be phased out completely - not just for public companies' financial statements, but for all SEC filings. As the Bernie Madoff scandal demonstrated, data transparency is just as important to regulating wealth-management institutions, banks, and other entities overseen by the SEC.
The technology industry, represented by the Data Transparency Coalition, already offers software tools that allow open data to be used effectively by investors, regulators, and the public. But for these tools to function, Congress must direct the SEC to fix and expand open data, not eliminate most of it.
The United Kingdom, China, Japan, India, and Korea have already taken steps to evolve their financial regulators. The European Union is set to follow soon. The United States is now at serious risk of being left behind. The nation's top regulators should not be policing the ever-more technologically sophisticated American economy with papers and pencils. It's time for the SEC to catch up with Wall Street.
Commentary by Hudson Hollister, the founder and executive director of the Data Transparency Coalition.