Research from Professor Kim Outlines How New SEC Rules on Redacted Material are Causing Increased Investor Risk
Without oversight, the stock market could easily turn into the wild west – companies could disclose or withhold any information they desired, allowing investors to potentially be throwing money at fraudulent companies – which is why regulatory agencies, like the U.S. Securities and Exchange Commission (SEC) are critical for maintaining a fair and honest marketplace.
“While transparency is crucial for investors to make sound decisions, it is also important to permit companies to withhold certain information from the public if the information is both proprietary and immaterial to investors,” explains Yongtae Kim, Associate Dean and Robert and Barbara McCullough Professor of Accounting. “Proprietary information may reveal a company’s trade secrets, thus harming the company’s competitiveness, and immaterial information refers to information that is not substantial or important to investors’ decision making.”
In 2019, the SEC adopted new rules around this information withholding process, which allowed companies to file redacted material contacts without seeking the SEC’s approval in advance, effectively removing the step in which requests were vetted for legitimate competitive harm and relevance to investors.
Following the regulatory shift, Kim and his colleagues noticed a significant rise in requests for confidential treatment. “We began to question not only the reason for the uptick in requests, but also considered whether companies were using this as a tactic to conceal unfavorable news from investors" Kim notes.
Kim’s research Do Firms Redact Information from Material Contracts to Conceal Bad News? finds exactly that. It suggests that managers redact information from material contracts to conceal bad news, especially when the litigation risk is low, when CEO’s equity-based compensation provides incentives to maximize their personal benefits, and when there is little external monitoring from institutional investors.
While companies claim they are protecting themselves by concealing information, evidence suggests otherwise. Because earnings cannot be manipulated forever, and bad news will come out one way or another, Kim and his colleagues examined future operating performance and stock price crash risk. The research finds that withholding bad news through confidential treatments will result in greater crash risk as well as poorer future performance, because it disrupts the natural cadence of the market and also lets companies continue with bad projects.
Given the stock market's delicate nature, these manipulative tactics can trigger a ripple effect.
For investors whose jobs and livelihoods revolve around informed decision making, it’s their right to have access to complete operational insights. Hoarding bad news from investors deprives investors of transparency, distorts market fairness, and fosters market uncertainty and instability.
The authors use Tesla as a noteworthy example of what this looks like in practice, citing that in the first two fiscal quarters of 2017, in which the company lost $955 million, Tesla made an unusually high number of confidential treatment requests – almost 3,000 redactions.
While not a new phenomenon, the 2019 rule change may further facilitate this practice, enabling companies to make more redactions for questionable reasons without formal scrutiny.
"I trust that this research underscores the necessity for robust oversight and regulation in this high-stakes industry," Kim remarks. " And in the future I hope to see policy revisions to enhance investor protection and market integrity."
Kim’s current/future research involves diverse topics, including the impact of climate risk on corporate disclosures, the relation between a firm’s reliance on human capital and earnings properties, the impact of information access on local government financing costs, the impact of disclosures on corporate innovation, the relation between technological development and corporate information environment, and the relation between ESG disclosure and government procurement contracts.