Joining forces to revamp disclosure
Legalese is out at the SEC. If reformers have their way, so is jargon’s derivative: ‘bifurcated communication’. That is what can happen when lawyers fail to work closely enough – or at all – with investor relations officers (IROs) when preparing regulatory disclosure documents, resulting in proxy statements, 10Ks and other filings that are indecipherable or uninformative.
IROs have long been putting their stamp on unofficial communications like the narrative section of annual reports and press releases. But there is a new movement to get more of their imprint on compliance documents filed with regulators. Gurus at the National Investor Relations Institute (Niri) started the push for more IR involvement in the disclosure process. Then CFA Institute and Business Roundtable joined the effort.
‘We don’t expect everyone to write like Warren Buffett,’ says Matthew Orsagh, senior policy analyst at the CFA Institute, the group which offers the certified financial analyst designation (and which was formerly know as the Association of Investment Management and Research). ‘But the language in disclosure documents needs to be more plain English, more accessible.’
In a series of panels that included Niri, BRT and CFA Institute, practitioners began rethinking what goes into an SEC filing, how it gets submitted and who is best placed to put it there in the context of discussing another problem: Short-termism in investor outlook.
After hearing CEOs complain that they felt forced to give up ‘seed-planting’ activities like research and development, and marketing to focus on quarterly expectations, the three groups looked for ways to encourage investors to take a longer view. They agreed investors would be better served if disclosure materials revealed more about companies’ ‘value drivers’ and strategy, which IROs often stress in their communications, Orsagh says.
Short-termism on the way out
The result of the discussions was a July 2006 white paper, ‘Breaking the short-term cycle: Discussion and recommendations on how corporate leaders, asset managers, investors and analysts can refocus on long-term value.’ Along with its controversial headline proposal to stop quarterly earnings guidance, the document highlighted dislosure written as though to ‘confuse, rather than inform, investors and analysts,’ and suggested that IR and legal functions should be better integrated.
Too often, though, lawyers take control of the compliance documents, writing them with the primary concern of limiting liability exposure. ‘I understand the position of a general counsel. It’s their job to make sure a company doesn’t get into trouble,’ Orsagh says. ‘But a short-term message gets short-term investors.’
Trends and risks
This effort follows the SEC’s own attempt to improve disclosure when it published guidance on writing management’s discussion and analysis (MD&A) in December 2003. Issuers were advised to provide a narrative explanation of the financial statements from the perspective of the CEO, focusing on the trends and risks ‘that keep him or her up at night.’
In a lengthy ‘how to’ guide, the SEC observed that MD&A rarely amounted to more than a boilerplate addition, strangely containing little analysis or discussion. Ostensibly coming from management teams themselves, the MD&A tended to recite the numbers from financial statements and disclose percentage changes in financial statement line items from period to period for a kind of ‘elevator analysis’ that was descriptive, but not informative, commissioners said.
While there have been improvements in the last three years, the problem persists. ‘Companies resort to the most basic MD&A,’ explains Donald Meiers, a securities partner with Steptoe & Johnson. ‘They look at any information they can readily glean from the available numbers. That becomes the lowest common denominator disclosure.’
Reformers say management’s story would be more complete if it contained more forward-looking statements, better explained trends and uncertainties, and discussed in more detail the business’ key drivers.
Meiers asks, ‘Why is it that everyone seems to be struggling with something that is not really all that difficult?’ There are a few possible explanations: Disclosure teams may comprise bad writers; CEOs are nervous about revealing too much of the corporate strategy; or the company may purposefully be obfuscating in order to conceal bad news.
The problem may also be systemic. ‘The reality of it is more often inadequate internal controls,’ Meiers explains. ‘A lot of lawyers just give up [trying to get a better picture]. In most cases, the processes are not in place and the companies are not investing sufficient time to make significant disclosures.’
What specific things can companies do to improve? Naturally, Thompson, a chief advocate of IR professionals, says ‘I feel very strongly that IR people need to get in and get in early.’
‘IR people should approach counsel to say the SEC is serious about improving disclosure,’ continues Thompson, the retired ex-president and CEO of Niri. ‘It’s a mistake to bring the IR people in at the tail end and say fix it up.’
IROs bring to the table their sense of the level of sophistication and interest of the shareholders, what information can move markets and what past disclosure caused problems, he says.
Thompson wants to see more IROs on disclosure committees. Meiers is lukewarm to the idea, saying the essential team probably comprises the CFO, the controller, the general counsel and someone from the internal audit committee. ‘The IRO is the person who brings the greatest degree of continuity as to what was said previously,’ he says. ‘But I’d want that person to be the quietest one in the room. I don’t think they’re the best informed.’
‘That attitude on a lawyer’s part does not surprise me,’ Thompson says. ‘Yet it’s true there are some companies where the IRO is not in the inner circle. In these cases, they are somewhat neutered.’
Filling out the picture
Whether on the team or on the sidelines, the IRO has a lot to contribute to elicit the most appropriate disclosure. Karl Groskaufmanis, a securities partner with Fried, Frank, Harris, Shriver & Jacobson, suggests reviewing draft disclosure with the IRO as a check to determine if a key trend is missing from the company’s filed reports.
Acting as devil’s advocate can be an outside counsel’s role, too. ‘I throw out questions,’ Meiers says. ‘It’s like throwing spaghetti noodles at a wall. Some stick, some don’t.’
Some of the most illuminating information comes up in conference calls, and transcripts are sometimes attached to official filings. So some are asking why that detail isn’t simply put in the MD&A. In these situations, ‘You’ve got to wonder who is driving the ship,’ Thompson says. ‘CEOs are usually pretty candid. But when the material gets turned over to the lawyers, there’s a gap.’
Thompson recalls one CEO taking on a prescient question during an investor Q&A about the shortage of engineers and its eventual effect on his company. ‘That’s not something you’ll find in a spreadsheet,’ he says. ‘Instead of waiting for those questions, take them on [in the MD&A].’
Meanwhile, the SEC is taking a harder look at MD&A and weak documents do draw comment letters from agency staff. Recently, it criticized Hershey for omitting analysis of the effect of civil unrest in Ivory Coast on its cocoa supply. An analyst ripped apart the prospectus of Chipotle Mexican Grill for presenting a raft of slogans like ‘when a chain isn’t a chain’ and ‘one burrito at a time’ as meaningful insight into company strategy. Even Buffett’s Berkshire Hathaway, often cited as the gold standard in disclosure, had its MD&A flagged, albeit on a fine point involving a confusing description of loss reserves estimates.
One alarming observation Thompson made during the short-termism symposia is that many companies actually like sticking to earnings guidance four times a year, a problem certain to mute reform efforts. ‘A significant majority of companies believe guidance keeps channels open between themselves and shareholders. But guidance is not just about earnings. Companies need to get into non-financial factors like trends and standards of achievement.’
IROs, of course, are trained to think in this broader way, yet they can’t produce disclosures that companies are either unable or unwilling to report in the first place.
For more information on how to write in plain English, consult these resources:
Tom Goldstein and Jethro K. Lieberman, The Lawyer’s Guide to Writing Well (University of California Press, 1989).
David Mellinkoff, Legal Writing: Sense & Nonsense (West Publishing Company, 1982).
Robin Williams, The Mac in Not a Typewriter (Peachpit Press, 1990).
Richard C. Wydick, Plain English for Lawyers (Carolina Academic Press, 2nd ed., 1985).
Plain English Pilot Program: Selected Plain English Samples (SEC Division of Corporation Finance, January 28, 1998).