Keeping it simple

Every year around this time, I start thinking about what to do with all the annual reports I’ve received over the past few months. Normally they make a one-way trip to the trash heap, but as I prepare to dispose of the mountainous pile, a thought comes to mind. ‘Aren’t these things supposed to be getting easier to read?’

From the evidence I see in front of me, the move toward the simplification of reports and the use of plain English has by no means gained widespread acceptance. Some companies have put a lot of time and effort into the matter, and with good results, but others seem content to send out forms that are intimidating and confusing – perhaps deliberately.

For companies looking to simplify their annual reports and other filings, there are a number of options. The easiest and most obvious is to cut down on the use of jargon, footnotes and appendices. Some companies have been successful at this through internal review, but many are looking to specialist advisors to help them not only extend the use of plain English, but also redesign the documents to include more effective charts, tables and other graphics.

The motivations for simplifying financial reports are many. For one, it can be very effective as an investor relations or PR exercise. Shareholders of all levels appreciate receiving documents that are easier and faster to read and allow them to access the information they need as efficiently as possible.

Elliott Saltzman, senior vice president of Addison, explains that one way to achieve greater trust is to combine certain sections of annual reports and change where information is displayed. ‘The glossy section of annual reports is sometimes not taken seriously, and one thing you have to do to gain trust is simplify it,’ he says. ‘What people understand, they trust – and what they trust, they will spend money on.’

Cost savings are also a significant consideration. It might not seem like much, but if an annual report can be cut by, say, ten pages, the printing and mailing costs can be reduced considerably. And, of course, there is the regulatory element. The SEC, under chairman Christopher Cox, has been a vocal advocate for the wider use of plain English in all types of filings, and the commission is likely to continue its efforts encouraging companies to disclose important financial information more effectively.

There definitely is a trend toward simplification, and this message is being heard loud and clear. It is evident that the SEC is going to continue its move in this direction, although some observers feel the commission can be its own worst enemy in this pursuit. Even its own document on simplification can be difficult to read, so it obviously has a long way to go with its own filings.

The move toward simplification and the more effective use of language is not a new phenomenon. In fact, the first discussion of the idea dates back many years, although there has been a renewed push in this area with the increases we’ve seen in transparency and disclosure.

‘Transparency is one of the foundations of our overall governance,’ says Sylvia Groves, assistant corporate secretary at Nexen, a diversified Canadian-based global energy company. ‘We consider plain English to be fundamental to transparent disclosure. Communicating clearly to everyone, from individual retail shareowners to sophisticated institutions, is only enhanced by making information clear and easy to read.’

One of the most obvious moves toward simplification is the treatment of Form 10K and its inclusion in the annual report. It has become common practice for US companies to include the full Form 10K in the annual report, but this is not necessarily a good practice on its own. ‘A lot of companies are just sticking a 10K in the back of the annual report,’ Saltzman explains. ‘Unfortunately this is not what the SEC intended, and we believe it is a transitory practice – it will not continue for long.’

He notes that the 10K was never really intended to be distributed to individual shareholders. It is supposed to be a compliance document for the SEC. However, since it is now being sent to shareholders, generally as part of other documents, the 10K should be in a format that people can easily understand, but this is not really the case at the moment – nor is it the case for the management discussion and analysis (MD&A). ‘I would estimate that nine out of ten investors cannot make heads or tails of the 10K. The same applies to the MD&A, and this is the part that is most often read,’ he exclaims.

For this reason, there is a great deal of interest in simplifying the 10K and the MD&A. Including both and placing them in the same part of the report, while a simple move, can also help. One good reason to place the MD&A and 10K together is that the financial elements of the 10K add gravitas to the narrative section of the MD&A, so the end result can, if presented properly, add up to more than the sum of its parts.

Companies are starting to view the MD&A as an effective way to underscore corporate strategy to the shareholding community, and in that regard the investor relations department is beginning to get more involved. This is part of a larger trend that is taking place in the market as the annual report begins to be seen as a marketing piece. Part of this movement involves the integration of topics such as socially responsible investing and corporate social responsibility (CSR).

‘The introduction of CSR to the annual report adds value and increases the trust factor,’ says Saltzman. ‘All these factors combined can result in a very powerful document. Unfortunately, more companies are not doing it than are.’

As strange as it sounds, simplification may not be as simple as one might think. Some companies have attempted to deal with the issue by using shorter words or even cutting down on the number of words used. This is not necessarily simplification and might even make documents more confusing if the approach is not managed thoughtfully. The introduction of plain English goes beyond the words that are chosen. It involves presenting a unified, coherent and easily digested message.

‘It is not just text or the way you write but the combination of information design and plain English that makes these documents easier to read and understand,’ says Saltzman.

Groves highlights that Nexen uses plain English throughout its public reporting. ‘We have a resident expert that works extensively on the design, format and language of our annual report and 10K, which we set up as a single document.’ And it goes beyond just the annual report. ‘From my perspective on the proxy, we take a continuous improvement approach and try to clarify it more each year, revising wording, adding tables and graphs. It was about three or four years ago when we rewrote it from the legalistic style into a plain English format.’

This holistic approach is important. Simply using graphs may create more problems than it solves, and companies need to be careful that, in simplifying language and presentation, the meaning is not lost or changed. This requires a lot of careful planning and often the support of specialist personnel or outside consultants.

But inserting charts without the proper consideration would be a mistake. If the chart or table needs extensive explanation, then its inclusion may defeat the purpose of simplification. ‘A chart should always make information easier to understand and not need a lot of explanation,’ says Saltzman. It is then important not to repeat that information elsewhere in the document.

One area that lends itself well to tabular presentation is compensation. Several companies, including Nexen, have moved in this direction and are receiving positive feedback from shareholders.

Apart from making complicated information more easily understood and easier to read, the use of charts and the simplification of language can have another, more practical benefit to corporations – saving money. Saltzman recalls a company that changed its MD&A to include more tables and improve the layout. The result was a reduction in length of four pages. The total distribution of the report exceeded one million copies, and because of the reduced size of the document, the company was able to save more than $160,000.

It is important to note that cost savings should not be the primary driver behind simplification efforts, but there is no doubt that companies looking for extra incentive could be encouraged by the prospect. Presenting a coherent message is one of the huge challenges faced by corporations when issuing all regulatory filings, especially the annual report. Getting the message wrong can have an adverse effect on the public perception of the firm, which in turn could lead to financial impacts.

It is not unusual for various parts of an annual report to be written in a vacuum. The chairman’s letter, MD&A, 10K and other sections may all be authored by separate sections of a company. In this case, it is highly unlikely that the document will retain a consistent tone and language. ‘Best practice would see companies always referring to themselves in financial terms and always in terms of business strategy,’ Saltzman stresses. ‘It is important that they get the strategy out there and that the message is coherent.’

Another significant area for simplification is the elimination of repetition. There are a lot of redundant listings of information in quarterly and annual reports. Between the MD&A, 10K, financial declarations and other sections, it is not unusual for some figures to appear three or four times. Much of this could be extracted and converted into a table or chart, which can then be used as a point of reference instead of repeating the information. Ideally, it is best to design charts that represent multiple fields of data and are easily comparable throughout the document.

There are other areas that can be readily simplified. Xerox presented a simplified business description section in its 2005 annual report. This statement, which forms item 1 of the 10K, is not usually included in the annual report, but with careful design, it can add considerable weight to the report. The inclusion of simplified business descriptions is likely to be a growing trend.

For companies in the early stages of undertaking simplification, it is important to remember that this is a constantly evolving field. Documents need to be reviewed on a regular basis and changed to keep pace with the latest developments. ‘For next year, we are having our resident expert go through it to give us ideas for improvements,’ says Groves, who envisions reviewing the process annually at least.

Many companies will wait to undertake a simplification review until the SEC or other market forces require them to do so, but they will find themselves missing out on potentially considerable benefits. With investor perception arguably more important now than ever before, being a leader in this evolving area of disclosure transparency could greatly benefit a company’s standing in the eyes of the market in the years to come.