Performance Perspectives Blog

Disclosure paradigm

by | Jun 4, 2010

I have become a big fan of Malcom Gladwell and have made it through Outliers: The Story Of Success, The Tipping Point: How Little Things Can Make a Big Difference, and Blink. I’m now working on his most recent book, What the Dog Saw: And Other Adventures and came across a discussion which has some relevance to our industry.

Unlike his earlier books, which have common themes running throughout them, this recent one is a hodgepodge of his earlier writings, including a discussion on the Enron case. Enron created SPEs (special-purpose entities) to overcome difficulties in obtaining financing and presumably for other purposes. And although they were documented in their financial records, there were questions as to whether or not enough information was provided. Gladwell writes that “you can’t blame Enron for covering up the existence of its side deals. It didn’t; it disclosed them. The argument against the company, then, is more accurately that it didn’t tell its investors enough about its SPEs.” (emphasis in original) He then asks, “But what is enough?” Each SPE (and Enron had 3,000) had paperwork in excess of 1,000 pages; edited versions averaged 40 pages.

This discussion on disclosures can extend to GIPS(R) (Global Investment Performance Standards) and what compliant firms share. Recall that the GIPS Executive Committee had proposed to require firms to disclose details about their risks in composite descriptions, and many in the industry were concerned about how much might be necessary; and, if enough wasn’t shown, would that then put their firm at risk?

The point at hand can be easily summarized by Gladwell: “You can try to make financial transactions understandable by simplifying them, in which case you run the risk of smoothing over some of their potential risks, or you can disclose every potential pitfall, in which case you’ll make the disclosure so unwieldy that no one will be able to understand it.”  Furthermore, “in an age of increasing financial complexity, the ‘disclosure paradigm’ – the idea that the more a company tells us about its business, the better off we are – has become an anachronism.”

I’d say it’s a good thing that the proposed risk disclosure requirement was dropped, because many firms feared this disclosure challenge: when do you have enough! The problem still remains, however, because (as noted in a recent newsletter) Jonathan Boersma, Executive Director of GIPS at the CFA Institute Centre for Financial Market Integrity and member of the GIPS Executive Committee, mentioned at last month’s PMAR VIII conference that the EC “feels strongly that risk should be addressed in the composite description.” The sample descriptions in Appendix C are apparently being used to imply this need. But, to put it simply, is a risk disclosure required or not? In a recent post I mentioned how a requirement found its way into the 2005 edition through the glossary, hardly where one would expect to look; are samples now a means to convey requirements? Hopefully, not.

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