On Transparency and Disclosure

How much would you like...about you...about others? About your company...your government agency...your non-profit?

Well, one thing we can all agree on is that the advance of technology certainly has a lot to do with the ongoing discussions about the important topics of transparency and [formal / official] disclosure by all types of organizations in the private, public and social sectors.  Technology has made it possible for those both inside and outside an organization to see all ...and for the organization to hide little. Tech tools are frequently creating crystal clear windows into many aspects of financial, legal, marketing, manufacturing, health and safety, environmental and others of organizational operations, disciplines, functions and decision-making.

Some unofficial disclosure is in real time; other unwanted disclosure is retrospective. Some organizations leak news, information, data and documents in real time.  At other times, the cover of the file cabinet is peeled back by outsiders -- just ask the lawyers about trends in "e-discovery" and the wholesale requests for all emails by both plaintiff and defendant bar!  Or ask the CFO or investor relations manager about third parties who perform detailed analysis on the company's public EDGAR financial filings combined with the equivalent of diving into the Dumpster for revealing documents.

Networking Armies Watching Corporations

One of the most informative books the Editors have read on Transparency related to the effects on institutions is [authors] Don Tapscott's and David Ticoll's "The Naked Corporation " How the Age of Transparency Will Revolutionize Business."  Tapscott and Ticoll argue that networking tools available to average citizens " and employees inside the business " are creating significant challenges for companies, government and not-for-profit institutions.  "Every company," they write, "has a stakeholder web ("e-web"), maybe several," at work peering into the institution.  (Examples: The largest nation's retailer, Wal-Mart Stores, has it external Web watchers via www.walmartwatch.com and www.aflcio.org/corporatewatch/walmart/.)

Tapscott and Ticoll explain: "A stakeholder web is a network of stakeholders that scrutinizes and attempts to influence a corporation's behavior.  Recently, studies of these networks gives them different names " transparency networks, corporate responsibility clusters, network armies, or smart mobs.  They quote Amy Cortes, who says, Whatever you call them, these forces are products of the Internet Age, united not by geography but by common cause and technology that lets them communicate freely and instantly..."

[The Editors urge you to read this important work if you want to know more about transparency and disclosure by stakeholders and how networkers can directly affect your own organization.]  (Published 2003, Free Press Division of Simon & Schuster.)

Required Corporate Financial Disclosure - Materiality

Much of the debate about transparency in Corporate America revolves around mandated disclosure of material information by the SEC and other regulatory agencies. Asking the question, "Is this material?..." can set off vigorous internal debates these days.  Answering incorrectly " deliberately " can lead to serious consequences for the firm and individuals having material information and making decisions about disclosure.

This debate about materiality of information can at times really be career-threatening for managers " the US Justice Department's Corporate Fraud Task Force (created early in 2002 by President George W. Bush after Enron's collapse) had resulted by 2004 in 500 corporate fraud convictions or guilty pleas, with criminal charges filed against 900 defendants (including 60 top officers).  Separately the SEC had brought more than 600 civil enforcement actions related to financial fraud or reporting (New York Times, January 14, 2005 news report). Disclosure is a very serious matter for corporate management! 

How Much Transparency Is Intentional?

Transparency is bit more difficult to define, measure, prescribe or manage for those who guide the fortunes of enterprises in all sectors: Just how transparent do you make your organization's finances?  Operations?  Research & Development?  Government relations?  Political contributions? Lobbying? Friendships with key public officials who can influence your business? Knowledge of competitors' business? And what do you do when others strip away your protective opacity to create more transparency?

An example is in the pharmaceutical industry " in January 2005 Business Week focused on "Big Changes for Big Pharma," which experts predicted will include much more disclosure about side effects and drug test results, both voluntary and mandated.  The editors of leading medical journals recently adopted their own rules to assure that there is more transparency in the reporting on results of new drug tests and clinical experience in the marketplace once a drug is in use.  Think of the revelations coming in the numerous Vioxx® trials...once more transparency is assured for the patients' experiences, will more [plaintiff] lawsuits follow?

Trend:  More Transparency, Like it or Not

In his book, "The Transparent Society," Dr. David Brin explored many fascinating aspects of transparency and the effects on individuals and institutions. "Transparency is clearly linked with Accountability," he observed, "and we tend to like Accountability when it focuses on others and don't like it much when others focus on our Accountability."  He set out a powerful Accountability Matrix for Transparency that can be useful for both strategy-setting and tactical response:  Think about the powerful tools and resources that are now available, and emerging; tools that:

• Help me see what others are up to;
• Help others see what I am up to.

• Help prevent others from seeing what I am up to;
• Help prevent me from seeing what others are up to.

In business, there is "public feedback regulation" that affects companies of all sizes, author Brin points out.  Airlines publish their on-time records; media report these to consumers.  Regulators don't need to do much of anything " the market will correct. Auto makers report their accident rates for marques and models of cars.  Consumer Reports editors and hundreds of auto writers do the "regulation," thanks to Free Speech and Free Markets.  Chemical companies report their chemical releases " the annual Toxic Release Inventory (TRI) among the regulators are local communities responding to real or perceived threats.

Government doesn't escape scrutiny:  Recall the revelations of the "Tuskegee Syphilis Study" of African-American men decades after testing ended?  Watergate revelations " still going on after 30 years!  The September 11 Commission published a book inches think with government failings and mis-calculations.  We were still reading the report when Hurricane Katrina struck the Gulf Coast " and more transparency into government decision-making became an orgy of information!  (For a details on Professor Brin's fascinating study of Transparency, see "The Transparent Society," published 1998, Copyright David Brin; Perseus Books.)

Prosecution / Disclosure / Non-Disclosure

There are some little known laws requiring more transparency in transactions " early "truth-in-disclosure" state statutes -- that can be used to investigate and prosecute managers. One example is New York State's Martin Act of 1924, preceding the landmark 1933 and 1934 federal securities laws; Attorney General Eliot Spitzer used Martin to go after investment bankers on allegations of deliberately slanting financial research peddled to investors.  Or New York's 1893 Donnelly Act, passed to prevent NY insurance brokers from colluding and price fixing " and used by the AG more than a century later to go after the major insurance brokerages on their practices (targeting companies such as AIG and Marsh & McLennan).

Question:  If there had been public disclosure of the industry practices [which the AG attacked] would there have been prosecutions?  Silly question.  But look what happened when the practices became highly transparent " the mutual fund prosecutions in New York and other states all began when an investment management professional visited Attorney General Spitzer to provide him with a look inside late trading, timing and other practices that she had observed in her office. 

Regulation FD Raises the Bar

The US Securities & Exchange Commission's Regulation Fair Disclosure " "Reg FD" " actually preceded the signing into law on July 30, 2002 the various provisions of the Sarbanes-Oxley (SOX) package of statutes. (SOX updated many existing statues, some on the books since the 1930s.)

Reg FD addressed the financial disclosure / financial reporting policies and practices of publicly-owned corporations in three areas " (1) selective disclosure of material, non-public information; (2) when insider trading arises in connection with a trader's "use" or "knowing possession" of non-public, material information; and, (3) when the breach of a family or other non-business relationship may give rise to liability under the mis-appropriation theory of insider trading.

Reg FD, said SEC, was issued to promote full and fair disclosure by issuers, and to clarify and enhance existing prohibitions against insider trading.

SOX Expanded Disclosure Rules

Within what we generally know as "SOX" are actually 11 separate titles of law, each with significant effect on the daily lives of corporate boards and managers and of importance to investors, money managers, analysts, and others.  These include:

• Title III " "Establishing the Framework for Corporate Responsibility" " the legislative intent now embodied in Section 300 rules " including clearly assigning responsibility related to hiring auditors to the board audit committee, and responsibility for attesting to financial reports by executives, who must have knowledge of material facts and internal controls; one of the effects of this part of SOX is that transparency must be robust inside the corporation in order for board and "C" executives to properly do their jobs.
   

• Title IV " "Enhanced Financial Disclosure," embodied now in Section 400 rules " including much more rapid disclosure of material changes, and adding momentum to what the SEC hopes will eventually be continuous, real-time financial disclosure by corporations.
   

• Title XI " known as the "Corporate Fraud and Accountability Act," increases penalties for those who tamper with records, or retaliate against whistleblowers.  The Federal government is in a position of authorizing or condoning certain types of whistle blowing.  (Some of which could be as simple as clicking the send button from inside and sending incriminating emails or documents to prosecutors, counsel and others outside the firm.)

"Why" Did You Do That?  Disclose...

Each year the American Institute of Public Accountants (AICPA)'s National Conference attracts legions of accountants to discuss recent and coming developments. The savvy CSFB research team of David Zion, CFA and Bill Carache, CPA, call this "Accountingfest," a groovy gathering that they say is the green eye-shaders' version of Woodstock!  At Accountingfest 2004, the pair advised, hot topics included "Disclosure of Accounting Motivated Transactions" " SEC staff, they reported, is beginning to pay more attention to the "why" a company entered into transactions. 

If a company thought it was a good idea to structure things around an accounting or disclosure guidance, Zion and Carache explained, "then SEC thinks there shouldn't be embarrassment to tell investors that is what the company did."  Among the things that could be revealed:  Whether management is really focused on the economics of the business or the accounting of the business " with more disclosure, investors could gain unique insights, they predict.

At "Accountingfest 2005," (December 2005) 2,000 accountants got the scoop on what SEC, FASB and PCAOB are focused on " Zion and Carache reported that the agenda included "Materiality," as in determining in financial statements whether an error was material " which SEC staff is thinking about.  The "Iron Curtain" approach focuses on how much the balance sheet mis-stated, which can result in mis-statements on the income statement. The Rollover measures the error based on how much the income statement mis-stated. How do companies compare and report on this?  Ahh...say the research team:  "We have no idea which method companies are using, as it is not a required disclosure." 

Commentary

Federal Reserve Bank of New York President William McDonough in September 2002 addressed corporate financial disclosure in a Washington DC speech: 

"Disclosure is most useful as a complement to accounting statements...firms should be encouraged and required to make otherwise non-mandatory disclosures if accounting statements are misleading or incomplete..."

"It is simply not enough for companies to disclose information. Investors must also pay attention to the information disclosed.  By reading proxy statements, investors can make up their own minds about issues...while there have been many major improvements in disclosure practices over the years, with hindsight, I think that less progress was made than initially hoped for...more could have been done.  In short, I believe that there is a public policy need to rethink the entire disclosure framework..."

Just months later, Mr. McDonough left the NY Fed to head the new Public Company Accounting Oversight Board (PCAOB), created by SOX, where he established new standards of oversight " and disclosure " for public company auditors.

He concluded his William Taylor Memorial Lecture in 2002 on this upbeat note:  "At the end of the day, I have no doubt that the underlying depth and flexibility of the US financial markets, combined with the heightened awareness of individual investors and the general public, will provide the necessary resilience to allow private and public sector [corporate governance] initiatives to take root.  We will see an even stronger financial system evolve..."

And More...

There are ongoing trends and developments in both transparency and disclosure that will affect the fortunes of private, public and social sectors.  The expansion of broadband access enables "leakers" to shovel huge volumes of documents from inside enterprises to outside mail boxes (physical and electronic).  The ubiquity of photo-enabled cell phones has already resulted in the transmission of actual events to news media " including the beating of suspects by police officers (which are guaranteed to make the top of the 11 o'clock news in your city).

We'll be advancing " well, more transparency for your benefit " on these trends and developments in accountability-central.  We're interested in your news and views as the editors explore these fascinating, related topics.

Deep Throat Revelations

Remember "All the President's Men," the best-selling book by Carl Bernstein and Bob Woodward (and the movie based on it)?  The furtive meetings in the dark corridors " scary stuff!  For three decades the identity of the most famous leaker of the Watergate scandal has been a parlor guessing game favorite.  Now we know " A retired FBI agent, W. Mark Felt, stepped forward to claim his 15 minutes of fame " "I'm the guy they used to call Deep Throat," he told Vanity Fair magazine.  His motivation is still unclear " patriotism? Being passed over for a top job?  Dislike of President Richard Nixon? 

More important: Is there a Deep Throat inside your organization today?  If so, he or she has many more technology tools available today than did the FBI's Mr. Felt in the early 1970s.  Leaking is much easier today than just scheduling meetings to hand over documents in dark alleyways!  You'll see the trends and developments documented here in accountability-central.

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-- From the Editors at Accountability " Central.

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