The fine line between financial disclosure and transparency

Between financial disclosure and Transparency

It is sometimes baffling that US with all its high financial disclosure standards still ended up with failed companies like Enron and WorldCom. Even with Sarbanes Oxley, Lehman still failed. Is it a failure of regulation or failure of inadequate disclosure? Perhaps it is in searching for these answers that world powers are overhauling their financial regulations and inevitably rolling out new financial disclosure standards.  Following the massive crisis in the international financial markets there has been an increased call by both the regulatory bodies, national governments and the general public for increased financial disclosure in the financial statements of especially quoted companies.

In line with the desire for increased disclosure several regulatory bodies all over the world are rolling out new disclosure standards for companies operating in their jurisdiction. There is even increased call for a common regulatory standard especially for financial institutions with stricter financial disclosure requirements. The big question however is if adequate financial disclosure will ensure stronger firms or financial institutions and reduce the incidence of distress especially in the financial sector?

What Does Financial Disclosure Mean?

Financial Disclosure is the release by a firm of all financial information concerning the company or financial institution that may influence an investment decision. All firms listed on a stock exchange are usually mandated to adhere to the disclosure requirements of the Exchanges they are listed on.

Quoted companies usually source for capital from the public hence they are usually subjected to higher standards of disclosure as investors need to be given all the information they need to make an intelligent decision on whether they should invest in a particular company. It is to make investing as fair as possible for everyone, that companies are mandated by regulatory bodies to disclose both good and bad information.

Where companies choose either deliberately or inadvertently to disclose only good information and hide negative information, there is a strong tendency for investors to be deceived into making the wrong investment choices and generally results in unproductive allocation of capital in the society. Also when there is selective disclosure of sensitive financial information to the public, it leads to a few people with access to investment sensitive information gaining advantage over those without. Hence, most regulatory authorities have strict rules against insider trading.

The US SEC has the Regulatory Fair Disclosure (FD) rule which   prevent selective disclosure by public companies to market professionals and certain shareholders. The Reg FD rule  states that  "Whenever an issuer, or any person acting on its behalf, discloses any material nonpublic information regarding that issuer or its securities to [certain enumerated persons], the issuer shall make public disclosure of that information... simultaneously, in the case of an intentional disclosure; and... promptly, in the case of a non-intentional disclosure

It is doubtful if this rule strictly applies in the Nigerian capital market where it is known that quoted companies first submit their financial statements to the Stock Exchange before it is made known to the public. There was a time that the Nigerian SEC once mandated that the results should be published simultaneously as it was being sent to the Exchange to prevent a possible insider abuse.

What is Financial Transparency?

The US SEC defines financial transparency as the timely, meaningful and reliable disclosures about a company's financial performance.  Transparency is about telling the complete story of an organization as seen through the eyes of management. It involves the use of nonfinancial indicators of current and future performance, risks, and other factors necessary to help investors and other interested parties to better understand the business.

When a company is focused on financial transparency, the firm goes beyond the financial figures contained in the financials statement to tell the story behind those figures. In transparent reporting model, management is expected to evolve a reporting model that includes material information about the firm's growth strategy, people issues, brand and market share, and supply chain issues, supported by quantitative nonfinancial performance measures and operating metrics like manufacturing capacity, employee turnover, units sold among others as it pertains to the industry the firm operates. In addition, transparency includes improving access to, timeliness of, and relevance of information that is useful to stakeholders.

Transparency is important as it goes above generally accepted accounting principles, Governmental Accounting Standards Board, or statutory reporting requirements, where and when needed, to provide users with the information they need to make informed decisions about an organization. It entails not only financial information but also nonfinancial information accompanying, by either law or custom, the audited financial statements.

Transparency is often easy when things are going well. But companies facing problems often have a tendency to hoard financial information. The preferred game is "no surprises. Disclose all material information as precisely and plainly as possible.   Investopedia, an online investment site states that "Transparency helps to prevent the corruption that inevitably occurs when a select few have access to important information, allowing them to use it for personal gain. Improved transparency can also lead to less price volatility in the stock market because all the market participants can base decisions of value on the same data."

Transparency is one of the silent prerequisites of any free and efficient market, as transparency is generally rewarded through the stock's performance.

Regulatory enforcement of financial transparency is however quite challenging. Hence, in developed economics, private initiatives have created market based incentives to encourage managements to adopt higher levels of financial transparency in their financial reporting. The Source Capital and BusinessDAY Financial Transparency Ranking Awards (FTRA) is to test transparency in the published  financial statements of Nigerian quoted companies and is Nigeria's first private sector initiative in that direction.