Disclosure over load: gaining control of the process.

• Author: Iannaconi, Teresa
• Position: Financial Reporting

A team of graduate students recommended selling Enron stock three years before the company went bankrupt. What does this say about the state of financial disclosure, and would it benefit more from enhancement rather than expansion?

As standard setters, regulators and others seem to continuously call for and deliver more regulations, more standards, more transparency and more disclosure, financial executives are having difficulty keeping up with the volumes of materials that are expected from them. They believe this plethora of statements and documents that they provide to users should already comprise more than enough information, and that should solve the problems of accounting fraud and financial reporting fraud.

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Indeed, many relate instances of "looking but not seeing" or "eyes wide shut." These contradictory statements describe what happens when too many financial disclosures impair their usefulness.

A new study shows than when it comes to financial reporting, quality may be more important than quantity. The report, a joint research project published by Financial Executives Research Foundation (FERF) and KPMG LLP, delved into the effect of increased financial disclosures from 2004 to 2010. Entitled Disclosure Overload and Complexity: Hidden in Plain Sight, the report observed that more financial disclosures are not necessarily better, and recommended financial disclosure enhancement rather than expansion.

A group of students at Cornell University's Johnson Graduate School of Management likely would agree with that recommendation. In 1998, using publicly available financial information, the students succeeded where professional investment analysts and investors failed. At that time, the students analyzed Enron Corp. and recommended selling the stock--three years before its bankruptcy. The student analysis determined that the stock was overpriced and questioned Enron's high debt level, its earnings quality and the long-term sustain-ability of its business model.

The students' research also caught the attention of author Malcolm Gladwell who discussed the research in his book, What the Dog Saw (Little, Brown and Co., New York, 2009). He devoted a chapter to the Enron implosion, entitled "Open Secrets--Enron, Intelligence and the Perils of Too Much Information." Throughout the chapter the author notes that each party that deciphered Enron's financial vulnerability obtained the relevant information from Enron's publicly filed disclosures, albeit with some level of difficulty. In a discussion of Enron's use of special purpose entities Gladwell noted, "... you 3 can't blame Enron for covering up the existence of its side deals. It didn't. It disclosed them" (emphasis added).

Although Gladwell goes on to question whether the disclosure in Enron's public documents was adequate for a complete understanding of the transactions, the discussion concludes with an observation based on a research paper, "Rethinking the Disclosure Paradigm in a World of Complexity," authored by Steven Schwarcz, a professor at Duke Law School, which observes that increasing financial complexity has resulted in the traditional disclosure paradigm of "more is better" becoming an anachronism.

Schwarcz argues that there is no disclosure model that can adequately address the disclosure necessary to understand financial complexity. He says a regulation should...