Canadian Securities Administrators (CSA) recently floated the idea of giving investors a lot less information. Seriously.
The notion results from a process that seems innocent enough: regularly re-examine disclosure requirements and explore what other countries do.
In fairness, several issues identified in CSA’s consultation paper (51-404) should be improved, but those items fall under housekeeping, such as eliminating redundant historical share price tables in prospectuses.
Other issues are central and thus more worrisome for where the country is heading in terms of balancing corporations’ wants with investors’ needs.
CSA asks for comments on three particular ideas that would further hamstring Canada’s weak regulatory environment.
1. Permitting semi-annual financial reporting
CSA proposes allowing companies to report their financials on a semi-annual basis, instead of quarterly. This would ostensibly allow companies to move away from a three-month horizon and focus on the longer term. But shifting the corporate focus to six months doesn’t move the needle much because longer-term thinking is denominated in years. Worse, the move raises a host of concerns.
A lack of comparability is probably the most obvious. Allowing some companies to report quarterly and others semi-annually creates information gaps.
For example, public and private information will drift even further apart over six months versus the current three, providing opportunities for insider information to leak into the market.
Also, earnings manipulation would be easier under reporting that’s semi-annual, with only half the checkpoints for six-month reporting. Manipulation might even be encouraged, as executives try to make reported results catch up with guidance, if actual numbers have drifted substantially over the prior six months. This would achieve the opposite of the intended goal of eliminating so-called quarterly capitalism and associated techniques for earnings smoothing.
These possibilities would result in questions about the motivations of companies that choose to provide less information to investors. The market might penalize companies, rather than credit them for taking a step back to supposedly ponder strategic direction.
Lastly, analysts and advisors would be challenged when comparing peer groups that use different reporting frequencies. Guesswork would inevitably fill in quarters with skipped reporting. Such an information void could create more volatile share prices.
2. Loosening requirements for filing business acquisition reports
Companies must file business acquisition reports (BARs) within 75 days of completing an acquisition that meets certain significance tests. The filing provides acquisition details, including historical financial statements of the acquired company, and pro forma statements for the combined entity.
Given our role as forensic accountants, we frequently search for BARs. Historical financial statements are valuable (especially for private enterprises, which aren’t obligated to report otherwise) since they outline the accounting policies and assumptions used by the prior entity. BARs can prompt intriguing questions if the accounting of assets changes once they’re acquired. For example, changes in revenue recognition or asset valuation can have a major impact on reported revenue. Is new management squeezing more out of assets, or is the accounting department performing sleight of hand?
3. Reducing annual and interim disclosure requirements
CSA proposes reducing the amount of detail provided in management’s discussion and analysis (MD&A), including removing prior period results and trends deemed insignificant by management. The supposed benefit: investors see only new information. However, prior period results give investors necessary context to adequately assess the current period’s figures.
The inclusion of prior results also dissuades companies from changing their level of disclosure on the fly, because it encourages apples-to-apples comparisons. Letting management decide what is important from quarter to quarter, without a frame of reference, could mislead investors.
We’ve found analysts often rush to issue their opinions as fast as possible, sacrificing detail in the process. For example, analysis often focuses only on earnings press releases and ignores the incremental information included in quarterly MD&As.
Consider the example of Canadian Pacific Railway when it reported its 2016 results. As soon as the company issued its earnings press release, big Canadian research firms published updates based on the scant details provided. Few looked at the company again once it released its more detailed MD&A almost a month later—yet only the MD&A contained the information needed to separate out non-operational gains from the company’s closely watched operating ratio.
In short, reduced disclosure in MD&As would result in sell-side analysts being influenced by management even more than is already the case.
CSA’s proposal to cut back on the amount of information investors receive speaks to the constant pressure on regulators from Canadian companies to do less. Advisors should be acutely aware of this tug-of-war and understand that companies can mislead investors, deliberately or otherwise. More—and more frequent—information is better, and, to identify companies that stand out in the market, advisors should focus on sources that provide detailed disclosures and analysis.