Yes, Climate Change does matter, says the SEC

On January 27th, the SEC commissioners voted to approve an interpretive release requiring companies to discuss the potential impact of Climate Change related legislation on their business. This is a very important announcement by the SEC, but falls short of anything that should cause any concern to any reporting company. This release by itself certainly should not create or cause additional work. From the SEC's point of view (and I certainly agree) companies should already be providing this information.

In her opening remarks, Chairman Schapiro said:

...the Commission is not making any kind of statement regarding the facts as they relate to the topic of “climate change” or “global warming.” And, we are not opining on whether the world’s climate is changing; at what pace it might be changing; or due to what causes. Nothing that the Commission does today should be construed as weighing in on those topics.The Commission is also not considering amending well-defined rules concerning public company reporting obligations, nor redefining long-standing interpretations of materiality. These rules and interpretations have served investors well for decades, and provide both the framework and flexibility necessary to apply to changing facts and circumstances. If something has a material impact on a company then it is something that needs to be disclosed — that has always been the case.

What is most important here is that she has said that the SEC is not taking a position on climate change, that is for the scientists and politicians. The SEC is simply reminding companies of their responsibility to provide full disclosure of risks to investors. She went on to say:

It is neither surprising nor especially remarkable for us to conclude that of course a company must consider whether potential legislation — whether that legislation concerns climate change or new licensing requirements — is likely to occur. If so, then under our traditional framework the company must then evaluate the impact it would have on the company’s liquidity, capital resources, or results of operations, and disclose to shareholders when that potential impact will be material. Similarly, a company must disclose the significant risks that it faces, whether those risks are due to increased competition or severe weather. These principles of materiality form the bedrock of our disclosure framework.

Again, reinforcing that this is the type of reporting and disclosure that companies should already be making. While I would have liked to see something much stronger, such as mandating reporting along the lines of the CDP (Carbon Disclosure Project), or even a variation on the GRI (Global Reporting Initiative) G3 standard, this is a good first step to providing investors with information that is important and relevant, with a Climate Change perspective in mind.

It remains my view that Reg S-K already provides the basis for requiring significant additional reporting on Climate Change risk, and in fact on the range of Sustainability issues. The requirement already exists to discuss all "known trends" and "uncertainties" that could impact liquidity or operations. Climate Change and Sustainability issues, regardless of one politics or belief system, are accepted by enough scientists, politicians, governments, companies and individuals to rise to the level of being a "known trend". If however an individual simply says "No, I do not accept that...", then those issues rise, due to the otherwise wide acceptance, to the level of an "uncertainty" and therefore must be discussed.

In his statements, Commissioner Louis Aguilar said:

Over two years ago, the Intergovernmental Panel on Climate Change concluded that it is "unequivocal" that the Earth's climate is warming. In October of last year, 13 federal agencies and departments published a coordinated annual report to Congress that reached the same conclusion. It is expected that climate change, if unchecked, will result in severe harm to ecosystems and people around the world.

Finally, Commissioner Aguilar also said:

As the Supreme Court has explained, doubts about materiality will be "commonplace," but these doubts should be resolved in favor of investors. Similarly, previous Commission MD&A guidance clearly requires disclosure of known trends, events, or uncertainties where materiality is uncertain.

It is great to see the SEC take the first step, now hopefully this will allow and encourage them to take the next.

It is NOT different this time, and XBRL will not avoid the coming crisis

Summary

There has been a lot of discussion suggesting that if there had been an XBRL taxonomy for MBSs and other CDOs (etc) and a taxonomy for government stimulus spending, that somehow the next crisis can either be averted or reduced - that the lack of transparency was a cause of the last crisis, and will contribute to the next.

I disagree with this view, and while I advocate the expanded use of XBRL for an increasingly wide range of business reporting applications, I do not think that a taxonomy or MBSs and CDOs (etc) would in any way either have avoided the crisis, or reduce its impact. Yes it would have increased transparency, but no, it would not have avoided the last crisis or the next one.

More data is a good thing, but data is not the same as political or business courage. Reasoned thinking has been disengaged, and "Its different this time" is the prevailing view. The last crisis was caused by a failure of trust, while the next one will be caused by a lack of political courage.

Trust, not Detail

The crisis was caused by a common group-think that said that house prices would continue to go up, that there was no bubble, and that when an agency gave a CDO a AAA rating, that the rating could be believed. Ratings serve as a form of trusted assessment of detailed information, and as such it was (and is) the responsibility of the rating agency to assess the risk of default on a total CDO package, and on the individual tranches of the package. Equally, no matter how complex the merging and re slicing of such tranches, it remained (and remains) the responsibility of the rating agency (or other rater) to understand what is in each tranche and to assign an appropriate rating.

The facts are that investors trusted rating agencies, and added their own prejudices, allowing that to drown out market indicators. "But this time it is different" is the common refrain during all bubbles, and this one was no exception.

But some were watching, and some were speaking about the potential risks. Others were watching, and were making their own investment decisions based on what their models told them.

I remember Chris Whalen in his weekly article (www.instituationalriskanalytics.com) warning of CDOs and subprime resets as far back as 2005 and 2006. Most recently, Dennis Santiago, CEO of Institutional Risk Analytics, told me "bottom line is that as long as people are allowed to create opacity on purpose in finance these problems will resurface from time to time."

Likewise, there have been a number of stories about the major players, and Goldman Sachs in particular. From Vanity Fair, January 2010 article on Goldman Sachs:

In the aftermath of the crisis, criticism erupted that Goldman had continued to sell mortgage-backed securities to its clients while betting against those very securities for its own account. Clearly, in the simplest terms possible, this is true: while Goldman was never the biggest underwriter of C.D.O.’s (collateralized debt obligations—Wall Street’s vehicle of choice for mortgage-backed securities), the firm did remain in the top five until the summer of 2007, when the market crashed to a halt.
Goldman argues that the buyers of their C.D.O.’s were themselves sophisticated investors who were capable of making their own decisions. In other words, they were counterparties. “You don’t shut your franchise down just because you have a view of a market,” says Cohn. “When we do an I.P.O., people don’t ask us our view of the stock market.” But a less generous interpretation was given in a recent McClatchy Newspapers series, which quotes an analyst report that describes Goldman as being “solely interested in pushing its dirty inventory onto unsuspecting and obviously gullible investors.” (A Goldman spokesperson says, “The statement is not true. The McClatchy series was characterized by unsubstantiated claims, innuendo, and outright falsehoods.” McClatchy, however, stands by its work.) And so, if the old Goldman was defined by its refusal to do hostile takeovers, the new Goldman is defined by its skill at protecting its own interests.

Clearly this was a case of a seller being happy to sell a product that the client wants to buy, regardless of how good or bad it is for the client. Sort of like a non-smoker selling cigarettes. All the additional XBRL tagged information would not have changed investment decisions, certainly not on a scale that would have influenced the outcome.

To use another analogy, paper based maps have improved in their level of detail and quality of content. In addition, technology has allowed the development of the GPS (Global Positioning System) and Google Maps applications, to mention just two. Yet the data is still there at the detailed level for anyone to look at. It is called the Yellow Pages and the local Printed Map.

Yet to day we get in cars are program in a destination, and blindly follow the instructions given to us, regardless of the outcome. We TRUST the GPS system. Hell, I bet if the GPS system suddenly went out, half the moms in America would not be able the find the soccer fields that they've been taking their kids to for the past years. They would be lost without the trusted system.

We TRUSTED the rating agencies and sellers of securitized debt instruments.

More data would not have changed the outcome, because investors would not have looked at the data, they TRUSTED the analysts and rating agencies. They also listened to the voices that said what they wanted to hear - "Its different this time".

The Next crisis

Just like the are listening to the same voices saying "Its different this time" about the 10% of GDP that the United States is borrowing last year, this year and for years to come. "It will be different this time, we are not Argentina". But it is not different this time.

And yet the data is there for everyone to see. I.O.U.S.A. was frightening before the crisis. It is just plain terrifying now, yet nothing is being done about it. The data is all there. Yes, a taxonomy for public spending to push that information where it belongs, into the public domain, is important and must happen. We will then be able to actually, as individuals, dissect government spending at the lowest level. The give winners will be the opposing political parties who will use the data to prove that one part or the other is spending money wastefully (usually in amounts that appear huge - $10s or even $100s of millions).  These exposures will certainly bring some "discipline" to spending, but will do nothing, absolutely nothing, to avert the coming crisis.

Tagging data at the lowest level is about efficiency and effectiveness, and must happen.And XBRL is the most effective standard for the tagging of business (that's what this is after all) information.

But all the stimulus money, line by line, tagged in XBRL at the lowest level will not change the simple fact that the next crisis is not about the data, it is about the decision making that says "Its different this time". So lets make the case for XBRL on the basis of what it will do, improve efficiency and effectiveness, not avert or limit the impact of the next crisis. That is not a data issue, and is a political issue.

Detailed data does not make political courage.

The SEC talks Climate Change: 27 January 2010

Yesterday in the notice of upcoming meetings, the SEC (Securities and Exchange Commission, the US regulator of listed companies) announced that they would be talking Climate Change. Well, actually they said they would be talking about two items, and Climate Change came in second.

The SEC says that:

Item 2: The Commission will consider a recommendation to publish an interpretive release to provide guidance to public companies regarding the Commission's current disclosure requirements concerning matters relating to climate change.

This could be very big news, or it could be very bad news. No question that the results of this meeting will be seen as good by some and very bad by others. The notice can be found here:

http://www.sec.gov/news/openmeetings/2010/ssamtg012710.htm

My hope is that they will determine that indeed Climate Change does rise to the standard of a "known trend" that will have a direct impact on businesses, and therefore companies will be required to specifically comment in their Management Discussion and Analysis (under Reg S-K).I believe that Reg S-K already provides adequate justification to require such reporting, and have written such before. A detailed discussion can be found here.

So, I'm looking forward to next week with anticipation.

More on Estimated Costs for XBRL tagging

The SEC's original estimate (here: http://www.sec.gov/rules/final/2009/33-9002fr.pdf, pages 6804/6805) of 125 hours for the face financials seems well in line with the results in the survey. The interesting thing is that the SEC estimates were based on actual participants in the Voluntary Filing Program. So it appears that when the SEC relies on the experience of real companies to estimate the costs, they got it pretty close (the time effort at least).

Unfortunately the SEC has, some years ago, made at least one serious error in cost estimates, but we'll get to that in a moment. There was no VFP for detailed tagged footnotes, as no taxonomy existed for the footnotes. The SEC's estimate was that it would required an additional 70 hours for tagging footnotes, at $250/hr for an estimated total of $17,500. The SEC has been very generous in their potential range of costs.

Now lets look at the new estimates (that I have already said I think are bogus at best) of 200 - 250 hours to detail tag the footnotes, keeping in mind that the face financials - the "easy part" are taking an average of more than 120 hours. At $250/hr, the new estimated cost is between $50,000 and $62,500 to tag the footnotes.

Now lets apply a multiplier from estimated face financials tagging time (from the "experts") of an average of "less than 80 hours" to 120+ hours. We get a 1.5 times multiplier, at least. Applying that the the detail tagged footnotes estimates, and we get between 300 and 375 hours, or $75,000 - $93,500.

Personally I hope that tagging processes and software will result in significantly faster tagging of footnotes, and fully expect that kind of quantum leap in software to happen quickly. But existing processes and software do not give my huge confidence that the first wave of filers will have an easy time tagging footnotes at detail.

So now - the SEC's estimate of cost for SOX section 404. http://www.sec.gov/rules/final/33-8238.htm#v

Using our PRA burden estimates, we estimate the aggregate annual costs of implementing Section 404(a) of the Sarbanes-Oxley Act to be around $1.24 billion (or $91,000 per company).¹⁷⁴ We recognize the magnitude of the cost burdens and we are making several accommodations to address commenters' concerns and to ease compliance, including:

• Requiring quarterly disclosure only of any change that has materially affected, or is reasonably likely to materially affect, a company's internal control over financial reporting; and
• An extended transition period for the new internal control reporting requirements.

I think it is fair to say that SOX section 404 cost businesses significantly more than the SEC's estimated $91,000.

So, the message (to me anyway) is clear - when the SEC asks a sample of participants how much it actually cost them to do something (the VFP), they are excellent at using that information to estimate more general costs to accomplish the same or a very similar task (face financials using the US GAAP taxonomy).

When estimating effort for tasks that there is no history to review, the SEC, like most of us, is very optimistic. In this case they estimated 70 hours for footnotes with the latest estimates now being 200 - 250 hours, with a likelihood that even those numbers significantly underestimate the actual effort.

XBRL - so how much effort is REALLY involved?

Summary

For years now (well, the past two to three years) the assumed wisdom has been that the creation of a set of XBRL documents for filling with the SEC would require between 40 to 80 person hours. Lately the figure of 30 to 50 has been used, with "10% taking more than 80 hours".

A recent survey raises serious questions about these estimates. While second and subsequent filings have taken significantly less time (as expected) then initial filing time commitment is much higher than has been touted. The lesson is that XBRL, and especially Phase II detailed tagging of footnotes, will cost businesses significantly more than they have been told to expect.

The facts are coming out, and it is time to stop pretending, and stop misleading. When 57% of respondents say that the effort for XBRL filing with the SEC exceeded 120 hours, there is much to do to restore the credibility of those providing resource estimates. Some real numbers would help.

The promise

Supporting the "its quick and easy" argument are quotes In a Journal of Accountancy article in November 2009,

Typically, companies take between 30 and 50 hours to complete their first-year submissions in XBRL, with about 10% of companies taking less than 10 hours and 10% taking more than 80 hours, according to Paul Penler, executive director of assurance services for Ernst & Young.  In year two, when companies will be required to detail tag footnotes, they might expect the process to take between 200 and 250 hours if the company does it itself or with a filing agent, he said.

I believe these estimates are bogus at best. But lets also be clear, Paul is not the only one who has made these estimates. The XBRL community has consistently underestimated the actual efforts involved in building taxonomies, tagging documents, time to adoption, rate of adoption, etc. And all these translate, simply, into underestimates of the true costs of XBRL. I have been as guilty as anyone in the XBRL community, of underestimaing effort and overestimating businesses willingness to invest their limited resources into something that I can see the benefits of, but the the investing business person does not yet understand. I sit on numerous calls listening to the high priests of XBRL making statements like "They just don't get it" and "If only they would..." and "We really need ot get the message out" and the best - "They just aren't listening". 

No plan survives contact with the enemy

Well the message is out. It is not as easy, as quick or as cheap as promised.

Last week the results of a joint AICPA/XBRL US Inc survey on company readiness of XBRL was released. What a difference real results make. The "plan" - convince those that will have to actually spend the money that it is cheap and easy, has just met the "enemy" - the reality of cost and effort.

I love the wording in the results. Always start with the "good news" first. Then the rest seems muted.

Preparation time for creating XBRL-formatted financial statement decreases dramatically after the first filing, according to respondents who have prepared multiple XBRL financials:

• 57% said it took them over 120 hours to complete their first submission; 64% of those that filed a second time around said it took less than 40 hours
• 45% of those that filed a second time said it was significantly easier the second time

Isn't that fantastic news: preparation time for creating XBRL-formatted financial statements decreases dramatically after the first filing. Ummm, we knew that and have been saying it for years.

 But - not 10%, but 57% said that it took them over 120 hours. Not 10% taking more than 80 hours. In fact, looking at the detail of the results and you get only 16% saying that it took them less than 80 hours. Not 90%.

And repeat effort? Well, I think we can guess that the results would not match the promise. I particularly like the line in the summary report: "45% of those that filed a second time said it was significantly easier the second time". Significantly easier for only 45% of filers. I certainly hope that the 3rd and 4th filings are significantly easier. Being fair, 14% of respondents to that question had not filed for a second time, so the total percentage of significantly easier is greater than 50% of second time filers.

This has to raise questions about the estimates being provided for the effort involved in creation of detailed tagged footnotes. I've written before that this is a major concern to me. I remain very concerned that the overhead involved, at a time when companies are tightly stretched for resources, could tarnish the image of XBRL as a standard for increased efficiency and effectiveness.

Certainly the "real" effort will play nicely into the hands of the consultants and major accounting firms who will happily sell resources to assist companies in meeting that resource gap. But XBRL is not about selling consultant services, except perhaps for some partners in those firms that have touted XBRL for years, invested heavily, and have felt the heat internally to deliver some real revenue for all this investment.

I'm reminded of a great quote, usually unattributed, that we read before every war - "Those that are talking don't know, and those that know aren't talking". The simple fact is that many of the mouthpieces have never actually spend the time required to create an SEC-ready XBRL instance document. They have never been able to take themselves away from their very important meetings to actually spend the 80 - 120 - ? hours involved in creating the XBRL.

Some Recommendations

It is painfully clear that the effort estimates that have provided a backbone for the arguments in favor of XBRL have been wrong. Regardless, I remain convinced that XBRL will deliver benefits across the information supply chain, especially to regulators and investors. I remain convinced that the range of opportunities for XBRL to increase business reporting efficiency and effectiveness are vast and that we have not even begun to think of all the ways XBRL will improve reporting, or the range of applications.

However, there are some lessons and recommendations that flow directly from this latest information:

• Footnote tagging will not be 200 - 250 hours of effort. That is a bogus number founded on nothing more than the best dreams of the advocates for XBRL. XBRL US and the SEC should run real exercises creating real instance documents, and publish the time and effort required.
  
• Companies should significantly increase their estimates for resource requirements.
• Companies in the "first wave" should start their footnote tagging exercises NOW.
• Companies coming up on their first XBRL filing should start planning as soon as possible, and should be having "trial runs" well before summer.
• Mouthpieces of the large firms should reconsider their estimates, and begin to give some honest assessments of the effort.

Who is Your Audience (CSR/ESG reporting)?

This article is a response to an online e-mail discussion askingIs there any point putting together a CSR report?" The resounding answe ris "Yes, provided you communicate with your intended audience"

It is all a matter of defining your audience, and in particular, the audience for you CSR / sustainability / ESG report, which I'll collectively refer to as the CSR report.

Lets think about a few primary audiences, because each has different needs:

1. General public / retail customers
2. Supply chain partners
3. Investors
4. Employees
5. Regulators

1. General public / retail customers

There is a growing and general acceptance that retail customers will purchase based on the perceived social conscience / "green" credentials, as long as the produce is also competitively priced. That is especially true today. This means that it is important for a company to burnish its CSR credentials through any medium possible, and that include the CSR report.

There is also the need to be seen to be pro-active, just in case they are "caught out" by some bad PR. When (if) that happens, the company is then ready to pull out all its good works, and make the appropriate noises about how they are doing everything to make certain is does not happen again.

2. Supply chain partners

This includes both their customers and their suppliers. Customers want to know that the company is following sound business practices, acting in a sustainable manner, and fundamentally reducing risks that may travel upstream. After all, when the bad stuff hit the fan, it get spread far and wide. So CSR / Sustainability / ESG reporting that provides comfort to commercial customers focuses in demonstrating how the business is also protecting its customers from potential PR risk. It also demonstrates that sustainability practices are being applied to drive down costs, thus being able to deliver future cost advantages that competitors may not be able to deliver.

Equally, effective reporting sends messages to suppliers about expectations, and gives suppliers key messages about what might endanger the existing business relationship, especially any potential situations in which a suppliers PR problems might impact the company. Clearly stated supplier CSR policies put suppliers on notice that they will need to maintain the highest CSR standards themselves in order to retain their position as suppliers, or to gain an advantage by becoming preferred suppliers. WalMart's actions recently are a great example of establishing expectations in their supplier community.

3. Investors

Investors, including the actual shareholders (the owners) and the investor community (those that advise existing and potential owners) are a legitimate audience. They want metrics; detailed information that will support and enable investment decision making. They want comparative information that is multi-year, and that can provide insights into the company's performance against other key players in the same industry. Frequently reports that focus on the first two audience groups fail to provide adequate information for this audience, and are dismissed as "fluffy bunny bullshit" by the analysts. Analysts want tables of information that span multiple years, and that clearly show future objectives and how those objectives will be achieved.

Recently the DVFA (the German Institute of Investment Analysts) release a set of KPI (Key Performance Indicators) for ESG. This set of KPIs is broken out by major industry groups, but also contains a core set of KPIs that that they expect to see regardless of the industry.

4. Employees

Sometimes the primary audience is right there in front of you, the employees of the company. CSR / Sustainability / ESG reports for employees are and should be focused on what the company is doing, and the role of employees in individually making it happen. There reports are motivational, and should serve to bring employees together for the effort. They also provide an opportunity for communication of changes that might otherwise be buried in a staff bulletin, or not communicated at all. A classic example was came from the results of the "Talk Back" process at New Zealand Post some years ago. One mail centre specifically spoke about the quality of lighting. This lead to a review, and improvements in overall lighting, improving both performance, quality of work environment, and costs.

5. Regulators

Finally companies communicate with regulators, both directly and indirectly through public messaging. The use of the CSR / Sustainability / ESG report to communicate support for and compliance with various standards is one such way. Reading the CSR reports for the building industry tends be like reading a prose version of how the reporting company is ensuring compliance with various health and safety legislation, or preparing itself for compliance with incoming GHG emissions standards.

In in the United States, the ability to demonstrate a strong legislative compliance program, complete with effective risk management processes, can be used as mitigating factors in sentencing for any crimes that the organization might be accused of being involved in. Communication of these programs in CSR reports is one way that companies, in effect, are using CSR reporting to communicate indirectly with regulators.

Summary:

Before judging a company's CSR report, consider what primary audiences are being addressed. As a company, before creating a CSR report, carefully consider who you want to be speaking to, and what are the key messages that you want that audience to take away. Finally, companies might consider creating multiple CSR reports, targeting specific audiences.

I hope this is helpful in addressing the question in the subject line of this e-mail stream.