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Full Disclosure: All Investors Need to Know

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

Accountants, investors, creditors, and other users of financial statements know that financial reporting is not only about the numbers. The notes to the financial statements can paint a more complete picture of how an entity operates and offer a context in which to understand the numerical amounts. Everything we needed to know about full disclosure, we learned in Accounting 101—it is an integral part of financial reporting's conceptual framework and is intended to provide third parties with the information they need to make an informed business decision about an entity. We were also taught that determining whether certain information should be disclosed rests primarily on whether it is likely to influence a user's decision. To ensure that full disclosure is not overly burdensome to the provider, this concept is tempered by a “cost-benefit” constraint.

Sam E. Antar, convicted felon, former CPA, and former CFO of Crazy Eddie, underscores the significance of disclosure to financial reporting. “Read the footnotes first,” he advises investors on his White Collar Fraud website (whitecollar-fraud.blogspot.com/p/advice.html). Crosschecking disclosures with those in prior periods can help investors spot inconsistencies and notice red flags of potential fraud. Antar warns that seemingly minor changes can have a huge impact on the bottom line. He speaks from experience. In the Crazy Eddie fraud, the change of a single word, from “Purchase discounts and trade allowances are recognized when received” to “recognized when earned,” allowed him to inflate the company's bottom line by approximately $20 million in 1987.

Simple Concept, but Hard to Apply

The recent release by the Financial Crisis Inquiry Commission of a document issued on February 14, 2008, by the Office of the Comptroller of the Currency (OCC), a federal agency that charters, regulates, and supervises all national banks, provides an example in which certain information could have had a significant impact on shareholders' decisions—but it was not disclosed. In this document, the OCC expressed concerns regarding Citigroup's (unrealistic) valuation of its illiquid collateralized debt obligations (CDO). Subsequently, the bank experienced significant losses—largely due to the faulty valuation models applied to these CDOs—and was eventually bailed out by the federal government to the tune of $45 billion. Yet the OCC's concerns weren't mentioned in Citigroup's financial report or in the auditor's report.

Why wasn't the OCC's concern disclosed in Citigroup's 2007 financial report? Sarbanes-Oxley Act (SOX) section 302 clearly lays out corporate officers' responsibilities for financial reporting. These responsibilities include certifying that the company's financial report “does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading.” Aren't regulatory concerns regarding the reliability of a company's valuation models the kind of information investors need to make an informed decision about a company? Did Citigroup's CEO and CFO believe that this information was immaterial? Would the costs of disclosing it have been overly burdensome? Did Citigroup violate (at the very least) the spirit of the law?

Furthermore, why didn't the independent audit report refer to the problems cited by the OCC? How can the investing public have confidence in the capital markets when omissions of material facts continue to go unaddressed by auditors? Perhaps it was KPMG's professional judgment that this information was immaterial. No one knows Citigroup better than KPMG—the firm has been Citigroup's auditor for more than 40 consecutive years—but questions linger regarding whether an auditor can be independent and objective, in appearance or fact, within the context of such a long relationship.

Investors know and accept that there are inherent risks in the market. What they can't and shouldn't accept are the risks that they are not receiving important information concerning their investments.

Unless public company officers, regulators, and auditors can maintain the integrity of financial reporting, U.S. capital markets will lose the ability to attract investor financing. Giving investors all the information they need to make an informed decision is essential to strong capital markets and sustainable economic growth.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief. ACFE Endowed Professor of Fraud Examination, York College, The City University of New York (CUNY), mkranacher@nysscpa.org.

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