To Disclose or Not to Disclose? Wells Fargo Woes Shine Light on a Knotty Problem -- 2nd Update
September 29 2016 - 2:31PM
Dow Jones News
By Michael Rapoport
When is something important enough to a company's business that
it should tell investors?
Wells Fargo & Co.'s sales scandal provides a real-life
window on the often-knotty question of deciding when a piece of
information is "material" and so must be disclosed to investors. In
part, that is because the rules are complex and not always well
understood -- many observers think materiality can be determined
simply by crunching the numbers, but that isn't always the
case.
Wells Fargo didn't disclose anything publicly about its
"cross-selling" abuses or looming settlement with regulators before
the pact was announced Sept. 8 -- including in its second-quarter
Securities and Exchange Commission filing weeks earlier, on Aug. 3.
Three Democratic senators who grilled the bank's chief executive
last week now have asked the SEC to investigate whether Wells Fargo
misled investors by failing to disclose the issue sooner.
While the bank's management had known since 2013 that some
employees had created deposit and credit-card accounts for
customers without their knowledge, the accounts were a tiny portion
of Wells Fargo's business. The settlement, which included a $185
million fine, was less than 1% of last year's earnings. The matter
was "not a material event," Chief Executive John Stumpf told a
Senate panel last week.
That is true in terms of the bank's income statement. Not so its
reputation or share price. The bank and Mr. Stumpf have faced a
political and public furor and the stock has lost nearly 10% since
the settlement, or about $23 billion.
Members of Congress have been skeptical of the bank's
contentions that its problems didn't rise to the level where it
would be required to inform investors. "If that's not
material...this occurring over a five-year period of time as a
systemic problem in the organization, I don't know what is," Rep.
Scott Garrett, (R., N.J), told Mr. Stumpf Thursday as the CEO
testified before the House Financial Services Committee.
Given the depth and breadth of the problems at the bank's retail
operations, which account for about half of profit and revenue,
others argue Wells Fargo should have given investors some signal a
problem was brewing. "It seems pretty significant to me if the
whole world's talking about it," said Philip Woodlief, an adjunct
professor of management at Vanderbilt University.
The three senators -- Jeff Merkley (D., Ore.), Elizabeth Warren
(D., Mass). and Robert Menendez (D.-N.J.)----have asked the SEC to
investigate whether Wells Fargo committed fraud by failing to
disclose its fake-account problems even as it was touting to
investors how many products it was selling to each customer. The
senators also asked the SEC to probe whether the bank violated
whistleblower protections.
"This certainly has a reputational risk to the company -- it
seems like that would have been material," Mr. Merkley said in an
interview with The Wall Street Journal earlier this week.
Spokesmen for the SEC and Wells Fargo declined to comment.
The standards for determining whether a piece of information is
material differ somewhat depending on the regulator involved. And
some regulators are considering changes in existing standards
around what is material information. In short, it is something of a
gray area.
Generally speaking, materiality depends on whether a reasonable
investor would consider the information important enough to affect
the investor's decision to buy a company's securities.
Many companies and investors use a rule of thumb that something
has to make up at least a specific portion of the company's
business to be considered material -- 10% of revenues, for
instance, or 5% of earnings. But companies are supposed to go
beyond the numbers and consider "qualitative" factors as well.
The SEC has said a relatively small error on the financial
statements could still be material if, for instance, it affects a
company's regulatory compliance, conceals illegal transactions or
increases management's compensation.
The key question, Mr. Woodlief said, is does a development
"affect the total information available to investors?"
The rules are murky enough that accounting experts can differ
about whether something is material. Jack Ciesielski, president of
accounting-research firm R.G. Associates, said Wells Fargo may have
viewed the cross-selling problems as an isolated issue that it
managed on its own, and noted the fake accounts comprised less than
2% of all those the bank opened during that time frame. "I think
it's got to be immaterial," he said.
Then again, Mr. Ciesielski said, when the bank was negotiating
with regulators over the matter and knew a settlement was possible
soon, then "I think they had to say something at that point."
The SEC is considering whether it should change its standards
for what's material, as part of a broader look at its disclosure
rules. In April, the commission asked for public comment on whether
it should "consider a different definition of materiality for
disclosure purposes," and on whether it should use "a combination
of quantitative and qualitative thresholds" for disclosure.
Write to Michael Rapoport at Michael.Rapoport@wsj.com
(END) Dow Jones Newswires
September 29, 2016 14:16 ET (18:16 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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