Disclosures are at the center of the public's crisis of confidence when it comes to the corporate world. They should be viewed as a very important and informative part of a research report, but until recently, they have gone relatively unnoticed. This article will define what a disclosure is and why it is important to investors. (To learn more about the corporate world, see 5 Of The World's Oldest Companies.)
TUTORIAL: Financial Statements
According to Webster's Dictionary, the definition of "disclose" is "to uncover or reveal." In research reports, a disclosure is a statement that reveals the nature of the relationship between the analysts, their employer and the company that is the subject of the research report (also known as the "subject company"). It also provides other statements (warnings) that investors should read.
The disclosure is as important to a research report as footnotes are to a corporate financial report. The Securities and Exchange Commission requires that all research reports contain a disclosure statement. In my article "Six Signs Of An Objective Research Report," I stated that if you are reading a research report that does not have a disclosure statement, you should throw it away. You should not trust a so-called research report that does not have a disclosure statement.
The importance of disclosures is evidenced by the fact that they appear at the end of the report and usually in very small print, like footnotes to a 10-k. A disclosure contains information on the relationship between the analyst, the brokerage firm that employs him or her and the subject company. It may take a magnifying glass and a strong cup of coffee, but if you read it you should be able to determine who "paid" for the research report and the degree of objectivity that may, or may not, be present. (To learn more, see Pick Better Stocks By Consulting Form 10-K.)
In Plain English
The bad thing about disclosure statements is that they are written by lawyers, who are more concerned about protecting the brokerage firm than providing easy-to-read information. Lawyers use legal boilerplate that makes disclosures verbose and hard to read (hence the need for the strong coffee). Disclosures have typically been printed in small type because they are long and because brokerage houses want to save paper (thus the need for a magnifying glass). (To learn more, see How To Interpret A Company's Prospectusand Where can I get a company's prospectus and/or financial statements?)
The key points covered, or stated, in most disclaimers are as follows (with my added comments and explanations):
- "This report contains forward-looking statements ... actual results may differ from our forecasts." (In plain English, "This is our best guess, but we may be wrong.")
- "This report is based on information from resources that we believe to be correct, but we haven't checked it." (In other words, "As recently proved, we all assumed that corporate financial statements contained true information about a company's operations. But, no analyst can audit a company's books to verify the truth of that assumption. That is the job of the accountants.")
- The nature of the relationship between the subject company and the brokerage firm. Does the firm make a market in the stock, and/or have they done investment banking for the subject company? (Brokerage firms do not produce research reports for free. Historically, income generated from trading, or investment banking, has funded research departments.)
- Whether or not the analysts and other members of the firm may trade or own shares in the subject company. (Is it bad that an analyst puts his money where his mouth is?)
- "This report is being provided for informational purposes only, and on the condition that it will not form a primary basis for any investment decision." (Then why are you giving me the report?)
- "Investors should make their own determination of whether or not to buy or sell this stock based upon their specific investment goals, and in consultation with their financial advisor." (Probably the best bit of advice in the disclaimer.)
More disclosure is always a good thing, but if history is a guide, the "new" disclosure rules will be no better than what we already have. Some of the current proposals call for the disclosure to be on the front page and to contain "more information." But, this requirement may result in more words and less information.
Disclaimers best serve investors when they are written in the KISS (keep it simple, stupid) style. For example, I propose the following format for disclaimers:
- This report is based on public information that we assume to be true and correct.
- My assumptions and forecast may be wrong.
- I own xx shares and have owned these shares for xx years.
- Our brokerage firm makes money by making a market and performing investment-banking services for the companies in this report.
- This investment may not be suitable for all investors. You must consider your specific investment goals and styles before investing in any stock. Consult with your financial advisor before making any investments.
Disclosures of this clear and succinct style will help investors regain some confidence in Wall Street. And they just may add some lawyers to the unemployment line.
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