Written by Bob Schneider Posted on April 15, 2007
"There are eight million stories in the Naked City. This has been one of them."
I was reminded of that tag-line from the famed TV crime drama when I recently re-read Max Rottersman's post on XBRL and Mutual Funds Compliance in which he wrote:
"I've witnessed millions of dollars and careers that have been ruined from incorrect or cavalier interpretations of the rules. I've never heard of someone losing their job over bad data. Therefore, XBRL will have a hard time selling itself to the fund community based on arguments for efficiency and data integrity. These promises are out-of-touch, if not irrelevant."
Since Max has been the chief compliance officer of a mutual fund, I'm certain he knows what he's talking about and I have no reason to contradict anything he says.
But I would like to suggest that, outside the mutual funds neighborhood, there are stories in the Compliance City -- maybe not eight million, but more than a few that carry a slightly different message. Here's one of them.
Long ago, for several years, I helped assure that the equity research of a large investment bank complied with Rule 472 of the New York Stock Exchange governing communications with the public by member firms. The rule has been changed and strengthened considerably since I helped administer it. But first as staff to the department's Supervisory Analyst and later as an SA myself, I had two types of responsibilities.
First, I was to ensure the analyst had a reasonable basis for making his recommendation (don't ask me how an SA could sign off on an Internet buy call based on the number of clicks its website got I don't know). Second, I had to make sure the analyst didn't write things like "This winner is the Alice Kramden of all stocks -- it's going to the moon, baby!"
Because most heads of research don't want to read analyst reports all day, the SA function is often delegated to people with (1) the (minor) analytical abilities necessary to pass the required Series 16 SA exam, and (2) some writing skills, so the report can be both SA'd and edited by only one set of eyes. (Of course, the lawyers reviewed all reports for legal matters, like Chinese Wall issues; but they didn't care about anything else.)
In any organization, most of the prestige and power go to the people who bring in the money. At a big brokerage, that's the investment bankers and traders. Although the words of big-name research analysts can move stock prices, the research product itself (mostly) commands only so-called soft dollars, which is not nearly as much fun as the hard stuff. In short, investment research is staff, not line. And if you're a staff person in a staff department like I was, you really are a nobody.
But a nobody with an additional responsibility beyond simple compliance: to make sure the firm published a quality editorial product. And that's where's data accuracy comes in.
Because even though it wasn't my job to check the analysts' numbers, it was my job to make sure readers could trust what they were reading, and that the firm's brand was protected. Because if an EPS estimate is shown as actual, or if 200X and 200Y data are reversed, or if pages 3, 16, and 22 of a report each have different numbers for cash flow, then readers begin to lose faith in what they're reading --not just for this one analyst but for all your other publications as well. In other words, whatever else the rest of the firm was up to, I was working in or at least considered myself to be working in -- financial publishing.
I don't want to make it sound like I stood there with sword unsheathed, fighting for data accuracy against a horde of sloppy and indifferent analysts. Obviously, no analyst wants a mistake-ridden report. But as analysts, they simply had different priorities 99% accuracy, especially on non-essential data, was certainly good enough. Of the thousands of reports I SA'd, I had analysts yell at me dozens of times for not getting their research published yesterday, but never once about messing up their numbers.
Most of the work I did made little difference. In retrospect, a lot of the time I was overzealous about producing a first-class editorial product when I should have been more attentive to analyst priorities, not to mention profit enhancement.
But very occasionally an SA erred in the other direction, and it cost us big time. One SA screw-up especially comes to mind (no, it wasn't me, but there but for the grace of God). An analyst did a report on a Swedish company, and somehow during the production process, krona-denominated figures were wrongly presented in US dollars. Upon reading the published report, the company, which had been an investment banking client, figured our firm didn't know what it was doing and took its business elsewhere.
What points am I trying to make? First, the compliance function may be used for non-compliance needs. The risk of sanction by the NYSE was small; but the necessary compliance function underpinned the objective of creating a first-class editorial product, which was deemed (rightly or wrongly) by management as a significant selling point for the firm's research. Making very bright, aggressive research analysts submit to an editorial process that wasn't somehow coupled with a compliance requirement would have been very difficult.
That the editorial process may have gone too far, and may have even introduced errors into the process, is cautionary, but irrelevant to my point management wanted significant control over its research product. And I'm certain compliance is used in similar fashion by other powerless entities in organizations to maintain some degree of control over powerful people who might otherwise be difficult to tame.
Second, although it's impossible to know if the adoption of XBRL would have assured that the Swedish company's data would have been published correctly, my sense is that interactive data will go a long way to reducing the possibility of such mix-ups in currencies as well as mistakes like wrongly labeled columns for yearly and quarterly data, forecasts presented as actuals, and so on. That's probably not a big selling point for XBRL among individual analysts, but it is certainly a positive for any organization that publishes financial information and wants to maintain its credibility in the marketplace.
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