2 Historical Basis for Disclosure

Question 1

What are four aspects of today’s financial corporate disclosure in terms of what standardized and normal companies consistently report?

Answer 1

1) high quality financial information
2) through well established reporting channels
3) reinforced by legal requirements
4) creating a rich bedrock of financial information for capital markets

Question 2

In 1929 the London Stock Exchange crashed due to _______________

Answer 2

prominent fraud claims

Question 3

What are four reasons the NYSE crashed one month later in 1929?

Answer 3

1) fraudulent investment practices
2) declines in consumer demand
3) misguided economic policy
4) overextended credit

Question 4

What are five impacts of the Great Depression?

Answer 4

1) wave of bank failures
2) record unemployment rate
3) declining income
4) GDP dropped 15% (compared to 1% during the Great Recession)
5) 80 percent drop in market value by end of June 1932

Question 5

What had disastrous consequences, eroded investor confidence, and had real world impacts of market failures?

Answer 5

Lack of transparency

Question 6

What did the US Supreme Court say in 1914 regarding disclosure as the basis of regulatory reform?

Answer 6

“sunlight is the best of disinfectants”

Question 7

What are two key elements to monitoring companies and investors that collectively shape capital markets?

Answer 7

public exposure and transparency

Question 8

What are three reasons the SEC was established in 1934?

Answer 8

1) protect investors
2) maintain fair, orderly and efficient markets
3) facilitate capital formation

Question 9

Scholars saw mandatory disclosure as a method to do what two things?

Answer 9

1) hold management accountable to their shareholders
2) promote the public interest

Question 10

The legislative history of formation of the SEC points to what two reasons?

Answer 10

1) protect investors
2) influence corporate behavior

Question 11

Congress referred to SCOTUS / Brandeis when expressing the hope that the disclosure of financial information would “________________”

Answer 11

“change the way business was conducted”

Question 12

Across countries, what are the most global and universal purposes for financial disclosure?

Answer 12

1) protect investors
2) foster sound markets

Question 13

What are three countries that are examples of the most universal purposes for disclosure?

Answer 13

Japan, Hong Kong, New Zealand

Question 14

The question of what information to disclose relied on what concept?

Answer 14

Materiality

Question 15

What is materiality?

Answer 15

A framework through which companies differentiate information that should be disclosed from that which is not necessary to disclose

Question 16

Materiality helps regulators to do what?

Answer 16

determine whether enforcement action is appropriate for false, misleading, or incomplete disclosures

Question 17

Materiality helps courts to do what?

Answer 17

Make final decisions in cases of disclosure-based litigation

Question 18

What does US case law demonstrate with regard to materiality?

Answer 18

It has changed over time

Question 19

What did the National and TSC joint filing of a proxy statement demonstrate with regard to materiality?

Answer 19

There was an allegation that executives at National served on TSC’s board that was not disclosed

Question 20

What does “total mix” refer to?

Answer 20

SCOTUS determined that information is material if its exclusion would alter the “total mix” of information considered by a reasonable investor

Question 21

Information is deemed to be material if it is:

Answer 21

“significantly likely” to be considered by a reasonable investor in investment decisions

Note: threshold is higher than “might be considered”

Question 22

What did the materiality definition expand to be assessed by?

Answer 22

The probability that an event might take place and the magnitude of the event on the company

Question 23

What did the SCOTUS case regarding Basis Inc and Combustion Engineering exemplify?

Answer 23

They made 3 public statements denying merger conversations were taking place, and then merged, leading to an investigation as to whether it was materially false or misleading to shareholders

Question 24

What is the probability and magnitude test?

Answer 24

Determination of materiality should consider the probability that an event will happen and the magnitude of the occurrence of the event

Question 25

What did the BP pipeline statement regarding corrosion detected at a “low manageable rate” exemplify?

Answer 25

A Federal court found the statements materially false given a second leak was identified months later after the first spill

Question 26

What does GAAP stand for?

Answer 26

Generally Accepted Accounting Principles

Question 27

What is historical cost accounting?

Answer 27

Measures the assets value as the actual cost paid at the time of purchase such that the value does not change over time

Question 28

After the tension of multiple non-standardized methods that persisted for over 10 years, what happened?

Answer 28

A new organization - Accounting Principles Board was formed and replaced the Committee on Accounting Procedure in 1959. All accounting firms followed APB guidance

Question 29

What are three key aspects of decision usefulness in terms of this shift of reported information?

Answer 29

1) shifted the emphasis of disclosure away from strict historical asset valuation
2) shifted purpose towards informing decisions rather than performing a singular function (e.g. to provide accurate measurement)
3) recognized the importance of providing foward looking statements

Question 30

What is a difference for how Australia, New Zealand and United Kingdom account?

Answer 30

They allow the revalue of property, plant and equipment (PPE)

Question 31

Globally, in the 1970s, the International Accounting Standards Committee was founded to standardize internationally in more sophisticated markets. What did it become?

Answer 31

In 2001 it became the International Accounting Standards Board (IASB)

Question 32

What does the International Accounting Standards Board do?

Answer 32

Oversees the development of the International Financial Reporting Standards (IFRS) required by public companies in over 140 jurisdictions

Question 33

What are three countries where IFRS is optional?

Answer 33

China, Japan, United States

Question 34

What replaced the Accounting Principles Board in the United States to establish U.S. GAAP?

Answer 34

Financial Accounting Standards Board (FASB)

Question 35

The American Institute for Certified Public Accountants published a report on decision-usefulness and stated what about environment and social goals?

Answer 35

1) they are equally important
2) environmental externalities such as pollution pose costs on the rest of society
3) the objective of financial statements is to report on activities of enterprise affecting society which can be determined and described and measured and are important to the role of the enterprise in the social environment

Question 36

CHECK FOR UNDERSTANDING: Why was disclosure the basis of regulatory reform in the wake of the 1930s stock market crash?

Answer 36

The stock market crash of 1929 sent shockwaves throughout global markets, leading
to global economic declines and the onset of the Great Depression in the United
States. The event provides perhaps the most striking example of how lack of transparency in capital markets can have disastrous consequences – harming socioeconomic well-being, bankrupting companies, and
eroding investors’ confidence in the information they rely on from companies to make investment decisions. Disclosure was the basis of regulatory reform in this defining period because disclosure is a means to promote transparency, and transparency is essential to fostering sound and efficient capital markets. As evidenced by the basis of the formation of the US SEC, regulated corporate disclosure is an effective mechanism to protect investors, positively influence
corporate behavior, and enable informed investor decisions.

Question 37

CHECK FOR UNDERSTANDING: What is the relevance of “materiality” in the context of disclosure, and how has the concept historically been interpreted?

Answer 37

The concept of “materiality” traditionally focuses on information that impacts financial performance and investor decision-making. n the wake of regulatory efforts to enhance transparency from corporations, the concept was adopted to provide guidance to reporting companies. Though companies were now held to higher standards of transparency, to require the disclosure of all information would place undue burden on reporting companies. “Materiality” dictates what companies are (and are not) obligated to disclose.

Question 38

CHECK FOR UNDERSTANDING: How has the purpose of accounting changed since the 1930s, and why did financial reporting move towards standardization?

Answer 38

In early years, accounting practices centered around accurate recordkeeping via historical cost accounting. This founding purpose shaped the accounting profession, where
accuracy and reliable record keeping are paramount. However, to serve their own
unique goals, firms began accounting and reporting financial information using a range of methodologies, ultimately inhibiting the comparability of financial statements. This fragmentation of accounting practices necessitated a push by accounting associations to come to a consensus regarding the true purpose of accounting and to promote standardization. The profession ultimately determined that accounting exists to provide information for the purpose of making economic decisions, which can include both historical records and forward looking information. High levels of adoption of standards such as the International Financial Reporting Standards (IFRS) and US GAAP allow investors around the world to efficiently source and use the information yielded through the standards. With higher levels of standardized disclosure comes more consistent, comparable, and reliable information across
markets, allowing investors to equally assess and compare companies’ performance and
prospects.