The dangers of a little knowledge

What is one to do when faced with City analysts who have not fully understood the details of Sarbanes-Oxley compliance, asks Robert Bruce.

There are many frustrations in being a financial director. One of the greatest is being lambasted in the newspapers for the share price dithering because of a perceived lack of clarity about what the company is up to.

Sometimes the reason is that the financial director has got something wrong. But mostly it is because the established channels of communication between the company and the markets have not been working smoothly. Analysts are the key.

Throughout the long period of time when the spectre of international financial reporting standards app-roached, analysts were pushing back the day when they would have to deal with it.

Every time you made a polite enquiry they would say they were actually frightfully busy on something else. The latest flurry of interim results was upon them. But they knew something big was on its way and would turn their attention to it in due course.

What they were doing is what their job forces them to do. They were firefighting. Information lands on them in an avalanche. They have every intention of sitting down in a quiet time to mug up on the changes ahead. But, as every good student of firefighting as a management culture knows, that period of quiet time never comes.

So, currently, they are all scrambling around trying to cope with the international financial reporting standards. And we all know what happens if there is a bit of an emergency on. Something else comes along to catch you off balance.

And so it is with the analysts. That something is Sarbanes-Oxley. For most of us this cloud has long moved from the horizon to a point where its lowering detail obscures the midday sun. But for the analysts it has yet to appear on their weather chart.

Take the latest research from PwC, for example. It covers analysts, investors and credit rating agencies around the world, roughly a third in Asia-Pacific, a third in Europe, and a third in the Americas.

Asked what they knew about the infamous section 404 of the Sarbanes-Oxley legislation, the section at the heart of certifying that a company’s corporate reporting can be relied upon, only four per cent bravely said they knew a great deal.

Then it was all downhill: 18 per cent said they had never heard of it; a further 22 per cent said they had heard of it but knew nothing about it; and a hesitant 38 per cent said they knew a little about it.

As you might expect, these low levels of understanding have worrying implications for what will happen when investor information containing less than fully positive details emerge.

When the survey asked the respondents whether they would mark down or sell shares on seeing that the auditors had issued a negative section 404 report, the answers were straightforward: 50 per cent said they were fairly likely and another 22 per cent said they were very likely to either mark down the shares or sell them in such circumstances. Another three per cent said they were ‘certain’ to take such action.

So financial directors are faced with a situation where the people who move the markets have little knowledge of an extremely important, if tiresome, chunk of legislation and 75 per cent of them are likely to dump stock because of it. Not surprisingly, the survey goes on to show that any negative section 404 disclosures would have a substantial impact on a company’s valuation.

It is likely to be a long, hard and dispiriting slog. But the benefits of doing it effectively will be great.