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Simplicity for Sophisticates

Making disclosure more readable will be vital in the post-reform era

August 2010

The financial reform bill signed into law by President Obama in July 2010 called for an investigation into broker-dealers’ duties toward investors, known as the fiduciary standard. This compromise between lawmakers – mandating only a study for now – will result in little immediate change in day-to-day broker practices. But the debate over fiduciary duty spawned by the legislative process raised some important issues we hope will be addressed in the study.

A central question is the amount of information disclosed to potential investors. The general belief is that so-called “sophisticated” investors need less information, while less financially seasoned – or retail – investors need more.

But in the wake of the financial crisis, even those who met the SEC’s technical definition of Sophisticated Investor found themselves confused by disclosure documents that weren’t always clear.

Gargiulo + Partners believes clearer communication is necessary for all investors, regardless of their level of sophistication. Basic prudence in structuring complex information not only makes it easier to decipher public and private disclosure documents; it can also improve a firm’s reputation for fair and transparent dealings.

Certainly, there are limits to how simple the communications for any financial instrument can be; securities laws mandate extensive disclosure. But firms can greatly improve this disclosure through simple, straightforward communications techniques: top-lining information, providing context, explaining relevance, and using plain language.

For example, consider the executive summary, a feature common to prospectuses, financial analyses, regulatory filings, and private placement memoranda for decades. What started as a helpful attempt to highlight key elements for decision-makers has morphed into its own distinct section, with a murky mission. It doesn’t always summarize the rest of the document, it often contains data not found elsewhere, and it leaves out other material details. In 1998, a Securities and Exchange Commission report lamented, “Many summaries now seem as long as the [disclosure] document itself.” To make executive summaries the helpful tool they were intended to be, firms must be diligent in summarizing their offerings, previewing the conclusions of each section, and selecting the right highlights.

The basic structure of a document – starting with the table of contents – can also go a long way toward improving clarity. Message titles, rather than generic topics, guide investors toward key findings before they’ve dug into the text. Rather than a title such as “Impact of Funds’ Capital Structures and Leverage Strategies on Performance,” a shorter yet more direct heading like, “Use of Leverage Increased Returns by 2%” provides useful, meaningful context. Starting each section with the conclusion or highlight, then building the case for it, increases the likelihood that investors will read on and thereby better understand crucial details.

A significant proportion of the losses sustained during the financial crisis can be attributed to market participants, of all kinds, being either unwilling to consider or unable to comprehend their investments. Human nature being what it is, it’s good practice to make sure financial communications don’t just disclose information but also provide conclusions that enlighten readers. Such efforts may help Wall Street win back investor confidence, no matter how regulatory reform ultimately takes shape.

Fear of Freshness
How to respond to market demand for crisper communications
Lost in Transparency
Disclosure is not enough - financial reform must also mandate clarity
Seeing Clearly
Transparency is no substitute for clarity
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