The OSC has issued Staff Notice 52-719, Going Concern Disclosure Review, commenting on a “need for improvement in both the timeliness and robustness of the going concern disclosures” and providing some examples for doing better. I always enjoy engaging with such regulatory publications and respectfully poking at them, and I hope I’ll be forgiven for doing the same here. The nature of my poke, I suppose, is that I’m not sure the issue really warrants the emphasis placed on it here (relative to all the other issues out there).
You might say, well what can be more important to investors than the core issue of whether or not a company can continue to operate? But I think that confuses the underlying concept. Looked at in the context of IFRS (which is much the same as Canadian GAAP in this respect), going concern disclosures aren’t primarily about communicating operating risk, but rather about the integrity of the accounting. The Framework sets out the concept as follows: “The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such an intention or need exists, the financial statements may have to be prepared on a different basis and, if so, the basis used is disclosed” (my emphasis).
The point of the italicized passage is that if the entity knows it’s going to (say) liquidate, then some of the values that would otherwise be included in the statements will make no sense – for instance, it will be obviously wrong to show carrying values for property, plant and equipment calculated on assuming an extended useful life. But the “if so” acknowledges that even if a liquidation is pending, the financial statements won’t necessarily have to be prepared on a different basis – for instance, if the balance sheet consists entirely of financial instruments measured at fair value for which no adjustment would be necessary. In this case, that passage of the Framework, read literally, wouldn’t require any additional disclosure; it would be indifferent in effect to whether a liquidation is pending or not.
IAS 1.25 expands on this: “When management is aware, in making its assessment (of the ability to continue as a going concern), of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern, the entity shall disclose those uncertainties.” But the point here, again, is about the relevance of those uncertainties to assessing the recognition and measurement decisions taken in preparing the statements, not about their implications as a whole. This is logical because any number of reasons might exist why a particular set of financial statements is a poor guide to the future (changes in economic conditions, enhanced competition, departures in key personnel, and so on), but none of these would typically be disclosed there. That’s the importance of MD&A and other aspects of the continuous disclosure regime.
So the OSC notice confuses the point I think when it says: “Going concern disclosures are important to investors as they provide warnings about significant risks that the issuer is facing and may help investors avoid or minimize negative consequences when making investment decisions.” It’s an odd statement to say the least, implying that the specific “going concern” label (on financial statements potentially appearing several months after the events it depicts) will resonate with investors, saving them from “negative consequences,” in a way that other disclosures about risk and uncertainty won’t. It’s hard to see why the OSC would even want that to be true.
The following passage compounds the oddity:
During our review, we often found it difficult, based on the entity’s public disclosures alone, to differentiate uncertainties that cast significant doubt on an entity’s ability to continue as a going concern from uncertainties that do not cast such doubt, and had to request additional information from the issuer for clarification. Investors do not have the ability to request this additional information and rely on the public disclosure record to make investment decisions. That is why clear robust disclosure is important. In order for the going concern disclosures to be useful to investors, the going concern disclosures should explicitly identify that the disclosed uncertainties may cast significant doubt upon the entity’s ability to continue as a going concern.
Again, this seems to place too much emphasis on a particular narrow form of articulation. An investor’s interest in the financial statements is ultimately focused on what it says about the prospects of her stake in the company, and those prospects are obviously affected by the existing uncertainties. But in most cases, going concern disclosure is (or should be) only an aspect of the uncertainty, not (as the notice implies) some kind of culmination of it. For example, an investor might buy into a going concern-challenged company at 5 cents per share, risking a loss of the entire 5 cents. Alternatively, she might buy shares of a big bank at $10 per share, risking a loss of much more than 5 cents per share on any given day, just based on normal volatility. Which of these situations poses the greatest risk for investors and merits the more prominent disclosure? The OSC seems to argue the former, but if investors don’t realize at the outset that buying into struggling penny stocks generates a risk of losing everything, then they’re not going to be helped by a few more disclosure elaborations. The big bank has a much greater prospect of wreaking havoc on individuals and markets, for any number of reasons (most of them presumably disclosed to some extent at least, but not necessarily prominently or clearly).
It seems to me then that the notice over-emphasizes the importance of these disclosures in two ways; first by inflating them beyond their precise technical function, and then by employing too simplistic a notion of risk and its impact on investors. The latter is the more serious weakness. It seems clear to me that rather than trying to cater to investors who need a neon warning sign on top of obvious operating challenges, regulators should be telling them they’re in over their heads. But the OSC doesn’t like to send that kind of message, because I suppose it seems too interventionist (or grim!) Consequently, it ends up catering to a weird and marginal concept of an investor who’s supposedly basically capable of investing in highly risky companies and yet too dumb to understand the danger signals unless they’re laid out in a prescribed, programmatic manner. It’s all done with the best intentions of course. But if you ask me, there’s no point trying to save people from themselves.
The opinions expressed are solely those of the author.