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What Good Are Disclosures That Go Unread?

By Howard Gleckman Back in the 1980s, a couple of hustlers tried to get rich selling tax-exempt bonds. Before their scheme collapsed, they convinced folks to invest $120 million in retirement homes that had no prayer of making any money.

Amazingly, they carefully laid out the scam in the prospectuses they gave to potential investors. They figured full disclosure would keep them out of trouble with the Securities & Exchange Commission. After all, they reasoned, it can't be fraud if you tell investors everything.

So they disclosed the huge upfront fees they paid themselves. They reported the heavy debt the projects were carrying. They even said the businesses had little chance of ever being profitable. Yet people invested anyway. "They had a simple technique," a lawyer familiar with the projects told me: "Sell 'em garbage. Just always tell 'em its garbage."

LESSON ONE. How did these guys find so many gullible investors? The suckers never read the prospectuses. They saw the part that promised 17% tax-exempt returns. But they never bothered with the details.

It seems there's a lesson here for everyone debating what to do in the wake of the collapse of Enron, Global Crossing, and, for that matter, all the dot-coms whose corpses are littering the financial landscape. The government, of course, needs to crack down on companies that lie on their financial statements. No matter how much proxy reading an investor does, it's hard to protect yourself from someone who is set on deception.

And the SEC would do all investors a favor if it pushed companies to write their proxy statements in a language resembling English. The legal gibberish that fills most financial disclosures may satisfy the letter of the law, but it isn't very illuminating.

However, no amount of reform will matter if people don't bother to read the information companies give them. And the sad fact is, few investors and shockingly few professional analysts ever bother combing through financial documents.

DON'T LEAVE TO OTHERS... Ordinary investors don't because they're intimidated by the numbers, because they don't have time, or because they're willing to leave the hard work to others. It's easy to guess what many people say: "I don't read that stuff. That's what I pay my broker for."

Except your broker may not be reading the financials either. Indeed, I'd venture to say some brokers, planners, and other investment professionals haven't looked at a financial statement since they got their securities license.

Stock analysts? Leave aside for a moment the question of whether they can be objective when they recommend stocks that their own companies underwrite. The real problem, even for those who are truly independent, is time. A securities analyst may be required to follow dozens of companies -- all of which are filing a blizzard of SEC-mandated paper throughout the course of a year. They simply don't have time to properly sift through all of it.

MAKE IT EASIER. A CEO tells the following story: A couple of years ago, a Wall Street analyst downgraded his company's stock. The CEO arranged to visit the analyst at his New York office. As the corporate exec tried to explain that the analyst had misunderstood some information disclosed in the company proxy, he noticed a stack of untouched financial statements piled in the corner of the guy's office. "Oh, those," the analyst reportedly said. "I never look at that s--t."

An extreme case? Maybe. A bit of hyperbole by an angry CEO? Perhaps. But overworked analysts simply can't review all the paper they see.

The message for the SEC is simple: Make this stuff easier to read. The message for market professionals is also clear: End the conflicts of interest and hire more analysts. You can afford it. And the message for investors: If you're not prepared to do some reading, buy shares in a mutual fund. Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington Watch, only on BusinessWeek Online

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