Hidden in plain sight: transparency’s bane of information overload
Are many modern financial scandals “hidden in plain sight”, needles in the haystack of information overload? And if so, do we need to revise the model of transparency we have been working with for the last decade?
The incomparable Malcolm Gladwell’s latest book “What the Dog Saw” contains a chapter detailing the uncovering of the scandals at Enron in which he slices out, delicately as ever, a counter-intuitive conclusion: whatever else Enron was, it was only just barely a “cover-up” in the classic sense. The Enron scandal was broken entirely by journalists whose major source was… Enron, their annual 10k filings with the Securities and Exchange Commission, and, in an initial phase, the willing face-to-face cooperation of executives trying to bolster their company’s share price.
EITI and other governance initiatives are focused on getting more information published, essentially treating the process of understanding and then explaining that information as inert or self-evident. But maybe what Gladwell shows us is that less is more. And maybe what that means in practical terms is that the next $100k that comes down the pipe for improving transparency could be as well spent on finding pro bono bankers, lawyers and accountants in the City of London to analyse what is already there, as in seeking to increase that quantity.
Compare Watergate with Enron, Gladwell says. Woodward and Bernstein uncovered the story, with the help of Deep Throat and pinging between reviewing documents and cultivating their sources. The documents were really only there to lead them to the next source (I’ve re-watched All the President’s Men three times in the last year because it’s such an inspiring, and instructive film about journalism. My favourite scene is currently where Bernstein worms his way into the home of a Republican Party volunteer in the evening by bumming a cigarette off his target’s sister who he instantly realises is abetting him. He then fumbles with the lighter to buy time, the sister serves him coffee, and the source comes back into the room, giving him a succession of ledes while all the while swearing she isn’t going to tell him anything).
Whereas Enron was broken first by Jonathan Weil , then a Wall Street Journal reporter, after he spent a month studying their annual reports and quarterly filings and talking to a dozen specialists on what it all meant. That led to other journalist reports and a Wall Street trader who announced he was going to start shorting Enron stock. Weil reported on Enron’s use of mark to market techniques to report profits that were anticipated for the future rather than cash in the bank. Then a couple of WSJ colleagues exposed Enron’s use of Special Purpose Entities (SPEs) – again by reading their reports. The public committee that investigated how it could all have happened concluded that Enron had not told the public “enough” about what they were doing with their SPEs, which are ways to raise loans without the ensuing debt appearing on the company’s balance sheets. But Gladwell points out that Enron filed reports on all its SPEs, and that the documentation probably ran in excess of two million pages – two million!
The same is true of the financial crisis of 2007-8. There have been relatively few instances of prosecution on the grounds of withholding information about derivatives. All the information to analyse what was happening, and predict the crash on the basis of overextended collateral, was there – Michael Lewis’s lucid book “The Big Short” recounts in detail the story of several investors who did just that, one a company made up of three 30-somethings operating from a garage in California building an entire investment fund from an initial $100,000 stake by shorting pretty much the whole banking system. Enron too had its out-of-industry analysts, a group of grad students at Cornell University’s business school who in 1998 chose to study Enron as a class project and ended up with a strong sell recommendation on the grounds that Enron was probably manipulating its stock price – a bunch of grad students in 1998!
Now let’s take this valuable theoretical principle to the oil industry in the developing world. Do the same conditions apply? In a word, somewhat.
It’s true that the amount of information, both quantitatively and qualitatively, does not compare to what you might find in an SEC filing or could ask for under any of the European freedom of access to information laws.
But there are sizeable amounts of information in the public sphere, even if they don’t compare to the reporting requirements of a country like the USA. Some oil companies, such as Talisman and Statoil, are required by home country legislation in Canada and Norway to detail all payments to governments country by country – what counts as disaggregated reporting in the EITI process. About half the countries that have produced EITI reconciliation reports have used a disaggregated basis for reporting. There are a few countries, such as Egypt and Azerbaijan, who also publish primary oil contracts because production sharing agreements with foreign companies have to be ratified by their parliaments as acts of law. It remains to be seen how the extractive industries will be affected by the provisions of the Wall Street Reform Act , passed in July this year, on project by project reporting worldwide now mandatory for all companies with an SEC listings – that’s to say all US companies and a sizeable number of international companies that use financial instruments to be listed on US stock markets.
There’s also no question that the main players in current transparency mechanisms have trouble digesting the information available to them now. Both civil society groups and parliaments in many of the EITI countries would be highly challenged if they had to parse company statements. The politically correct response here is to talk about “capacity building” to help them get there. The World Bank, the IMF, various other bilateral donors and transnational civil society respond to this by paying for various workshops to teach the essentials of financials, issues, and perhaps also basic numeracy. But this is in some, perhaps many, cases like trying to teach singing to someone who is tone deaf.
In no sense is this meant as disparagement. I covered energy markets for Reuters for many years. And it was only more than a decade after I left the agency, when I came into contact with the energy industry again from a governance perspective, that I realised that at the time when I was filing reports to be used in trading markets for what was then the dominant information provider in those markets, I didn’t really understand the industry. I was conscientious and reasonably competent. I understood what I needed to know to do what I needed to do – file a daily market report on the latest numbers and compare them to the last set. But not what those numbers really meant. And, here’s the critical part – I had a quarter-million dollar education – mostly public schooling, in case you’re wondering, just my round-up figures from 5 to the age of 24 (and a year in my late 30s) in UK and US educational institutions, all competent, some excellent.
So let’s not single southern civil society out. When oil companies say there is no need for an audit of their accounts within EITI because they are already audited to international standards, how many people outside professional accountants, and perhaps even accountants specialised in the energy sector, would be able to say with confidence reading those documents that the audit had been well or badly, or sneakily, or over-restrictively done?
So why not get the blue chip expertise on board? I was recently at a conference of oil industry negotiators – big firm lawyers for the most part – in which several people said they did pro bono work for developing country governments in the oil industry. Let’s not get too excited too fast. The whole point of doing pro bono work is bragging rights afterwards and it’s easy to imagine that what was in fact a few days of a junior associate gets turned into something far more grandiose when it is described at client or board meetings. But there must be a way of harnessing that dynamic, and those resources to the EITI process and other governance initiatives.