For many CFOs, it is sometimes the three-billion-dollar bane of their existence.
Both the size of typical 10-Ks, and the amount of time and money spent on them, have ballooned over the past several years, financial professionals say, driven by legal mandates such as Sarbanes-Oxley, greater disclosure demands by the standards-setting , and the ever-growing need to disclose more risk information to avoid lawsuits.
"Certainly the document has grown in length," says Loretta Cangialosi, Pfizer's senior vice president and controller, observing that the financial section of the pharmaceutical giant's 10-K has grown 10% to 15% over the past five years.
"Primarily, the regulators and the accounting standards" are driving this bulking-up process, she adds. "Financial instruments is an area where we see pages and pages of disclosures. They don't say much, but we have to put them in."
Regulations require that disclosures about pensions -- along with information about derivatives and fair value -- be provided on a "one-size-fits-all" basis for financial and non-financial companies. That adds to the thickness of the document, and decreases its usefulness to ordinary investors, in the view of many in corporate finance.
"Do people understand the difference between the benefit obligation and the accumulated obligation?" asks Cangialosi, who chairs the committee on corporate reporting. "I'm not sure anybody really reads this bit."
Enter: The Lawyers
And then, the skills of the legal profession come into play -- both on the corporate side, and among plaintiff lawyers who force corporate lawyers to think defensively, often at the expense of clarity and brevity.
"Corporate lawyers are always very good at avoiding disclosure and qualifying everything," says Jacob Zamansky, a New York-based litigation attorney who has arguably added to the upsurge of concern about lawsuits. "These 10-Ks are as opaque as ever. Investors are no more informed than they were before."
There are other ways, too, that "litigation issues have played a role in increased disclosure requirements," as Lorraine Malonza understates the situation. Says Malonza, FEI's senior manager, technical accounting: "A good example is contingency disclosures, where users want additional information and companies fear they are not disclosing enough, thus opening themselves up to potential lawsuits if cases are settled soon after filing a 10-K and the information is not adequately disclosed."
She specifically cites Sarbanes-Oxley, which requires that "auditors audit both the financial information and controls in place," for increasing the heft of 10-Ks. At the same time, however, she notes that this requirement has improved earnings quality by providing "increased assurance that the information is more reliable."
Explaining, and Explaining, the Risks
Yet another major contribution, according to John May, a PricewaterhouseCooper partner, has come from the SEC's 2005 mandate that companies include risk factors in annual reports. "The SEC," he says, is "trying to get this type of information into its normal review process."
Goodwill impairment adds a "very subjective" element to 10-K disclosure, he says, because it often is difficult to concentrate "just those reporting units where there's a reasonable chance of impairment in the near-term."
Still, the increased disclosure requirements in some ways have improved the quality of information provided to investors, says May. "The FASB efforts on financial instruments and derivatives came about because of the desire to give investors more transparency," he notes. With the many new disclosures adding to the transparency, he says, "I think you have to balance that" against concerns over the size of the 10-K. Also helping with transparency has been the SEC's "plain English" directive, and other efforts, which help companies "think of (their 10-Ks) as more of a communications document."
The desire for such better communications notwithstanding, Gary Kabureck, Xerox vice president and chief accounting officer, questions whether there is "too much detail" in annual reports. Using the forest-for-the-trees analogy, Kabureck notes that the audited financial section of his company's 10-K "has grown from 31 pages in 1999, and is now 67 pages -- and that's using a similar font and type size."
Kabureck, who is one of the vice chairs of FEI committee on corporate reporting, said that a committee member working at a "high-tech" company quipped that a reader of his 10-K would have to get "halfway through the disclosures to realize what we sell."
Can We "Start from Scratch"?
The 10-K is an "overly legal document," says David McGirr, CFO of Lexington, Mass.-based Cubist Pharmaceuticals. "Roughly 65% of the pages are really the legal stuff," while the remaining 35% contains the truly relevant financial information. "The 10-K should be an important document that should be helpful" to investors, rather than one filled with information about "everything that could possibly happen," he argues. "We're a small, profitable pharmaceutical company, which has a Dec. 31 year end." His 10-K, coming out at the end of February, only gives his finance staff "about two weeks' break" before it has to work on Cubist's 10-Q.
McGirr would like to see the SEC and the financial community "start from scratch" on a 10-K redesign -- a process that might aim for a reduction in the report's sheer size, while avoiding just "adding and adding and adding" to it. In some instances, the current need to make each section of the document a self-contained entity forces a preparer to insert "exactly the same paragraph" multiple times, he says. "If the information is already there, reproducing it 20 pages later doesn't add much" -- at least in terms of investor value.
While "the quality of disclosures has improved," according to Pfizer's Cangialosi, "the quantity is getting overwhelming. Investors have to sift through it themselves and decide for themselves what is significant."
Part of the problem, she says, is that the 10-K has a readership that includes "analysts who do models and mom-and-pop investors," and lots of categories in-between, each with different needs. "As a preparer, I always ask 'who wants this' and the answer is always 'investors.'"