Credit crisis is warning for improved financial disclosure

The uncertainty in the ongoing credit crisis demonstrates the need for more transparency of financial information for investors and the public, said Christopher Cox, chairman of the Securities and Exchange Commission.

He has initiated efforts to identify and track data that could indicate potential fraud related to unregulated securities, called credit default swaps, which emerged as a form of insurance for risky mortgages at the height of the housing bubble, he said at a recent agency event.

But Cox said he wants to incorporate transparency in the foundation of how SEC discloses the financial data of public companies. The SEC is planning to modernize its disclosure system from one that depends on forms to an interactive process under the agency’s 21st Century Disclosure Initiative to help the public understand detailed financial reports and complex investment instruments.

“Above all in the current turmoil, the markets and investors need transparency,” Cox said at a roundtable discussion on modernizing SEC’s disclosure system last week.

SEC’s Enforcement Division is investigating potential fraud by issuers of securities in financial institutions and abusive manipulation of those securities, he said. The SEC has required that certain hedge funds, broker-dealers and institutional investors file statements regarding trading and market activity, including the trading of credit default swaps, in the securities of financial firms.

SEC’s Office of Information Technology, working with the Enforcement Division, is creating a common database of trading information, audit trail data and credit default swaps clearing data, Cox said. SEC’s Office of Economic Analysis will analyze the data across markets to identify possible manipulative patterns.

There is a significant opportunity for manipulation in the $58 trillion credit default swaps market because it is “completely lacking in transparency and virtually unregulated,” he said.

Cox initiated the the agency's transparency effort in June, before the credit crisis hit with full force. He plans to have a blueprint for modernization by the end of the year.

The SEC plans to overhaul the current Electronic Data Gathering, Analysis, and Retrieval system, or EDGAR, to give investors and the public faster and easier access to key financial information about public companies and mutual funds. The Interactive Data Electronic Applications system, based on an architecture being developed, would use interactive data, such as Extensible Business Reporting Language (XBRL), to report required financial data. With XBRL, interactive data tags uniquely identify individual items in a company's financial statement.

With a modernized platform, SEC said it would move to a company file system that would collect, manage and provide for investors core information about a public company or fund in a centrally organized interactive data file. Companies would add to that information as required by SEC disclosure regulations.