The SEC, Madoff and XBRL

You probably have never heard of XBRL. If you havent, and you are the least bit interested in how regulatory agencies can avoid future Madoff  like events, and in government transparency for our bailout tax dollars, you should take a minute to get up to speed on what XBRL can do.

XBRL is a version of XML for financial reporting. To the SEC’s credit, they have become a big proponent, requiring $5 Billion Market Cap companies to start reporting using XBRL as of this past June, with the next 1800 in market size required in 2009, and everyone else in 2010.  The value of XBRL is that by creating standardized tags for data elements (ie, net income , cash, interest, etc), companies will not only have to conform their financial statement line items to the defined tags, but in doing so it will make it much easier for investors and regulators alike to analyze and compare the financials of various companies. All good so far.

Here comes the but..

XBRL is here and ready, but our government isnt using it for anything it does. Tracking the bailout would be a perfect application for XBRL. There is absolutely no reason why we couldnt or shouldnt use it since all technical systems and reporting requirements would be new and could easily be built around XBRL.

IN addition, there is no reason why every entity that has to report to the SEC, and even those that don’t  shouldn’t be required to use XBRL. From investment advisors like Madoff, to hedge funds, to mutual funds, to ETFs, brokers, dealers, market makers,to banks and each and every loan that is made, you name it, all should be required to format their financial data in XBRL.   In fact, the smart thing for the SEC to do is to demand that any new financial instrument, regulated or not, needs to have an XBRL taxonomy assigned to it for future reporting pursposes before it could be sold.  This would simplify any future reporting requirements and allow the SEC to review and analyze before its regulates, having the advantage of a body of data to guide it.  For the filing companies, It certainly would not be a hardship. It is  no worse than requiring websites to use HTML before they can publish to the web. Its that easy.

By acquiring data in XBRL format, it becomes  easy to import into databases that can be monitored and analyzed. Think of it as turning the government into a quant shop for data they receive.  Like a quant shop, the data could be monitored and analyzed in realtime looking for everything and anything it believes are indicative of problems, including the Madoff test for no variability in reported returns.

The beauty of this system is that while it wont catch everything, it will automate much of what had been a manual process of review by regulatory staff.  It wont take a painstaking audit of  suspects chosen on a best efforts basis.  Outliers and exceptions will quickly become apparent as will trends and repetitive problems.

Not only will XBRL be a tool for government, but it could be a tool for government watchdogs as well.  We as taxpayers should demand that every penny spent and committed be defined in XBRL and presented on a .gov site in realtime.  We can start with the bailout money and how its being spent. In fact, President Obama’s use or lack of use of XBRL for government will be a beacon as to just how much transparency we can expect from his administration.

We are about to enter a period where the most recommended solution for avoiding future crisis like the one we are experiencing now,  is increased regulation. I happen to agree with the SEC Commisioner when he said “Transparency is a powerful antidote for what ails our capital markets”   We can never come up with perfect regulations to solve the problems we have yet to see. WE will never anticipate the results of unintended consequences. We can require  that all those that participate in the capital markets contribute their data and hope that the data guides us to avoid those problems.

Far from perfect I know, but its far better than what happens today

30 thoughts on “The SEC, Madoff and XBRL

  1. Ed Hardy shirts

    Comment by hrewj -

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  5. I couldn’t agree more!

    Vivek Kundra, the D.C. CTO who’s rumored to be a possible US CTO, and I are writing a book titled “Democratizing Data,” (“Democratizing data makes it automatically available to those who need it when and where they need it based on their roles and responsibilities, in forms they can use, and with the freedom to use it as they choose — while simultaneously protecting security and privacy.”) about how innovations such as XBRL allow us to change from the old way in which data would flow into a company or government agency and only small parts would eventually emerge, into one in which there would be real-time sharing of information with the entire workforce and, in some cases (Id argue the bailout would be one of these) with the general public, to rebuild faith in companies and government through transparency. I recently wrote a piece in TechPresident arguing that automatic reporting via XBRL should be part of the stimulus package and any more TARP spending: http://tinyurl.com/88go3l

    Comment by W. David Stephenson -

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  7. I am no expert in XBRL.

    I assume the code can be used as a type of RFID tag to verify the existance of fund.
    Most hedge funds want to retain their privacy, and therefore claim they
    can’t divulge total transparency due to investment privacy issues.

    If the code could be used to simply verify that Assets + Cash = reported balances
    weekly, there would be privacy argument from the funds and this should be adopted. Of Course , many of these funds are dealing with non-marketable securities, that would make the process a bit trickier. They could default to 45c on the $ for reporting puposes thoug.

    Someone needs to develop a system to verify the funds are really there while providing the privacy the funds seek!

    Comment by Dan Ellis -

  8. As an investment advisor with a software background, I find it surprising and insightful that you’ve chosen XBRL as a blog topic. Many of these comments rightly indicate that XBRL won’t solve all of our problems, but it can certainly be a valuable tool for increasing transparency.

    Thanks for sharing your thoughts.

    Comment by Kevin O'Reilly -

  9. In deference to the CEO of Edgar,If you look at Madoffs EDGAR filings at the SEC they told us nothing. If the company that fills out the EDGAR forms lies,decieves and just plain withholds any pertenant information for your EDGAR filing then it is worthless and if the watchdog SEC is on the take and they do not care to investigate the fraudulant EDGAR filing then we are screwed. So Mr EDGAR CEO how can you and your company promise us the public that your filings are truthful?If you can do that then you should be bragging, if not, you just want to make money like any other corporation. How about looking out for us for once. I bet your company had lobbyist working for you so that the SEC uses for forms? Tell us the truth.

    Comment by Buzz -

  10. Keep it simple:
    Set Madoff’s bail at 50 billion dollars
    pay everyone back or go to jail.

    Comment by BA -

  11. Mark,

    Great points and nice exposure for XBRL.

    Thanks.

    Best Regards,
    Bryan Feinberg
    CEO/Zephyr
    http://www.zephyrnet.com
    +972 544 330 045 Phone
    +972 722 766 161 Fax
    Skype: Babuyaya

    Comment by Bryan Feinberg -

  12. LOL at the RTF comment. MS created the Rich Text Format.

    Comment by chat -

  13. LOL at the RTF comment. MS created the Rich Text Format. Yes, it’s a pain with email because of the tnef encoding, but you have to remember that it was created in 1987! XML isn’t something MS can “destroy.” You should probably learn more about things before you post.

    Having a common data format for this really should have been in place a long time ago. And hopefully the specification isn’t open to a lot of “interpretation” like EDI specs; there’s no reason for it to be.

    Comment by Mufaka -

  14. Mark – Thoughtful concept, but thinking it through in reality for example, “In fact, the smart thing for the SEC to do is to demand that any new financial instrument, regulated or not, needs to have an XBRL taxonomy assigned to it for future reporting pursposes before it could be sold”, this would be impractical. New products and their “time to market” horizon are a key differentiators in an investment company’s arsenal. Waiting for XBRL “committees” to approve a standard before its traded wouldn’t be practical in the real world. They say that a lock will keep an honest man honest, but a thief will find a way. The real trick would be to smoke out the thief “before” he has an opportunity to manipulate the system. I guess it will ultimately boil down to end users and customers doing their own due dilligence and rejecting the non-transparent or opaque operator.- tom in thailand

    Comment by Tom Ricciardi -

  15. The real question is how long will it take someone to figure out a creative way to hide information in the new standardized XML format? That being said, I’ll admit that importing the data into some sort of data warehouse will certainly be a step in the right direction when it comes to proactively doing analysis.

    Comment by Maggie -

  16. I also agree that an XBRL format reporting standard would in and of itelf make fraudulent reporting more obvious. However, it might make it more tedious. I would imagine that most pblic companies would have an issue disclosing detailed numbers for fear that they could be used against them by competitors, but if everyone was forced to do the same, I suppose it would be fair. They’ll still never voluntarily agree!

    Comment by Michael Fontana -

  17. Ask and you shall receive: SEC mandates XBRL

    http://www.nextgov.com/nextgov/ng_20081219_3214.php

    Comment by econ365 -

  18. I think writing to senators, representatives and president elect Obama is a great idea, and to make it easier for those who want to do the same, I thought I would post these links:

    To get the message of: “every penny spent and committed be defined in XBRL and presented on a .gov site in realtime,” you can use the following links.

    http://www.senate.gov/contacting/index.cfm

    http://www.house.gov/writerep/

    President elect Obama

    http://change.gov/page/content/contact/

    Comment by Curtis Walker -

  19. XBRL may indeed be a leap forward, but the old rule of garbage-in-garbage-out still applies.

    Madoff, like any securities firm, had to report to the SEC, but according to the No More Corporate Secrets blog, there’s very little meaningful information in their online reports, and the auditor’s report is not available:

    http://nomorecorporatesecrets.blogspot.com/

    Mr. Madoff’s Secrets

    Comment by davidjs -

  20. Someone even tried to blow the whistle on Madoff with a detailed
    analysis and the SEC didn’t give a hoot.

    Comment by escapistsoul -

  21. It`s hard to believe the SEC comes after M.Cuban for what is essentially
    chump change to him. Yet, this Madoff guy commits fraud which will impact
    the global economy and they don`t bother investigating this guy after years of
    red flags. Now they are saying his niece is married to one of the investigators.

    Great idea regarding XBRL MarK. I wish more of us had the great logic skills
    you have.

    Comment by gregoryrue -

  22. Mark – Im the CEO at EDGAR Online – and I wanted to Thank you for recognizing one of the most important things happening in the financial markets in 15 years! With the implementation of XBRL the SEC is about to move the financial transparency in the United States from analog to digital !!!

    When the SEC was created in 1934 it immediately required public companies to start reporting the state of their company to shareholders. In 1993 the SEC made a huge leap forward by requiring companies to file centrally with the EDGAR system. These two simple concepts that we take for granted – centralized, and regular reporting makes the US the most transparent market in the world.

    However the reports that are being filed are massive documents that have become simply inconsumable by mere mortals. In 1993 the IBM 10K was 350k today it is 6.3mb. XBRL requires a company to report comparable facts instead of burying numbers in disclaimers, legalese, and marketing language. Imagine having the ability to compare pension liabilities, tax obligations, oil reserves, bank’s balance sheets, fuel costs, etc et.

    The SEC is doing this first for 10Ks and 10Qs for Equities but the reality is that every single asset class needs to move to this format. Today as an investor in an Asset Backed Security you cant track the loan that are in the tranche you own from cradle to grave because there is no centralized common reporting of this information. In spite of the fact that there are great cash flows in these ABS’s no one is willing to buy them – – because no one can figure out which loans are good and which loans are toxic (current estimate 10%). Today’s vote by the SEC is the first step – -However EVERY Asset Class must move to XBRL.

    Say what you will about the Chairman Cox – but two and half years ago he realized regulators and investors were simply outgunned – -people were burying reality in mounds of narrative. I have to give him credit for being the loudest proponent of this unsexy piece of infrastructure – -moving the market to a 21st century digital reporting standard.

    As an aside – -EDGAR Online was a founding member of the XBRL consortium. We have created the largest XBRL database in the world for US Public companies, and we have helped more US companies file in XBRL than anyone in the world to date. We know first hand the incredible information that is locked up in these filings – -and are thrilled that the world is about to understand this also.

    Philip Moyer
    CEO/President
    EDGAROnline

    Comment by pmoyer -

  23. If a Madoff investor had figured out after talking with the company that they were operating a giant Ponzi scheme, wouldn’t the Cuban action brought by the SEC discourage him from selling for fear of committing insider trading? Are we now on the other side of the looking glass? – Jeff

    Comment by jsmitchell -

  24. Good points, but there were MANY other red flags that were obvious about Madoff. Anyone conducting due diligence would see that he executed and cleared every trade and offered zero transparency to his operations. He also used a no name auditor when he could have easily used one of the Big 4. What happened is people ignored all the red flags because they trusted his name. While I still do feel sorry for those who lost everything, it was not a smart decision to blindly trust Madoff…. XBRL would have exposed the lack of variations in returns, but there were plenty of other red flags that were quite obvious

    Comment by gsgoldst -

  25. Using XBRL could lower the bar for startups in this space,
    and promote more free software tools for handling financial
    data.

    Comment by nothardly -

  26. How about making the rules even simpler? Why not make every publicly traded company report its full, daily stream of cash-flows through something like XBRL? Then let institutional investors do what they want with the data. Let the market decide what it means.

    Notice how this makes it harder for the few that are willing to bend the rules to benefit at the expense of the many who place straight. Playing with the cards face up means bluffing is not a viable strategy for managers anymore.

    The current trends in the accounting profession are to distill and summarize more information rather than to spit more out to the public. That’s not surprising since it just gives accountants more job security and political power. But the trend needs to be reversed if we’re ever going to eliminate systemic risk.

    Comment by Michael F. Martin -

  27. Pingback: theceodaily.com» Morning Update » December 16, 2008

  28. It would be terrific if usaspending.gov started using a standard like XBRL.

    Comment by rubicator -

  29. Most excellent. Too few understand the power of XML and therefore XBRL.

    The bigger concern: keeping big brother (Micro$oft) from destroying XML
    like it has Rich Text Format (RTF).

    -ski

    Comment by consultski -

  30. Mark,

    I agree increased transparency is good, but XBRL adoption does not add any requirements for additional data. XBRL is just the taxonomy for disclosure. It is good that we are creating a standard for data exchange, but nothing in XBRL requires additional disclosure.

    On the disclosure side, the SEC is pushing IFRS, the international standard for Financial Reporting which many believe is much loser than the current US GAAP standards. Thus regulator actions could make future Enrons and Madoffs more likely.

    So, you have regulators making moves to ease the method of disclosure, but actually loosening the reporting standards at the same time. Nothing in what they are doing is going to help us prevent folks that just lie in their disclosures, of course.

    Scott

    Comment by aheadfull -

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