To Disclose or Not to Disclose? Wells Fargo Woes Shine Light on a Knotty Problem

When is something important enough to a company’s business that it should tell investors?

Wells Fargo & Co.’s sales scandal provides a real-life window on the often-knotty question of deciding when a piece of information is “material” and so must be disclosed to investors. In part, that is because the rules are complex and not always well understood — many observers think materiality can be determined simply by crunching the numbers, but that isn’t always the case.

While the bank’s management had known since 2013 that some employees had created deposit and credit-card accounts for customers without their knowledge, the accounts were a tiny portion of Wells Fargo’s business. The settlement, which included a $185 million fine, was less than 1% of last year’s earnings. The matter was “not a material event,” Chief Executive John Stumpf told a Senate panel last week.

That is true in terms of the bank’s income statement. Not so its reputation or share price. The bank and Mr. Stumpf have faced a political and public furor and the stock has lost nearly 10% since the settlement, or about $23 billion.

Given the depth and breadth of the problems at the bank’s retail operations, which account for about half of profit and revenue, others argue Wells Fargo should have given investors some signal a problem was brewing. “It seems pretty significant to me if the whole world’s talking about it,” said Philip Woodlief, an adjunct professor of management at Vanderbilt University.

The three senators — Jeff Merkley (D., Ore.), Elizabeth Warren (D., Mass). and Robert Menendez (D.-N.J.)—-have asked the SEC to investigate whether Wells Fargo committed fraud by failing to disclose its fake-account problems even as it was touting to investors how many products it was selling to each customer. The senators also asked the SEC to probe whether the bank violated whistleblower protections.

“This certainly has a reputational risk to the company — it seems like that would have been material,” Mr. Merkley said in an interview with The Wall Street Journal earlier this week.

An SEC spokesman declined to comment. A Wells Fargo spokesman declined to comment on whether the bank should have disclosed its problems sooner; he couldn’t immediately be reached for comment on the senators’ request for an SEC investigation.

The standards for determining whether a piece of information is material differ somewhat depending on the regulator involved. And some regulators are considering changes in existing standards around what is material information. In short, it is something of a gray area.

Generally speaking, materiality depends on whether a reasonable investor would consider the information important enough to affect the investor’s decision to buy a company’s securities.

Many companies and investors use a rule of thumb that something has to make up at least a specific portion of the company’s business to be considered material — 10% of revenues, for instance, or 5% of earnings. But companies are supposed to go beyond the numbers and consider “qualitative” factors as well.

The SEC has said a relatively small error on the financial statements could still be material if, for instance, it affects a company’s regulatory compliance, conceals illegal transactions or increases management’s compensation.

The key question, Mr. Woodlief said, is does a development “affect the total information available to investors?”

The rules are murky enough that accounting experts can differ about whether something is material. Jack Ciesielski, president of accounting-research firm R.G. Associates, said Wells Fargo may have viewed the cross-selling problems as an isolated issue that it managed on its own, and noted the fake accounts comprised less than 2% of all those the bank opened during that time frame. “I think it’s got to be immaterial,” he said.

Then again, Mr. Ciesielski said, when the bank was negotiating with regulators over the matter and knew a settlement was possible soon, then “I think they had to say something at that point.”

The SEC is considering whether it should change its standards for what’s material, as part of a broader look at its disclosure rules. In April, the commission asked for public comment on whether it should “consider a different definition of materiality for disclosure purposes,” and on whether it should use “a combination of quantitative and qualitative thresholds” for disclosure.