At The Money: Finding the Hidden Alpha in SEC filings

Is there Alpha to be found hidden in SEC filings? Management does seem to hide lots of bad news by just barely complying with the law. Recent indicators are this is getting worse. Michelle Leder is a researcher covering Corporate SEC-filings; she founded the research service “Footnoted” focusing on uncovering material information hidden in corporate SEC filings. She's the author of the book, financial “Fine Print, Uncovering A Company's True Value.” Each week, “At the Money” discusses an important topic in money management. From portfolio construction to taxes and cutting down on fees, join Barry Ritholtz to learn the best ways to put your money to work. See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

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• 2:25Barry Ritholtz?

  Have you ever wondered what management buries in their SEC filings? Do they faithfully follow their obligations to their shareholders? Or do they see how much they could get away with either not disclosing or hiding? To help us unpack all of this and what it might mean for your portfolio, let's speak to Michelle Leder. She is an SEC filings wonk and specialist and founder of the research service Footnoted, focusing on uncovering material information hidden in corporate SEC filings. She's also the author of the book Financial Fine Print: Uncovering a Company's True Value.

• 3:08Barry Ritholtz?

  So Michelle, let's just start out with a basic definition. What is disclosure? What are the rules that the SEC requires all companies to provide to their investors?

• 3:22Speaker 03

  Believe it or not, a lot of the main rules, or the framework if you will, it dates back to 1933. Think about that for a minute. That's the basic framework, if you will, like the foundation of the house, dates back to 1933, which is kind of amazing. It's 92 years ago. And think about how much has changed in the markets. There's the internet, for example, and you don't have to call your broker and say, "Buy me some pork bellies" or whatever. It's really kind of amazing that the primary framework dates back over 90 years. Of course, it's been updated over the years, but this is sort of the foundation of the house. This is what companies and their attorneys go back to time and time again.

• 4:04Speaker 03

  They'll talk about the 1933 Act, which of course, came after 1929 and the Great Depression. And that was what started the SEC.

• 4:14Barry Ritholtz?

  So let's talk a little bit about the various filings. Most of us are familiar with the quarterlies, the 10-Qs, but there are also 8-Ks and 10-Ks and merger proxies. Tell us the broad documents that every company is either required to file with the SEC or when a specific event happens is triggered and then has to do a filing.

• 4:39Speaker 03

  Yeah, so at a bare minimum, publicly traded companies have to file three 10-Qs a year. That's the quarterly report and one 10-K, and that's the annual report. And then, you know, 8-Ks are filed on an as-needed basis. And those are often thought of as material events, but it's also earnings releases or, you know, maybe a press release. I think a lot of people think that press releases are equivalent to 8-Ks, and that's actually not true. Companies will often put out a press release and maybe they'll attach it to an 8-K, maybe they won't. But, you know, there's a difference between them. Companies will often disclose something in an 8-K that they never intend to put a press release out on.

• 5:23Barry Ritholtz?

  That's really interesting. And to that point, I love this quote of yours. Companies know they have to disclose bad news, but they also know they don't have to post it on a billboard. Explain what are their obligations? What do they have to say and when?

• 5:41Speaker 03

  In general, if something is, the definition is basically something that a reasonable investor would want to know, and that's what triggers an 8-K. A lot of people think that, you know, the shorthand is like something material. But, you know, materiality is in the eye of the beholder. You know, something that might be material to me may not be material to you. And there's a lot of judgment calls. There's no real, like, tests. I mean, of course, like, you know, if the CEO resigns and he, you know, absconds with, like, you know, $500 million, that's a pretty easy test. But, you know, you don't see a lot of those, right? There's something a lot less, you know, significant. And then there's a discussion of like, well, do we need to disclose this? Do we not? And I've seen it, quite frankly, all over the map.

• 6:25Speaker 03

  I mean, I've seen companies, for example, you know, the most minor enforcement thing that a company can do is get a comment letter from the SEC. And that's basically like, hey, we noticed this thing. Can you explain it a little bit more? And then the more serious thing is a Wells notice. And I've seen companies like, for example, which is, you know, pretty serious. It's, it involves providing much more detailed information. Attorneys are involved, blah, blah, blah. And, you know, I've seen some companies not disclose a Wells notice. And I've seen some companies disclose a comment letter. So it really can be all over the map. And that's what makes it a little bit confusing and a little bit, you know, hard to figure out. You can't always say, if this happens, we have to disclose. Sometimes there's a lot of wiggle room in there.

• 7:06Barry Ritholtz?

  For, for people who are just curious, the comment letters tend to be pretty minor. A Wells notice typically gets sent to a firm when the SEC has concluded an investigation and is planning on bringing an enforcement action. I would imagine that's fairly material all the time. Am I wrong?

• 7:27Speaker 03

  You would think, but I've seen companies wait instead of like, you know, instead of putting out an 8K that they've received a Wells notice, they'll say that they, you know, they'll wait until the Q to disclose that. And, you know, of course, the Q is all focused on the earnings. So it's like, you know, buried in there somewhere, usually in their legal disclosure or maybe a risk factor. You know, other tricky things that companies will do all of a sudden, and I've seen this over and over again, like instead of a subpoena, they'll say subpoenas, they'll suddenly make something plural. They won't put out a press release and say, oh, hey, by the way, we got another subpoena. And, you know, companies play these kind of tricks. I mean, they do settle changes and it's really up to you as the investor to catch them.

• 8:11Barry Ritholtz?

  So what are some of the more common tricks you see that management uses to technically comply with the law and disclose material bad news to investors while at the same time trying to minimize attention to that?

• 8:28Speaker 03

  Yeah, I mean, probably the number one thing, you know, I see is like companies waiting until late on a Friday or the Wednesday before Thanksgiving. With some reason, they can choose when they want to disclose. The rule is actually you have to disclose within four business days. But of course with holidays and, and other things that can often be, you know, stretched. It's not as if like, you know, the CFO suddenly resigns and you've got to disclose it that minute. I've seen companies wait four days to disclose that, you know, and that's following the letter of the law. Now, I would think that if the CFO suddenly resigns from the company, as an investor, you want to know about that right away.

• 9:03Barry Ritholtz?

  Yeah, so the Friday night data dump. After 4 o'clock but before the SEC closes at 5:30 is legal but sounds a little sketchy. How often do you find these sorts of things are disclosing information that ultimately affects the stock's price?

• 9:23Speaker 03

  I would say, you know, pretty often, although it's not an instantaneous thing. You know, a lot of what I do is I see an early warning sign. You know, here I'm out in LA and I often think about it as going to the dermatologist and saying, "Hey, I see this mole on my upper arm. Is that cancer or do I not have to worry about it?" You know, that's the type of thing I think it's like it's it's an early warning sign that there could be a potential problem. But, you know, rarely I would say do you find like what I would call like what someone might call a smoking gun. It's not like, you know, like, oh, the CEO embezzled, you know, $500 million, whatever, and we're filing for bankruptcy, you know, Monday morning type of thing.

• 10:05Barry Ritholtz?

  Tell us about the non-disclosure disclosure. I love that phrase.

• 10:09Speaker 03

  Companies know that they have to disclose stuff and, you know, what they often do is they'll give you the bare minimum of facts and that's what they do. So they might say like, for example, you know, Director Alan Smith resigned on a Friday, but they don't tell you that, you know, oh, maybe he was a member of the audit committee or maybe he was the former CEO of the company or maybe he was chairman of the audit committee or, you know, any number of other information and that requires you to go to another filing, the proxy statement really, to figure out, was he a longtime director? Had he only served on the board for three months? You know, all of these things are, you know, information that companies have, but they're not providing it to their investors. So that's like, that's what I would call non-disclosure disclosure.

• 10:52Speaker 03

  It's like they're giving you the bare minimum, but not giving you anything more.

• 10:56Barry Ritholtz?

  So let's talk about some metadata red flags, something else, a phrase I've picked up from you. I've read discussions about repeated amendments of various filings or reports that are consistently late. How much of this is just, hey, the world is complex and sometimes these things don't happen on time? And how much of this is? Potentially predictive of real problems at the company.

• 11:24Speaker 03

  Well, I would say anytime a company can't get its 10K or 10Q in on time, that's a potential problem. If that happens repeatedly, you know, that's pattern recognition, right? Like if it goes on for a quarter, for, you know, several quarters, or, you know, longer, that's, you know, a potential problem, right? Companies know, you know, for the most part, they have to get their Qs in 40 days after the close of the quarter. And so, you know, if they don't, those companies that don't get their filings, their 10Qs in on time, if they're on a September quarter, that's an indication of a potential issue. You know, if it's the third time they haven't been able to get their 10Q in on time, you know, and of course, there's exceptions. Maybe the company's going through a big merger, right? Like, you know, when you saw like, for example, like the Albertsons Kroger thing, you know,

• 12:08Speaker 03

  a couple of years ago, you know, there was like problems there because like, you know, it was like they were trying to merge the company and there was all this regulatory stuff. And, you know, so like if you can easily explain a late filing, okay, you know, I wouldn't say that every single time a late filing is a problem, but I would say more often than not, it is.

• 12:25Barry Ritholtz?

  So, your website is called Footnoted. Tell us an example of what looked like a minor footnote in a company filing or disclosure that you spotted that later turned out to be a really big story.

• 12:41Speaker 03

  Well, I think, you know, there's a couple of examples. One is like Zoetis, the major animal pharmaceutical company. You know, I started looking into them earlier, well, late last year, I would say, the toward the tail end of 2024. And I put out some research to my clients back in February of this year. At the time, you know, I think they were underplaying their, the dangers associated with one of their so-called blockbuster drugs, this drug called Librela.

• 13:08Barry Ritholtz?

  If I recall, their drug was causing seizures and deaths on, in dogs that had no previous history of that. They literally should not have been released to the veterinary community. Give us another example that, that a footnote turned out to be a big story.

• 13:28Speaker 03

  Yeah, well, back in, you know, in 2022, you know, Nicola had like a, what I would call a seemingly minor disclosure. It was about a sudden resignation, you know, by an executive, not the CEO or CFO, just another, you know, like another person who was a named executive. That's a formal term, which is usually the five top executives at a company. Suddenly, you know, and it seemed kind of unimportant, but then it turned out to be an early sign of like basically rats abandoning the ship. And of course, we all know Nicola wanted filing for bankruptcy.

• 14:00Barry Ritholtz?

  Yep.

• 14:00Speaker 03

  And so it's kind of like following those breadcrumbs and trying to figure out what's really going on at the company. You know, what are they disclosing? What are they trying to tell investors? How can I, you know, try to figure out what's going on?

• 14:12Barry Ritholtz?

  How do you separate what's really a material red flag and something that might actually be tradable to just the normal CYA language that's in every legal document a corporation produces?

• 14:26Speaker 03

  I think that's a great question. And quite frankly, Barry, it's kind of tricky, right? Like it's, it's, there is a lot of CYA language in the filings and it can be problematic. I mean, I'd like to think that, you know, after 20 years of reading SEC filings pretty, you know, intensely or intensively, that I'm pretty good. My BS meter is pretty well defined and I can kind of tell when something is CYA versus something is, you know, more serious. But yeah, I mean, of course, there is a lot of that language, you know, the filings are ultimately written by lawyers. Now, maybe they're written by lawyers. I've seen a lot more these days. Maybe they're written by, you know, chat GPT or whatever AI, whatever

• 15:09Speaker 03

  AI platform they want to use to write these filings. But ultimately, it's the lawyers that are signing up and lawyers are obviously tend to be risk averse.

• 15:17Barry Ritholtz?

  Given the ubiquity of AI these days, how significant is AI in things like corporate filings? And how, how do you use AI to kind of figure out? What's going on with with all these different things?

• 15:34Speaker 03

  Well, I think AI is pretty significant in corporate filings. You're seeing it, you know, more and more. And I've certainly, I think I read a journal story like, you know, two or three weeks ago that talked about filings and quarterly reports and even conference call trans, you know, conference call, um, you know, scripts are being written by AI and, you know, being used to kind of train executives on how to answer questions, you know, whereas before it used to be sort of in person and, you know, kind of that thing. So I think like AI is of course, you know, becoming much more common in this type of thing. Um, what I think is, you know, interesting, and then of course there's the tools that are being used to uncover what's going on in the filings. I do use AI. There's a tool that I've been using a lot lately.

• 16:18Speaker 03

  It's called FinTool and it's interesting because it's really AI definitely designed around SEC filings as opposed to a more generic AI like a chat or like, you know, Claude or, you know, pick your AI tool of choice. This one's strictly focused on SEC filings and financial disclosures. And I find it to be pretty good. Of course, AI is not perfect. Um, and so you have to kind of, you know, figure things out. It's not going to get everything. But I think, you know, increasingly it's becoming, it can be a helpful tool in trying to detect patterns. So like, for example, if I wanted to know like how many CFOs, let's just say Company X has had in the past 10 years, you know, in the past, I would have had to dug through

• 17:03Speaker 03

  different filings, you know, I mean, you know, Bloomberg would of course have that information on the terminal. But, you know, that's the type of thing that AI can really help you with, things like that, like is, is kind of going through and putting the pieces together.

• 17:16Barry Ritholtz?

  Really, really interesting. So to wrap up, if you're an active trader or if you buy speculative stocks or even if you have questions about the management of some of the companies you own, it might be useful to pay attention to their SEC filings, especially the things they may not want you to see, items they're dumping on a Friday evening or barely meeting the minimum disclosure requirements. There's a, there's gold in them there hills if you know where to look and if you know how to interpret it. I'm Barry Ritholtz. You're listening to Bloomberg's At the Money.

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