Date: December 15, 2023
First published in Straits Times on 15 December 2023
What is the appropriate test of materiality that companies should apply when making corporate disclosures?
This question has direct relevance to the case of cord-blood bank service provider Cordlife Group, which is embroiled in controversy and the target of no small amount of criticism, following lapses in its storage of thousands of cord-blood units.
The cord blood banking company – which is being investigated by the Ministry of Health (MOH) – responded on Dec 10 to queries from the Singapore Exchange (SGX) on why its board did not make any earlier announcements on the temperature irregularities or the audit conducted by the ministry.
Cordlife on Nov 30 was suspended by the MOH from collecting new cord blood and human tissue following unannounced MOH audits on the company in August and November following a complaint from a member of the public in July.
In those audits, MOH found seven of the company’s 22 cord-blood storage tanks being kept at temperatures above 0 degrees Celcius.
SGX noted that Cordlife was aware that there were tanks exposed to temperatures beyond acceptable limits for several days in February, March and June 2022, but had not made any announcements.
Cordlife replied by saying “certain members” of its management team were alerted by an employee in June 2022 of irregular temperatures in one tank for several days in June, and the management had taken “immediate actions and carried out internal investigations to further understand the issue”.
Even though its board was informed of irregular temperatures in one of its tanks in February 2023, the company did not make any announcement as it assessed that there would be “no material impact on the financial performance of the group” for the 2022 and 2023 financial years.
The test of materiality that was applied was therefore whether the financial statements would be impacted, taking into account that the group had “adequate provisions to offset against the potential financial impact of any fee refunds or waivers of the remaining storage years that may be offered to clients in connection with the incident”.
In short, even though thousands of customers would later find that their cord-blood units were exposed to inappropriate temperatures, thus rendering them unusable, the company did not make any disclosures for several months.
Stated differently, it appears that the emotional impact on customers was not deemed sufficiently important, or for that matter, material to warrant prompt disclosure.
The immediate question is: If the Jun 2022 or even the Feb 2023 lapses had been disclosed promptly, how many customers would not have had to suffer the emotional distress they are now undergoing?
A recent commentary described Cordlife’s disclosure practice as “cavalier’’, given the severity of the incidents and the widespread damage caused.
The Securities Investors Association (Singapore) or Sias agrees with this description but would like to go one step further and offer our own interpretation of the correct benchmark of materiality which should have been applied as this holds valuable lessons for all companies when adverse events occur.
Granted, materiality is an elusive concept and application of the term often comes down to a judgment call. However, the impact of an event on the financial statements is only one dimension to be assessed; the other, possibly more important one, is the conclusions that might have been drawn by a reasonable person had the news been disclosed promptly.
In this connection, any description of “reasonable person” would have to include a “reasonable investor’’ as well. In Cordlife’s case, the market’s reaction to the MOH news was immediate and devastating – its shares crashed by as much as 65.9 per cent, before closing 31.9 per cent lower at 31 cents on Dec 1, a level at which they have since remained.
Clearly, reasonable investors, when informed of the temperature lapses, reacted very negatively to the news despite the company’s earlier conclusion that there would be no impact on its financials.
It should be obvious from this that the correct approach is to evaluate materiality through an objective lens by putting aside potential biases or considerations regarding reputational damage.
On top of quantitative factors, all qualitative factors would have to be considered as well, since reasonable persons and investors would require such data to make informed decisions.
By focusing on the immediate financial impact when determining materiality and not considering the longer-term impact on customers and investors, Cordlife’s Board has done a disservice to all its stakeholders, which would have to include the broader community.
Cordlife is in the business of storing cord-blood, which is an excellent source of stem cells which can be used in later life to treat several disorders, including cancer. That several storage tanks were exposed to sub-optimal temperatures, thus damaging stored units struck at the heart of the very business the company is in, and disclosures should have been swift and immediate.
To only focus on the financial impact when deciding on materiality was patently wrong.
- The writer is Mr David Gerald, Founder, President and CEO of the Securities Investors Association (Singapore)
