The Critical Importance, and Changing Face, of Corporate Transparency

With so much current emphasis on popular buzz words, it's easy for companies and investors to lose sight of exactly what's meant when reference is made to "corporate governance." For too many, the concept conjures up questions about the appropriate number of independent directors, the nature of various corporate committees, and the timing of shareholder access to corporate proxy machinery.

But emphasizing these company attributes can obscure the single most critical feature of corporate governance-namely, transparency.

The implosion of so many companies over the past several years-and the legislative, regulatory and prosecutorial solutions to those implosions-all have focused on one over-arching issue: Can a company's reported financial results be believed? Put another way, has the company told us everything we really need to know to make an accurate assessment of its current performance and future prospects? The principal focus of recent regulatory efforts has been to ensure that companies mean what they say, say what they mean, and say it all on a timely basis.

The string of corporate crises emphasized an already painfully obvious inherent weakness in our current disclosure system-it provides public investors with far less relevant information than sophisticated investors routinely demand and receive when they make private investments in the same companies. Our public disclosure system has, until very recently, been founded upon a virtually exclusive backwards look-what has the company done and from where has the company come? And yet, sophisticated investors all seek current and forward looking information-information about how the company is doing now, and how it is likely to perform over the coming months and years.

Last month, the SEC took another major step to metamorphose our disclosure system from its backward-looking perspective into a current disclosure system. It did this by amending Form 8K to require companies to disclose eight broad categories of additional critical information within four business days of their occurrence.

For some, these new rules simply mean new checklists to satisfy minimal requirements. But to the savvy, these changes are an important call for companies to assess the strength and effectiveness of their current disclosure methodologies, practices and policies. Here are some approaches public companies should consider implementing:

Recognize and give effect to the critical attribute all disclosures must fulfill.

The SEC has often stated its disclosure goal is to give investors an accurate view of their company, seen "through the eyes of management." In order to satisfy this fundamental and over-arching requirement, companies must ensure that critical information, on which management relies in making "real-time" day-in and day-out decisions, is promptly funneled to those responsible for crafting corporate disclosures, both current and periodic.

Expend the necessary energy, intellectual creativity and expense to establish an effective and continuous disclosure assessment process.

For many companies, disclosure has been a quarterly or annual event. Given the changes to Form 8K, and the importance of corporate transparency to the marketplace, approaching disclosure as an episodic event is no longer possible, if it ever was.

Instead, companies must assign clear responsibility for the continuous collection, aggregation and assessment of corporate information, and develop methodologies that ensure that timely decisions are made on what corporate data and developments to disclose.

Develop a "current disclosure" mindset.

Although the SEC has specifically enumerated eight additional events that require Form 8-K disclosure, and required other current disclosures previously required to be made quarterly or annually, it encourages companies to use Form 8-K to describe any significant event in the life of the company.

In recent times, our markets have become extremely volatile. "Bad" news, or "surprise" information, can negatively impact company's market capitalization in seconds. Those companies that utilize Form 8K to minimize surprises for the marketplace will find their stock price less vulnerable to the vicissitudes of a volatile stock market.

In a similar vein, companies should consider employing an "affirmative" disclosure regime.

Under existing law, public companies don't have a general affirmative obligation to update their corporate disclosures between filings of annual and quarterly reports, and the SEC didn't impose such an obligation. Instead, the SEC identified events it believes are "unquestionably or presumptively material."

The absence of a general affirmative update obligation has permitted public companies to delay material information disclosures until the due date for their next periodic report, or until an 8K filing is required. But following this approach leaves companies subject to greater volatility in their share prices when they finally do announce information that is, or can be construed as, negative or a surprise.

Ensure current disclosures set forth the appropriate context in which investors can assess the significance of the required disclosures.

The SEC didn't require management to include an analysis of the effects of the required current disclosure events, given the concern that a "mini-MD&A" analysis would be too difficult to craft in the abbreviated Form 8-K filing period.

But the absence of a formal requirement doesn't obviate the implicit requirement that companies must accompany any Form 8K disclosure with all material information necessary to avoid misleading investors. If transparency is the goal, companies can only achieve that by ensuring that the contextual significance of whatever disclosures they make is understandable to reasonable investors.

Contemporaneously document current disclosure decisions.

The final SEC rules include a limited "safe-harbor" provision against fraud liability, if a company makes a good faith judgment that it cannot or should not make "current" disclosure. In order to take advantage of this safe harbor, however, companies need to ensure that the thought processes by which a non-disclosure decision was reached are articulated and preserved.

It is also important to evaluate a non-disclosure decision, not just when the next periodic report is required (at which time the limited new safe harbor automatically expires), but also throughout the period between the initial non-disclosure decision and the time when the next report must be filed. Disclosure assessments are, by definition, ongoing judgments, and events may change sufficiently so that an earlier decision to defer disclosure is no longer valid.

Avoid the temptation to avoid negative disclosures.

As noted, the SEC's goal has long been to give investors the most accurate and complete current picture of a company, as seen through management's eyes. In this endeavor, the SEC has been frustrated by the rapid spread of good news, but the glacial flow of bad. The new Form 8-K requirements are meant to change this. And, the market ultimately rewards companies that deliver news on a timely and accurate basis, even if the news is sometimes bad.

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This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.