Sarbanes-Oxley's subtle disclosure costs.

Criticism of the high costs of the Sarbanes-Oxley Act of 2002 has focused primarily on its requirements related to internal controls over financial reporting. However, little attention has focused on the hidden costs of the Act, in particular the increased time and advisory sophistication required to comply with the complex, time-sensitive disclosure system it has brought about.

**********

The unexpectedly high expense of compliance with The Sarbanes-Oxley Act (Sarbanes-Oxley or SOX) (1) has generated considerable debate (2) about the cost-benefit of the legislation to public companies, investors, and the capital markets. The primary focus has been on direct, out-of-pocket, expenses such as accounting fees, Section 404 (3) compliance expenses, and increases in directors' fees and D & O liability insurance premiums. (4) Concerns have also been expressed over increased costs that are less easily quantifiable (but that are nonetheless real and significant), including allocation of management time and resources, larger internal accounting staffs, and increasingly risk-averse boards whose time is spent avoiding liability rather than creating shareholder value. (5)

A more subtle cost in the new corporate governance environment is the rigor and sophistication required to comply with the increasingly "rapid and current" disclosures required by SOX and the SEC, (6) as reflected by the 2004 passage of the SEC's expanded, 8-K disclosure requirements (New 8-K Rules). (7) Taken together, SOX and the new rules have generally expanded the specific disclosures required to be made in periodic reports, press releases, and other disclosure documents. Significantly, the reforms have also accelerated the timeframe within which disclosure must be made. Faster response time (along with expanded reporting obligations) while arguably good for the overall market, also decreases the probability of successful compliance. Human error under time pressure increases the chance of disclosure error by a company, thereby increasing the risk of individual liability of its directors for failing to adequately oversee corporate disclosure.

Changing the Board Meeting Process to Respond to SOX

Further exacerbating the corporate pressures associated with expanded disclosure requirements and reduced timeframes for required disclosure, companies and boards have had to significantly modify their preparation for, and conduct and memorialization of, board meetings in order to meet the increased responsibilities and oversight demanded in today's markets. (8) A reasoned response to the changed environment is to improve the quality of the preparation period for board meetings, perform more extensive analyses, involve a broader range of the company's professional advisors in the planning and board process, and to document the resulting analyses and actions.

Overall, that's probably a good result. However, it also has the consequence of creating more disclosable information in a process whose importance is frequently minimized within traditional disclosure analysis. In other words, issuers and directors have not historically regarded board meetings as being a major precipitating event or link in the SEC disclosure chain. The intuitive legal view of board meetings and process is that the issue to focus on is corporate and director liability under substantive law (i.e., Business Judgment Rule) rather than viewing this process as a key component immediately and dramatically impacting an issuer's public disclosure obligations.

The net impact of a changed role for the board process is increased costs for all public companies. Because of the real-time nature of this disclosure environment, there is a concern that only larger public companies can truly meet all their obligations. They generally have a deeper financial staff, and frequently employ an inside, disclosure-sensitive, general counsel who fits comfortably into an expanded disclosure environment and role. Smaller public companies, by their nature, frequently lack the internal (and sometimes external) legal and …