SOX 409''s Limited Impact: New Rules Won''t Demand Reporting Systems Overhaul
Section 409 of Sarbanes-Oxley requires public companies to rapidly disclose information on material changes in the financial condition or operations. The lack of specificity of this section initially created concern because in its broadest interpretation it could have demanded public companies operate with an "open kimono" at all times, disclosing all manner of information. A few software vendors picked up on this scary aspect of section 409 as a marketing tool. Some point to the need to report the information faster as a reason for expanding the use of reporting on structured information. Others suggest that document management and other unstructured information systems will ensure compliance.
Ventana Research says: nonsense.
The section clearly states that public companies will have to comply with rules enacted by the SEC. As interpreted by the SEC, Section 409 is far less onerous from a reporting standpoint than some had first postulated. Yet vendors continue to cite section 409's broad wording as if it set the requirements.
Events Currently Triggering Form 8-K
The SEC's Form 8-K is used by companies to file reports that call attention to events that are of importance to investors. Currently the SEC requires companies to issue an 8-K if any one of these 12events occurs:
1. Change in control;
2. Acquisition or disposition of assets;
3. Bankruptcy or receivership;
4. Changes in the certifying accountant;
5. Resignations of directors;
6. Publications of financial statements and exhibits;
7. Change in fiscal year;
8. Any disclosure under Regulation FD;
9. Amendments to the registrant's code of ethics or waiver of a provision of the code of ethics;
10. Temporary suspension of trading under the employee benefit plans;
11. Results of operations and financial condition; or
12. Other materially important events.
The common thread to all but Regulation FD and "material events" items is management never learns of these developments through corporate reporting systems. Conceivably the other two actions may be driven by reporting systems (e.g., companies pre-announcing quarterly results) but these are derived from existing systems and there is no legal compulsion to actively use IT systems to discover material events.
The Proposed 11 Events Triggering Form 8-K
The SEC is expanding the list of disclosable events to include 11 additional events that would trigger a Form 8-K filing requirement. None of these will require new IT systems, in our opinion. Four of the 11 new disclosable events are never captured as structured information that can be reported on.
These four events include:
1. Entry into a material agreement not made in the ordinary course of business;
2. Termination of a material agreement not made in the ordinary course of business
3. Creation of a direct or contingent financial obligation that is material to the company; and
4. Any material limitation, restriction or prohibition, including the beginning and end of lock-out periods, regarding the company's employee benefit, retirement and stock ownership plans
More important, if the impact of any of these four is big enough to be material, the company's legal staff will create and/or review the documents and flag them for disclosure. No need for new systems here.
Another 4 of the 11 new disclosable events are external developments never captured in the company's structured information systems. There is never anything to report on. Management becomes aware of the events through a letter, phone call, or e-mail.
These events include:
5. Termination or reduction of a business relationship with a customer that constitutes a specified amount of the company's revenues;
6. A change in a rating agency decision, issuance of a credit watch or change in a company outlook;
7. Movement of the company's securities from one national securities exchange or inter-dealer quotation system of a registered national securities association to another, delisting of the company's securities from an exchange or quotation system, or a notice that a company does not comply with a listing standard; and
8. Conclusion or notice that security holders no longer should rely on the company's previously issued financial statements or a related audit report.
The ninth event is already reported by existing accounting/IT systems:
9. Events triggering a direct or contingent financial obligation that is material to the company, including any default or acceleration of an obligation
Unless management is hopelessly incompetent, companies covered by the law that are in danger of violating covenants are getting frequent, specific reports on whether they are (or will be) in violation of loan requirements and the like. The CFO, the controller, and the treasurer are very likely already aware of it. The real change stemming from Sarbanes-Oxley and the change in SEC regulations is this: when a company's internal forecasts show a probable default on loan obligations or other adverse financial events, the company will have to issue an 8K a lot sooner than before (or in delaying, create documentation that will cover their collective behinds).
Lastly, there are two events that also use existing software (often spreadsheets) and reporting systems to support decision making and analysis, but hardly require new systems.
These are:
10. Exit activities including material write-offs and restructuring charges, and
11. Any material impairment. The events are a result of management decisions and, thus, no reports are needed to alert them.
The SEC's new 8-K trigger events specifically do not speak to a requirement to report in real time as to changes in trends, which has been the underpinning of much of the discussion on why information systems need beefing up. There is no requirement to disclose agreements in the process of being drafted which might require more sophisticated content management software to track the status of contracts.
Assessment
Companies have many reasons to buy, expand, and enhance their reporting systems, analytical applications, planning tools, content management and other Performance Management IT systems. The software, intelligently implemented, can create significant value for public companies by giving them deeper, more consistent, or a timelier view into operations; improve execution; and so on. Quite apart from Sarbanes-Oxley, to be competitive or to set objectives, all companies must have a clear view of potential material changes in the financial condition or operations. While Section 409's vagueness initially created uncertainty, Ventana Research asserts its current interpretation by the SEC will have no meaningful impact on the structured or unstructured information systems requirements of public companies. It is possible that the SEC will expand the scope of events that must be reported in ways that require more robust reporting and analytics. For now, though, public companies should focus on how their real business issues can be addressed by IT.
