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Sarbanes-Oxley: Too Much Disclosure?

Joseph W. Bartlett, Founder of VC Experts.com


A contrarian impulse was triggered by a recent article entitled "The Buy-Side Revolution" (Wall Street Journal, 9/27/2002) by Charles Wolfe, Jr., who is a senior economic advisor and corporate fellow in international economics at Rand and a senior research fellow at the Hoover Institution. One of Wolfe's theses in his article is that non-professional investors are being advantaged by the recent developments in regulating how public companies present the results of their operations including financial statements to the marketplace. He thinks that with the improvement he cites resulting from Sarbanes-Oxley and several of the SEC's initiatives "it is entirely possible for investors [and he means non-professionals] to become sufficiently knowledgeable about investments products, to ask the right questions and demand the information necessary to make better decisions in accord with their own preferences and judgments."

He rejects the notion advanced by some financial professionals that "investment products are too technical and arcane for individual investors to understand as well as they understand consumer products and services."

The problem, as I see it, is exemplified by a recent public disclosure filed by AT&T in connection with the Comcast transaction. The disclosure statement was 800 pages long and, in my view, that renders the disclosures unreadable to anybody other than a financial professional. The contrast with private equity where the investors, at least from the Series A Round onward, are largely professionals, is extraordinary. If an issuer seeking capital from venture capitalists were to present a disclosure statement that was 100 pages long, let alone 800 pages long, the document would not even make it in the door. At one point, the idea was that you had to present the VCs with an "elevator pitch," meaning a document they could read as the elevator was going from floor to floor.

Of course, once the asset manager became serious about investing in making a private equity investment the due diligence process starts and a good deal of data would be collected on the investment opportunity (but in rare cases 800 pages worth). However, the point in both private and public equity is that there are a number of opportunities to choose from. If all you want to do is invest in AT&T to the exclusion of any other opportunity, then I suppose it is feasible to wade through 800 pages of text to find the information you want. If you want to compare AT&T stock to 100 other stocks on the New York Stock Exchange, then I submit the AT&T disclosures are useless unless it is your job as a securities analyst to do nothing but read the disclosure statements in the industries you cover.

My point is not to oppose the reforms we are seeing in today's environment. They are long overdue and the integrity of the markets is at stake, a point Arthur Levitt made in a speech some years ago at NYU law school and hew as prescient on the issue. My point is that the principle of unintended consequences, if the pendulum swings too far, threatens the classic "throw the baby out with the bath water" effect. As Sarbanes-Oxley and other exposure to civil and criminal liability threaten boards, audit committees, management, auditors and counsel, human nature takes over. In order to protect one's self (and the SEC's Plain English requirements to the contrary notwithstanding), the disclosure statements are going to grow like Topsy, risk factors will become extended ad infinitum, the notes to the financial statements, the qualifications in the M&A section, 800 pages may appear brief as self protection generates prolixity. We all know where we want to go with these reforms. The trick is to get there without a structure which, for example, will result in the IPO market never resuscitating itself and private equity finance suffering from the inability to provide upside compensation to key executives.

Last week, in an interview with Mark Director of Kirkland & Ellis, we looked at some more of the practical aspects of what fund managers and their counsel can do to avoid any pitfalls. An excellent piece, we encourage you to review it.


joe@vcexperts.com