SEC report card 2007; The commission tackled proxy access, Sarbanes-Oxley refinements, terrorism ties, securities markets globalization, and other business and financial-reporting developments. How did it measure up?

Directors & Boards, Summer, 2008 by Ralph Ferrara, Riva Khoshaba Parker, Joseph J. Migas

LAST YEAR WE GRADED the SEC's performance in 2006, and came out with a harsh critique. This year, we are more optimistic, although it is a cautious optimism. We note two trends driving the SEC. The first is its continued move to clarify and simplify Sarbanes-Oxley--a law that continues to cause grief more than six years after taking effect. Unfortunately, many of these reforms still do not go far enough, or the SEC's attempted clarifications served to inject new ambiguity into an already complicated process. The second is the increasing attention paid to global issues. There are signs that the SEC is finally coming to terms with the increasingly globalized marketplace, and taking note of rising rival markets and their regulator counterparts. This made it a year of many proposed changes, many of them positive, most of them as-yet unfulfilled.

1. Aborted "Terror Tool"

FIN PERHAPS THE MOST BISARRE move of 2007, the SEC created (and quickly disassembled) a "terror tool" on its Web site that was supposed to provide information on which companies did business with or in the countries on the State Department's list of state sponsors of terrorism. The tool listed the name of each country on the State Department's terror watch list; each country name linked to a list of companies doing business with that country; each company name linked to the portion of the annual report discussing operations in that country. The Web tool, unveiled last June, came under almost immediate criticism from multiple sectors, uniting both business groups and humanitarian groups in their opposition to the SEC's tactics.

Corporations listing on American exchanges have been required to disclose their ties to states on the terror watch list for years. The SEC's tool was designed to eliminate the need to comb through numerous filings in order to learn which companies operate where. However, critics charged the SEC simply compiled a list of companies with the words "Sudan," "Iran," "North Korea," "Syria" or "Cuba" in their annual reports. (The SEC, in the news release issued when it withdrew the Web site, denied that it had simply conducted a word search without regard for context.) The resulting tool, critics charged, was misleading to investors. For example, a company reporting that it had withdrawn from Cuba, a company that reported providing medical supplies to refugee camps in Sudan, and a company with oil contracts in Iran, would each be identified as doing business with sanctioned countries, even though the level and nature of involvement is starkly different. Critics were also concerned that some companies had withdrawn from the countries in question since their last annual report, leaving the information on the Web site outdated.

On July 20, less than a month after unveiling the tool, the SEC pulled it from its Web site. Chairman Christopher Cox announced that the tool would be withdrawn until it could be reconfigured to address the concerns; but he noted that the use of data tags in annual reports - a technological initiative the SEC has been pushing for the last few years - might obviate the need for such a tool at all. In November 2007, the SEC revived the issue for commentary, asking whether the commission should "develop mechanisms to facilitate greater access to companies' disclosures concerning their business activities" in or with countries on the State Department's terror watch list.

This unusual, and ultimately ill-fated, initiative is an instance of SEC overreaching in 2007. The SEC seems to confuse its role as a market regulator - one that involves establishing rules, including required disclosures, and policing their compliance - with a more normative role that seeks to make qualitative judgments about (otherwise legal) activities in an effort to "name and shame" companies. The SEC, as a market regulator, does not have a foreign policy agenda and lacks the expertise needed to make qualitative judgments about a company's foreign operations. It should leave this area of operations to those best equipped to deal with it--the State Department, OFAC, and the nongovernmental organizations whose mission is to make qualitative judgments about good and bad business practices. Investors concerned about this issue already have access to the information using the SEC's Edgar tool to search disclosures already contained within company filings. The less-than-one-month duration of the tool indicates just how much an ill-conceived idea it was. An "F."

2. New rules on reserves reporting forthcoming

THE SEC HAS SIGNALED that it may update its reserves reporting requirements, at long last heeding objections from the extractives industries that its methodology was outdated, geared towards Texas-style oil fields (which differ in shape and composition from many fields around the world), and did not take into account the considerable technological advances that had taken place in drilling and extraction since the rules were formulated in 1978. The current methodology is widely considered to under-report a company's reserves, and is more restrictive than prevailing rules worldwide. In a rare, and welcome, sign of humility, the SEC has voted to issue a concept release for updating such rules, and seeks public comment on whether to allow companies to adopt a more flexible approach for estimating reserves, using different technologies, and possibly a different pricing model. The SEC also seeks comments on whether reserves estimates should be independently confirmed by a third party.