A Proposal to Revise the SEC Instructions for Reporting Waivers of Corporate Codes of Ethics for Conflicts of Interest

Abstract

Enron's collapse focused attention on its application of its Code of Ethics to related-party transactions. That focus produced section 406 of the Sarbanes- Oxley Act of 2002, which attempts to regulate conflicts of interest between officers and their companies through codes of ethics that public companies adopt. Pursuant to SOX section 406(a), the Securities and Exchange Commission issued new regulations requiring each public company to disclose whether it has a code of ethics, and if a company has not adopted such a code, to explain why it has chosen not to do so. SEC rules also require each company that has a code to disclose any waiver of the code for certain officers whom the SEC rules identify, in a timely manner under Item 5.05 of Form 8-K. However, some companies have adopted a hypertechnical interpretation of the SEC's definition of a "waiver " -- "the approval by the registrant of a material departure from a provision of the code of ethics"--such that these companies do not report the "approvals," and the investment community does not learn of the officer's conflict in a timely way. To remedy this shortcoming, this paper proposes that the SEC change its definition of a waiver in Instruction 2(1) to Item 5.05 to include "every approval by the registrant that permits executive or senior officer participation in conflict-creating transactions and activities. " This change should prevent companies from using internal approvals to avoid waiver disclosures.