The Sarbanes-Oxley act places stringent guidelines on corporate governance, and many executives are hurrying to bring their companies into compliance. How can a contract management system help?
The business press in recent months has been dominated by waves of corporate scandals, and several well-respected companies have had to dramatically restate their earnings. It's not surprising then that a poll of corporate executives taken by Kennedy Information, publisher of Shareholder Value magazine, found that 46 percent said these scandals have harmed the way investors viewed their companies. ("In Corporate America It's Cleanup Time," Fortune Magazine, September 2,2002, By Jerry Useem.)
"Investors increasingly demand full transparency of accounting policies and their effects," ("Firms Still Fall Short on Disclosure, SEC says," Washington Post, February 28,2003 by Kathleen Day) the SEC noted in a "guidance" that detailed its expectations for annual reports. In July of 2002, legislators passed the Sarbanes-Oxley Act to help re-establish trust in corporations. The most sweeping change in corporate governance since the Great Depression, the Sarbanes-Oxley Act is designed to prevent corporate and accounting fraud by increasing the transparency of corporate finances, policies and practices.
The Sarbanes-Oxley Act mandates that corporations develop sound internal controls as well as provide timely and accurate disclosure of financial information to investors. The Act also specifies oversight and penalties to enable enforcement of these requirements. While most corporations focus on aspects of the Sarbanes-Oxley Act that govern financial transactions, the Act also has implications for the commercial contracts that underlie each financial transaction. This is an area that most companies today are ill prepared to manage. Contract management software has emerged as a powerful solution that provides organizations with greater visibility into contracts, enabling the control and disclosure necessary to comply with the requirements of the Sarbanes-Oxley Act.
The Role of Contract Management in Improving Corporate Governance
Good contract management is critical for enabling corporations to fully comply with several key Sarbanes-Oxley Act provisions including certification requirements, rules requiring enhanced internal controls and disclosure mandates. "Sarbanes-Oxley is sending a wake up call to many executives who realize they had better get a handle on the commitments being negotiated in their corporations," according to Tim Cummins, executive director of the International Association of Contract and Commercial Managers. "Yet even now, many are turning to the General Counsel in the expectation this will fix the problem and provide instant answers. In come cases, it probably will; but in many it is going to lead to frustration. There is a world of difference between 'contracts' and 'contracting' one is a document, the other is an end-to-end business process."
The Sarbanes-Oxley Act's certification requirements place tremendous responsibility on CEOs and chief financial officers (CFOs) to guarantee the accuracy and reliability of all financial information in their 10K and annual reports. The financial information that appears in these reports is a snapshot of what actually happened in the previous financial period. This, in turn, is often driven by a set of underlying contracts that detail what should have happened.
Consider the example of a software company signing a complex five-year agreement comprised of licensing, professional services, maintenance and training fees. The contract may have several milestones linked to service delivery that determine when revenue can be recognized. The contract may state that the customer pay for professional services when the contract is signed. Yet, according to Generally Accepted Accounting Principles (GAAP), the company may only be able to recognize the revenues in the quarters when the services are actually delivered. The financial statements certified by the CEO must accurately reflect these contractual complexities.