Back in the age of Thick, Glossy Paper—an era which reached its zenith in the 1990s right along with technology stocks—the best corporate annual reports were lit­tle four-color financial masterpieces, expertly weaving photos and charts and loads of financial stats into a pleasing whole that was part pro­paganda, to be sure, but also a comprehensive analysis of a company’s business, competitors, and prospects. But have you checked out an annual report lately? Too often it’s an ugly, mini­malist thing called a “10-K wrap,” really nothing more than an artless data dump written for SEC lawyers. A wrap is about as investor-friendly as a shareholder meeting in Antarctica. And the cheap paper it’s printed on might not make the grade in the loo at corporate headquarters. 

So what happened to the traditional annual report? Enron happened. WorldCom happened. Adelphia happened. So, in the end, Uncle Sam happened. When Congress hurriedly passed the Sarbanes-Oxley bill back in 2002, it was the most sweeping securities and corporate gover­nance reform since the New Deal. Like those Great Depression–era laws, Sarbanes-Oxley was a government reaction to a stock-market crash—at least in the technology sector. Sarbanes-Oxley was pitched as a regulatory means of bolster­ing public confidence in public companies and American financial markets. 

Now CEOs and chief financial officers are required to certify personally the accuracy of finan­cial statements. Companies also have to disclose more information, including full reporting on the effectiveness of their internal financial controls. No executive wants to end up in prison—or on the business end of a shareholder lawsuit—because of an overly exuberant letter to shareholders in an annual report. 

In addition, the Internet had its usual game-changing effect. Rather than spend extra money on a flashy report that gives a total view of a busi­ness and its corporate culture, why not send a numbers-heavy, nuts-and-bolts report and leave it up to investors to make their way to the company website if they want a more comprehen­sive view? In 2000, the SEC adopted Regulation FD, for “fair disclosure,” which mandated that all publicly traded companies must disclose material information to all investors at the same time. That’s why companies now allow investors to listen in on management’s quarterly conference calls with Wall Street analysts and to view the various PowerPoint presentations that companies give to institutional-investor conferences around the country. Financial graphics are a lot cooler on the Web, too. 

No executive wants to end up in prison—or on the business end of a shareholder lawsuit—because of an overly exuberant letter to shareholders in an annual report.

Yet the critical result of all this isn’t merely that many annual reports are considerably less glitzy than their counterparts in pre-Sarbanes-Oxley days. The more important effect is that compa­nies are also making less effort to present financial information in a way that makes sense to individ­ual investors who, unlike professional securities analysts, may not have an MBA or CFA. Some companies are skipping annual reports altogether in favor of 10-K wraps, which simply repackage the data-dense annual financial report that com­panies send to the SEC. “In an era where average citizens are being asked to take more responsibil­ity for their financial futures, bulky documents and hard-to-use online formats are a barrier to their ability to succeed,” says Dominic Jones, an inves­tor-relations consultant and founder of the IR Web Report. “In my opinion, compliance is only one half of effective disclosure. Clear communication is the other half. But we’re seeing less communication since Sarbanes-Oxley.” 

And this isn’t just about annual reports being less user-friendly than in the past. Beyond that, Sarbanes-Oxley might be making America less investor-friendly. It would certainly be a shame if another unintended consequence of Sarbanes-Oxley was that individuals soured on investing just at the time when the stock market might be part of the solution for creating a post-Social Security retirement and savings system.  

Making Americans more mar­ket-averse wasn’t the aim of the legislators who passed Sarbanes-Oxley, or that of President Bush who signed it. But now that might be the result. “I have yet to encounter any truly dedicated annual-report producer who applauds Sarbanes-Oxley,” says Sid Cato, who has critiqued and rated annual reports for a quarter century. “None of them has surfaced as an advocate of the change—a change, needless to say, for the worse.” As for individ­ual stockholders, Cato says, they are “the major victims.” He foresees “an insufficient, gloss-over-the-details approach that will result in a massive turnoff of the individual shareholder…. Corporate America has seen this as an opening toward less disclosure, not more, and a down-and-dirty book long on folderol and short on substance.” The Sarbanes-Oxley effect on annual reports, Cato says, is an invitation to produce “nonsense rather than substance.” 

George Stenitzer, a corporate communica­tions executive at Tellabs, a telecommunications equipment company in Naperville, Illinois, says he senses that companies are splitting up into two camps. One is trying to meet only the min­imum standard of a technically accurate and legally compliant report so that the company, as Stenitzer says, can “check the box and say, ‘We did it.’” Other companies, though, are try­ing to convey an understanding of the business with their reports. “It’s not just a recounting of the numbers, because these days you’ve seen the numbers in January and by the time the reports come out,” says Stenitzer, who produces widely praised annual reports. “The real question is: How does management see the business in that context? What challenges have you had and how did you face them?” It is an approach informed by his experience with investor focus groups. “They absolutely do not believe a CEO letter if it doesn’t really wrestle with the major problem of the business,” Stenitzer says. “They just nix the whole report.” 

Consider Stenitzer’s 2006 report for Tellabs. It starts with a succession of big, colorful photos overlaid with graphics that explain the company’s business as a developer of telecommunications net­working products. The report then proceeds to tell clearly how Tellabs’s business is changing, illustrat­ing the transformation with some helpful pie charts about its revenue mix. In the shareholder letter, chief executive Krish Prabhu tells of the challenge of meeting growing broadband needs. Prabhu then does a Q&A that uses, Stenitzer promises, actual shareholder questions. In general, Stenitzer thinks annual reports should always contain financial highlights with percentage changes, an 11-year financial history because it allows investors to cal­culate a 10-year compound annual growth rate, some breakouts for the segments within divisions of the company, and forward-looking informa­tion that really gives a sense of what management thinks. Yet in the Sarbanes-Oxley era, such candor is increasingly rare. 

“I can’t think of an annual that’s improved thanks to Sarbox—other, perhaps, than Tellabs,” Cato says. He calculates that, according to a lengthy set of cri­teria, only a scant 7.7 percent of annual reports are “reflecting well on the company whose name is on the cover.” Basically, Cato assigns points in various categories: Does the report shed light on compe­tition, market position, and market shares? Does the report contain detailed biographical data on corporate officers? Does it go beyond the five-year disclosure of financial data demanded by the SEC? 

The report analyzed 40 companies’ compensation statements and found that ‘most fail to even meet the readability standards that many U.S. states require for insurance forms.'

Another way of gauging the state of the annual report in America is to assess the quality of the language used—and the results there are equally discouraging. The SEC requires that explanations about executive and director compensation be written in plain English, but that doesn’t seem to be happening. Earlier this year, Dominic Jones’s IR Web Report analyzed 40 companies’ compen­sation statements and found that “most fail to even meet the readability standards that many U.S. states require for insurance forms.” After subject­ing the statements to the Gunning-Fog readability test, which analyzes a document based on sentence length and the number of complex words used, the report found that the average score was 16.45, comparable to an academic paper. Articles in The Wall Street Journal, by comparison, usually rank around 11, while those in Reader’s Digest average an index of 8. 

Yet even if many traditional annual reports don’t have all the information that perhaps they should and aren’t written as clearly as one would like, they are still better than 10-K wraps. According to a 2006 study by the National Investor Relations Institute (NIRI), 66 percent of annual reports include five-year financial summaries, versus 56 percent of wraps; 52 percent of annual reports include margin information versus 49 percent of wraps; 47 percent of annual reports include return-on-equity data versus 32 percent of wraps; 28 percent of annuals include return-on-assets data versus 20 percent of wraps. 

Worse, 10-K wraps are getting more popular. The NIRI also found that 56 percent of companies are opting for a wrap instead of a conventional annual report. Remember, the wrap is nothing more than an SEC report stuck between a couple of pages of explanatory material and probably a terse, no-non­sense letter to shareholders. Sure, the 10-K supplies plenty of numbers. But numbers without analy­sis or context may be little help to investors. And while annual report producers say their main goals are communicating corporate strategy and “value drivers,” wrap producers focus on “cost savings” and “ease of production.” What’s more, 80 percent of annual-report producers say they are trying to communicate to existing individual shareholders and 76 percent to potential individual sharehold­ers. But only 65 percent of wrap producers consider existing individual share­holders a key audience and just 58 percent focus on potential individual shareholders. 

Wraps are all about keister-covering, not communications. “For the average reader, a 10-K can be a fairly daunting document,” says Terry Davis, former president of See See Eye, a graphic design and communica­tion firm in Atlanta that produces annual reports. “From the appearance standpoint, it’s a much more legal, boilerplate sort of document. In the day when public companies were doing more traditional annual reports, more care and consideration were given to charts and graphs to help interpret data…for the reader. Some of that goes by the wayside when you’re trying to cut costs. So you’ve created more work for your reader.” 

Companies are fleeing the NYSE—some three dozen in 2007—for overseas destinations because of cumbersome and costly Sarbanes-Oxley requirements.

But less work and expense for your company. For starters, the 10-K wrap only takes about 2.7 months to produce, versus 3.7 for the traditional annual report, according to the NIRI. Traditional annual-report managers at companies are more likely to use an outside writer and pay more for doing so than if they are merely churning out a wrap. The fee for outsourcing the writing of a traditional report generally ranges from $10,000 to $14,999; for a 10-K wrap, the fee is $5,000 to $7,500. Then you have to make the report look pretty. A majority of com­panies employ an outside designer, no matter the format. The typical design fee for an annual report is in the $60,000 to $80,000 range. The fee for a 10-K wrap is usually only $20,000 to $40,000. 

Minimalist 10-K wraps are exactly what inves­tors get from two of the best-known New Economy companies, Amazon.com and eBay. For eBay shareholders, the 2006 annual report ran about 100 pages, consisting of a full-color cover featuring a multiethnic group of eBay employees, followed by a one-and-a-half-page boosterish sharehold­ers letter from chief executive Meg Whitman and board chairman Pierre Omidyar. And that’s fol­lowed by page after page of data and dry text. With Amazon, shareholders got a 96-page, black-and-white report. No photos anywhere, though as a bonus it does include the 1997 shareholders let­ter along with the 2006 version from founder and chief executive Jeff Bezos. Dominic Jones, the communications consultant, recalls fondly when “companies made an effort to put on a show with a fancy annual report with lots of color and photos.” The commonplace 10-K wraps of today are hard to love, he says, because the SEC filings they reprint “are horrible to read. They use an unfamiliar struc­ture and nomenclature—and information design is virtually nonexistent. It’s even worse now because most people rely on the Web for their information. Reading online is 25 percent slower than on paper, not counting the time it might take to download a big annual report in PDF, the most common for­mat companies use.” 

Yet if many companies had their way, the annual report would be an online creature only. The New York Stock Exchange, for instance, has pushed for the elimination of the requirement that listed companies put hard-copy annual reports into shareholders’ hands. Noting that three-fourths of Americans have Internet access and thus are likely to do research online, the NYSE says that the ability to review a company’s annual report on the Web electronically “provides a more timely, efficient, and cost-effec­tive method for companies to provide and investors to access current financial information.”

Last summer, the SEC unanimously voted to require publicly traded U.S. compa­nies to give shareholders the option to view proxy materials on the Internet. Under the rule change, companies must provide shareholders 40 days’ notice before the annual shareholder meeting date and must pass along information on how to access Internet materials in addition to supplying the meeting details. The notice must also provide an email address, tele­phone number, or website where shareholders can request paper copies of proxy materials. 

So what about taking the next step and per­mitting companies to provide an annual report only online and to mail out hard copies to those shareholders who request one? The Web is a place “where the investor might get a more robust and holistic experience of the culture and people and products,” Davis says. “But it kind of puts share­holders in the position of having to go after the company for information.” Davis may be in the annual report business, but she makes a good point. There are still plenty of older individual investors who either aren’t computer-savvy or have access to the Web only through a public computer at the local library. 

If American investors ever require more use­ful disclosure from companies, the pressure may come from the fact that European companies have a reputation for offering far more accessi­ble annual reports—and more effective investor communications in general—than their U.S. counterparts, says Jones, the investor-relations consultant. “At some point, that has to have a neg­ative effect on corporate America’s attractiveness to investors, especially when firms like E-Trade plan to offer direct international trading to retail investors,” he con­tends. And at the same time, companies are fleeing the NYSE—some three dozen in 2007, including Bayer and British Airways—for over­seas destinations because of cumbersome and costly Sarbanes-Oxley requirements. But there is an upside to all of this. For once, shareholders, exchanges, and many corporations all seem to be on the same page and in agreement about some­thing: Sarbanes-Oxley just isn’t working. 

James Pethokoukis is the money and poli­tics columnist for U.S. News & World Report.