ANNUAL REPORT
A document published by public corporations on a
yearly basis to provide stockholders, the public,
and the government with financial data, a sum-
mary of ownership, and the accounting practices
used to prepare the report.
Annual reports measure a corporation’s
financial health. They focus on past and present
financial performance, and make predictions
about future prospects. By law, any corporation
that holds an annual meeting for stockholders
or security holders is required to issue an annual
report. Regulations set down by the SECURITIES
AND EXCHANGE COMMISSION (SEC) specify in
detail what information the report must include
about the corporation’s finances, markets, and
management. The rules are strict: the SEC can
levy stiff penalties if corporations fail to comply.
Traditionally a rather dry and factual docu-
ment, the annual report has acquired a larger
audience in recent years as corporations increas-
ingly treat it as not merely a legal obligation but
also a public relations opportunity. Yet, even as
annual reports take on the appearance of glossy
magazines, promote corporate public relations,
and make political arguments, they remain
bound by legal concerns about completeness
and accuracy, and sometimes expose corpora-
tions to lawsuits when they fall short.
Although federal law governing the financial
industry is quite old, its application to annual
reports grew in complexity from the mid-1970s
to the mid-1990s. This authority derives from
two laws: the Securities Act of 1933 (15 U.S.C.A.
§ 77a et seq.) and the Securities Exchange Act of
1934 (15 U.S.C.A. § 78a–78jj). The 1933 law
requires issuers of securities to file financial
information with the federal government; the
1934 law authorizes the SEC to act as a regula-
tory body over the financial industry. In 1974,
the SEC tightened requirements on annual
reports by specifying a broad range of informa-
tion that must be provided, and it frequently
amended them in subsequent years. Corpora-
tions have consequently made greater efforts to
scrutinize their reports for compliance with the
law, increasing the role of lawyers in producing
what was once the work of accountants.
These requirements address financial and
general information. An annual report must
include a balance sheet reflecting changes in the
corporation’s financial worth, an income and
cash flow statement, and other relevant docu-
mentation, all of which must be reviewed first
by outside auditors. A statement by manage-
ment must analyze past performance as well as
discuss prospects for the following years; if cir-
cumstances change, corporations have a duty to
issue corrected information. In addition, they
must make public details about products and
services, domestic and foreign markets, and the
backgrounds of directors and executive officers.
Corporations that fail to comply with all the
requirements can face enforcement proceedings.
In such cases, the commission has the power to
invalidate the election of directors and decisions
made at the shareholders’ meeting, which can
necessitate issuing a revised annual report.
Administrative remedies also exist. Under the
Securities Enforcement Remedies and Penny
Stock Reform Act of 1990 (15 U.S.C.A. § 77g et
seq.), the SEC can use violations of any securi-
ties laws to force corporations to make full dis-
closures in their reports. Corporations that are
in the process of registering for the first time
with the SEC are particularly scrutinized for
overly optimistic projections.
Besides federal penalties, wishful thinking in
annual reports can lead to lawsuits. Hoping to put the best spin possible on their achievements and prospects, corporations sometimes attract
CLASS ACTION suits from shareholders who
allege that the corporations have exaggerated or
misled the public. One of many examples is a
suit brought against Pizza Time Theatre (In re
Pizza Time Theatre, 112 F.R.D. 15 [N.D. Cal.
1986]). Its 1982 annual report had cartoon characters
bragging, “We’re going full speed ahead!”
And so they were: nine months later, Pizza Time
Theatre declared BANKRUPTCY. Shareholders
brought a class action suit against the corporation
and its directors, citing the report’s overly
optimistic tone, but the suit was discharged in
bankruptcy.
Beyond requiring that annual reports meet
financial and general information regulations,
the law says nothing about the rest of their contents.
Corporations are free to package their
reports as they please, and the form itself is constantly
evolving: current annual reports borrow
from the flashy graphic styles of magazines, can
be released on videodisc and computer disk, and
sometimes even include gifts. Particularly interesting
is a trend toward using these reports—
usually via the president’s letter—to address
political issues. As powerful forces in the body
politic, corporations rarely refuse an opportunity
to make their influence felt on government,
especially when pending legislation may affect
their interests. In the early 1990s, for example,
some annual reports from the medical industry
targeted the ill-fated HEALTH CARE reform proposals
of the Clinton administration.
Annual reports became a source of widespread
public interest after the sudden collapse
in 2002 of Enron, the seventh largest U.S. corporation.
Within a few months other major corporations
disclosed major financial difficulties,
which came as a surprise to shareholders and
regulators that had relied on upbeat financial
information contained in these corporations’
annual reports. The credibility and legitimacy of
corporate financial data quickly became a topic
of political debate.
The collapse of Enron was predicated on
fraudulent accounting practices that concealed
the amount of debt the corporation had accumulated.
Federal prosecutors accused the major
accounting firm of Arthur Andersen of aiding
Enron’s corporate officers in this enterprise and
successfully won a conviction against the firm
for its actions, including the destruction of documents.
A careful review of Enron’s annual
reports revealed that certain transactions were
buried in obscure footnotes or were not
reported at all.
During 2002, the SEC and Congress examined
the shortcomings of annual reports and
other corporate reporting practices. In a bipartisan
effort, Congress passed and President
GEORGE W. BUSH signed the SARBANES-OXLEY
ACT, also known as the Accounting Industry
Reform Act, in July 2002 (Pub.L. 107-204, 116
Stat. 745, [2002]). The act seeks to address CORPORATE
FRAUD by, among other things, requiring
chief executive and chief financial officers to
personally certify the accuracy of the financial
information contained in quarterly and annual
reports. The certification must state that the
officers have read the report, and must confirm
it contains no misstatements or omissions and
that it is a fair presentation. An officer who
knowingly makes a false certification will be
subject to fines of up to $5 million and a prison
sentence of up to 20 years. In addition, officers
will be forced to repay bonuses that were based
on inaccurate financial earnings.
The SEC also responded by demanding that
all major U.S. corporations recertify the accuracy
of their 2002 annual reports or risk prosecution.
A number of corporations took the
opportunity to change their financial statements.
In the wake of the 2002 scandals, the
expectation is that annual reports will be more
accurate in detailing the financial health of corporations.
FURTHER READINGS
Malveaux, Suzanne. July 31, 2002. “Bush Signs Bill to Stop
‘Book Cooking’.” CNN.com: Inside Politics. Available
online at (accessed May 30, 2003).
Monks, Robert A. G., and Nell Minow, eds. 2001. Corporate
Governance. 2d ed. New York: Blackwell.
Practising Law Institute. 1994a. The Annual Report to Shareholders.
Corporate Law and Practice Course Handbook
Series, January–February.
—. 1994b. Annual Reports to Securityholders and Disclosure
in Annual Reports. October–November.
Winkler, Carol. December 26, 2002. “Weighing SEC Ability
to Fight Fraud.” Boston Globe.
CROSS-REFERENCES
Board of Directors; Financial Statement.
