Item 406: Code of Ethics Disclosure Requirements

Item 406 of the Securities and Exchange Commission’s (SEC) Regulation S-K establishes a disclosure requirement for public companies regarding their ethical standards. As a component of the Sarbanes-Oxley Act of 2002, this rule was designed to improve corporate accountability and transparency. The regulation mandates that companies inform the public about the ethical guidelines for their top financial executives, ensuring investors have visibility into the standards governing a company’s financial reporting.

Defining the Code of Ethics

For Item 406, a “code of ethics” is a set of written standards designed to deter wrongdoing and promote ethical behavior. The SEC does not mandate adopting a code, but the disclosure requirements create a strong incentive to do so. The code must establish standards to foster honest and ethical conduct, including procedures for handling actual or apparent conflicts of interest.

A compliant code must also promote full, fair, accurate, and timely disclosure in reports a company files with the SEC and in other public communications. This provision links the ethical conduct of executives to the integrity of the financial information provided to the market. The code must also address compliance with applicable governmental laws, rules, and regulations.

The document needs to outline a mechanism for the prompt internal reporting of any code violations to an appropriate person identified within the code. It also has to ensure accountability for adherence to its standards. While a company may have a broader code of conduct, the one disclosed under Item 406 must apply to the principal executive officer, principal financial officer, principal accounting officer or controller, or similar positions.

Required Disclosures for the Code

The main requirement of Item 406 is the disclosure a company must make in its annual report, typically the Form 10-K. In this filing, the company must state whether it has adopted a written code of ethics that applies to its senior financial officers. If a company has not adopted such a code, it is obligated to explain its reasoning for not doing so.

If a company affirms it has a code of ethics, it must then make that code available to the public. The SEC provides three distinct methods for fulfilling this obligation. The first option is to file the code of ethics as an exhibit to its Form 10-K annual report.

A second method is to post the text of the code on the company’s corporate website. If a company chooses this route, it must disclose its website address in its annual report and state its intention to provide the code there. The third option is to state in its annual report that it will provide a copy of the code of ethics to any person without charge upon written request.

Handling Amendments and Waivers

Disclosure obligations extend beyond the initial annual report. Companies must provide timely updates on any changes or exceptions, including any substantive amendments to the code. An amendment is any change that alters the principles or requirements of the code.

A “waiver” is the company’s approval of a material departure from a code provision. An “implicit waiver” is also a disclosable event and occurs when a company fails to take action within a reasonable period regarding a known material departure from the code by a senior officer.

When an amendment or waiver occurs, the company must disclose the event within four business days. This is accomplished by filing a Form 8-K with the SEC or by posting the information on its website. If a company uses its website, it must have previously disclosed its intention to do so in its annual report, and the information must remain online for at least 12 months.