Foremost, the Sarbanes-Oxley Act of 2002 (“Sarbanes” or “Act”) is not specifically aimed at regulating any particular aspect of intellectual property, but rather incorporates the latter by general reference within its provisions regarding the safeguard of corporate assets.  The extensions to intellectual property are therefore subject to interpretation, and in many cases substantial debate, in the absence of specific regulatory guidance.

Sarbanes presently applies only to public companies; however there is a strong likelihood that its mandates will evolve to an application of best business practices regardless of business structure.  As much of the Act addresses audit protocols and obligations, it is a natural presumption that the accounting profession will arrive to a consistent approach to fiscal reporting, even as applied to non-public companies.

            Although Sarbanes has a broad application to corporate governance, there are several provisions that more directly address intellectual property.  These are briefly introduced below to establish a basis, and will be more fully explored in the context of creating a compliance model relating to specific intellectual properties.

§302  Corporate responsibility for financial reports

This section requires that the principle executive officer(s) and the principle financial officer(s) make five key certifications with each filing under the Securities Exchange Act of 1934.[1]  These certifications are that:

1. The officer has reviewed the report,

2. Based on the officer’s knowledge, the report does not contain any untrue statements of material fact and does not omit material facts required to fully evaluate the other statements,

3. Based on the officer’s knowledge, any financial information included in the report fairly represents the company’s operations and condition,

4. The officer has established internal controls and has maintained such to ensure the information is made known to the certifying officers, and that the effectiveness of the controls has been tested within 90 days of the report’s submission, and

5. Any design or operational issues within these controls that have or may have an adverse effect on the company’s ability to “record, process, summarize, and report financial data”[2] before or subsequent to the date of the report.  Further, any fraud requires disclosure, regardless of materiality.

Section 906, similarly titled, provides for criminal sanctions directly against the corporate officers that fail to comply with these certification requirements.[3]  This attachment to involved individuals is intended to shift the risk of material misstatement away from the corporate entity that may wish to gamble on a misleading statement for strategic reasons, and accomplishes such by making the officers individually liable for up to five million dollars and/or twenty years imprisonment on a finding of willfulness.

As the first three elements above are dependent upon a properly constructed control structure, much of the initial scholarship regarding the intellectual property implications immediately following the Act focused on identification and valuation of these assets.  A year prior to Sarbanes, the Financial Accounting Standards Board (“FASB”) had reacted to the audit environment via the passage of FASB Statements 141[4] and 142[5], which require the classification and reporting of intangibles severable from goodwill into key asset categories that parallel the basic types of intellectual property, limited however to acquired assets.

§404 Management assessment of internal controls

Formalizing the certification aspect under §302, this section establishes an obligation regarding the control mechanisms.  It directs the SEC to prescribe rules requiring “an adequate internal control structure and procedures for financial reporting”[6] and requires an assessment of this structure at the conclusion of the company’s fiscal year. 

In addition to the creation of the control structure to be certified by the company’s officers under §302, this section contains a certification requirement of its own.  Under such, each accounting firm involved in the audit must attest to the assessment made by the company’s management, and prohibits such an attestation from being a the subject of a separate engagement.

Applied against this section and others, §103 requires the Public Company Oversight Board, a group established within Sarbanes, to create rules to assure the independence of the accounting community.[7]  In essence, this requirement intends to distance the auditors from any management pressures that may influence attestation to false or misleading statements.

§409  Real Time Issuer Disclosures

As Sarbanes arose in the aftermath of several accounting scandals, this section perhaps best encapsulates the investor protection intent of the Act, and in doing so most likely provides the greatest uncertainty for the intellectual property practitioner.  The section reads:

“Each issuer reporting under section 13(a) or 15(d) [of the Securities Exchange Act of 1934] shall disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphical presentations, as the Commission determines, by rule, is necessary or useful for the protection of investors and in the public interest.”[8]

            Reasonable minds may differ, and this section provides a wealth of elements to facilitate such variances in opinion.  Materiality is subjective, and early scholarship after the passage of Sarbanes envisioned a regime wherein all transactions impacting key intellectual properties would be immediately subject to disclosure. 

The question of “rapid and current” was directly answered in an SEC release made effective in August 2004, which established a reporting requirement within four days of a qualified triggering event.[9]  This same release established eight new items to the 8-K disclosure form, and amended others preexisting either on the 8-K or alternate periodic reporting devices.[10]  These events will be covered in greater detail below.

            Again, Sarbanes is not legislation with a specific intent to manage intellectual property, but rather to protect corporate assets and ensure that sufficient information is available to the public to facilitate educated investment decisions.  Unfortunately, this intent does little to qualify a definite standard of materiality, but does offer some rough guidance to practitioners wishing to comply with the objective of the Act.

            Sarbanes in its entirety is an intimidating series of pronouncements regarding ethics, disclosures, and controls.  The accounting guidance and regulatory responses that effect many of the Act’s mandates are complex, and the criminal sanctions imposed for non-compliance offer little to ease the discord that a corporate officer or practitioner may experience.

            As applied to intellectual property, many of the indirectly-specified activities necessary for compliance are simply a matter of good business practice.  Many public companies had likely installed processes around their intellectual property portfolios prior to the Act’s passage, even if the disparate processes weren’t built around the central disclosure theme.  For these companies, Sarbanes prompts further development and coordination of systems already in place.  For companies that had not seriously considered their intellectual property assets, the Act provides enough detail to create a framework for system development.

            In order to arrive at full compliance, a company must consider five primary activities in the following chronological order:

1. Inventory of Intellectual Property Assets – At the most basic level, a company must know what assets it has in order to protect, value, or disclose key events affecting those assets. 

2. Valuation – With the focus on financial impacts, it is then necessary to establish a value for each identified asset based upon accepted and well-documented principles.

3. Establishment of Controls – Once the portfolio is fully identified and valued, a structure is necessary to preserve these values, protect against unauthorized use, and to provide for disclosure to the certifying officers and ultimately the public when financial results will be impacted.

4. Maintenance of Controls – Intellectual property changes in time and geography, and any control mechanism instituted must be periodically subjected to audit itself to ensure its continued function as noted above.

5. Disclosure Requirements – As the control mechanisms identify key event, the company’s officers must be able to determine the necessity for, timing of, and form of disclosure.

Inventory of Intellectual Property Assets

            Some intellectual properties are much more evident within a company, particularly where a granting document has formalized that company’s exclusive right.  Any company has a core portfolio of products and/or processes that are highly visible, and even if they are not intimately connected to the details, the officers of a company are likely aware of the existence of key patents and trademarks.  Scholastic is certainly aware of its copyrights covering the “Harry Potter” series.[11]  By their prevalence within a company, these are the assets most likely to be secured within a company’s docketing and maintenance systems.

            A patent certificate securing the exclusive right to make, license, or feasibly ignore a product or process provides visibility.  Likewise, a registered trademark is likely utilized within branding or key messaging to customers, which makes it an easy inclusion in the audit.  A copyright within a publishing company is an obvious inclusion.

By definition, however, intellectual property assets may not be readily apparent, as each employee within a company potentially has knowledge, concepts, and ideas that have either have not been shared or remain disclosed only to a limited internal audience.  At no time should it be presumed a company’s portfolio is limited to those assets that may be reflected in current financial or intellectual property management systems, as it is likely that these systems could feasibly exclude items that have not yet risen to a certain level of significance.

A patent application must first undergo considerations of novelty[12] and obviousness[13] before it becomes an enforceable right.  It may ultimately mature to a patent, or may be denied, but in either case the lack of the certificate is more probative to valuation than to inventory, as the underlying concept survives the formalized right.  Similarly, counsel may determine internally that an item will not pass the above considerations, and decide instead to retain the product or process as a trade secret.  The intellectual property itself endures regardless of the form of protection secured, even if the lack of protection prompts a different valuation in the next step.

Engineers are often required to maintain notebooks detailing daily activity as an item of proof in the event of a future patent infringement suit.  Without commenting on the value of this control system, it must be immediately realized that the notebook maintained by each engineer may well contain concepts for future development.  Assuming that the company has retained the rights to the notebook and its contents through an employment agreement, a proper intellectual property audit would include those concepts.[14]

            Returning to the trademark example, registration provides proof of the underlying rights.  By definition, trademarks operate as an indicator of source and quality of the underlying goods, and situations may arise where a mark is not immediately registrable.  For example, if a mark is descriptive, it must first acquire distinctiveness to secure a registration, and during this period the company is attempting to build the appropriate recognition and equity.[15]  The mark, although not registered, still operates as a trademark and is thereby an asset.  Even prior to actual commercialization, a marketing department may have a branding strategy that integrates developmental items, perhaps those contained in the engineers’ notebooks referenced above.  Although the future mark to be applied may not have a present value, it is arguably an asset to be considered within the audit.

            By design or via continued use, companies may also develop a specific trade dress that operates as the same indicator of source and quality.  Where this overall impression acquires secondary meaning enabling its function as this indicator, a protectible right exists and bears consideration independent of other intellectual properties that may underlie it.[16]

            Within a publishing house, copyrights are a key asset of trade and are as visible as patents in a manufacturing concern.  Not as apparent may be the various product and process publications, training manuals and videos, and internally-developed software that may be covered by copyright, even if not formalized via submission to the Copyright Office.[17]

            Beyond the actual ownership of intellectual property, the company should also consider any licensing agreements that it is a party to.  A contracted right to use another’s creation still bears a degree of risk associated to the underlying asset, regardless of title.

Three key lessons should be carried from the above commentary.  Foremost is that the inventory of intellectual property assets is exclusive of the valuation phase, and therefore should be conducted without consideration of present utility or value.  This approach allows for the identification of concepts that may be matured into commercial products or processes, and at the other end of the spectrum, those assets where continued maintenance is fiscally and strategically deficient (i.e., a trademark to be retired in light of a new product launch).

            Second, it should be evident that the audit phase requires a cross-disciplinary approach and should not rest solely with accountants and attorneys.  Intellectual property is created in all departments of a company, and even then may not be recognized by the creator without interaction with other professionals (i.e., an engineer may not recognize the commercial potential of a concept unless marketing is integrated to the process). 

            Third, the audit will be incorrect the day after it is conducted, as the engineer will scribe another concept in his notebook, sales will find an opportunity in another country, and marketing will create another design.  The initial audit is intended to uncover all items of intellectual property at a given point in time and geography, with a control structure to be implemented to assure that such an asset database remains current.

            Although tedious, the inventory function does serve business purposes exclusive of Sarbanes compliance.  In addition to the obvious benefit of getting departments to work together on the development of ideas, an audit may uncover opportunities for enhancement of the portfolio.  For example, if a company was previously utilizing a mark in a single state but had recently introduced the mark to interstate commerce, it may decide to procure a federal registration.  Likewise, the audit may identify the negative circumstance where another entity  had already procured a similar registered mark, making expansion a risky endeavor.

            A company must know what assets it has before they can be valued, utilized, or reported upon.  The audit step assures that the initial portfolio for consideration is properly and fully represented.

Valuation of Intellectual Property Assets

            Whereas tangible assets typically have a value of their own regardless of use, the worth of intellectual property depends largely upon utilization.  As many of the assets identified in the inventory phase are actively employed in the company, some questions as to use may have already been foreclosed, however the audit itself may raise questions regarding the continued potential of an intellectual property asset.

            As an example, a company may opt to manufacture an item for which it owns a patent, thus bearing the entire risk of obsolescence, quality, supply chain, and other impact events, but also holding the potential for incremental earnings in the marketplace.  Alternatively, the company may decide to shift some of the risk to an external party via a licensing agreement, and dependent on how the contract is drafted, may be able to secure a consistent cash flow regardless of commercial success.  A patent used to block another from launching a competitive upgrade has value in the revenue it protects, independent of the owner’s decision to employ the patent in his own product.  Likewise, a blocking patent may have little value if the owner has no ability to utilize or license such and no interest from the “blocked” company.  Of course, a creation may pass the statutory tests and a patent may issue, but such doesn’t guarantee commercial fit and the patent may be deemed worthless.

            Because trademarks are intimately linked to goodwill by virtue of their function as indicators of source and quality, there are limitations on the ability to transfer such by sale or license as to protect against consumer confusion.[18]  Unlike patents and copyrights, trademarks are dependent upon use for the exclusive right to continue, and may be limited to certain classes of goods.    Despite these apparent restrictions, however, a company still has some discretion of how it will employ a trademark, as it may choose to invest heavily in promoting it as a leading brand name, or may instead retain such as a minor element of an ad campaign.  As a trademark may not become incontestable for five years from first use, a company bears the risk of investing in a mark that may be rendered invalid at a later date, for reasons of prior use by another, upon a finding that the mark has become generic, or for other statutorily-defined rationale.  These risks will be considered within the controls section.

      In addition to use, intellectual property assets are subject to valuation changes as a function of time.  A company’s prime patent may find overnight obsolescence if a competitor launches an innovation, consumer tastes shift, or a regulatory agency issues restrictive guidance.  As with the inventory phase, the initial valuation will be subject to question as soon as it is completed.  To establish credibility, the valuation should contain the following:

1. Documentation of assumptions – Working with the cross-functional team established for the inventory phase, a company should make the effort to understand the current and future position of each asset.

2. Synergy with other intellectual properties – Others may make a caramel-flavored soft drink, but Coca-Cola has expanded the soda’s trademark to an empire of branded products.[19]  The public may enjoy the formula, a trade secret, but a strong argument can be made that they are buying the brand first.

3. Valuation methodologies – There are many forms of valuation, and a plethora of textbooks written by economists, accountants, and attorneys addressing proper methods of assigning a value to a particular asset.  Where a direct revenue stream is attributable to a single patent, for example, the valuation may be as simple as a compounded cash flow.  This simplicity is complicated where multiple patents are utilized in different combinations in an assortment of products, where blocking patents are secured to protect revenue streams, and where trademarks are utilized to build equity in a brand.

            Whatever model is adopted for each asset, the focus of the valuation phase must be upon documentation.  As the audit exercise moves into the control phase, it is critical that the method be consistently repeatable and reconcilable when it becomes necessary to switch techniques (i.e., a patent is taken out of active service and is instead licensed for a fixed revenue flow to an external manufacturer).

Establishment of Controls

            The primary mandate of Sarbanes is the creation of a structure to protect corporate assets, as reflected in the §404 management assessment and the §302 certifications.  The inventory and valuation elements support this system of controls by providing the initial portfolio and relative worth of the assets therein.  Both of these stages also included components of risk assessment, methods of utilization, and internal management.

            A properly-constructed system of controls must be both proactive and reactive, again with a focus on documenting repeatable best practices, key events, and actual results.  As with the previous audit steps, this element requires cross-discipline cooperation.  In many cases, existing intellectual property management systems may be integrated to the larger control mechanism, as in the case of trademark docketing software.

            The value of intellectual property may be negatively impacted by the actions of internal employees as well as external entities, so it is critical that controls are established to address both groups.  A company should consider the following general protections:

1. The revision of employee and contractor agreements as appropriate to include specific verbiage addressing intellectual property, clearing stating the ownership of any developments on behalf of the company and consequences of breach.[20]

2. The review of confidentiality agreements executed with contractors, suppliers, and customers to ensure that any disclosures made in the course of business with these external entities are protected.

3. The review of licensing arrangements to ensure that any contracted use is limited to specific goods, locations, and timing, as appropriate.

4. The conduct of an information systems audit to restrict access to key information.  In addition, as it is likely that these same systems will create the financial statements being certified, this audit should determine the integrity of the data therein and adopt a data retention policy to secure documentation.

            An internal program educating employees on the critical importance of the company’s intellectual property is advisable as well.  A sales and marketing professional may be the first to see a competitive product at a trade show or sitting in a customer’s warehouse, and it must be second nature for this individual to inform management for an assessment of possible patent infringement.  If an employee spots the use of a key trademark being used in an inappropriate manner, there should be a communication path allowing counsel to draft a corrective action to the infringing party.  Likewise, this education program should highlight that even daily processes may provide competitive advantage, whether or not termed trade secrets, and that every employee bears the responsibility of protecting such items from disclosure.

            All of the intellectual property assets identified in the inventory phase may not be eligible for formalized rights for reasons already discussed.[21]  It is also likely that a ranking becomes apparent, as some assets will certainly be more keyed to a company’s financial performance than others.  Although the control system must address the full portfolio, it is appropriate that stronger systems are placed into service around these key assets.

            Formalized rights grant a company stronger rights in the underlying intellectual property.  A registered trademark, for example, allows an owner to apply to customs to exclude infringing imports.[22]  These enhanced rights come with enhanced obligations through additional filings, maintenance payments, and use obligations (in the event of trademarks), so it critical that the controls system is capable of cataloging these deadlines.[23]  Again, some off-the-shelf software is available to manage this administrative task, and may be integrated into the larger structure.

            Whereas systems must obviously address assets already in existence, a process for future development should likewise be implemented.  Prior to launching a new trademark, it is a relatively minor task to procure a trademark clearance letter highlighting any use by others.  As present U.S. law permits a trademark application to be based upon intended use, the six-month statutory window, and applicable extensions,  should be employed to protect from competitive appropriation prior to the commercial launch.[24]  The trademark application should be drafted to include all classes of product reasonably anticipated under the mark, and protection should be sought in all countries where expansion is likely.

            Before constructing the claims for a patent application, a practitioner must develop a full understanding of the prior art, which must be disclosed in the patent application.  Strategically, these prior art references should be utilized in constructing the patent claims as widely as possibly to prevent other parties from appropriating elements, while concurrently remaining narrow enough to escape classification as overly-broad.

            Once a product or process employing one or more forms of intellectual property is commercialized, the function of the control system expands to monitor the assets in the marketplace and to go on the defensive.  A trademark’s value is based upon its continued ability to function as the indicator of source and quality, so it is vital that a company protect that functionality.  The Lanham Act establishes means to oppose the prospective registration of another’s mark[25] or to cancel a mark already registered[26] in the event that a company believes it will be harmed by said mark.  A company can integrate a monitoring service into its controls to highlight instances of possibly infringing uses.

            Aggressive defense of intellectual properties is important.  The more successful a product is in the marketplace, the more likely it is that other parties will attempt to capitalize on its success.[27]  A company’s controls should be designed to incorporate administrative and legal remedies as appropriate, again with a focus on documentation.  In some cases, the failure to pursue a claim can result in a full or partial loss of the exclusive right,[28] whereas in other cases the right is retained but has been negatively impacted.[29]

            Returning to the ambition of Sarbanes, however, it bears stating that there are financial consequences to maintaining and defending an asset.  Business decisions must be integrated with the management of the portfolio as well, and there may be circumstances where the officers adjudge that defense of an asset may cost more than the forward value of that asset.  A control structure may not ignore this reality, nor may it predict all circumstances where this judgment may be made.  The system should provide for such an evaluation and provide for documentation of the ultimate decision.

            Every form of intellectual property has specific registration and maintenance requirements, as well as unique issues in the commercial marketplace.  In spite of these differences, a few key lessons should be derived from this phase of the audit:

1. Review and revise existing contacts concerning intellectual property assets to ensure that they are defined and protected as broadly as possible, and that necessary disclosure to and use by others is limited in scope.

2. Educate employees on the critical importance of the company’s assets, and establish a communication device to permit rapid reporting of key events.

3. Where possible and desired, formalize the intellectual property right and establish systems to maintain that right.

4. Defend the right by utilizing all available regulatory and statutory authorities, within the economic judgment of the company.

Maintenance of Controls

            External and internal factors make it necessary to evaluate and iterate upon the controls system to ensure that it continues to correctly identify issues impacting the financial health of the company.  §302 of the Act specifically requires an officer to certify that the controls system has been maintained, and ignoring developments directly violates this mandate.

            Externally, the intellectual property environment changes through the enactment of new laws, changes in administrative interpretations and procedures, and via judicial intervention.  A system developed just a few months ago would not consider key developments in the Doctrine of Equivalents[30] and peer-to-peer file sharing.[31]  The control system must be structured to incorporate changes in substantive law, and to relate these external changes to the values of the company’s specific assets.

            Additionally, the external environment may force changes into a company’s portfolio.  If a competitor releases a new product that essentially commandeers the market, it may depress the value of a company’s lead product to such a degree that the balance of the portfolio is likewise affected.[32]  The sudden bankruptcy filing of a licensee may leave an intellectual property owner with an asset without a steady revenue flow, or restrained by a bankruptcy court under a reorganization agreement.  The unavailability of a key component to a patented item or a competitor’s successful cancellation of one of company’s key trademarks should prompt both a change in valuation and a change to the control structure to accommodate such an impact presently and in future circumstances.

            Internally, the creation of a new product may result in a planned obsolescence of an existing one, causing a shift in the controls to allow for the timed phase-out.  An expiring patent may change a company’s full portfolio such that other continuing products are depressed in the competitive marketplace.  An acquisition of another company should prompt an evaluation of the two systems and a plan to transition to one,

            Regardless of effort, the initial control system will not address every contingency that a company may face.  Important to Sarbanes compliance is that the company establish a reasonable system of controls and with it a structure to continuously evaluate its adequacy to inform.  Indeed, the officers must certify that the effectiveness has been tested within the ninety days prior to a report based upon the system, and must further disclose any deficiencies in the system affecting prior or future reporting capabilities.

Disclosure Requirements

            The key result of the inventory, valuation, and creation of a control system lies in the ability to provide accurate financial reporting and to rapidly disclose those events expected to have a material financial impact on the company.  Materiality remains largely a matter of personal judgment, however the SEC has introduced a few pieces of guidance below.

            As noted above, the SEC established a four-day disclosure obligation through the revised Form 8-K, which also established key categories subject to disclosure.[33]  The categories most appropriate to the intellectual property aspect of Sarbanes and the SEC classification for each are as follow:

1. Entry in a Material Definitive Agreement (Item 1.01)

2. Termination of a Material Definitive Agreement (Item 1.02)

3. Completion of Acquisition or Disposition of Assets (Item 2.01)

4. Costs Associated with Exit or Disposal Activities (Item 2.05)

5. Material Impairments (Item 2.06)

Entry in a Material Definitive Agreement (Item 1.01)

            Early after the passage of Sarbanes, numerous commentaries considered the circumstance where a required disclosure of a material event might actually mitigate the effect by virtue of the release of information to the market.  By example, if a company was considering a licensing agreement that when implemented would substantially increase earnings, the early disclosure of the pending event might prompt competition to take suppressing steps that would negate the disclosure’s subject.

             Reacting to commentary stating that “disclosure of non-binding agreements could cause significant competitive harm to the company and create excessive speculation in the market,”[34] the SEC eliminated the requirement of disclosure as relating to non-binding agreements.  In addition, a materiality standard was applied to the requirement of listing each party’s obligations under the agreement, releasing the requirement except in the circumstance where the provision itself is material.

            Similarly, the revised Form 8-K removed the requirement that the agreement itself be filed as an exhibit, answering the concern that requests for confidential treatment would not be adequately addressed within the four-day period.  It did, however, maintain that material agreements would continue to be required with the periodic filings, and encouraged voluntary filing with the Form 8-K when no confidential treatment is required.

            In November 2004, the SEC released additional guidance that addressed the timing of materiality, stating that an 8-K is not necessary in the event that a previously immaterial agreement becomes material unless an amendment is then enacted on the agreement.  The SEC maintained, consistent with the above, that the newly-material agreement would need to be filed with the periodic reports, pursuant to prior guidance.[35]

            The standards of materiality incorporated herein by reference to Regulation S-K provide two points of guidance pertinent to intellectual property.  The first concerns contracts not made in the ordinary course of business, and itself utilizes the word material to qualify those items that must be included.[36]  The second establishes a bright-line 15%-of-assets materiality threshold for contracts concerning the acquisition or sale of property.[37]

            In the world of intellectual property, this item maintains a degree of confidentiality while parties negotiate the licensing and sale of assets.  Once executed, the exclusion of the exhibit requirement also operates to provide a degree of protection to the provisions of the agreement until the date of the next periodic agreement, at least in respect to non-material provisions. 

Termination of a Material Definitive Agreement (Item 1.02)

            Termination under this item does not include the termination of an agreement by virtue of an expiration date or the completion of all obligations under the agreement, but is instead intended to disclose unanticipated terminations.  In addition to supplying a description of the agreement and circumstances pertaining thereto, the SEC requires disclosure of any early termination fees incurred.

            Paralleling Item 1.01, the SEC has specifically stated that an 8-K does not need to be filed under this item until the actual termination occurs, addressing the possible use of within a negotiation context.[38]  The proposed revisions would have included a requirement of an analysis by management stating the theorized effects of the termination, but the SEC opted to remove this element from the final rules and maintain such only in the periodic filings.

            As applicable to an intellectual property portfolio under Sarbanes, these rules provide some certainty as to the licensing of assets by providing guidance on disclosure timing.  The team creating the control structure, however, will certainly wish to anticipate the effects of the termination regardless of the immediate need to disclose such, as the impact will still need to be reflected in financial reports and periodic SEC filings.

Completion of Acquisition or Disposition of Assets (Item 2.01)

            There is certainly a relationship between this item and the two SEC disclosure items previously noted, as the entry and termination of material definitive agreements may culminate in the acquisition or disposition of assets.  A threshold of “significant assets” is established within this item that heightens this relationship.[39]

            For intellectual properties, this item has potential for market impact where the agreement initiating the transaction was not material at the time of creation and therefore not disclosed, but is deemed significant under the above test and subject to disclosure at the time of completion.  As the SEC maintained the general disclosure requirement for agreements in the periodic reports, this circumstance should be limited.

Costs Associated with Exit or Disposal Activities (Item 2.05)

            Key to this section is the obligation to disclose costs upon a managerial decision to terminate a long-lived asset or to exit a line of business.

            As regards the former, it is difficult to arrive at an example in the scope of intellectual property, as the dedication of a patent or copyright to the public may not bear any direct costs.  A trademark may fade for lack of use without further direct cost.[40]

            The latter activity provides an easier example in the context of a publishing concern that has licensed major cartoon characters for use in coloring books.  Should the publisher decide to exit the coloring book market, there may be costs arising from the termination of the licensing agreements via contract termination costs.  If the coloring book business was a minor element of the company, it may not meet the material definitive requirements of Item 1.02.

Material Impairments (Item 2.06)

            This item is likely the most applicable to intellectual property outside of the licensing aspect, as it requires disclosure upon the conclusion that an asset has been impaired and if management determines a charge reflecting this impairment is required under GAAP.  The SEC has stated that because impairment is often tested in conjunction with financial statement preparation, a separate Form 8-K is not necessary if the impairment is reported within these statement filed with the periodic report.

            The control system above was structured to capture and report upon the various events and contingencies that might impact the intellectual property portfolio, and this item creates the disclosure obligation.  Although the SEC’s statement regarding the normal timing for impairment testing may be accurate, a company and its officers must be aware that this does not excuse non-disclosure between periodic filings where impairment has occurred.  For example, if a regulatory action invalidates a key use for a patent, or if a cancellation against a company’s key trademarked brand is successful, the officers of a company are under an obligation to disclose.

            Three years after the Act was enacted, scholarship specifically directed at intellectual property under its mandates has fallen off after a panicked surge in its first year.  The SEC guidance issued in August 2004 may have alleviated much of the angst that Sarbanes delivered to intellectual property practitioners by foreclosing some of the more egregious scenarios of disclosure imagined by the accounting and legal professions.

            Regardless, intellectual property assets abound within every company, and the audit process serves both compliance and business purposes by uncovering underutilized assets, creating a comprehension of the portfolio’s worth across the organization, and prompting protection of that worth.  Even in the absence of Sarbanes, the audit would be a good business practice, and the fact that it also serves to satisfy the disclosure and investor knowledge foci of the Act underscores the value of the process.