A couple of months ago, the Securities and Exchange Commission issued a corporate governance report card to Fortune 500 companies. The grades were subpar, and many received an "Unsatisfactory" in conduct. But has the teacher been too harsh?

In the wake of scandals that brought down Enron, WorldCom, and others, the SEC instructed companies to include more relevant information in their annual 10-K filings and to make them easier to understand. That advice was not exactly taken to heart, however. In an analysis of 350 members of the Fortune 500, the agency noted several shortcomings, especially with the section called "Management's Discussion and Analysis." The MD&A is supposed to adequately explain a company's financials, important business developments, future prospects, competition, and so forth.

As I noted in SEC Flunks Fortune 500, the agency criticized management teams, saying many "simply recited financial statement information without analysis, or presented boilerplate analyses that did not provide any insight into the companies' past performance or business prospect as understood by management." Another sore spot: the continued abuse of "pro forma" accounting, where many exclude certain expenses as one-time items even though they tend to recur on a regular basis.

We have backed the SEC -- which has been directed by Congress to implement the sweeping Sarbanes-Oxley Act -- every step of the way as it tries to clear up the muddy waters of MD&A and fair disclosure. That said, it's only fair to point out there are two sides to every story, and there may be very good reasons many companies are hesitant to be as forthcoming as we'd like them to be. In addition, there are questions as to whether the Feds are attacking the problem the right way.

Cost and confusion
The first thing that should be understood is that it's not easy following dozens of rules and regulations. "Individual and corporate SEC compliance is daunting," says Jud Hennington of the law firm Maynard, Cooper & Gale in Birmingham, Ala. "The legislative response to the bad acts of a few companies has been to impose substantial costs on a large number of far less culpable businesses, and with possibly unintended consequences."

Hennington contacted me after reading my Fortune 500 story. He has nearly 20 years of experience dealing with SEC compliance, public company disclosure, and corporate investments. He has also served as president and CEO of a privately held Internet services firm, and he told me it's hard to imagine the incentive these days for holding a senior position with a public company. "Given the increasing emphasis on restricting the rewards associated with going public, who wants to deal with Byzantine SEC regulations in secondary areas?"

Surprisingly, new SEC Chairman William Donaldson empathizes. "There's a lot of nervousness about exactly what the rules mean," he told CBS MarketWatch, "and that creates a distraction for people running companies."

Consider that 11 new rules the commission adopted in January totaled over 1,000 pages and a quarter-million words, and you begin to have some idea what public companies have to wade through as they attempt to comply with regulations. It's lawyer heaven.

Most would agree that we live in a litigious society, and that may be one big reason MD&As are generally a poor read. "One can hardly be surprised at the lack of information in there, given the fact that discussion about future prospects, projections and the like have always been a source of opportunity for the plaintiff's bar," says Hennington. "The safe harbor for such disclosures remains, for the most part, judicially untested. Who wants to be the first with arrows in their back?"

Chilling effect
Because of these costs and possible legal ramifications, rigid SEC regulations may have an unintended effect on the markets. Specifically, Hennington wonders how far Congress can go before quality companies start abandoning public money in favor of large, private investors and more debt: "Some may decide that a few sophisticated institutional investors or lenders with deep pockets are preferable to a host of smaller investors represented by a legislative body more interested in scoring political points than in creating real incentives for cooperative market reforms."

Ah, political points. Hennington certainly echoes the sentiments of many when he speaks of "private attorneys general who are willing to attempt to turn every misstep into a national crisis." The main question here is whether some legislation is designed more to promote the careers of politicians than to truly deal with the problems at hand.

The bottom line is whether the current and proposed rules and regulations will make a difference. "It's not clear that we're better off today than we were then, but for the possibility we've minimized the opportunity for institutions to benefit from early, selective disclosure," Hennington says. "The question remains whether the net effect of disclosure reforms, taken as a whole, have had a net result of improving returns to individual investors."

Happy medium?
Hennington's points are well taken, and it's heartening the SEC is aware of some of the problems. I certainly agree with Chairman Donaldson that a change in spirit, attitude, and the current culture of ethics would go the farthest toward doing the most while costing the least.

It's wishful thinking to believe that it will happen quickly, but there's no doubt it can be done. There are plenty of examples of well-run companies that communicate with their investors clearly and effectively. Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) is the first to come to mind.

Using clearer and more forthright language costs exactly nothing, and helps alleviate the need for myriad rules and regulations. Changing management structure and compensation so that long-term results are valued more than this quarter's EPS estimates can go a long way toward eliminating the motivation for corrupt behavior.

Rex Moore can verify that no animals were harmed during the writing of this column. At press time, he owned shares of Berkshire Hathaway. The Motley Fool's disclosure policy is certified dolphin-free.