High-Tech Investor
Neil Gold
October-November/2002
The egregious corporate behavior at companies such as Enron, Tyco, WorldCom and Global Crossing has prompted the U.S. Congress, the Securities and Exchange Commission (SEC) and stock exchanges to reform U.S. securities laws and regulations governing companies, including foreign companies, whose shares are traded in the U.S.
The new legislation, known popularly as Sarbanes-Oxley, is the most far-reaching overhaul of U.S. securities laws since they were adopted in the 1930s. The new law establishes an independent oversight board for the accounting industry, creates higher standards for corporate governance (including rigorous standards for audit committees and more frequent and transparent disclosures of corporate transactions), requires securities analysts to maintain greater independence from investment banks, and creates new civil and criminal penalties for violations. It requires the SEC to review a company's reports filed with the SEC at least once every three years, restricts the non-audit services that may be performed by a company's auditors, requires off-balance sheet transactions to be disclosed and mandates the adoption of a code of ethics for senior financial officers.
These new obligations, some of which are highlighted below, will impose substantial additional burdens and liabilities on public companies and their officers and directors, require more time and attention from management and board members, and increase the costs and expenses associated with being a public company.
Audit: The audit committee, not management, will be responsible for the appointment, compensation and oversight of a company's outside auditors. The outside auditor must report directly to the audit committee, not to management. All members of the audit committee must be independent directors, with a new, stricter test applied in determining independence. A company must disclose whether the audit committee includes at least one financial expert with experience in preparing or auditing financial statements and experience with internal accounting controls. These requirements will cause most public companies to revise their internal procedures and result in management having less influence over the auditing process.
Certifications: The chief executive officer and chief financial officer must certify that all quarterly and annual reports filed with the SEC contain no untrue statements or omissions of material fact and fairly present the company's financial position. They must also certify that they have reviewed the company's internal controls and report on their effectiveness. For foreign private issuers, the certification requirements apply to the annual report on Form 20-F, but not to the filing of a current report on Form 6-K. There are criminal and civil penalties for false certifications. As the certification requirement is already in effect, CEOs and CFOs are taking much greater care in reviewing SEC filings.
Loans to Officers: Public companies are prohibited from lending or arranging a loan to a director or officer. They also may not make any material modifications to or renewals of any existing loan arrangements. There are many types of transactions, such as the provision of split-dollar life insurance that may violate this provision. Companies must be careful to review all arrangements that could be considered to be a loan to a director or officer.
Insider Trading: Directors and executive officers, as well as shareholders holding 10 percent or more of equity, must now file a form with the SEC within two business days of any transaction relating to a company's shares. Previously, the filing could be made by the 10th day of the month after the transaction occurred. By July 2003, the SEC must adopt rules requiring these forms to be filed electronically on EDGAR within one business day. Directors, executive officers and shareholders of foreign private issuers are still exempt from these filing requirements.
Corporate Governance: Nasdaq has proposed over 25 rule changes for its listed companies. The Nasdaq proposals, which must be approved by the SEC, call for, among other things, a majority of independent directors on boards, regular meetings of independent directors and a greater role for independent directors in compensation and nomination decisions. Nasdaq would also require shareholder approval of all stock option plans and a corporate code of conduct for officers and directors. Foreign companies would have to disclose any exemptions granted them from Nasdaq's corporate governance policies and would have to file a semi-annual report with the SEC and Nasdaq.
Many of these new requirements will require interpretation over time by SEC rules or clarifying amendments by Congress. While some view the new laws as an overreaction to the well-publicized examples of corporate misbehavior, it clearly reflects a desire to send a wake-up call to those with corporate leadership responsibility.
The new legislation, known popularly as Sarbanes-Oxley, is the most far-reaching overhaul of U.S. securities laws since they were adopted in the 1930s. The new law establishes an independent oversight board for the accounting industry, creates higher standards for corporate governance (including rigorous standards for audit committees and more frequent and transparent disclosures of corporate transactions), requires securities analysts to maintain greater independence from investment banks, and creates new civil and criminal penalties for violations. It requires the SEC to review a company's reports filed with the SEC at least once every three years, restricts the non-audit services that may be performed by a company's auditors, requires off-balance sheet transactions to be disclosed and mandates the adoption of a code of ethics for senior financial officers.
These new obligations, some of which are highlighted below, will impose substantial additional burdens and liabilities on public companies and their officers and directors, require more time and attention from management and board members, and increase the costs and expenses associated with being a public company.
Audit: The audit committee, not management, will be responsible for the appointment, compensation and oversight of a company's outside auditors. The outside auditor must report directly to the audit committee, not to management. All members of the audit committee must be independent directors, with a new, stricter test applied in determining independence. A company must disclose whether the audit committee includes at least one financial expert with experience in preparing or auditing financial statements and experience with internal accounting controls. These requirements will cause most public companies to revise their internal procedures and result in management having less influence over the auditing process.
Certifications: The chief executive officer and chief financial officer must certify that all quarterly and annual reports filed with the SEC contain no untrue statements or omissions of material fact and fairly present the company's financial position. They must also certify that they have reviewed the company's internal controls and report on their effectiveness. For foreign private issuers, the certification requirements apply to the annual report on Form 20-F, but not to the filing of a current report on Form 6-K. There are criminal and civil penalties for false certifications. As the certification requirement is already in effect, CEOs and CFOs are taking much greater care in reviewing SEC filings.
Loans to Officers: Public companies are prohibited from lending or arranging a loan to a director or officer. They also may not make any material modifications to or renewals of any existing loan arrangements. There are many types of transactions, such as the provision of split-dollar life insurance that may violate this provision. Companies must be careful to review all arrangements that could be considered to be a loan to a director or officer.
Insider Trading: Directors and executive officers, as well as shareholders holding 10 percent or more of equity, must now file a form with the SEC within two business days of any transaction relating to a company's shares. Previously, the filing could be made by the 10th day of the month after the transaction occurred. By July 2003, the SEC must adopt rules requiring these forms to be filed electronically on EDGAR within one business day. Directors, executive officers and shareholders of foreign private issuers are still exempt from these filing requirements.
Corporate Governance: Nasdaq has proposed over 25 rule changes for its listed companies. The Nasdaq proposals, which must be approved by the SEC, call for, among other things, a majority of independent directors on boards, regular meetings of independent directors and a greater role for independent directors in compensation and nomination decisions. Nasdaq would also require shareholder approval of all stock option plans and a corporate code of conduct for officers and directors. Foreign companies would have to disclose any exemptions granted them from Nasdaq's corporate governance policies and would have to file a semi-annual report with the SEC and Nasdaq.
Many of these new requirements will require interpretation over time by SEC rules or clarifying amendments by Congress. While some view the new laws as an overreaction to the well-publicized examples of corporate misbehavior, it clearly reflects a desire to send a wake-up call to those with corporate leadership responsibility.
Neil Gold is a partner in the New York office of Fulbright & Jawarski L.L.P. and focuses his practice on corporate and securities law. He can be reached at ngold@fulbright.com.
Neil Gold
