Wednesday 26 Oct 2005 Securities Lecture Notes Outside Assignment - read all of the MD&A and note all of the disclosures o then go back and evaluate registrants compliance with item 303(a)(3) tell how they complied identify forward looking statements tell whether think complied in providing those statements – did they meet the requirements if see anything that should have been in the discussion that’s not there note it Sarbanes Oxley - Bush thought this law went too far - effective July 30, 2002 - market plunge between March 2002 and July 2002 by 27% decline - December 2001 Enron scandal; June 2002 Worldcom scandal o combined with market effect looked like what had happened prior to the great depression - bill passed almost unanimously - Targets of Legislation o top executives – CEOs and CFOs Congress didn’t like that they were in a position to claim that they were defrauded requires them to be part of/know what going on o accounting principles/rules too thin equity investments rules had become too artificial and unrealistic need more oversight of the accounting profession lack of independence of auditors (were getting majority of info from consultants and not the auditors to find out the consequences) accountants are supposed to be independent (represent the public) o lawyers who are not counsel but just part of the process inappropriate self limitation of lawyers imposes a positive obligation to go up the ladder – must check with/inform the board, not just the in-house counsel o securities analysts performance found to be deficient b/c were often just shills for the UW department often did not keep their objectivity b/c were also part of the UWs o reform governance of public companies - see p. 3 of the outline (Westlaw document) for goals of the Act - who does the Act apply to o does not apply to all corporations o does not apply to non-profits o applies to public corporations companies registered under the ’34 Act private companies that have filed registration statements with SEC to sell stock to the public as soon as file the reg. statement then subject to this Act o see p.4 of the handout o not all provisions apply to all public companies some apply only to listed companies - Public Accounting . . . . o see p. 4 handout o new SRO – self regulating organization o SEC appoints the chair - Strengthen Auditor Independence o see fn.24 for an example of the cross-selling that was occurring at this time
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this Act prohibited auditing firm from providing 9 different services i.e. book keeping (any accounting related services); financial system information design and implementation; appraisal and value; etc. etc. (see the handout) none of these may be performed by the auditor now try to render these services to companies that don’t render auditing services o Taxes auditor may render these services but must be approved by the audit committee of the Board in advance and must disclose this to the SH most tax departments no longer provide their services for audit clients o applies to all companies registered under 34 Act Reform the Board’s view towards accounting o not doing a good job of protecting SH by policing accountants carefully enough o mandates the establishment of independent audit committees that will have exclusive jurisdiction over audit activities applies to all companies listed on stock exchange will have sole responsibility for audit function company will have two boards – traditional board and a separate committee for auditing purposes each member of audit committee must be independent o ALL outside directors (not on board, no more than 10% in shares, etc.) must contain at least one financial expert (see bottom p.7 for definition) o if not then must explain to the SH why have no financial expert o more than just savvy in business – must know accounting, accounting theory, and have accounting experience see p. 8 for what the auditing committee will be responsible for can hire their own counsel o now have independent auditors AND independent auditor committees Expanding Professional Responsibility of Corporate Counsel o used to be that professional responsibility was governed by state law o now rules for conduct in representing public companies has become federal regulated by SEC preempts state law CA fighting this o SEE the flowchart handout o Permissive Noisy Withdrawl see p.1909 left hand column 205.3(d)(2) this is NOT mandatory may disclose to the extent Nx o (1) prevent future financial injury to the investors o (2) prevent perjury o (3) rectify or repair past harm caused by material violations material need not do this CA has issued an ethics alter to CA lawyers that if do this then may be disciplined by the Bar including being removed from bar sole option is to quit inform SEC at your risk until the issue reaches an appellate court that finds the CA law is preempted by the federal legislation
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Enron Example - E would create a special purpose entity as an independent company - under accounting rules the SPE had to have at least 3% equity investment (outside parties investment); and up to 97% of capital could come from loans - E would sell an asset, take back cash or a note from the SPE, book a profit on the sale and the SPE would own the asset
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a number of these assets when sold to SPE lost money, such loss would be on SPE books and not reflected on Enron o losses are realized but not effected (Enron) If SPE was truly an independent party then this formula would work o however here were guaranteed from loss by Enron and Enron guaranteed the loans Enron on both sides of the deal and is therefore selling to itself not to independent third parties
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GENERAL OVERVIEW Lawyers Liability / Responsibilities 205.3(d)(2) pg 1909 General Rule of Confidentiality – absent client consent to disclose that information, that rule is without exception (no permitted disclosure even with fraud or harm) (NOW – permit disclosure to non party third parties in the case of harm or fraud) o Attorney may reveal confidential information (d)(2)(1) & (3) – to prevent future injury (report to the SEC) and to rectify past injury o CA lawyer should not make that disclosure until upheld by an appellate court CEO and CFO -> Certification of the statements This is a direct response to the CEO’s saying that I did not know (that my time is spent doing other things) The corporate establishment supported Congresses assumption that CEO”s should know the business o No one is suggesting that the certification provisions are to be amended / relaxed / or gotten rid of 7 items that must be certified o Eyes have run across the report o No omission or misstatement o That the report fairly presents the condition of the company (“Fair Presentment”) broader than GAAP -> you need to give investors a fair picture o Certifying officers are responsible for (I have established and maintained appropriate disclosures processes and procedures)
SECTION 404 (Widely despised section) (to show that internal controls are adequate) Requires internal control report o (1) states management's responsibilities for maintaining adequate internal controls and procedures for financial reporting, and o (2) expresses management's conclusions on the effectiveness of the controls and procedures. Further, the company's auditor must attest to and report on management's evaluation of the controls and procedures. The auditor's report is to be included in the Form 10-K as well. Under proposed SEC rules, "internal controls and procedures" are those relating to the preparation of financial statements for external purposes in accordance with GAAP. This have proved to be very costly for the companies to do THE BIG PROBLEM IS THE SMALLER COMPANIES PAYING VERY MUCH IN ORDER TO COMPLY There is a move to relax the requirements of section 404 for smaller companies (currently these requirements have been deferred for 1 year for smaller companies) o Currently if you have 10M in assets + 500 share holders o If you get under 300 shareholders you do not have to apply for any of these requirements (but must take an affirmative action to de register) SECTION 906 - creates a new criminal statute with certification requirements completely independent of those of Section 302 Knowing violation – 1M and / or prison for 10 years (I know the # are not right / but I did not know I was violating) Willful Violation – 5M and / or prison for 20 years (I know the #’s are not right / and I did know I was violating)
REVIEW WHAT SHOULD KNOW FOR THE EXAM Limitation on Accountants (pg 6) o Ancillary services that they may do with the consent Pg 7 – 8 – Responsibility of the Audit Committee o Establish independent audit committee Familiar with responsibilities of corporate Counsel (pg 8 and the chart distributed) Remember Permissive Disclosure Rules CEO & CFO Certification SECTION 404 SECTION 906 Sarbanes only applies to companies that are registered under the 1934 act and from the time they file a registration statements under the 1933 act Evaluation of Sarbanes Oxley