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IS THERE A NEW SHERIFF IN
CORPORATEVILLE?
THE SARBANES-OXLEY ACT OF 2002: NEW
OBLIGATIONS FOR DIRECTORS, OFFICERS,
ACCOUNTANTS AND LAWYERS
San Francisco
Aug 8, 2003
Thomas O. Gorman
Porter, Wright, Morris & Arthur
Background
Corporate scandals raised a common question: where
were the officers, directors, auditors, lawyers and regulators
when the events at the likes of Enron and WorldCom
transpired?
Sarbanes-Oxley was the reaction; a new code of corporate
ethics, with teeth
“This law says to every dishonest corporate leader: ‘You
will be exposed and punished. The era of low standards and
false profits is over. No boardroom in America is above or
beyond the law.’” Statement of President George W. Bush on
signing, July 30, 2002.
The Approach
“Premised on the notion that nothing concentrates the
¡
mind like the prospect of a hanging, Sarbanes-Oxley
added strong penalties for corporate wrongdoing to a
variety of regulatory initiatives already under way.
Essentially the law tries to restore confidence in
¡
business through regulation of executives and their
advisers, including accountants and lawyers.
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 1
The Guardians of Shareholder Dollars
The Act imposes new obligations on insiders, adds
¡
safeguards to ensure independent oversight and
empowers the supposed watchdogs – Perhaps a new
sheriff?
x Audit Committees -- Revitalized and Empowered
x Executives -- Code of ethics, Expanded Certification
Requirements and Prohibitions on self-dealing
x Auditors -- End to self-regulation, new auditing
standards and rules ensuring independence
x Attorneys -- Express Reporting obligations where
knowledge of corporate wrongdoing
Audit Committee: Old Watch Dog –
Perhaps a New Sheriff?
New Structure, Mandate and Powers:
¡
x Only Independent Directors can serve on audit committee
x At least one member must be a “financial expert”
x Charged with appointment, compensation and oversight of any
independent audit report or related work
x Must establish procedures for receiving complaints relating to
accounting, internal controls and auditing matters
x Authority to retain advisors necessary to carry out duties
Corporate Responsibility
“A strong dose of character, honesty, and ethics in corporate
America wouldn’t hurt” Congressman Mike Oxley, July 25,
2002
x Code of ethics: Issuers must adopt code of ethics for senior
financial officers, or disclose the lack thereof and the Issuer’s
reason for not adopting a code
x Augmented prohibitions on self-dealing:
Sec. 402 prohibition on loans to officers/directors
Sec. 306 precludes officers/directors from trading in issuer’s
stock during pension fund “blackout” period
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 2
Corporate Responsibility (cont’d)
New Requirements for Financial Certification -- an end to the
era of “I don’t know corporate finance.”
Principal officers must certify to their knowledge that:
x the signing officer has reviewed the report;
x that the financial information fairly presents in all material respects
the financial condition of the issuer;
x that the signing officer is responsible for establishing and
maintaining the internal controls of the company;
x that the signing officers have disclosed to the auditors/audit
committee any significant deficiencies in the internal controls, any
fraud or any significant changes in the internal controls.
Corporate Responsibility (cont’d)
New Sanctions:
Personal Accountability: If Issuer is required to restate financial
statements as a result of misconduct, the CEO and CFO must pay back
any bonus or incentive compensation paid during year following the
improper reporting
Officer/Director Bar:
x Sec.305 lowers the showing required from “substantial unfitness” to
“unfitness”
x Sec.1105 -- SEC can impose officer/director bar through a cease
and desist proceeding where violation of Sec. 17(a)(1) of the 1933
Act, Sec. 10(b) of the 1934 Act, or rules under either section
Auditors: New Oversight and Safeguards for
Independence
The SEC and the Public Company Accounting Oversight Board: End of
the era of self-regulation
x Section 101 of the Act establishes the Board
x Section 102 requires all public accounting firms which prepare audit
reports for publicly traded companies to register.
x The Board is given significant authority to set auditing standards
and investigate/discipline auditors, subject to SEC oversight.
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 3
Auditors: New Standards
Perhaps a New Sheriff?
Auditing standards:
¡
x Although the Board is directed to consult with the public and
industry, it is the Board that is empowered to promulgate new
auditing standards, subject to SEC approval
x The Board is directed to establish new ethical and quality control
standards for auditors
New restrictions to eliminate potential conflicts of interest
Audit partner rotation every five years
Expanded audit opinions
Auditors: Registration and Oversight
Registration: Public Company Auditors required to
register with the Board; Foreign firms required to submit
to the Board’s jurisdiction
Board Oversight Powers:
¡
x Authority to conduct periodic inspections of firms
x Investigate possible violations of the Act and its rules
x Hold Administrative hearings to determine whether a violation
has occurred
x Can request that the SEC issue subpoenas
Auditor Oversight (cont’d)
Disciplinary proceedings. Sanctions available to the Board
¡
include:
x Suspension;
x Monetary fines up to $100,000 for an individual and $2 million for a firm.
For intentional, knowing, reckless or repeated instances of negligence
the fines can be increased up to $750,000 for an individual and $15
million for a firm.
Other Sanctions:
x Debarment
x Criminal Fines and Imprisonment for “knowingly and willfully” destroys
audit work papers within five years of an audit, Section 802
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 4
Auditor Independence
New Safeguards for Auditor independence:
Generally, the Act prohibits registered public accounting
¡
firms from providing “non-audit” services to the public
companies they audit
Issuers must disclose fees paid for audit and non-audit
¡
services
Firms must rotate audit partner every five years
¡
Firm cannot audit public company if current member of Sr.
¡
Mgt. was employed by the firm and participated in the
company’s audit the prior year
Expanded Audit Opinions
Additional Reporting Obligations for Auditors, opinions must
now specify:
x Scope of auditor’s testing of internal controls
x Auditor’s findings based on testing
x Evaluation of whether internal controls are sufficient to accurately
reflect transactions/dispositions of assets
x Evaluation of whether internal controls provide reasonable assurance
of adherence to GAAP and management authorization of
receipts/expenditures
x Description of any “material weakness” in internal controls and
“material noncompliance”
Lawyers: New Obligations & Reporting Duties
The Act gives the SEC explicit authority to set forth “minimum
standards” for attorneys practicing before the Commission:
Counsel required to “report evidence” of a material violation of the
securities laws, breach of fiduciary duty or similar violation by chief
legal counsel or chief executive officer – Perhaps another new
sheriff?
x If response insufficient, must report to audit committee, other independent
Board Committee or Board of Directors
Ethics rules for attorneys practicing before the SEC
Sanctions:
Like auditors, attorneys can be barred from practicing before the
Commission
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 5
Lawyers: Rulemaking Ongoing
SEC Rulemaking -- Controversial provisions dropped or on
hold:
Extended comment period for “noisy withdrawal” provision
Dropped requirement for attorneys to document report of material
Violation, response and retain documentation;
Withdrew limited waiver provision; although policy of entering into
confidentiality agreements when in public interest affirmed
Ethics Reinforced by Expanded Liability
New securities fraud crime: New offense of securities fraud
¡
which prohibits knowingly executing or attempting to
execute a scheme or artifact to defraud investors in publicly
traded companies.
New obstruction of justice crimes
¡
Section 804 increases the statute of limitations for
¡
securities fraud
Increased penalties. Other provisions of the Act increase
¡
existing criminal penalties
Copyright by Thomas O. Gorman, Porter, Wright, Morris & Arthur, L.L.P. 6
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