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President Bush signed the Sarbanes-Oxley Act (the "Act") on July 30, 2002, which had been approved the prior week by the House and the Senate. This Bill has far reaching affects on publicly traded companies, auditors, attorneys, analysts and investment banks. A total review of the Act is beyond the scope of this article, but we will focus on those areas of the Act that are particularly important to public companies, their counsel and financial officers.

The Act provides for the establishment of the Public Company Accounting Oversite Board which will oversee many of the various existing organizations in the accounting profession and provide for the registration of those public accounting firms that provide audits to "Issuers." The Act defines "Issuer" as an issuer of securities that are registered under Section 12 of the Securities Exchange Act of 1934 (the "1934 Act"), or that is required to file reports under Section 15(d), or that files or has filed a registration statement under the Securities Act of 1933 (the "1933 Act") that has not become effective and that has not been withdrawn. Therefore, an Issuer is not only a publicly traded company, but also a company that is in the process of registering its securities under the 1933 Act.

Of immediate importance to public companies are the provisions of the Act regarding corporate responsibility, enhanced financial disclosures and auditor independence. Much of the remainder of the Act is intended to toughen antifraud provisions and the penalties for violating securities laws.

Corporate Responsibility

Audit Committees. The Act establishes a statutory requirement for the establishment of audit committees by Issuers consisting solely of independent members of the board of directors. A member will not be considered independent if he or she has accepted any consulting, advisory or other compensatory fees from the Issuer or is an affiliated person of the Issuer or subsidiary. This is broader than the prior requirements of Nasdaq and the NYSE. Audit committees must also establish procedures for the receipt, retention, and treatment of complaints received by the Issuer regarding accounting, internal accounting controls or auditing matters and confidential anonymous submissions by employees of the Issuer of concerns regarding questionable accounting or auditing matters. Under the Act, audit committees are authorized to engage advisors and the Issuer must provide appropriate funding for those advisors.

Officer Certifications. In compliance with the Act, the SEC has proposed rules requiring the principal executive officer or officers and the principal financial officer or officers to certify in each annual or quarterly report:

• the signing officers have reviewed the report;
  
  
• based on the officer's knowledge, the report does not contain an untrue statement of material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading;
  
  
• based on such officer's knowledge, the financial statements and other financial information included in the report fairly present in all material respects the financial condition and results of operations of the Issuer;
  
  
• they (a) are responsible for establishing and maintaining internal controls, (b) they have designed such internal controls to insure the material information is made known to such officer, (c) have evaluated the effectiveness of the internal controls within 90 days prior to the report, and (d) have presented in the report their conclusions about the effectiveness of their internal controls based on the evaluation as of that date;
  
  
• they have disclosed to the Issuer's auditors and the audit committee any significant deficiencies in the design or operation of the internal controls which could adversely affect the Issuer's ability to record, process, summarize and report financial data and have identified for the Issuer's auditors any material weaknesses in internal controls, and any fraud whether or not material that involves management or other employees who have significant influence in the Issuers internal controls; and
  
  
• they have indicated in the report whether or not there are significant changes in the internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation including any corrective actions with regard to significant decencies and material weaknesses.
  
  

Improper Influence on Audits. The Act makes it a criminal act for any officer or director of an Issuer, or any person acting under the direction thereof, to take any action to fraudantly influence, coerce, manipulate or mislead any independent, public or certified accountant engaged in the performance of an audit of the financial statements of that Issuer for the purpose of rendering such financial statements materially misleading.

Forfeiture of Bonuses and Profits. If an Issuer is required to prepare a restatement of its financial statements due to material noncompliance as a result of misconduct with any financial reporting requirement under the applicable securities laws, the CEO and the CFO of the Issuer shall reimburse the Issuer for (a) any bonus or other incentive based or equity based compensation received by that person from the Issuer during the 12 month period following the first public issuance or filing with the SEC of the financial document imbodying such financial reporting requirement, and (b) any profits realized from the sale of securities of the Issuer during that 12 month period. There is no definition in the Act of profits, and one could visualize extreme cases where officers sold securities that had no basis and would be required to reimburse the Issuer for substantially all of the proceeds from the sale of those securities.

Insider Trading during Pension Fund Blackout Periods. The Act provides that it is unlawful for a director or executive officer of an Issuer to directly or indirectly purchase, sell or otherwise acquire or transfer an equity security of the Issuer during any blackout period imposed in connection with pension funds with respect to such equity security if the security was acquired in connection with his or her service or employment as a director or executive officer. Violation of this prohibition results in the director or officer being required to pay any profit realized by such individual from the purchase, sale or acquisition or transfer to the Issuer irrespective of the intention on the part of the individual in entering into the transaction. There is also a provision permitting third party prosecution for recovery of these profits in the same manner as actions are brought under Section 16(b) of the 1934 Act. The Issuer is required to timely notify each director, officer and the SEC of each blackout period. Further, were adopted amendments to ERISA regarding the contents of the notice of blackout periods to participants or beneficiaries under applicable plans.

Rules Regarding Attorneys. The SEC has been instructed to adopt rules for attorneys practicing before the SEC, which will include requirements that attorneys report evidence of material violations of securities law or breach of fiduciary duty or similar violations by the company or any agent thereof to the chief legal counsel or chief executive officer of the company. If such officers do not respond appropriately to the evidence, the attorney must report the evidence to the audit committee or to another committee of the board comprised solely of directors not employed directly or indirectly by the Issuer or to the entire board of directors.

Enhanced Financial Disclosures

Periodic Reports. The Act requires the SEC to adopt rules regarding disclosure of material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the Issuer with unconsolidated entities or other persons that may have a material current or future effect on financial condition, changes in financial condition, results of operation, liquidity, capital expenditures, capital resources or significant components of revenues or expenses. The SEC must also adopt rules regarding disclosure of pro forma financial information, and particularly requiring that the information be presented in a manner that does not contain an untrue statement of material fact or omit to state a material fact necessary in order to make the pro forma financial information, in light of the circumstances under which it is presented, not misleading. The pro forma information must also be reconciled to the financial condition and results of operations of the Issuer under generally accepted accounting principals.

Conflict of Interest Provisions. A particular interest to some Issuers will be the provisions of the Act making it unlawful for any Issuer to extend or maintain credit, arrange for the extension of credit or renew an extension of credit in the form of a personal loan to any director or executive officer of the Issuer. An extension of credit maintained by the Issuer on the date of enactment, July 30, 2002, shall not be subject to the provisions of this subsection provided there is no material modification to any term of any such extension or credit or any renewal of any such extension of credit on or after the date of enactment.

There are exceptions to the general rule, which provide that extensions of credit may be made to directors and executive officers by specific types of Issuers provided they are made in the ordinary course of consumer credit business of the Issuer, of a type is generally made by the Issuer to the public, and made by such Issuer on market terms or terms that are no more favorable than those offered by the Issuer to the general public for the extensions of credit. Further, if the loan is subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act, the prohibition will not be applicable if the Issuer is an insured depository institution.

Amendments to Section 16(a). Section 16(a) has been revised to require directors, officers and principal stockholders to file change of ownership filings (Form 4's) before the end of the second business day following the day on which the subject transaction has been executed, or at such other time as the SEC may establish by rule. Further, beginning no later than July 30, 2003, a Form 4 filing must be filed electronically. The new requirements become effective as of August 29, 2002.

Assessment of Internal Controls. The Act requires the SEC to establish requirements that each annual report contain an internal control report which shall state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting and contain an assessment as of the end of the most recent fiscal year of the Issuer of the effectiveness of the internal control structure and procedures of the Issuer for financial reporting. The Act also requires each registered public accounting firm that prepares or issues the audit report for the Issuer to attest to and report on management's assessment of the internal controls of the Issuer. An attestation made under this requirement must be made in accordance with standards for attestation engagements issued or adopted by the public board.

Code of Ethics for Senior Financial Officers. The Act requires the SEC issue rules requiring each Issuer to disclose whether or not, and if not, the reason therefor, such Issuer has adopted a code of ethics for senior financial officers, applicable to its principal financial officer and comptroller or principal accounting officer, or persons performing similar functions. The SEC is also required to revise Form 8-K to provide for the immediate disclosure of any change in or waiver of the code of ethics for senior financial officers. The code of ethics must have standards which are reasonably necessary to promote (a) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships, (b) full, fair, accurate, timely, and understandable disclosure and periodic reports required to be filed by the Issuer, and compliance with applicable governmental rules and regulations.

Audit Committee Financial Expert. The Act requires the SEC to issue rules requiring each Issuer to disclose whether or not, and if not the reasons therefor, the audit committee of that Issuer's comprise of at least one member who is a financial expert, as such term is defined by the SEC. This disclosure would be consistent with the financial expert requirements set forth in the Act and also the requirements under the NYSE and Nasdaq.

Enhanced Review of Periodic Reports. The Act requires the SEC to review, not less frequently than every three years, the disclosures made by Issuers under Section 13(a) of the 1934 Act for companies which have a class of securities listed on a national securities exchange or traded on a automated quotation facility. Certain companies should expect to be reviewed more frequently, particularly if it has issued material misstatements of financial statements in the past, has stock that is significantly volatile, has one of the larger market capitalization, is an emerging company with disparities in price-to-earnings ratio, or is an Issuer who's operations significantly effect any material sector of the economy.

Real Time Issuer Disclosures. The Act requires each Issuer to disclose to the public on a rapid and current basis any additional information concerning material changes in the financial condition or operations of the Issuer. These disclosures must be made in plan English, and may include trend and qualitative information and graphic presentations as the SEC may determine by rule.

Auditor Independence

Non-Audit Services. The Act provides that a registered pubic accounting firm and any associated person of that firm that performs an audit for the Issuer required by the rules of the SEC, shall not provide any non-audit services, which includes bookkeeping or other services, financial information systems design and implementation, reappraisal or evaluation services, fairness opinions, contribution in kind reports, actuarial services, internal audit outsourcing services, management functions or human resources, broker or dealer, investment advisor or investment banking services, legal services and expert services unrelated to the audit, and any other services that the board determines by regulation as impermissible. However, the firm may engage in non-audit services, including tax services, that are not described in the proceeding sentence, for an audit client if the activity is approved in advance by the audit committee.

Pre-approval Requirements. Audit committees must approve in advance auditing services and non-audit services provided to the Issuer by the Issuer's auditor. There a de minimis exception for the pre-approval requirement with respect to non-audit services. If the aggregate amount of such non-audit services provided to the Issuer constitutes not more than 5% of the total amount of revenues paid by the Issuer to its auditor during the fiscal in which the non-audit services are provided, such services are not recognized by the Issuer at the time of engagement to be non-audit services, and such services are properly brought to the attention of the audit committee of the Issuer and approved by the audit committee prior to the completion of the audit, or by one or more members of the audit committee who are members of the board of directors to whom authority to grant such approvals has been delegated by the audit committee. Any approval by an audit committee of non-audit services to be performed by the auditor of the Issuer must be disclosed in the investor's periodic reports.

Audit Partner Rotation. The Act requires that the leading or coordinating audit partner having primary responsibility for the audit, or the audit partner responsible for reviewing the audit, must be rotated every 5 years.

Reports to Audit Committee. The auditing firm is required to timely report to the audit committee of the Issuer (a) all critical accounting policies and practices to be used, (b) all alternative treatments of financial information within generally accepted accounting principals that have been discussed with the management officials of the Issuer, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public accounting firm, and (c) other material written communications between the registered public accounting firm and the management of the Issuer, such as any management letter or schedule of unadjusted differences.

Conflicts of Interest. It is unlawful for the audit firm to perform an audit service for an Issuer if a chief executive officer, controller, chief financial officer, chief accounting officer, or any person serving in an equivalent position for the Issuer, was employed by the accounting firm and participated in any capacity in the audit of the Issuer during the one year period proceeding the date of the ??? of the audit.

Conclusion

In coming months, public companies will be reviewing their existing corporate governance documents and should take into account the new statutory provisions set forth the Act, as well as the SEC's implementation rules. Companies will need to amend their audit committee charters to comply with new guidelines under NYSE and Nasdaq, together with the independence requirements of the Act. Codes of ethics for financial officers should also be adopted if not already in place. Insider trading policies will be revised to reflect the new blackout provisions. Significant changes are going to be required in the timing and content of the reports. As the result, the Act has a very broad reach and will result in a substantial amount of work for individuals interested in and responsible for corporate governance.

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