Summary of The Sarbanes-Oxley Act of 2002
|To:||Our Clients and Friends|
|From:||Olshan Grundman Frome Rosenzweig & Wolosky LLP|
|Date:||August 6, 2002|
|Re:||The Sarbanes-Oxley Act of 2002|
You will find attached a summary of the principal provisions of the Sarbanes-Oxley Act of 2002 on Corporate Accounting Reform and Investor Protection, enacted July 30, 2002 (the "Act"). The Act was passed in response to calls for more strict and comprehensive regulation concerning corporate governance and responsibility and includes provisions relating to enhanced financial disclosure, corporate fraud and auditor independence and establishes an accounting oversight board. The complexity of the Act and the speed (some might say haste) with which it was passed raise many legal and practical issues that will require analysis and consultation between public companies and counsel. Many sections of the Act prescribe or will necessitate rulemaking by the Securities and Exchange Commission (the "SEC").
Several important provisions of the Act became effective on enactment. Two sections of the Act, Section 302 and Section 906, require certification by the chief executive and chief financial officers of an issuer's periodic reports filed under the Securities Exchange Act of 1934 (the "1934 Act"). Section 302 directs the SEC to adopt rules for certification within 30 days after enactment of the Act. However, Section 906 took effect immediately and requires that all periodic reports containing financial statements filed under either Section 13(a) or 15(d) of the 1934 Act be accompanied by a certification that the periodic report fully complies with the requirements of Section 13(a) or 15(d) and that the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer. Section 906 does not prescribe the form of the certification or the method by which it is to be made. In the absence of immediate rulemaking, we recommend that the certification be filed as an exhibit to periodic reports and that it include language to the effect that the certification is based upon the officer's knowledge. We have prepared a suggested form of certification, which we would be pleased to provide at your request. We will continue to monitor Congressional and administrative guidance in this area and update our recommendations should circumstances warrant.
You will find that the Act affects many of the established practices of public companies. This memorandum provides general information only and does not constitute legal advice that may be applied to any particular situation. Please contact the Partners in our Corporate Department for further advice and assistance.
The Sarbanes-Oxley Act of 2002 on
Corporate Accounting Reform and Investor Protection
I. Corporate Responsibility (Sections 301-308)
- Amends Section 10A of the 1934 Act to include standards relating to the Audit Committee. The provision:
- makes the Audit Committee responsible for the appointment, compensation and oversight of the work of the public accounting firm employed by the issuer;
- requires that each member of the Audit Committee be a Director and otherwise independent, i.e., not affiliated (except as a Director and Board committee member) with the issuer or its subsidiaries and not the recipient of consulting, advisory or other compensatory fees from the issuer or its subsidiaries; and
- requires the Audit Committee to establish procedures for the receipt, retention and treatment of complaints received by the issuer concerning accounting, internal control and auditing matters and the confidential, anonymous submission by the issuer's employees of accounting and auditing concerns.
- Requires the principal executive and principal financial officers to certify in each annual and quarterly report submitted under either Section 13(a) or 15(d) of the 1934 Act:
- that the officer has reviewed the report;
- based on the officer's knowledge, that the financial statements and other included financial information does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which made, not misleading;
- based on the officer's knowledge, that the financial statements and other included financial information fairly present in all material respects the issuer's financial condition and results of operations;
- that the officer is responsible for establishing and maintaining the issuer's internal controls to ensure that material information is communicated to the certifying officers, has evaluated the effectiveness of the issuer's internal controls and has presented in the report his conclusion concerning the effectiveness of such controls;
- that the officer has disclosed to the Audit Committee and the issuer's public accounting firm any significant deficiencies in the issuer's internal controls and any fraud, whether or not material, of management or other significant employees; and
- that the officer has described in the report any significant changes in internal controls or other factors that could significantly affect subsequent reporting.
Within 30 days after enactment of the Act, the SEC is required to adopt rules implementing the preceding provisions.
- Requires principal executive and financial officers to reimburse an issuer for any bonus or other incentive- or equity-based compensation received and any profits resulting from the sale of the issuer's securities during the 12-month period following an accounting restatement due to material non-compliance with financial reporting requirements.
- Prohibits trading by directors and executive officers in securities of an issuer acquired in connection with service or employment in such capacities during pension fund blackout periods. Profits from such trading are recoverable by the issuer regardless of intent.
- Requires the SEC to issue rules relating to minimum standards of professional conduct for attorneys practicing before it, including:
- requiring the reporting by such an attorney to the issuer's chief executive or chief legal officer of evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the issuer or its agents; and
- should such chief executive or legal officer fail to respond appropriately to the evidence presented, requiring the attorney to report such evidence to the Audit Committee (or other Board committee comprising solely outside directors) or the Board of Directors.
II. Enhanced Financial Disclosures (Sections 401 – 409)
- Requires the SEC to issue final rules within 180 days after enactment of the Act requiring:
- disclosure in annual and quarterly reports of all material off-balance sheet transactions and relationships that may have a material current or future effect on an issuer's financial condition, results of operations, liquidity, capital expenditures and resources; and
- presentation of pro forma financial information included in periodic or other reports filed with the SEC in a manner that is not misleading and can be reconciled with the issuer's reported financial condition and results of operations.
- Prohibits (with limited exceptions) the extension, maintenance or renewal of credit in the form of a personal loan to or for any director or executive officer of an issuer.
- Effective 30 days after enactment of the Act, requires persons who must file beneficial ownership reports under Section 16(a) of the 1934 Act to disclose changes in such ownership before the end of the second business day following the day on which the change occurred.
- Requires the SEC to make rules requiring that each annual report filed under Section 13(a) or 15(d) of the 1934 Act contain an internal controls report that would include an assessment of the effectiveness of the issuer's internal control structure, and further requiring the issuer's public accounting firm to report on such assessment.
- Directs the SEC to issue rules requiring issuers to disclose whether or not (and if not, the reason therefor) they have adopted a code of ethics for senior financial/accounting personnel.
- Requires each reporting issuer to disclose to the public in plain English on a rapid and current basis information concerning material changes in the financial condition or operations of the issuer in such form as the SEC determines by rule.
- Directs the SEC to issue rules requiring issuers to disclose whether or not (and if not, the reason therefor) members of the Audit Committee include at least one financial expert. The definition of financial expert encompasses a person's experience, as well as factors such as knowledge and understanding of GAAP, financial statements and internal controls.
III. Public Company Accounting Oversight Board (Sections 101-109)
- Establishes the Public Company Accounting Oversight Board to oversee the auditing of public companies and to:
- register public accounting firms;
- establish auditing, quality control, ethics, independence and other standards relating to audit reports for issuers;
- conduct inspections of registered public accounting firms; and
- conduct investigations and disciplinary proceedings concerning, and impose sanctions on, registered public accounting firms.
- Requires accounting firms preparing audit reports for public companies to register and submit to periodic inspections by the Oversight Board (annually for firms providing audit reports for more than 100 issuers and once every three years for the remainder).
IV. Auditors' Independence (Sections 201-209)
- A registered public accounting firm performing an audit for an issuer is prohibited from (unless exempted by the Oversight Board) contemporaneously providing non-audit services, including the following:
- bookkeeping or other services related to the issuer's accounting records or financial statements;
- financial information systems design and implementation;
- appraisal or valuation services, fairness opinions;
- actuarial services;
- internal audit outsourcing services;
- human resource functions;
- broker-dealer, investment advisory and banking services; and
- legal and other expert services unrelated to the audit.
The registered public accounting firm may engage in non-audit services, including tax services, other than those listed above, if pre-approved by the issuer's Audit Committee.
- Requires that the lead (or coordinating) audit partner and the audit partner reviewing the audit be changed no less frequently than every five years.
- Mandates certain periodic reports by the public accounting firm to the Audit Committee.
V. Corporate and Criminal Fraud Accountability (Sections 801-807)
- Prohibits (and imposes a fine and/or incarceration for) knowingly altering, destroying or falsifying records with the purpose of obstructing an investigation in a matter within Federal jurisdiction or bankruptcy. Requires the retention by an accountant conducting an audit of audit and review workpapers.
- Makes non-dischargeable in bankruptcy debts incurred in violation of securities fraud laws.
- Provides whistleblower protection against retaliation and discrimination.
VI. White Collar Crime Penalty Enhancements (Sections 901-906)
- Amends provisions of Federal criminal law to increase penalties for attempts and conspiracies to commit criminal fraud offenses, mail and wire fraud and ERISA violations.
- Requires the certification of financial statements discussed in the introduction to this memorandum.
VII. Corporate Fraud Accountability (Sections 1101-1107)
- Imposes fines and incarceration for the knowing alteration, destruction or concealment of documentation with intent to impair its use in an official proceeding. Increases criminal penalties under the 1934 Act.