Disclosure Required by Sections 406 & 407 of the Sarbanes-Oxley Act of 2002

Client Alert


To:   Our Clients and Friends
From:   Olshan Grundman Frome Rosenzweig & Wolosky LLP
Date:   February 5, 2003
Re:   Disclosure Required by Sections 406 & 407 of the Sarbanes-Oxley Act of 2002

On January 23, 2003, the Securities and Exchange Commission (the "SEC") released final rules implementing Sections 406 and 407 of the Sarbanes-Oxley Act of 2002 (the "Act").  The rules require an issuer, other than a registered investment company or an asset-backed issuer, to disclose whether its audit committee has at least one serving "audit committee financial expert" and whether the issuer has adopted a code of ethics and made or granted any subsequent amendments to or waivers from such code.  Issuers generally must comply with the new disclosure requirements in their annual reports for fiscal years ending on or after July 15, 2003; however, small business issuers need not comply with the audit committee financial expert disclosure requirements until they file annual reports for fiscal years ending on or after December 15, 2003.

Audit Committee Financial Experts

Under the new SEC rules, an issuer must disclose whether it has serving on its audit committee at least one audit committee financial expert. [1]  If so, the issuer must also disclose the name of the expert and whether the expert is independent [2] of management.  If an issuer does not have such an expert it must disclose this fact, as well as explain why it does not.

An audit committee financial expert is defined by the SEC as a person possessing the following attributes: 1) an understanding of generally accepted accounting principles and financial statements; 2) the ability to assess the general application of such principles in connection with the accounting for estimate, accruals and reserves; 3) experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the issuer's financial statements, or experience actively supervising one or more persons engaged in such activities; 4) an understanding of internal controls and procedures for financial reporting; and 5) an understanding of audit committee functions. [3] 

An audit committee financial expert will not be subject to increased liability by reason of his designation.  The SEC has included in the new audit committee disclosure item a safe harbor provision.  A person who is determined to be an audit committee financial expert will not be deemed an expert for any other purpose as a result of being designated or identified as an audit committee financial expert.  Such expert will not have any duties, obligations or liabilities that are greater than the duties, obligations and liabilities imposed on such person as a member of the audit committee and board of directors.  The designation or identification of an expert does not affect the duties, obligations or liabilities of any other member of the audit committee or board of directors. 

Issuers are required to include the new disclosure in their annual reports on Forms 10-K, 10-KSB, 20-F or 40-F. The requirement to provide the new audit committee disclosure item is included in Part III of Forms 10-K and 10-KSB, enabling a domestic issuer that voluntarily chooses to include this disclosure in its proxy or information statement to incorporate this information by reference into its Form 10-K or 10-KSB if it files the proxy or information statement with the SEC no later than 120 days after the end of the fiscal year covered by the Form 10-K or 10-KSB.

Code of Ethics

Under the new SEC rules, an issuer must disclose whether or not it has adopted a code of ethics for its principal executive officer, principal financial officer, principal accounting officer or controllers, or persons performing similar functions. [4]  The SEC defines a code of ethics as written standards that are reasonably designed to deter wrongdoing and to promote: 1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; 2) full, fair, accurate, timely and understandable disclosure in reports and documents that a registrant files with, or submits to, the SEC and in other public communications made by the issuer; 3) compliance with applicable governmental laws, rules and regulations; 4) the prompt internal reporting to an appropriate person or persons identified in the code of violations of the code; and 5) accountability for adherence to the code.  For the purposes of this rule, a code of ethics may be part of a larger code covering additional topics and persons. 

If an issuer has not adopted such a code it must disclose why.  Furthermore, whenever there is an amendment to or waiver [5] from an issuer's code of ethics, such issuer must make immediate disclosure [4] on Form 8-K or via the Internet. [6]  An issuer providing disclosure on Form 8-K or via the Internet [9] must do so within five business days after the amendment or waiver. [9]  However, an issuer may only make such disclosure using the Internet if it has previously disclosed in its most recently filed annual report that it may choose to the use the Internet to disclose amendments or waivers.

An issuer must make its code of ethics publicly available in any one of three ways: 1) by filing a copy as an exhibit to its annual report; 2) by posting the text, or relevant portion thereof, on its Internet website, provided however, that it discloses its Internet address and intention to provide disclosure in this manner in its annual report on Form 10-K, 10-KSB, 20-F or 40-F; or 3) by providing an undertaking in its annual report on one of these forms to provide a copy to any person without charge upon request.

An issuer will have to include the new code of ethics disclosure in its annual report filed on Form 10-K, 10-KSB, 20-F or 40-F.


These are only brief descriptions of the SEC's new rules.  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.

[1] While the Act does not state who shall be the responsible party within each issuer to determine whether a person qualifies as an audit committee financial expert, the SEC believes that the board of directors should make the determination.

[2] Independence under Section 7(d)(3)(iv) of Schedule 14A is determined by the applicable definition of independence under rules of the New York or American Stock Exchange or Nasdaq.  Issuers whose securities are not so listed or traded are to select one of such definitions and disclose their selection.  Foreign private issuers of the Act are exempt from making independence disclosures until the SEC adopts its final rules pursuant to Section 301 of the Act.

[3] A person must have acquired such attributes through any one or more of the following: 1) education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions; 2) experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions; 3) experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or 4) other relevant experience.  If a person qualifies as having "other relevant experience," the issuer's disclosure must describe it.  Examples of such persons might include those in the investment banking and venture capital industries.

[4] Section 406 of the Act does not require that the code of ethics apply to principal executive officers.  The SEC rules have gone beyond the Act in including principal executive officers as covered persons.

[5] A waiver is a material departure from a provision of a code of ethics and includes implicit waivers where an issuer fails to take action regarding a material departure within a reasonable period of time.

[6] An issuer must describe the nature of the amendment or waiver, as well as give the name of the person to whom the waiver was granted and the date of the waiver.

[7] This rule applies only to principal executive officers, principal financial officers, principal accounting officers or controllers, or persons performing similar functions; amendments or waivers to or from provisions affecting only directors do not require disclosure.

[8] When disclosure is made using the Internet, the information disclosed must remain on the issuer's website for 12 months and retained by the issuer for five years.

[9] A foreign private issuer does not have to make immediate disclosure of amendments or waivers; instead it may make such disclosure in its annual report under the Securities Exchange Act of 1934.  However, a foreign private issuer may make such immediate disclosure on Form 6-K or its website.

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