Corporate responsibilities have increased dramatically since the recent passage of the Sarbanes-Oxley Act, the modifications to the corporate governance standards adopted by the New York Stock Exchange (NYSE) and proposed by Nasdaq, and the proposal and adoption by the SEC of significant revisions to the disclosure rules and forms. Many of the items will require some degree of corporate fine-tuning or even restructuring, and even items with deferred effective dates will need advance planning.
Certain of these items will not be applicable to public companies that are traded on the over-the-counter bulletin board. However, Nasdaq has announced its plans to replace the bulletin board with its new Bulletin Board Exchange (BBX) sometime in 2003. Companies listed on the BBX will be required to comply with certain qualitative listing standards (as opposed to quantitative measures, such as minimum stock price and float requirements) which may well include many if not all of the new requirements.
The following is a corporate checklist of certain of the principal items that require prompt attention. The effective dates given refer to outside dates by which regulations are to be implemented; that means that the SEC or self regulatory organizations could adopt rules that require compliance prior to the outside dates set by Congress.
I. Board of Directors (NYSE and Nasdaq listing standards)
A. A majority of the board (other than a 50% controlled company) must be independent. (NYSE effective in 24 months)
(a) NYSE -- A director is not independent if in the past 5 years he/she was an employee of the company, affiliate of the auditor, was part of an interlocking directorate in which an executive officer of the company serves on the compensation committee of the company that employs the director, or whose immediate family member serves in any of the described positions.
(b) Nasdaq - A director is not independent if the director or his or her family receives more than $60,000 per year except for board service ($200,000 for non-profits).
B. Required committees of the board
(a) Must be comprised of entirely independent directors (NYSE effective in 24 months, but must have at least 1 independent director in 12 months)
(b) Must have a written charter (Effective in 6 months) that requires the committee to:
(1) Nominate qualified people
(2) Develop and recommend corporate governance principles
(3) Conduct oversight and reevaluation of management
(4) Annually evaluate the committee's performance(c) Nasdaq would allow a single, non-independent director if he/she is an officer and 20% stockholder
(a) Must be comprised of entirely independent directors (NYSE effective in 24 months, but must have at least 1 independent director in 12 months)
(b) Must have a written charter (Effective in 6 months) that requires the committee to:
(1) Set compensation for executives and produce written report
(2) Review and approve CEO goals and objectives
(3) Evaluate CEO performances in light of those goals
(4) Set CEO compensation based on evaluation
(5) Make recommendations on incentive and equity plans
(6) Conduct annual self-evaluation
C. Corporate governance guidelines (Effective in 6 months)
(a) Corporate governance guidelines
(b) Charters of most important committees
(c) Code of business conduct and ethics
(a) Qualification standards for directors
(b) Responsibility of directors
(c) Directors' access to management
(d) Director compensation
(e) Education for directors
(f) Succession plans for management
(g) Performance of self-evaluation
(a) Conflicts of interest
(b) Corporate opportunity
(c) Confidentiality
(d) Fair dealing
(e) Protection and use of assets
(f) Compliance
(g) Reporting illegal and unethical conduct
II. Audit Committee (Effective in 6 months)
A. Must have at least 3 entirely independent director members. Independence means director cannot accept any fee or be an affiliate of the company or any subsidiary. Each must be financially literate (as interpreted by the board) with at least one member being a "financial expert" (Sarbanes-Oxley) and having accounting or related financial management expertise (NYSE). Nasdaq would permit one non-independent director for "exceptional and limited circumstances" for a member who is not an officer, employee or family member if the board determines that it is in the best interest of the company.
B. "Financial expert" means that the person has, through education or experience
C. Audit committee shall have funding allocated to it, in the discretion of audit committee, to hire and pay auditors and advisors, and has authority to employ of counsel and other advisors for itself. (Sarbanes-Oxley Act)
D. Audit committee must have written charter that addresses:
(a) To assist board oversight of
(1) Integrity of financial statements
(2) Legal and regulatory compliance
(3) Auditor qualifications and independence
(4) Performance of internal audit function and auditors(b) Prepare report for publication in company's proxy statement
E. Company must have internal audit function
F. Nasdaq requirement that audit committee must review and approve all conflicts of interest issues
III. Officer Certifications (Currently Effective)
A. Principal executive officer and principal financial officer must certify in annual and quality reports (Sarbanes-Oxley Act, Section 302) that:
(a) Established and are maintaining internal controls
(b) Designed internal controls to ensure material information is made known to the officers
(c) Evaluated effectiveness of controls within 90 days of report
(d) Presented their conclusions in the report on effectiveness of the controls
B. Testing the System: New Regulation S-K Item 307 requires officers to report on the testing and evaluation of the internal controls within 90 days of the filing of any Exchange Act periodic report.
C. Internal control assessment (Sarbanes-Oxley Act, Section 404)
(a) States responsibility of management for establishing and maintaining internal controls
(b) Contains an assessment of effectiveness of the internal controls structure and procedures
D. Certification by CEO and CFO of periodic reports containing financial statements (Sarbanes-Oxley Act, Sec. 906)
E. CEO annual certification to NYSE that CEO is not aware of any violation of listing standards
IV. Insiders (Sarbanes-Oxley Act)
A. Forfeitures of bonuses and profits on sales of company stock (Effective in 6 months)
B. Bar on directors and officers from serving as a director or officer of public company. (Effective in 6 months)
C. Prohibited trading during blackouts (Effective in 6 months)
D. Prohibition on loans to executives (Currently Effective)
E. Reports of changes in beneficial ownership (Currently Effective)
F. Code of ethics for senior financial officers (Effective in 6 months)
(a) honest and ethical conduct, including handling of actual or apparent conflicts
(b) full, fair, accurate, timely and understandable disclosure
(c) compliance with rules and regulations
G. Rules to foster integrity
V. Disclosure
A. Sarbanes-Oxley Act (Effective in 6 months)
B. Real Time Disclosures (No effective date specified)
C. SEC Rules and Proposals (pending)
A. Establishment of Public Accounting Board to oversee auditing firms
B. Prohibition on influence of audits
C. Requiring SEC to apply enhanced review of periodic reports and to mandate review at least every three years
D. Securities analysts and research reports
(a) Investment in issuer
(b) Any compensation that is payable to broker
(c) Whether the company is or was a client of the broker
(d) All compensation, including investment banking fees
(e) Other conflicts
E. Penny Stock Bar
F. Qualifications of associated person of broker-dealer and investment adviser and impact of State Securities Commission orders
G. Criminal penalties for altering documents, and 5 year records retention requirement
H. Statute of limitation increased to 2 years after becomes aware, but not more than 5 years from date of event
I. Whistleblower protection - protects against any discharge, demotion, suspension, threat, harassment or reduction in discretion
J. Stock Exchange penalties
K. Equity compensation plans to require shareholder approval (NYSE and Nasdaq) L. Removal of discretionary authority of brokers to vote on management compensation plans that involve less than 5% of stock
VII. Recommendations
The recent legislating and rulemaking activity places on the board and management significantly heightened responsibilities in fulfilling the same - and some new - duties. The board and management therefore must refocus on the substantive subject of their duties and the process by which they comply with their duties. The following is a checklist of some of the items generally that the board and audit committee should institute:
A. Substantive areas of responsibility
(a) Is there in place a system of controls and is it adequate for the company's needs? Have the auditors reviewed it and are they satisfied with it? Has counsel reviewed it?
(b) Are checks and balances in place to assure compliance? To detect non-compliance?
(c) How frequently is the system tested, when has it last been tested, and what were the results?
(d) If the results are not satisfactory, how should the system be improved? What have the auditors remarked about the system?
(a) Set qualification for board members and standards of conduct that include:
(1) Code of ethics
(2) Insider trading policy
(3) Confidentiality policy
(4) Reporting of concerns
(b) Establish system of distribution of material information to board and committee members
(c) Provide system for monitoring and prompt reporting of trading in company stock
(d) Board agenda should provide for discussion of company results, reports on operations and financial condition, trends and projections
(a) Review issues affecting results of operations, financial condition and liquidity, present or anticipated:
(1) Critical accounting policies and material assumptions
(2) Revenue recognition policies
(3) Expensing policies and capital charges
(4) Liquidity position, availability of funds and possible limitations on liquidity
(5) Contingent liabilities and cash obligations
(6) Asset revaluations, impairment issues and possible write-downs
(7) Adequacy of reserves
(8) Restructuring charges
(9) Off-balance sheet transactions
(10) Impact of transactions completed or in process
(11) Related party transactions, including loans or extensions of credit to or for directors and officers
(b) Review relationship with auditors
(c) Be aware of changes in accounting treatment and material difference in results when compared to other periods
(d) Look for trends in company's business and factors that could impact future performance or financial condition
B. Audit committee to meet with management, internal audit or compliance staff and independent auditors, and receive reports and carefully review and discuss:
(a) all periodic and current SEC reports, press releases and statements to analysts, and internal supporting material
(b) at least quarterly internal summaries of operations for major business segments, by product and region, together with recent industry data and update on significant competitors
(c) comparison of operations with preceding comparable periods and projections, and summaries of reasons for changes
(d) updates on transactions, integration of completed transactions, effect of proposed transactions and status of transactions in process
(e) summary of material litigation and claims, pending or threatened
(a) receive management reports on and meet with management regarding system of internal controls, recent testing and efficacy
(b) review auditor's letters to management and auditor's reports to audit committee and board
(c) changes in critical accounting policies and estimates, including any changes in treatment of any items
(d) report by counsel on compliance
(a) meet with management and discuss
(b) review supporting schedules for accounting treatment
(c) obtain backup for accounting changes or modified estimates
(d) review or become familiar with underlying transactions
(e) anticipated changes
C. Board to receive and carefully review and discuss:
D. Officers
(a) Implement internal control systems
(b) Test the system within 90 days of filing any Exchange Act report
(c) Obtain input of independent auditors on the system
(a) Consider establishing disclosure committee to assist in making disclosure decisions and to review disclosures
(b) Adopt disclosure review guidelines and procedures
(c) Implement method of checking supporting and testing data
(d) Clear press releases, earnings estimates, analyst guidance and Exchange Act filings
(a) Appoint appropriate officer (perhaps general counsel) (and secondary person) as persons to whom issues, complaints and potential problems may be reported, and publicly announce implementation
(b) Appointed person should have open-door policy
(c) Adopt confidentiality policy for complaints and complainants, and higher level of review if no response is received
(d) Announce policy protecting whistleblowers
09.05.02
Poliakoff, Abba David
Walsh, Michele Bresnick
Bulgin, Andrew D.