Legal Bulletins

Background hero atmospheric image for Corporate Responsibility Checklist

Corporate Responsibility Checklist

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)

  1. Independence means: No material business relationships with the company.

    (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).

  2. Non-management directors must meet regularly without management. (Effective in 6 months)

B. Required committees of the board

  1. Audit committee (described below)
  2. Nomination/corporate governance (except controlled company) (Effective in 6 months)

    (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

  3. Compensation committee (Effective in 6 months)

(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)

  1. Include in website (Effective in 6 months)
    (a) Corporate governance guidelines
    (b) Charters of most important committees
    (c) Code of business conduct and ethics
  2. Corporate governance guidelines to include
    (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
  3. Waivers from the above standards must be promptly disclosed
  4. Code of business conduct and ethics to include compliance standards and procedures addressing:

    (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

  1. an understanding of GAAP and financial statements
  2. experience in preparing or auditing of financial statements, and the application of principles in connection with accounting for estimates, accruals and reserves
  3. experience with internal controls
  4. an understanding of the audit committee function

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)

  1. Audit committee shall establish procedures for receipt, retention and treatment of complaints regarding accounting, internal controls and auditing, and for the confidential treatment of concerns from employees. (Sarbanes-Oxley Act)
  2. Audit committee authority to be expanded (NYSE) (Effective in 6 months) to grant it sole authority to hire and fire auditors and to approve any non-audit relationship with auditor.
  3. Under new attorney reporting, corporate counsel must report problems to audit committee.

D. Audit committee must have written charter that addresses:

  1. The committee's purpose, which is

    (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

  2. Duties and responsibilities, which are
    1. Hire and fire auditors
    2. Annually review report of auditors on internal quality control procedures, any issues regarding controls and independent audits, and to assess auditor's independence
    3. Discuss annual and quarterly financial statements and MD&A with auditors and management
    4. Discuss press releases and earnings guidance
    5. Obtain professional advice
    6. Discuss policies regarding risk management
    7. Meet with management, internal and external auditors
    8. Review any audit problems
    9. Set auditor hiring and firing policies
    10. Report regularly to the board
    11. Annual performance evaluation of the committee

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:

  1. They reviewed it
  2. To their knowledge, it contains no untrue statement or omission
  3. To their knowledge, the financial statements and other financial information fairly present the company's financial condition in all material respects
  4. Signers are responsible for and have:

    (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

  5. Signers have disclosed to the auditors and audit committee all significant deficiencies and weaknesses in the internal controls, and any fraud involving management or employees involved with controls.
  6. Signers have indicated in report whether or not there were any significant changes or other factors that could affect internal controls subsequent to the evaluation date, including any corrective actions.

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)

  1. Each Form 10-K to contain report which:
    (a) States responsibility of management for establishing and maintaining internal controls

    (b) Contains an assessment of effectiveness of the internal controls structure and procedures

  2. Auditor must attest to and report on management report

D. Certification by CEO and CFO of periodic reports containing financial statements (Sarbanes-Oxley Act, Sec. 906)

  1. The report fully complies and fairly represents in all material respects financial condition and results of operations.

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)

  1. Recovery of profits
  2. Private right of action
  3. Notice to participants

D. Prohibition on loans to executives (Currently Effective)

  1. Prohibits extending, maintaining or arranging for credit or loan to executives, or modifying terms of existing loan
  2. Certain exceptions available for specific loans made in the ordinary course of business on terms available to unrelated third parties

E. Reports of changes in beneficial ownership (Currently Effective)

  1. Changes reported within 2 business days
  2. All filings to be made electronically within 1 year; issuer to provide copies on website

F. Code of ethics for senior financial officers (Effective in 6 months)

  1. Must disclose in periodic reports if company has code of ethics for senior financial officers, including principal financial officer, controller and principal accounting officer.
  2. Immediate Form 8-K disclosure of any change or waiver
  3. Code of ethics means standards reasonably necessary to promote

    (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

  1. Prohibition on influencing audit
  2. Whistleblower protection
  3. Longer statute of limitations
  4. Director and officer bar
  5. Additional disqualification provisions include state securities administrator orders finding violations

V. Disclosure

A. Sarbanes-Oxley Act (Effective in 6 months)

  1. Periodic reports that include financial statements must contain material correcting adjustments to GAAP that have been identified by auditor.
  2. SEC to promulgate rules to disclose all off-balance sheet transactions (including contingent obligations) and relationships with affiliated entities which may impact financial condition.
  3. SEC to promulgate rules on pro forma financial statements to assure that the disclosure does not contain any misleading statements or omissions, and to be able to reconcile it with GAAP.

B. Real Time Disclosures (No effective date specified)

  1. Each issuer is obligated to disclose in plain English on a rapid and current basis information concerning material changes in financial condition and operations, including trend or qualitative information.

C. SEC Rules and Proposals (pending)

  1. Accelerated filing of periodic reports (adopted)
  2. Disclosure of critical accounting policies
  3. Website access to periodic (and insider trading) reports
  4. Enhanced comprehensive Form 8-K disclosure on accelerated filing basis
    VI. Other Provisions

    A. Establishment of Public Accounting Board to oversee auditing firms

    1. Impose seven year records maintenance requirements
    2. Require second partner review of auditing work
    3. Establish quality control standards

    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

    1. Restrict pre-publication and clearance by investment banker
    2. Prohibit retaliation for adverse reports and build Chinese walls
    3. Disclosure in public appearances 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

    1. NYSE public reprimand letters
    2. Nasdaq delisting

    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

    1. Internal Controls

      (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?

    2. Directors

      (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

    3. Accounting

      (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:

    1. Operations:

      (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

    2. Internal Controls

      (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

    3. Accounting issues - matters affecting results of operations, financial condition and liquidity:

      (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

    4. Generally, get management certification for all areas of concern

    C. Board to receive and carefully review and discuss:

    1. Operations: all periodic and current SEC reports, proxy statements, press releases and comparison with preceding periods
    2. Internal Controls: independent auditors' letters to management and reports by audit committee
    3. General counsel report on compliance

    D. Officers

    1. Internal controls

      (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

    2. Disclosure

      (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

    3. Complaints

      (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

    4. Schedule periodic meeting with auditors and audit committee.