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The Application of Sarbanes-Oxley to Non-U.S. Companies

Client Advisory

November 2002

Introduction

Most of the provisions of the Sarbanes-Oxley Act of 2002 (the "Act") apply to non-U.S. public companies that are required to file periodic reports with the SEC ("Non-U.S. Reporting Companies"). Some of these provisions are already in effect while others require the SEC to adopt rules before they will take effect. Although the SEC has the power to exempt Non-U.S. Reporting Companies from some of the provisions of the Act, the SEC has not yet done so except in certain limited instances, and it will take time before it might do so with respect to other provisions, if at all.

What follows is a brief description of the provisions of the Act as they apply to Non-U.S. Reporting Companies. Also included in this advisory is a description of those rules that have been adopted or proposed by the SEC to the extent they are applicable to Non-U.S. Reporting Companies. In addition, this advisory covers the rules proposed by Nasdaq in connection with independent directors on the boards of Non-U.S. Reporting Companies and audit committee requirements.

The Certification Requirements

Under the Act, two new sets of certifications by CEOs and CFOs are required in the annual reports filed by Non-U.S. Reporting Companies on Forms 20-F and 40-F. The certification requirements do not apply to interim reports on Form 6-K. Under §302 of the Act, the CEO and CFO must certify the accuracy and completeness of the information contained in each annual report. They must also certify that they have established, maintained and evaluated disclosure controls and procedures to ensure the timely and complete up streaming of information necessary to prepare the periodic reports. The CEO and CFO must also certify that internal controls have been put in place for purposes of accurate financial statement reporting and control of the company's assets.

In answer to certain frequently asked questions about the Act, the SEC published on November 14, 2002 its view that an amendment to an annual report on Form 20-F requires certification of the accuracy and completeness of the information contained therein even if the Form 20-F was originally filed prior to August 29, 2002 when the certification requirements went into effect.

In addition, and separately, §906 of the Act requires that a company's CEO and CFO certify the accuracy and completeness of the information contained in each periodic report and that the report complies with the Securities Exchange Act of 1934, as amended (the "Exchange Act").

The certification requirements of §302 require a standard that, to the executives knowledge, the financial statements included in the report "fairly present" in all material respects the financial condition, results of operations and cash flow of the company. This standard is broader than U.S. GAAP and will require CEOs and CFOs and all other employees making accounting or disclosure determinations to base their decisions not just on GAAP but on the "fairly presents" standard. The "fairly presents" standard is similar to the UK standard and is meant to cover the selection and proper application of accounting policies, the disclosure of financial information that is informative and reasonably reflects the underlying facts and the inclusion of other information necessary to give investors a materially complete picture of the issuers financial condition, results of operations and cash flows. The SEC has not provided a script for the disclosure controls and procedures that companies must now adopt in order to ensure the timely up-streaming of accurate and comprehensive information required for the periodic reports. Nonetheless, the following are some of the more commonly adopted procedures in response to the new certification requirements:

  • Companies should develop checklists and review procedures to assist in performing the due diligence necessary for preparing the periodic reports and create a record of what was done.
  • The SEC has recommended the formation of a disclosure committee to evaluate the materiality of disclosure and stay on top of the preparation process of the periodic reports so that there is sufficient time to deliberate over disclosure issues. The members of the disclosure committee should include the principal accounting officer, the general counsel, the head of investor relations and the principal risk management officer.
  • CEOs and CFOs may wish to obtain sub-certifications of management to confirm that those up-streaming the information to be included in the periodic reports know of no reason why the information they are passing on is incorrect.
  • The periodic reports should be submitted by the outside auditors and management to the audit committee, which should discuss any issues arising in connection with the preparation of the report. At the same time, the audit committee should receive a report from the CEO and CFO regarding the disclosure controls and procedures that are in place and any deficiencies that have been detected in them.

While the §302 requirement does not apply to an interim report on Form 6-K, it is not entirely clear whether the §906 requirement applies. Most law firms however, believe it does not because the SEC does not view the Form 6-K as a "periodic" report, nor does it view such report as being "filed" with the SEC.

For further information regarding the certification provisions of the Act please consult www.clm.com for our client advisory entitled What You Need To Know About The Certification Requirements of the Sarbanes-Oxley Act of 2002.

Relevance Of Certifications To Directors Who Are Not The CEO Or CFO

It should be noted that a false certification by a CEO or CFO may have serious ramifications beyond the criminal penalties that the CEO and CFO will face for perjury. Any certification that turns out to be false may mean that the financial statements filed in the past were incorrect and this will require restatements of past financial statements. Class action attorneys are keeping a close watch on the certifications and restatements, as are insurance companies. These restatements may mean class action suits against directors for being derelict in their duty to oversee the preparation of the periodic reports, and it may lead insurance companies to rescind the director and officer insurance policies on the grounds that the insurance companies relied upon financial statements which turned out to be incorrect.

Refunds Of Compensation If Financial Statements Restated

The Act (§304) provides that if a company is required to restate financial statements "due to the material non-compliance of the issuer, as a result of misconduct, with any financial reporting requirements under the securities laws," the CEO and CFO must each reimburse the company for any bonus or equity-based compensation they received during the twelve months after the financial statements which had to be restated were filed with the SEC and to disgorge any profits realized from the sale of company stock during that period. Most likely, such CEOs and CFOs will be unable to collect reimbursement for this disgorgement under the company's charter and bylaws or under any D&O insurance policies.

Prohibition On Loans To Directors And Executive Officers

The Act (§402) prohibits Non-U.S. Reporting Companies from extending credit, or arranging for the extension of credit in the form of a personal loan to or for a director or an executive officer of the Non-U.S. Reporting Company. Existing loans may stay in place, but they may not be modified or renewed. Certain limited classes of loans are excepted if they are made in the ordinary course of the company's consumer credit business and made on the same terms as generally available to the public. This prohibition appears to affect several types of employee compensation arrangements that are common practice in the U.S. that involve extensions of credit, such as lending employees the exercise price to exercise options.

In the absence of SEC guidance, several questions have arisen regarding what loans are permitted and what are not. Recently, a consensus of 25 law firms expressed their views in writing that certain activities would be permissible under §402. In expressing this consensus, the law firms have pointed out that in their view, the transaction in order to be prohibited must take the form of a loan rather than a mere extension of credit and that the loan will not be considered a personal loan if the primary purpose of the loan is to advance the business of the company. Similarly, these law firms are of the view that where an extension of credit is made in the ordinary course of business primarily for company purposes, but involves a limited ancillary personal credit, it should not be prohibited under the Act. Thus, in the opinion of the 25 law firms, the following activities should be allowed:

  • Advances of cash, in accordance with company policy, to cover reimbursable travel and similar expenses incurred while performing executive responsibilities.
  • Personal use of company credit card such as where company policy permits limited ancillary personal use (e.g. personal items included in hotel room charges) and requires settlement within a reasonable period of time.
  • Personal limited use of company car ancillary to business use where reimbursement is required to be made within a reasonable period of time.
  • Advances of reimbursable relocation expenses, if treated the same as travel and similar advances.
  • Payment of sums to employees contingent upon their remaining with the company for a determined period of time with a provision requiring the employee to reimburse the issuer if he or she terminates employment before the agreed upon date.
  • Defense fees advanced by the company pursuant to charter, by-laws or indemnification agreements or advanced pursuant to director and officer insurance policies to cover the defense costs of directors and officers sued in the course of performing their duties.
  • Cashless exercise of options where the broker handling the exercise and sale of the option, advances to the employee the exercise price and is reimbursed out of the proceeds of the sale of the underlying stock.

The full text of the advisory of the 25 law firms of which the above is only an incomplete summary is available at www.realcorporatelawyer.com/loan25firms.pdf.

Board Of Directors

Boards of Directors Under Current Nasdaq Policy

Under Nasdaq Rule 4350 (c) and Rule 4350 (d)(2)(A), boards of directors of Nasdaq listed companies must have three independent directors. However, Non-U.S. Reporting Companies are not required to do any act that is contrary to the laws or accepted business practices of their home jurisdiction. Accordingly, Nasdaq has the ability to provide exemptions from such corporate governance standards and has historically been receptive to exemptive requests.

An independent director is defined by Nasdaq as a person other than an officer or employee of the company or its subsidiaries, or an individual other than one with a relationship that the board of directors has determined could interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The existing rules preclude certain individuals from being considered independent.

Boards of Directors Under the Proposed Nasdaq Rules

Under the proposed Nasdaq rules, the board of directors of Nasdaq listed companies will be required to have a majority of independent directors. The proposed rules define independent director as a person other than an officer, employee of the company or its subsidiaries or an individual other than one with a relationship that the board of directors has determined would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The proposed rules also preclude certain individuals from being considered independent.[1] The Act has no such requirement.

The proposed Nasdaq rules also require that independent directors must have regularly scheduled meetings where only independent directors are present and that independent directors should oversee executive compensation and director nominations.

The proposed Nasdaq rules state that they should not be construed to require non-U.S. companies to act contrary to their generally accepted business practices or to violate the laws of their home jurisdiction. Accordingly, Nasdaq retains the power to provide exemptions from its corporate governance requirements, except to the extent that such exemptions are contrary to the federal securities laws. Further, the proposed rules require that a company that receives an exemption must disclose in its annual report filed with the SEC each requirement that it was exempted from and describe any alternative practice that the company implements in lieu of the proposed corporate governance requirement.

In any event, having a majority of independent directors on the board is gaining recognition as a best practice by many institutional investors. Accordingly, companies throughout the world may want to comply with this requirement rather than seek an exemption.

Audit Committees

Audit Committees Under Sarbanes-Oxley

The Act (§301) requires that by April 26, 2003, each company which has securities listed on a national securities exchange or national securities association (such as Nasdaq) must have an audit committee of its board consisting entirely of independent directors. Independence for purposes of the Act means that no member of the audit committee may be an affiliate of the company and no member may receive any consulting or advisory fees from the company other than director and committee fees. The audit committee will be directly responsible for the appointment, compensation and oversight of the accounting firm that audits the company's financial statements.

The audit committee must establish procedures for handling complaints regarding accounting, internal accounting controls or auditing matters and must have authority to engage independent counsel or other advisors. The audit committee must also resolve any disagreements between the auditors and management.

In answer to certain frequently asked questions about the Act, the SEC published on November 14, 2002 its view that the audit committee rules described above do not apply to companies whose securities are traded on the over-the-counter bulletin board market.

It is possible that the SEC will not impose an audit committee requirement on Non-U.S. Reporting Companies. If the SEC does not exempt Non-U.S. Reporting Companies from these provisions, then for those companies that do not have, or are not permitted under home country law to have an audit committee, the entire board of directors will be deemed the audit committee (§2 of the Act).

Audit Committees Under Existing Nasdaq Rules

The existing Nasdaq rules require Non-U.S. Reporting Companies to have an audit committee of at least three members, comprised solely of independent directors, each of whom is able to understand financial statements or will be able to do so within a reasonable period of time after appointment to the audit committee. An independent director is defined by Nasdaq as a person other than an officer or employee of the company or its subsidiaries or other than an individual that the board of directors has determined has a relationship that could interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The existing rules indicate that under exceptional and limited circumstances, one director who is not independent and is not a current employee or an immediate family member of such employee may be appointed to the audit committee if the board determines that membership by such individual is in the best interests of the corporation and the board discloses it in its next annual proxy statement. Under the existing Nasdaq rules, Non-U.S. Reporting Companies are not required to do any act that is contrary to the laws or the accepted business practices of their home jurisdiction. Accordingly, Nasdaq has the ability to provide exemptions to Non-U.S. Reporting Companies from its corporate governance requirements and has historically been receptive to exemptive requests.

Audit Committees Under the Proposed Nasdaq Rules

The proposed Nasdaq rules provide that Nasdaq listed companies must have an audit committee composed of at least three members who (1) qualify as "independent" substantially as defined in the paragraph entitled, "Audit Committees Under Existing Nasdaq Rules" above (2) meet the criteria for independence set forth in §301 of the Act as defined in the paragraph entitled "Audit Committees Under Sarbanes-Oxley" above and (3) do not own or control 20% or more of the company's voting securities. The proposed Nasdaq rules also preclude certain individuals with substantially similar attributes to those described in footnote 1 from being considered independent.

Under exceptional and limited circumstances, the proposed Nasdaq rules permit one director, who does not meet Nasdaq's independence requirements listed above and who is not currently an officer, and is not an employee or family member of an employee, to be appointed to the audit committee provided such member does not serve longer than two (2) years and may not chair the audit committee. If such circumstances exist, the board of directors must determine that the individual's membership on the audit committee is in the best interest of the corporation and must disclose in the next annual proxy statement the nature of the relationship and reasons for its determination.

Under the proposed Nasdaq rules, Non-U.S. Reporting Companies are not required to do anything that is contrary to the laws or accepted business practices of their home jurisdiction. Accordingly, Nasdaq has the ability to provide exemptions from its corporate governance requirements.

Financial Experts On Audit Committees

Financial Expert Under Sarbanes-Oxley

On October 22, 2002, the SEC issued its proposed rules in accordance with §407 of the Act, which will require Non-U.S. Reporting Companies to disclose in their Annual Reports on Form 20-F, but not in interim reports, the number and names of the audit committee members that the board has determined to be "financial experts." In order to qualify a person as a "financial expert" the board of directors must be satisfied that the person possesses all of the following six attributes:

  • An understanding of generally accepted accounting principles ("GAAP") and financial statements;
  • Experience applying GAAP in connection with the accounting for estimates, accruals and reserves that are generally comparable to the estimates, accruals and reserves, if any, used in the company's financial statements;
  • Experience preparing or auditing financial statements that present accounting issues that are generally comparable to those raised by the company's financial statements;
  • Experience with internal controls and procedures for financial reporting;
  • An understanding of audit committee functions; and
  • Experience in the Non-U.S. Reporting Company's home country, generally accepted accounting principles used by the company and the reconciliation of financial statements with U.S. GAAP.

In determining whether a potential financial expert has all of the above mentioned attributes, the proposed rule requires the board to consider a list of nine factors. These address whether the candidate has a public accounting background, experience in financial statements and an understanding of audit committees.

The SEC has clarified in the proposed rule that merely appointing a person as the "financial expert" should not impose a higher degree of individual responsibility compared to other audit committee members or members of the board. Nor would the "financial expert" be considered an "expert" for the purposes of Section 11 of the Securities Act of 1933, which gives investors the right to sue experts in connection with untrue statements of material facts or omissions to state material facts in registration statements.

This requirement will likely limit the reservoir of potential candidates. The fact that a person served as an audit committee member in the past does not automatically make that person a financial expert within the meaning of the Act and boards may likely conclude that none of the present audit committee members are financial experts. An external search for financial experts to join as audit committee members may run into roadblocks for several reasons. The candidate may be concerned that being the financial expert makes him or her a high profile target for shareholder suits. The company may not be able to afford the compensation that the financial expert may request for this perceived exposure. The deadline by which a financial expert must be added to the audit committee is by January 26, 2003 may be too close for the company to meet. For Non-U.S. Reporting Companies creating an audit committee for the first time, the challenges may seem even greater.

The proposed SEC rule does not oblige a company to actually have financial experts on board but only requires the company to disclose if it has such experts and if not, why not. A Non-U.S. Reporting Company could comply with the requirements of the Act by stating that it does not have a financial expert because there is no requirement under the law of its home jurisdiction to have one. Of course, the absence of financial experts on audit committees may cause investor relation problems. One solution that has been recommended for a company that cannot find an audit committee member with the required qualifications, is to retain a financial expert as an outside consultant. This solution would be consistent with §301 of the Act which authorizes audit committees to engage outside advisors.

Financial Expert Under The Existing Nasdaq Rules

Each company must certify that one member of the audit committee has past employment experience in finance or accounting, which results in the individual's financial sophistication.

Financial Expert Under the Proposed Nasdaq Rules

Each company must certify that at least one member of the audit committee is a "financial expert." In considering whether a member qualifies as a "financial expert," the Board of Directors should consider: (1) a person's education and experience as a public accountant or similar position and (2) whether a person has sufficient financial expertise in accounting and auditing as specified in §407 of the Act.

Disclosure of Off-Balance Sheet Transactions

The Act (§401) directs the SEC by January 26, 2003 to require public company disclosures of all material balance sheet transactions and obligations, contingencies and other relationships of the company with unconsolidated entities or other persons that may have a material current or future effect on its financial statements or on significant components of revenues and expenses.

In its proposed rule of November 2, 2002, the SEC clarified that this new disclosure would be located in a separately captioned statement in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" ("MD&A") section of a Non-U.S. Reporting Company's Annual Report on Form 20-F or on Form 40-F, but will not be required in an interim report on Form 6-K.

In its proposed rule the SEC has defined the term "off-balance sheet arrangement" as any arrangement to which an entity not consolidated with the company is a party, under which the company has (i) any obligation under a guarantee or similar arrangement, (ii) a retained or contingent interest in assets transferred to such unconsolidated entity, (iii) a derivative (i.e., a security whose value will depend on the success of the arrangement) to the extent that its fair value is not fully reflected as a liability or asset on the financial statements, or (iv) any obligation, including a contingent obligation, to the extent that it is not fully reflected in the financial statements even if it is not required by GAAP to be so reflected.

Under the proposed rule the company would have to disclose the significant terms of the arrangement and in particular, the amounts of revenues, expenses and cash flows arising from the arrangements, the nature and total amount of any interests retained, securities issued and other indebtedness incurred and the nature and amount of any obligations of the company arising from the arrangements.

Disclosure would not be required for off-balance sheet arrangements where the likelihood that a particular off-balance sheet arrangement or obligation will materialize is remote.

From a practical point of view, financial investors in the U.S. are very leery of off-balance sheet transactions particularly after the bad reputation they received in Enron. It is unlikely that the SEC will exempt Non-U.S. Reporting Companies from this annual requirement.

Use Of Non-GAAP Financial Statements

In a new Regulation G included in a proposed rule published November 5, 2002, the SEC indicated that whenever a company discloses material information that includes a non-GAAP financial measure, the company must disclose the most directly comparable financial measure calculated in accordance with GAAP. A non-GAAP financial measure is a numerical measure of a company's financial performance, financial position or cash flow that excludes amounts that are included in the comparable measure calculated in accordance with GAAP or includes amounts that are excluded from the comparable measure under GAAP. A disclosure by a Non-U.S. Reporting Company will be deemed in accordance with GAAP if it is in accordance with the GAAP the company uses in preparing its financial statements in its home country.

The proposed Regulation G would not apply to a Non-U.S. Reporting Company if (i) its securities are listed or quoted outside the U.S., (ii) the non-GAAP financial measure and the most comparable GAAP financial measure are not calculated in accordance with U.S. GAAP, and (iii) the disclosure is made outside the United States, or is included in a written communication that is released only outside the United States. A communication will be considered released only outside the United States even if (i) U.S. journalists or other third parties have access to it, (ii) the information will appear on company web sites that are accessible from the United States (so long as they are not targeted at persons located in the United States) and (iii) the information will be included in a submission to the SEC on Form 6-K.

It remains to be seen if the SEC will limit its rule regarding pro-forma financial results with respect to press releases issued in the U.S.

Rapid Disclosure of Information Concerning Material Changes in Financial Condition or Operations

The Act (§409) added a provision to the Exchange Act requiring companies to disclose to the public in "plain English" on a rapid and current basis information concerning material changes in its financial condition or operations. The requirement that issuers disclose on a rapid basis information concerning material changes in their financial condition became effective when the Act was enacted and contemplates that the SEC will adopt rules specifying the kind of information that must be rapidly disclosed although the Act imposes no deadline on the SEC to do so.

The SEC recently proposed additions to the Current Report on Form 8-K reporting requirements for U.S. reporting companies in order to create more real time disclosure. These provisions may provide a platform for the implementation of this provision. Consistent with the SEC's reluctance in the past to require Non-U.S. Reporting Companies to file quarterly and current reports (currently it requires only that English language translations of home country disclosures be submitted to the SEC) the SEC may exempt Non-U.S. Reporting Companies from these rapid disclosure requirements. If applied to Non-U.S. Reporting Companies, the rapid disclosure provision would constitute a significant change.

It might be prudent, therefore, for Non-U.S. Reporting Companies to begin to implement a system for making these kinds of disclosures available through Form 6-K filings or otherwise on a real time basis.

Code Of Ethics For Principal Officers

The proposed rules implementing §406 of the Act require reporting companies, including Non-U.S. Reporting Companies, to disclose in their annual reports (on Form 10-K, 20-F or 40-F) whether or not they have adopted a written code of ethics for their principal executive and financial officers.

The rule also requires a Non-U.S. Reporting Company to disclose in its annual report, any changes in or waivers to the code of ethics that have occurred in the past fiscal year.

A code of ethics is defined to mean standards necessary to promote:

  1. honest and ethical conduct, including ethical handling of conflicts of interest between personal and professional relationships;
  2. avoidance of conflicts of interest, including disclosure to an appropriate person identified in the code of any material transaction or relationship that reasonably could be expected to give rise to such a conflict;
  3. complete an understandable disclosure in reports and documents submitted to the SEC and communicated to the public;
  4. compliance with governmental rules and regulations;
  5. the prompt internal reporting to an appropriate person or persons identified in the code, of violations of the code; and
  6. accountability for adherence to the code.

A company, including a Non-U.S. Reporting Company, would also have to file a copy of its code of ethics with its annual report.

The proposed rules would not require a company to adopt a code of ethics if it has not already done so, but they would require a company that does not have a code of ethics that meets the definition of the rule to explain why it does not have one.

A Non-U.S. Reporting Company that does not wish to adopt a code of ethics can disclose that it has not done so because the laws of its home country do not require it to adopt one.

Limits On Non-Audit Services

The Act (§201) requires that following a phase-in period of 180 days after the Oversight Board starts operations, auditors will be prohibited from performing certain designated non-audit services on behalf of a public company client contemporaneously with their audit and may perform other non-designated services and tax advice only with the advance approval of the audit committee and with appropriate disclosure in the company's SEC reports.

The designated non-audit services that an auditor may not perform are:

  • Bookkeeping or other services related to the accounting records or financial statements of the audit client;
  • Financial information systems design and implementation;
  • Appraisal or valuation services, fairness opinions, or contribution-in-kind reports;
  • Actuarial services;
  • Internal audit outsourcing services;
  • Management functions or human resources;
  • Broker or dealer, investment adviser, or investment banking services; and
  • Legal services and expert services unrelated to the audit.

The Act gives the Oversight Board, subject to the review of the SEC, the right on a case by case basis to exempt any person or public accounting firm, or any particular transaction from the provisions of §201.

Auditor Rotations, Conflicts And Independence

The Act (§203) requires that following registration with the Oversight Board the audit firm must rotate its lead audit partner every five years. The possibility of firm wide rotations will be studied by the Comptroller General over the next year. The Act now prohibits an audit by a firm if the issuer's chief executive officer, chief financial officer, or chief accounting officer was employed by the auditor and participated in the audit of the issuer in the past year.

Prohibiting Improper Influence On The Conduct Of Audits

The Act (§303) requires the SEC to adopt rules by April 26, 2003 which would make it unlawful for any director or officer, or any person acting under their direction, to "fraudulently influence, coerce, manipulate or mislead" an accountant engaged in an audit to render the financial statements materially misleading.

In its proposed rule issued on October 18, 2002, the SEC has clarified that "persons acting under [the] "direction of officers and directors" who could potentially be liable under the rule could include customers, vendors, or creditors of the company, who, under the direction of an officer or director of the company, provide misleading information to the company's auditor. Others who might be covered include partners or employees at accounting firms as well as attorneys, securities professionals or other advisers if they are instructed by officers or directors, for example, to pressure an auditor to limit the scope of the audit, to issue a report on the company's financial statements that is not warranted in the circumstances of the case, not to withdraw an issued report or not to communicate matters to the company's audit committee.

In the proposed rule, the SEC states that the rule could be violated by an attempt to influence the auditor even if that attempt did not actually succeed in affecting the audit or the review.

  • offering the auditor bribes or other financial incentives, including offering continued engagement for audit or non-audit services;
  • providing the auditor with inaccurate or misleading legal analysis;
  • threatening to cancel existing non-audit or audit engagements if the auditor objects to the company's accounting
  • seeking to have a partner removed from the audit engagement because the partner objects to the company's accounting;
  • blackmail; and
  • making physical threats.

The proposed rule does not exempt Non-U.S. Reporting Companies or other persons acting under their direction.

Public Accounting Oversight Board

As required by §101 of the Act, on October 25, 2002, the SEC appointed a five member Public Company Accounting Oversight Board to oversee the auditing of public companies. The Oversight Board is required by the Act to be organized and effective no later than April 26, 2003 and each public accounting firm must register with the Oversight Board within six (6) months thereafter. The Oversight Board will register, inspect and discipline public accounting firms and establish and enforce auditing, quality control and independence standards, all subject to broad SEC oversight. Registration with the Oversight Board will be expressly required for non-U.S. accounting firms if those firms audit Non-U.S. Reporting Companies. Specifically, the Act §106 provides that if a non-U.S. accounting firm issues an opinion or otherwise performs material services upon which a U.S. public accounting firm relies in issuing all or part of an audit report or opinion contained in an audit report, that foreign accounting firm will be deemed to have consented to (i) produce its audit work papers to the Oversight Board or the SEC in connection with any investigation by the Oversight Board or the SEC with respect to that audit report and (ii) to be subject to the jurisdiction of the U.S. courts for purposes of enforcement of any request for the production of work papers.

The Oversight Board and the SEC may exempt any foreign public accounting firm, as is necessary or appropriate in the public interest or for the protection of investors.

Standards Of Professional Conduct For SEC Counsel

The Act (§307) requires the SEC by January 26, 2003 to promulgate rules of professional responsibility for securities lawyers who appear and practice before the SEC. The rules must require lawyers to report evidence of any material violation of securities laws or breach of fiduciary duty to the company's chief legal counsel or CEO. If the counsel or CEO do not "appropriately respond," then the attorney must report the evidence to the audit committee or the board of directors.

For the purposes of §307 of the Act, a person will be deemed to be "practicing before the Commission," if that person (i) transacts any business with the SEC, or (ii) is an attorney, accountant, engineer or other professional or expert, who prepares any statement, opinion or other paper filed with the SEC in any registration statement, notification, application, report or other document.

In a release issued on November 6, 2002, the SEC clarified that an attorney's reporting obligation under §307 would be triggered if the attorney "reasonably believes" that a material violation has occurred or is about to occur even if the attorney does not know this for sure. The attorney would be obligated to document his report of the violation and the company's response thereto and to retain such correspondence for a reasonable time. According to the release, if an outside attorney receives no appropriate response to his report either from the Chief Legal Officer, CEO, the board of directors or the audit committee, the attorney may make a "noisy withdrawal." This means that the attorney may send a notification to the SEC disaffirming a filing or document previously made with the SEC and this would not constitute a violation of the attorney/client privilege. The release states that the proposed rules will provide that an attorney may reveal confidential information to the SEC to the extent necessary to prevent the commission of an illegal act which the attorney reasonably believes will result in the perpetration of fraud or substantial injury to others.

At the time of writing this advisory, the SEC has not yet issued its proposed rules under §307. However, in its release the SEC has stated that the proposed rules would cover non-U.S. attorneys who appear and practice before the SEC. Nevertheless, the SEC will seek comments on how to ensure that the requirements of the new rules will not conflict or inappropriately interfere with the activities of non-U.S. lawyers.

Escrow of Extraordinary Payments

The Act provides that if, while the SEC is investigating suspected violations of the U.S. securities laws by a company or any of its directors or officers, the company makes unusual payments to any of those persons, the SEC may seek a court order requiring that the payments be put in escrow until the conclusion of legal proceedings regarding the suspected violation. This may become a powerful bargaining tool with which the SEC can compel companies to settle SEC allegations.

There is nothing in the Sarbanes-Oxley Act that says this provision does not apply to non-U.S. companies. However no one knows how the U.S. courts would enforce the escrow requirement upon non-U.S. companies in connection with payments to persons who are not U.S. residents.

Other Provisions

The Act extends the statute of limitations in private securities fraud actions brought under the U.S. securities laws to the earlier of five years (previously three years) after the alleged violation or two years (previously one year) after its discovery, for actions commenced after the enactment.

The Act also provides criminal penalties for destroying audit records and for destroying or falsifying any documents in order to impede an investigation.


Questions regarding Sarbanes-Oxley may be directed to Steven J. Glusband (glusband@clm.com), Raphael S. Grunfeld (grunfeld@clm.com) or Robert A. McTamaney  (mctamaney@clm.com) of our New York Office (212-732-3200).  Christina Gray  assisted in the preparation of this advisory.

Endnote

[1] NASD Manual - The Nasdaq Stock Market,  Proposed Rule 4200 (a) (15).  The proposed independence standard under the Nasdaq proposed rules provides a list of certain relationships that preclude a board finding of independence  including: (1) a director employed by the company, its parent or subsidiary within the past three years; (2)  a director who has accepted or has an immediate family member who has accepted payments in excess of $60,000 other than as compensation for board service, benefits under a tax qualified plan, or non-discretionary compensation during the current fiscal year or the previous three fiscal years; (3) a director who is an immediate family member of an individual who was employed as an executive officer by the company its parent or its subsidiaries within the last three years; (4) a director who is a partner, controlling shareholder or executive officer of an organization to which the company made or from which the company received payments that exceed 5% of the recipient's gross revenues of the year or $200,000, whichever is more, in the current  year or previous three  years; (5) a director who has served on an interlocking compensation committee within the past three years; and (6) a director who was a partner or employee of the company's outside auditor and worked on the company's audit, within the past three years.



Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
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