Locking the Barn Door: New Legal Requirements after Enron

Following the Enron scandal and the revelation of financial wrongdoings by other companies, Congress passed the Sarbanes-Oxley Act of 2002. The law provides sweeping changes to the oversight of the public accounting industry, increases corporate governance and disclosure standards for public companies, and increases the penalties for those that violate the securities laws.

The Act is designed to prevent the use of deceptive practices in management and accounting. Enhanced financial reporting and disclosure requirements help promote the Acts goals by:

• Increasing criminal penalties for corporate wrongdoing;
  
  
• Increasing disclosure requirements for periodic reports filed pursuant to the Exchange Act, particularly with respect to off-balance sheet liabilities and pro forma financial statements;
  
  
• Increasing the authority and responsibilities for audit committees and introducing new independence standards for audit committee members;
  
  
• Creating a new Public Company Accounting Oversight Board;
  
  
• Creating professional responsibility standards for attorneys;
  
  
• Limiting the scope of services that auditors may perform for Issuers;
  
  
• Accelerating the disclosure of insider trading activities; and
  
  
• Eliminating loans by Issuers to officers and directors.
  
  

The following is a brief summary of how the 2002 Act will affect key players in the securities world.

Business Owners

The 2002 Act applies to companies that issue publicly traded securities, their executives, and auditors. Privately owned companies generally are not affected. The new corporate accounting reform does not in any way disturb the relationship between privately owned companies and their accountants.

Public Corporations

Under the Act, both the chief executive officer (CEO) and the chief financial officer (CF0) must certify that each of their company's annual or quarterly financial reports fairly presents the company's financial condition and results of operations for the periods reported. CEOs and CFOs must also certify that the reports are not misleading and make certifications regarding internal controls or any significant deficiencies in them.

Material changes in a company's condition need to be disclosed more quickly than previously required. There are stricter disclosure requirements about transactions between companies and their directors, officers, and principal stockholders. Personal loans to executive officers and directors are prohibited, although a loan existing on July 30, 2002 is "grandfathered" as long as it is not substantially changed or renewed on or after that date.

The new law also provides that each member of a public company's audit committee must not be a director of the company and must be "independent." An audit committee member must receive only "board-related" compensation and may not be an "affiliated person" of the corporation (such as a company executive).

Accounting Standards And Oversight

The Securities and Exchange Commission (SEC), the federal agency charged with control of the securities industry, has new oversight responsibilities over firms auditing public companies subject to the securities laws via a newly formed five-member board. To provide qualifying audits, accounting firms must register with the board. The board will establish auditing standards for the registered firms and conduct periodic inspections of the firms.

During the period when auditing services are being performed for a client company, registered firms will not be allowed to provide the client with certain non-audit services. Among others, these services include: bookkeeping or other accounting or financial statement services, financial information systems design and implementation, appraisal or valuation services and fairness opinions, actuarial services, and management functions or human resources. Tax services may be provided only if approved by the company's audit committee.

Limits On Securities Analyst Conflicts And Notice Of Pension Blackouts

The Act also places limits on securities analysts whose firms also conduct investment-banking business with a publicly traded companies. In an effort to prevent conflicts of interests, the 2002 Act also requires defined contribution retirement plans to provide participants with advance notice of "blackout" periods. "Blackout" periods are periods of more than three consecutive business days during which their ability to direct or diversify their plan investment will be suspended or restricted. Directors and officers will not be able to purchase or sell company stock during blackout periods in which at least half of the plan's participants are suspended from purchasing or selling stock.

Penalties And Safeguards

The Act also increases penalties for corporate financial fraud and violations of the pension law. The new law also contains measures designed to protect employees of publicly traded companies who lawfully provided information or assist in an investigation regarding violations of the securities laws or fraud against shareholders. Under the Act, it is against the law to fire, demote, suspend, harass, or threaten such employees.

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