A 2002 (the Act), the Securities and and in other public - - PDF document

Corporate Finance Alert

January 29, 2003

Update on the Sarbanes-Oxley Act: SEC Adopts Final Rules Relating to Corporate Codes of Ethics, Audit Committee Financial Experts and New Form 8-K Disclosure

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s directed in the Sarbanes-Oxley Act of 2002 (the “Act”), the Securities and Exchange Commission (the “SEC”) recently issued final rules implementing Sections 406, 407 and 409 of the Act regarding corporate codes of ethics, financial expert audit committee members, and public disclosure of earnings releases

• r announcements.

Corporate Codes of Ethics

Under Section 406 of the Act, the SEC issued final rules requiring public companies to disclose in their annual reports whether or not they have adopted a written code of ethics, which applies to its principal executive officer, principal financial

• fficer, principal accounting officer or controller, or

persons performing similar functions (a company may have separate codes of ethics for different types

• f officers). In order to satisfy the SEC’s

requirements, the code of ethics must set forth standards that are reasonably designed to deter wrongdoing and to promote:

·

honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

·

full, fair, accurate, timely, and understandable disclosure in reports and documents that the company files with, or submits to, the SEC and in other public communications made by the company;

·

compliance with applicable governmental laws, rules and regulations;

·

the prompt internal reporting to an appropriate person or persons identified in the code of violations of the code; and

·

accountability for adherence to the code. Companies are not required by the final SEC rules to adopt a code of ethics, however, companies that do not will be required to publicly disclose why they have not. A company that has adopted a code of ethics will be required to make it available to the public either by (i) filing it as an exhibit to its annual report, (ii) posting it on its Internet website (and disclosing this fact along with the Internet address in its annual report), or (iii) including an undertaking in its annual report to provide a copy to any person upon request without

• charge. A company will also be required to

disclose on Form 8-K or its website any changes to

• r waivers of any provisions of the code of ethics

relating to its principal executive officer or senior financial officers within five business days of the amendment or waiver. (Note that the website

• ption may only be used if the company has

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previously indicated in its most recently filed annual report that it may use that method.) Effective Date Companies will be required to provide the disclosures relating to their code of ethics in annual reports for fiscal years ending on or after July 15, 2003.

Audit Committee Financial Experts

Under Section 407 of the Act, the SEC issued final rules requiring public companies to disclose in their annual reports whether or not they have at least one “audit committee financial expert” serving on their audit committee, and if they do, the name of at least one such person (it is permissible, but not necessary, to name more than

• ne person), and whether or not they are

independent from management1. Although companies are not required by the rules to have audit committee financial experts, companies that do not will be required to publicly disclose that they do not and explain why not. The SEC rules state that it would not be appropriate for a company to state that it does not have an audit committee financial expert if its board has determined that such an expert does in fact serve on the audit committee. Definition of “Audit Committee Financial Expert” The definition of “financial expert,” now referred to by the SEC as “audit committee financial expert,” has been the subject of substantial controversy since the SEC’s initial rule proposal release on October 22, 2002. As a result, the SEC has expanded the definition of who will qualify as an audit committee financial expert. The final rules define an audit committee financial expert as a person who has all of the following attributes:

·

an understanding of generally accepted accounting principles and financial statements;

·

the ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves (as opposed to the proposed requirement to have experience applying such principals in connection with estimates, accruals and reserves that are generally comparable to those in the company’s financial statements);

·

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 company’s financial statements, or experience actively supervising one or more persons engaged in such activities (this test has been broadened to include experience other than “preparing or auditing”);

·

an understanding of internal controls and procedures for financial reporting (this test was broadened from “experience with internal controls and procedures”); and

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·

an understanding

• f

audit committee functions. Under the final rules, a person must have acquired such attributes through any one or more

• f the following:

·

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;

·

experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions;

·

experience overseeing or assessing the performance

• f

companies

• r

public accountants with respect to the preparation, auditing or evaluation of financial statements (this option was not included in the proposed rules); or

·

• ther relevant experience.

Safe Harbor Following the SEC’s release of its proposed rules, some parties expressed concern that the identification of a person as a “financial expert” would increase his or her potential liability as an audit committee member. In response to those concerns, the final rules contain a safe harbor that provides:

·

a person who is determined to be an audit committee financial expert will not be deemed an “expert” for any purpose as a result of being designated or identified as an audit committee financial expert;

·

the designation or identification of a person as an audit committee financial expert does not impose on such person any duties, obligations

• r liability that are greater than the duties,
• bligations and liability imposed on such

person as a member of the audit committee and board of directors in the absence of such designation or identification; and

·

the designation or identification of a person as an audit committee financial expert does not affect the duties, obligations or liability of any

• ther member of the audit committee or board
• f directors.

Effective Date Companies other than small business issuers must comply with the audit committee financial expert disclosure requirements in their annual reports for fiscal years ending on or after July 15,

• 2003. Small business issuers will be required to

comply for fiscal years ending on or after December 15, 2003.

New Item 12 of Form 8-K

The SEC amended Form 8-K by adding a new Item 12 entitled “Disclosure of Results of Operations and Financial Condition.” Item 12 requires a reporting company to furnish to the SEC a Form 8-K within five (5) business days of any

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public announcement or release disclosing material non-public information regarding its results of

• perations or financial condition for an annual or

quarterly period that has ended. Item 12 requires a registrant to identify briefly the announcement or release and include the announcement or release as an exhibit to the Form 8-K. If a registrant’s earnings announcement or release includes the use

• f a non-GAAP financial measure2, such registrant

will be required to disclose on the Form 8-K (or the exhibit attached thereto) furnished pursuant to Item 12:

·

the reasons why such registrant’s management believes that the presentation of the non- GAAP financial measure provides useful information to investors regarding such registrant’s financial condition and results of

• peration; and

·

to the extent material, the additional purposes, if any, for which such registrant’s management uses the non-GAAP financial measure that are not otherwise disclosed. Item 12 does not apply to the public disclosure

• r release of earnings estimates for future or
• ngoing fiscal periods or to the repetition of

previously disclosed information by a registrant. The requirement to furnish a Form 8-K under Item 12 does not apply to issuers that make public earnings releases or disclosures solely in their quarterly reports or annual reports filed with the

• SEC. Item 12 does not require registrants to issue

earnings releases or similar announcements, however such releases or announcements will trigger the requirements of Item 12. An exception to the requirements of Item 12 exists if non-public information is disclosed orally (whether telephonically, by broadcast or webcast or through other similar means) by a registrant in a presentation that is complementary to, and occurs within forty-eight (48) hours after, a related, written release or announcement has been furnished on Form 8-K. A registrant will be excused from furnishing an additional Form 8-K with regard to such oral disclosure of non-public information if:

·

the related, written release or announcement has been furnished to the SEC on Form 8-K pursuant to Item 12 prior to the oral presentation;

·

the oral presentation is broadly accessible to the public by dial-in conference call, webcast

• r similar technology;

·

the financial and statistical information contained in the oral presentation is provided

• n the registrant’s website, together with any

information that would be required under new Regulation G3; and

·

the oral presentation was announced by a widely disseminated press release that included instructions as to when and how to access the oral presenation and the location of the regsitrant’s website where the financial and statistical information would be available. Effective Date The requirement to furnish earnings releases and similar announcements to the SEC on Form 8- K will apply to earnings releases and similar announcements made after March 28, 2003.

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1

Please see our Corporate Finance Alert dated January 14, 2003, entitled “Proposed Audit Committee Standards for Listed Companies,” available at www.lowenstein.com/ sarbanes-

• xley.html, for more detail regarding audit

committee member independence.

2 The SEC defines a “non-GAAP financial measure”

as a “numerical measure of a registrant’s historical

• r future financial performance, financial position
• r cash flows that: (i) excludes amounts, or is

subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the issuer;

• r (ii) includes amounts, or is subject to

adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented.”

3 Regulation G is a new disclosure regulation

implemented by the SEC pursuant to the Act which requires, among other things, registrants that disclose or release non-GAAP financial measures to include in that disclosure or release a presentation of the most comparable GAAP financial measure and a reconciliation of the non- GAAP financial measure with the most comparable GAAP financial measure.

For more information about the new SEC rules, or

• ther corporate government disclosure measures, please

contact Peter H. Ehrenberg, Esq., Member of the Firm and Chairman of Lowenstein Sandler’s Corporate Department and its M&A and Corporate Finance Practice Group, Alan Wovansiker, Esq. or Steven M. Skolnick, Esq., each a Member of the Firm and a member of the Firm’s Corporate Department and its M&A and Corporate Finance Practice Group, or Douglas N. Bernstein, counsel, Mathew B. Hoffman or Lisa C. Fodor, associates, and a members of the Corporate Department and M&A and Corporate Finance Practice Group, at (973) 597-2500.

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