In response to the Enron collapse and the bankruptcies of WorldCom, Global Crossing and other corporate giants, Congress enacted Public Law 107-204, commonly known as the Sarbanes-Oxley Act (“SOA”) on July 30, 2002. It has been said that SOA is the most far-reaching legislation pertaining to public companies and the persons and professionals associated with them since the 1930s. While SOA generally imposes requirements and restrictions only on public companies, closely-held companies may be able to learn a lesson or two from it by re-focusing on certain key corporate and fiduciary responsibilities.
Highlights of the SOA
The official text of SOA is 66 pages in length, and contains 11 sections. It is intended to apply not only to U.S. publicly-traded companies, but also to certain other “issuers” with registration or reporting requirements pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”). SOA mandated the creation of the Public Company Accounting Oversight Board (“PCAOB”), which is a non-profit corporation whose mission is to oversee the auditors of public companies. The PCAOB consists of two CPAs and three non-CPAs, and is funded through mandatory fees placed on public companies. The PCAOB has the ability to enact and enforce auditing standards and rules for public company auditors, and the ability to investigate and discipline auditors who do not comply with its standards. Its aim is to protect the interests of investors and restore public faith in the accounting procedures and disclosures of public companies.
SOA established a number of reporting requirements for auditors of public companies. Reports generated by the public company’s auditor are to be submitted to that company’s audit committee (discussed below), if one exists, rather than to management. Auditors must report any new “critical” accounting policies, alternative treatment of financial information and any accounting disagreements to the audit committee. Auditors cannot perform non-audit services (such as bookkeeping, appraisals, actuarial services, and information systems design and implementation) to avoid the possibility of “self-serving” audits. An auditor is also prohibited from conducting an audit if one of the public company’s top officials (such as CEO, CFO or controller) had been employed by the auditor and worked on the company’s audit during the preceding one-year period. The head of the audit team must be rotated, in most instances, every five years.
Standards for corporate governance and guidelines for director and executive officer activities are also addressed by SOA. The CFO or CEO must certify the appropriateness of financial statements and disclosures contained within them, and must confirm that the disclosures fairly present, in all material respects, the operations and financial condition of the public company. It is illegal for any officer or director of a public company to fraudulently influence, coerce, manipulate or mislead any auditor so that financial statements are materially misleading. In short, the CFO or CEO of the public company must certify each quarterly and annual report filed with the Securities and Exchange Commission to confirm that the officer has reviewed the report and the truthfulness of the information in it, and that the report does not contain an untrue statement of material fact. The certification must also indicate, among other things, that the CFO or CEO has disclosed to the auditor any significant deficiencies in the design and implementation of “internal controls” that are intended to monitor fraud within the company, and that that officer has disclosed any fraud involving management or employees involved in the company’s internal controls. Any “off-balance sheet” transactions that could materially impact the current or future financial condition of the company must be disclosed in the company’s public filings. Loans to executive officers and directors are prohibited, except in certain limited circumstances. Federal income tax returns of the company must be signed by the CFO or CEO.
Each public company is encouraged to have an audit committee consisting of members of its board of directors. When no audit committee exists, the board of directors in its entirety must fill that function. The audit committee is responsible for the appointment and oversight of the auditor, and must implement procedures for the receipt and treatment of complaints received by the company regarding accounting, internal controls and auditing. The audit committee must also have authority to hire independent legal counsel or other advisors to assist it to carry out its duties. Activities of the audit committee must be appropriately funded by the company. Each company’s annual report must contain an “internal control report” which assesses, on an annual basis, the internal control structure and procedures for financial reporting.
Lessons for a Closely-Held Company
What can shareholders and directors of closely-held companies learn from SOA? The possibilities are endless, but perhaps the following ideas deserve some thought:
In other words, in jurisdictions where compelled defamation is a viable cause of action, courts recognize an exception to the usual rule requiring communication of the defamatory statement by the defendant where it is reasonable to anticipate that the defamed party will be compelled to disclose the content of the defamatory statement to a third party. Hence, the full moniker of the claim is compelled self-publication defamation. (See, e.g., McKinney v. County of Santa Clara, 110 Cal. App.3d 787 (1980); Van-Go Transport Co., Inc.; J.Crew Group, Inc. v. Griffin, No. 90 Civ. 2663, 1990 WL 193918 at 2 (S.D.N.Y Nov.27, 1990)).
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