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COMPLIANCE& SOX

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SARBANES-OXLEY ACTAt Issue

If the governance of the modern corporation isn’t completely broken, it is going through a severe crisis of confidence. At risk is the very integrity of capitalism.

Directors who fail to direct and CEOs who fail at moral leadership are arguably the most important challenge facing corporate America today.

Business Week (May 6, 2002)

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SARBANES-OXLEY ACTThe Solution Starts At Home

The recent corporate collapses have involved many breakdowns: in ethics, in trust, in common sense, to name a few. But perhaps the most troubling breakdown is in corporate oversight.

Directors, senior executives, and Wall Street analysts all failed miserably by missing – or concealing – danger signals until it was too late.

Regulators will no doubt have plenty to say on the issue, but the most zealous reformers should be the companies themselves.

Fortune (May 27, 2002)

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CORPORATE GOVERNANCE STANDARDS

1900: NYSE requires distribution of annual reports to stockholders 1909: NYSE requires annual stockholders’ meeting 1926: NYSE adopts “one share, one vote” standard 1929: Stock market crash 1932: Increased financial disclosure and independent audits become mandatory 1934: SEC is formed 1955: Shareholder approval required for certain corporate acquisitions

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1968: AMEX publishes first guide establishing listing standards 1977: NYSE requires establishment of an audit committee comprised of independent directors 1985: NASDAQ initiates its first corporate governance listing standards 1987: Treadway Commission (COSO) established to define responsibilities of the auditor in detecting and preventing fraud

CORPORATE GOVERNANCE STANDARDS

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1999: NYSE/AMEX/NASD adopt new rules based

on Blue Ribbon Committee on Improving the

Effectiveness of Audit Committees

2002: Sarbanes-Oxley Act (July 30, 2002)

CORPORATE GOVERNANCE STANDARDS

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SARBANES-OXLEYMajor Objectives

Improve corporate governance Reform public accounting (auditing) Reform Wall Street practices Attack insider trading and obstruction

of justice (document retention)

“Restore confidence in capital markets”

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Title I: Public Company Accounting Oversight Board

Title II: Auditor Independence

Title III: Corporate Responsibility, Disclosure, and Governance

Title IV: Enhanced Financial Disclosures

SARBANES-OXLEY ACTMajor Provisions

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Title V – Analyst Conflicts of Interest Title VI – Commission (SEC) Resources

and Authority Title VII – Studies and Reports Title VIII – Corporate and Criminal

Fraud Accountability Title IX – White-Collar Crime Penalty

Enhancements Title X – Corporate Tax Returns Title XI - Corporate Fraud and

Accountability

SARBANES-OXLEY ACTOther Provisions

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PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD

Established by Sarbanes-Oxley

Broad powers to regulate audits and auditors of public companies

Appointed by the SEC

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PCAOB Register public accounting firms

Establish auditing standards

Inspect registered public accounting firms

Conduct investigations and disciplinary proceedings – with ability to sanction auditors and audit firms

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AUDITOR INDEPENDENCE

Prohibits certain “nonaudit services”– Bookkeeping, financial systems design, appraisal or

valuation, actuarial, internal auditing outsourcing, management or human resources, broker-dealer or investment banking, others per PCAOB

Audit committee must pre-approve all auditing and non-auditing services

Audit partner rotation– Audit firm rotation was discussed

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AUDITOR INDEPENDENCE

Audit Committee is directly responsible for oversight of external auditors

Auditor required to discuss– All critical accounting policies and practices– All alternative accounting and disclosure

treatments– Other material written communications

“Cooling – off” period– CEO, CFO, Controller, etc.

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CORPORATE RESPONSIBILITY & GOVERNANCE

Audit Committee = independent directors

Audit Committee has responsibility to appoint, compensate, and oversee public accounting firm performing the audit

Audit Committee has responsibility to resolve disagreements over financial reporting between management and external auditors

Audit Committee must establish “whistle-blower” procedures– New penalties for retaliation against them

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CORPORATE RESPONSIBILITY & GOVERNANCE

Requires executives and financial officers (CEO & CFO) to certify financial reports are accurate, complete and fairly presented

Also must certify the state of internal controls

Outlaws improperly influencing the auditor

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CORPORATE RESPONSIBILITY & GOVERNANCE

Reimbursement of bonuses and profits if public was misled

Removal of “substantial unfitness” standard Prohibits trading during a pension

“blackout” period Minimum standards for attorneys

– Both in-house and outside counsel Any reimbursed funds from guilty parties be

added to a fund for the benefit of victims

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ENHANCED FINANCIAL DISCLOSURES

Off-balance sheet arrangements and obligations

Prohibits loans to executives and directors

Insider trades within two business days

Adoption of code of ethics for senior financial officers and requirements

Whether at least one member of the audit committee is an “Audit Committee Financial Expert”

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Reconciliation of non GAAP revenue to most directly comparable GAAP measure

Requires management to establish and maintain adequate internal controls and report annually on:– Management’s responsibility for such– Effectiveness of such internal controls

Assessment of internal controls by management is to be subject of an attestation report by the external auditor

ENHANCED FINANCIAL DISCLOSURES

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PRIVATE COMPANIESWho Should Adopt SOX

May soon go public Contemplating a combination with

a public company Large Not-for-profit entities

– Audit committees becoming common Significant absentee owners Creditors may require SOX

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PRIVATE COMPANIESWhat parts of SOX?

More than internal controls Independent audit committees

– “Financial expert”– Compensation & funding of committee– Approval of nonaudit services

Certification of financial statements Codes of ethics Whistle-blower procedures and

protections

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CORPORATE AMERICAAfter SOX

Must have autonomous & vigorous audit committees– “Take charge”

Financial information is inherently judgmental– Financial statements are NOT precise– Users must appreciate this fact– FMV reporting will increase volatility– Non-financial disclosures will become more important– Auditors’ opinions on overall “fairness” of statements– Financial reporting should be as clear and concise as

possible

Committee for Economic DevelopmentMarch 28, 2006

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CORPORATE AMERICAAfter SOX

Give SOX (esp. 404) a chance to work– PCAOB has issued new guidelines– Learning curve effects

Excessive executive compensation can be tamed by Compensation Committees

Directors must be selected and appraised by independent nominating committees– Issue of Non-Executive Chair– Direct nomination by shareholders

Committee for Economic DevelopmentMarch 28, 2006