The Sarbanes-Oxley Act of 2002 generally prohibits public accounting firms from

Sarbanes-Oxley Act of 2002

Sarbanes-Oxley Act of 2002 (the "Act") was signed into law on July 30, 2002 and became effective August 29, 2002. A far-reaching piece of landmark legislation, the Act represents an attempt to alter fundamentally the ways in which business is conducted, and the manner in which accounting companies perform statutorily mandated audits. In short, Sarbanes-Oxley may represent the most comprehensive legislation to affect the accounting, auditing and financial services professions, as well as corporations and, in some respects, members of the general public, since the Securities Act of 1933 (the "1933 Act") and the Securities Exchange Act of 1934 (the "Exchange Act"), respectively.

In enacting the new law, Congress sought to address the systematic and structural weaknesses that became apparent in the American capital markets following the collapse of the Enron and WorldCom Corporations, as well as others. The preeminent influence of the U.S. financial markets across the globe ensures that the Act's provisions, along with its implementing regulations, will carry a major impact worldwide. In promulgating the new measure, House and Senate lawmakers sought to correct the shortcomings in the efficacy of the auditing system, as it then existed, revealed by the crisis, and to address a perceived breakdown in corporate finance and broker-dealer responsibility.

Sarbanes-Oxley, then, establishes a comprehensive framework for the reform and modernization of public company auditing oversight through the creation of a powerful and independent accounting oversight board, charged with the responsibility of supervising the conduct of those who audit public companies. By limiting the scope of non-audit activities that can be offered by an auditor to a client, moreover, the Act aims to further enhance the independence of auditors from corporate management.

Included in the Act's many significant provisions are measures designed to improve corporate financial reporting, in terms of both quality and transparency, and to enhance investor decision making. Lucid statutory provisions designed to limit, and bring to the public light, conflicts of interest that may affect securities research analysts are also included.

Under Sarbanes-Oxley, company audit committees are responsible for the appointment, compensation, and management of their auditors. Audit committee members, moreover, may not be affiliated persons, except in their capacity as Board members, and are prohibited from accepting consultant fees.

Insider trading during pension fund blackout periods is prohibited under the Act, while inside transactions in the stock of a company must be promptly disclosed, generally within two days of the transaction.

The Act makes senior corporate management directly responsible for the financial reporting and disclosures made by their public companies, and clearly establishes that chief executive and financial officers are responsible for the material presented in the financial reports of their companies.

Finally, the Act creates a new crime of securities fraud on the federal level, carrying a strict 25-year prison sentence, and authorizes substantially greater funding for the Securities and Exchange Commission ("SEC").

An outline of some of the more significant provisions of the Act is set forth below.

Public Company Accounting Oversight Board

Section 101 of the Act establishes the Public Company Accounting Oversight Board (the "Board") to oversee the audit of public companies in an effort to protect investors and to "further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by and for, public investors.'' Specifically, the Board is charged with responsibility for the (1) registration of public accounting firms; (2) establishment of certain standards relating to the preparation of audit reports in accord with the requirements of Section 103; (3) conduct of inspections and investigations, as well as the prosecution of disciplinary proceedings; (4) enforcement of compliance; (5) Board's budget and management; and (6) any other duties or functions that the Board determines are "necessary or appropriate to promote high professional standards…."

The Board is to be comprised of 5 prominent members of "integrity and reputation" who have demonstrated a commitment to the interests of investors and the public, and are possessed of a certain degree of financial acumen. No more than two of the members are permitted to have been certified public accountants. Members of the Board will serve on a full-time basis.

Under Section 102 of the Act, any public accounting firm that performs or participates in any audit report with respect to any public company must register with the Board. In addition, registered public accounting firms must file with the Board annual reports. Applications and the annual reports of registered public accounting firms must be available for public inspection and, beginning 180 days after the SEC deems the Board operational, only registered public accounting firms may perform audits for public companies.

Section 103 of the Act addresses standards relating to auditing, quality control and ethical standards, stating that the Board shall, by rule, establish standards for the preparation and issuance of audit reports. In fulfilling its charge, the Board is directed to require that each registered public accounting firm prepare, and maintain for at least 7 years, audit work papers and any other information related to an audit report.

Each audit report of public companies must be approved by two partners, one of these partners is required to have been involved in the audit, while the other must concur. The auditor must also describe, in each audit report, the scope of testing he or she performed on the internal control structure and procedures of the issuer, as required by Section 404(b). Finally, requirements for every registered public accounting firm are to be included in the Board's quality control standards with respect to the monitoring of professional ethics, consultation within a firm, supervision of audit work, hiring and advancement of personnel and other requirements.

The Board is also required to conduct a continuing program of inspections to assess the degree of compliance of each registered accounting firm and associated persons under Section 104 of the Act. Inspections are to be conducted annually for large public company accounting firms and no less frequently than tri-annually for smaller firms. In conducting these investigations, the Board will inspect and review selected audits and review a firm's engagements, evaluate the sufficiency of the quality control system of the firm, as well as the manner of documentation, and perform other testing as needed.

Section 105 of the Act empowers the Board to conduct investigations into any act, omission or practice committed by any registered public accounting firm, or associated person, in violation of the Act. This authority extends to violations of the securities laws applicable to audit reports. The Board may also impose disciplinary penalties or remedial sanctions for violations. Civil fines are hefty: up to $200,000 for natural persons and $2 million for others. Larger fines may be imposed if the Board finds intentional or repeatedly negligent conduct. Suspension or revocations of registration are also within the Board's power. Finally, the Board may impose sanctions upon registered firms or individuals in supervisory roles for failure to supervise.

Adding to the global importance of the Act, Section 106 provides that the Act is applicable to foreign public accounting firms that prepare or furnish audit reports or which perform material support service upon which a registered public firm relies in issuing its audit report in connection with any public company. The Act also applies when the foreign firm prepares audit work papers.

Section 108 amends the 1933 Act to allow the SEC to recognize, as "generally accepted" for purposes of the securities laws, any accounting principles established by a standard setting body that meets certain requirements.

Auditor Independence

In an effort to create greater auditor independence, Section 201 of Sarbanes-Oxley amends the Exchange Act to prohibit registered public accounting firms, and associated persons, from performing certain non-audit services while conducting an audit. These services include:

• 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;
• legal services and expert services unrelated to the audit; and
• any other service that the Board determines, by regulation, is impermissible.

A registered public accounting firm may engage in any non-audit service, including tax services, not described in the paragraphs above, so long as the activity is approved in advance by the audit committee of the issuer.

Section 206 of the Act amends the Exchange Act making it unlawful for a registered public accounting firm to perform for an issuer any audit service if a chief executive officer, controller, chief financial officer, chief accounting officer, or any person serving in an equivalent position for the issuer, was employed by that registered independent public accounting firm and participated in any capacity in the audit of that issuer during the one-year period preceding the date of the initiation of the audit.

Corporate Responsiblity

Section 301 of Sarbanes-Oxley amends the Exchange Act and instructs the national securities exchanges and associations to prohibit the listing of any security of any issuer that is not in compliance with the requirements set forth below:

• The audit committee of each issuer will directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by the issuer, and each such registered public accounting firm shall report directly to the audit committee.
• Independent auditors are to report directly to the audit committee. Each member of the audit committee is to be independent in the sense that, subject to SEC exemption, an audit committee member may not accept any consulting, advisory, or other compensatory fee from the issuer; or be an affiliated person of the issuer or any subsidiary.
• Audit committees are to establish procedures for dealing with complaints, including the receipt, retention, and treatment of complaints received by the issuer regarding accounting, internal accounting controls, or auditing matters, and the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters.
• Audit committees have the authority to engage independent counsel and other advisers, as is deemed necessary.
• Each issuer is to provide for appropriate funding, as determined by the audit committee, in its capacity as a committee of the board of directors, for payment of compensation to the registered public accounting firm employed by the issuer for the purpose of rendering or issuing an audit report, and to any advisers employed by the committee.
  

Section 302 of the Act requires, in connection with each annual or quarterly report submitted to the SEC by the company pursuant to Sections 13(a) or 15(d) of the Exchange Act (in most cases, the 10-K, 10-Q and 8-K), certification of an officer of the company acknowledging that he or she (a) has reviewed the report; (b) to the best of his knowledge, agrees that the financial statements and other financial information included in the report do not misstate or omit any material facts and fairly represent the financial condition and results of the operations of the company for the applicable reporting period in all material respects; (c) is responsible for the establishment and maintenance of internal controls; and (d) has disclosed to auditors or audit committee all significant deficiencies, material weaknesses or fraud involving any internal controls.

Section 906 of the Act, on the other hand, requires that the CEO and CFO (or their equivalents) of each public company certify in each periodic report required under Sections 13(a) or 15(d) of the Exchange Act (including each SEC Form 10-K and Form 10-Q) that the report fully complies with the Exchange Act requirements and that information contained in each report fairly represents, in all material respects, the financial condition and results of operations of the company. This certification, which is in addition to the certification required by Section 302 of the Act, carries criminal penalties for false certifications.

The Act, in Section 306, prohibits directors and officers of public companies from trading securities obtained in connection with an equity compensation plan during pension plan black-out periods.

Enhanced Disclosure Requirements

Section 401(a) of Sarbanes-Oxley amends the Exchange Act and requires that every financial statement prepared in accord with generally accepted accounting principles contain all material correcting adjustments that have been identified by a registered public accounting firm. In addition, the SEC is required under the subsection to issue final rules mandating that each annual and quarterly financial report required to be filed with the SEC shall disclose all material off-balance sheet transactions, arrangements, obligations and other relationships of the issuer with unconsolidated entities or other persons that may have a material effect on the current or future financial condition of the issuer.

Section 402 of the Act again amends the Exchange Act by generally prohibiting public companies from loaning money to its directors and officers and executive Split Dollar Life Insurance arrangements.

Section 403 shortens the time period for filing Section 16 reports. Effective as of July 30, 2002, Section 16 reports must be filed electronically via the SEC's Electronic Data Gathering, Analysis, and Retrieval System (EDGAR).

Each public company must state in its SEC Forms 10-K and 10-Q whether or not, and if not, why it has not, adopted a code of ethics for senior financial officers. Changes to or waivers of the code of ethics must be disclosed on SEC Form 8-K under Section 406 of the Act.

Section 404 provides that companies required to file under the Securities Exchange Act of 1934 are required to include in their annual reports a "report of management on the company's internal control" over financial reporting. This report must include:

• a statement of management's responsibility for establishing and maintaining adequate internal control over financial reporting for the company;
• management's assessment of the effectiveness of the company's internal control over financial reporting as of the end of the company's most recent fiscal year;
• a statement identifying the framework used by management to evaluate the effectiveness of the company's internal control over financial reporting; and
• a statement that the registered public accounting firm that audited the company's financial statements included in the annual report has issued an attestation report on management's assessment of the company's internal control over financial reporting.
  

Under the new rules, registered public accounting firm's attestation report is required as part of the annual report. Management must also evaluate any change in the company's internal control over financial reporting that occurred during a fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting.

In addition, Section 302 certification requirements have been revised to require issuers to provide the certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 as exhibits to certain periodic reports.

Compliance Dates: "Accelerated filers," as defined in Exchange Act Rule 12b-2 must comply with the management report on internal control over financial reporting disclosure requirements in its annual report for that fiscal year.

Companies that were not accelerated filers as of the end of its first fiscal year ending on or after June 15, 2004, including a foreign private issuer, must begin to comply with the annual internal control report for its first fiscal year ending on or after April 15, 2005.

A company must comply with the exhibit requirements for the certifications required by Sections 302 and 906 of Sarbanes-Oxley Act of 2002 and changes to the Section 302 certification requirements in its quarterly, semi-annual or annual report.

Section 409 of the Act require public companies reporting under Sections 13(a) or 15(d) of the Exchange Act to disclose, on a "rapid and current" basis, any material changes in the financial condition or operations of the company.

Research Analyst Conflicts of Interest

In a measure designed to foster greater public confidence in securities research, and to protect the objectivity and independence of securities analysts, Section 501 of the Act obligates the SEC and, by delegation, national securities exchanges and registered associations, to adopt rules reasonably designed to address the conflicts of interest that can arise when securities analysts recommend equity securities in research reports and public appearances.

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