Business Law 1

Corporate Scandals Brought Strict New Laws in 2002
William D. Gould and Thomas Henry Coleman

William D. Gould, Troy and Gould Professional Corporation, Los Angeles, and Thomas Henry Coleman, Law Offices of Thomas H. Coleman. Thomas Coleman is a contributing author to Advising and Defending Corporate Directors and Officers, published by CEB. Troy and Gould Professional Corporation’s website address is <www.troygould.com> and Mr. Coleman can be reached by e-mail at thomas-coleman@sbcglobal.net

More than a year has passed since several giant corporations began to crumble. Public indignation followed shocking revelations of boardroom shenanigans, and legislators reacted quickly.

Criminal prosecution of this financial corruption proved quite problematical, so legislators at the Federal and State levels rapidly developed new laws designed to deter directors’ and officers’ future financial misdeeds.

New Federal Legislation: The Sarbanes-Oxley Act of 2002.

The Sarbanes-Oxley Act of 2002 was signed into law by President Bush on July 30, 2002. This Act makes sweeping changes in the law governing public companies and will significantly impact accounting firms, law firms, investment banks and securities firms.

Most of the new legal requirements did not come into immediate effect, and many have been and are being implemented by SEC rule making. The Act’s requirements are applicable to boards and management of publicly-traded companies, including foreign companies listed in the US. Several important provisions of the law applied immediately or almost immediately. In particular:

• As of July 30, 2002, the Act prohibits public companies from extending personal loans to their directors or executive officers, subject to limited exceptions. Such loans in existence as of the Act’s effective date are not affected as long as they were not materially modified or renewed thereafter.

• There are two sections of the Act that require CEO/CFO certification of periodic reports filed with the SEC. Pursuant to Section 302 of the Act, the SEC has recently promulgated rules under which CEOs and CFOs must certify annual and quarterly reports filed with the SEC. Section 906 of the Act is self-executing and provides that a company’s CEO and CFO must certify that each periodic report containing financial statements filed with the SEC "fully complies" with the reporting requirements of the Securities Exchange Act of 1934 and that the information contained in the periodic report "fairly presents, in all material respects, the financial condition and results of the operations" of the company. Any CEO or CFO who files a certification knowing that the report did not comply or was false is subject to criminal fines and imprisonment.

• By its terms, Section 906 applies to all quarterly and annual reports, beginning with second-quarter 10-Qs that were due on August 14, 2002.

• The Act accelerates the filing deadline for the reporting of securities transactions by executive officers, directors and 10% shareholders. Effective August 29, 2002, Form 4s must be filed within two business days following the date upon which the transaction is executed. (Previously, the filing was not due until the 10th day of the month following the trade.)

New California Corporate Accountability Legislation.

Governor Gray Davis has signed into law several new bills as part of California’s response to the recent spate of corporate scandals.

New Annual Statement Requirements

Under prior law, both California corporations and foreign corporations qualified to do business in this State were required to file with the California Secretary of State every two years information statements identifying their directors and executive officers and setting forth other basic information regarding the corporation. Under Assembly Bill No. 55, these information statements, which are publicly available, must now be filed annually.

Assembly Bill No. 55 also requires a "publicly traded company" – one with securities traded on a national or foreign stock exchange or as to which two-way (bid and asked) prices are regularly published in the National Daily Quotation Service or similar service – to include in its annual information statement the following new information:

• the identity of its independent auditors and a description of any non-audit services performed by the auditors within the previous 24 months;

• the date of the most recent audit report by the corporation’s independent auditors, along with a copy of the audit report;

• the annual compensation paid to each director and executive officer of the corporation, including the number of shares or options that "were not available to other employees;"

• the amount and terms of any loans at a "preferential loan rate" made by the corporation to any director or executive officer during the previous 24 months; and

• whether, during the past 10 years, the corporation or any of its directors or executive officers:

_filed for bankruptcy;
_was convicted of fraud; or
_was found liable for more than $10,000 for violations of any "federal security laws or any security or banking provision of California law."

New Restrictions on Public Accountants

The Governor also signed several bills regulating the conduct of accountants who are licensed in California. Although these regulations do not apply directly to corporations or other companies, they will affect the relationship between corporations and other companies and their public accountants.

Assembly Bill No. 2970 amends California’s Business and Professions Code to prohibit an accountant licensed by the California Board of Accountancy from accepting employment with a "publicly traded corporation" or its affiliate within 12 months after the issuance of a "financial report" if both of the following criteria exist:

• the accountant participated in an audit engagement for the corporation and was responsible for exercising significant judgment in the audit process; and

• the prospective employment with the corporation would permit the accountant to exercise significant authority over accounting or financial reporting, including accounting or financial reporting controls.

Assembly Bill No. 270 prohibits California-licensed accountants from performing services for a "client" (including private corporations and publicly held companies) or the client’s officers or directors for a "commission" or receiving such a commission while the accountant also is performing:

• an audit or review of the client’s "financial statement;"

• a compilation of the client’s financial statement where it is reasonable to expect that third parties will rely on the financial statement and the compilation report fails to disclose the lack of independence on the part of the accountant; or

• an examination of "prospective financial information."

The California Board of Accountancy is to adopt regulations implementing these new requirements.

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