Searching for transparency: corporate responsibilities in the wake of the Sarbanes-Oxley Act

California CPA, Oct, 2002 by Horace L. Nash, Scott J. Leichtner, Nicole A. Black

RIORITIES for corporate America are changing.

Companies that want to be successful still care about earnings per share, but regulators now demand more for investors- responsibility and transparency.

The Sarbanes-Oxley Act of 2002 and related SEC rulemaking feature important corporate governance and securities reporting requirements. Companies have just begun to digest the new law and regulations, and we anticipate that compliance practices regarding these requirements will continue to evolve for many months.

AUDIT COMMITTEE MEMBERSHIP

Independence

The Act requires the SEC, by April 26, 2003, to issue rules prohibiting the Nasdaq Stock Market and the New York Stock Exchange from listing any company that does not have an audit committee consisting solely of independent directors. To qualify as "independent," a director may not receive consulting, advisory or other compensatory fees, other than as a board or committee member, and may not be an affiliated person of the company or any of its subsidiaries. The SEC may exempt particular relationships that do not meet these independence standards.

It remains to be seen how Nasdaq and the NYSE will regulate director independence. They already, had proposed new listing standards for their member companies prior to the passage of Sarbanes-Oxley. Nasdaq proposed that audit committee members not qualify as independent if they:

* Control 20 percent or more of the company's voting securities;

* Have a relative who in the past three years has been an executive officer of the company or any of its subsidiaries;

* In the past three years have been part of an "interlocking directorate" in which an executive officer of the company serves on the compensation committee of another company that employs the director;

* Are an executive officer of a charity to which the company makes payments exceeding the greater of $200,000 or 5 percent of the company's or charity's gross revenues for the year in which the contribution is made; and

* Are a former partner or employee of an independent auditor that worked on the company's audit engagement within three years.

The NYSE proposed rules under which a director would not qualify as independent unless the board of directors determines that the director has no material relationship with the company. The basis for that determination must be disclosed in the company s annual proxy statement.

In addition, directors would not qualify as independent if, in the past five years, they, or any immediate family member were:

* A company employee;

* Part of an interlocking directorate; or

* Affiliated with or employed by an auditor of the company or an affiliate.

Furthermore, directors who qualify as "independent," but also beneficially own 20 percent or more of the company's stock, may not chair or be a voting member of the audit committee.

Once these independence standards are approved by the SEC and finalized, each company will be required to assess what action is necessary to realign its audit committee membership.

FINANCIAL EXPERT

The Act requires that the SEC issue rules requiring each company to disclose in its periodic reports whether its audit committee includes at least one "financial expert."

Naturally, many public companies will wish to install at least one financial expert on the audit committee, and many already have initiated searches for qualified candidates.

The term financial expert hasn't been formally defined yet, but Congress has instructed the SEC to consider whether a person has:

* An understanding of GAAP and financial statements;

* Experience with preparing or auditing financial statements of comparable companies and applying such principles in connection with accounting for estimates, accruals and reserves;

* Experience with internal auditing controls; and

* An understanding of audit committee functions.

AUDIT COMMITTEE RESPONSIBILITIES

Overseeing Outside Auditors

The Act requires that the audit committee, rather than management, have direct responsibility for appointing, compensating and overseeing the work of any audit firm employed by the company. While this historically has been standard practice for many companies, it's now mandated for all.

Approval of Audit and Non-Audit Services

The audit committee will be required to pre-approve all audit and non-audit services provided by a company's independent auditors. Pre-approval also may be given by an Audit Committee member to whom the committee has delegated authority.

Under certain circumstances, a very limited exception to this pre-approval requirement is available if the company did not recognize services to be non-audit services at the time of the engagement. In addition, the Act requires disclosure of any approval of non-audit services in a company's periodic reports.

Establish Procedures for Tips and Complaints About Auditing and Accounting Matters

The Act requires audit committees to establish procedures to receive, retain and respond to complaints the company receives regarding its accounting, internal accounting controls or auditing matters, including confidential, anonymous submissions from employees regarding questionable accounting or auditing matters.