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The Emerging Company
and the SEC:

The Significance of
the Sarbanes-Oxley Act

See also:
Corporate Governance c. 2004
      How Do Today's Rules Affect Me?

          Outrageous financial malfeasance and voracious fraud are now seen to have been endemic during recent years within many celebrity corporations of the Fortune 500® . Public opinion throughout the world as well as corporate and government leaders have been shocked. Consequently, these scandals have provoked strong statutory and regulatory responses. Perhaps most momentous is the Sarbanes-Oxley Act of 2002, signed by President on Bush July 30, 2002, conferring much tougher regulatory and enforcement powers upon the U.S. Securities and Exchange Commission (SEC).

          Understandably, the popular media focus is upon the luminaries of the corporate world -- the Fortune 500®. But there are more than 12,000 publicly traded companies subject to SEC regulation and the rigorous requirements of Sarbanes-Oxley. Most of these corporations are not large. What does Sarbanes-Oxley mean for an officer or a director of one of the 95 percent of these smaller publicly traded companies?

          A lot!

          Although the Sarbanes-Oxley Act is quite lengthy, detailed and complex, it is simply a serious directive to raise significantly the standards of corporate transparency and accountability. These standards are coupled with enhanced sanctions, criminal as well as civil, to assure compliance. The past 65 years have not witnessed a more important or comprehensive law addressing the processes of corporate governance.

          An overview of the Sarbanes-Oxley Act highlights:

Bullet   Increased transparency and disclosure:

   ...   "Real-time" disclosure.
   ...   The reconciliation of pro forma reporting with Generally Accepted Accounting Practices (GAAP).
   ...   Full financial disclosure of all off-balance sheet and related parties transactions.
   ...   Expanded disclosure in connection with internal controls -- financial as well as non-financial.

Bullet   Enlarged and more specific responsibilities for the Audit Committee.

Bullet   Public certification of financial reports and internal controls by the CEO and CFO.

Bullet   A rigorous "insider" transaction regimen:

   ...   Reimbursement is to be exacted from the CEO and the CFO following a financial restatement attributable to misconduct.
   ...   New loans to the directors and executive officers are proscribed.
   ...   Most transactions involving company securities must be reported within two business days for Section 16 filers.

Bullet   Public auditors are subject to substantially increased regulation under the new Public Company Accounting Oversight Board (SEC).

   ...   Public auditors now severely circumscribed in the non-audit work (management and technology consulting) for their audit clients.

          First, it is important to understand that this new law and its complementary regulations impose tough, complex and onerous requirements upon all public corporations. This is of special concern to the smaller emerging corporation. There is no longer room for simply "doing what we know is right" or appointing one of "the best and brightest" technical or marketing superstars to a position of financial management in the rapidly emerging public company. Only the best and most seasoned legal and accounting counsel can guide the public company confidently through these new standards of corporate transparency and accountability.

          Let's look at just a few representative new requirements; e.g.,

Increased transparency and disclosure:

Bullet   The Act orders the disclosure on a "rapid and current basis" (i.e., real-time) of such additional information pertaining to substantive changes in the corporation's operations or financial condition that the SEC ascertains to be essential for the protection of investors.

Bullet   The SEC will be issuing new regulations concerning pro forma financial information:

   ...   Pro formas cannot contain any material omission or misstatement.
   ...   Pro formas are to be reconciled with GAAP.
   ...   Applicable both to pro formas in SEC filings as well as to any press release or public disclosure.

Bullet   The SEC will be issuing new regulations assuring Form 10-K/10-Q disclosure of:

   ...   Relationships with unconsolidated entities or other parties that may have a significant current or future effect on the financial condition, results of operations, liquidity or material elements of expenses or revenues.
   ...   All substantive off-balance sheet transactions, obligations and arrangements.

Bullet   Every report presenting GAAP financial statements needs to reflect all substantive correcting adjustments identified by a registered public accountant (i.e., effective following registration of Auditors with the Public Company Accounting Oversight Board.

Bullet   Periodic reports have to announce whether or not a Code of Ethics has been implemented by the corporation, and if not, why not?

   ...   A Form 8-K must reveal any change in or waiver of the Code of Ethics.

          While these new investor disclosure rules may appear to be keenly comprehensive, serious defects remain; e.g., the level of compliance with a corporation's bank covenants. The activating cause of the Williams Communications Group and the Enron Corporation bankruptcies, for example, was the breach of the corporations' bank covenants enabling their banks to exercise their rights to demand immediate repayment of loans. To adequately protect investors, it has been proposed that the SEC compel corporations to report, at least quarterly, the essential elements in their borrowing agreements, disclosure of their fulfillment of these covenants, the probability that any non-compliance could trigger these covenants, and the events that could cause such a triggering to occur. Any significant changes between quarters should require filing immediately a Form 8-K and well as an informative press release.

          Especially in the smaller emerging public company, Sarbanes-Oxley places an almost overwhelming burden upon the CEO and the CFO. The frightening consequences of failing to meet these enhanced standards carry criminal sanctions including imprisonment! What steps can be taken to meet these enlarged responsibilities?

Bullet   First and foremost, the CEO and the CFO must acquire full knowledge of all SEC standards of compliance and reporting requirements; it is no longer acceptable to "plead ignorance by saying these tasks have been delegated to others either within or outside the Corporation." These two corporate officers have personal responsibility and liability for the corporation's reporting and public disclosures; e.g., see the SEC's mandatory Statements by Company CEOs and CFOs presented on the SEC's Website. A number of fine executive education programs now offer training in these issues. Undistracted participation in one of these programs is now unavoidable and has the highest priority.

Bullet   On behalf of the corporation, the CEO and CFO must engage independent and preeminent legal counsel and a registered public accounting firm. Old boy networks are now suspect. Much of compliance requires understanding the many details of a labyrinth of reporting and disclosure regulations, and only an experienced professional organization can be conversant and comply fully with all of these regulations. Again, we now need to clear much higher hurdles of corporate transparency and accountability.

Bullet   Every public corporation is now required to elect a professionally competent Board of Directors that is truly independent -- psychologically as well as legally. Real as well as perceived conflicts of interest cannot be tolerated; cronyism is illegal! But these new requirements offer the CEO and CFO the opportunity to strengthen their executive team dramatically. Members of the Board can be organized into both strategic as well as functional work groups developing mutual trust and the ability to challenge senior management constructively -- dissent is obligatory! Although perhaps frequently unnerving, an engaged and vigorous Board can be the CEO's and CFO's most valued resource.

Bullet   Finally, traditional but non-critical duties may be off-loaded:

   ...   The job descriptions for CEOs and CFOs are being rewritten, splitting off the tasks not essential to compliance with the flurry of new laws and reporting requirements of Sarbanes-Oxley. For example, BMC Software, Inc. has separated the attention-consuming tasks of chief strategic financial planner from the CFO's job so that adequate undistracted time is available to focus on the new regulatory, disclosure and compliance requirements emanating from Washington.

   ...   Knowlegeable CFOs' can be engaged through professional service firms to augment and strengthen the work of a public corporation's own CFO. Some firms (e.g., Tatum Partners) offer a unique service model whereby one of their partners may be hired as an employee, or retained on a part-time or interim basis. The partner remains a partner of the professional service firm, allowing continuous access to the intellectual capital of the other partners. This arrangement is especially flexible and helpful in meeting the new Sarbanes-Oxley regulatory, disclosure and compliance standards.

          One of the most important jobs of the responsible CEO and CFO is to attract and retain a loyal foundation of shareholders. Loyalty can only be built upon trust and confidence. And trust and confidence in any relationship grow from transparency and accountability.

          At first glance, the Sarbanes-Oxley Act of 2002 appears to make the jobs of the CEO and the CFO of public corporations much more demanding, complex, and even unnerving. It does! But the purpose of Sarbanes-Oxley is congruous with the mission of the conscientious CEO and CFO -- to maintain an open and honest relationship with the shareholders of the corporation. Responsible corporate directors and officers share an equal interest with the SEC in maintaining an open and honest relationship with investors. While admittedly onerous, Sarbanes-Oxley is simply a much-overdue tool to help the directors and officers of the public corporation do the job they have been hired to do -- the job they want to do on behalf of their shareholders.


We are pleased to acknowledge the constructive contribution of the Directors Roundtable through its program, "Key Issues Facing Boards of Directors: The Revolution in SEC Disclosure & Enforcement," on Tuesday, October 15, 2002, in Boston, Massachusetts USA
RoundTable Logo
Jack Friedman
Chairman of the Board


See also:

Get on Board:
The Sarbanes-Oxley Act's impact is felt throughout corporate America -- even if you're privately held

Robert A. Adelson, Esquire

Your comments and suggestions for these pages are most welcomed!

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Thomas A. Faulhaber, Editor

Telephone: 617.232.6596 -- FAX: 617.232.6674

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Revised: December 11, 2002 TAF

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