Chapter 17 - § 17.9 • CORPORATE ACCOUNTABILITY AND GOVERNANCE REQUIREMENTS

• Jurisdiction: Colorado

§ 17.9 • CORPORATE ACCOUNTABILITY AND GOVERNANCE REQUIREMENTS

Congress enacted, and President Bush signed, the Sarbanes-Oxley Act of 2002 in response to the disastrous corporate disclosures, financial statement restatements, insider trading allegations, and financial fraud that was disclosed to the public commencing in October 2001 and continuing through 2002. In fact, the Sarbanes-Oxley Act could well have been called the Enron-Arthur Andersen-WorldCom-Global Crossings-MerrillLynch Act. In any event, Congress greatly expanded the provisions of the federal securities laws in an effort to impose greater accountability on management. In many cases, these new statutory provisions mesh with numerous requirements being imposed on publicly traded issuers by NASDAQ and the stock exchanges. Among these requirements are the following:

1) Management must certify financial statements that are filed with the SEC. Section 906 of Sarbanes-Oxley was effective immediately, and added 18 U.S.C. § 1350 to the criminal code. This requires the chief executive and financial officers of an issuer filing reports with the SEC to "certify" in writing that the financial statements meet the requirements of the 1934 Act. It also imposes criminal penalties on persons who file false certifications. In United States v. Smith,²¹⁷ the former chief financial officer for HealthSouth Corp. pled guilty to securities fraud, including a count against him for filing a false certification under the Sarbanes-Oxley Act.
2) Section 302 of Sarbanes-Oxley added a second, more extensive, certification requirement that became effective upon the adoption of Rules 13a-14 and 13a-15 and the addition of Items 307 and 308 to Regulations S-K and S-B.
3) Sarbanes-Oxley has followed the lead of NASDAQ and the NYSE expanding the importance and authority of corporate audit committees. Section 301 added § 10A(m) to the 1934 Act and mandates that companies trading on national securities exchanges and national securities associations (NASDAQ) have audit committees consisting of independent directors.

• The audit committees must pre-approve any situation when the company asks its auditor to perform non-audit services (with only a de minimis exception provided) (1934 Act § 10A(i)).
• The auditors report to the audit committee, not to management (1934 Act § 10A(k)).
• The audit committee must establish anonymous procedures for the receipt, retention, and treatment of complaints received from persons regarding accounting, internal controls, or auditing matters (1934 Act § 10A(m)(4)).
• The audit committee was granted the express authority to retain advisors and required each issuer to "provide for appropriate funding as determined by the audit committee" (1934 Act § 10A(m)(5) and (6)).
• When an audit committee has a financial expert, the company's disclosure must identify the financial expert; when the company's audit committee does not have a financial expert, it must explain why not.²¹⁸ In many cases, the company does not want to name an audit committee financial expert because of the perception that doing so may increase that person's risk of personal liability. Item 407(d)(5)(iv)(B) of Regulation S-K provides the SEC's opinion that:

The designation or identification of a person as an audit committee financial expert pursuant to this Item 407 does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee and board of directors in the absence of such designation or identification.

NASDAQ and the NYSE rules further expand the role and the responsibility of the audit committees, including a mandate that the audit committees approve all related party transactions before such transactions take place.

Sarbanes-Oxley did not stop at the audit committee. It also added a number of provisions to the securities laws that directly impact management:

• Management (directors and other affiliates) are now required to report share transactions within two business days, rather

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