The Sarbanes-Oxley
Act of 2002, signed into law by President Bush on July 30, 2002,
represents a groundbreaking set of rules and regulations regarding
corporate governance and financial reporting. The Sarbanes-Oxley
Act of 2002-or the "Act" for short-was a response to
recent corporate and accounting scandals.
Since the
Act was signed into law, the Securities and Exchange Commission,
under the authority of the Act, has released an extensive array
of rules and regulations, the bulk of which are applicable, primarily,
to public companies. Additionally, the stock exchanges have each
changed their listing standards in response to the Act's requirements.
Private companies,
however, are not immune from the Act.
Some parts
of the Act apply to private companies right now. Other parts,
though not currently applicable, will start to apply to private
companies the moment they file for an initial public offering,
or an "IPO." This article summarizes certain aspects
of the Act currently applicable to private companies, as well
as some of the steps a company should take if it's contemplating
"going public" or being acquired in the future.
A Brief
Look at the Act
The Act was
designed to safeguard the interests of the investing public. The
recent corporate and accounting scandals highlighted the need
to impose increased standards on financial reporting in particular.
These standards stem from the view that certain "best practices"
should be implemented by public companies, and then enforced by
the Securities and Exchange Commission, for the benefit of the
investing public. Specifically, the Act is designed to:
- Improve
the quality and transparency of financial reporting.
- Enhance
the reliability of independent audits.
- Impose
harsher penalties for violations of law.
Among other
things, the Act requires increased disclosure and dissemination
of financial information, and increased accountability for the
executive officers who are responsible for such disclosure and
dissemination. The Act also mandates heightened standards of independence
for members of a company's audit committee and for the public
accounting firms that perform audits.
What Applies
to Private Companies Now?
Certain parts
of the Act must be complied with by all companies, whether public
or private. Here are some aspects of the Act that apply to private
companies right now:
- Prohibition
of Taking Action Against Whistleblowers. The Act imposes fines
and up to 10 years in jail for knowingly retaliating against
any person, including interfering with their employment, for
providing law enforcement any truthful information relating
to any federal offense.
- Prohibition
of Destroying, Concealing or Falsifying Documents. The Act imposes
fines and up to 20 years in jail for knowingly altering, destroying,
concealing or falsifying any record, document, or tangible object
with the intent to impede, obstruct or influence a federal investigation
or any bankruptcy case. To this end, private companies should
implement document retention policies, and make sure that all
of their employees are aware of, have read and follow them.
- Increased
Penalties for Securities Fraud. The Act extends the statute
of limitations for the time in which federal securities law
cases may be brought.
- Increased
Liability for Attempted, or Conspiracy to Commit, White Collar
Crimes. The Act provides that any attempt to commit, or conspiracy
to commit, any white collar offense or violation of consumer
protection law is now punishable to the same extent as the underlying
offense.
- Notice
of Defined Benefit Plan Blackout Periods. Pursuant to the Act,
plan administrators must give 30 days advance notice under defined
benefit plans for any blackout period-which means any time when
participants are prohibited from directing their account assets
for more than 3 days.
In What
Other Ways Should a Private Company Voluntarily Comply with the
Act?
In addition
to the provisions of the Act that apply to all companies, any
private company contemplating an IPO should consider taking steps
to voluntarily comply with those parts of the Act that apply only
to public companies, since certain provisions of the Act will
apply immediately once the company files a registration statement
to go public. Compliance with the Act is also a prudent course
of action for any private company with eyes to become an acquisition
target. Though a detailed discussion of each requirement of the
Act is beyond the scope of this article, here are some things
a private company should consider doing now:
- Establish
a Charter Listing the Qualifications and Responsibilities of
Directors. The Act puts a very strong emphasis on director
independence and requires independent directors to serve on
various committees. Private companies should consider adding
independent directors now to reinforce the integrity of the
Board to outsiders and so that, upon an IPO, the company will
have enjoyed the opportunity to find the right fit.
- Establish
an Audit Committee and Charter. The Act requires that each
public company maintain an audit committee and a charter. The
audit committee must be comprised solely of independent directors,
and charged with the oversight of financial audits and reporting.
For now, private companies should at least establish an audit
committee and a charter, even if the committee is not made up
of independent directors, so that when the right independent
directors are found, everything will be in place.
- Have
the Audit Committee Hire the Auditors and Approve Non-Audit
Service in Advance. The audit committee should assume responsibility
for hiring the independent auditors and overseeing the audit
process and approving in advance any non-audit services rendered
by the auditor.
- Establish
and Review Processes for Internal Controls. The Act requires
that a public company have in place internal accounting controls
and procedures sufficient to gather the information needed to
evaluate and reflect in the company's financial statements.
Private companies should establish such controls now to help
ensure the accuracy of their financial statements, and so that
upon an IPO they will already be in place and in effect.
- Adopt
a Code of Conduct and Ethics. The Act requires public companies
to disclose whether or not they have a code of ethics for senior
financial management-if they don't have one then they have to
justify why. Stock exchanges, moreover, require listed companies
to have a code of conduct and ethics that applies to directors,
officers and employees. Private companies should adopt a code
of conduct and ethics that applies to all of its directors,
officers and employees. A well drafted and enforced code of
conduct and ethics promotes a positive public perception of
the integrity of the company's business.
- Provide
a Means for Anonymous Complaints by Employees. The Act requires
a company's audit committee to have a procedure that allows
employees to submit anonymous complaints regarding auditing
practices and other non-compliance issues.
- Company
Loans. The Act prohibits public companies from making any
loans to its executive officers or directors after June 29,
2002. If a private company has any such loans in place, it will,
prior to filing its registration statement for its IPO, have
to extinguish such loans to comply with the Act. Loans that
existed prior to July 29, 2002 are permitted to remain outstanding
so long as they are not materially amended. As such, private
companies, if they are currently making such loans, should include
a condition in the loan that an IPO or sale of the company triggers
an immediate obligation of repayment.
Conclusion
Private companies
must comply with certain parts of the Act right now, and would
be well-advised to start complying with other parts of the Act
that are specifically applicable to public companies. This recommendation
is especially true if the goal is to become a public company or
to be acquired. However, even if a private company's goal is not
to become public or be acquired, a private company may reap the
benefits associated with improved internal controls and governance,
which may indirectly increase the company's value to investors,
while at the same time reducing the company's exposure to litigation.
After all, an ounce of prevention is worth a pound of cure.
Marc Alcser
and Brent Triff are associates in the corporate department of
Stradling Yocca Carlson & Rauth, a full-service business law
firm of more than 100 lawyers based in Newport Beach, California.
Mr. Alcser and Mr. Triff work extensively with companies in the
high technology industry. Stradling Yocca Carlson & Rauth's
commercial practice concentrates on corporate securities, corporate
finance, mergers and acquisitions, public offerings and other
related matters. The firm also has significant litigation, intellectual
property, tax, employment law, real property and public law practices.
Stradling Yocca Carlson & Rauth's Orange County office is
at 660 Newport Center Drive, Suite 1600, Newport Beach, California
92660. For more information, phone 949-725-4000 or visit the firm's
website at www.sycr.com.
* DISCLAIMER:
This article is not legal advice, and should not be relied upon
as such. Instead, it is a general interest article providing an
overview of some aspects of the Sarbanes-Oxley Act of 2002.
