Shoring up Investor Confidence: Corporate Accounting Reform

America’s financial markets stand on a foundation of trust in the integrity of reported corporate earnings. When news of fraudulent activities at certain large companies greatly weakened investor confidence this year, Congress and the President responded with a corporate accounting reform law — the Sarbanes-Oxley Act of 2002 (the "2002 Act") — which was signed into law on July 30, 2002.

The requirements of the 2002 Act apply to companies that issue publicly traded securities, their executives, and auditors. Therefore, privately owned companies generally are not affected. The new corporate accounting reform does not in any way disturb the relationship between privately owned companies and their accountants. Thus, as long as your business does not issue (and has not registered to issue) publicly traded securities, we can continue to provide you with the same range of services — both audit and non-audit — that we have been providing until now, even if your company has several shareholders.

Under the 2002 Act, chief executive officers and chief financial officers must certify (based on each executive’s knowledge) that each annual or quarterly financial report issued is not misleading and that it fairly presents the company’s financial condition and results of operations as of and for the reported periods. Additional certifications regarding the evaluation of internal controls and disclosure of significant deficiencies in those controls also are required.

Companies will have to disclose any material changes in their condition more quickly than previously required. The 2002 Act requires stricter disclosures of transactions between companies and their directors, officers, and principal stockholders. Personal loans to executive officers and directors are prohibited, although a loan existing on July 30, 2002, is "grandfathered" as long as it is not materially modified or renewed on or after that date.

In addition to these changes, the new law provides that each member of a public company’s audit committee must be a director of the company and must be "independent." Essentially, this means an audit committee member may receive only "board-related" compensation and may not be an "affiliated person" of the corporation (such as a company executive).

The 2002 Act establishes a new five-member oversight board under the jurisdiction of the Securities and Exchange Commission that will regulate the auditing of public companies subject to the securities laws. Only accounting firms that register with the board will be able to prepare or issue audit reports on publicly traded companies. The board will establish auditing standards for the registered firms and conduct periodic inspections of the firms.

During the period when auditing services are being performed for a client company, registered firms will not be allowed to provide the client with certain non-audit services. Among others, these services include: bookkeeping or other accounting or financial statement services, financial information systems design and implementation, appraisal or valuation services and fairness opinions, actuarial services, and management functions or human resources. Tax services may be provided only if approved by the company’s audit committee.

The 2002 Act contains provisions intended to prevent conflicts of interests for securities analysts whose firms also conduct investment banking business with a publicly traded company. Additional provisions of the 2002 Act require defined contribution retirement plans to provide participants with advance notice of "blackout" periods — periods of more than three consecutive business days during which their ability to direct or diversify their plan investments will be suspended or restricted. Directors and officers will not be able to purchase or sell company stock during blackout periods in which at least half of a plan’s participants are suspended from purchasing or selling the stock.

The 2002 Act increases the penalties for corporate financial fraud and violations of the pension law. Moreover, the new law contains measures designed to protect employees of publicly traded companies who lawfully provide information or assist in an investigation regarding violations of the securities laws or fraud against shareholders. Under the Act, it is against the law to fire, demote, suspend, harass, or threaten such employees.

The significant corporate accounting reforms summarized above were enacted in response to the misguided actions of certain individuals in a few firms. You can be confident that throughout this troublesome period, neither our commitment to the highest professional standards nor our tradition of trustworthy client service has changed. You also can be sure that we will continue to provide accounting, auditing, tax, and business consulting services with integrity and the highest regard for your trust in our firm.

The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed.