Choate Alert

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The Sarbanes-Oxley Act
of 2002
October 2002
CHOATE HALL & STEWART Exchange Place Boston MA 02109 | t 617 248 5000 f 617 248 4000 | www.choate.com p 1
On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002 (the Act).
The Act makes important, and in many cases, dramatic changes in the laws affecting
public corporations and their officers, directors and auditors.
Congress has responded to the recent corporate scandals and calls to prevent future
abuses by enacting new rules in a number of principal areas. In particular, the Act:
imposes new obligations on corporate officers and directors and audit committees
(see Section I. New Obligations of Corporate Officers and Directors below);
requires additional, new disclosures in public companies periodic reports, and
increased review of those reports by the Securities and Exchange Commission (the
SEC) (see Section II. New Disclosure Requirements and Increased SEC Review
below);
creates a new regulatory structure for oversight of public accounting firms (see
Section III. Public Accounting below);
imposes new and increased criminal penalties on corporate officials who violate
these new mandates and engage in other acts of misconduct relating to their corpo-
rate duties (see Section IV. Expansion of SECs Enforcement Powers and New
Criminal Penalties below); and
contains various other provisions that, among other things, govern the conduct of
attorneys and provide protection for corporate whistleblowers (see Section V.
Miscellaneous Provisions below).
The Act contains 69 sections covering an array of topics. As with most sweeping leg-
islation, the Act contains some ambiguities that will require interpretation. The Act
also contemplates a substantial amount of rulemaking by the SEC and other agencies
to implement a number of its provisions. The effective dates of the provisions vary,
and the ultimate effect of the Act is yet to be fully determined. This Alert is intended
to summarize briefly some of the key provisions of the Act and is not intended as a
The Act contemplates sub-
stantial rulemaking by the
SEC and other agencies to
implement its provisions.
p 2
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ment regulations should
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If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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full analysis of the matters presented. Annex A attached to this Alert briefly outlines
these key provisions and their effective dates. We will continue to monitor develop-
ments in the implementation and interpretation of the Act.
As you may be aware, in the months prior to enactment of the Act, the SEC, the
New York Stock Exchange and NASDAQ had published proposals and guidance on a
broad array of topics applicable to public companies and their officers and directors.
These proposals include increased and accelerated public company disclosure and the
composition and operation of audit committees. We will monitor the effect on those
proposals as the Act is implemented.
I. New Obligations of Corporate Officers and Directors
The Act imposes new duties on corporate officers and directors and, in some
instances, creates new criminal and civil penalties for failure to comply with those and
previously existing duties.
A. CEO/CFO Certification of Financial Reports
The Act imposes new standards of officer responsibility for financial reports, in an
obvious response to the position taken by Kenneth Lay of Enron and others that they
were unaware of their own companies accounting irregularities. By August 29, 2002,
the SEC is to publish rules requiring that the principal executive officer or officers
and the principal financial officer or officers of public companies certify each annual
and quarterly report, subject to civil enforcement by the SEC (Civil Certification).
The Civil Certification will require the CEO and CFO to certify with respect to each
report that:
the signing officer reviewed the report;
based on the officers knowledge, the report does not contain an untrue statement
of a material fact or omit to state a material fact necessary in order to make the
statements, in light of the circumstances under which the statements were made,
not misleading;
based on the officers knowledge, the financial statements, and other financial infor-
mation included in the report, fairly present in all material respects the financial
condition and results of operations of the company as of, and for, the periods pre-
sented in the report;
The Act imposes new
standards of officer respon-
sibility for financial reports.
p 3
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the signing officers:
are responsible for establishing and maintaining internal controls;
have designed such internal controls to ensure that material information relat-
ing to the company and its consolidated subsidiaries is made known to such
officers by others within those entities, particularly during the period in which
the periodic reports are being presented;
have evaluated the effectiveness of the companys internal controls as of a date
within 90 days prior to the report; and
have presented in the report their conclusions about the effectiveness of the
internal controls based on their evaluation as of that date;
the signing officers have disclosed to the companys auditors and the audit commit-
tee of the board of directors:
all significant deficiencies in design or operation of internal controls which
could adversely affect the companys ability to record, process, summarize,
and report financial data and have identified for the companys auditors any
material weaknesses in internal control; and
any fraud, whether or not material, that involves management or other
employees who have a significant role in the companys internal controls; and
the signing officers have indicated in the report whether or not there were signifi-
cant changes in internal controls or other factors that could significantly affect inter-
nal controls subsequent to the date of their evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
In addition, a criminal provision of the Act requires that each periodic report contain-
ing financial statements be accompanied by a written statement from the CEO and
CFO (Criminal Certification) that the report fully complies with the requirements
of the Securities Exchange Act of 1934 (the Exchange Act) and fairly presents, in all
material respects, the financial condition and results of operations of the company. An
officer who knowingly certifies a report that does not meet all the requirements
of this provision is subject to a maximum fine of up to $1,000,000 and imprisonment
for up to 10 years; an officer who willfully certifies a false report is subject to a
maximum fine of up to $2,000,000 and imprisonment for up to 20 years.
These certification requirements are different than (and in addition to) the certifica-
tion required by the SEC pursuant to its June 2002 order. Under that order the CEO
A criminal provision of the
act requires that each
periodic report containing
financial statements be
accompanied by written
certification from the CEO
and CFO.
p 4
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If you would like to consult
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program, contact either
partners:
Kevin Lesinski: 617 248 5233
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and CFO of each public company with annual revenues in excess of $1.2 billion are
required to file sworn certifications as to the accuracy of periodic reports.
While the Act provides the SEC until August 29, 2002 to issue its rules with respect
to Civil Certification, it appears that the Criminal Certification may be required for all
reports filed on or after the date of enactment of the Act. This is of particular interest
to the large number of public companies that have not already filed a Form 10-Q for
the quarter ended June 30, 2002. Companies should discuss with legal counsel the
appropriate procedures to follow in connection with Criminal Certification and begin
to follow those procedures to be ready to certify their next periodic report. In the
meantime, we will continue to monitor any official clarification from the SEC, the
Department of Justice or others on this topic.
B. New Requirements Relating To Audit Committees
The Act also gives more responsibility to, and imposes additional obligations on, the
audit committees of public companies. Beginning January 26, 2003, no company
may be registered on a national securities exchange unless it complies with new rules
pertaining to its audit committee. Under the Act, the audit committee is directly
responsible for appointment, compensation and oversight of the work of any regis-
tered public accounting firm (including the resolution of disagreements between man-
agement and the auditor regarding financial reporting) for the purpose of preparing
and issuing audit reports, and each such accounting firm must report directly to the
audit committee. Audit committees will need to be composed entirely of independ-
ent members of the companys board. Independent means that the member may
not, other than in his or her capacity as a member of the audit committee, the board
of directors, or any other board committee, accept consulting, advisory, or other com-
pensatory fees from the company, and may not be an affiliated person of the com-
pany. The Act allows the SEC to exempt a particular relationship from the independ-
ence requirements, as the SEC determines appropriate in light of the circumstances.
Each audit committee must establish procedures for:
the receipt, retention and treatment of complaints received by the company regard-
ing accounting, internal accounting controls, or auditing matters; and
the confidential, anonymous submission by employees of concerns regarding ques-
tionable accounting or auditing matters.
Each audit committee must also have the authority to engage independent counsel
and other advisers, as it determines necessary to carry out its duties. Public companies
Audit committees will need
to be composed entirely of
independent members of
the companys board.
p 5
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will be obligated to provide appropriate funding, as determined by the audit commit-
tee, for payment of compensation of any independent advisers so employed by their
audit committees.
C. Prohibition on Loans to Executive Officers and Directors
Effective immediately, the Act prohibits personal loans to any director or executive
officer of any company, with certain limited exceptions. Although the Act contains a
grandfather clause for currently outstanding loans, such loans may not be modified
or renewed. The exceptions to the prohibition are for:
home improvement and manufactured home loans;
consumer credit, or any extension of credit under an open end credit plan, or a
charge card; and
extensions of credit by a registered broker or dealer to its employees, subject to cer-
tain limitations.
D. Revised Section 16 Reporting Requirements
Effective August 29, 2002, the Act amends Section 16 of the Exchange Act to require
certain insiders (i.e., directors, executive officers and beneficial owners of more than
10% of any class of stock) to file statements of transactions in their companys securi-
ties on Form 4 by the second day after execution of each transaction. Currently, such
reports are due within 10 days of the end of the month in which a transaction takes
place. Companies should promptly advise all of their Section 16 reporting persons of
this change and update their filing procedures.
In addition, beginning not later than July 30, 2003, these filings, which currently
may be made with the SEC either in paper or electronically via EDGAR, will be
required to be filed electronically and the company will need to provide the statement
on its corporate website by the end of the business day after the filing.
E. Trading Prohibition during Benefit Plan Blackouts
The Act bars trading by executive officers and directors of any equity securities
acquired by them in connection with service or employment as a director or executive
officer during a blackout period under a public companys individual account plans
(that is, 401(k), profit sharing and other defined contribution plans). For purposes of
this trading prohibition, a blackout period is any period of more than three consec-
utive business days during which the ability of at least 50% of the participants or ben-
eficiaries under all of the companys individual account plans to purchase, sell or
transfer their interests in any of the companys equity securities is temporarily sus-
Certain insiders will be
required to file statements
of transactions in their
companys securities by the
second day after execution.
p 6
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If you would like to consult
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your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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pended by the company or a plan fiduciary. A blackout period does not include any
regularly scheduled period during which participants and beneficiaries may not pur-
chase, sell or transfer their interests so long as such restriction is incorporated into the
plan and disclosed to employees in a timely manner. The company is required to noti-
fy executive officers and directors and the SEC of a blackout period. In addition, plan
administrators are required to notify affected plan participants and beneficiaries of a
blackout period. Any profits realized by insiders in violation of this prohibition would
be recoverable by the company.
These trading prohibitions take effect on January 26, 2003. The Act charges the SEC,
in consultation with the Secretary of Labor, with issuing rules to clarify these provi-
sions. The Act provides that good faith compliance with the requirements in advance
of the issuance of such regulations will be treated with compliance with these provi-
sions.
F. Improper Influence on Conduct of Audits
The Act prohibits any officer or director of a public company, or any other person
acting under direction of an officer of director, from taking any action to fraudulent-
ly influence, coerce, manipulate, or mislead any independent public or certified
accountant engaged in the performance of an audit of the financial statements of the
company for the purpose of rendering such financial statements materially misleading.
The Act instructs the SEC to issue final rules or regulations in connection with these
prohibitions by April 26, 2003.
G. Forfeiture of Bonuses and Trading Profits by CEO and CFO
Effective upon enactment, if a public company is required to restate financial state-
ments due to the material noncompliance of the company, as a result of misconduct,
with any financial reporting requirement under the securities laws, the chief execu-
tive officer and the chief financial officer of the company must reimburse the compa-
ny for:
any bonus or incentive-based or equity-based compensation received from the com-
pany during the 12 months following the first public issuance of the financial state-
ments that need to be restated; and
any profits realized from the sale of the companys securities during that 12-month
period.
The Act does not define misconduct or specify whose misconduct will give rise to
the reimbursement obligations under this provision.
p 7
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compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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H. Temporary Freeze of Payments
During an investigation involving possible violations of federal securities laws by a
public company or any of its officers, directors or other affiliated persons, extraordi-
nary payments (whether compensation or otherwise) to its officers, directors or
other affiliated persons can be temporarily frozen. Upon petition of the SEC, a feder-
al court may freeze payments for up to 45 days (subject to an additional 45-day
extension) in an interest-bearing account.
I. Officer and Director Bars
Immediately upon enactment, the Act has reduced the standard required for the SEC
to bar an officer or director who has violated securities laws from serving as an officer
or director of any public company by requiring that the SEC prove the unfitness,
rather than the substantial unfitness, of such person to serve in such a capacity. In
addition, the Act allows the SEC to bar directors or officers through an administra-
tive cease-and-desist proceeding, rather than through a court order.
II. New Disclosure Requirements and Increased SEC Review
The Act contains a number of provisions addressing the timing, manner and sub-
stance of a public companys disclosure and the review by the SEC of that disclosure.
A. Real Time Disclosure
In language with potentially broad and novel implications, the Act requires public
companies to disclose to the public on a rapid and current basis any additional
information concerning changes in the financial condition or operations of the com-
pany as the SEC determines. This provision could substantially change public compa-
nies intra-quarterly reporting obligations, depending upon how the SEC interprets
the provision. The Act does not specify what information must be disclosed or how it
needs to be disclosed (e.g., via a Form 8-K filing or in some other way) or a time
frame within which the SEC must promulgate regulations to implement this provi-
sion. Currently, though, the SEC has outstanding proposals to increase substantially
the information required to be disclosed on Form 8-K and to require filing of the
Form 8-K with that information within a two-day period. It is unclear how the Act
will affect those proposals. It is also not clear whether this requirement will, like cur-
rent New York Stock Exchange rules, allow companies to exercise some degree of
business judgment on the precise timing of the disclosure.
B. Additional Financial Disclosures in Periodic Reports
The Act also requires additional disclosures in annual and quarterly reports (i.e., Form
10-Ks and Form 10-Qs).
The Act has reduced the
standard required for the
SEC to bar an officer or
director who has violated
securities laws from
serving as an officer or
director of any public
company.
The Act requires public
companies to disclose "to
the public on a rapid and
current basis" any addition-
al information concerning
changes in the financial
condition or operations of
the company.
p 8
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ment regulations should
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If you would like to consult
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management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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All material correcting adjustments that have been identified by a public account-
ant in accordance with GAAP and SEC rules and regulations must be reflected in
the reports.
The SEC must issue final rules by January 26, 2003, requiring disclosure of all
material off balance sheet transactions, arrangements, obligations, and other rela-
tionships of the company with unconsolidated entities or other persons that may
have a material current or future effect on the company.
The SEC must issue final rules by January 26, 2003, providing that pro forma
financial information included in any periodic report, public disclosure or press
release shall be presented in a manner that (1) does not contain any untrue state-
ment and is not misleading, and (2) reconciles it with the financial condition and
results of operations of the company under GAAP.
C. Management Assessment of Internal Controls
The SEC must also issue rules requiring that each annual report contain an internal
control report, which shall:
state the responsibility of management for establishing and maintaining adequate
internal control structure and procedures for financial reporting; and
contain an assessment, as of the end of the most recently ended fiscal year, of the
effectiveness of those controls.
D. Code of Ethics for Senior Financial Officers
The Act directs the SEC to issue rules by January 26, 2003, requiring public compa-
nies to disclose whether they have adopted a code of ethics for senior financial offi-
cers, applicable to their principal financial officer, comptroller and principal account-
ing officer, and if not, why not. Any change in or waiver of the code of ethics needs
to be disclosed immediately on Form 8-K.
The Act defines a code of ethics to mean standards that are reasonably necessary to
promote:
honest and ethical conduct, including the ethical handling of actual or apparent
conflicts of interest between personal and professional relationships;
full, fair, accurate, timely and understandable disclosure in the companys periodic
reports; and
compliance with applicable governmental rules and regulations.
Each annual report must
contain an internal control
report.
p 9
If you know what
documents exist and
where to find them, daily
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compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
Choate Alert
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E. Disclosure of Audit Committee Financial Expert
The Act directs the SEC to issue rules by January 26, 2003, to require each public
company to disclose in its periodic reports whether or not the companys audit com-
mittee includes at least one member who is a financial expert, and if not, why not.
The Act suggests factors that the SEC should consider in defining the term financial
expert. These factors include:
an understanding of GAAP and financial statements;
experience in preparing or auditing financial statements of generally comparable
companies and the application of such principles in connection with the accounting
for estimates, accruals and reserves;
experience with internal accounting controls; and
an understanding of audit committee functions.
F. Increased Frequency of SEC Review of Periodic Disclosures
The Act also directs the SEC to establish a regular and systematic review of the SEC
filings of public companies at least once every three years. The SEC is to schedule
reviews based on a number of risk factors, including consideration of the companys
market capitalization, whether the company has issued a material restatement of
financial results, market price volatility, whether the company is an emerging compa-
ny with disparities in price to earnings ratios, and whether the companys operations
significantly affect any material sector of the economy.
III. Public Accounting
A. Creation of the Public Accounting Oversight Board
The Act creates the Public Accounting Oversight Board (Board), a five member
body under the general supervision of the SEC. The Board will have broad powers
over all accounting firms performing audits for public company clients. All such audit
firms must be registered with the Board within 180 days after the Board is formally
organized, which, in turn, must occur within nine months of passage of the Act. The
Board is empowered to establish accounting standards, inspect accounting firms for
compliance, and conduct investigations and disciplinary proceedings upon any regis-
tered public accounting firm and their associated persons. Its five members must
be prominent individuals of integrity and reputation only two of whom are or have
been certified public accountants. The Board is to be appointed by the SEC.
The Act authorizes the Board to establish auditing, quality control, and ethics stan-
dards, including the requirement that audit reports be subject to second partner
The SEC must establish a
regular and systematic
review of the SEC filings of
public companies at least
once every three years.
The Public Accounting
Oversight Board will have
broad powers over
all accounting firms per-
forming audits for public
company clients.
p 10
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ment regulations should
be assured.
If you would like to consult
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program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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review by a qualified person . . . other than the person in charge of the audit, or by
an independent reviewer.
Accounting firms that perform audits must file with their Board registrations a con-
sent to cooperation and compliance with the Boards directives. In its investigations,
the Board may request the production of documents and testimony, and may also
request that the SEC subpoena documents and testimony from any person, including
from audit clients. Information obtained by the Board in the course of its investiga-
tions may be shared with the SEC, and, at the direction of the SEC, with the
Attorney General of the United States, state prosecutors, and state regulators. Failure
of a registered accounting firm to cooperate can lead to suspension or revocation of
the firms registration. Failure of an associated person to cooperate with the Board
may lead to suspension or debarment of that individual from association with a regis-
tered public accounting firm.
The Board is empowered to impose a wide range of sanctions if it finds that a regis-
tered public accounting firm or associated person has violated the Act, the Rules of
the Board, or the securities laws, including:
temporary suspension or permanent revocation of Board registration;
temporary or permanent suspension or bar of a person from further association
with any registered accounting firm;
temporary or permanent limitations on the activities, functions, or operations of
such firm or person;
a civil money penalty of up to $100,000 for an individual or $2,000,000 for
accounting firms; and
up to $750,000 for an individual and $15 million for firms in the case of intention-
al misconduct or repeated instances of negligent conduct.
B. New Provisions Governing Auditor Independence
The Act contains new restrictions on the services which may be offered by public
accounting firms to their audit clients. Beginning 180 days after the Board begins
operations, such firms are precluded from providing, contemporaneously with audits,
any non-audit services. Non-audit services are broadly defined to include:
bookkeeping;
financial information systems design and implementation;
appraisal or valuation services, fairness opinions or contribution-in-kind reports;
Public accounting firms
may not provide non-audit
services to their audit
clients.
p 11
If you know what
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where to find them, daily
operations should run
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compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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actuarial services;
internal audit outsourcing services;
management functions or human resources;
broker or dealer, investment advisor or investment banking services; and
legal and expert services unrelated to the audit.
The Act requires that the lead audit partner and reviewing audit partner of a public
companys auditor be changed every five years. The Act does not require that a public
company rotate its audit firm but does instruct the Comptroller of the United States
to conduct a study of the advisability of mandatory firm rotation.
A new prohibition against conflicts of interest is contained in the Act. No registered
accounting firm may perform audit services for a client if the clients CEO, CFO,
Controller, or Chief Accounting Officer was employed by the audit firm during the
one-year period prior to the audit.
IV. Expansion of SECs Enforcement Powers and New Criminal
Penalties
The Act expands the SECs enforcement powers in several important ways. First the
Act provides that any violation of the Act is deemed a violation of the Exchange Act,
thus empowering the SEC to use the full range of powers, remedies and penalties
available under the Exchange Act. In addition, as mentioned above, the SEC is given
authority to temporarily freeze extraordinary payments to directors, officers and
employees of companies under investigation. The Act also significantly increases
appropriations for the SECs enforcement staff which will give the SEC more
resources to enforce the Act aggressively.
The Act also adds potentially extraordinary new criminal penalties for violation of the
Act and for other corporate conduct that formerly was sanctioned principally through
the regulatory enforcement and civil proceedings, with prosecution being a relatively
infrequent occurrence. New criminal offenses include:
a new felony for altering, destroying, concealing or falsifying documents with the
intent to obstruct or influence the investigation of any matter within the jurisdic-
tion of any department or agency of the United States, including actions taken with
respect to such records in contemplation of any such investigation, with a maxi-
mum 20-year sentence;
a new felony for knowingly and willfully violating the new five-year work paper
retention requirement for corporate audit records, with a maximum 10-year sentence;
Any violation of the Act is
deemed a violation of the
Exchange Act.
The Act also adds potential-
ly extraordinary new
criminal penalties for viola-
tion of the Act and for other
corporate conduct.
p 12
If you know what
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where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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a new felony for securities fraud, making it a crime to knowingly (1) execute a
scheme or artifice to defraud any person in connection with any security of a pub-
lic company, or (2) obtain any money or property in connection with the purchase
or sale of a security of a public company by false pretenses, a broad new statute
with a maximum 25-year sentence; and
a new felony for a CEO or CFO to provide the financial statements certification
required by the Act knowing the certification is inaccurate. A knowing violation
carries a maximum fine of $1 million and imprisonment for up to 10 years; a will-
ful violation carries a maximum fine of $5 million and imprisonment for up to 20
years. Significantly, the Act does not define knowing and willful for purposes of
this provision.
The Act also increases penalties for existing white collar crimes, as follows:
the maximum sentence for willful violations of the Exchange Act is increased from
10 years to 20 years and the maximum fine is increased from $1 million to $5 mil-
lion;
the maximum sentence for mail fraud and wire fraud is increased from 5 years to
20 years; and
the maximum sentence for defrauding of a pension fund is increased from 1 year to
10 years.
Under the Act, the United States Sentencing Guidelines are to be reviewed, essential-
ly to ensure that sentences adequately reflect what Congress perceives to be the seri-
ousness of corporate misconduct and misconduct by officers and directors of public
companies. The Sentencing Commission may well issue stringent new sentencing
guidelines or amendments to existing guidelines after undertaking this review. The
Act requires that such new guidelines or amendments be promulgated not later than
January 26, 2003.
V. Miscellaneous Provisions
A. Regulation of Attorneys
The Act also regulates the conduct of attorneys (both in-house and outside counsel)
appearing and practicing before the SEC in the representation of public companies.
The Act instructs the SEC to issue final rules by January 26, 2003, setting forth mini-
mum standards of professional conduct for such attorneys, including a rule requiring
attorneys to report evidence of a material violation of securities laws or a breach of
fiduciary duty or similar violation by the company to the chief legal counsel or the
p 13
If you know what
documents exist and
where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
Choate Alert
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chief executive officer of the company and, if the counsel or officer does not appro-
priately respond to the evidence, to then report the evidence to the audit committee
or to the board of directors.
These requirements appear to alter the ethical obligations generally thought to be
imposed on lawyers currently and raise questions as to how they would operate in
practice. The rules to be promulgated by the SEC may provide some clarification.
B. New Rules for Securities Analysts
The Act adds a new provision to the Exchange Act, requiring that rules be adopted
within one year to address conflicts of interest that can arise when securities analysts
recommend equity securities in research reports and public appearances. The provi-
sion is designed to improve the objectivity of research and provide investors with
more useful and reliable information. These rules will restrict prepublication clear-
ance or approval of research reports, limit the supervision and compensatory evalua-
tion of securities analysts to officials employed by broker dealers who are not engaged
in investment banking, and preclude broker dealers from retaliating against or threat-
ening to retaliate against securities analysts employed by the broker dealer as a result
of an adverse negative or otherwise unfavorable research report. Securities analysts
will be required to disclose in each research report conflicts of interest, including
whether the analyst has debt or equity investments in the company, whether compen-
sation has been received from the company, whether the company is a client of the
registered broker dealer, and other matters.
C. Longer Statute of Limitations for Civil Securities Fraud Actions
The Act extends the statute of limitations for civil securities fraud cases significantly.
Currently, a private action for securities fraud must be filed within one year of the
date of discovery and a maximum of three years after the alleged violation. Under the
Act, such actions may be filed as late as two years after discovery and as late as five
years after the date of the alleged violation. Companies should review their director
and officer liability insurance policies in light of this change and discuss the effects
with their insurance providers.
D. No Discharge of Securities Law Liabilities in Bankruptcy
Effective immediately, the Act amends the United States bankruptcy code so that
debts arising under claims relating to federal or state securities law violations or any
securities fraud or manipulation cannot be discharged.
Securities analysts will be
required to disclose in each
research report conflicts of
interest, including whether
the analysts had debt or
equity investments in the
company, whether compen-
sation has been received
from the company, and
whether the company is a
client of the registered bro-
ker dealer.
The Act extends the statute
of limitations for civil secu-
rities fraud.
p 14
If you know what
documents exist and
where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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E. Protection of Whistleblowers
The Act includes a civil remedy to employees of public companies who provide evi-
dence of fraud to others. In addition, all employers, not just public companies, should
be aware that the Act creates a new broad new criminal penalty for retaliation against
whistleblowers. Under the Act, it is now a felony punishable by 10 years imprison-
ment to knowingly, with the intent to retaliate take any action harmful to any per-
son, including interference with the lawful employment or livelihood of any person,
for providing to a law enforcement officer any truthful information relating to the
commission or possible commission of any Federal offense.
p 15
If you know what
documents exist and
where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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This Alert is a summary of the Act for general informational purposes and is not a
full analysis or legal advice, which must be based on specific facts. You should seek
specific legal advice before acting on any of the subjects discussed above.
CORPORATE DEPARTMENT
James A. McDaniel William P. Gelnaw, Jr. James W. Hackett Jr.
617 248 5280 617 248 5034 617 248 2133
jmcdaniel@choate.com wgelnaw@choate.com jhackett@choate.com
Richard N. Hoehn Robert V. Jahrling Frederick P. Callori
617 248 5041 617 248 5148 617 248 5239
rhoehn@choate.com rjahrling@choate.com fcallori@choate.com
William C. Rogers
617 248 5043
wrogers@choate.com
GOVERNMENT ENFORCEMENT PRACTICE GROUP
R.J. Cinquegrana Diana K. Lloyd John R. Baraniak, Jr.
617 248 4002 617 248 5163 617 248 2114
rjcinquegrana@choate.com dlloyd@choate.com jbaraniak@choate.com
p 16
If you know what
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where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
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Annex A: Effecti ve Dates of Pri nci pal Provi si ons of the Act
Action Effective Date
CEO/CFO Certication of Financial Reports
CEOs and CFOs are required to provide civil and criminal
certication as to the accuracy of nancial statements and other
disclosures in periodic reports.
SEC is required to issue
rules requiring civil
certication within
30 days. Criminal
certication appears
to become effective
immediately.
New Requirements Relating to Audit Committees
Audit committees must be comprised entirely of independent,
outside directors.
The audit committee is required to hire and oversee auditors.
Audit committees must establish certain procedures.
Audit committees have the authority to engage independent
counsel and advisers.
SEC is required to issue
rules within 270 days.
Prohibition on Loans to Executive Ofcers and Directors
Prohibition on most personal loans from companies to directors
and executive ofcers.
Prohibited loans that are currently in existence cannot be modi-
ed or renewed.
Immediate.
Revised Section 16 Reporting Requirements
Accelerates disclosure of transactions by directors, executive
ofcers and 10% owners to two business days following the
execution of the transactions.
Form 4 must be led electronically.
30 days for two business
day ling obligation.
Electronic ling obligation
to start no later than one
year after enactment of
the Act.
Insider Trading During Pension Fund Blackouts Periods
Prohibits Directors and ofcers from trading in company stock
during a pension fund blackout.
180 days.
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Action Effective Date
Improper Inuence on Audits
Prohibits insiders from improperly inuencing auditors for the
purpose of rendering nancial statements materially misleading.
SEC required to propose
rules within 90 days and
issue nal rules within 180
days.
Forfeiture of Bonuses and Trading Prots by CEO and CFO
CEOs and CFOs required to disgorge incentive compensation
and trading prots after restatements of nancial statements
based on misconduct.
Immediate.
Temporary Freeze of Payments
Extraordinary payments to ofcers, directors and afliated per-
sons can be temporarily frozen during an investigation of pos-
sible federal securities law violations by a company or any such
persons.
Immediate.
Ofcer and Director Bars
SEC has authority to disqualify individuals from serving as di-
rectors and ofcers.
Real Time Disclosure
Requires companies to report material changes to their nancial
condition or operations on a rapid and current basis.
Requires SEC
implementing rules.
No required date for
implementing rules.
Additional Financial Disclosures in Periodic Reports
Disclosure of pro forma nancial information must be recon-
ciled with GAAP.
Off-balance-sheet accounting and the use of special purpose en-
tities must be disclosed.
SEC required to issue rules
within 180 days.
Management Assessment of Internal Controls
Provides that a companys annual report contain an internal
control report.
Requires SEC to
implement rules.
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Action Effective Date
Code of Ethics for Senior Financial Ofcers
Companies must disclose in their periodic reports whether they
have established corporate codes of ethics for senior ofcers,
and if not, why they havent established a code of ethics.
Also requires companies to disclose any waivers of or changes
in their code of ethics.
SEC is required to propose
rules within 90 days and
issue nal rules within 180
days.
Disclosure of Audit Committee Financial Expert
Companies must disclose whether there is a nancial expert
on the audit committee.
SEC is required to issue
rules within 270 days,
except for rule requiring
disclosure of nancial.
Increased Frequency of SEC Review
SEC will review a companys lings at least once every three
years.
Frequency of review will depend on factors such as market capi-
talization and stock price volatility.
Immediate.
Creation of the Public Accounting Oversight Board
Establishes a self-regulatory auditor oversight board, subject to
SEC oversight.
The board will establish auditing standards, but could instead
defer to the rules of a private body like the AICPA.
The board would annually inspect rms that audit more than
100 public companies, and inspect all other rms at least once
every three years.
The board will have the power to investigate and discipline
rms and accountants.
Board must be ready to be
certied by the SEC within
270 days. Audit rms must
be registered within 180
days of that certication.
New Provisions Governing Auditor Independence
Auditors are prohibited from providing eight categories of non-
audit services contemporaneously with an audit.
All other non-audit services must be pre-cleared by the audit
committee.
Audit partner for a company must be rotated every ve years.
See Public Accounting
Oversight Board above.
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CHOATE HALL & STEWART Exchange Place Boston MA 02109 | t 617 248 5000 f 617 248 4000 | www.choate.com
If you know what
documents exist and
where to find them, daily
operations should run
more smoothly and
compliance with govern-
ment regulations should
be assured.
If you would like to consult
with Choate attorneys on
your companys document
management and retention
program, contact either
partners:
Kevin Lesinski: 617 248 5233
Diana Lloyd: 617 248 5163
Choate Alert
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A
}
Action Effective Date
Criminal Provisions
Denes new criminal offenses involving conspiracy, fraud and
violation of securities law and direct the United States Sentenc-
ing Commission to review sentencing guidelines for certain
white collar and other crimes.
Appears to be
immediate.
Regulation of Attorneys
Requires attorneys to report evidence of material securities law
violations or breaches of duciary duty to the general counsel
or CEO.
If they do not respond appropriately, attorney must report the
evidence to the audit committee or full board.
SEC required to establish
rules within 180 days.
New Rules for Securities Analysts
Directs SEC or self-regulatory organizations to adopt rules gov-
erning research analyst conicts of interest.
NASD and NYSE already approved rules that would comply
with this requirement.
SEC or SRO must adopt
rules within one year.
Longer Statute of Limitations for Civil Securities Fraud Actions
Extends statute of limitations in private securities fraud actions
from three years to ve years.
Immediate. Applies only to
actions commenced after
enactment.
Whistleblower Protection
Provides job protection against retaliation for employees of
companies who provide information regarding violation of se-
curities or antifraud laws.
Immediate.
No Discharge of Securities Law Liabilities in Bankruptcy
Disallows discharge in bankruptcy of debts arising under securi-
ties law claims
Immediate.