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May 5, 2003New audit coMMittee requireMeNts for listed coMpaNies as well as code of ethics disclosure requireMeNts for all reportiNg coMpaNies uNder sarbaNes- oxleyContactThis memorandum highlights some of the new requirements that will Rick AlsipPartner, Louisville apply to audit committees of domestic reporting companies listed on 502.562.7298an exchange or Nasdaq under the SEC’s recent rule-making under ralsip@wyattfirm.com1Sarbanes-Oxley . These new rules became effective April 25, 2003, This article is intended and direct the exchanges and Nasdaq to have final listing standards for educational purposes only and is not intended adopted and approved by the SEC by December 1, 2003 which pro-as legal advice. This article hibit the initial or continuing listing of any security of a company that is considered attorney advertising in some 2fails to meet these new requirements . Listed domestic companies jurisdictions.must be in compliance with the new listing rules by the earlier of their first annual shareholders’ meeting after January 15, 2004, or October 31, 2004, except for small business companies who have until January 1, 2005 to comply.Although these audit committee re- of certain amendments or waivers to quirements will only apply to listed their code of ethics) beginning with the companies, listed companies as well annual report for their first fiscal year as other reporting companies that are ending after July 15, 2003. L O U I S V I L ...
Voir
Contact
Rick Alsip
Partner, Louisville
502.562.7298
ralsip@wyattfirm.com
This article is intended
for educational purposes
only and is not intended
as legal advice. This article
is considered attorney
advertising in some
jurisdictions.
LO U I S V I L L E
. K Y
L E X I N GTO N
. K Y
B O W L I N G G R E E N
. K Y
N E W A L B A N Y
. I N
N A S H V I L L E
. T N
M E M P H I S
. T N
J AC K S O N
. M S
F O R T C O L L I N S
. C O
W W W.
W YAT T F I R M
. C O M
This memorandum highlights some of the new requirements that will
apply to audit committees of domestic reporting companies listed on
an exchange or Nasdaq under the SEC’s recent rule-making under
Sarbanes-Oxley
1
. These new rules became effective April 25, 2003,
and direct the exchanges and Nasdaq to have final listing standards
adopted and approved by the SEC by December 1, 2003 which pro-
hibit the initial or continuing listing of any security of a company that
fails to meet these new requirements
2
. Listed domestic companies
must be in compliance with the new listing rules by the earlier of their
first annual shareholders’ meeting after January 15, 2004, or October
31, 2004, except for small business companies who have until January
1, 2005 to comply.
Although these audit committee re-
quirements will only apply to listed
companies, listed companies as well
as other reporting companies that are
not listed companies will be subject to
additional audit committee and auditor
independence requirements, which are
discussed in a separate memorandum.
This memorandum also highlights the
new code of ethics disclosure require-
ments for domestic reporting compa-
nies as implemented by the SEC under
Sarbanes-Oxley
3
. These disclosure re-
quirements apply to all domestic report-
ing companies, regardless whether they
are listed on an exchange or Nasdaq.
These rules became effective March
3, 2003, and reporting companies
must begin complying with the rules
(including providing current disclosures
of certain amendments or waivers to
their code of ethics) beginning with the
annual report for their first fiscal year
ending after July 15, 2003.
Audit Committee
Requirements for Listed
Companies
Independence
Each member of the audit committee of
a listed company must be a member of
the board of directors and must oth-
erwise be independent. The following
summarizes the minimum criteria for
measuring independence established
in the SEC rules. Nasdaq and the
exchanges may impose (and their rule
proposals suggest that they intend to
May 5, 2003
New audit coMMittee requireMeNts for
listed coMpaNies as well as code of ethics
disclosure requireMeNts for all reportiNg
coMpaNies uNder sarbaNes-oxley
1
The final SEC rules regarding audit committee requirements for listed companies are contained in Release
Nos. 33-8220; 34-47654; IC-26001, available at http://www.sec.gov/rules/final/33-8220.htm. This paper
does not address the special requirements or treatment of investment companies, asset-backed issuers, foreign
private issuers or other specialized issuers.
2
It is important to note that the SEC makes clear that the exchanges and Nasdaq may adopt more stringent
audit committee and board requirements as part of their listing standards in addition to those required under
the new SEC rules.
3
The final SEC rules regarding code of ethics disclosures are contained in Release Nos. 33-8177; 34-47235,
available at http://www.sec.gov/rules/final/33-8177.htm.
W YAT T TA R R A N T & C O M B S L L P
impose) higher independence standards on audit com-
mittee members and determine the consequences for
failing to meet such standards, so long as the minimum
standards required by the SEC are met
4
.
To be independent, an audit committee 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 (e.g., board or committee fees):
•
accept directly or indirectly any consulting, advisory
or other compensatory fee from the company or any
subsidiary thereof
5
, or
•
be an affiliated person of the company or any subsid-
iary thereof.
•
An audit committee member will be deemed to have
accepted indirectly any consulting, advisory or other com-
pensatory fee if such a fee is accepted
•
by a spouse, a minor child or stepchild or a child or
stepchild sharing a home with the member, or
•
by an entity in which such member is a partner, mem-
ber, an officer such as a managing director occupying a
comparable position or executive officer, or occupies a
similar position (except limited partners, non-managing
members and those occupying similar positions who, in
each case, have no active role in providing services to the
entity) and which provides accounting, consulting, legal,
investment banking or financial advisory services to the
company or any subsidiary of the company. Other com-
mercial relationships (e.g., lending) are not covered by
this provision.
In determining whether an audit committee member con-
stitutes an affiliated person of the listed company or any
subsidiary thereof, the SEC’s existing concepts of affilia-
tion and control under the Exchange Act apply. Persons
will be deemed not to be in control of a specified person
for purposes of applying this provision if the person is not
the beneficial owner, directly or indirectly, of more than
10% of any class of voting equity securities of the speci-
fied person and is not an executive officer of the specified
person, though a person’s failure to qualify for this safe
harbor will not be construed as indicating that the person
is in control of a specified person unless control is actually
established under the circumstances. Executive officers,
directors who are also employees, managing members
and general partners of an affiliate will also be consid-
ered affiliates for purposes of applying this provision.
An exemption from the affiliation prohibition is provided
for companies that are just becoming listed companies
provided that there is at least one fully independent audit
committee member at the time of listing, a majority of ful-
ly independent members within 90 days of listing and all
fully independent members within one year of listing. An
audit committee member that sits on the board of direc-
tors of a listed company and an affiliate of the company
(e.g., a bank holding company and its bank subsidiary) is
also exempt from the affiliation prohibition if the member,
except for being a director on each such board of direc-
tors, otherwise meets the independence requirements
regarding affiliates for each such entity, including the
receipt of only ordinary-course compensation for serving
as a member of the board of directors, audit committee
or any other board committee of each such entity.
Note – If a listed company does not have an audit com-
mittee, the entire board of directors is deemed to be
performing the audit committee’s functions and must
satisfy each of the requirements described in this memo-
randum that would otherwise have been imposed on
the company’s audit committee, including the foregoing
independence requirements.
Responsibilities relating to auditors
Each listed company’s audit committee, in its capacity as
a committee of the board of directors, must be directly
responsible for the appointment, compensation, retention
and oversight of the work of any registered public ac-
counting firm engaged (including resolution of disagree-
ments between management and the auditor regard-
ing financial reporting) for the purpose of preparing or
issuing an audit report or performing other audit, review
or attest services for the company. In addition, each such
registered public accounting firm must report directly to
the audit committee.
Complaint procedures
Each listed company’s audit committee must establish
procedures for:
•
the receipt, retention and treatment of complaints
received by the company regarding accounting, internal
accounting controls or auditing matters, and
4
The current NYSE and Nasdaq rule proposals contain heightened standards of independence for audit committee members than those mandated
by the SEC rules. For example, these rule proposals mandate certain cooling off periods for directors previously employed by the company. The
rules would also consider a director to not be independent if the director was involved in a broader range of businesses doing business with the listed
company than the range of businesses addressed under the SEC rules.
5
Unless the rules of the exchange or Nasdaq provide otherwise, compensatory fees do not include the receipt of fixed amounts of compensation un-
der a retirement plan (including deferred compensation) for prior service with the listed company, provided that such compensation is not contingent
in any way on continued service.
W YAT T TA R R A N T & C O M B S L L P
•
the confidential, anonymous submission by employ-
ees of the company of concerns regarding question-
able accounting or auditing matters.
The SEC did not specify what specific procedures
should be adopted.
Ability to engage professional advisors
Each listed company’s audit committee must have the
authority to engage independent counsel and other
advisors, to the extent it deems necessary to carry out
its duties. According to the SEC, this authority may be
crucial for the audit committee to be able to secure
adequate outside expertise to carry out its functions,
particularly when a conflict with the company’s man-
agement arises.
Audit committee funding
Each listed company must provide for appropriate
funding, as determined by its audit committee in its
capacity as a committee of the board of directors, for
the payment of the following:
•
compensation to any registered public accounting
firm engaged for the purpose of preparing or issuing
an audit report or performing other audit, review or
attest services for the company;
•
compensation to any advisors employed by the
audit committee; and
•
ordinary administrative expenses of the audit com-
mittee that are necessary or appropriate in carrying
out its duties.
No funding limits are imposed under the SEC’s rules.
Again, these requirements are designed to enhance
the audit committee’s ability to perform its functions
independent of the company’s management, particu-
larly when a conflict with management arises.
Exemptions, ensuring compliance, ability
to cure violations, etc.
Under the SEC rules, the exchanges and Nasdaq
must adopt rules prohibiting the initial or continuing
listing of any security (not just equity securities) of a
company that does not satisfy the foregoing audit
committee requirements. The SEC rules address
and provide exemptions in certain situations involv-
ing multiple listings of different securities by a listed
company (including through subsidiaries), as well as
in other situations.
The rules adopted by the exchanges and Nasdaq also
must require an executive officer of a listed company
to promptly notify the exchange or Nasdaq, as ap-
plicable, of any material noncompliance with these
audit committee requirements. In addition, such rules
must provide the listed company with an opportunity
to cure any noncompliance with such requirements.
Such rules may also provide that to the extent that an
audit committee member ceases to qualify as inde-
pendent as a result of actions beyond such member’s
reasonable control, then upon notice to the exchange
or Nasdaq, the member may continue to serve on
the audit committee until the company’s next annual
meeting or one year from the date such member
ceased to be independent.
The SEC rules also provide some instruction on how
to address, and indicate that they do not conflict
with, situations in which a listed company’s govern-
ing law or documents or other home country legal or
listing provisions requires or permits shareholders to
ultimately vote on, approve or ratify some of items
covered by the new requirements (e.g., appoint-
ment of an auditor), or the listed company’s home
jurisdiction’s legal or listing provisions prohibit the full
board of directors from delegating some of the audit
committee’s responsibilities under the new require-
ments to the audit committee or limits the degree of
such delegation.
Audit committee disclosures
Listed companies will need to disclose in their an-
nual reports and proxy statements for shareholder
meetings at which directors will be elected their
reliance on any exemption from the foregoing listed
company audit committee requirements provided in
the SEC rules and how such reliance will materially
adversely affect the audit committee’s ability to act
independently and otherwise satisfy such require-
ments. In addition, listed companies must disclose
or incorporate into their annual reports the identity of
the members of their audit committees, and disclose
if the entire board serves as or performs the functions
of the audit committee. In light of the revised listing
standards the exchanges and Nasdaq are required to
adopt, conforming changes have also been made to
the existing proxy statement disclosure requirements
regarding audit committee independence.
W YAT T TA R R A N T & C O M B S L L P
B
Code of Ethics Disclosure
Annual code of ethics disclosure
All reporting companies (not just listed companies)
must disclose in their annual reports whether they
have a code of ethics for their principal executive of-
ficer, principal financial officer, principal accounting
officer or controller, or persons performing similar
functions. If the company does not have a code of
ethics for such persons, it must explain why. A code
of ethics is defined as written standards that are
reasonably designed to deter wrongdoing and 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 dis-
closure in reports and documents that the company
files with, or submits to, the SEC and in other public
communications made by the company;
•
compliance with applicable governmental laws,
rules and regulations;
•
the prompt internal reporting of violations of the
code to an appropriate person or persons identified
in the code; and
•
accountability for adherence to the code.
The SEC rules do not indicate specific language that
should be contained in the code of ethics, includ-
ing as to what specific compliance procedures and
disciplinary measures should be included. The SEC
acknowledges that a company may have a different
code of ethics for different types of officers.
Location of code of ethics
A reporting company has three choices in disclosing
or making available a copy of its code of ethics or
the portion thereof covering the applicable officers.
These choices include:
•
filing a copy of the code of ethics as an exhibit to its
annual report filed with the SEC;
•
posting the text of the code of ethics on its internet
website and disclosing, in its annual report, its inter-
net address and the fact that it has posted the code of
ethics on its internet website; or
•
undertaking in its annual report filed with the
SEC to provide to any person without charge, upon
request, a copy of the code of ethics and explain the
manner in which such request may be made.
Form 8-K or internet disclosure regarding
changes or waivers to code of ethics
A reporting company must file a Form 8-K within five
business days after it either amends its code of ethics
or grants a waiver thereof to the applicable officers.
Such filing must briefly describe:
•
the nature of any amendment to a provision of the
company’s code of ethics that applies to the com-
pany’s principal executive officer, principal financial
officer, principal accounting officer or controller, or
persons performing similar functions and that relates
to any item included within the definition of a “code
of ethics” under the SEC rules (i.e., if the amendment
relates to an item not addressed by such definition,
then no disclosure or filing is required), and
•
if the company has granted a waiver, including an
implicit waiver, from a provision of the code of ethics
to one of these officers or persons that relates to one
or more of the items included within the definition of
“code of ethics” under the SEC rules, the company
must briefly describe the nature of the waiver, the
name of the person to whom the waiver was granted,
and the date of the waiver.
As an alternative to such a filing, a reporting com-
pany may make such disclosure on its website within
the same five business day period provided that it has
disclosed in its most recent annual report its intention
to make such disclosures on its website as well as the
website address. Such disclosure must remain on
the company’s website for at least one year, and the
company must keep such information for at least five
years thereafter.
A waiver from the code of ethics arises when there
is a material departure from a provision of the code
that is approved by the company. An implicit waiver
arises when the company fails to act within a reason-
able time regarding a material departure from a
provision of the code that has been made known to
an executive officer of the company.
