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Leslie Bonacum
Neil Allen

Final Rules On Sarbanes-Oxley Mark End Of Chapter, But Not Last Word On Securities Reform, According To CCH

CCH Outlines SEC Rules and Outstanding Reform Issues

(RIVERWOODS, ILL., January 24, 2003) – On the heels of news that more than one-half of households now own stock and with a congressionally mandated deadline looming, the Securities and Exchange Commission (SEC) finalized some of the more controversial rules ordered under the Sarbanes-Oxley Act of 2002. In back-to-back meetings on Wednesday and Thursday, the SEC issued rules that affect publicly traded companies, as well as their accountants and attorneys and the mutual funds industry. All this, and the rulemaking is not done yet, according to CCH INCORPORATED (CCH), a leading provider of securities law information and software.

"Organizations have a lot to digest from just this week’s rulemaking activity, sifting through the final rules, figuring out how they apply and how their firms will meet the deadlines for compliance, which, in some instances are within the next few months," said James Hamilton, JD, senior securities law analyst for CCH.

"And, there are still some important rules to be finalized, including high-profile issues such as research analyst conflict of interest and a final decision on whether or not attorneys will be required to alert the SEC of corporate wrongdoing," Hamilton added.

Following, CCH provides an overview of the final rules the SEC issued this week as well as an outline of key items that still remain undecided.

Final Rulemaking

Auditor Independence

When this rule goes into effect this spring, accounting firms will be federally barred for the first time from providing specific services to their audit clients, including: bookkeeping or other services related to accounting records or financial statements; financial information systems design, appraisal or valuation services; actuarial services; management functions or human resources; broker or dealer or investment advisor services; and legal services.

The SEC, however, did back away from restricting auditors from providing tax planning services. Under the new rules these services, including tax compliance and tax advice, will be allowed as long as the company’s audit committee approves. The SEC limits this work to areas that don’t impair the independence of the accountant and the rule does restrict accounting firms from representing a client before tax court or other areas of advocacy. Companies also will have to disclose to investors total fees paid to auditors, whether for non-audit or audit work.

Additionally, accounting firms will have to rotate their lead partner (the partner in charge of the audit engagement) every five years and rotate non-lead auditors every seven years. Following five years with a client, the rules require a lead partner to satisfy a five-year cooling off period before returning to auditing that client; a two-year cooling-off period is required for those under the seven-year rotation. The new rules also bar accountants from earning compensation for non-audit services from a company they are auditing.

Another cooling-off period applies to auditors who go to work as employees for a client. These individuals are barred from undertaking certain positions within a company they’ve audited within the past year.

Smaller accounting firms got some relief. Firms with fewer than five audit clients and fewer than 10 partners may be exempt from the partner rotation rules and compensation rules provided that the exempted firms are reviewed by the Public Company Accounting Oversight Board every three years. However, foreign firms, which hoped to avoid most of the Sarbanes-Oxley standards, must comply with the partner rotation provisions as well as the cooling off periods, according to CCH.

These rules become effective 90 days after they’re published in the Federal Register.

Record Retention Rules

In accordance with Section 802 of the Sarbanes-Oxley Act, the SEC passed rules requiring auditors to hang on to more audit-related documents for a longer period of time.

Under the new rules, auditors must retain records relevant to audits and reviews of financial statements, including workpapers, for a minimum of seven years after the audit or review is filed with the SEC. The current timeframe is just five years.

The definition of relevant documents also was expanded and further defined with workpapers to include "those documents that record the audit or review procedures performed, the evidence obtained, and the conclusions reached by the auditor."

Compliance with this rule must begin by October 31, 2003.

Attorney Professional Standards

Perhaps even more controversial than the auditor independence rules has been the proposal to federally regulate attorney conduct. Under Section 307 of Sarbanes-Oxley, that will now be the case.

Specifically, these rules require attorneys – including both in-house and outside counsel – to report evidence of a material violation of securities law or breach of fiduciary duty by a company or one of its agents to the company’s chief legal counsel or the chief executive officer. If the officials do not appropriately respond, the attorney must report the evidence to the company’s audit committee or to its board of directors.

These rules will go into effect six months after being published in the Federal Register.

However, the SEC tabled, for the time being, the most contentious part of the proposal, which had required an attorney to make a noisy withdrawal – essentially quitting and informing the SEC of the reason - if the directors of the company did not act appropriately after learning of the violation.

The SEC hasn’t abandoned the idea, but is seeking additional input on the noisy withdrawal clause over the next 60 days before making a final ruling on this. It’s also proposing alternative approaches, whereby the company, instead of the attorney, would have to publicly disclose either the attorney’s withdrawal or the attorney’s written notice that he or she was not satisfied with the response the company made to a possible material violation. Such disclosure would be made via forms 9-K, 20-F or 40-R.

"In the rules on lawyer conduct, the SEC wants to make it clear that lawyers for public companies work for the stockholders and not for management," said Hamilton. "If the lawyer believes there is wrongdoing, the rule creates an obligation and proper path for the lawyer to address the concerns. Adoption of the noisy withdrawal would extend this path outside the firm directly to the SEC."

Management Certification of Mutual Fund Shareholder Reports

Even before passage of the Sarbanes-Oxley Act, the SEC had adopted rules requiring CEOs and CFOs of publicly held companies to certify their company’s financial reports. Now, under Section 302 of Sarbanes-Oxley, investment companies will have to file shareholder reports on Form N-CSR and the reports will have to be certified by management.

As is already required of publicly held companies, investment companies will also now be required, under Sections 406 and 407 of Sarbanes-Oxley, to disclose whether they have adopted a code of ethics for senior officers and disclose any waivers from the code. Finally, the rule requires at least one financial expert on the audit committee of an investment company.

These are among the fastest of the final rules to go in effect, with compliance required 30 days after their publication of the rules in the Federal Register.

Proxy Voting Disclosure

Mutual funds and other investment companies will be required to disclose to investors how they voted shares they hold in individual companies under amendments adopted by the SEC this week. Investment companies also must disclose the policies and procedures they used to determine how they voted their shares and file this information annually with the SEC.

Although the mutual fund industry offered qualified support for the SEC’s proposal, it objected to requirements to disclose detailed information about each and every proxy vote cast. This mandate, the industry contended, would subject funds to substantial new costs and burdens with no measurable benefit to shareholders and possibly politicize the process of voting proxies.

This rule goes into effect August 31, 2004.

The SEC also unanimously approved a rule requiring investment company advisors to adopt written procedures over their proxy voting policies and procedures, with information on how investors can get voting information.

These rules become effective 180 days after Federal Registration publication.

Greater MD&A Disclosure

The SEC also approved rules on off-balance sheet activity, to implement Section 401(a) of Sarbanes-Oxley. The rules require companies to include a special subsection within the Management’s Discussion and Analysis section of their disclosure documents to discuss off-balance sheet arrangements and to show a table of payments under specified contractual obligations. The MD&A is part of the disclosure documents companies are required to file quarterly and annually with the SEC.

The rule states the SEC will define "off-balance sheet" activity by looking at concepts in accounting literature, and in general include the following items: guarantee contracts; retained or contingent interests in assets transferred to an unconsolidated entity; derivatives classified as equity; and material variable interests in unconsolidated entities.

Compliance will have to begin in filings to the SEC for the fiscal years ending June 15, 2003 for off-balance sheet disclosure or Dec. 15, 2003 for contractual obligations disclosure.

Unfinished Business

While the last week has seen a whirlwind of activity to meet the congressionally mandated January 26, 2003, deadline for many of the requirements under Sarbanes-Oxley, securities reform continues.

In addition to a final ruling on whether or not to adopt the noisy withdrawal proposal as part of the attorney professional standards, other hot issues still to be ruled on are:

Improper Influence on Conduct of Audits

The Sarbanes-Oxley Act also directed the SEC to create rules prohibiting a company’s officers and directors – and others acting under the direction of these individuals – from attempting to "fraudulently influence, coerce, manipulate or mislead" an auditor with the intent of making the company’s financial statements misleading.

"The proposed rules under Sarbanes-Oxley will provide the SEC with an additional means to discourage such conduct, as well as help enhance the credibility of financial statements," said Hamilton.

Hamilton also points out that the SEC is interpreting the phrase under the direction of a company’s officers or directors to include not just employees under these individuals’ supervisions, but also could include company employees, as well as customers, vendors or creditors who, under the direction of an officer or director, provide false or misleading information to auditors.

The Commission is to issue final rules on this by the end of April.

Securities Analysts Conflicts of Interest

A final piece of unfinished business is the requirement imposed by Section 501 of Sarbanes-Oxley that the SEC, an exchange or securities association adopt rules designed to address conflicts of interest facing securities analysts. The rules must be drafted to foster greater public confidence in securities research and protect the objectivity and independence of stock analysts who publish research intended for the public.

Rules on this must be adopted by July 30, 2003.


CCH INCORPORATED, founded in 1913, has served four generations of business professionals and their clients. The company produces approximately 700 print and electronic products for securities, tax, legal, banking, securities, human resources, health care and small business markets. CCH is a wholly owned subsidiary of Wolters Kluwer North America. The CCH web site can be accessed at The CCH Business and Finance Securities Group web site can be accessed at

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Editor’s Note: Ongoing analysis of securities law reform is at


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