The Sarbanes-Oxley Act

In light of the Enron scandal and other recent financial scandals in the US, on 30 July 2002 George Bush signed a new federal act into law, the so-called Sarbanes-Oxley Act, in order to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.

Among the issues regulated by the Sarbanes-Oxley Act are remuneration of board members and management, auditing, disclosure obligations, and corporate governance in general. The act focuses on the individuals responsible in listed companies within these areas, i.e. CEOs, CFOs, directors serving on audit committees, corporate legal counsels and independent auditors.

In the US, the Sarbanes-Oxley Act is expected to have a significant impact on these areas, but, moreover, it has already affected similar regulatory measures in the EU (see the article also on this News site on Modernisation of the EU Company Law).

The act prescribes, among other things:

  • that CEOs and CFOs shall return any bonus or other incentive-based or equity-based compensation and any profits realised from the sale of securities in the company that the officer has received during the 12-month period prior to publication of a financial statement that has to be restated as a result of misconduct,

  • that directors and executive officers are prohibited from trading in securities in the company, which they have received as remuneration, during blackout periods applying to the company's pension plans,

  • that it shall be unlawful to issue or extend existing loans or credit to directors or executive officers,

  • increased disclosure requirements, including publication in annual and quarterly reports of all off-balance sheet transactions that may have a material effect on the company's financial condition,

  • that CEOs and CFOs shall certify in writing each periodic report containing financial statements, including that the report fairly presents the financial condition and results of operation of the issuer, and that they have designed efficient internal control procedures in order to ensure that material information concerning the company is made known to them,

  • that the Securities and Exchange Commission (SEC) shall be entitled to bar individuals, temporarily or permanently, from serving as directors or officers if they are unfit for such duties (previously, the SEC could only institute legal proceedings before the courts and only regarding persons that were substantially unfit),

  • that the SEC shall issue standards of conduct for attorneys appearing and practising before the SEC, including a rule requiring attorneys to report evidence of material violations of securities law or similar violation to the chief legal counsel or CEO of the company or, if the counsel or CEO does not appropriately respond to the evidence, to the audit committee,

  • that companies shall have an audit committee consisting of independent directors that shall be responsible for the appointment, compensation and oversight of the work of the auditors employed by the company, and

  • that auditors shall be independent, that they may not be elected for more than 5 years in succession, and that it shall be unlawful for the auditors to provide to the company in which they have been elected auditors any non-audit service.

The act came into force upon the signature on 30 July 2002. Certain provisions have immediate effect, but the major part requires implementation measures to be carried out by the SEC and the American stock exchanges. To a large extent, these measures have already been carried out. Thus, the NYSE and NASDAQ have tightened their listing rules, including by the following requirements:

  • The majority of the members of the board of directors must be independent.

  • All equity-based remuneration schemes must be approved by the general meeting, and management incentive programmes must be approved by a majority of independent directors (the latter is only required by NASDAQ).

  • All issuers must establish a code of ethics.

Furthermore, no later than 1 year from the coming into effect of the act, the SEC or the American stock exchanges must provide rules on the conflict of interest that arises when security advisors publish recommendations concerning certain shares while at the same time carrying out investment activities.

Companies registered outside the US will, to a large extent, also be affected by the Sarbanes-Oxley Act, as it applies to all issuers, irrespective of their country of origin, that are listed at an American stock exchange, registered or otherwise obliged to notify the SEC, or have filed and not withdrawn a registration statement with the SEC.

By Gitte Lansner, attorney-at-law