Year-End Sarbanes-Oxley Score Card: The Effective Dates Keep Rolling In

Thursday, January 1, 2004 - 01:00
Peter H. Ehrenberg
Katherine Varker

One of the most difficult aspects of providing advice regarding Sarbanes-Oxley developments is remembering the phase-in periods for regulations that do not become immediately effective. As we approach the 2004 New Year, we write this article to remind practitioners of the changes taking effect in applicable disclosure rules.

We begin with the good and the bad news for public issuers. On the "good news" side, in June of 2003, the SEC announced that implementation of the requirement (imposed pursuant to Section 404 of the Sarbanes-Oxley Act) that issuers publish a report on internal control over financial reporting has been deferred for an additional year. Accelerated filers will not be required to include an internal controls report in their annual report on Form 10-K until they file their annual report for their first fiscal year ending on or after June 15, 2004. In general, an "accelerated filer" is a reporting company which has at least $75,000,000 of voting and non-voting securities owned by non-affiliates. For a given fiscal year-end, the test is applied as of the last day of the issuer's second quarter.

Similarly, accelerated filers will not be required to include the attestation from their auditors (to the effect that their auditors concur with their internal controls report) until the filing of the 10-K for the first fiscal year ended on or after June 15, 2004. All filers that are not accelerated filers, including foreign private issuers, will have an additional ten months before Section 404 becomes effective.

Now, for the bad news: the accelerated filing schedule announced by the SEC on September 5, 2002 becomes operative in 2004. For accelerated filers, the 10-K for their first fiscal year ended on or after December 15, 2003 must be filed within 75 days (as opposed to 90 days) after year-end. The following year, that period is shortened again to 60 days. Once the period is reduced to 60 days for the 10-K, the next three quarterly reports on Form 10-Q will be due within 40 days (as opposed to 45 days) after the end the quarters. During the following year, that time period is shortened to 35 days.

Other phase-in periods, most of which should be less traumatic than the implementation of the Section 404 and accelerated filing rules, are described below:

Code Of Ethics

Issuers with fiscal years ended after July 15, 2003 are required by Item 10 of Form 10-K and Item 406 of Regulation S-K to disclose in their annual reports on Form 10-K whether or not they have a code of ethics applicable to their principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Issuers that have such codes of ethics are required to file such codes of ethics as new Exhibit 14 to their annual report on Form 10-K. Additionally, such issuers must either post their code of ethics on their website and disclose the location of such posting in their annual report or must confirm in their annual report that they will make copies of their code of ethics available for investors upon request and explain how such requests are to be made. Issuers that do not have such codes of ethics in effect are required to disclose why they have not implemented such codes of ethics. These disclosure obligations are not to be confused with the rules of the New York Stock Exchange and NASDAQ, which generally extend beyond the requirements of Regulation S-K.

Availability Of SEC Filings

Issuers should recall that last year, the SEC amended its 10-K disclosure rules to require accelerated filers to disclose in their annual report:

• the issuer's website address, if it has one;

• whether the issuer makes available, free of charge or through its website, its SEC reports, "as soon as reasonably practicable after such material is electronically filed with or furnished to the Commission";

• if the issuer does not make such filings available on its website, an explanation as to why it does not do so; and

• if the issuer does not make such filings available on its website, whether it will provide electronic or paper copies of its filings free of charge upon request.

Audit Committee Financial Expert

Commencing with fiscal years ended on or after July 15, 2003, issuers are required by Item 10 of Form 10-K and Item 401(h) of Regulation S-K to identify the name of at least one "audit committee financial expert" who is a member of the issuer's audit committee and to disclose whether such individual meets the independence test set forth in Item 7(d)(3)(iv) of the SEC's Schedule 14A. The SEC permits, but does not require, issuers to disclose the identities of other audit committee members who also may satisfy the definition of an "audit committee financial expert". The definition of "audit committee financial expert" is set forth in Item 401(h)(2) of Regulation S-K.

Principal Accounting Fees And Services

Commencing with the 10-K for fiscal years ended on or after December 15, 2003, issuers are required by new Item 14 of Form 10-K to disclose two years of information regarding the fees paid to their independent auditors. Since Item 14 of the 10-K is now included in Part III of the 10-K, issuers may incorporate a proxy statement disclosure regarding such fees and services into the 10-K, provided that the definitive proxy statement is mailed to stockholders no later than 120 days after year-end.

Repositioning Of Controls And Procedures Disclosure

So as to confuse all practitioners, the "controls and procedures" disclosure has been moved from Item 14 of the 10-K to a new item 9A of the 10-K, which is included in Part II of the 10-K.

Issuer Repurchases

On November 10, 2003, the SEC finalized its amendments to Rule 10b-18, a regulation that erects a safe harbor for certain issuer repurchases of their own securities. In the same release but unrelated to the 10b-18 safe harbor, the SEC now mandates a new disclosure table, applicable for quarterly and annual reports, describing issuer repurchases during the immediately preceding quarter. This rule goes into effect for periods ending on or after March 15, 2004. Thus, for calendar year issuers, this rule will go into effect with respect to quarterly reports filed for the period ending March 31, 2004.

Audit Committee Charter And Composition

Several years ago, the proxy rules were amended to require issuers to set forth, as an appendix to their proxy statements, a copy of the audit committee's charter, unless a copy of the charter was filed by the issuer within the past three fiscal years. The proxy rules also require issuers to indicate whether each of the members of their audit committee are "independent" within the description of "independence" in the listing standards applicable to them. If any one of the members of the audit committee is not independent by virtue of a listing standard permitting one exception to the independent audit committee requirement, the proxy statement must disclose the nature of the relationship that makes such individual not independent and the bases for the Board's determination that exceptional or limited circumstances exist for including such non-independent director on the audit committee.

Reconstituting The Board Of Directors

Both the Nasdaq and the New York Stock Exchange have recently adopted rules defining director independence and requiring issuers to take certain steps relating to the independence of Board decisions. Thus, for example, the Nasdaq rules (subject to exceptions for so-called "control corporations" and subject to exceptions permitting one non-independent director in certain limited circumstances):

• require that the majority of the directors on the board of a Nasdaq-listed company be independent and that such issuers must disclose in their proxy statements which of their board members have been determined by their board to be independent;

• require that boards of Nasdaq-listed companies conduct regularly scheduled meetings attended solely by those members of the Board who are independent (executive sessions);

• require that compensation of the chief executive officer and all other officers must be determined (or recommended to the board for determination) either by a compensation committee consisting solely of independent directors or by a majority of the independent directors;

• require that nominations made by a board of directors (as distinct from nominations made by shareholders) for board service may only be made by a nominating committee comprised solely of independent directors or by a majority of the independent directors;

• preclude membership on the audit committee by persons who participated in the preparation of the financial statements of the issuer or its subsidiaries at any time during the past three years; and

• effective January 15, 2004, require that each "related party transaction" be approved on an ongoing basis either by an issuer's audit committee or by another independent body of the board of directors.

In general, compliance with these Nasdaq requirements must be achieved by the earlier of the issuer's first annual meeting of shareholders after January 15, 2004, or October 31, 2004.

New Disclosure Requirements Regarding Nominating Committees And Communications Between Shareholders And Boards Of Directors

The SEC has also implemented new disclosure rules relating to nominating committees and communications with the board of directors in time for this year's proxy season; the new proxy disclosures apply to all proxy statements first sent to shareholders on or after January 1, 2004. These new rules:

• require issuers to make a variety of disclosures regarding the manner in which directors are nominated and the extent of shareholder involvement in that process;

• require issuers to include in their proxy statements a statement as to whether or not their boards have a process for shareholders to follow in sending communications to the board, and either a statement disclosing the manner in which shareholders can send such communications or, if no such process exists, an explanation as to why the board believes it is appropriate not to have such a process; and

• require issuers to disclose in their proxy statements the issuers' policy, if any, with regard to board members' attendance at annual meetings and the number of board members who attended the prior year's annual meeting.


The SEC's new rules will undoubtedly cause havoc for those issuers who rely heavily on the prior year's disclosure documents in preparing their new disclosure documents. Inside and outside counsel cannot permit themselves to fall prey to that habit. Hopefully, the checklist set forth above will provide assistance in avoiding the many pitfalls presented by the SEC's transition rules.

Peter H. Ehrenberg is the Chairman of the Corporate Department and the Corporate Finance/M&A Practice Group of Lowenstein Sandler PC, based in Roseland, New Jersey. He can be reached at 973-597-2350. Katherine Varker is a member of the Corporate Department and the Corporate Finance/M&A Practice Group. She can be reached at 973-422-6430.

Please e-mail the authors at or with questions about this article.