On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “Act”) which contains substantial new requirements for public companies, the accounting firms that audit public companies and the lawyers providing legal services for public companies. A separate client advice memorandum from Dorsey & Whitney LLP gives further detail on the provisions of the Act.
The Act does not contain any express exemptions for foreign private issuers. Most of the provisions of the Act will become effective only when the SEC adopts implementing regulations. Because some provisions of the Act may conflict with non-U.S. rules and practices, we expect that when it adopts its regulations the SEC will consider the extent to which foreign private issuers and their auditors should be exempted from the Act’s requirements. We will be addressing these issues as they arise.
Certain provisions of the Act, however, are effective immediately (without the necessity of any implementing regulations from the SEC), and these provisions purport to apply both to U.S. public companies and foreign private issuers with reporting obligations under the Securities Exchange Act of 1934 (the “Exchange Act”). The purpose of this memorandum is to provide our foreign private issuer clients and their professional advisors with guidance as to issues raised by the Act that may require their immediate attention.
Certification of SEC Reports by CEOs and CFOs
Section 302 of the Act directs the Securities and Exchange Commission (the “SEC”) to adopt rules on or before August 30, 2002 that requires the principal executive officer or principal financial officer to certify in each annual or quarterly report filed pursuant to either Section 13(a) or 15(d) of the Exchange Act the following:
- the signing officer has reviewed the report;
- the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading;
- the financial information fairly present in all material respects the financial condition and results of operations of the issuer;
- the signing officers
- are responsible for establishing and maintaining internal controls;
- have designed such internal controls to ensure that material information relating to the issuer is made known to such officers by others;
- have evaluated the effectiveness of the issuer’s internal controls; and
- have presented in the report their conclusions about the effectiveness of their controls based on their evaluation as of that date;
- the signing officers have disclosed to the issuer’s auditors and the audit committee of the board of directors
- all significant deficiencies in the design or operation of internal controls; and
- any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer’s internal controls; and
- the signing officers have indicated whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation.
The Section 302 certification requirement only goes into effect when the SECs rules go into effect, which the Act directs the SEC to complete before August 30, 2002. The SEC announced today that it intends to adopt final rules “that would apply the [Section 302] certification requirement to foreign private issuers filing annual reports on Form 20-F and Canadian issuers filing Form 40-F.” See SEC Release No. 34-46300 (August 2, 2002)
In addition to the certification requirement of Section 302 of the Act, under Section 906 of the Act, effective immediately each periodic report filed by an issuer pursuant to Section 13(a) or 15(d) of the Exchange Act that contains financial statements must be accompanied by a written statement by the CEO and CFO certifying that:
- the report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act; and
- the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the issuer.
Section 906 provides that a CEO or CFO who certifies a report “knowing” that it does not comport with the certification is criminally liable for a fine of up to US$1,000,000 or imprisonment of up to 10 years, or both. If the CEO or CFO “willfully” certifies the report “knowing” that it does not comport with the certification he or she is liable for a fine of up to US$5,000,000, or imprisonment for up to 20 years, or both.
For purposes of the Section 906 certification requirement the term “issuer” would include:
- Any company with securities registered under Section 12 of the Exchange Act (which includes all companies with securities listed on a U.S. stock exchange, Nasdaq or the OTC Bulletin Board); and
- any company that is required to file reports with the SEC under Section 15(d) (which includes companies that have issued registered public debt in the U.S., even if they have no U.S. listed securities).
The Section 906 certification requirement is self executing and presently in effect. It is clear that this requirement applies to foreign private issuers when they file an annual report on Form 20-F or Form 40-F.
It is unclear how this requirement will apply to foreign private issuers submitting quarterly or semi-annual financial statements to the SEC under a Form 6-K. Section 906 of the Act applies to any “periodic report” which is “filed” pursuant to Section 13(a) or 15(d) of the Exchange Act. SEC Rule 13a-16 requires foreign private issuers to “make” reports on Form 6-K as opposed to the requirement under Rule 13a-1 to “file” an annual report. We believe there is a strong argument that reports on Form 6-K are not “filed” within the meaning of Section 906, and that certification of reports on Form 6-K is not required. Also, an argument can be made that Form 6-Ks are not “periodic” reports as there is no set time frame for filing under the Exchange Act and these filings only need to be made if required under the issuer’s local law or by a stock exchange or otherwise distributed to stockholders. We have spoken to the SEC on this issue and they would not affirm our understanding; however they did not offer a contrary position. It is not clear whether definitive guidance will be available on this issue from the SEC or the Department of Justice (which is responsible for enforcement of criminal statutes such as Section 906) soon.
The certification of Form 6-K reports raises serious concerns for Canadian and other foreign issuers that must soon file their interim financial statements for the period ended June 30, 2002 in their home jurisdictions. In the absence of definitive guidance from the SEC, we recommend that foreign company CEOs and CFOs implement procedures to put themselves in the position to certify the reports. We will provide upon request information as to the procedures we believe are appropriate to support certification. Given the severe penalties associated with an incorrect certification, however, we do not recommend that certifications be given without appropriate review. This is especially true given indications from the language of the statute that the degree of “knowledge” required to give rise to criminal liability of CEOs and CFOs may be less than actual knowledge that the report fails to satisfy the requirements of this certification.
We will advise foreign issuers in a case by case basis as to how they should respond to Section 906 in their particular circumstances.
Loans to Officers
Section 402 of the Act amends Section 13 of the Exchange Act to prohibit any issuer directly or indirectly to extend credit or maintain credit or to arrange for an extension or to renew an extension in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of an issuer. Existing loans, providing they are not amended or extended, are grandfathered.
The following loans are exempt from the prohibition: loans made in the ordinary course of the public company’s consumer credit business that are of the same type and no more favorable then those made by the company to the general public, margin accounts for employees of public company brokerage firms, except to buy stock of that company, and loans by financial institutions to their employees that are subject to insider lending restrictions under the Federal Reserve Act.
At this time foreign private issuers are subject to Section 402 of the Act. We do not know whether further legislation or SEC regulations will be adopted to exempt foreign private issuers from Section 402 in whole or in part. Unless and until such action is taken, however, foreign issues should comply with the requirements of Section 402.
Pre-Approval of Non-Audit Services
Although the Act includes independence requirements applicable to auditors which will become effective only after the newly mandated “Public Company Accounting Oversight Board” is in operation (which is to commence no later than the end of March 2003), the Act requires that, effective immediately, audit committees approve all audit and non-audit services provided by the company’s outside auditors (subject to certain de minimis exceptions). Non-audit services include, for this purpose, the provision of tax services by the auditor. These approvals may be obtained at the time of engagement of the auditor for an annual audit, if the services are set forth as part of the annual audit plan. Any such approvals of non-audit services must also be disclosed in the company’s periodic SEC reports.
Review of Periodic Reports
The Act directs the SEC to establish procedures for review of the periodic reports of each reporting issuer at least every three years. The reports of foreign issuers are not excluded. Typically, annual reports filed on Form 20-F are not regularly reviewed, and reports filed on Form 40-F under the U.S. Canadian Multijurisdictional Disclosure System (MJDS) are never reviewed.
It remains to be seen how the SEC will implement this directive with respect to the reports of foreign private issuers. We certainly expect to see the SEC staff reviewing annual reports on Form 20-F much more frequently than in the past. There is also a significant likelihood that the SEC will either begin to review Form 40-F reports, or, more likely, to follow through with its rumored intention to narrow or eliminate the use of Form 40-F and to require Canadian issuers with equity securities listed in the United States to file annual reports on Form 20-F or Form 10-K.
August 2, 2002