Last week the SEC adopted final rules under Sections 302 and 403 of the Sarbanes-Oxley Act of 2002:
- The Section 302 rules require that CEOs and CFOs certify the information contained in their companies’ SEC annual and quarterly reports and that the companies maintain "disclosure controls and procedures".
- The Section 403 rules implement the accelerated filing deadline for reporting on Form 4 changes in beneficial ownership by officers, directors and principal security holders under Section 16 of the Securities Exchange Act of 1934 (the Exchange Act).
In addition, yesterday the SEC adopted final rules that will phase in accelerated filing deadlines for annual and quarterly reports of certain public companies.
CEO and CFO Certifications in Annual and Quarterly Reports and Maintenance of Disclosure Controls and Procedures
On August 29, 2002, the SEC released final rules as directed by Section 302 of the Sarbanes-Oxley Act of 2002 regarding CEO and CFO certifications of annual and quarterly reports and the maintenance of "disclosure controls and procedures" (the "Section 302 Rules"). The Section 302 Rules supersede similar proposals by the SEC in June 2002 and became effective upon issuance, except that certifications relating to disclosure controls and procedures apply only to reports covering periods ending on or after August 29, 2002.
What Do the Section 302 Rules Require?
Certification by CEO and CFO
A company’s CEO and CFO must certify in every annual or quarterly report that:
- They have reviewed the report;
- Based on their knowledge,
- the report does not contain any material misstatements or omissions;
- the financial statements, and other financial information included in the report, fairly present in all material respects the company’s financial condition, results of operations and cash flows;
They are responsible for establishing and maintaining "disclosure controls and procedures" (a new defined term discussed below) and they have:
- designed the disclosure controls and procedures to ensure that all material information is made known to the officers;
- evaluated the effectiveness of the disclosure controls and procedures within 90 days prior to the date of the report;
- indicated in the report whether there were significant changes that could significantly affect internal controls subsequent to the evaluation;
- presented in the report their conclusions about the effectiveness of the disclosure controls and procedures based on the evaluation; and
- disclosed to the company’s auditors and audit committee any deficiencies or weaknesses in the internal controls or any fraud that involves employees who have a significant role in the internal controls.
Fair Presentation Standard
The certification that the financial statements and other financial information (including financial footnotes, selected financial disclosure and MD&A) "fairly present" in all material respects the company’s financial condition, results of operations and cash flows covers "a standard of overall material accuracy and completeness that is broader than financial reporting requirements under generally accepted accounting principles." This "fair presentation" standard encompasses the proper selection and application of accounting policies, the disclosure of adequate financial information to reasonably reflect underlying transactions, and the disclosure of other information necessary to present "a materially accurate and complete picture of the issuer’s financial condition, results of operations and cash flows."
Liability of Certifying Officers
The SEC states that a CEO or CFO who provides a false certification could be subject to SEC action for violating Section 13(a) or 15(d) of the Exchange Act, and to both SEC and private actions by shareholders for violating Section 10(b) and Rule 10b-5 of the Exchange Act. However, we believe that the certifications will have no significant practical effect on private actions under Rule 10b-5.
Disclosure Controls and Procedures
The Section 302 Rules require companies to maintain a system of "disclosure controls and procedures" that are designed to ensure that information required to be disclosed in Exchange Act filings or submissions is recorded, processed, summarized and disclosed on a timely basis, and to evaluate the effectiveness of the disclosure controls and procedures within 90 days prior to filing each annual and quarterly report. The new defined term "disclosure controls and procedures" is broad in scope and refers to controls and procedures relating to all required disclosure, whether or not of a financial nature. The existing concept of "internal controls" is also covered by the certifications but relates more narrowly to a company’s internal financial reporting and control of its assets.
The SEC did not specify the particular disclosure controls and procedures companies should adopt. Each company must develop and tailor to its particular business and management and supervisory practices a comprehensive process that will support the required CEO and CFO certifications and result in the timely and accurate gathering, processing and disclosure of relevant information. Failure to implement disclosure controls and procedures in compliance with the rules may itself constitute an actionable violation.
The Section 302 Rules require senior management, including the CEO and CFO, to supervise and participate in the periodic evaluation of the design and operation of the company’s disclosure controls and procedures, and that the CEO’s and CFO’s conclusions regarding these evaluations be disclosed in the annual and quarterly reports. These periodic evaluations should ensure that disclosure controls and procedures evolve with a company’s business over time.
Although the SEC does not specify particular disclosure controls and procedures, it recommends-as it did in its June 2002 proposed certification rules-that companies establish disclosure committees to consider the materiality of information and determine disclosure obligations. This committee, which would report to senior management, could be composed of the following:
- principal accounting officer or controller,
- general counsel or other senior legal official responsible for disclosure matters,
- principal risk management officer,
- chief investor relations officer, and
- other officers or employees senior management deems appropriate.
We expect that disclosure committees will become the norm.
Which Filings Are Covered?
The Section 302 CEO and CFO certifications are required for "periodic reports" (quarterly and annual reports, including amendments) filed under Section 13(a) or Section 15(d) of the Exchange Act, including filings by foreign private issuers. Current reports on Form 8-K or Form 6-K are not "periodic reports" and do not require the certifications.
All companies that file Section 13(a) or Section 15(d) reports are required to maintain disclosure controls and procedures, and these controls and procedures should not be limited in application to the preparation of annual and quarterly reports. They should apply to all company SEC disclosure, including current reports on Forms 8-K and 6-K, proxy statements and information statements.
What Is the Form of Section 302 Certification?
The SEC leaves no uncertainty as to the manner of making the Section 302 certifications. The Section 302 Rules amend the SEC forms for annual and quarterly reports and add the certifications immediately following the existing signature sections, which are unaltered. The mandated certifications included in the amended forms may not be changed in any respect. The certifications must be signed by each of the CEO and CFO personally and not on his or her behalf.
What About Section 906 Certification?
The certification required by the Section 302 Rules is separate from, and in addition to, the certification required for periodic reports under Section 906 of the Sarbanes-Oxley Act. Accordingly, both Section 906 and Section 302 certifications are required for periodic reports under the Exchange Act. The SEC’s statement in the Section 302 Rules that reports on Forms 8-K and 6-K do not constitute "periodic reports" implies that the Section 906 certifications need not accompany these Forms either.
What Should Companies Do? - Practical Considerations
CEOs and CFOs should conduct a reasonable diligence process to support their required certifications. The diligence process should be structured so that it forms the core of the required periodic evaluation of disclosure controls and procedures. The appropriate procedures to support certification and evaluation will depend on a company’s particular management, organizational structures, and financial and other reporting, and will vary by company.
Here are some practical considerations:
- Evaluate Existing Disclosure Controls and Procedures and Internal Controls. The company should evaluate its existing disclosure controls and procedures and internal (financial) controls, compare them with the Section 302 requirements, and address identified deficiencies with improved procedures and appropriate documentation. The company should consider appointing one person to study the new rules to ensure and document the company’s compliance.
- CEO and CFO Review of Report. The CEO and CFO should carefully review any report being certified and understand the procedures used to gather and process information and to prepare the report.
- Include Appropriate Personnel in Review Process; Form a Disclosure Committee. The CEO and CFO will want appropriate personnel to participate in the review of the report and the evaluation of disclosure controls and procedures. Consider including in the review process those officers or senior managers who have decision- or policy-making authority over business divisions, units or functions that may significantly affect the company’s financial results or operations. Also consider including those managers who can help the CEO and CFO review the company’s procedures for gathering and reporting the financial and other information included in the report. Absent compelling reasons to the contrary, the company should form a non-Board disclosure practices committee. At a minimum, the individuals discussed earlier as potential members of the disclosure practices committee should be considered to be included on the review team.
- Meet or Communicate with Review Team. The personnel identified to help in the certification and evaluation process should carefully review the report. After this review, the CEO and CFO should meet or communicate with these personnel to discuss the disclosure controls and procedures and the accuracy and completeness of the disclosures in the report. The reviewing personnel should be prepared to discuss the disclosures in the report generated by them or by personnel under their supervision, or that relate to corporate functions in which they have a significant role. Topics for discussion may include:
- Assessment of the materiality to the company of specific events, developments or risks;
- Financial reporting issues that are significant to the company;
- The "Management’s Discussion and Analysis" section of the report, including the company’s critical accounting policies, any known trends, uncertainties or events that could have a material effect on revenues, income or liquidity, and the company’s liquidity and capital resources;
- Internal audit procedures and adequacy of internal controls;
- Procedures used to ensure that financial statements comply with applicable accounting principles;
- Material reporting matters where the person primarily responsible for the matters, either alone or in consultation with other personnel or advisors, made significant judgments; and
- Evolution of reporting systems in connection with changes or growth in the company.
- Subcertification. The CEO and CFO should consider whether to obtain "subcertifications" from appropriate company personnel. In subcertifications, appropriate personnel certify information (or the absence of material information) to support the CEO’s and CFO’s certifications. As an alternative, the CEO and CFO should consider whether it would be more practical to obtain oral representations from appropriate company personnel, which could be memorialized in a written report, to support the certifications.
- Meet with Auditors and Audit Committee. The CEO and CFO should consider meeting independently with the company’s outside auditors (and internal auditors, if any) to discuss whether they have any material concerns about the accuracy, completeness and reliability of the financial or other information in the report, the process of preparation of the report, or the internal controls and financial systems that generated the information in the report. The CEO and CFO should conduct follow-up discussions with relevant company personnel, if necessary. The CEO and CFO should apprise the audit committee members of the review process and make the required audit committee disclosure regarding any deficiencies, weaknesses or fraud relating to the company’s internal controls.
- Legal Compliance Review. The CEO and CFO should work with the company’s appropriate legal and financial reporting personnel to confirm that the report fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act.
- Documentation. The company’s general counsel and chief accounting officer should consider preparing a memorandum detailing the procedures used to review each report and conduct the evaluation of the disclosure controls and procedures to support the certifications and evaluation disclosure.
Accelerated Form 4 Filing Deadline
Section 403 of the Sarbanes-Oxley Act of 2002 requires that Form 4 reports for Section 16 reporting persons be filed within two business days following most changes in stock ownership that occur on or after August 29, 2002. The two-business-day reporting period begins on the date a transaction is executed, not when the transaction settles. On August 27, 2002, the SEC adopted final rules to implement the accelerated filing deadline and addressed related matters.
Two-Business-Day Filing Deadline for Form 4 Transactions
Under the SEC’s amendments to the rules under Section 16 of the Exchange Act, most transactions by a reporting person (executive officer, director or 10% or greater beneficial owner) that result in a change in beneficial ownership must now be reported within two business days after the date the transaction is executed. Included in the transactions subject to the accelerated filing deadline are those between a reporting person and an issuer that are exempt from short-swing profit recovery under Rule 16b-3 of the Exchange Act, and that previously were eligible for deferred reporting on Form 5 (including stock option grants and other awards from an issuer, dispositions to an issuer and discretionary transactions under employee benefit plans). Form 4 reports must be received by the SEC by 5:30 p.m. (Eastern time) on the second business day following a transaction to be considered timely. Late filings must be disclosed in an issuer’s proxy statement and on the cover page of the issuer’s annual report on Form 10-K.
The SEC confirmed that deferred reporting on Form 5 remains available for transactions unaffected by these rule amendments, such as for gifts of securities, and that transactions previously exempted from Section 16(a) reporting altogether remain exempt. Exempt transactions include routine acquisitions under tax-qualified plans (such as 401(k) plans), acquisitions under employee stock purchase plans qualified under Section 423 of the Internal Revenue Code and the reinvestment of dividends or interest pursuant to broad-based dividend or interest reinvestment plans. The reporting person should indicate changes in holdings that result from exempt transactions in the holdings column of the next required Form 4 or 5. The SEC has confirmed that a reporting person may rely in good faith on the last plan statement in reporting holdings pursuant to 401(k) plans and other exempt plans.
Alternative Method to Calculate Commencement of the Two-Business-Day Filing Deadline for Rule 10b5-1 Plans and Discretionary Transactions Under Employee Benefit Plans
The new SEC rules permit the reporting person to use a "deemed execution date" for purposes of calculating the commencement of the two-business-day filing period for two types of transactions required to be reported on Form 4.
- Rule 10b5-1 Trading Plans. Transactions effected pursuant to a contract, instruction or written plan for the purchase or sale of equity securities that satisfy the affirmative defense requirements of Exchange Act Rule 10b5-1(c) where the reporting person does not select the date of execution are deemed to be executed on the earlier of:
- The date the executing broker or dealer notifies the reporting person that the trade has been executed; and
- The third business day after the trade was executed.
A reporting person will not be deemed to select the date of execution of limit order transactions under a Rule 10b5-1 trading plan, but will be deemed to select the date of execution for transactions under a trading plan or market order that take place on a pre-determined date.
- Discretionary Transactions. Discretionary transactions pursuant to employee benefit plans where the reporting person does not select the date of execution are deemed to be executed on the earlier of:
- The date the executing plan administrator notifies the reporting person that the trade has been executed; and
- The third business day after the trade was executed.
A "discretionary transaction" involves an intra-plan transfer of previously invested assets into or out of an issuer’s securities fund or a cash-out from an issuer’s securities fund.
Amended Forms 4 and 5
The SEC has amended Form 4 to conform to the requirements of the accelerated filing deadline. The amended Form 4 and related instructions are available at http://www.sec.gov/about/forms/form4.pdf and http://www.sec.gov/about/forms/form4data.pdf. The new Form 5 is not yet available.
Electronic Filing; Interim Guidance
The SEC continues to encourage reporting persons (and companies filing on their behalf) to begin electronically filing Section 16 reports now even though electronic filing is not yet required under the Sarbanes-Oxley Act. To facilitate this, the SEC currently will accept electronic filings that are not in the standard box format for Section 16 reports as long as all the required information is presented in proper order. To begin electronic filing, each reporting person must obtain an individual EDGAR access code. These can be obtained by completing a Form ID available from the SEC’s Web site at http://www.sec.gov/about/forms/formid.pdf. We would be happy to assist you in obtaining the EDGAR access codes and having your Section 16 reports filed electronically.
Accelerated Filing Deadlines for Annual and Quarterly Reports
On September 5, 2002, the SEC adopted final rules that will accelerate filing deadlines for annual and quarterly reports of "accelerated filers," which is defined as companies:
- with a common equity public float of at least $75 million as of the last business day of their most recently completed second fiscal quarter;
- that have been subject to Exchange Act reporting requirements for at least 12 calendar months, and have previously filed at least one annual report; and
- that are not eligible to use the SEC’s special forms for small business issuers.
The accelerated deadlines will apply to an accelerated filer after it first meets the conditions listed above as of the end of its fiscal year.
The new deadlines will be phased in over the next three years as follows:
|Period Covered by Report||10-K FilingDeadline Following Year End||10-Q Filing Deadline Following Quarter End|
|Fiscal Year Ending Prior to December 15, 2003 and Following Three Quarters||90 days||45 days|
|Fiscal Year Ending On or After December 15, 2003 But Prior to December 15, 2004 and Following Three Quarters||75 days||40 days|
|Fiscal Year Ending On or After December 15, 2004 and Subsequent Quarters||60 days||35 days|
For example, the first accelerated Form 10-K filing for an accelerated filer with a December 31 fiscal year end would cover the 2003 fiscal year and be filed within the first 75 days of 2004, and each of its Forms 10-Q for the first three quarters of fiscal 2004 would be filed within 40 days of the end of the quarter.
The SEC is considering accelerating the filing deadline for foreign private issuers filing annual reports on Form 20-F, but did not change the existing deadline in its recent release.
In addition to the acceleration of filing deadlines for periodic reports of accelerated filers, the SEC made conforming amendments to provisions of Regulation S-X relating to the timeliness of financial statements included by accelerated filers in other SEC filings, such as Securities Act and Exchange Act registration statements and proxy and information statements. As a result, "financial statements included in a registration statement or proxy still will be required to be at least as current as any financial statements filed under the Exchange Act."
Web Site Disclosure
Beginning with Form 10-K annual reports filed for fiscal years ending on or after December 15, 2002, each accelerated filer must disclose in its annual report:
- its Web site address, if it has one;
- whether it will make its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and all amendments to those reports available without charge on its Web site as soon as reasonably practicable after it files such reports with the SEC; and
- if it will not make such reports available in this manner, the reasons why it will not do so and whether it will make paper or electronic copies available without charge upon request.
The SEC suggests that issuers maintain on their Web sites their SEC reports for at least a 12-month period, and encourages a more extensive archive of prior filings.
Text of the Act
You can find the full text of the Section 302 Rules at http://www.sec.gov/rules/final/33-8124.htm, of the Section 16 rule amendments at http://www.sec.gov/rules/final/34-46421.htm, and of the rules accelerating Form 10-K and 10-Q filing deadlines at http://www.sec.gov/rules/final/33-8128.htm. You can find further discussion of the Sarbanes-Oxley Act and other recent laws and regulations of interest to public companies on our website.