SEC Rulemaking and Other Initiatives: Accommodations
The following is a summary of certain SEC rules, promulgated under the Sarbanes-Oxley Act (SOA), and exemptions or other accommodations for foreign issuers, accounting firms or other market participants provided under those rules. To determine whether you meet the criteria for a particular exemption, please refer to the text of the appropriate rule and consult with a legal adviser as may be necessary.
Internal Control over Financial Reporting (SOA Section 404)
In June 2003, the SEC adopted rules requiring US registered companies to provide on an annual basis a management report on the company's system of internal control over financial reporting and on a quarterly basis a report of material changes to those controls. Section 404 also requires the company's auditor to attest to, and report on management's assessment of the effectiveness of the company's internal controls and procedures for financial reporting in accordance with standards established by the Public Company Accounting Oversight Board.
- In August 2006, the Commission announced that it was issuing a final rule to grant relief from Section 404(b) compliance for foreign private issuers that are accelerated filers (but not large accelerated filers), and that file their annual reports on Form 20-F or 40-F. These companies will have their compliance deadline extended for an additional year, so that they will not begin complying with the Section 404(b) requirement to provide an auditor's attestation report on internal control over financial reporting in their annual reports until fiscal years ending on or after July 15, 2007. This group of issuers will be required to comply only with the Section 404 requirement to include management's report on internal control over financial reporting in the Form 20-F or 40-F annual report filed for their first fiscal year ending on or after July 15, 2006.
- At the same time, the Commission also proposed a rule to grant relief to smaller public companies by extending the date by which non-accelerated filers must start providing a report by management assessing the effectiveness of the company's internal control over financial reporting. The initial compliance date for these companies would be moved from fiscal years ending on or after July 15, 2007, until fiscal years ending on or after Dec. 15, 2007. The Commission also proposes to extend the date by which non-accelerated filers must begin to comply with the Section 404(b) requirement to provide an auditor's attestation report on internal control over financial reporting in their annual reports. This deadline would be moved to the first annual report for a fiscal year ending on or after Dec. 15, 2008. The comment period for this rule proposal ended on September 14, 2006.
- In March 2005, the Commission announced that it would extend for an additional year, until July 15, 2006, the compliance date for foreign private issuers with respect to internal control over financial reporting requirements, promulgated under Section 404 of the Sarbanes-Oxley Act. In affording this extension, the Commission recognized that many foreign companies are facing regulatory and reporting challenges in addition to internal control reporting, particularly companies in the European Union who must prepare their financial statements for the first time in 2005 in accordance with International Financial Reporting Standards. For additional guidance on internal control over financial reporting requirements, see the SEC staff's statement on "Management's Report on Internal Control over Financial Reporting," which was released in May 2005.
- For foreign private issuers, disclosure of material changes in internal control over financial reporting will be made on an annual basis rather than a quarterly basis.
- Foreign private issuers must use a suitable framework for evaluating internal controls, but are not required to use a US framework. Specifically mentioned as suitable alternatives are the "Guidance on Assessing Control" published by the Canadian Institute of Chartered Accountants and the "Turnbull Report" published by the Institute of Chartered Accountants in England & Wales.
Creation of the Public Company Accounting Oversight Board (SOA
The Public Company Accounting Oversight Board (PCAOB) is a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act to oversee, among other things, accounting professionals who provide independent audit reports for publicly traded companies. The PCAOB's rules require the registration of all accounting firms, foreign and domestic, that audit or provide substantial services relating to the audit of an SEC-registered public company.
- Foreign audit firms received an additional nine months, until July 19, 2004, to register with the PCAOB.
- Subject to certain qualifications, the PCAOB will allow an applicant to withhold information from its registration application if disclosure of such information would violate foreign law. The firm must identify the information at issue and must provide: (i) a copy of the conflicting foreign law; (ii) a legal opinion as to the conflict; and (iii) an explanation of its efforts to seek consents or waivers to eliminate the conflict, as well as a representation that the applicant was unable to obtain such consents and waivers.
- In its roster of accountants, foreign public accounting firms are required to list only accountants who are a proprietor, partner, principal, shareholder, officer, or manager of the applicant and who provide at least ten hours of audit services for any issuer.
- PCAOB Rules 4011 and 4012 permit varying degrees of reliance on inspections of foreign accounting firms conducted by the home country's oversight body, based on a sliding scale the more independent and robust a home country system, the higher the reliance on that system.
Strengthening the Commission's Requirements Regarding Auditor Independence (SOA Title 2)
In January 2003, the SEC adopted amendments to its existing requirements regarding auditor independence to enhance the independence of accountants that audit and review financial statements and prepare attestation reports filed with the Commission. The rules recognize the critical role played by audit committees in the financial reporting process and the unique position of audit committees in assuring auditor independence. Among other things, the rules list certain non-audit services, including legal services, the provision of which by an auditor to its issuer client would impair an accounting firm's independence. In addition, the rules require audit partners working for a particular issuer to rotate after five or seven years, depending on the partner's level of participation in the audit. The rules also require a cooling-off period for certain audit firm partners and managers before they can take employment with an issuer audit client.
- The Commission noted that, as a general matter, the rules are not intended to prohibit foreign accounting firms from providing services that an accounting firm in the United States may provide. For example, in some jurisdictions it is mandatory that someone licensed to practice law perform tax work, and that an accounting firm providing such services, therefore, would be deemed to be providing legal services. In determining whether or not a service would impair the accountant's independence solely because the service is labeled a legal service in a foreign jurisdiction, the Commission will consider whether the provision of the service would be prohibited in the United States as well as in the foreign jurisdiction.
- The Commission further noted that many of the modifications to the proposed rules, such as those limiting the scope of partner rotation and personnel subject to the "cooling off period," have the added benefit of addressing particular concerns raised about the international implications of these requirements.
Listed Company Audit Committee Requirements (SOA Section 301)
In April 2003, the SEC adopted a new rule requiring the national securities exchanges and national securities associations (SROs) to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirements mandated by the Sarbanes-Oxley Act. Among other things, these requirements provide that all audit committee members be independent directors and that the audit committee be directly responsible for the appointment, compensation and oversight of the issuer's audit firm.
- Foreign private issuers were afforded additional time to comply with new listing rules (by July 31, 2005 rather than October 31, 2004);
- Non-management employees may serve as audit committee members, consistent with co-determination and similar requirements in some countries;
- Shareholders may select or ratify the selection of auditors, also consistent with requirements in many countries;
- Alternative structures such as statutory auditors or boards of auditors may perform auditor oversight functions where such structures are provided for under local law;
- Foreign government and controlling shareholder may have representation on audit committees subject to certain conditions;
- Where a listed company is one of two dual holding companies, those companies may designate one audit committee for both companies so long as each audit committee member is a board member of at least one of the companies;
- Foreign governments are exempt from the audit committee requirements;
- The term "audit committee expert" was expanded include a person with an understanding of an issuer's home country GAAP rather than US GAAP.
Insider Trades during Pension Fund Black-Out Periods (SOA
In January 2003, the Commission adopted new Regulation Black-out Trading Restriction (BTR), which prohibits executive officers and directors of US registered companies from buying or selling company shares during pension black-out periods, when regular employees are also prohibited from engaging in such transactions by their pension plans.
The application of Regulation BTR to the directors and executive officers of foreign private issuers is limited to situations where (i) 50% or more of the issuer's pension plan participants and beneficiaries located in the United States are subject to a temporary trading suspension, and (ii) the affected participants and beneficiaries represent more than 15% of the issuer's worldwide employees, or the plan has more than 50,000 participants total.
Implementation of Standards of Professional Conduct for Attorneys (SOA Section 307)
In January 2003, the SEC adopted a rule establishing certain minimum standards of conduct for attorneys appearing and practicing before the Commission, including a requirement that attorneys report material breaches of securities laws or fiduciary duties to more senior personnel within a company, and ultimately to the board if the problems are not addressed.
The rule excludes "non-appearing foreign attorneys," which are defined as those attorneys who: (1) are admitted to practice law in a jurisdiction outside the United States; (2) do not hold themselves out as practicing, or giving legal advice regarding, United States law; and (3) conduct activities that would constitute appearing and practicing before the Commission only (i) incidentally to a foreign law practice, or (ii) in consultation with United States counsel. This definition effectively excludes many, but not all, foreign attorneys from the rule's coverage. Foreign attorneys who provide legal advice regarding United States securities law, other than in consultation with United States counsel, are subject to the rule if they conduct activities that constitute appearing and practicing before the Commission.
Conditions for Use of Non-US GAAP or Pro Forma Financial Information SOA (Section 401(b))
In January 2003, the SEC adopted new rules and amendments to address public companies' disclosure or release of certain financial information that is calculated and presented on the basis of methodologies other than in accordance with generally accepted accounting principles (GAAP). The SEC's new Regulation G requires that US registered issuers provide the following information as part of the disclosure of a non-GAAP financial measure: (1) a presentation of the most comparable financial measure calculated in accordance with GAAP; and (2) a reconciliation of the differences between that measure and the non-GAAP measure.
Regulation G contains a limited exception for foreign private issuers. Specifically, Regulation G does not apply to public disclosure of a non-GAAP financial measure by, or on behalf of, a registrant that is a foreign private issuer if: (i) the securities of the foreign private issuer are listed or quoted on a securities exchange or inter-dealer quotation system outside the United States; (ii) the non-GAAP financial measure is not derived from or based on a measure calculated and presented in accordance with generally accepted accounting principles in the United States; and (iii) the disclosure is made by or on behalf of the foreign private issuer outside the United States, or is included in a written communication that is released by or on behalf of the foreign private issuer outside the United States.
Foreign Bank Exemption from the Insider Lending Prohibition (SOA Section 402)
Section 13(k) of the Securities Exchange Act of 1934, as added by Section 402 of the Sarbanes-Oxley Act, imposes a prohibition on loans to insiders by both domestic and foreign issuers. Section 13(k) also included an exemption for US federally insured banks that are subject to the insider lending restrictions under the Federal Reserve Act, but contained no corresponding exemption for foreign banks subject to similar insider lending restrictions in their home jurisdictions.
In April 2004, the SEC adopted an exemption for qualified foreign banks that meet specified criteria comparable to those required for domestic banks. Among other things, the criteria includes a requirement that the foreign bank is either subject to a deposit insurance regime in its home country, or the Federal Reserve Board has found it to be subject to "comprehensive supervision or regulation on a consolidated basis."