Dear Yitzhak,
Last week I read in the paper about the aftermath of Enron, and all the paranoia that is flying around about all financial statements of public trading companies being misstated, and how Uncle Sam was going to crack down on company executives. We are thinking of going public in the States or doing an M&A, what does this mean to us?
Signed
Executive
Dear Executive,
You are right, something is flying around the US these days, butit is not paranoia. It is rathervalid mistrust in the prepared financial statements and reports of publicly traded companies, be they domestic companies based in the US, or foreign private issuers such as those based in Israel.
During the summer, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Act") "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities law, and for other purposes." The purpose of such a law is to further regulate the "issuer" (the company issuing shares to the public). “Issuer” is defined in section 3 of the Securities Exchange Act of 1934, as amended. The law relates to an issuer whose securities are registered under section 12 of the Securities Act of 1934, as amended, or that is required to file reports under section 15(d), or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933, as amended, and that has not been withdrawn.
(By the way, take a look at some previous articles I wrote in this column sometime back and you will see I went over the Securities and Exchange Commission (SEC) laws and regulations and dealt at the time with the Securities Act of 1933 and Securities Exchange Act of 1934, as amended, as well as the process and the law in the raising of capital.)
What this means is that publicly traded companies and those companies on the way to becoming publicly traded, including foreign private issuers from Israel, are affected. The Israeli executive of an Israeli publicly traded company in the US will find himself or herself being held to a high level of company and personal liability as well as accountability. The Act puts a high emphasis on enhancement of white-collar crime penalties, corporate fraud, and accountability, by establishing a non-profit corporation to work with the SEC, in establishing standards and rules to insure the integrity of the system to the investor. Though certain aspects might conflict with law in Israel regarding limited personal accountability as an executive of an Israeli company, if you want to raise capital in the US, you will be under US rules.
Public Company Accounting Oversight Board
Under the Act, the Public Company Accounting Oversight Board (the "Board"), a non-profit corporation, is established to oversee the audit of public companies that are subject to the securities laws through insuring the preparation of informative, accurate, and independent audit reports. It will register public accounting firms that prepare audit reports for issuers, establish standards and rules for auditing, quality control, ethics, and independence. It will inspect registered public accounting firms and conduct investigations and disciplinary proceedings as required. It will have the power to sue, with the approval of the SEC. Any foreign public accounting firm that prepares or furnishes the audit report with respect to any issuer, shall be subject to this Act, similar to the US public accounting firm, with some exceptions.
To accomplish this, Section 19 of the Securities Act of 1933 was amended to allow the SEC to recognize as generally accepted for purposes of the securities laws any accounting principles established by a standard setting body such as the Public Company Accounting Board. Further, the Board will deal with or cause certain agencies to deal with issues of auditor independence through pre-approval of auditing services, audit partner rotation, dealing with issues effecting the auditor reports and audit committees, conflicts of interest, examining the issue of mandatory rotation of registered public accounting firms of issuers.
Corporate Responsibility
The audit committee of each issuer in its capacity as a committee of the board of directors, shall be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by the issuer, including resolution of disagreements between management and the auditor regarding financial reporting, and such audit board members will be required to meet various standards of independence prior to becoming members of the audit committee to insure the intent of the Act.
The principle executive officer and the principal financial officer will be signing and certifying various standards of each annual or quarterly report filed with the SEC and the public. Foreign reincorporation will have no effect on lessening the legal force of the Act. The Act deals in detail with insider trades, issues of bonuses and profits, and improper influence in the conduct of audits. It requires the SEC to issue rules dealing with the professional responsibility of attorneys of the issuer regarding their obligation to report material violations of the securities laws or breach of fiduciary duties or similar violations by the issuer or any of its agents to the SEC.
Enhanced Financial Responsibility
The Act places a heavy emphasis on amending the financial disclosure obligations of the issuer. Section 13 of the Securities Act of 1934 regarding accuracy of financial reports is amended to deal with off-sheet balance sheet transactions, SEC rules for pro forma figures, personal loans to executives, transactions involving management and principal stockholders, directors and officers, management assessment of internal controls, and a code of ethics for the principal financial officer and comptroller. The audit committee will be composed of at least one member who is a financial expert. The SEC will have enhanced review of periodic disclosures by the issuers who have issued material restatements of financial results, have experienced significant volatility in their stock price as compared with other issuers, emerging companies with disparities in price to earning ratios, and other factors.
Therefore the bottom line for the Israeli executive is that the company governance papers such as the article of association have to change to adapt to this Act, the committees of the board have to be in line, the personality liability of the executives of the company, particularly the managing director and financial officer have increased dramatically, and this is only the beginning. Within the next 180 days as required under the Act, new standards, rules and pronouncements will be issued by the Board and the SEC.
Regards,
Yitzhak
Published by Globes [online] - www.globes.co.il - on September 9, 2002