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Regulation and Compliance > Federal Regulation > SEC

Congress Acts To Stop Corporate Abuse

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After watching domestic equity markets decline at an alarming pace, insurers and fund managers breathed a sigh of relief as Congress passed the Sarbanes-Oxley Act of 2002.

Recent accounting and analyst scandals had contributed to sharp declines in the equity markets, hurting new sales and hurting revenues as fund net asset values declined.

Investors have reacted negatively to corporate accounting and other scandals, and the effect of these scandals on the equity markets has been dramatic.

The S&P 500 fell by 200 points–over 20%–in the month after WorldCom announced it was restating its earnings. Stock funds had $18 billion in outflows in June alone–the third largest monthly outflow in history.

For variable annuities, net inflows in 2001 were down 32% from 2000 levels.

In response to these concerns, Congress passed the Act overwhelmingly with votes of 99-0 in the Senate and 423-3 in the House, and the President signed it into law on July 30.

Among the Acts major provisions is the creation of the Public Company Accounting Oversight Board to regulate the accounting profession. A private, non-profit corporate entity, the Board will be comprised of five members appointed by the Securities and Exchange Commission for five-year terms, two members of which shall be certified public accountants.

This Board shall:

Adopt auditing standards;

Adopt independence standards;

Inspect auditing firms;

Conduct disciplinary proceedings against public accounting firms and their personnel, who could face revocation of their license and fines up to $15 million;

Require public accounting firms to register with the Board; and

Be funded by fees on public companies based on their market capitalizations.

The Act prohibits accounting firms from providing certain non-audit services contemporaneously with an audit of any public company.

Prohibited services include: bookkeeping, financial information systems design, appraisals, and management functions, as well as legal and expert services unrelated to the audit.

Other non-audit services can be provided only if approved by the audit committee of a companys board of directors. Auditors will have to be engaged by audit committees composed entirely of independent directors.

Recent controversies have suggested that securities analysts face compromising influences from investment banking clients of their firms. In response, Sarbanes-Oxley directs the SEC to require that securities firms create a firewall between research and investment banking personnel. Investment banking employees who retaliate against analysts who issue unfavorable reports would face penalties.

Analysts will also be required to disclose financial interests that they or their firms have in the securities they evaluate.

Corporate attorneys, normally policed by organized state bars, also face new “federalized” ethical requirements and minimum standards of professional conduct.

Under rules that must be adopted by the SEC, a corporate attorney must report evidence of securities law violations to a companys chief legal counsel or chief executive officer. If appropriate action is not taken, the attorney must report evidence of the violation to the companys audit committee, to its independent directors or to the board of directors as a whole. Penalties for failure to comply include censure, suspension or permanent revocation of the privilege to practice before the SEC.

Sarbanes-Oxley also contains numerous other provisions that address corporate responsibility. It prohibits personal loans to corporate directors and executive officers. It requires CEOs and chief financial officers to certify financial statements. It provides tougher criminal penalties for fraud.

The full impact of the Act will not be known until the SEC issues implementing regulations over the course of the next year.

Insurers and fund managers are hopeful that the new legislation will help restore investor confidence, which is essential to the health of industry participants.

Jeffrey S. Puretz (left) is a partner and Thomas C. Bogle is an associate in the Washington D.C. office of the law firm of Dechert. Their respective e-mail addresses are: [email protected] and [email protected].

Reproduced from National Underwriter Life & Health/Financial Services Edition, August 12, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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