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US raises the bar for raising capital Back  
Mark Dorff examines the implications of recent US securities & accounting reform legislation for Irish companies.
In the wake of the severe bear market and the wave of recent corporate scandals, at the end of July the United States Congress passed major securities and accounting reform legislation - the Sarbanes-Oxley Act 2002. The Act covers a wide range of matters relating to accounting, financial reporting and corporate governance. Many of the provisions of the Act apply to foreign companies listed on US stock exchanges, including Irish companies such as Elan, Iona and Riverdeep.
The Act makes a number of major changes to the US rules governing public companies. The changes are aimed at improving corporate governance (particularly the role of audit committees), increasing company disclosures, and requiring corporate officers to certify that they have in place internal structures and procedures to ensure accurate accounting. The Act significantly increases criminal penalties for a range of corporate abuses. In addition, the Act creates the PCAOB.
The Act also requires accounting firms that audit public companies in the US to register with the PCAOB, adds new requirements and restrictions on accounting firms designed to ensure auditor independence, and expands the oversight and enforcement mechanisms of the United States Securities and Exchange Commission (SEC) and establishes such mechanisms for the PCAOB. Among the key provisions that are immediately applicable to foreign companies listed in the US are:
• As noted above, the CEO and CFO of each company must personally certify the accuracy of the company’s financial statements in each periodic report filed the SEC. Such certifications must also address the company’s disclosure controls and procedures (as defined by the SEC) including confirmation that the required controls have been established and evaluated and that any deficiencies have been properly addressed.
• Companies may not make, extend, renew or modify any loan to their executives, officers or directors (although arrangements in place on 30 July 2002 may remain in place but may not be modified).
• If a company is required to restate its financial statements due to material non-compliance with financial reporting rules, its CEO and CFO each must reimburse the company for compensation and other profits earned during the 12-month period following the occurrence of the violation.
The Act contains a number of other provisions that will (or are expected to) apply to foreign companies but that are subject to SEC rulemaking procedures prior to effectiveness, including:
• Provisions relating to the PCAOB;
• Requirements regarding the make-up and duties of company audit committees;
• Requirements regarding establishment of internal accounting and disclosure controls and a codes of ethics; and
• Increased requirements regarding disclosure of off-balance sheet transactions and pro forma earnings disclosure.
The most obvious criticism of the Act is that it will almost certainly increase the cost of raising capital in the US for foreign companies. In addition, commentators have raised objections to a number of provisions that are likely to conflict with home country laws. For example, in Ireland, a company’s independent auditors are normally appointed by the annual general meeting of shareholders. However, the Act requires the audit committee to be solely responsible for engaging the independent auditors. In addition, the Act contains a number of provisions relating to the make-up of company audit committees and other corporate governance matters and also gives the PCAOB access to audit work papers of all accounting firms performing audit work for foreign companies that are publicly listed in the US. These provisions may also conflict with home country rules in Ireland and other jurisdictions in the European Union. Historically, the SEC has shown broad deference to foreign companies and potential conflicts with home country rules, primarily in an effort to encourage foreign companies to raise capital and seek public listings in the US. While the Act does not contain any express exemptions for foreign companies, the SEC has broad authority to effect such exemptions as it may see fit. However, the SEC’s ability to grant exemptions may be limited in situations where the Act specifically addresses foreign companies and their auditors (for example, the requirement regarding access to foreign auditor work papers). In addition, as some of the recent corporate scandals in the US involve foreign issuers (such as Global Crossing, a Bermuda company) the SEC may be pressured to limit the exemptions for foreign companies.
The European Commission has written to the SEC expressing its concerns over the impact of the Act on European companies and encouraging exemptions from a number of provisions for foreign companies and their auditors. Recent press coverage suggests that opposition within the EU is likely to continue to grow. The big four accounting firms are also understood to be developing a joint response to the Act.
The Act has also been subject to wide-ranging criticism in the US from companies and their advisors as being unnecessarily burdensome and not particularly well thought through. In response to these criticisms, some commentators have pointed out that it is important to remember that raising capital in the US and seeking a public listing is not something that exists as a matter of ‘right’ but rather is a ‘privilege’ in connection with which it is reasonable to expect regulatory equirements, increased costs, etc. In other words, even if the SEC does grant exemptions to foreign companies with respect to certain provisions of the Act, the Act signifies that the ‘bar has been raised’ in connection with accessing the US capital markets.
Turning to more practical matters, lawyers, auditors and other advisers are busy assisting their clients to understand the Act and its implementation. Companies that are currently listed in the US are presumably in the midst of this process, and companies that are considering a listing should take note of the Act and familiarise themselves with its provisions. Some of the recommendations that we have discussed with our foreign company clients include:
• Reviewing internal accounting and disclosure controls, including document review procedures, procedures to document and discuss concerns and issues that come up during the audit process, procedures to ensure that special attention is given to sensitive issues raised by regulators, and the importance of documenting such procedures and the fact that they are being followed.
• The possibility of undertaking an independent corporate governance audit, which can be conducted by the company’s outside counsel (or an independent consultant). It may be advantageous to use the company’s outside counsel for this type of project because of the attorney-client privilege and the established relationship of trust between the outside counsel and the company. On this point, it is important to stress the ‘independence’ of the audit, which may mean that the report needs to be delivered directly to the board of directors without prior approval by management.
The Act is complicated and raises many questions, many of which relate to the applicability of the Act to foreign companies. Some of these questions will be answered as the SEC works through its rulemaking procedures and others will depend on the practices developed in the field by companies and their advisors. In addition to the points raised above, foreign companies with questions or concerns about the Act should be talking to their advisers (lawyers, auditors and outside consultants) to obtain the benefit of the advisers’ broad-based experience with other clients and colleagues. Regardless of how the application of the Act and its interpretation develop over the coming months, the Act clearly signifies that the ‘bar has been raised’ in connection with accessing the US capital markets.

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