Annual Review of Insolvency & Restructuring Law 2003 - Developments in the United States
Amendments to NYSE and NASD Rules
On 4 November 2003, the Securities and Exchange Commission (SEC) adopted a final order approving amendments to New York Stock Exchange (NYSE) and National Association of Securities Dealers (NASD) rules relating to corporate governance standards for listed companies. These rules supplement the existing requirements of the Sarbanes-Oxley Act applicable to all SEC-registered companies.
The new standards introduced include:
- the majority of directors must be independent (ie not have a relationship that would prevent that director's judgement from being independent);
- independent directors must meet in regularly scheduled executive sessions without management or other non-independent directors;
- executive compensation and board nominations must be approved or recommended by independent directors;
- companies are bound by committee composition, charter and other requirements for audit committees and the board nominating process;
- companies must adopt a code of conduct and set forth requirements for waivers of the code of conduct;
- companies must make an immediate public announcement upon receipt of an audit opinion with a going concern qualification; and
- the audit committee or another committee of the board consisting of independent directors must approve related-party transactions.
Companies registered outside the United States will not be required to adopt the NYSE corporate governance standards but must disclose any significant differences between their practices and the NYSE standards.
There is a transition period under the new standards: Nasdaq-listed issuers must be in compliance by 31 October 2004, and listed, foreign private companies must comply by 31 July 2005.
There is a partial exemption under the standards for companies of which 50 per cent or more of the voting power is controlled by another entity. Such companies will not have to comply with the requirements relating to independent directors or committee requirements.
Sarbanes-Oxley update
The US Government introduced the Sarbanes-Oxley Act 2002 on 30 July 2002. Some of the Act's provisions came into force immediately, while others will require rules to be promulgated by the Securities and Exchange Commission (SEC) over time.
The Act increases the accountability of directors and executive officers; enhances disclosure obligations; includes steps to ensure auditor independence; provides that audit committees must be independent; and increases the responsibilities of the audit committee.
To date, the SEC has proposed the following rules to give effect to the provisions of the Sarbanes-Oxley Act.40
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Rules relating to the disclosure of financial information, restrictions on insider trading during pension-fund blackout-periods and disclosure of information about corporate codes of ethics and audit-committee financial experts. Companies will need to identify the use of non-standard accounting practices and certify that financial reports are not untrue or misleading.
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Rules requiring mutual funds and other registered managed investment companies to file shareholder reports in a prescribed form and also requiring the principal executive and financial officer to certify the information contained in the reports.
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Rules to strengthen auditor independence and require additional disclosures to investors about the services provided to issuers by the independent accountant. For example, the rules provide that certain partners on the audit engagement team must rotate after no more than five or seven consecutive years and require that disclosures be made to investors of information related to audit and non-audit services provided by, and fees paid to, the auditor.
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Rules to direct national securities markets to prohibit the listing of any security of an issuer not complying with the audit committee requirements set out in the Sarbanes-Oxley Act. The proposed rule would apply to domestic and foreign-listed issuers; however, special provisions have been included to address the special circumstances of particular foreign jurisdictions. For example, under certain conditions, non-management employees may serve as audit-committee members and shareholders may select or ratify the selection of auditors.
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Rules requiring financial reports to disclose all material, off-balance sheet transactions and arrangements and contractual obligations and commitments of the company.
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Rules requiring accounting firms to retain records relating to audits or reviews for seven years.
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Rules imposing obligations on attorneys to report evidence of a material violation of US securities law to the company's chief legal officer or chief executive officer. If the reporting attorney does not receive an 'appropriate response' to his or her report, the attorney must report the evidence to the company's audit committee.
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Rules directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with the audit committee requirement established by the Sarbanes-Oxley Act.
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Rules requiring reports by insiders disclosing their securities holdings to be filed electronically with the SEC.
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Rules prohibiting company officials from improperly influencing the auditors of company financial statements.
On 6 February 2003, the SEC voted to adopt Regulation AC (Analyst Certification). This regulation requires broker-dealers to include in research reports that they publish a certification by the research analyst that the views expressed in the report accurately reflect the analyst's personal views about the subject securities and issuers. The analyst will also need to certify whether his or her compensation is related, directly or indirectly, to the views or recommendations expressed.
On 30 June 2003, the SEC approved a series of rules that require shareholder approval of equity compensation plans, including stock option plans. The two independent sets of rules were first proposed by the New York Stock Exchange and the Nasdaq Stock Market in October 2002, and have been the subject of various amendments since then. The rules will strengthen corporate governance by providing shareholders with the power to influence the existence of employee share schemes, which can have the potential to dilute shareholder interests.
Bankruptcy reform
The House of Representatives passed the Bankruptcy Abuse Prevention and Consumer Protection Act 2003 on 19 March 2003. The Act is awaiting consideration by the Senate. It introduces a number of reforms in relation to individual and small business bankruptcies, designed to curb perceived abuse of the bankruptcy system and promote personal financial responsibility. The major reforms are that individual debtors will be means-tested and will be presumed to be abusing the bankruptcy process if their income exceeds certain limits. Small business will be given less time to file reorganisation plans under Chapter 11 and must abide by uniform accounting and reporting standards. There is also a range of provisions designed to protect consumers with credit arrangements.
Another post-Enron legislative measure, the Corporate Accountability in Bankruptcy Act,41 was introduced by Senate Finance Committee chairman Charles Grassley and passed by the House of Representatives in April 2003. This is expected to be considered by the Senate at the same time as the Bankruptcy Abuse Prevention and Consumer Protection Act 2003 on 19 March 2003.
The Act provides that bonuses, loans and other excessive compensation provided to corporate officers, directors, and employees who have committed securities law violations can be recovered by the trustee when a company declares bankruptcy within four years of the violations. The trustee can also claw back any bonuses, loans or other excessive or extraordinary compensation (as determined by the court) made to a corporate officer within a year before the date on which the company filed for bankruptcy.
Footnotes
- Information about rules and regulations adopted by the SEC is available from the SEC's website at http://www.sec.gov.
- 108th Congress 1st Session, s832.
Annual Review of Insolvency & Restructuring Law 2003: Glossary
