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Sarbanes-Oxley Act and New NYSE and NASDAQ Listing Requirements: Consequences for Private Equity and Mergers and Acquisitions Transactions


January 7, 2004

The Sarbanes-Oxley Act and the revised NYSE and NASDAQ listing standards have significant implications and consequences for private equity and mergers and acquisitions transactions. In November 2003, the SEC approved the revised NYSE and NASDAQ listing requirements. It is now standard procedure that Sarbanes-Oxley “due diligence” and review is conducted by investors, acquirers, investment bankers, lawyers and accountants in connection with private equity and mergers and acquisitions transactions. We are recommending use of a Sarbanes-Oxley/NYSE/NASDAQ action checklist to assist this process, which supplements legal due diligence checklists. In addition, officers’ and directors’ questionnaires have been materially revamped and updated as a result of Sarbanes-Oxley, NYSE and NASDAQ listing requirements.

Sarbanes-Oxley and the revised NYSE and NASDAQ listing standards effect board composition and audit committees and create new corporate governance standards. Sarbanes-Oxley also provides increased disclosure, certification of financial reports by chief executive officers and chief financial officers and new accounting reforms.

We are, therefore, in an environment of enhanced and rigorous corporate governance.

Board of Directors

A majority of the board of directors of a listed company must be independent. Please also note that:

  • Audit, nominating/corporate governance and compensation committees of NYSE-listed companies must be comprised entirely of independent directors. An executive session limited to independent directors should be held once a year. All independent directors, rather than just the compensation committee, should approve CEO compensation.
  • For NASDAQ companies, audit committees must be entirely independent. The compensation or nominations committee, or a majority of the independent directors, may recommend certain actions to the full board for determination, rather than taking those actions unilaterally. If a NASDAQ company has a nominating and compensation committee, it should be comprised of independent directors. A formal resolution must be adopted by the board with respect to the nominations process.

The above requirements do not apply to “Controlled Companies” – generally companies 50% or more of whose equity is owned by another company.

A director may not have any material relationship with the listed company in order to meet independence requirements. The basis for the independence determination must be disclosed in the annual proxy statement under NYSE and NASDAQ rules. Both NYSE and NASDAQ have certain “cooling off” periods that apply to the no material relationship requirements that permit a company and a director to transition affiliations. Care should be taken to review all affiliations of a director to determine director independence.

The consequences of the enhanced independent board requirements mean increased involvement by board members (especially independent directors), longer and more board meetings, more board committees and continuing director education.

Audit Committees

The audit committee of listed companies must be comprised of three or more members. Audit committee members must be independent and may not accept any consulting, advisory or other compensatory fees from the company (other than fees for serving as a board or committee member). An audit committee member who is not an executive officer, director or shareholder of more than 10% of any class of the company’s equity securities will not be deemed to control the company, and thus not be deemed to be an “affiliate” of the company.

Each issuer registered with the SEC (including non-listed reporting companies) must disclose in its SEC reports whether it has one member of its audit committee who is a “financial expert.” Many companies without a “financial expert” are now searching for qualified accountants or individuals with accounting background to serve as an independent director who fulfills this “financial expert” requirement.

Audit committees have significant responsibilities under Sarbanes-Oxley. Serving as a member of an audit committee entails highly serious duties and work. Audit committees:

  • be responsible for the appointment, compensation and oversight of the issuer’s auditors, and the auditors must report directly to the audit committee;
  • create and maintain procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, and the confidential, anonymous submission by employees regarding questionable accounting or auditing matters; and
  • have the authority and adequate funding to engage independent counsel and other outside advisors to fulfill their duties.

Because serving on an audit committee entails such an expanded and highly-qualified role, care should be taken before one agrees to be nominated and serve on an audit committee.

Section 16 Reporting

Officers, directors and 10% shareholders must report electronically any changes in beneficial ownership of equity securities within two (2) business days of the transaction rather than within ten (10) days after the end of the month in which the transaction occurred.

Prohibition on Loans to Directors and Officers

Loans by a registered company to directors or officers are prohibited under Sarbanes-Oxley.

D&O Insurance

The directors’ and officers’ liability insurance of many public companies has increased dramatically as a result of Sarbanes-Oxley and the revised NYSE and NASD listing requirements.

Effects Going Forward

Boards of public companies will need to be comprised of a majority of independent directors. Audit committees will need to be comprised solely of independent directors. Directors will be expected to allocate and devote substantially greater amounts of time to board and committee meetings. Board and committee meetings will be more frequent and longer. Additional expanded financial information, financial statements and other information will be supplied by registered companies to board members. Board minutes will need to reflect expanded board discussion, coverage and deliberation on financial and other matters.