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Proposed Sarbanes-Oxley Regulations Will Require
Internal Complaint Procedures
[March 2003]
Overview
On January 8, 2003, the Securities and Exchange Commission (the
“SEC”) voted unanimously to propose new regulations (the
“Proposed Rules”) mandating, among other things, that
listed companies’ audit committees create anonymous internal
complaint procedures.
The rules implement Section 301 of the Sarbanes-Oxley Act of 2002
(the “Act”) and direct the national securities exchanges
and national securities associations (collectively, the Self Regulatory
Organizations (“SROs”)) to prohibit the listing of any
security of an issuer whose audit committee is not in compliance
with the five requirements established by the Act. The creation
of an anonymous internal complaint procedure is one of these five
requirements. The rules also specify required levels of board audit
committee independence, including the authority to retain and fund
an independent accountant or outside advisors.
Because the Proposed Rules would only affect SRO listing criteria,
they will not impose internal complaint procedures on private companies
or companies traded over-the-counter or on the “pink sheets.”
Nevertheless, as a matter of good corporate practice, issuers should
consider establishing procedures relating to the receipt, retention
and treatment of internal complaints (confidential or otherwise)
regarding accounting, internal accounting controls or auditing matters.
This advisory discusses the various alternatives available to audit
committees for establishing such procedures.
The SEC must finalize these rules by April 26, 2003. They will
be put into effect by the SROs no later than one year after the
SEC publishes the final rule in the Federal Register.
Complaint Procedures Required
The Proposed Rules require the board audit committee of a listed
issuer (or, if the issuer does not have an audit committee, the
full board of directors) to establish procedures for:
(i) [t]he receipt, retention and treatment of complaints...regarding
accounting, internal accounting controls, or auditing matters”
and
(ii) [t]he confidential, anonymous submission by employees
of the listed issuer of concerns regarding questionable accounting
or auditing matters.”
They do not, however, specify what specific characteristics of
an internal complaint procedure will satisfy these general requirements.
Instead, an advisory accompanying the proposed rules states that
“[g]iven the variety of listed issuers in the U.S. capital
markets, we believe companies should be provided with flexibility
to develop and utilize procedures appropriate for their circumstances.
We expect each audit committee to develop procedures that work best
consistent with its company’s individual circumstances.”
As a practical matter, an employer’s program will most likely
evolve from similar policies and procedures that may already be
in place for dealing with reports of things like workplace discrimination
or harassment, conflicts of interest, complaints of Medicare or
Medicaid fraud, or concerns about bribes or kickbacks. The extent
of an employer’s resources (including the available time of
audit committee members) will also dictate whether the complaint
procedure is administered internally, or outsourced through a third-party
hotline. As might be expected, vendors providing confidential anonymous
hotline services have become dramatically more visible in the wake
of the Act.
While neither internally-maintained, nor third-party hotlines are
necessarily preferred, the latter do generally make it easier to
ensure employee confidentiality and anonymity — two of the
general requirements of the Act.
Another general consideration is that, regardless of the procedures
developed, the audit committee should retain oversight over the
processing of such complaints. In this regard, written procedures
should be developed for timely investigating and responding to such
complaints.
Finally, employers should make their chosen reporting process known
to employees, noting the availability of anonymity. Creating an
atmosphere that allows for confidential, anonymous disclosure will
go a long way toward ensuring that potentially improper accounting
or auditing conduct is exposed in time to stop what could be devastating
financial consequences.
Employers are encouraged to consult DWT counsel to determine which
procedures best suit their particular circumstances and meet their
obligations under the Act.
Determinations of Compliance and Opportunity to
Cure Defects
Section 301 of the Act does not impose specific mechanisms to guarantee
ongoing compliance by issuers. However, in order to assist the SROs
with enforcement of the statutory audit committee requirements,
the Proposed Rules would require a listed issuer to notify its SRO
promptly after one of its executive officers becomes aware of any
material noncompliance with the proposed requirements. The Proposed
Rules would require that, once noncompliance was determined, the
SROs provide established procedures for an issuer to cure the violation.
Next Steps for Audit Committees
Board audit committees should begin now to consider the alternatives
for complying with the Proposed Rules. Although not final, it is
likely these rules will be adopted with relatively minor modifications
and subsequently acted upon by the SROs. In addition to formal compliance
with continued listing criteria, the establishment by an audit committee
of effective internal complaint procedures should cultivate open
and effective channels of information, encourage proper individual
conduct and alert the board’s audit committee to potential
problems before serious consequences arise.
This Corporate Finance Advisory is a publication
of the Corporate Finance Department of Davis Wright Tremaine LLP.
Our purpose in publishing this Advisory is to inform our clients
and friends of recent developments in corporate finance. It is not
intended, nor should it be used, as a substitute for specific legal
advice as legal counsel may only be given in response to inquiries
regarding particular situations.
Copyright © 2003, Davis Wright
Tremaine LLP. Please do not reprint, or post on your website, without
explicit permission.
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