Ethics Practice

Golden Parachutes

A contract in which a corporation agrees to make payments to key officers in the event of a change in control of the corporation.

SOX - Internal ControlSection 404 "Best Practices" for financial controls may include:

A disclosure committee to review procedures and processes A disclosure coordinator - one contact person A time line and responsibility chart Established document procedures Lots of consultation with internal audit and outside advisors Subcertifications Codes of Conduct for accounting and financial employees

Poison Pill

A shareholder rights plan aimed at discouraging or preventing a hostile takeover

Improving Boards and Board Members

Building a Better Board  Define the role the board intends to undertake Be explicit about their financial goals Widen the talent pool for directors Encourage constructive dissent Divide and delegate work to promote deeper analysis  Being a Better Board Member  Be willing to change management Be willing to do lots of homework Control the flow of information Meet outside of the CEO's sphere Don't sacrifice performance for collegiality

SOX Section 304

CEOs and CFOs must reimburse their companies for any bonus or other incentive-based compensation earned, or trading profits received, in the 12-month period following financials that are restated as a result of misconduct

Improving Corporate Governance

Changes in boards of directors "outside" directors stronger board committees diversity Establish committees for: audit nominating compensation public policy Board should "get tough" with the CEO

SOX Section 402

Companies may not make personal loans to executive officers and directors

Codes of Conduct

Conflicts of interest Protecting proprietary information Receiving gifts Giving gifts Discrimination Sexual harassment Kickbacks General conduct Employee theft Proper use of assets

SOX Costs

Cost of compliance can be as much as three times the cost prior to the Act's implementation Members of the Business Roundtable expect to pay from $1 million to $10 million for SOX compliance One study found that the average costs for internal control compliance was $3.1 million

SOX - Liabilities and Penalties

Criminal penalties for document destruction or alteration or obstruction of a federal investigation (fines, imprisonment or both) Criminal penalties for knowingly defrauding shareholders (fines, imprisonment or both) 906 Certification penalties Addresses penalties for white-collar crime, mail fraud, willful violations of the Exchange Act and the defrauding of pension funds Adds whistleblower protections

SOX - Internal Control

Defined as a process designed by, or under the supervision of, the company's principal executive and financial officers, or persons performing similar functions, and effected by the company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Framework must be based on a suitable, recognized control framework

Duty of Loyalty

Directors have a duty of loyalty in all dealings with the corporation

Board Member Liability Duty of Care

Directors must exercise the care of an ordinarily prudent and diligent person in a like position, under similar circumstances.

Choice of Entities - General Partnership and LLCs

General Partnership - Two or more persons who are engaged in business as co-owners. Limited Liability Company - A limited liability company is a non-corporate business entity whose owners (members) have limited liability and can participate actively in its management. It can be managed by its members or nonmember managers.

SOX - Code of EthicsSection 406

Issue: Codes Were Waived for Company Employees (Ex: Enron CFO, Andy Fastow) Resolution: Companies must disclose whether they have adopted a Code of Ethics for CEO and Senior Financial Officers If they have not adopted such a code, they must state why Code is to address such matters as conflicts of interest, accurate financial reporting, and compliance with governmental rules and regulations Must be publicly available Must disclose any waivers of the Code

SOX - CEO and CFO CertificationsSection 302

Issue: Corporate management has primary responsibility for the preparation of financial statements and the creation of programs and systems of control to ensure that accurate information finds its way into those statements Resolution: CEO and CFO must certify that the quarterly and annual reports do not contain any materially untrue statements or half-truths based on their knowledge the financial information is fairly presented they are responsible for the company's internal financial controls and that they have evaluated the effectiveness of such controls they have reported any weaknesses in the controls and any fraud to the auditors and audit committee

SOX - Internal ControlSection 404

Issue: How can CEOs and CFOs know that the information that they certify is reliable? Resolution: Each annual report must contain an "internal control report" Stating the responsibility for management for establishing and maintaining an adequate internal control structure so that accurate financial statements could be produced and Containing an assessment, as of the end of the most recent fiscal year, of the effectiveness of the internal control structure and procedures Requires auditors to audit the internal control assessment of the company

SOX - CEO and CFO CertificationsSection 906

Issue: Inaccurate reports filed with the SEC Solution: CEOs and CFOs must certify that the quarterly and annual reports are accurate Penalties: Adds a criminal provision punishing these officers if they intentionally certify SEC filings containing financial statements "Knowing" violations = up to $1 million and 10 years in prison "Willful" violations = up to $5 million and 20 years in prison

Sarbanes-Oxley Act of 2002

Limits the nonauditing services an auditor can provide Requires auditing firms to rotate the auditors working with specific companies Makes it unlawful for accounting firms to provide services where conflicts of interests exist Enhances financial disclosure with requirements, such as: reporting off-balance sheet transactions prohibiting personal loans to executives and directors requiring auditors to assess and report upon internal controls Audit committees must have at least one financial expert CEOs and CFOs certify and are held responsible for financial representations Whistle-blowers are afforded protection Code of Ethics disclosure Companies are required to protect whistle-blowers without fear of retaliation It is a crime to alter, destroy, conceal, cover up or falsify documents to prevent its use in a federal government lawsuit

SOX - Enforcement

Makes a violation of SOX a violation of the Exchange Act Grants SEC temporary freeze authority over payments to persons suspected of violating securities laws Lowers threshold of conduct of a director or officer, which may prohibit that person from acting as a director or officer of any public company Adds equitable relief to the list of remedies that the SEC may seek under the Exchange Act

Whistle-Blowing Mechanisms

May phone in their inquiries about the company's code of ethics or report suspected wrongdoing Could damage morale in certain cases

Identifies nine factors to be considered in charging an organization. Those factors are

Nature and seriousness of offense Pervasiveness of wrongdoing History of similar conduct Disclosure and cooperation* (privilege and attorney fees) Existence and adequacy of compliance program Remedial actions, including implementation or modification of compliance program Collateral consequences Adequacy of prosecution of individuals Adequacy of civil or administrative remedies

SOX Section 306

Prohibits directors and executive officers from buying or selling company stock during a pension fund "blackout period"

Federal Sentencing Guidelines

Reduced penalties to those companies with ethics programs that were found guilty of ethics violations Two major benefits accrue to organizations that follow these guidelines: It mitigates severe financial and oversight penalties Some prosecutors are choosing not to pursue some actions when the companies in question already have sound programs in place if they follow these guidelines

Corporate Governance

Refers to the method by which a corporation is being governed, directed, administered or controlled and to the goals for which it is being governed Is concerned with the relative roles, rights, and accountability of such stakeholder groups as Owners Board of Directors Managers Employees

Why establish a compliance program

Rules and regulations require it SOX Section 301, 406 and related SEC rules regarding audit committee complaint procedures and codes of ethics NYSE/Nasdaq corporate governance rules

SOX - Other Disclosure Requirements

SEC Review: SEC must review disclosures made by NYSE, Nasdaq or AMEX-listed companies on a regular basis, including review of financial statements. Off-Balance Sheet Transactions and Contractual Obligations: Companies must disclose all material off-balance sheet transactions, arrangements, obligations, and other relationships with unconsolidated entities that might have a material impact on the financial statement. Requires disclosure of "Non-GAAP Financial Measures" Different requirements for periodic filings and press releases

Publicly Held

Shares are owned by a large number of people and are widely traded SEC Registrations Registered Under the Exchange Act of 1934 Required if stock is held by 500 or more persons and has total assets exceeding $10 million dollars Issued Securities Subject to a Registered Public Distribution Under the Securities Act of 1933 -- also usually considered publicly held

Privately Held

Shares of stock are usually held by a small number of persons, frequently relatives or friends Larger, privately held companies typically have "angel" investors or venture capital investors

Board Member Liability

The Delaware Chancery Court ruled that it is the duty of the board of directors to ensure that a company has an effective reporting and monitoring system in place.  If the board fails to do this, individual directors can be held personally liable for losses that are caused by their failureto meet appropriate standards.

Insider Trading

Using critical information from inside a company and using that information for one's own personal financial gain. Regulation FD - requires companies to publicly disclose any meaningful information that is provided to shareholders and security professionals.

In determining whether to bring charges and what charges to bring, the SEC will consider:

What compliance procedures were in place to prevent the misconduct and why those procedures failed Where in the organization the misconduct occurred and how high up was knowledge of the misconduct Whether the behavior was systemic or symptomatic

Role of an Ethics Officer

coordinate the program with top management develop, revise, & disseminate the code of ethics develop effective ethics training tools establish audit & control systems develop enforcement techniques revise the program as needed

Six Steps in Implementing a Code of Ethics

distribute internally & externally assist employees in understanding specify management's role make employee's responsible for understanding the code establish grievance procedures provide a concluding statement

Executive and Director Pay is Reported

the Proxy Statement

Business Judgment Rule

there is no liability (absent a conflict of interest, bad faith, illegality, or gross negligence, and, in some cases, ordinary negligence) for errors of judgment, but the director must have been reasonably diligent before the rule can be invoked.