Corporate
Aug. 8, 2002
Learning to Play by New Corporate Rules
SAN FRANCISCO - One month before President Bush signed the Sarbanes-Oxley Act on corporate responsibility, lawyers at Gray Cary Ware & Freidenrich's new corporate governance advisory group were at the ready, firing off e-mail alerts, warning clients about the pending legislation.
Last Friday at 8 a.m., three days after Bush signed the act, Gray Cary conducted a seminar over the Internet, explaining the corporate oversight bill to existing and prospective clients.
"There can be no doubt that the enforcement environment today is very scary," warned Diane Holt Frankle, co-chairwoman of Gray Cary's mergers and acquisitions group, and now a member of the firm's corporate governance group, during the Webcast introduction.
Corporate directors and officers are now "under a microscope," Frankle said. "In fact, they are guilty until proven innocent."
Gray Cary is not alone in issuing such warnings. Along with tighter regulation of how corporations account for, and certify, quarterly reports, the Sarbanes-Oxley Act appears to have created a cottage industry in corporate governance within a number of Bay Area law firms.
Last week, Fenwick & West; Wilson Sonsini Goodrich & Rosati; Morrison & Foerster; Cooley Godward; Brobeck, Phleger & Harrison; and other law firms announced their own corporate governance seminars around the Bay Area. Each firm has posted summaries of the 130-page act on its Web site, offering to help clients establish procedures to comply with it.
"We want our existing clients to know we are all over this," said Scott Stanton, a member of Gray Cary's corporate governance team in San Diego.
As law firms jockey for position to prove they are capable of counseling companies on the broad range of the act's sweeping provisions, as well as new rules proposed by National Association of Securities Dealers, lawyers say they must focus on the provisions creating the most hand-wringing among executives. In the short run, those concerns include certification of 10-Qs, or second quarter reports, due to the Securities and Exchange Commission by Aug. 14, and a ban on loans by corporations to officers and directors.
Gordon Davidson, chairman of Fenwick & West, said his firm has not created a separate corporate governance practice group - yet. In writing memos on Sarbanes-Oxley for clients, all of the firm's approximately 90 corporate lawyers are quickly becoming experts on corporate governance, Davidson said.
"Virtually our whole corporate group has become a corporate governance group," he said.
Davidson defines corporate governance as the set of rules by which a company's board of directors governs the firm, complies with regulations and sets "best practices," or a company's ethics.
Many Bay Area lawyers say the two provisions in the Sarbanes-Oxley Act that have caused the most consternation deal with the role chief executive officers and chief financial officers play in certifying annual and quarterly earnings reports.
First, according to Section 302 of the act, CEOs and CFOs must review the reports, which previously they did not have to do. Among other requirements, the officers must certify that, to their knowledge, the reports do not contain any material misstatements or omissions. Importantly, the rules are required to be effective by Aug. 29.
"Section 302 contemplates that it will take 30 days for the SEC to finalize the rules and that it will take additional time for companies to understand the rules and develop procedures for complying," Davidson said.
However, another provision, Section 906, which applies to second-quarter reports currently being filed by companies, makes it a crime to file a false statement in the reports whether or not the officers know about it.
"There could be a disclosure [in the reports] that's technically required, that's inadvertently omitted and immaterial, that results in criminal sanctions," Davidson said.
"The apparent inconsistencies [of Sections 302 and 906] have been confusing to lawyers and clients alike," Davidson said. "It almost seems like a mistake, but it's clearly part of the law that's in effect today."
The penalty for inadvertently omitting information is up to a $1 million fine and 10 years in prison. Willful omissions can mean up to $5 million in fines and 20 years in prison.
That fact has led CEOs and CFOs to seek their own criminal lawyers, independent of the law firms representing their companies, to help them avoid criminal liability.
Davidson said legal groups such as the American Bar Association have been trying to get clarification of the inconsistencies from the U.S. Securities and Exchange Commission and congressional staffers before the Aug. 14 filing deadline.
Howard Clowes is a partner in Gray Cary's San Francisco office who pushed for the formation of the firm's corporate governance advisory group about five months ago, when the Enron scandal broke. The group comprises 23 lawyers, including at least one from each of the firm's seven offices.
According to Clowes, Section 402 of the act, the provision that prohibits personal loans by companies to executive officers or directors, has created a number of unintended consequences for Silicon Valley companies in particular.
"The loan provision is so broad that it effectively prohibits anything that looks or smells like a loan," Clowes said.
That includes loans that were often made to executives, but later forgiven, he said. The provision might also cover relocation and home financing loans that Bay Area companies used to lure employees to move here from out of state.
"That was a standard relocation feature, and that can't happen again," Stanton said.
Section 402 also seems to cover the popular Silicon Valley practice of same-day sale of stock options, Stanton said. In the 1990s, technology firms offered options in lieu of salary increases to attract or retain employees.
In exercising stock options, employees do not actually put up their own money. Instead, stockbrokers cover the cost of the transaction, which is guaranteed by the company.
Though the Sarbanes-Oxley Act doesn't name options specifically, lawyers said, same-day sales of stock options could be considered a form of loan. As a result, Gray Cary has advised clients to suspend same-day sales of stock options until the SEC has clarified the provision.
Stanton said the Sarbanes-Oxley Act is creating new business opportunities for law firms.
Technology companies that had been closely watching their legal budgets might have to open their wallets to make sure they're in compliance with the new laws, he said.
Along with individual executives, he said, company board members also are looking at hiring independent outside counsel to avoid criminal liability.
Still, Stanton said, law firms must tread carefully in interpreting the new law. "This corporate governance shakeup creates opportunities for all these law firms to expand their client base," Stanton said. "But if they don't execute properly, they can lose clients."
For the Record An article published in the San Francisco Daily Journal on August 7, 2002 incorrectly stated that, under Section 906 of the Sarbanes-Oxley Act, corporate officers may be held criminally liable whether or not they know about false statements in certified quarterly reports filed with the Securities and Exchange Commission. In fact, to be held crimi-nally liable, the officers must have known that the certification was false. Because of the error, a comment by Fenwick & West chairman Gordon Davidson was mischaracterized. We regret the error.
Joel Rosenblatt
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