Switzerland: Sarbanes And The States

The year that has passed since the passage of the Sarbanes-Oxley Act of 2002 ("Sarbanes"), and subsequent Securities and Exchange Commission ("SEC") interpretive rules, permits sufficient perspective for an initial examination of its effect throughout the various states. Fifteen states have seriously considered adoptive legislation only to permit the particular bills to be largely tabled, rejected, or watered-down. The major objection to adaptation of Sarbanes is that it would be overly burdensome and oppressive on smaller businesses. This objection is understandable given the applicability of Sarbanes to only corporations with over 500 shareholders. Some state legislators have suggested that a reasonable standard for private businesses with fewer shareholders would be to apply the equivalent state statutes to businesses with more than 20 employees. But even in these cases the Sarbanes and subsequent SEC rules were considered too burdensome and irrelevant to the requirements of small businesses.

States which have considered such legislation are: California, Colorado, Connecticut, Florida, Illinois, Kentucky, Maryland, Massachusetts, Montana, New Jersey, New Mexico, Ohio, New York, Texas, and Washington. Progress in each of these states will be examined, and in the process the general tenor and philosophy of the legislatures should become evident.

(See http://www.aicpa.org/download/statelegis/state_acctg_reform_legislation.pdf for regularly updated information.)

One would expect pathfinder California to lead the national trend. If so, there is trouble afoot for those wishing a cascading effect of Sarbanes upon state securities and accountancy laws. Reality and heavy lobbying by the business community eroded an initial burst of enthusiasm in the state assembly and senate. Assembly bill AB 664, introduced February 19, required a CPA who performs an audit for any corporation, profit or non-profit) to report to the audit committee all accounting policies used during the audit and all alternative disclosures and treatments discussed with management of the corporation. Further, corporations would have been required to disclose if they have adopted a code of ethics for its senior financial officers and would have increased the criminal penalties for violating the Corporate Securities Act of 1968 to 20 years or less jail-time and a fine of $10 million or both from the previous maximum of 5 years in jail. This bill failed, as did a companion Senate Bill 766 which would have amended the Government Code sec. 25500, a critical part of the California Securities Act of 1968, calculated to prohibit manipulation of the financial markets. It would have eliminated the requirement that false and misleading statements be intentional and permits findings of liability based solely on ordinary negligence. Also, the requirement of showing that a person has been engaged in buying or selling securities in order to be liable for securities fraud was likewise eliminated. Concern was expressed by such lobby groups as the Civil Justice Association of California, to wit:

Assembly Bill 665, introduced the day after AB 664, passed the assembly on May 15 and referred to the Senate Committee on Business and Professions for consideration in 2004. It would exclude individuals who represent a CPA, bookkeeping or tax preparation firm from being a public member of the California Board of Accountancy Interestingly, the provision requiring a corporation to have an audit committee comprised entirely of independent directors was stricken.

California also rejected the Corporate Three Strikes Act (SB 335) that would have banned corporations and other entities (such as LLCs) convicted of three felonies from doing business in California. SB 335 applied to entities formed in California and perhaps to quasi-California corporations, entities qualified to do business in California, and even entities with subsidiaries in California, if the subsidiaries were convicted of felonies.

However, several bills have been successfully enacted. For example, three accounting-reform bills have become part of California law:

1. CPAs must report within 30 days after any restatement of a financial to the client in addition to reporting any judgment of settlement of more than $30,000, or any amount if dishonesty, fraud or theft is involved.
2. Audit documentation must be retained for 7 or more years; and,
3. CPAs with significant audit responsibilities are prohibited from taking an executive-level position with the client for 1 year after performance of the audit.

As will be seen, several states also have related pending legislation. Additionally,

AB 55 (effective January 1, 2003) amended California Corporations Code sections 1502 and 2117, adding a new section 1502.5. As explained in California Secretary of State, Notice of Legislative Change - Corporate Disclosure Act (AB55), AB55 Notice (Rev. 01/2003), the successful bill:

1. Enacts the California Corporate Disclosure Act, which requires additional information (pertaining to every "publicly traded company") to be included in the statement of information filed by domestic stock corporations and foreign corporations. "Publicly traded company" means a company with securities that are either listed or admitted to trading on a national or foreign exchange, or is the subject of two-way quotations, such as both bid and asked prices, that is regularly published by one or more broker-dealers in the National Daily Quotation Service or a similar service.
2. Changes from biennial to annual the filing requirement for Statements of Information filed by domestic stock corporations and foreign corporations.
3. Requires the Secretary of State to make the information in the Statements available and open to the public for inspection, and specifies that by December 31, 2004, the Secretary of State must make the information available through an on-line data base.
4. Establishes a Victims of Corporate Fraud Compensation Fund, to be administered by the Secretary of State, and requires the Secretary of State to adopt regulations regarding the administration of the fund and the eligibility of victims to receive compensation. In addition to the current $20.00 filing fee for statements of information, the bill requires the payment of a $5.00 disclosure fee when the required statement of information is filed. Half of the $5.00 fee will be used to further the provisions of the bill, including the establishment of the online database, and the other half will be used to compensate victims of corporate fraud.

The legislative changes in AB 55 are inapplicable to limited liability companies (LLCs) and nonprofit corporations.

Still resting in the Senate Judiciary Committee is SB 917, relating to Code of Corporate Responsibility, that would, on and after January 1, 2017, establish both a public and a private right of action against any director of a California corporation if the corporation "violates any . . . law designed to protect the environment, violates human rights, adversely affects the public health or safety, damages the welfare of the communities in which the corporation operates, or violates the dignity of its employees. . . . " The only defenses available to a director would be to prove either (1) he was not on the board at the time, (2) he voted against the bad action at a board meeting or (3) the corporation had annual revenues of less than $15 million. Otherwise, this bill appears to create strict liability for directors for exceedingly vague actions such as violating people's dignity or harming a community's welfare. If a plaintiff can show intent, the possibility of punitive damages would exist as well.

In January of 2003 the Colorado House killed two bills, HB 1116 and HB1227. The former would have amended the accountancy statute to reclassify accounting fraud from a class 3 misdemeanor to a class 3 felony. The latter would have prohibited a CPA from accepting employment from a publicly traded company or the corporation’s affiliate for a period of one year if the CPA participated in the audit engagement or was a person in charge of or partner on the engagement.

However, on June 5, the Governor signed into law HB 1218 which prohibits a board of directors from authorizing a loan to a director of a public company or entity that meets the definition of an issuer under Sarbanes-Oxley Act, thus excluding smaller public companies, private companies, non-profit corporations and mom-and -pop operations.

On July 9, the Governor signed into law SB 1035 that, as amended, revised the accountancy statutes to:

1. Provide penalties for CPAs who violate the Securities and Exchange Act of 1934;
2. Change the makeup of the Board of Accountancy from 4 CPAs to 5 and from 3 public members to 4;
3. Allows the Board to increase fines up to $100,000;
4. Requires CPAs to retain work papers of their publicly held companies for 7 years.

No legislation was seriously proposed with respect to stricter corporate governance a la Sarbanes.

For example, Florida came close to passing a stringent peer review requirement. When Enron’s stock plummeted, the state pension fund lost approximately $300 million, prompting Florida’s senate to approve legislation requiring peer review for all firms providing attest services. The peer review reports could have been the basis for the board’s taking disciplinary action against firms doing "substandard" work. The bill was defeated in Florida’s house of representatives when its lone CPA pointed out that Andersen had received a clean peer review report just before Enron’s collapse. (Journal of Accountancy On Line, Special Report: Sarbanes-Oxley Act Tops NASBA Meeting Agenda, February, 2003. https://www.cpa2biz.com/News/Journal+of+Accountancy/February+2003/Special+Report+Sarbanes+Oxley+Act+Tops+NASBA+Meeting+Agenda.htm). No other governance bill has since been proposed in Florida except for a whistleblower statute that was enacted in 2003, section 112.3187, entitled the "Whistle-blower's Act."

Writing in Viewpoint, Vol. 1, No. 19 (May 30, 2003), pp. 553-556, Florida attorney Geoff Morgan summarizes the issues raised in consideration of the applicability of Sarbanes to the states:

The new section is intended to prevent agencies or independent contractors from taking retaliatory action against an employee who reports to an appropriate agency violations of law on the part of a public employer or independent contractor that create a substantial and specific danger to the public's health, safety, or welfare. It was further the intent of the Legislature to prevent agencies or independent contractors from taking retaliatory action against any person who discloses information to an appropriate agency alleging improper use of governmental office, gross waste of funds, or any other abuse or gross neglect of duty on the part of an agency, public officer, or employee.

On June 27, the Governor enacted an amended bill (HB 2568/SB 1530) which prohibits a business to bid or enter into a contract with the state that has been convicted of a felony under Sarbanes or the Illinois Securities Law for a period of 5 years from the date of conviction. The bill was amended to eliminate a provision that would have banned a firm from doing business in Illinois, if the guilty business individual(s) was no longer part of the firm.

Another bill (HB 3591) vainly attempted to amend the accountancy statutes to prohibit CPAs from providing consulting services to their clients being audited.

The January, 2003 attempt by the sponsors of SB 10 to enact a Kentucky Corporate Responsibility Act of 2003 was defeated in the Judiciary Committee. It would have increased penalties for falsifying business records or financial statements. It also would have created investment principles for financial organizations that provide investment services to the state.

Meeting a similar fate was the simultaneously introduced SJR 3, which would have merely requested state agencies with investment responsibilities to review their procedures for investment, accounting and auditing to report back to the General Assembly.

Defeated in the Senate Finance Committee, the bill, known as the Corporate Accountability Act of 2003 (SB 560), introduced January 2003, would have amended the Corporations and Associations Code to incorporate definitions and provisions contained in Sarbanes. The following position of the Maryland State Board of Public Accountancy ("MACPA") regarding Senate Bill 560 reflects a general consensus throughout most of the state legislatures:

Currently awaiting action from the Joint Committee on Commerce and Labor is SB 59, which requires that State Retirement Investment Boards divest in public companies that have failed to develop and implement policies that prohibit auditing firms from having consulting contracts with the company being audited, or have failed to create audit and compensation committees composed of independent board members. It also contains provisions to protect whistleblowers, regardless of business size. Pursuant to the proposed statute, the court may: (1) issue temporary restraining orders or preliminary or permanent injunctions to restrain continued violation of this section; (2) reinstate the employee to the same position held before the retaliatory action, or to an equivalent position; (3) reinstate full fringe benefits and seniority rights to the employee; (4) compensate the employee for 3 times the lost wages, benefits and other remuneration, and interest thereon; and (5) order payment by the employer of reasonable costs and attorneys' fees. Likewise, the employer is entitled to said costs and attorney fees if the suit was without basis in law or fact.

Comprehensive SB 342 has been languishing in the Senate Business & Labor Committee since February 2003, and thus probably has been permitted to die. However, if resuscitated and enacted, it would generally revise the laws providing for corporate accountability by:

1. Requiring the filing of a statement of compliance with Sarbanes:
2. Requiring retention of audit reports and financial statements in compliance with Sarbanes;
3. Providing for enforcement of corporate accountability laws;
4. Prohibiting the state from investing in or contracting with a corporation no in compliance with Sarbanes;
5. Authorizing the Board of Public Accountants to adopt rules requiring licensees who audit publicly traded corporations to maintain audit papers and other information related to any audit report in accordance with Sarbanes.

The New Jersey legislature was quickly out the gate immediately after Sarbanes was enacted. Beginning September 2, 2002, bill A 2684 was introduced which even went beyond Sarbanes to prohibit CPAs from providing non-audit services to privately held companies. Further, A 2684 prohibited any from performing an audit for 1 year of any business entity if the CEO, Controller, CFO or CAO or any person serving in an equivalent position was employed by that auditing firm and participated in any capacity in the audit. A 2684 was killed in the Regulated Professional and Independent Authority Committee, after which the bill was withdrawn by its sponsor, State Assemblyperson Neil M. Cohen. Announced a relieved Ohio Society of CPAs on August 7, 2003:

The Ohio Society of CPAs the New Mexico Society of CPAs made a similar statement to their sister society in New Jersey. Stated Gari Fails, president and CEO of the New Mexico Society in response to amend their 1999 Public Accountancy Act to prohibit CPAs from performing audit services for a client if the firm, or an affiliate of the firm , had performed consulting services for the same client within the past 3 years: "This is only going to be a burden on small business if passed." Unlike Sarbanes, the bill of concern, HB 495, which died in committee after being introduced in February 2003, would have applied to private companies. (http://www.ohioscpa.com/member/article.asp?article=566-3)

The only measure passed by the legislature of New Mexico relating to Sarbanes was HJM 86 requesting the State Auditor to study the need for stricter conflict of interest standards for CPAs.

S 4834, introduced in April, 2003, generally provided for oversight of public accountants – including the definition of misconduct by accountants, conflicts of interest, mandatory peer review of firms, and penalties for professional misconduct. It also provides protection for whistle blowing employees who report illegal activities. It presently rests on the table with the Committee on Higher Education after being amended June 6 by striking the provisions related to peer review, "reportable conditions," work paper retention, and prohibiting the scope of services for private companies with less than 20 employees and gross annual revenues of less than $2 million. The bill contains various provisions, some of which go beyond Sarbanes, i.e. auditor rotation and scope of services restrictions that apply to both SEC registrants and private companies with less than 20 employees and gross annual revenues of less than $2 million.

Similar to California, the bill also contains a section entitled "Reportable Conditions" whereby CPAs must report a wide variety of events to the Board, including any events occurring outside New York. Such events include:

1. Restatement of a financial statement or material related disclosure;
2. Any civil action or judgments (final or interim) against the CPA based on allegations of dishonesty, fraud or breach of fiduciary responsibility;
3. Any settlement or award by judgment or arbitration;
4. The initiation of any investigation by any governmental body;

Also resting with the Committee on Higher Education are A 8286 (establishing penalties for professional misconduct of fines up to $20,000 for individual and $100,000 for firms and establishes mandatory peer review for firm registration) as well as SB 3139, A 1226 and A 4160.

SB 3139, prohibits CPAs from providing non-audit services to their audit clients and requires that partnerships or sole proprietors register as an accounting firm and that each number of present owners in the firm shall be equal to or greater than the number of names that appear in the firm’s name.

A 1226 prohibits CPAs from providing non-audit services to their audit clients. A 4160 prohibits accountants from providing accounting services to any corporation, the shares and bonds of which are publicly traded, for 5 years after such accountant performs an audit on such corporation; SB 3140 increases criminal penalties for business entities and their auditors for knowingly issuing financial statements for which the auditor engaged in professional misconduct. It has been amended and returned to the Corporations, Authorities and Commissions Committee. The bill also provides that each violator be jointly and severally liable to stockholders, partners, lenders or other investors.

Introduced March 25, 2003, and referred to the Codes Committee on June 10, is A 7238, known as The Integrity in Auditing Act. This bill prohibits auditors from providing non-audit services (i.e. bookkeeping, appraisal or valuation, tax, legal, investment and assurance services) to any business organization or public service corporation. The bill also imposes civil penalties and provides that violators be held jointly and severally liable for damages.

Also in the committee is SB 3140 which increases criminal penalties for business entities and their auditors for knowingly issuing financial statements for which the auditor engaged in "professional misconduct" as to be defined by the New York Board of Regents.

Gov. Bob Taft has signed HB 7, Ohio’s answer to Sarbanes, into law. The Corporate and Securities Reform bill, effective in November, 2003, provides reforms for smaller companies that register securities with the Ohio Department of Commerce, and represents an even-handed, responsible approach to corporate accountability. Upon enactment, HB 7 will:

1. Require corporate representatives to certify financial records, when making registration filings with the Division.
2. Establish limits on, and require disclosures of, loans to company insiders, when making registration filings with the division.
3. Prohibit improper influence on accountants who prepare or audit financial statements to be used in connection with the purchase or sale of securities in Ohio.
4. Prohibit the Division from accepting the registration of securities for companies that have no business plan (known as "blank check offerings").
5. Clarify that an investment opportunity need not be in writing to constitute a "security."
6. Empower the Division to ask a court to order the subject of an injunctive action to make restitution or offer rescission to victimized investors.
7. Increase penalties for white-collar crimes, including upgrading the theft of $1 million or more from a third degree felony to a first-degree felony.
8. Lengthen the statute of limitations for both civil and enforcement actions to those outlined in the Sarbanes-Oxley law. (http://www.ohioscpa.com/member/article.asp?article=384)

The Texas attorney general would have enhanced power to investigate business fraud under SB 1059, proposed by Sen. Rodney Ellis, D-Houston (and effective September 1, 2003), which makes it a felony for corporate officials to knowingly sign false financial statements. "I want to do as much as I can to give our attorney general and our securities board the tools that they need so that if this ever happens again we’re not all just wrenching our hands and trying to figure out if we can do something," Ellis said. Ellis, an investment banker, said he modeled the legislation after New York State, which gives more power to its attorney general.

Senate Bill 1059 places new ethics and disclosure requirements on financial advisers of state pension and endowment funds. "This legislation will prohibit investment managers and advisers that do business from having any hidden client relationship with other businesses that can influence their recommendation," said Rep. Ken Marchant, R-Carrollton, who filed a companion bill, House Bill 2039. SB 1059 and HB 2039 would create a corporate integrity unit with the Office of Attorney General. The unit would assist district attorneys and county attorneys in investigating and prosecuting corporate fraud. Another provision in the bills would require corporations doing business with the state to report any financial irregularities with their companies.

Ellis and Marchant filed separate bills, now awaiting passage, to give enhanced power to the State Securities Board and allow the attorney general to seek the "disgorgement of any economic benefit" gained by a defendant who violates Texas securities laws. This could include a bonus, fee, commission, option, proceeds, profit from or loss avoided through the sale of the security. "That’s the key to what’s been lacking in Texas law – the ability to go after an individual who has engaged in corporate malfeasance," said Texas Securities Commissioner Denise Crawford. (Houston Chronicle.Com, March 11, 2003 http://www.chron.com/cs/CDA/story.hts/metropolitan/1812842)

A related bill, SB 536, died in committee. It would have allowed agencies including the attorney general, insurance department, securities board, State Board of Public Accountancy and the Public Utility Commission to share confidential information with one another. SB 605, introduced the same time, faced similar death. It would have required annual reports by corporations prepared by the corporation and reviewed by the officers signing the filing. Attempting to fraudulently influence, coerce, manipulate or mislead an independent auditor would have been a felony offense.

On May 14, 2003, the Governor of Washington signed HB 1211, which defines working papers and requires that they be kept for a period of seven years, thereby aligning itself with SEC Rules adopted January 23, 2003. The bill also requires licenses to report within 30 days to the Board of Accountancy, any sanction, suspension, revocation, or modification of their license by the SEC, any federal agency, any State Board of Accountancy or any other state agency. The licensee is also required to report when he or she has been charged with a violation that could result in a suspension or revocation of a license by a federal or defined state agency or for violation of ethical or technical standards. HB 1211 also gives the Board of Accountancy the power to impose a fine in an amount not to exceed $30,000 for any of the following offenses: dishonesty, fraud, negligence or a violation of a rule of professional conduct promulgated by the Board.

Signed the same day was HB 1219, making the altering, destroying, shredding, mutilating or concealing a record a class B felony – with a fine not exceed $500,000 and/or 10 years imprisonment.

As can be seen, the anticipated cascade of state legislation in conformity with the spirit of Sarbanes appears to be more of a slow drip coming from only 1/3 of the legislative taps in the United States. Concerns of small businesses, private companies, non-profit corporations, and various accountancy groups and lobbies have successfully countered the movement toward state reform, as is the negative effect of additional regulations during strained economic times. Clearly, the enthusiasm, which the state legislators first exhibited following the passage of Sarbanes, was more political show than political determination to force passage of enabling legislation.

The American Institute of Certified Public Accountants ("AICPA") formed a

special committee devoted to state regulations and dealing with new state proposals as they occur in reaction to Sarbanes. AICPA has taken the position that additional government regulation of private companies by the states, in conformity with Sarbanes, would constitute an unreasonable governmental restriction on the freedom of those business entities to choose which service providers they use." A Reasoned Approach to Reform-White Paper (Jan. 2003) http://www.aicpa.org/download/statelegis/index.asp) This is because there has not been the same harm caused to the public because of use of auditors by private companies’ use of auditors to provide both audit and non-audit services. Also, most private corporations are significantly smaller than public companies with a large asset and shareholder base and income. Although AICPA considers some measures to have merit and should be considered, but at the same time considers many to be unworkable and overbroad. Finally, to the extent that states enact divergent audit regulations "the resulting complexity would significantly hinder compliance, monitoring and interstate business." Ibid.

With respect to State Whistleblower Protection Laws most states have some sort of statutory or common law "whistleblower" or anti-retaliation laws.  Like the federal whistleblower laws, not every lawyer will know about these laws, especially laws outside their own state. These states and the District of Columbia have recognized a public policy exception to the "employment at will doctrine": Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, Tennessee, Texas, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.

Some states have explicit statutory protections for whistleblowers. These include: California, Connecticut, Delaware, Florida, Hawaii, Louisiana, Maine, Michigan, Minnesota, Montana, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Tennessee, and Washington.

There are also state laws that offer special protections just for their own state or local government employees: Alaska, Arizona, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Missouri, Montana, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Washington, West Virginia, and Wisconsin. (http://whistleblowerlaws.com/protection.htm)

The next year or so should demonstrate the true resolve of the states, which if not given further impetus by additional Enron/Anderson type scandals, may end up becoming a situation of the unstoppable force of corporate reform and fair accountability confronting the unmovable objects. Pending the outcome of legislation in the various states, companies should remain current with the existence of the various initiatives and conduct themselves as reasonable or required.