2002 CLERP 9: Corporate governance, audit rules and continuous disclosure

Different attitudes to corporate governance and the release of CLERP 9.

In the US, the Bush Administration passed the Sarbanes-Oxley Act (see summary) as its response to Enron and other corporate financial misdeeds. In Australia, CLERP 9 has just been released dealing with the Ramsey proposals on audit regulation and the corporate disclosure regime. The Australian Labor Party has also weighed into the area with the release of its discussion paper on August 29 dealing with what it believes are measures that could improve corporate governance. The following is a brief summary of the corporate governance proposals from the government, the US and the ALP.

The Australian Government's response to corporate governance:

• Amend the law to increase the maximum civil penalty for contraventions of continuous disclosure provisions from $200,000 to $1 million.

• Make audit committees mandatory for Australia's top 500 listed companies

• Make audit partner rotation compulsory after 5 years.

• Amend the law to give the Australian Securities and Investments Commission additional powers to issue infringement notices and financial penalties in relation to contraventions of the continuous disclosure regime.

• Amend the law to provide protection for "whistleblowers".

• Expand the role of the Financial Reporting Council to include public oversight of audit independence in Australia. Auditing standards will also have the force of law on the same basis as accounting standards issued by the Australian Accounting Standards Board.

• Amend the law to require disclosure in annual reports of categories and fees of all non-audit services provided by an audit firm.

• Amend the law to require audit committees to certify that receipt of certain non-audit services did not compromise audit independence.

• Reform areas of auditor liability by allowing auditors to incorporate and seek agreement of the States to introduce proportionate liability.

• Revise civil and criminal penalties applying to financial reporting offences to ensure consistency and adequacy.

• Establish a Shareholders and Investors Advisory Council to provide advice on disclosure reforms to ensure they meet the needs of retail investors.

The US Government's response to corporate governance:

1. Disclosures. The Act requires new or more expeditious disclosures and directs the SEC to issue rules requiring other disclosures.

• Quarterly CEO/CFO certification of periodic reports.

• Quarterly CEO/CFO certification and report on internal controls.

• Annual management report on internal controls.

• Financial statements must reflect auditors' material adjustments.

• Quarterly disclosure of off-balance sheet transactions.

• Other quarterly disclosures regarding finance-related procedures: senior finance code of ethics, Audit Committee financial expert, non-audit services provided by auditors.

• Disclosure of changes to or waivers of the senior financial officer ethics code.

• Section 16(a) stock transaction reports within two business days, with next-business-day Internet posting by issuer and SEC.

• Regular SEC review of disclosures.

• Rules coming for "real time disclosures" and pro forma financials.

2. Audit Committees. The Act establishes new rules for the composition and duties of audit committees. Audit committees also will be affected by regulations applicable to auditors, and some of the disclosure rules noted above.

• Independence (under a new definition of the term).

• Inclusion of a "financial expert" as a member.

• Auditor appointment and oversight.

• Restrictions on non-audit services.

• Financial statements must reflect auditors' adjustments, with auditors protected from improper influence.

• Reports by CEO and CFO to audit committee of significant control deficiencies and any management fraud.

• Timely reports to the audit committee by auditors of critical accounting policies and discussions with management.

• Complaint/whistleblower procedures.

• Legal and other advisers.

3. Other corporate governance provisions. The Act also establishes new rules affecting other areas of corporate governance. In particular, several provisions affect officer and director compensation and stock trading.

• CEO and CFO disgorgement of bonuses and stock profits upon a restatement.

• No loans to directors or executive officers.

• No trading during individual account plan blackout periods.

• Disclosure duties for attorneys.

4. New crimes and enhanced penalties. The Act establishes new crimes and increases the maximum penalties for certain existing crimes.

• False certification of periodic reports.

• Securities fraud.

• Destruction of corporate audit records.

• Destruction or alteration of records to impede a federal investigation or bankruptcy case.

• Tampering with records or otherwise impeding an official proceeding.

• Retaliation against informants.

• Penalty enhancements.

5. Provisions affecting securities or other civil litigation and SEC administrative enforcement. The Act contains a few provisions that will or may affect private securities litigation. It also creates two new private civil actions, and expands the SEC's remedies in administrative and civil actions.

• Statute of limitation for private securities fraud actions lengthened.

• Individual debts from securities judgments, orders, or settlements nondischargeable in bankruptcy

• Administrative complaint and civil lawsuit for informants.

• Shareholder action for disgorgement of profits for trading during blackout periods.

• SEC temporary freeze order against "extraordinary payments."

• Lower standard for SEC officer and director bar.

6. Federal regulation of auditing firms. A new entity called the Public Company Accounting Oversight Board will regulate and oversee auditing firms.

• Registration.

• Auditing and professional standards.

• Inspection.

• Investigation, discipline, and sanctions.

• GAAP largely unaffected.

7. Analyst conflicts of interest. The Act requires the SEC or SROs to adopt rules addressing conflicts of interest involving securities analysts.

ALP corporate governance proposals include:

• Doubling the penalties for serious breaches of the Corporations Act;

• Introducing legislation to protect corporate whistleblowers;

• Implementing the recommendations of Professor Ramsay and in addition, banning the provision of certain non-audit services to audit clients;

• Requiring auditors to specifically report to shareholders and to a company's audit committee on instances of aggressive accounting;

• Requiring auditors to attend and answer questions at annual general meetings;

• Requiring the full disclosure of arrangements governing executive remuneration and enforcing the requirements for disclosure in the Corporations Act;

• Expensing share options;

• Providing to all shareholders any information provided to analysts during an analyst briefing;

• Requiring shareholders to be given the following information about candidates for directorships:

– all relationships between the candidates and the company;

– any relationship between the candidate and the directors of the company; and

– any other directorships held by the candidate.

• Improve analysts' independence by ensuring that they always act in the interests of the users of the reports – not in the interest of the analyst or the firm which employs the analyst; and

• Requiring voting by trustees of superannuation funds supervised under the Superannuation Industry (Supervision) Act if the level of voting does not increase to levels comparable with overseas

Further policy options are suggested in the following areas:

• Auditor independence and the integrity of financial statements;

• Executive remuneration;

• Corporate disclosures and information for investors;

• The composition of boards; and

• Analyst independence.

* AICD is preparing a response to CLERP 9

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