Serving as an independent director carries serious obligations and responsibilities.

Following the passage of the Sarbanes Oxley Act of 2002 (SOX), the role of independent directors has become that of securities monitor. They must be informed of developments within the company, ensure good processes for accurate disclosures and make reasonable efforts to assure that disclosures are adequate. Independent directors, like inside directors, should be fully aware of the company’s press releases, public statements and communications with security holders and sufficiently engaged and active to questions and correct inadequate disclosures.

Disclosure and Transparency

The basic premise of federal securities laws is disclosure and transparency. The theory behind this regulatory structure is that if a Company is forced to disclose information about particular transactions, plans or programs, the company and its officers and directors will take greater care in making business decisions. If a director knows or should know that his or her company’s statements concerning particular issues are inadequate or incomplete, he or she has an obligation to correct that failure.

It is the Securities and Exchange Commission’s (SEC) viewpoint that independent directors should play a significant role in the direction of a company’s affairs, particularly when they have relevant expertise, experience and sophistication. According to the SEC, independent directors must not only be familiar with their company’s communications to the public, but must also compare these communications with what they know to be the facts. Additionally, they are then responsible to follow up and practice vigilance in ensuring that communications are complete and accurate.

Internal Systems Protect Company Operations

All independent directors have an obligation to question employees or legal counsel as to the background of issues or the need for disclosure of specific information. If they are aware of specific non-disclosures, they must inquire into the situation. All independent directors should insist on internal systems so that they have regular and sufficient information about the company’s affairs. Moreover, directors who review, approve, or sign their company’s proxy statements and periodic reports must take steps to ensure the accuracy and completeness of the statements, or face personal regulatory liability for the failure to do so.

The SEC has the power to bring actions against independent directors for misstatements or omissions in offering documents under the Securities Act of 1933, as amended, for fraud under Section 10 of the Securities Exchange Act of 1934, as amended or for aiding and abetting Company securities laws violations. SOX specifically authorizes the SEC to seek “any equitable relief that may be appropriate or necessary for the benefit of investors.” The SEC often utilizes this power to pursue injunctive relief such as a prohibition to act as a public company director in the future, which reputational damage potential can act as a motivator.

Although all directors have direct personal liability for statements made in a registration statement or other filing signed by such directors, Rule 176 promulgated under the Securities Act of 1933, as amended, provides a due diligence defense to such actions. To invoke the due diligence defense the defending director needs to be diligent and verify facts and statements.

Better Compliance Limits Exposure

Even though independent directors are not responsible for every single company statement or even all of the company’s securities compliance, certain directors may be well situated to achieve better compliance, such as members of the audit committee or directors who sign company filings. The SEC has indicated that it intends to utilize its powers to require directors to take their role as securities monitors seriously. To date, however, the SEC has pursued very few cases against independent directors, and most of such cases have been settled without fanfare and generally involve injunctive relief. Moreover, successful private litigation against independent directors is rare.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

Historically the regulation of corporate law has been firmly within the power and authority of the states. However, over the past few decades the federal government has become increasingly active in matters of corporate governance. Typically this occurs in waves as a response to periods of scandal in specific business sectors or in the financial markets. Traditionally, when the federal government intervenes in these situations, they enact regulation either directly or indirectly by imposing upon state corporate regulations.

Specifically, the predominant method of federal regulation of corporate governance is through the enactment of mandatory terms that either reverse or preempt state laws on the same point. The most recently prominent example is the passing of the Sarbanes Oxley Act of 2002 (SOX).

Sarbanes Oxley (SOX)

SOX regulates corporate governance in five matters: (i) SOX prevents corporations from engaging the same accounting firm to provide both audit and specified non-audit services; (ii) SOX requires that audit committees of listed companies be composed entirely of independent directors and to disclose which such directors are financial experts; (iii) SOX requires that the corporation’s CEO and CFO certify that the periodic reports do not contain material misstatements or omissions and that the financial statements are accurate; (iv) SOX compels forfeiture of CEO and CFO incentive compensation in the event of an earning restatement; and (v) SOX bars corporations from making loans to executive officers.

Each of these provisions requires the corporation to govern itself accordingly, regardless of whether the board of directors deems the actions to be a useful deployment of resources and regardless of the individual facts and circumstances surrounding that corporate entity. Such provisions limit the ability of directors to negotiate, research and agree to corporate actions that solve and address the unique challenges faced by their individual organization. That is, each of these mandates directly contradicts the essence of state corporate governance.

Delaware and Model Act

State corporate law is generally based on the Delaware and Model Act and offers corporations a degree of flexibility from a menu of reasonable alternatives that can be tailored to companies’ business sectors, markets and corporate culture. Moreover, state judiciaries review and rule upon corporate governance matters considering the facts and circumstances of each case and setting factual precedence based on such individual circumstances. The traditional fiduciary duties that govern state corporation laws include the duties of care and loyalty and are tempered by the business judgment rule.

Duty of Care

The duty of care requires that directors exercise the same level of care that would be expected from an ordinarily prudent person in the conduct of his or her own affairs. This includes making an informed decision, seeking the advice of experts when necessary and considering both the positive and negative impacts of a decision. The duty of loyalty is essentially a proscription against conflict of interest and self dealing. The business judgment rule basically says that if a director follows both his duty of loyalty and duty of care, than the decision should be deferred to.

Although the federal government may have the right motives in enacting regulations which effect corporate governance, there is always controversy when they cross “sate lines.” State regulators and judiciaries are usually the best posture to establish and enforce corporate governance regulations. It is a given that director actions that result in a fraud upon shareholders and investors is actionable under federal (and state) securities laws, however, it is still questionable as to whether the federal government is the proper regulatory authority to set forth particular mandates of director responsibility.

Delaware Corporations Act

The Delaware Corporations Act together with decisions of the Delaware Court of Chancery provides a reliable source for corporate governance matters. These state laws allow for the quick response to emerging problems in a way that the strict mandates of the federal government cannot.

Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

On October 13, 2009, the Securities and Exchange Commission (SEC) officially extended the date for non-accelerated filers to comply with Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX) until their fiscal years ending on or after June 15, 2010. Since the adoption of the rules implementing Section 404(b) on June 5, 2003, the time period for compliance by non-accelerated filers has been extended several times. It is widely believed that this extension, for six additional months, will be the last. Companies other than non-accelerated filers are already subject to Section 404 compliance. Although “non-accelerated” filers are not specifically defined, such filers include small business entities.

Among other things, Section 404(b) of SOX requires companies to include in their annual reports filed with the SEC, an accompanying auditor’s attestation report, on the effectiveness of the Company’s internal control over financial reporting. In other words, reporting companies must employ their auditor to audit and attest upon their financial internal control process, in addition to the financial statements themselves. One of the reasons that implementation has been delayed for non-accelerated filers, was the need for the SEC to provide guidance to both auditors and reporting companies as to how to structure internal controls, and what structure or structural deficiencies an auditor is to opine upon.

To assist companies and auditors in complying with the new rules, the SEC approved the issuance of PCAOB of Auditing Standard No. 5 providing guidance as to the Audit of Internal Controls Over Financial Reporting that is Integrated with an Audit of Financial Statements. In addition, the SEC has issued interpretative guidance to assist management of reporting companies in complying with the internal control evaluation and disclosure requirements. See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33-8810 dated June 20, 2007.

PCAOB of Auditing Standard No. 5 together with Release No. 33-8810 was intended by the SEC to make internal control over financial reporting audits and management evaluations of ICFR more cost-effective by being risk-based and scalable to a company’s size and complexity. Whether they meet these goals remains to be scene, however, many non-accelerated filers are finding the increased auditor expense alone to be cost prohibitive, let alone setting up the mandated infrastructure to avoid negative audit comments (for example, having only one officer responsible for financial reporting alone results in negative comments, regardless of the structure in place to ensure that the single officer properly records and reports all transactions).

The SEC has indicated that the last postponement for the Section 404(b) auditor attestation requirements for non-accelerated filers allowed time for the PCAOB to issue final staff guidance on auditing internal financial controls for smaller companies and for the SEC staff to evaluate whether their current guidance is the most cost-effective for smaller public companies. The PCAOB published staff guidance for auditors of smaller public companies on January 23, 2009 describing how auditors can apply the principles described in Auditing Standard No. 5 and providing approaches to particular issues that might arise in the audits of smaller, less complex public companies.

The SEC directed its staff to conduct a study in order to assess whether the SEC guidance and PCAOB guidance hare having the intended effect of facilitating more cost effective evaluations. The results of this study were made public on October 2, 2009. The most recent postponement is to allow smaller public companies and their auditors to digest and implement the results of these most recent studies and guidelines.

The SEC has made clear that they believe that all steps and guidance to implement Section 404(b) for non-accelerated filers has been completed and that auditors and small public companies should proceed forthwith to prepare to comply. That is, there will be no further delays. How these guidelines will be implemented and the additional cost to small public companies still causes great concern to those small companies that have been impacted by the recent economic downturn, which is the vast majority.

Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!