May 20, 2004

More on Internal Controls Deficiencies

I have received quite a few emails about my Tuesday blog from members that said they didn’t get the logic about the internal deficiencies disclosure in Progress Energy’s 10-Q. They asked if the process is substantially dependent on the “human performance” factor – and that performance proved deficient – why wouldn’t that be a “process deficiency”? If one’s disclosure process relies solely on the memory of an employee for compliance, and that employee forgets, gets sick, etc., isn’t that evidence of a weakness in the process – not just a human performance problem?

My guess is that the SEC might view “human factors” as contributing to a disclosure controls process deficiency – but perhaps not an internal controls deficiency. One member asked whether the term “financial reporting” in the context of management’s report on internal control over financial reporting and the related auditor attestation covers proxy statement disclosure (e.g., executive compensation and other non-financial statement stuff).

My two cents is that this term doesn’t include those types of matters – and language in the SEC’s 404 adopting release seems to say the same thing: “Our definition does not encompass the elements of the COSO Report definition that relate to effectiveness and efficiency of a company’s operations and a company’s compliance with applicable laws and regulations, with the exception of compliance with the applicable laws and regulations directly related to the preparation of financial statements, such as the Commission’s financial reporting requirements.” But disclosure controls obviously does cover proxy disclosure – that whole Venn diagram thing…

New GAO Study Targets Shareholder Access and More

The Government Accounting Office issued a new report this week that recommends 12 actions for the SROs to take. GAO had been was asked to discuss 3 matters: the status of the SEC recommendations to the three markets for improving their equity listing programs; the SEC’s oversight of Nasdaq’s moratorium on the enforcement of certain of its listing standards and the status of affected listed companies; and actions the three largest markets have taken to strengthen corporate governance.

Below are the recommended actions that are most relevant to corporate finance folks like us – some are moot or minor; some could be cause for concern:

– ensure that the Division of Corporation Finance place a high priority on establishing and meeting time frames for completing its rulemaking related to shareholder access to the director nomination process and reviewing issuers’ qualitative disclosure requirements related to potential director and director nominee conflicts of interest

– work with Nasdaq and Amex to ensure that the public receives early and ongoing notification of issuers’ noncompliance with their markets’ quantitative continued listing standards—using issuer’s receipt of the initial deficiency notice as the reference point for determining when public notification should begin or, if approved in a manner consistent with our following recommendation, the filing of the revised Form 8-K

– ensure that the SEC expeditiously finalizes the rule requiring that issuers file the Form 8-K after receiving notice of being deficient with their market’s listing standards and include a time frame for doing so that, consistent with its initial proposal, ensures early public notification of issuers’ noncompliant status

– work with Amex, Nasdaq, and NYSE to assess the feasibility of providing early and ongoing public notification of issuers’noncompliance with qualitative listing standards

– work with Amex to ensure that issuers disclose the names of those directors that they have designated as independent

– work with the SROs to further enhance board independence by giving serious consideration to requiring issuers, through listing standards, to establish a supermajority of independent directors and to separate the positions of CEO and chairman, recognizing that a reasonable period of time would be needed to make such changes effective

– work with the SROs to ensure that they have established effective processes for ensuring issuers’ compliance with corporate governance listing standards

NYC Legal Aid in Dire Trouble

One member asked that I use the power of the blog to highlight the troubles faced by the NYC Legal Aid Society that recently issued layoff notices to 254 staffers – more than 20% of their 759 staff attorneys – in a bid to close a $21 million budget shortfall forecast for its fiscal year starting July 1. It’s my pro bono announcement about a worthy pro bono organization.