The Sarbanes-Oxley Act of 2002 is arguably the most important piece of federal legislation in 30 years and is the most important piece of corporate accountability legislation since the Securities and Exchange Act of 1934. It was signed into law on July 30, 2002, and among its objectives is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to U.S. securities laws. It is critical good news for investors.

The highlights are described here, but a word of caution is needed. This is a lengthy act and contains many important details. This article is an overview of the more important general features.

The first important concept is that this act affects U.S. public companies and foreign companies and auditors whose stock is registered on a U.S. stock exchange. Therefore, it does not affect all companies or their officers, directors and auditors. This brings up the first of many questions. Will private, closely held U.S. companies be sued by shareholders (or others) for violations of existing law, such as CUTPA, citing a violation of Sarbanes-Oxley as the moral basis for the suit?

The act itself starts out with the auditor. An independent public company oversight board is established to register public accounting firms and to establish (under SEC supervision) standards governing audits, auditor independence and audit ethics. The auditor's first duty is to the shareholders and the board of directors — not to the executives who hire them. The auditor must be rotated at least every five years and the CEO, CFO, controller and CAO cannot have been employed by the company's audit firm within one year of the start of an audit. The CEO and CFO will no longer be able to say they were not informed about the complete financial dealings of their own company.

The officers and directors of a public company must comply with much higher standards. For example, the CEO and CFO must certify that their annual and quarterly reports are accurate. If they don't review the financials or don't certify them, there are stiff financial penalties (up to $5 million) and long jail terms prescribed (up to 20 years).

CEOs and CFOs face another thorny issue. They will lose any bonuses or other incentive-based compensation and profits from stock gains if their company must restate its financials as a result of misconduct by any person. This forfeiture is for the 12 month period following the first publication, or filing, of the erroneous accounting information (§ 304).

Attorneys and accountants must report any misconduct they discover to the CEO or Chief Legal Officer and the officer must act on this information. If he doesn't, then the misconduct must be reported to the audit committee of the board or the board itself. The act does not say when or how the officer must act. This will be the subject of future regulations but it is likely to mean "soon" and "appropriately." Financial reporting is going to be enhanced. Off balance sheet transactions and all contingent obligations must be reported on all quarterly and annual reports. There can be no new loans to executive officers or directors if those loans are not normally offered to the public under the same circumstances.

Brokerage houses are also under new rules. By July 30, 2003, the SEC (or its delegate) will establish new rules to make sure there are no conflicts of interest between their analysts, broker/dealers and investment bankers (§ 501).

People outside the power structures of large corporations do not know how long it took for some unscrupulous people to find a way around the Securities Act of 1934.

Congress has anticipated that this may happen again, so they have called for a number of studies to close any loopholes. For example, they will study the consolidation of public accounting firms. They will study the function of credit rating agencies in the securities market and they will study past violations to see what was done and how they did it to close those loopholes.

Other new changes in the law include a provision that any debt created for a securities law violation is non-dischargeable in bankruptcy.

Accountants must maintain their audit files for five years from the end of the fiscal period covered by the audit. It should be noted that the Act itself is not entirely internally consistent because (for example) another section requires audit papers be kept for seven years. These inconsistencies will be fixed. Loopholes will be closed and public companies will be forced to be completely candid with the public. This should go a long way to re-establishing trust in U.S. public companies and in our economy. It is anticipated that this will attract renewed foreign investment in U.S. companies. Economically and psychologically, this should eventually aid in restoring the U.S. economy.

This article originally appeared in the September 30, 2002, edition of the Connecticut Law Tribune. It is reprinted with permission of the publisher.