The Sarbanes-Oxley Act (“SOX”) was adopted to address a broad range of corporate governance and accounting concerns following the recent stock market collapse and revelations regarding actions which, at best, represented very aggressive corporate and financial transactions and, at worst, involved massive frauds upon the market. SOX substantially changes the way companies, their officers and directors, and their financial and other advisors conduct business. It applies specifically to companies that are required to file periodic reports with the Securities and Exchange Commission. While it is still too early to determine the full impact SOX will have, it would be shortsighted to believe its broad and fundamental changes will be limited to public companies.
SOX corporate governance practices represent a “best practices” standard imposed solely upon public companies. A failure to comply with this standard may result in sanctions including, but not limited to, substantial fines and criminal prosecution for public companies and their officers, directors and advisors. However, any private company that contemplates going public or being acquired by a public company must recognize this standard and adjust its activities accordingly, including adopting board member selection and decision-making policy changes to ensure that corporate actions are taken by a board that includes SOX independence requirements, appointment of independent audit and compensation committees, and selection of independent auditors to ensure that actions are not questioned later when a public offering or acquisition by a public company is contemplated.
SOX corporate governance practices also may be characterized as the standard against which officers and directors should be measured for private litigation. Although officers and directors generally are protected by the business judgment rule, it does not take much imagination to foresee the adoption of the SOX standard as the basis of determining whether commercially reasonable operational and decision-making policies were followed with regard to any action taken by officers or directors, with the presumption that a failure to follow SOX policies could establish a lack of due diligence or breach of fiduciary duty. This could result in a greater likelihood of personal liability for errors in judgment made by officers and directors.
Private companies also may expect SOX considerations to impact capital-raising activities in private placements of equity or debt securities and in loan transactions. Potential investors and financial institutions can be expected to examine whether SOX independence and corporate governance procedures have been applied to company operations and the compilation of financial statements and records. Again, it requires little imagination to conclude that greater credibility or deference will be granted to statements or records prepared in a manner consistent with SOX, including SOX auditor independence rules, when an investor or institution contemplates an investment or loan.
If you would like further information regarding SOX requirements and how they may affect your private company, please contact us. We would be pleased to review your current procedures and to suggest measures that may enable you to meet SOX standards.