SARBANES OXLEY AND ITS APPLICATION TO PRIVATE COMPANIES AND NON PROFIT ORGANIZATIONS

On July 30, 2002, the Sarbanes-Oxley Act (“Act”) was signed into law and immediately impacted public corporations by mandating revisions to their respective financial reporting and auditing practices. While the focus of the Act is on public companies -- the only two notable exceptions relating to document retention and whistleblower protection -- it provides privately held companies, including non-profit entities, with a benchmark upon which to measure their corporate governance and financial reporting practices. A recent survey conducted by American Management Association determined that a substantial majority of both privately held and non-profit entities had established or maintained internal controls and procedures for financial reporting since the initiation of the Act. The law in fact has established a “best practices” standard that most auditors as well as lenders and D&O insurance providers are now applying to privately held companies.

While the Act may not be directly applicable to your organization, compliance with its provisions may ensure that your company’s directors and officers recognize the fiduciary duties accompanying their roles within your organization by mandating certain oversight responsibilities. This may be particularly useful for hospitals and other health care entities, which already are subject to higher scrutiny because of the Medicare and Medicaid programs. Compliance with the Act also will be required for private companies anticipating going public and companies seeking potential business partners, investors, purchasers, donors, contributors and the like. In fact, many of the traditional practices of privately held companies may be considered illegal under Sarbanes Oxley (e.g., loans to officers, intra-company transactions, etc.)

Your company may benefit greatly by recognizing the following goals of the Act and implementing the following practices and procedures to create a corporate compliance program on par with the standards applicable to publicly traded companies.

I. Compliance with the Act will assist both in the oversight of your company’s accounting and reporting practices and the elimination of potential conflicts of interest between the company and its auditors

A. Your company should consider establishing an audit committee responsible for the selection, oversight and compensation of the company’s audit accounting firm. To assist in this regard, your audit committee should contain one member who has substantial education and experience as a public accountant or financial or accounting officer.

B. Each member of the audit committee must be a member of the board of directors. Additionally, no member of the audit committee may accept compensation from the company.

C. In selecting an audit accounting firm, the company should be careful to avoid any auditor that has a pre-existing employment relationship with any company officer or director.

D. Your audit accounting firm should not provide any non-audit services to your company, i.e., bookkeeping, financial information systems design, actuarial services, etc.

E. Your company should establish procedures for the treatment of complaints concerning accounting or auditing matters and anonymous submissions by employees concerning questionable accounting or auditing matters (i.e., “Whistleblower Protection”). Your company should also create a written policy regarding documentation retention and destruction, the following of which should be required of all directors, officers and employees.

II. Compliance with the Act will increase accountability on the part of the company’s board of directors and executive management

A. Your company should adopt a Code of Ethics governing the affairs of its officers and directors. This is advisable for all entities regardless of whether they are publicly traded, private, for-profit or non-profit and charitable entities.

B. The company’s principal executive officer and the principal financial officer should certify in each financial report that they have reviewed the documents and that, based on their knowledge, the financial report does not contain untrue statements and does not omit statements resulting in a misleading report and that the financial statement fairly represents the company’s financial condition.

C. The company should enact a policy whereby if it is required to prepare an accounting restatement because of material noncompliance due to misconduct on the part of the principal executive officer and/or the principal financial officer, then such officer(s) shall reimburse the company for any bonus received during the previous 12 month period.

D. The company’s income tax returns should be signed by its President or Chief Executive Officer.

III. Compliance with the Act will enhance disclosures and the company’s financial reporting

A. The company’s financial reports should reflect all material correcting adjustments identified by its auditors as well as all material off-balance sheet transactions that may have a material current or future effect on its financial condition.

B. The company should prohibit personal loans of any kind to any company or director or officer.

C. The company should prepare on an annual basis an internal control report stating the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting and an assessment of the effectiveness of such procedures over the past year. The company should also consider having its auditor prepare a written report regarding the company’s assessment.

Conclusion

While the Sarbanes-Oxley Act is still a very new statute and there has not yet been much case law decided, one thing is clear: the legislature has enabled courts to take a closer look at the financial practices and internal affairs of business entities. Because of this increased focus on corporate management, corporations would be well advised to consult with their professional advisors to determine the applicability of the Act and the specific means by which they can comply with its provisions.

If you require any further information regarding Sarbanes-Oxley, please contact John J. Matteo, jmatteo@jackscamp.com or Jason A. Pardo, jpardo@jackscamp.com at the law firm of Jackson & Campbell in Washington, D.C., should you have any questions or would like to discuss these matters in further detail.

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¹ American Management Association survey, published Aug. 19, 2003, www.amanet.org/press/amanews/SOX2003survey.htm

The contents of this Business Alert are intended for general informational purposes only and should not be considered legal advice. Moreover, the mailing of this Business Alert is not intended to create nor does it constitute an attorney-client relationship.

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