Corporate governance issues: United States and the European Union.

The European Union Commission was concerned that European company issuers and auditors would be unfairly treated (because they were already subject to stringent measures in their home markets) and that added regulation would only impose unnecessary burdens and costs. (71) Indeed, a letter from Alexander Schaub, director-general of the Directorate-General for Internal Market and Services at the European Commission, to the then-Secretary of the SEC, Jonathan Katz, belabored this point. (72) Regardless of what the rationale was for not wanting SOX to apply to these foreign companies, the enactment of SOX and its application undoubtedly extended to all foreign companies listed in the United States and their auditors, regardless of origin. (73) In other words, companies and auditors based in other countries or jurisdictions came under the direct jurisdiction of the United States authorities regardless of the legal and economic culture in their own country. (74) European Union auditors preparing or involved in providing audit reports for their companies listed in the United States, were, for example, subject to the Oversight Board. (75) Should SOX, therefore, apply only to U.S. companies, thus excluding foreign companies? Given the number of foreign issuer registrants and international competition for investments and capital, it is harder for the SEC to apply a stringent rule to U.S. companies and not to foreign companies. (76) One of the risks inherent in the applicability of SOX to non-U.S issuers is that some of the Act's provisions may conflict with those in force in the companies' country of incorporation. (77) Because corporate governance laws tend to emanate from the country of incorporation, such laws may be very different--different legal systems, different regulations and accepted practices prevailing with a country that may conflict with those of SOX. (78) It was even observed that some foreign-listed companies considered delisting from the New York Stock Exchange (NYSE) or SEC because of SOX. (79) Looking at some particular provisions and its impact on foreign companies is therefore imperative.

B. Provisions relating to CEO and CFO; Criminal Sanctions

Section 302 of the Sarbanes-Oxley Act requires the SEC adopt rules requiring the CEO and CFO of a public company in each quarterly and annual report to personally vouch for the accuracy of the report, and to certify the accuracy of the company's financial statements and that the company has adopted adequate internal controls. (80) As stated earlier, this means, based on their knowledge, these executives claim the reports filed with the SEC do not contain any material misstatement or omission. (81) In particular, the CFO and CEO must certify: 1) that the financial statements and other financial information included in the reports are true and correct, and fairly present the financial conditions and results of operations of the issuer; and 2) that the company has implemented effective disclosure controls and procedures to assure transparency. (82) The conflict of this requirement with those of other countries is obvious; in Germany and France, the laws basically provide for the collegial responsibility of CEOs and CFOs with respect to the truthfulness and accuracy of financial statements. (83) Similarly, English corporate governance rules ignore the individual certification requirement and look to the collective responsibility of the board for the company's account. (84) Likewise, under Italian law, the annual accounts of a company are prepared by the entire board of directors on a collegial basis. (85) Consequently, the SOX requirement that the CEO and CFO individually certify the accounts transforms what was an internal responsibility to the company into a responsibility to all third parties. (86)

Section 304, which deals with forfeiture of certain bonuses and profits, requires the CEO and CFO to reimburse the company for any bonus, incentive, equitybased compensation, or any profit from the sale of securities of the company, received during the twelve months prior to any earnings restatement if such compensation is the result of material noncompliance by the company with any financial reporting requirements under the federal securities law. (87) This section appears to make the CEO and CFO responsible for reimbursing their bonuses and profits to the issuer even where others are found to have been responsible for the misconduct that led to the issuer's violation, and even if the CEO and CFO were not at all involved in the misconduct. Although this provision does not appear to have an equivalent rule in most European jurisdictions, it does create a problem of double regulation: (88) under Italian corporate governance rules, for example, the possibility of bringing actions that would require the directors to return a part of their compensation seems to exist only when those directors have caused harm to the corporation through failure to carry out their duties to the corporation. (89) France, on the other hand, recognizes the possibility for criminal jurisdictions to fine directors by an amount up to ten times the gains earned by directors in violation, although such sanctions could only be provided in the context of an action for damages. (90) Hence, France has no equivalence to SOX Section 304. (91)

Section 305 expands the SEC's ability to remove directors and officers and bar them from serving as such in a publiclyheld corporation by showing their unfitness to serve on the board as a result of violating the antifraud provisions of the securities laws. (92) The standard used prior to implementation of the section was "substantial unfitness," which was apparently a higher standard and therefore more difficult to show than the section's requirement to show mere "unfitness." (93)

Section 906 provides for stiff criminal sanctions for CEOs and CFOs who fail to comply with certain financial certification requirements in addition to those under section 302. (94) Section 906 imposes a $1 million fine (USD), 10 years in prison, or both for persons who knowingly violate the certification requirement; and a $5 million (USD) fine, 20 years in prison, or both for willful violation of the provision. (95) In addition to the increased maximum criminal penalties, SOX also directed the U.S. Sentencing Commission (96) to review and amend federal sentencing guidelines for a number of criminal offenses relating to securities and accounting fraud; hence, the new guidelines which were already increased in 2002 were again increased in 2003 in response to the mandate contained in the Act. (97) The overall result is sentencing is now far more severe in the United States than it is in other countries. For example, under the new guidelines, the penalty for a CEO guilty of certain significant accounting frauds is life imprisonment, far more severe than the penalty for the federal crime of murder, which is imprisonment for 30 years to life. (98)

This Act was tested as Richard Scrushy, former CEO of HealthSouth Corp, "was acquitted of all eighty-five counts with which he was charged, including one of knowingly certifying false financial statements in violation of Section 906 of the Act." (99) Supporters of the Act feel that Scrushy was acquitted under Section 906 because either the case was too complicated for the jurors or "because conviction under section 906 requires finding of guilt for other counts of fraud." (100)

The European Union High Level Company Law Experts reviewed whether--and, if so, how--the E.U. should coordinate and strengthen the efforts undertaken by member states to improve corporate governance. (101) The Experts' investigation raised four main focus points that similarly relate to the aforementioned discussions as a whole: 1) provision of information for shareholders and creditors, in particular better disclosure of corporate governance structures and practices; 2) strengthening shareholders' rights and minority protection, in particular supplementing the right to vote by special investigation procedures; 3) strengthening duties of the board, in particular the accountability of directors where the company becomes insolvent; and 4) recognizing the need for a European corporate governance code or coordination of national codes in order to stimulate development of best practices and convergence. (102) With specific consideration of the Enron disaster and implementation by the United States of the Sarbanes-Oxley Act, the Commission reviewed issues related to best practices in corporate governance and auditing, paying particular attention to the role of nonexecutive and supervisory directors, the remuneration of management, and the responsibility of management for financial statements and auditing practices. (103)

C. Audit Committee Independence

Section 301, which, to some extent, encompasses the discussion above with regards to auditing, sets forth the independence requirements for members of the audit committee of listed companies. (104) Under the SEC provisions of Rule 10A-3 (as directed by Section 301 of the Act), the audit committee members of companies listed on securities exchanges must meet two specific conditions with respect to auditor independence: 1) they may not directly or indirectly accept consulting, advisory, or any other compensatory fees from the company or its subsidiaries other than board and committee fees; and 2) they may not be "affiliated" persons of the company or any of its subsidiaries. (105)