President Bush signed the Sarbanes-Oxley Act of 2002 into law on July 30, 2002, creating a dramatic redesign of federal securities laws. Some provisions are effective immediately, while others will be effective as soon as the Securities and Exchange Commission adopts the relevant rules, which it must do within mandated time periods ranging up to one year from the date of adoption.

This summary covers only the key points of the Act relating to the need for independent directors in relation to a company's audit committee, but does not cover any of the other provisions of this very complex legislative package. Implementation of the Act will require resolution of ambiguities and further rulemaking by the SEC. Please contact your lawyer to discuss how the Act will apply to your specific circumstances.

Audit Committees and Outside Audit Firms

Audit Committees: Functions and Role Requirements to Be Effected Through Listing Standards

Section 301 of the Act directs the SEC to adopt rules, effective no later than April 26, 2003, that direct the national securities exchanges and NASDAQ to set certain listing standards (similar, in part, to recent proposals by the exchanges) that impose the following requirements on audit committees, their functions and roles:

• Independence. The audit committee must be composed entirely of independent directors. To be "independent" under the Act, an audit committee member may not accept any consulting, advisory or other compensatory fee from the company, except in his or her capacity as a board or board committee member, and may not be an 'affiliated person' of the company or any of its subsidiaries. Certain law firms have suggested that a person becomes an affiliate when that person owns 5% or more of the stock of the company. Other law firms believe that the test is at 20%.
• Authority to Engage Advisors. The audit committee must have the authority, and any funding it finds appropriate, to engage the outside auditing firm, independent counsel and other advisers as it determines necessary to carry out its duties.
• Employee Complaint Procedures. Audit committees must establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters, and for the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters.

Financial Expertise of Audit Committee

Section 407 of the Act directs the SEC to issue rules, effective no later than January 26, 2003, requiring disclosure in companies' periodic reports whether or not (and if not, why not) at least one member of the audit committee is a 'financial expert' as the SEC may define such term.

Auditor Independence

The Act directs the SEC to adopt rules regarding auditor independence as follows:

Audit Committee Oversight of Outside Auditing Firm

• Section 301 of the Act requires the national securities exchanges and NASDAQ to adopt the following listing requirements, effective no later than April 26, 2003:
• audit committees must be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm employed by the company (including resolution of disagreements between management and the auditor regarding financial reporting) for the purpose of preparing or issuing an audit report or related work;
• the accounting firm must report directly to the audit committee.

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