Keep your Company Warm with SOX--Private Company Finance and the Sarbanes Oxley Act of 2002

Passed in the wake of the Enron and WorldCom debacles, the Sarbanes-Oxley Act of 2002 (“SOX”) is considered by many to be the most significant legislative change in securities regulation since the Securities Act of 1934. While most SOX provisions apply only to public companies, there are a variety of reasons private companies should become familiar with SOX’s requirements and consider voluntarily complying with the new legislation. The following are some of the more salient reasons for private company compliance:

• Venture capital investors, insurer and lenders may demand compliance due to the heightened scrutiny directed at all companies in regard to corporate governance.

• Implementation of corporate governance standards prior to an IPO may help facilitate the process of going public. While both the Nasdaq and NYSE allow for a grace period in implementing SOX requirements, rules relating to the independence of the board of directors and prohibition against loans to executive officers take effect immediately.

• Potential acquirers are likely to view companies with established governance standards more positively given the ease with which such companies can be assimilate and the shared corporate culture such standards engender.

• Several SOX provisions already apply to private companies, such as the prohibition on the destruction of documents with the intent to impede or obstruct a federal investigation and enhanced penalties for securities fraud and other white-collar crimes.

Although none are legally mandated, private companies should complying with the following SOX requirements before going public:

• Independence of the Board of Directors. The NYSE and Nasdaq have recently adopted rules mandating that companies listed on their exchanges have a majority of their board of directors be independent. Nasdaq guidelines provide that a director is not independent if he or she has been employed by the company or its subsidiaries during the current year or any of the past three years, received more than $60,000 from the company in any of the past three years or has a family member who has served as an executive officer during the past three years.

• Audit Committee. Private companies considering an IPO should prepare for such eventuality by electing an independent audit committee, one or more of whose members are experienced in preparing, auditing, analyzing or evaluating the financial statements of entities similar to the company at issue. Additionally, new SOX and exchange rules require that more stringent independence guidelines be applied to audit committees than even the board of directors. Under Section 301 of SOX, for example, no audit committee member may accept any consultancy, advisory or other compensatory fee from an issuer, except for fees in connection with serving on the committee itself.

• Compensation Committee. The NYSE now requires board of directors to establish a compensation committee to set and approve compensation for executive officers of the issuer. Nasdaq’s rules do not require a separate committee to address compensation decisions, but does require those decisions to be made either by the independent members of the board of directors or by a committee of independent directors.

© 2004 Wahab & Medenica LLC