SEC Year in Review Significant 2002 Developments

During 2002, corporate scandal took center stage. Accounting debacles at many large, well-known companies were discussed repeatedly in the press and companies such as Worldcom, Enron, and Adelphia became household names. In response, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the Act) on July 30, 2002. The law was designed to both combat corporate fraud and hold companies and others accountable. The Act, however, was very broad in many respects and delegated responsibility for developing the underlying details to the SEC. As a result, the SEC spent significant time in 2002 proposing, and in some cases, finalizing an enormous number of rules. These rules address specific sections of the Act, as well as items on the SEC's own agenda, and cover matters such as CEO/CFO certifications, acceleration of filing deadlines, and independence.

The following comments summarize the recent rules. They are categorized between those finalized in 2002 and those, as of December 31, 2002, still in the proposal stage. To the extent Financial Reporting Letters have previously been issued regarding the rules, a reference to the specific letter (containing additional details) has been provided. All rules, proposed and final, are available on the SEC's Web site, www.sec.gov, under Regulatory Actions and underlying captions titled Proposed Rules, Final Rules, and Other Commission Orders and Notices.

Final Rules and Commission Statements

Disclosure of Equity Compensation Plan Information (release no. 33-8048)

Over the past 10 years there has been a dramatic increase in the use of equity compensation. There has been a similar increase in investor concern about the potential dilutive effect of equity compensation plans, the absence of full disclosure to shareholders about these plans, and the adoption of many plans without shareholder approval. As a result, on December 21, 2001, the SEC issued new disclosure requirements for equity compensation plans. These disclosures are required in annual reports on Form 10-K and Form 10-KSB for fiscal years ending on or after March 15, 2002. They are also required in proxy and information statements for meetings of, or actions by, shareholders involving equity compensation plans that occur on or after June 15, 2002. The requirements do not apply to foreign private issuers.

The following disclosures are required for all equity compensation plans (including individual compensation arrangements) in effect as of the end of the most recent fiscal year. The disclosures should be provided in a tabular format (as prescribed by the rule) and may be aggregated (rather than provided on a plan-by-plan basis) into two categories - those equity compensation plans approved by shareholders and those not approved.

• The number of securities to be issued upon exercise of outstanding options, warrants, and rights.
• The weighted average exercise price of outstanding options, warrants, and rights.
• The number of securities remaining available for future issuance.

Commission Statement about Management's Discussion and Analysis of Financial Condition and Results of Operations (release no. 33-8056)

In January 2002, the SEC issued Financial Reporting Release (FRR) No. 61, which, as a precursor to future rulemaking, encouraged improved disclosures in the following three areas:

• Liquidity and capital resources, including off-balance sheet arrangements.
• Certain trading activities involving non-exchange traded contracts accounted for at fair value.
• Relationships and transactions with persons or entities that derive benefits from their non-independent relationship with the registrant.

Certain trading activities - the SEC's focus is on the adequacy of disclosures for trading activities involving commodity contracts that, in the absence of quoted market prices, are accounted for at estimated fair values. Information about these trading activities, the contracts, the assumptions used in estimating their values (including variables and inputs), and the reasonably likely outcomes (based on varying circumstances and measurement methods) should be considered for inclusion in MD&A.

Transactions with related parties - MD&A should describe all material transactions involving related persons or entities, including the business purpose, the identity of the related parties, how the transaction prices were determined, and any ongoing commitments (contractual or otherwise) related to the arrangement. Additionally, to the extent the transaction has been disclosed as having been evaluated for fairness, the SEC would expect an explanation as to how the evaluation was made. For purposes of identifying related parties, the SEC cautions that the definition should not be limited to those falling within the definition of "related parties" as contained in SFAS No. 57, Related Party Disclosures. For example, such disclosures could apply to an entity that is owned by former senior management of the registrant. In such a situation, their former management positions may result in the negotiation of terms that are more or less favorable than those available on an arm's length basis from clearly independent third parties.

Mandated EDGAR Filing for Foreign Issuers (release no. 33-8099)

The SEC issued new rules on May 14, 2002 requiring foreign private issuers and foreign governments to file their securities documents electronically through the EDGAR system. The requirement applies to registration statements filed under the Securities Act of 1933 (the 33 Act), as well as other reports and documents filed under the Securities Exchange Act of 1934 (the 34 Act). By requiring electronic filings, the SEC hoped to realize the same investor benefits and efficiencies in information retrieval and analysis for foreign private issuers as previously achieved for domestic issuers.

The requirement to file electronically applies to any filings (including Form 20-F, Form 6-K, registration statements, etc.) made on or after November 4, 2002. However, for registration statements initially filed before November 4, 2002, the SEC permitted subsequent amendments to be filed on paper, provided the registration statement was declared effective on or before December 31, 2002.

The rules also eliminated the requirement for any first-time EDGAR filer, domestic or foreign, to submit a paper copy of the electronic filing to the SEC.

Ownership Reports and Trading by Officers, Directors and Principal Security Holders (release no. 34-46421)

On August 27, 2002, the SEC issued rules accelerating the filing deadline for changes in beneficial ownership reports required to be filed by officers, directors, and principal security holders under Section 16(a) of the 34 Act. Forms 3, 4, and 5 are now required within two business days of all trade executions (i.e., trade date).

The SEC also encouraged registrants to file these Section 16(a) reports electronically and to simultaneously post them on the registrants' web sites. On December 20, 2002, the SEC proposed rules (release no. 33-8170, Mandated Electronic Filing and Website Posting for Forms 3, 4 and 5) that would require such electronic submissions and postings in the future.

Certification of Disclosure in Companies' Quarterly and Annual Reports (release no. 33-8124)

On August 29, 2002, the SEC issued rules to implement Section 302 of the Act. The new rules require registrants to design, maintain, evaluate, and report on the effectiveness of their "disclosure controls and procedures" (a newly-defined term that encompasses controls to ensure full and timely disclosure throughout a registrant's report). The rules also require companies to report significant deficiencies in internal controls and certain frauds to the audit committee of the board of directors. The rules place responsibility for meeting these requirements on a company's chief executive officer and chief financial officer. These officers must provide certifications in which they acknowledge these responsibilities and affirm that they have fulfilled them. The officers must also certify as to their involvement in preparing the reports and the overall fairness of the information they contain. Specifically, they must affirm that they have read the periodic report and that based on their knowledge, the report is not misleading and fairly presents the company's financial information.

These rules apply to periodic filings, including amended filings, made on or after August 29, 2002. However, for filings covering periods ending before August 29, 2002, only the CEO/CFO certifications regarding involvement and fairness of the information contained in the report are required. The additional certifications and disclosures regarding the evaluation of disclosure controls and procedures are only required in filings covering periods ending on or after August 29, 2002. The rules apply to domestic issuers (including small business issuers), as well as foreign private issuers (including those Canadian companies filing under the multijurisdictional (MJDS) system).

See the Financial Reporting Letter issued in October 2002, SEC Requires Officers to Certify Periodic Reports and Accelerates their Due Dates, for further details.

Acceleration of Periodic Report Filing Dates and Disclosure Concerning Website Access to Reports (release no. 33-8128)

On September 5, 2002, the SEC issued rules that accelerate the due dates for the periodic reports of certain registrants. Companies subject to these rules, known as "accelerated filers," are generally large, seasoned SEC reporting companies. Specifically, they are companies that have a public float of at least $75 million (as of the end of the second fiscal quarter), have been subject to the 34 Act reporting requirements for 12 months, and have filed at least one annual report (as of the end of the fiscal year). Small business issuers and foreign private issuers are exempt from these rules.

The initial test for "accelerated filer" status must be performed for the first fiscal year ending on or after December 15, 2002. If a company does not meet the criteria for an "accelerated filer" in the initial test, subsequent annual testing is required. Once a company satisfies the criteria, it remains an "accelerated filer," unless and until it subsequently qualifies as a small business issuer.

In response to concerns about accelerating reporting this year, the rule phases in the accelerated due dates over a two-year period. The phase-in period will begin for reports filed by companies that meet the definition of "accelerated filers" as of the end of the first fiscal year ending on or after December 15, 2002. The first accelerated filings will be for annual reports on Form 10-K for fiscal years ending on or after December 15, 2003. Upon completion of the phase-in period, accelerated filers will be required to file their annual reports on Form 10-K within 60 days after fiscal year-end, and their quarterly reports on Form 10-Q within 35 days after quarter-end.

The rules also require accelerated filers to disclose in their annual reports on Form 10-K (for fiscal years ending on or after December 15, 2002), the following information regarding web site access to reports:

• The registrant's internet address, if it has one.
• Whether the company makes available, free of charge, or through its web site, 34 Act filings (e.g., Forms 10-K, 10-Q, and 8-K) as soon as reasonably practicable after they are filed with the SEC.
• And, if the company does not make its filings available in this manner, the reasons why and whether paper copies will be provided at no charge.

Proposed Rules

Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies (release no. 33-8098)

On May 10, 2002, the SEC issued a rule to require a separately captioned section in MD&A regarding the critical accounting estimates made by companies in applying accounting policies and the initial adoption of certain accounting policies. The proposal builds on the disclosures the SEC encouraged registrants to make in FRR No. 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, issued in December 2001. However, since many registrants, in response to FRR 60, simply reiterated the accounting policies section of the financial statements, the proposed rule clarifies that the focus should be on discussing significant estimates and their inherent uncertainties. The proposed rule would require disclosures about critical accounting estimates ranging from a description of the estimate (and the underlying assumptions and methodology) to a discussion quantifying the impact on financial performance if such estimates were to change. Upon initial adoption of a significant accounting policy (other than one mandated by a new accounting pronouncement), a company would need to describe the accounting principle adopted (as well as alternative methods not selected, if applicable) and the impact on the financial statements (discussed in qualitative terms).

This disclosure, generally applicable to all public companies, would be required in annual reports, registration statements, and proxy and information statements. Updates in quarterly reports would also be required for material changes in critical accounting estimates. For foreign private issuers, the disclosures would address GAAP used in the primary financial statements, as well as U.S. GAAP, but would only be required in annual reports and registration statements. Small business issuers that provide a plan of operations in lieu of MD&A (those that had no revenue for the last two fiscal years) would be exempt from the rules. Although the rule is not yet final, the SEC staff has indicated that the disclosure guidance in the proposed rule should be used as a guide for all current filings (including those for 2002 calendar year registrants).

See the Financial Reporting Letter issued in June 2002, SEC Proposals, for further details.

Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date (release no. 33-8106)

On June 17, 2002, in an effort to provide investors with better and faster disclosure of important corporate events, the SEC issued rules that would broaden the events that would require reporting under cover of Form 8-K and would accelerate the filing deadlines. Specifically, the SEC identified 11 new items that would require disclosure in a Form 8-K. These would include entry into or termination of a material agreement (not in the ordinary course of business), the creation of material direct or contingent financial obligations, material impairments, and exit activities including material write-offs and restructuring charges. Further, the proposed rules would accelerate the due dates for all Form 8-K filings, which currently range from five business days to fifteen calendar days after the event depending on the nature of the event, to two business days.

Improper Influence on Conduct of Audits (release no. 34-46685)

On October 18, 2002, the SEC, as directed by Section 303(a) of the Act, issued rules to prohibit officers and directors of an issuer, as well as persons acting under their direction, from taking any action to fraudulently influence, coerce, manipulate, or mislead an auditor for the purpose of rendering the financial statements materially misleading.

See the Financial Reporting Letter issued in November 2002, SEC Proposes New Rules to Implement Four Sections of the Sarbanes-Oxley Act, for further details.

Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002 (release no. 33-8138)

On October 22, 2002, the SEC issued rules that would implement the following three sections of the Act. These rules would apply to all public companies.

• Section 404 - the rules would require management to evaluate and report on the effectiveness of a company's internal controls and procedures for financial reporting in each periodic (quarterly and annual) report. Additionally, the rules would require a company to engage its auditor to examine, and report on, management's annual evaluation. The auditor's attestation report would be required to be included in each annual report.
• Section 406 - the rules would require a company to disclose whether it has adopted a code of ethics for the company's principal executive officer and senior financial officers and, if not, the reasons why. They would also require disclosure of any changes to, or waivers of, any provisions of the code of ethics.
• Section 407 - the rules would require a company to disclose whether its audit committee includes at least one member who is a "financial expert" and define the term.

Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments (release no. 33-8144)

On November 4, 2002, the SEC issued rules that would require comprehensive disclosure about a company's off-balance sheet arrangements in annual and quarterly reports, thereby implementing the requirements of Section 401(a) of the Act. The rules would also require a company to provide an overview of its contractual obligations and contingent liabilities and commitments, in a tabular format specifically prescribed by the rule. These proposed requirements codify, to a great extent, guidance previously provided through FRR 61 issued in January 2002 (as discussed above). The rules would generally be applicable to all registrants with the following limited exceptions. Small business issuers would not be required to provide disclosures concerning contractual obligations and contingent liabilities and commitments. Foreign private issuers, including MDJS filers, would be subject to all disclosure requirements, but only in annual reports.

See the Financial Reporting Letter issued in November 2002, SEC Proposes More Rules to Implement the Sarbanes-Oxley Act, for further details.

Conditions for Use of Non-GAAP Financial Measures (release no. 33-8145)

On November 5, 2002, the SEC issued rules regarding the presentation of "pro forma" amounts in public disclosures. These rules would implement Section 401(b) of the Act. The rules would formally regulate the public disclosure of non-GAAP financial measures, which are defined as those financial measures derived by adjusting GAAP amounts in a manner that is inconsistent with GAAP. For example, non-GAAP financial measures would include "operating income excluding non-recurring charges and income" and "EBITDA" (earnings before interest, taxes, depreciation, and amortization).

The rules would prohibit companies from using non-GAAP financial measures that contain untrue facts or omit facts that are necessary to prevent the measures from being misleading. They would apply to public disclosures not filed with the SEC, as well as those included in SEC filings, although more extensive disclosures and greater prohibitions would apply to those non-GAAP financial measures included in filings with the SEC. In addition, the rules would require companies that issue earnings releases to file them under cover of a Form 8-K. The rule would generally be applicable to all registrants; however, certain exceptions would apply to foreign private issuers if the measures are not calculated based on U.S. GAAP financial measures and the information is disseminated outside the U.S.

See the Financial Reporting Letter issued in November 2002, SEC Proposes More Rules to Implement the Sarbanes-Oxley Act, for further details.

Insider Trades During Pension Fund Blackout Periods (release no. 34-46778)

On November 6, 2002, the SEC issued rules to implement the requirements of Section 306 of the Act, which prohibits directors and executive officers from purchasing or selling company equity securities during a pension fund blackout period, if such securities were acquired in connection with their service to the company. They would clarify what a blackout period is, to whom the restrictions apply, and what types of transactions and securities would be subject to the trading restrictions. In addition, the rules would require companies to notify officers and directors of impending blackout periods, as well as the SEC, by filing the notifications under cover of Form 8-K.

See the Financial Reporting Letter issued in November 2002, SEC Proposes More Rules to Implement the Sarbanes-Oxley Act, for further details.

Retention of Records Relevant to Audits and Reviews (release no. 33-8151)

On November 21, 2002, the SEC, under the direction of Section 802 of the Act, issued rules governing record retention by public accounting firms. The rules would require accounting firms to retain audit workpapers and certain other records relevant to their audits and reviews of issuers' financial statements for five years. Other records would include documents that contain conclusions, opinions, analyses, or financial data related to the audit or review.

Strengthening the Commission's Requirements Regarding Auditor Independence (release no. 33-8154)

On December 2, 2002, the SEC issued rules to implement the sections of the Sarbanes-Oxley Act that deal with auditor independence. The rules address Sections 201, 202, 203, 204, and 206 of the Act, which deal with nature of services, audit partner rotation, employment of audit team members, audit committee administration of engagements, and communications with audit committees. The rules would significantly expand the role an audit committee must play in administering a company's relationship with its auditors. They would also significantly limit the scope of services accounting firms can provide to their publicly held audit clients. They would also require companies to expand their disclosures concerning fees paid to auditors and would require audit committees to disclose policies for pre-approval of non-audit services.

The proposal is particularly controversial because it contains rules that would exceed the requirements of the Act by (a) imposing significantly more rigorous partner rotation requirements, (b) raising questions as to whether certain tax services may be performed by a company's auditors, and (c) affecting the manner in which accounting firms compensate partners. As such, certain of the proposed rules would have a profound effect on the relationships between public companies and their auditors.

The rules would apply to foreign registrants, as well as domestic registrants, although the SEC has specifically requested comments regarding conflicting legal requirements that may impact foreign private issuers.

See the Financial Reporting Letter issued in January 2003, SEC Proposes New Auditor Independence Rules, for further details.

For Further Information

If you would like further information, please contact your BDO USA, LLP engagement partner or one of the following partners:

Lee Graul (312) 616-4667

Debbie MacLaughlin (312) 616-4656

Jeff Lenz (312) 616-3944

Wayne Kolins (212) 885-8595

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