(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Commission Adopts Sarbanes-Oxley Rulemaking Measures

The Securities and Exchange Commission finished what Chairman Harvey L. Pitt referred to as the busiest month in the agency's history by approving final rules dealing with auditor independence, conduct standards for lawyers, mutual fund proxy disclosure, off-balance sheet arrangements, management certification of investment company reports and record retention. The SEC action was necessary to implement the requirements of the Sarbanes-Oxley Act.

Auditor Independence

The auditor independence rule outlines a number of specific areas in which auditors may not engage. The SEC used its discretion under the Sarbanes-Oxley Act, however, to allow tax work by auditors. The SEC had previously proposed an auditor independence rule last summer prior to the enactment of the reform bill, and re-drafted the measure to conform with the new law.

Accounting firms cannot provide nine specific tasks for their audit clients under the new rule. These activities are: 1) bookkeeping, 2) appraisal services, 3) actuarial services, 4) management functions or human resources work, 5)broker-dealer, investment adviser or investment banking services, 6) legal services and other expert services unrelated to auditing, 7) internal audit outsourcing, 8) financial information systems design and implementation, and 9) any other expert services unrelated to the audit, as defined by the SEC. The rule does permit accountants to perform tax compliance and planning work and tax advice, however, as long as the company's audit committee approves.

The SEC limits this work to areas that do not impair the independence of the accountant. Under the new rule, audit firms could not represent a client before tax court or other areas of advocacy. Furthermore, companies must disclose to investors all fees paid to auditors, whether for non-audit or audit work. The disclosure may include the total amount paid, however, without making a distinction for non-audit versus audit work. In addition, the rule requires auditors to rotate out of firms every five years in the case of a lead auditor and up to seven years for auditors without primary decision making ability. A lead partner after serving five years with a client cannot return to that client until satisfying a five-year cooling off period. A two-year period would apply for those under the seven-year rotation.

Accountants will also be barred from earning compensation from a company they are auditing for services based on non-audit functions. Auditors are also barred from working for companies they have audited within the past year. The new rule also requires auditors to provide details to the company's audit committee before filing with the SEC.

The SEC exempted small firms with fewer than 10 partners and fewer than 5 SEC audit clients from the provisions of the rule. In order to qualify for the exemption, firms must be reviewed by the Public Company Accounting Oversight Board every three years. Foreign firms must also comply with the partner rotation provisions, as well as the cooling off periods. The rule has additional guidance for foreign firms offering non-audit work. According to the SEC, the agency is willing to work with other agencies over foreign firm regulation. This new rule will take effect 90 days after Federal Register publication

Investment Company Measures

Another new rule approved by the SEC deals with management certification of investment company reports, as required by Section 302 of the Sarbanes-Oxley Act. As with the auditor independence rule, the SEC had required public company CEO certification prior to passage of the Sarbanes-Oxley Act. With the new rules applicable to investment companies in place, funds will now have to file reports certified by management on Form N-CSR. The rule also requires disclosures concerning the adoption of codes of ethics under Sarbanes-Oxley Sections 406 and 407. Finally, the rule requires at least one "financial expert "on the audit committee of an investment company.

The effective date of these changes is March 1, 2003, except that the effective date of the removal of the certification requirement from Form N-SAR for registered management investment companies other than small business investment companies is May 1, 2003.

A new final rule, effective August 31, 2004, will also require that investment companies disclose how they vote their proxies. Commissioner Paul S. Atkins voted against the rule, saying he believes that it will increase fund costs. Commissioner Cynthia A. Glassman also expressed concern about the rule, but the commissioner voted to adopt the rule "with reservation. " She said she believes that most mutual fund shareholders are more concerned with a fund's performance than with how it votes. According to Commissioner Glassman, "a vocal minority including special interests" is promoting the disclosure, and this group "may not represent the quiet majority." Mr. Atkins said that some funds, especially those that advertise themselves as socially conscious, already make their voting records public and that there is no need for the SEC to mandate this. The SEC also unanimously approved a rule to require investment company advisers to adopt written procedures over their proxy voting policies, with information on how investors can get voting information. This rule is effective 180 days after Federal Register publication.

Record Retention

Other agency action dealt with record retention under Sarbanes-Oxley Act Section 802. Pursuant to this section, accounting firms will be required to retain for seven years certain records relevant to their audits and reviews of issuers' financial statements. Records to be retained include an accounting firm's workpapers and certain other documents that contain conclusions, opinions, analyses or financial data related to the audit or review. According to the SEC, most firms will be able to store these records electronically to minimize warehousing costs. The SEC adopted a seven-year period for retention, instead of a five-year period. This period conforms with a Sarbanes-Oxley Act mandate that requires the Public Company Accounting Oversight Board to require seven-year retention.

The effective date for these changes is March 3, 2003. Compliance will be required for audits and reviews completed on or after October 31, 2003.

Off-Balance Sheet Activities

The SEC also approved a final rule on off-balance sheet activity to implement Section 401(a) of the Sarbanes-Oxley Act. This section requires annual and quarterly reports to include details on material off-balance sheet transactions, as well as on other arrangements that may affect operations, liquidity, capital expenditures, capital resources or significant components of revenues and expenses. The rule requires that companies provide details on off-balance sheet and similar activity in a separate caption of the management's discussion and analysis section of its financial reports. The rule applies generally to such activities as guarantee contracts, retained or contingent interests in assets transferred to an unconsolidated entity, derivatives classified as equity and material variable interests in unconsolidated entities. Compliance will be required by June 15, 2003, for off-balance sheet activity and by December 15, 2003, for contractual obligations.

Attorney Conduct Rules

The SEC approved final standards for lawyer conduct, as required by Sarbanes-Oxley Act Section 307. The basis of the rule, according to the SEC, is a belief that lawyers for public companies work for the stockholders and not for management. If the lawyer believes there is wrongdoing, the rule creates an obligation and proper path for the lawyer to address the concerns.

As adopted, the rules contain several modifications from the original proposal. The SEC decided to remove the "noisy withdrawal" provision, which was directed at lawyers who believed that the company had not adequately addressed their concerns. As proposed, attorneys retained by the issuer would be required to withdraw from representing the issuer and to indicate that the withdrawal was based on professional considerations. Within one business day, the attorneys would have been required to give written notice to the Commission of the action. The SEC intends, however, to reissue the "noisy withdrawal" provisions separately for further comment.

Lawyers will also be covered only if they are actually providing legal advice to the company. Accordingly, a lawyer must receive notice if a document the lawyer worked on will be filed with the SEC. The "appearing and practicing" definition of the rule will not apply to lawyers who are not providing the company with legal advice. In addition, "non-appearing foreign attorneys" will be excluded from the rule, unless they provide advice on U.S. law. The rule will outline objective circumstances under which attorneys with a reasonable belief that a violation has occurred will have to bring their concerns forward.

The final rule also removes documentation requirements that some commentators worried would adversely affect the attorney and client relationship. Language in the new rule is intended to assure issuers that they may direct their lawyers to conduct investigations and to defend them in litigation without impairing the protections applicable to lawyer-client privilege. The SEC did not concur, however, with comments that the agency should leave lawyer standards with state bar associations, but the Commission would not object if state bars had stricter standards than the SEC. Chairman Pitt stated that he has not been satisfied with the response of state bars generally to complaints forwarded by the SEC.

The rule also provides for an alternative method, allowing, but not requiring, companies to set up qualified legal compliance committees to hear evidence of wrongdoing by lawyers. These committees would include at least one member of the audit committee and two or more independent board members. The committees could take items to the SEC if the company failed to take proper action. This would provide an alternative to the requirement that a lawyer must disaffirm a document in these circumstances. Finally, the rule has a clause stating that only the SEC can bring actions based on lawyer misconduct, and not private parties. he lawyer conduct rule will become effective 180 days after Federal Register publication.

Although the SEC approved these new rules and rule amendments pursuant to the Sarbanes-Oxley Act, it has not made all the related releases available to the public by press time. CCH has begun to update federal securities products with the available amendments and will continue to do so over the next several weeks as the SEC continues to issue all related releases.

¨ The adopting releases will be published in a forthcoming report