Covington & Burling
July 2002
SECURITIES
CEO & CFO Sworn Statements – SEC Order No. 4-460
Overview of SEC Order 4-460
O
n June 27, 2002, the SEC issued Order 4-460 (available at
http://www.sec.gov/rules/other/4-460.htm) requiring both the CEO and CFO of each
of the nation’s 947 largest public companies to swear to the accuracy and completeness
of their company’s recent SEC reports and to indicate whether they have reviewed the
attestation with their audit committee.
Specifically, the Order requires that the principal executive officer and principal financial
officer of each covered company each certify in writing, under oath, that, to his or her
best knowledge, based upon a review of the company’s “covered reports,” no covered
report contained a material misstatement or omitted to state a material fact necessary to
make the statements in the report, in light of the circumstances under which they were
made, not misleading as of the end of the period covered by the report. In the case of a
report on Form 8-K or definitive proxy materials, the certification is as of the date on
which it was filed. “Covered reports” include the company’s most recently filed Form 10K and all subsequent definitive proxy materials and reports on Form 10-Q and Form 8-K
(and any amendments thereto).
If the CEO or CFO cannot attest to the foregoing, he or she may file a statement under
oath describing the facts and circumstances that would make the required statement
incorrect. In addition, the certifying officer must attest as to whether he or she has
reviewed the contents of the sworn statement with the company’s audit committee (or, in
the absence of an audit committee, with the independent directors).
The sworn statements must be filed in written form no later than the close of business
on the first date on or after August 14, 2002, that a Form 10-K or Form 10-Q is required
to be filed by the company.
Practical Compliance Guidelines – Best Practices
Many companies are wondering how they should respond to Order 4-460. While the
Order does not outline any rules or minimum standards to follow in preparation of the
sworn statements, in the current environment and given the stakes involved, certifying
officers (and their companies) should approach this task with care. Although differing
facts and circumstances at each company necessarily mean that there is no universal
solution, we suggest that covered companies consider the following guidelines as a
starting point for their certification processes:
Establish Review Team – In order to implement the process recommended
below, a certifying officer will need the assistance and expertise of staff. We
recommend the formation of a team of highly competent members of the company’s accounting, finance, legal, risk management and investor relations
departments to support the officers’ certification process. This team should be
closely supervised by the CEO and CFO and should meet with them throughout
the process.
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Identify, Gather and Distribute Covered Reports – The first step for the
Review Team is to identify and gather all of the filings that must be certified.
This will include the company’s most recently filed Form 10-K and all Form 10Qs, Form 8-Ks and definitive proxy materials filed after the date of filing the
Form 10-K, including amendments to any of these filings. If the first filed report
on or after August 14, 2002, is the Form 10-K, then the certification will only
apply to the Form 10-K. The covered reports should be distributed immediately
to the certifying officers.
Conduct Review
• Review Processes and Procedures – To satisfy the “best knowledge” standard and to establish the foundation of a thorough review of
the covered reports, we recommend that certifying officers focus on
ensuring that their company’s internal controls, record-keeping practices
and SEC filing preparation procedures are all adequate and effective.
In this regard, companies should consider the SEC’s June 17th proposed rule that, when adopted, will require the CEO and CFO of every
domestic reporting company to file certifications with respect to their
company’s quarterly and annual reports. Notably, this proposed rule will
also require CEOs and CFOs to certify that their company maintains
sufficient procedures to provide reasonable assurance that it is able to
collect, process and disclose all information required to be included in
its annual reports.
In the proposed rule, the SEC recommended that reporting companies
establish an internal review committee charged with determining the
materiality of information and the timeliness requirements with respect
to the disclosure of material information. The SEC further recommended that this committee be comprised of the company’s principal
accounting officer, risk management officer, investor officer and general
counsel. While these are only recommendations from the SEC and are
not required under Order 4-460, they do provide insight as to what the
SEC is thinking, and companies should give them careful consideration
during the certification review.
• Conduct Critical Review – At the outset, the certifying officers
should thoroughly and critically reread all of the covered reports and
related documentation. Beyond this, they should take whatever additional steps are necessary to clarify any issues or answer any questions
raised during the review process – including meeting and questioning
the Review Team, other members of management, outside counsel,
external auditors or others.
Although circumstances will vary from company to company, we recommend that each of the certifying officers considers the following issues
during his or her review process:
Ö
Is there anything in the covered reports that I do not fully
understand or seems questionable to me?
Ö
Was anything omitted from the covered reports that could
be material to a reasonable investor?
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Ö
Were there any significant issues debated during the preparation of the covered reports? If so, how were they
resolved?
Ö
Does the Review Team know of any “red flags” uncovered
during the preparation of the covered reports? Do I know
of any “red flags?”
In performing this review, the certifying officers should also consider
whether the company has appropriately addressed the following topics,
which are current hot-button disclosure items at the SEC:
Ö
Related party transactions
Ö
Critical accounting policies
Ö
Revenue recognition
Ö
Expense (including interest) capitalization
Ö
Off-balance sheet debt instruments and special purpose
vehicles
Ö
Reserve adequacy
Ö
Derivatives
Document Process and Findings – The certifying officers should thoroughly
document the review process – including personnel involved, meeting dates,
issues discussed and corrective actions taken – to demonstrate the completeness of the review and the extent to which the certifying officers’ reliance on the
Review Team and other corporate processes was justified. While we understand that some certifying officers are considering requiring their subordinates to
confirm in writing that they are not aware of any material misstatements or omissions, this approach may not be feasible for all companies. In all events, however, the certifying officers should ensure that none of the members of the
Review Team had any knowledge of any material misstatements or omissions or
was aware of any reason why the certifying officers should not execute the
sworn statements.
Dealing with Problems – If the review process uncovers misstatements or
omissions, the Review Team (and ultimately the certifying officers) will first need
to determine their materiality. The SEC will apply the existing standard for
determining the materiality of disclosure information, which is whether (1) there
is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision and (2) there is a substantial
likelihood that the information would be viewed by the reasonable investor as
having significantly altered the “total mix” of available information. Please note,
however, that the SEC has stated that there are no bright line percentage
thresholds for determining materiality, and quantitatively small accounting errors
may be material under certain circumstances.
If an issue appears material, then the certifying officers have two options. The
most straightforward response would be to correct the error in an amendment to
the erroneous filing. Alternatively, the certifying officers are permitted to
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describe in their statements the facts and circumstances that would make their
required certifications incorrect. Because the company would almost certainly
have an obligation to correct erroneous reports immediately, the second option
makes little sense. Absent unusual circumstances – for example, an inability to
complete a corrective amendment on time – the preferred corrective action is to
file an amendment to the erroneous report as soon as possible.
Audit Committee Review – After reviewing the covered reports, meeting with
the Review Team and following up on any questions, concerns or red flags, the
certifying officers should meet with the audit committee (or, in the absence of an
audit committee, the company’s independent directors) to review the procedures
employed in their review and the contents of the sworn statements. We recommend that the audit committee be contacted early in the process so that members understand the audit committee’s role under the Order and the certifying
officers’ compliance plan. In addition, the certifying officers should take the
opportunity to solicit any recommendations that the audit committee might have
to enhance the certification process.
File Certification and Necessary Amendments – At the end of the process,
the company must file all necessary amendments to the covered reports and
the sworn statements. The sworn statements must be filed in paper copy – not
electronically via EDGAR – and are to be delivered (fax is acceptable) to
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, DC 20549 by the close of business on the first date
that a Form 10-K or Form 10-Q is required to be filed on or after August 14,
2002 (for calendar filing companies, this will be August 14, 2002).
Frequently Asked Questions
What is meant by “to the best of my knowledge?”
The “best knowledge” standard implies a reasonable amount of inquiry and diligence on behalf of the certifying officer to confirm the facts and circumstances
involved in the covered reports. Clearly, it will not be enough for a CEO to
argue that he or she relied upon his or her subordinates to get the numbers
right. The review procedures discussed above should be helpful in meeting this
standard.
What is meant by “based upon a review of the covered reports?”
Related to the “best knowledge” inquiry, certifying officers should take this Order
very seriously and implement a rigorous review process that critically reevaluates all of the covered reports for accuracy and completeness.
Will the level of review be different for certifying officers that were at the
company when the covered reports were prepared and filed as compared
with certifying officers that are new?
Although it is possible that certifying officers who were not with the company
when the covered reports were filed could argue that the “best knowledge” standard as applied to them should be lower, it is our understanding that the SEC
intends to apply a uniform standard to all certifying officers. This will obviously
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place an increased burden on new officers to thoroughly investigate and review
the covered reports that were prepared prior to their arrival at the company.
What constitutes a “material” misstatement or omission?
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Although the Order does not specifically set forth a standard of materiality, we
understand that the SEC will apply the traditional standard discussed above.
Given the current environment and the extraordinary level of scrutiny that the
sworn statements are likely to receive, SEC comment letters may take on a
heightened level of importance and perceived materiality. Certifying officers
may, for example, be unwilling to certify covered reports that are subject to
unresolved SEC comments, regardless of their true belief as to the materiality of
the comments. This could pressure companies to resolve outstanding SEC
comments quickly (and less favorably) or force them to file amended reports
that they might otherwise not. If a problem arises related to unresolved comments, certifying officers will need to look closely at the materiality of the SEC’s
comments and make some tough judgments about how best to respond. In the
worst case scenario, a certifying officer may refuse, in his or her sworn statement, to certify a covered report that is subject to an outstanding SEC comment
letter.
What liability do officers face for incorrect certifications?
The obligation to file a truthful certification should be taken very seriously. False
certifications could give rise to private causes of action, SEC enforcement
actions and criminal sanctions for a variety of charges, including fraud, perjury,
filing a false statement with a government agency and obstruction of justice. In
addition to potential criminal sanctions, persons who file incorrect certifications
could be forced to pay civil penalties, disgorge ill-gotten gains or be barred from
future service as an officer or director of another public company.
Has this Order increased the CEO’s and CFO’s liability?
We believe that the obligation to file sworn statements has increased certifying
officers’ liability in the following ways:
Ö
The certification is made personally, rather than “on behalf
of the registrant.”
Ö
The certification relates to several covered reports (e.g.,
the Form 10-Q and definitive proxy materials) that the certifying officer may not have had to sign before.
Ö
The “under oath” requirement expands the potential available criminal liability to include perjury.
Ö
The certification appears broader than current filing
requirements in that it requires the certifying officer to
attest that the covered reports contain no material misstatements or omissions.
What role should the audit committee play in complying with the Order?
Interestingly, the Order does not require the participation of the company’s audit
committee in the process of reviewing the covered reports. The sworn
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statements only require the certifying officers to declare whether they have
reviewed the contents of the statements with the audit committee (or, in the
absence of an audit committee, the independent members of the company’s
board). Therefore, it is conceivable that the certifying officers could leave the
audit committee out of the review process completely or that the audit committee members themselves could refuse to participate. Certainly, the audit committee’s potential liability increases the deeper it delves into the review process.
That said, given the importance of the audit committee in ensuring the reliability
of a company’s financial statements and the likely public fallout of a failure to
participate in the review, we believe that it would be unwise to exclude the audit
committee from this process.
Can the sworn statements be faxed to the SEC?
We have confirmed with the SEC staff that the sworn statements – which may
not be filed electronically – may be faxed to Secretary Katz’s office at (202) 9429651.
Can the sworn statements be filed early?
Although the Order is not clear on this issue, we have confirmed with the SEC
staff that the sworn statements may be filed prior to their due dates (August 14,
2002, for calendar year reporting companies). Further, if the sworn statements
are filed early, then they need only attest to the accuracy of covered reports on
file with the SEC as of the date of the filing. Thus, if the certifying officers of a
calendar year reporting company file their sworn statements prior to filing the
company’s Form 10-Q on August 14, 2002, the sworn statements would not
have to attest to the accuracy of the subsequently filed Form 10-Q (or any
amendments to any previously filed covered reports that are filed after the certification). Some companies may wish to consider filing the sworn statements
early, particularly in situations where a certifying officer will be leaving a company prior to the filing deadline. On balance, however, we think investors and the
public may have questions with any company whose officers have not certified
second quarter reports.
David B.H. Martin
Russell P. Kanjorski
If you have any questions concerning the material discussed
in this client alert, please call any of the following members
of our securities practice group:
London
Washington
New York
San Francisco
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Kelly Vance
David Martin
Bruce Bennett
Andi Vachss
44.20.7067.2040
202.662.5128
212.841.1060
415.591.7069
© 2002 Covington & Burling
This information is not intended as legal advice, which may often turn on specific facts. Readers should seek specific legal advice before
acting with regard to the subjects mentioned here.