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What Does Sarbanes-Oxley Have to Do with Me?
A Community Bank Primer on Corporate Governance Issues
By: I. Thomas Bieging, Esq.

What do Enron, Worldcom, Qwest and Anytown Community Bank have in common? The answer is that each can be expected to feel the impact of the Sarbanes–Oxley Act of 2002, regardless of whether it is a publicly-traded company.

Congress’s response to corporate fraud, greed, and slip-shod accounting practices was quick in election year 2002. The Sarbanes-Oxley Act of 2002 passed by Congress on July 30, 2002 was Congress’s response to the headlines appearing daily in the business sections of newspapers chronicling corporate mismanagement and SEC laxness. The response was not unlike one with which all bankers are familiar.

In 1989, Congress responded to the savings and loan crisis with a “quick response”, which has come to be known as FIRREA – the Financial Institution’s Reform, Recovery and Enforcement Act of 1989. While both pieces of legislation can be criticized for their excesses, one thing is certain. Just as the effects of FIRREA have lingered over a decade and have permeated all levels of the financial institution industry, so will the effects of Sarbanes-Oxley be felt for years to come and ultimately impact both publicly and non-publicly traded financial institutions. The purpose of this article is to provide the managers and directors of non-publicly traded financial institutions with a “heads up” as to how they may experience the impact of Sarbanes-Oxley.

Predictions such as those contained in this article are not difficult in light of current pronouncements from various regulatory agencies. Recently, a panel of federal regulators in Ohio made up of representatives of the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corporation speaking to a group of accountants stated that corporate governance would be a “chief supervisory concern” in the year to come. In this same vein, FDIC Chairman Powell announced in October that the FDIC was considering mandating that all FDIC-insured banks comply with the new law. The Federal Reserve has already advised financial institutions that it is working to develop policies in accordance with Sarbanes-Oxley. Recently, Federal Reserve Governor Susan S. Bies, commenting to the National Conference on Banks and Savings Institutions conducted by the American Institute of Certified Public Accountants, stated that recent events leading to Sarbanes-Oxley serve as a “wake up call” to corporate boards, management, accountants and auditors. From these opening salvos, the handwriting on the wall is apparent: Be aware of the provisions of Sarbanes-Oxley.

Financial institutions that are affected directly by Sarbanes-Oxley fall into two categories. First are those institutions (banks, thrifts and their holding companies) that have a class of securities registered under Section 12 of the Securities Act of 1934, or are otherwise required to file periodic reports (10-K’s and 10-Q’s) under Section 15d of the Securities and Exchange Act of 1934. A second category of banks, thrifts, or holding companies that will be affected, somewhat less, are those top tier holding companies required to file forms FRY-6 and that have total assets of $500,000,000 or more, or insured depository institutions with total assets of $500,000,000 or more.

The statutory and regulatory requirements do not extend to community banks that are outside the categories described above. However, based on the regulators’ comments, we anticipate that certain provisions of Sarbanes-Oxley will indirectly have an impact on all financial institutions through adoption of analogous “safety and soundness” standards similar to Sarbanes-Oxley by the various financial institution regulatory agencies.

Those sections of Sarbanes-Oxley which we are referencing, and a brief description of their potential impact on non-reporting financial institutions are described below:

1. Section 201. SERVICES OUTSIDE THE SCOPE OF PRACTICE OF AUDITORS. This section limits the role of auditors to that of auditing. A public accounting firm that provides auditing services may not provide such additional services such as bookkeeping, development of financial information systems, appraisals, fairness opinions, internal audit outsourcing or management functions. The trends at all levels will be to assure that independent auditors are not auditing the impact of their other services to their audit customers. Non-reporting companies should review their auditor relationships and consider whether additional relationships between the auditor and the financial institution may adversely impact independence and the quality of the audit.

2. Section 204. AUDITOR REPORTS TO AUDIT COMMITTEES. This section requires that the public accounting firm report directly to the audit committee all critical accounting policies and practices; alternative treatments of financial information that have been discussed with management, including the ramifications of the use of such alternative treatments; and any material written communications between the public accounting firm and management (e.g., the management letter). This section is consistent with the theme of Section 203 and may be deemed advisable as a way to ensure that the board is fully aware of material accounting issues and to benefit the financial institution with the perspectives of non-management directors.

3. Section 206. CONFLICTS OF INTEREST. Reporting companies are prohibited from employing a public accounting firm if the reporting company’s chief executive officer, controller, chief financial officer, or chief accounting officer was employed by the public accounting firm within one year of the date of the initiation of the audit.

4. Section 302. CORPORATE RESPONSIBILITY FOR CORPORATE REPORTS. This is the section of Sarbanes-Oxley that requires the principal executive officer and principal financial officer of a reporting company to certify annual reports. The certification indicates that to the officer’s knowledge, the report does not contain any untrue statements of material fact or omit material facts. Additionally, among other requirements, the signing officer must indicate that in his or her opinion the financial report fairly presents in all material respects the organization’s financial condition and results of operation. Boards of directors of non-reporting financial institutions may well request of their own senior management such assurances in this era of renewed accountability to shareholders by management and boards of directors.

5. Section 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS. The effectiveness of internal controls has been a concern for financial institution regulators since at least the enactment of the Federal Deposit Insurance Corporation Improvement Act of 1991. Sarbanes-Oxley has a similar theme requiring that a reporting company’s annual report contain a section regarding the responsibility of management for establishing and maintaining adequate and internal controls along with an assessment of the effectiveness of those controls. Renewed emphasis can be expected at all levels of the financial institution industry on such internal controls.

6. Section 407. DISCLOSURE OF AUDIT COMMITTEE FINANCIAL EXPERT. Reporting companies are required to have at least one member of the audit committee who is deemed to be a “financial expert”. Such financial experts are considered to be someone who, through education and experience as a public accountant, auditor or principal financial officer, has an understanding of generally accepted accounting principles and financial statements, along with experience in the preparation or auditing of financial statements of generally comparable organizations. With the increased responsibilities and accountability of boards of directors, the wisdom of including a “financial expert” on any board cannot be challenged. The devil is in the detail as to how to attract such a financial expert in the current environment.

While the Sarbanes-Oxley Act of 2002 limits its scope of applicability to reporting banks, thrifts and holding companies there can be little doubt that the principles contained in the Act will be carried down by federal regulatory agencies to all levels of the financial institution industry. Those banks, thrifts and holding companies that begin now to assess their corporate governance in light of Sarbanes-Oxley will be in a better position to respond to regulatory concerns which will be expressed in the months and years come.

©2002, Bieging Shapiro & Burrus LLP. All rights reserved.

Contact I. Thomas Bieging, Esq. at tb@bsblawyers.com

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