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SEC OKs Rules on Financial Conduct

Wave of new policies includes more disclosure on pro forma results and limits on executive stock sales.

January 16, 2003|Jonathan Peterson | Times Staff Writer

WASHINGTON — The Securities and Exchange Commission on Wednesday sought to prevent companies from releasing deceptive financial results and also moved to ban stock trading by top managers during times when rank-and-file employees are restricted from selling their own shares.

In addition, the SEC approved a rule requiring companies to disclose whether they have financial experts on their board audit committees. But the commission gave companies some latitude in determining who qualifies as an expert.

The unanimous SEC decisions came as officials raced to meet deadlines mandated by Congress for tougher regulations in the wake of last year's string of corporate debacles. The wave of new requirements arises from last summer's Sarbanes-Oxley legislation, in which Congress sought to protect the interests of investors and prevent a recurrence of the financial scandals at Enron Corp. and other firms.

Outgoing Chairman Harvey L. Pitt said the SEC is in the midst of "the busiest two weeks of rulemaking in this agency's history."

The SEC commissioners agreed to make companies give the public more information about pro forma financial results, which often exclude one-time costs and were particularly popular with high-tech firms during the market mania of the 1990s. Under the new rule, companies will have to show investors how such pro forma results jibe with generally accepted accounting principles.

"This is a huge step forward," said Commissioner Roel C. Campos.

The SEC also banned a firm's directors and executive officers from trading company stock during periods of three days or more when rank-and-file workers are not allowed to sell shares held in their own 401(k) retirement plans. The rule was prompted by the huge stock sales made by high-ranking Enron executives as the company slid into bankruptcy protection.

"It's only fair that the officers, directors and employees are treated similarly," said Commissioner Cynthia Glassman.

In addition, the SEC approved rules requiring firms to disclose whether they have a code of ethics for their officers and whether their audit committee includes a financial expert.

Some companies had complained that the term "financial expert" was a vague and perhaps difficult standard that would exclude otherwise qualified people from serving on audit committees. The rule approved Wednesday sets a lower standard, although it requires that the individual have an understanding of financial statements and accounting standards.

"Financial expertise counts, but there's no reason to be rigid here," Commissioner Harvey Goldschmid said.

The SEC is still putting the finishing touches on new policies designed to bolster the independence of auditors by restricting services such firms may provide to their audit clients, as well as a rule that will lay out the responsibility of lawyers to report malfeasance they may discover at a client firm.

The flurry of rulemaking is drawing a mixed response from outside observers.

"This is a once-in-a-lifetime type of sea change," said Lynn E. Turner, a former chief accountant at the SEC. Turner said that no individual rule was the key: "It takes a whole package to get the change in culture and impact in the markets that Congress was looking for."

Others, however, were less impressed, saying that in the aftermath of the corporate scandals, the marketplace is demanding more conscientious accounting regardless of the SEC.

"One way or the other, pro forma [financial reporting] is going the way of the hula hoop," said Nell Minow, editor of the Corporate Library, a Web site that follows corporate governance issues.

In a related development Wednesday, the Financial Accounting Standards Board, which sets accounting standards in the U.S., approved new rules that clamp down on the abuse of creative financing deals that allowed firms such as Enron to shift debt off their books.

The new standard represents one of the most significant changes in accounting rules inspired directly by Enron's collapse. The rules involve so-called special purpose entities and when they can be excluded from a parent company's books.

The now-infamous special purpose entities (SPEs) typically are partnerships that are often used by companies to move debt off their balance sheet. Many have legitimate uses, but others are structured specifically with the intent of concealing debt from investors.

Under the new rules, companies that bear the majority -- or more than 50% -- of risk of expected losses or gains from a special purpose entity must also reflect that SPE's assets and liabilities on their balance sheet.

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Reuters was used in compiling this report.

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