SEC Adopts Code of Ethics Disclosure Rules

01/24/2003

On Wednesday, January 15, 2003, the SEC adopted rules implementing Section 406 of the Sarbanes-Oxley Act of 2002 (the “Act”).

The SEC’s new rules under the Act require public companies to disclose in each annual report on Form 10-K (U.S. companies), Form 40-F (Canadian companies) or Form 20-F (non-U.S. companies) whether they have adopted a code of ethics that applies to their principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions.  If the company does not have a code of ethics that meets the requirements of the new rules, the company must disclose in its annual report the reasons why it has not adopted a code of ethics.

If a public company has a code of ethics that meets the SEC’s requirements, the company must make its code of ethics available to the public.  In addition, changes to, or waivers of, the code of ethics that apply to the officers or activities subject to the new rules must be publicly disclosed.

Definition of “Code of Ethics”

Under the new rules, a “code of ethics” is defined in new Item 406 of Regulation S-K and new Item 406 of Regulation S-B as a codification of standards that is reasonably designed to deter wrongdoing and to promote

  • Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;

  • Full, fair, accurate, timely and understandable disclosure in SEC reports and in other public communications;

  • Compliance with applicable governmental laws, rules and regulations;

  • Prompt internal reporting of violations of the code of ethics to appropriate person or persons identified in the code of ethics; and

  • Accountability for adherence to the code of ethics.

A public company must have a code of ethics in place that addresses all of the above items in order to be able to state that it has a code of ethics that complies with Section 406 of the Act and avoid having to explain in its annual report why it does not have a code of ethics that meets the new requirements.

The SEC believes that codes of ethics should vary from company to company and that decisions regarding the exact contents of a company’s code of ethics, compliance procedures and disciplinary measures are best left to each individual company.  Therefore, the new rules do not specify every detail that must be addressed in a code of ethics or prescribe any specific language that must be included in a code of ethics.  The SEC strongly encourages companies to adopt codes of ethics that are broader and more comprehensive then the minimum necessary to meet the new disclosure requirements.

Making the Code of Ethics Publicly Available

The new rules require each public company that claims to have in place a code of ethics that meets the above requirements to make its code of ethics available to the public by one of the following methods:

  • Filing the code of ethics as an exhibit to the company’s annual report;

  • Posting the code of ethics on the company’s website and disclosing in the company’s annual report a notice containing the company’s website address and stating that the code of ethics has been posted on the website; or

  • Providing in the company’s annual report that a copy of the code of ethics can be obtained without charge, upon request, and explaining how to make such a request.

If a company has in place a document that meets the SEC’s requirements for a code of ethics and that applies to a broader range of activities and broader class of persons than is addressed by the SEC’s rules, the company need only file, post or provide the portions of the document that address the ethical considerations contained in the SEC’s definition of “code of ethics” and that apply to the company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions.

Disclosure of Changes to, and Waivers of, the Code of Ethics

The new also rules require each public company to disclose any change to its code of ethics that applies to any officer in the group that is covered by the rules or any grant of a waiver of the code of ethics to any such officer.  A company must disclose only those changes or waivers that relate to one of the elements of a code of ethics that is contained in the SEC’s definition of a code of ethics.

A company is not required to disclose technical, administrative or other non-substantive amendments to its code of ethics.  For purposes of the rules, the term “waiver” means the approval of a material departure from a provision of the code of ethics.  An implicit waiver is deemed to be a waiver.  An “implicit waiver,” is defined as the failure to take action within a reasonable period of time regarding a material departure from a provision of the code of ethics that has been made known to an executive officer of the company.

Changes to, and waivers of, the code of ethics that require disclosure must be disclosed on Form 8-K or on the company’s website.  If a company desires to use its website to disclose changes to, or waivers of, its code of ethics, then the company must 

  • Have disclosed in its most recently filed annual report that the company intends to disclose any such changes to, or waivers of, its code of ethics on its website and included the address for its website in such annual report;

  • Make the information regarding the change or waiver available on its website for a period of at least 12 months; and

  • Retain the disclosure regarding the change or waiver for a period of no less than five years and make the disclosure available to the SEC upon its request.

Whether the disclosure is made on Form 8-K or on the company’s website, the company must make the required disclosure within five business days of the change to, or waiver of, its code of ethics.  The disclosure must include the nature of the amendment or the nature of the waiver, the name of the person to whom the waiver was granted and the date of the waiver.

A foreign private issuer must disclose any changes to, or waivers of, its code of ethics in its annual report on Form 20-F or 40-F.  Although a foreign private issuer is not required to disclose changes to, or waivers of, its code of ethics on Form 6-K or on its website, the SEC strongly encourages foreign private issuers to use those means to disclose such changes or waivers.

Effective Time

The new rules become effective 30 days after they are published in the Federal Register.  As of Friday, January 24, 2003, the new rules had not yet been published in the Federal Register.  Public companies will be required to provide disclosure regarding whether or not they have a code of ethics that meets the requirements of the new rules in their annual reports that apply to fiscal years ending on or after July 15, 2003.  For companies that operate on a December 31 fiscal year end, the disclosure will first be required in their annual report filed in 2004.  Companies must comply with the requirements regarding disclosure of changes to, or waivers of, their code of ethics beginning on or after the date on which they file their first annual report in which disclosure of their code of ethics is required.

Recommendations

To address the SEC’s new disclosure rules regarding codes of ethics, public companies should consider the recommendations below.

  • Public companies should determine whether they currently have a code of ethics in place that will satisfy the requirements of the SEC’s new rules.  If a company does not have a code of ethics that meets the new requirements, the company must decide whether it will either disclose that it does not have the required code of ethics or adopt a code of ethics that meets the requirements of the new rules.  We believe most public companies will want to be able to state that they have a code of ethics in place that meets the SEC’s requirements.

  • Both NYSE and NASDAQ have pending before the SEC proposed new listing standards that will require companies that wish to remain listed to adopt codes of conduct and to publicly disclose any waivers of their code of conduct.  As currently drafted, both the NYSE proposal and the NASDAQ proposal would apply to a broader class of persons and cover a broader range of topics than the new SEC rules.  Given the inconsistent coverage of this topic by the SEC, NYSE and NASDAQ, it is widely anticipated that the SEC will, at a minimum, conform the NYSE and NASDAQ proposals with each other.  Companies that do not need to address the SEC’s new disclosure requirements until their annual reports are filed in 2004 may want to delay adopting a code of ethics, or amending their existing code of ethics, to respond to the SEC’s new rules until after the new NYSE or NASDAQ listing standards applicable to them are finalized.

  • Many public companies may already have policies and procedures in place that apply to more company personnel and a broader range of activities than are addressed by the SEC’s new rules and the NYSE and NASDAQ proposals.  For example, a public company may have standards of professional conduct in place that regulate the activities described in the SEC’s new rules as well as other items, such as the use of company computers for non-business purposes.  A company in such a position should consider taking advantage of the provisions of the new rules that allow the company to publicly disclose or make available only those provisions of its code of ethics that apply to the persons and ethical considerations that are addressed by the SEC’s new rules.

  • Public companies that intend to disclose that they have a code of ethics that meets the requirements of the SEC’s new rules should select the method they will use to make the code of ethics publicly available.  Although the risk associated with filing the code of ethics as an exhibit to an annual report is small, companies should be aware that materials that are filed with the SEC can more easily be used as the basis for civil liability under the securities laws as compared to materials that are posted on the company’s website.  In addition, companies should consider the likelihood that a relatively limited number of persons will go to the trouble of contacting the company to request a copy of the code of ethics if the company decides to make its code of ethics available only upon request.

  • Public companies should determine the individual or individuals that are authorized to make changes to, or grant waivers of, their code of ethics and implement procedures for obtaining waivers when they are required, making the determination as to whether a change is substantive or a waiver is material and the timely disclosure of any such substantive changes or material waivers.  Companies should consider granting the audit committee or another board committee composed of at least a majority of independent directors the sole authority to make changes to the code of ethics.  If possible, the ability to grant waivers should also be limited to such committee. 

  • Public companies should ensure that the individuals that are covered by a code of ethics are aware of their obligations to comply with the company’s code of ethics.  For example, a company could require the covered individuals to annually acknowledge having received and reviewed the code of ethics.

  • If a public company decides to utilize its website to disclose changes to, or waivers of, its code of ethics, the company should make the required disclosure in its Form 10-K regarding its intent to so use its website and put procedures in place to ensure that the required disclosures are timely posted on the website and remain on the website for at least 12 months from the date they are posted.  Companies should also adopt procedures to comply with the five year record-keeping requirements of the new rule.

Further Information

This Alert is a publication of Haynes and Boone, LLP and should not be construed as legal advice on any particular facts or circumstances.  This Alert is for general informational purposes only, and may not be quoted or referred to in any other documents or legal proceeding without our prior written consent.  The publication of this Alert is not intended to create an attorney-client relationship.

If you would like to learn more about the Act and the rules and regulations relating to the Act, please feel free to contact your regular Haynes and Boone attorney.

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