Financial Experts

Summary

For their listed companies, NYSE and Nasdaq require:

all audit committee members to be financially literate
at least one to be a financial expert

S-K 407(d)(5) requires disclosure about
audit committee financial experts

Adopted by SEC per SOX Act § 407

NYSE 303A.07(A)

Relevant part is in 303A.07(A) commentary

Each member of a NYSE-listed audit committee
must be financially literate

as interpreted by the company's board
in its business judgment

At least one member must have
accounting or related financial management expertise

as interpreted by the company's board
in its business judgment

Can use S-K 401(h) criteria, to establish expertise

Applies to:

Does not apply to:

NYSE FAQ

SEC approval order

NASD Rule 4350(d)(2)(A)(i)

Text of Rule

Each member of a NASDAQ-listed audit committee must "be able to read and understand fundamental financial statements"

Must certify that at least one member has
past employment experience in finance or accounting,
or other financial sophistication,
including by being a CEO, CFO or other senior officer
with financial oversight responsibilities

Applies to:

Foreign private issuers, unless granted an exemption
"Business development companies," unless registered under 1940 Act

Does not apply to:

Limited partnerships
Registered management investment companies
Passive entities
Asset-backed issuers

SEC approval order

"Legislative history"

SEC Disclosure Requirements S-K 407(d)(5)

SEC Rule

Carry-over of old S-K 402(h) / S-B 401(e)

No substantive change was made
See SEC release 33-8732 (2006) Footnote 471
Text of old S-K 402(h)

Financial expert defined -- S-K 401(h)(2)

Initially proposed definition generated critical comment
as being too restrictive
SEC discussion of changes made to definition

Necessary attributes:

Understands financial statements and GAAP
Can assess the accounting for
estimates, accruals and reserves
Has experience with financials as complex as
that of the issuer
Understands internal controls and procedures
Understands audit committee functions

Necessary experience - Attributes acquired:

Principal financial or accounting officer,
Controller, or
CPA, or
Actively supervising the foregoing, or
Other relevant experience
(details must be disclosed - Instr. 2)

Determination to be made by issuer's board

Board should assess personal / professional integrity (scroll down from n. 33)
Review any relevant disciplinary proceedings

S-K 401(h)(1) requires disclosure in annual reports of:

Whether issuer has at least one "audit committee financial expert, issuers may disclose whether they have more than one
If yes, must provide name and whether "independent" (scroll back from n. 18)
If no "audit committee financial expert," must explain why not
Note: other rules require audit committee members of US listed companies to be "independent"
Note: SEC issued technical correction to clarify that disclosures are required only in annual reports, not in registration statements
Can put disclosure in proxy statement / incorporate by reference See Instr. 1

Safe harbor from liability -- S-K 401(h)(4) (scroll back from n. 34) In SEC's view:

Not deemed an "expert"
Status does not impose any additional duties, obligations or liability
A matter of disclosure only, required by SOX Act
But see state case law developments

Applies to:

SEC reporting companies, generally -- Reg S-K Item 401(h)
Small business issuers -- Reg S-B Item 401(e)
Foreign private issuers - Item 16A of Form 20-F
Canadian issuers - Instruction B.(8) to Form 40-F
Special provisions made for foreign and Canadian issuers
also, need not comply until 7.31.05

Does not apply to:

Asset-backed issuers (Instr. 4)
Investment companies are addressed under different rules

Practice Aids

AICPA's "Audit Committee Matching System"
Online service to match qualified CPAs with companies seeking financial experts for their boards

Practice survey - Deloitte

Checklist

Questionnaire - Preston Gates

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