Sarbanes-Oxley? It sounds more like a debilitating disease than a remedy for corporate malfeasance.

The unusual moniker notwithstanding, the latest securities legislation drafted by Congressman Michael Oxley (R.-Ohio), chairman of the House Financial Services Committee, and Senator Paul Sarbanes (D.-Md.), is widely considered one of the most significant corporate reform bills passed in more than 60 years. True to its billing, the Sarbanes-Oxley Act contains a considerable number of provisions geared toward cleaning up corruption on Wall Street and creating greater transparency in company balance sheets - fund companies included.

Audit committees for the first time will now have the responsibility of overseeing their companies' external audits, in order to prevent the kind of accounting fraud that led to the collapse of Enron.

Members of corporate audit committees have long been viewed as puppets acting at the behest of powerful executives, rubber-stamping company policies without assessing their merits. But these panels will now have sole discretion in hiring auditors and guaranteeing the integrity of both the internal and outside audit.

Picking an Expert

One of the key provisions of the new audit rules calls for the selection of at least one financial expert to serve on the audit committees of public companies, or to disclose to the Securities & Exchange Commission that it does not have such an expert. Under the original interpretation of the law, there were very stringent criteria for a qualifying financial expert: One had to be either an experienced auditor or a former top-level executive of a company. But with the SEC modifying its terms to allow for a more liberal interpretation of the definition, the designated expert is only required to demonstrate applicable knowledge and experience of the audit process. The SEC now defines such a financial expert as a person who has "thorough education or experience as a public accountant or principal financial officer, comptroller or principal accounting officer of an issuer, and understanding of generally accepted accounting principles."

The language of the provision raises the question of whether companies will designate a true financial expert or not, seeing as it is not absolutely required. So it will be interesting to see what sort of tack mutual fund companies take. An attorney serving on a mutual fund advisory board told Mutual Fund Market News, speaking off the record, that roughly one-half of his clients plan to declare a financial expert, while the other half are "holding their fire." As is the case with any business practice that is not obligatory, it may come down to competition, or the idea of "keeping up with the Joneses."

One of the most oft-heard complaints from fund complexes about the new rules is that it will take time to find a suitable candidate for that particular post. "The problem I'm hearing, quite popularly, is that it's not so easy to find people," said Tim Smith, a director and senior vice president at Walden Asset Management in Boston. "Even people with significant business experience may not have the qualifications, in the narrow sense."

While fund companies may be willing to comply with the new audit regulations, the reality is that the time frame for the recruitment of a viable candidate will ultimately dictate their compliance.

"I don't think it will be revolutionary," said Gary Cohen, a partner at Foley & Lardner in Washington who specializes in securities regulation, "but every mutual fund company is going to have to do something." If a mutual fund company were to opt to disclose that it did not have a financial expert, it would likely be buried within the framework of an obscure SEC filing

A few of the most significant adjustments Cohen mentioned were that funds will have to "retool their charters" and prepare for a fuller agenda, a moderate rise in costs and mounting paperwork. But Cohen believes that complying will, on the whole, be a smooth transition for many fund companies. The burden imposed on an operating company, for instance, in the manufacturing industry, is much heavier compared to that of a mutual fund company, he added.

Legal Jeopardy

Another major concern expressed by members of the fund community is that the heightened profile and responsibility of an audit committee and its designated expert will be accompanied by an increasing number of lawsuits. To that end, potential audit committee members may find that it is not worth shouldering the risk, especially if compensation for their service remains the same. Sixty-three percent of the fund complexes polled by Management Practice Inc. in January indicated that compensation for service on the audit committee would increase because the number of meetings would double, and not because of a hike in compensatory fees doled out for each meeting.

Realizing the legitimacy of cost and litigation concerns, the SEC attached a "safe harbor" provision to Sarbanes-Oxley clarifying that the SEC does not intend to "increase or decrease the current level of liability of audit committee members, or the designated financial expert."

Ultimately, the audit provision of Sarbanes-Oxley represents a major stride in fiduciary responsibility, although its impact on the mutual fund industry appears to be somewhat measured. The issue is "muddled" by mutual funds taking steps that are not necessarily required of them but, rather, in the "spirit" of Sarbanes-Oxley, Cohen said.

Given the current economic climate and the wave of corporate scandals investors have weathered, one has to keep in mind that the mere appearance of impropriety may cause irreparable damage.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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