Sarbanes-Oxley Section 404; Safe Harbor for R&D Companies

On Tuesday 27 May, 2003, the Securities and Exchange Commission voted to adopt rules concerning reports on internal control over financial reporting and certification of disclosures in Exchange Act periodic reports.

The new rules implement Section 404 of the Sarbanes-Oxley Act of 2002. Under the final rules adopted by the Commission, a company's annual internal control report will have to contain: (a) a statement of management's responsibility for establishing and maintaining adequate internal control over financial reporting for the company; (b) a statement identifying the framework used by management to evaluate the effectiveness of this internal control; (c) management's assessment of the effectiveness of this internal control as of the end of the company's most recent fiscal year; and (d) a statement that the company's auditor has issued an attestation report on management's assessment. Disclosure of all material weaknesses in such control is required, and companies will not be able to report that the company's internal control over financial reporting is effective if any material weaknesses exist. The evaluation of those controls must be based on a suitable, recognized control framework that is established by a body or group that has followed due-process procedures, including the broad distribution of the framework for public comment. Companies will also be required to perform quarterly evaluations of changes that have materially affected or are reasonably likely to materially affect the company's internal control over financial reporting.

The rules define the term "internal control over financial reporting" to mean a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. This includes those policies and procedures that: (a) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant's assets that could have a material effect on the financial statements.

Companies, other than foreign private issuers, meeting the definition of an "accelerated filer" in Securities Exchange Act Rule 12b-2 will be required to comply with the management report on internal control over financial reporting requirements for fiscal years ending on or after June 15, 2004. All other issuers, including small business issuers and foreign private issuers, will be required to comply for their fiscal years ending on or after April 15, 2005.

In addition, the final rules will amend the exhibit requirements for periodic reports to add the certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act to the list of required exhibits to be included in reports filed with the Commission. Under the final rules, the specific form and content of the Section 302 certification will be set forth in the applicable exhibit filing requirements for a company's periodic reports. The amendments will permit companies to "furnish" rather than "file" the Section 906 certifications with the Commission, and the certifications will not be subject to automatic incorporation by reference into a company's Securities Act registration statements unless the issuer takes steps to include the certifications in a registration statement. The rules and form amendments concerning Section 302 and Section 906 certifications generally will become effective sixty days after their publication in the Federal Register.

The Commission also voted to adopt a new Rule 3a-8 under the Investment Company Act to provide a nonexclusive safe harbor from the definition of investment company for certain research and development companies. The new rule will become effective sixty days after its publication in the Federal Register.

We will send an email to alert you as soon as the text of the final rules is available.

The Commission has also released the following final rules (accessible via the underlined hyperlinks):

Should you have any questions or require any assistance regarding any of the above items, please do not hesitate to contact us or any of our colleagues at Vinson & Elkins.

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