Sarbanes-Oxley Trumped In One State

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The American Banker

The Sarbanes-Oxley Act apparently did not go far enough to suit California lawmakers.

Under a law that took effect this month, public companies based in California or doing business there have to give the state extra layers of detail on insider activity.

The law also applies to companies whose stocks are traded over the counter and on pink sheets but not registered with the Securities and Exchange Commission. Banking attorneys say that would include more than 100 community banks exempt from Sarbanes-Oxley’s reporting provisions.

The California Corporate Disclosure Act was signed by Democratic Gov. Gray Davis in late 2002 in response to the Enron and WorldCom scandals. Once a year, public companies doing business in the state have to report all stock options and loans made to their directors, as well as information on bankruptcies, fraud convictions, or fines for violations of securities or banking laws by the company or its officers or directors. The California Secretary of State will then publicize the information on its Web site.

Previously, a public company had to file a report every two years, and all it had to disclose was its name and address, its directors and executive officers’ names and addresses, and the business it conducted.

California is the only state to have passed its own version of the federal legislation, which tightened the rules governing auditors, corporate executives, and directors. Most other state legislatures were out of session when President Bush signed Sarbanes-Oxley into law in July, though some are expected to consider their own corporate governance reforms in current legislative sessions.

Consumer groups say the new state law was needed.

“If banks or other companies are breaking the rules and regulations of the state, then Californians should know about it,” said Doug Heller, senior consumer advocate with the Foundation for Taxpayers and Consumer Rights, in Santa Monica. “Hopefully, this will encourage banks and other companies to get better guidance on how to more rigorously follow the state’s laws, rather than try to hide their mistakes.”

But Mark E. Aldrich, an attorney with Aldrich & Bonnefin PLC in Irvine, Calif., said that companies, particularly those not registered with the SEC, have long regarded this information as private. Now, these banks should expect calls from the public to explain any infractions, even inadvertent ones. For example, a bank may have believed it was acting properly when it made a loan to one of its directors, only to be fined because regulators deemed it an improper “preferential” loan.

“The rules around preferential loans are so complicated and can be very subjective, that a bank may not have thought it was doing anything wrong,” Mr. Aldrich said. “But now, banks need to be prepared for these issues to be raised by the public — including shareholder activists who are looking for any type of ammunition against the board and management.”

Daniel J. Doyle, the president and chief executive officer of the $283 million-asset Central Valley Community Bancorp in Clovis, said: “I would call this the big brother of Sarbanes-Oxley. It’s definitely more onerous. Also, I think it’s just another opportunity for regulators to find some little technical mistake where we forgot to dot an ‘i’ or cross a ‘t’ and then fine us for it.”

Mr. Heller said his organization fought to include stiffer penalties for failure to report all the required information, but Gov. Davis vetoed a version of the bill that had the harsher penalties and sent it back to the Legislature to be reworked. The one that made it into law allows the state attorney general to seek injunctive relief against companies not in compliance.

The new California law may also expose to the federal law those banks that are not registered with the SEC, even though the Sarbanes-Oxley Act was not aimed at such companies, said Thomas A. Zaccaro, a regional trial counsel for the SEC in Los Angeles.

Many banks will have a hard time with some of federal law’s particulars, said David Baris, executive director of the American Association of Bank Directors in Bethesda, Md.

Take the requirement that they disclose whether they have “financial experts” serving on their audit committees, other than the professionals providing accounting services to the bank. They will have to explain to the public why they have no experts on those committees. (Nasdaq is considering making the recruitment of such experts a requirement of companies trading on its exchange.)

The “experts” provision could be a problem for many banks, especially those in rural areas, Mr. Baris said. Though the SEC‘s amended definition of a financial expert is an improvement on the one in its earlier draft, such banks may still have trouble getting separate experts to serve on their committees.

It is doubtful that banks in California will scramble to physically find financial experts; even its most rural banks are a short drive from major metropolitan areas. Recruiting truly independent ones to be on an audit committee may be another story, Mr. Aldrich said.

“People aren’t just going to serve to do banks a favor — they need a personal reason,” he said.

Usually, banks have enticed local professionals to serve on their boards by giving them the opportunity to earn fees by providing consulting services to the bank – something that financial experts serving on their audit committees can no longer do. Now, Mr. Aldrich said, recruiting such professionals for that particular committee “may require an increase in board fees — banks are going to have to make it more attractive to serve.”

Consumer Watchdog
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