Audit-related fees. This category includes assurance and related services reasonably related to the audit or review of the financial statements. These are services traditionally performed by the auditor and would include, among others: employee benefit plan audits; due diligence related to mergers and acquisitions; accounting consultations and audits in connection with acquisitions; internal control reviews; attest services that are not required by statute or regulation; and consultation concerning financial accounting and reporting standards.
Tax fees. This category includes all services performed by the auditor's tax professionals such as for tax compliance, tax planning, and tax advice, except those services related to the audit as discussed above. The Release states that tax compliance generally involves preparation of original and amended tax returns, claims for refund and tax payment-planning services, which encompass a diverse range of services, including assistance with tax audits and appeals, tax advice related to mergers and acquisitions, employee benefit plans, and requests for rulings or technical advice from taxing authorities.
All other fees. This category remains unchanged from the existing rule in that it captures fees not disclosed in the other categories.
Disclosure of pre-approval policies. The new rules require disclosure of the audit committee's pre-approval policies and procedures and the percentage of the total fees paid to the auditor where the de minimis exception to pre-approval of non-audit services was used. This information should be provided by category. In lieu of a description of its pre-approval policies, companies could include a copy of its policies and procedures in its proxy statement or Form 10-K. The procedures should describe, if applicable, the specific processes in place that monitor activities where the de minimis exception is invoked. This disclosure is required in the proxy statement and may be incorporated by reference to satisfy the separate Form 10-K requirement.
Transition. These disclosure provisions are effective for periodic annual filings for the first fiscal year ending after December 15, 2003.
Some practical considerations for audit committees
In connection with complying with these new rules, audit committees should consider the following:
Audit committee charters. Companies should review their audit committee charters and consider whether they should be refined to reflect some of the specific requirements of audit committees set forth in the Release, specifically including reference to approval of certain permissible non-audit services, authority to establish compliant delegated pre-approval policies related to permissible non-audit services, and auditor reports and communications to the audit committee.
Approving permissible non-audit services. In approving permissible non-audit services, audit committees will be required to evaluate how several complex services should be classified, and whether they fit into the various categories of prohibited or permissible non-audit services. With regard to certain non-audit services, moreover, the new rules permit an auditor, acting in the face of a rebuttable presumption, to conclude that specified non-audit services that would otherwise be non-allowable would not be subject to audit procedures and therefore qualify as permissible. The audit committee, however, will be effectively required to concur in this determination through its broader approval of audit and non-audit services. In making these difficult determinations, audit committees might request specific explanation from the auditor as to why the services in question should be viewed as allowable under the new rules. In addition, the auditor should be asked to explain why the proposed non-audit services are consistent with the underlying principles of independence enunciated in the Release, violations of which would impair the auditor's independence. Specifically, the auditor should satisfy the audit committee that the proposed non-audit service does not cause the auditor to be functioning in the role of management, does not result in the auditor auditing his or her own work, and does not result in the auditor serving in an advocacy role for his or her client.
Pre-approval policies and procedures. Audit committees should recognize that the new rules require them to develop committee policies and procedures relating to pre-approval of permissible non-audit services or policies related to delegated pre-approval if the audit committee chooses to act on such basis. These policies must be either disclosed or described in the company's proxy statement or Form 10-K if the proxy statement disclosure is not incorporated by reference. While these procedures might be placed in the audit committee charter, they need not be so included, and may be best kept separate from the audit committee charter, so they can be quickly and flexibly updated and adapted by the audit committee, without requiring formalities of full board approval and re-publication of the full audit committee charter.
Approve all audit and non-audit services by May 6, 2003. From and after May 6, 2003, all audit and permissible non-audit services must have been approved by the audit committee. Services being performed now which may extend past May 6, 2003 should be confirmed as being performed under engagement letters in place on or prior to May 6, 2003.
Gonnella Baking Company v. Clara's Pasta
Di Casa, Ltd (March 4, 2003)
<http://www.state.il.us/court/Opinions/AppellateCourt/2003/1stDistrict/March/Html/1013039.htm>
By J. Matthew Pfeiffer, Rolewick & Gutzke, P.C., Wheaton
Issue:
Whether corporate officers who conduct purported corporate business during a period when the corporation has been dissolved might not be absolved of personal liability during that period of dissolution, even if those officers were unaware of the dissolution.
Facts/conclusions:
The plaintiff filed a complaint against defendant Clara Melchiorre, who was the president and secretary of the co-defendant, Clara's Pasta di Casa, an Illinois corporation. On December 1, 1997, the corporation was involuntarily dissolved for failing to file an annual report and pay an annual franchise tax. During 1998 and 1999, Melchiorre, on behalf of the corporation, ordered baked goods from the plaintiff. In response to Melchiorre's oral request, the plaintiff delivered baked goods to the corporation. Throughout 1998 and 1999, the plaintiff received partial payments for the delivered goods; however, as of May 1, 1999, the corporation carried an outstanding balance that remained unpaid by Melchiorre and the corporation.
In January 2001, the plaintiff filed suit against the corporation and Melchiorre seeking damages for breach of contract. In the first count of the complaint, the plaintiff alleged the corporation breached an oral agreement for the sale of goods by failing to pay the agreed sum due in exchange for those goods. In the second count, the plaintiff alleged Melchiorre was personally liable for the corporation's debt because she ordered the goods purporting to be an agent of the corporation. In support of the complaint, the plaintiff attached copies of the corporation's account statement.
Melchiorre filed a motion to dismiss the second count of the complaint alleging that although the corporation was dissolved at the time of the disputed transactions, it was later reinstated pursuant to section 12.45 of the Illinois Business Corporation Act of 1983 (805 ILCS 5/12.45 (West 2000)). Therefore Melchiorre could not be held personally liable for corporate debt because the corporation is deemed to have continued without interruption.
Melchiorre later amended her motion to dismiss and filed a supporting affidavit to include allegations that she did not know the corporation had been involuntarily dissolved in 1997. Specifically, she alleged neither her attorney, who was the registered agent for the corporation, nor the Secretary of State notified her personally that the corporation had been dissolved.
The trial court dismissed the count against Melchiorre pursuant to her motion. However, the appellate court reversed that decision and remanded the cause for further proceedings.
Law/analysis:
In determining that the count against Melchiorre is not barred by affirmative matter, the appellate court considered the application of section 12.45(d) of the Illinois Business Corporation Act of 1983 (805 ILCS 5/12.45(d) (West 2000)). At the time of this litigation, section 12.45(d) provided in part:
Upon the issuance of the certificate of reinstatement, the corporate existence shall be deemed to have continued without interruption from the date of the issuance of the certificate of dissolution, and the corporation shall stand revived with such powers, duties and obligations as if it had not been dissolved; and all acts and proceedings of its officers, directors and shareholders, acting or purporting to act as such, which would have been legal and valid but for such dissolution, shall stand ratified and confirmed.
805 ILCS 5/12.45(d) (West 2000).
The appellate court noted that Illinois courts have greatly limited the application of section 12.45(d) in cases involving the personal liability officers acting while corporations are dissolved, citing Cardem, Inc. v. Marketron International, Ltd., 322 Ill. App. 3d 131, 135-36 (2001) (where the court held that corporate officers who conducted purported corporate business during a period of dissolution are not absolved of personal liability incurred during that time) and Chicago Title & Trust Co. v. Brooklyn Bagel Boys, Inc., 222 Ill. App. 3d 413, 420 (1991) (where the court stated "[S]ection 12.45(d) does not transform individual liability into corporate liability or create a legal fiction contrary to the true nature of events"). However, the court ultimately held that an officer might be personally liable for debts assumed on behalf of a dissolved corporation if it is shown that the defendant knew, or because of his or her position should have known, about the involuntary dissolution. At the very least, such a showing is sufficient to defeat a motion to dismiss such as the one filed by Melchiorre.
In this case, the court determined that Melchiorre should have known of the corporate dissolution due to her position as president and secretary of the corporation. Whether or not Melchiorre was actually unaware of the involuntary dissolution was irrelevant to the appellate court, as were Melchiorre's contentions that neither her attorney, who was the registered agent for the corporation, nor the Secretary of State notified her personally of the dissolution. Instead, Melchiorre's status as an officer of the corporation resulted in the presumption that she at least should have been aware of the corporation's involuntary dissolution.
In seeking to uphold her dismissal from the case, Melchiorre relied upon H&H Press, Inc. v. Axelrod, 265 Ill. App. 3d 670, 680 (1994), in which the appellate court reversed a judgment holding an individual defendant, Amy Kulek, personally liable for expenses incurred on behalf of a dissolved corporation. However, the appellate court distinguished H&H Press, Inc. by noting that Kulek was not the president of the corporation and, in fact, was not even an actual officer but was deemed a "de facto" vice-president based on her representations to customers and suppliers.
In light of this decision, corporate officers (presidents, in particular) should regularly check the status of their respective corporations' status with the Illinois Secretary of State. Otherwise, such officers expose themselves to personal liability for obligations purported to be those of the dissolved corporation, even if they claim to be unaware of the dissolution.
Small v. Fritz Companies, Inc.
Supreme Court of California (April 7, 2003)
<http://www.courtinfo.ca.gov/opinions/archive/S091297.PDF>
By Leasa J. Baugher, Rolewick & Gutzke, P.C., Wheaton
Issue:
Whether a cause of action exists under state common law for stockholders in California who are wrongfully induced to hold rather than sell stock based on a corporation's fraudulent statements and negligent misrepresentations.
Facts/conclusions:
Harvey Greenfield, a stockholder, (stockholder) filed action against Fritz Companies, Inc., (Fritz) a corporation, the company president, the chairman of the board and the chief financial officer. The action was filed as a class action on behalf of all shareholders in Fritz who were stockholders between April 2, 1996 and July 24, 1996 and who relied on the defendant's "material misrepresentations and omissions ... and who were damaged thereby."
The cause of action originated from a press release issued by the Corporation on April 2, 1996 and the third quarter report to stockholders, issued on April 15, 1996 reporting third-quarter revenues of $274.3 million, net income of $10.3 million and earnings of $29 per share. On July 24, 1996, Fritz revised the numbers reported in April and reduced earnings to $3.1 million for the third quarter and announced it expected to incur a loss of $3.4 million for the fourth quarter. Fritz's stock price plunged more than 55 percent on that day closing at $12.25 per share, which was a $15.25 per share loss for the day.
The Stockholder's complaint alleges that the discrepancy between the April and July report was the result of "improper accounting for merger and acquisition costs; improper classification of ordinary operating expenses as merger costs; improper revenue recognition; improper capitalized software development costs; and failure to allow for uncollectable accounts receivable." The complaint further alleged that Fritz and the officers of the corporation knew or should have known that the third-quarter report was inaccurate and misleading and intended investors to rely on the misrepresentations.
Stockholder further claims that had Fritz disclosed the correct third-quarter revenues, net income and earnings on April 2, 1996 as required by GAAP, Fritz's stock price would have declined and all then-current stockholder's would have had an opportunity to sell above the $12.25 per share value on July 24, 1996.
Fritz demurred the Stockholder's second amended complaint on two grounds: (1) "California law does not recognize any [cause of action] on behalf of shareholders who neither bought nor sold shares based upon any alleged misstatement or omission; and (2) the complaint failed to plead with the requisite specificity the facts alleged to constitute actual reliance." The trial court sustained the demurrer on the second ground and entered judgment for Fritz. The court of appeals reversed the trial court. The appeals court held that the stockholder's complaint "stated causes of action for fraud and negligent misrepresentation and alleged actual reliance with sufficient specificity."
A divided California supreme court reversed the court of appeals based on the stockholder's failure to plead the specificity required to establish actual reliance. The case was returned to the trial court granting the stockholder's leave to amend their complaint. The supreme court did conclude, "California law should allow a holder's action for fraud or negligent misrepresentation."
Law/analysis:
The California supreme court looked to other states that recognize forbearance from selling stock as sufficient reliance to support a holder's cause of action, citing cases from Massachusetts, New Jersey, New York and Connecticut. The court defined forbearance as the decision not to exercise a right or power and therefore sufficient consideration to support a contract and to overcome the statute of frauds.
The court relied on the Restatement 2nd of Torts in establishing liability for forbearance. Quoting Section 531 of the Restatement, "[o]ne who makes fraudulent misrepresentation is subject to liability to the persons or class of persons whom he intends or has reason to expect to act or refrain from action in reliance upon the misrepresentation, for pecuniary loss suffered by them through their justifiable reliance in the type of transaction in which he intends or has reason to expect their conduct to be influenced." (Rest.2d Torts, § 531).
In establishing a holder's cause of action under state law, the California supreme cwourt looked at the holding by the United State's supreme court in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). In Blue Chip, the U.S. Supreme Court held Rule 10b-5 of the Securities Exchange Act did not permit a holder's cause of action but that holder's retained remedies in state courts. The California supreme court held that a common law remedy does exist under state law for holder's who were wrongfully induced into holding stock, and who can plead with sufficient specificity that they actually relied upon the inducement.
The California supreme court outlined requirements for potential future litigants, in holder's actions, "the plaintiff must allege actions, as distinguished from unspoken and unrecorded thoughts and decisions, that would indicate that the plaintiff actually relied on the misrepresentation. Plaintiffs who cannot plead with sufficient specificity to show a bona fide claim of actual reliance do not stand out from the mass of stockholders who rely on the market."
Therefore, holders of stock who are induced to hold by the fraudulent statements or negligent misrepresentations issued by the corporate leadership may be able to establish a holder's cause of action based on state common law. To maintain the action, the holder must establish actual reliance on the fraudulent statements and the negligent misrepresentations as distinguished from the intangible influence of other market indicators and their impact on the holder's unrecorded thoughts and decisions.
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