A specialty chemical company recently informed the Securities and Exchange Commission that it violated new rules prohibiting loans to executives. It also said a deficiency identified by its auditor caused the company's disclosure controls and procedures not to be effective at a “reasonable assurance level.”
Although the case involves a very small company, it provides insight into Section 402 as well as Section 404 of Sarbanes-Oxley, the high-profile provision that officially goes into effect Nov. 15.
The company is Amex-listed Technology Flavors & Fragrances, a $15.6 million, Amityville, N.Y.-based company maker of aromas and flavors that are put into foods, beverages, perfumes and other products.
In early August, TFF revealed that—as part of a review of the company's financials for the six months ended June 30—its independent auditors, BDO Seidman, had informed TF&F’s audit committee that a matter involving the company's internal controls and operations were considered to be "reportable conditions," as defined under standards established by the American Institute of Certified Public Accountants.
Specifically, the company said that back in April, it loaned $40,000 to a senior executive officer, in violation of Section 402 of the Sarbanes-Oxley Act, and the company's internal controls procedures did not prevent such a violation from occurring.
According to a public filing, BDO "has advised the company that they consider the matter to be a 'material weakness' that, by itself or in combination with any other factor may result in a more than remote likelihood that a material misstatement in our financial statements will not be prevented or detected by our employees in the normal course of performing their assigned functions.”
According to the filing, the company carried out an evaluation, under the supervision and with the participation of its management including its chief executive officer and chief financial officer, of the effectiveness of the design and operation of the company's disclosure controls and procedures as of June 30, 2004.
“Based on the foregoing, the company's chief executive officer and chief financial officer determined that the deficiency identified by BDO caused the company's disclosure controls and procedures not to be effective at a reasonable assurance level,” it added.
Technology Flavors asserts, however, that it is trying to remedy the deficiency and did not note any other material weaknesses or significant deficiencies in the company's disclosure controls and procedures during their evaluation. “The company continues to improve and refine its internal controls,” it added.
It also insisted that the violation of Section 402 “was inadvertent.”
A lawyer for the company, Barry Shapiro of Meyer, Suozzi, English & Klein, says, “Controls have been adjusted to avoid what was an innocent transaction.”
Regulatory Reaction
So what happens next?
According to Charles Lundelius, senior managing director for the Securities Transactions and Market Regulation Consulting Group of FTI Consulting, since the auditors have identified this as a material weakness, the company must correct the internal control problem by the time it files its 10-K. Otherwise, “management will not be able to conclude [under Section 404] that the company's internal controls are effective,” he insists.
It’s less clear, however, how the SEC might react.
Sauer
This is because the regulator has intentionally not provided interpretations of Section 402. “It was one of the most controversial aspects and one of the most criticized aspects of Sarbanes-Oxley,” points out Richard Sauer, partner with Vinson & Elkins.
Yet, even though the Commission has not served up interpretive guidance, it could still bring an enforcement case regarding 402, say lawyers. And they stress even though the company voluntarily brought the matter to the SEC’s attention, it does not preclude further legal action by the regulator. “Disclosure by the company does not prevent an investigation,” adds Lundelius, who says the SEC can always commence an informal or a formal investigation.
“The fact that the company reported and fixed it doesn’t mean it isn’t liable,” adds Sauer. However, he stresses that when determining whether to take action, the SEC would probably take into consideration the fact that the company voluntarily confessed.
But, even if the SEC brings a case against a company regarding 402, it will make sure it is very sound. Adds one lawyer, “They don’t want the chance its case is challenged and it loses.”
No comments yet