Transcript Golden Gate University Title Slide

Sarbanes-Oxley and
Corporate Real Estate
2006 SIOR Spring Convention
La Quinta Resort & Club · La Quinta, California
April 22, 2006
Presented by
Richard C. Mallory, Esq.,
Allen Matkins Leck Gamble & Mallory LLP
(415) 273-7488 • [email protected]
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Materials prepared in part by Terry Connelly, Dean, School
of Business, Golden Gate University, with commentary by
Marc Greenberg, Associate Professor and Director of the
Intellectual Property Law Program, Golden Gate University
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Corporate Ethics and Trust in
Today’s Financial World
• “If you do right by the numbers, the numbers will do right by you.”
Unnamed freshman chemistry instructor
Circa 1961
• “We can make the numbers come out any way we want.”
Unnamed Wall Street Executive
Circa 1991
• “We’re Enron; we don’t need to have good accounting.”
Unnamed Enron employee
Circa 2001
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US Newspaper Headlines
June 26, 2002:
• Just a random, ordinary day at the office…
– “Adelphia Communications Files for
Bankruptcy-Court Protection“
– “U.S. Investigates British Bankers in Enron
Case”
– “Qwest Tries to Justify Accounting Methods to
a Staunch SEC”
– “WorldCom Admits $3.8 Billion Accounting
Error”
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Headlines…
• Just a random, ordinary day at the office…
– “Lenders’ Deals Aided Energy-Firm Results”
– “Teen Settles Matter With SEC of Scheme to
Raise Stock Price”
– “Many CEOs bend the rules (of golf) – 82%
admit being less than honest on their
scorecards, survey says”
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The Sarbanes-Oxley Act of 2002
• One month later…..
– Dow Jones Industrial Average had fallen from 9126 to
7532 – a 17.5% decline.
– The Sarbanes-Oxley Act of 2002 was approved by the
US Congress and signed by the President: “to protect
investors by improving the accuracy and reliability of
corporate disclosures.”
– Sarbanes-Oxley: The most significant legislation
regulating corporate and financial market behavior
since the Securities Acts of 1933 and 1934.
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• Sarbanes-Oxley was a comprehensive, systemic
response to systemic, large-scale corruption.
– In 2002, corporate write-downs amounted to 140% of
reported earnings of public companies, reflecting
adjustments to previous reported earnings between
1998 and 2001.
– And this was before any announcements in 2003 or
2004 or this year, like the $9 billion restatement by
Fannie Mae.
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Impact on Issuers of Listed
Securities
• Specifically Related To Officers
– Two separate CEO/CFO certification requirements:
• Criminal provision requiring certification in each filed periodic report
containing financial statements stating that the report (i) “fully complies” with
the Exchange Act requirements (no materiality qualifier); and (ii) “fairly
presents, in all material respects, the financial condition and results of
operations of the issuer.”
• A civil provision requiring certification that (i) the financial statements and
other financial information “fairly present in all material respects” the
company’s financial condition; and (ii) the officer accepts responsibility for
and makes several other representations regarding internal controls.
– Can’t be blind to ‘red flags’, deaf to whistleblowers, dumb about
accounting.
– Increases risk of personal liability for shareholder losses on future
restatements.
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Impact on Attorneys and Others
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SEC to establish rules for corporate attorneys requiring them to report
evidence of a material violation of securities law, a breach of fiduciary duty or
similar violation by the company to its Chief Legal Counsel or CEO.
If management does not respond appropriately, the attorney must report the
evidence to the audit committee.
Any person who knowingly alters, destroys, mutilates, conceals, covers up or
falsifies, or makes a false entry in, any document with intent to impede,
obstruct or influence any government department or agency investigation (or
conspires to do so) may be fined and jailed for up to 20 years.
Any person who knowingly executes or attempts a scheme or artifice to
defraud in connection with a public security may also be fined or jailed; this
provision expands possible criminal liability exposure both inside and outside
the company to include legal, accounting and financial advisors.
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In Summary:
• Sarbanes-Oxley Creates New Federal Civil and
Criminal Standards for Corporate and Professional
Behavior on Matters Previously Left to the States
Or Self-Regulatory Bodies.
– Sarbanes-Oxley has a comprehensive, systemic impact.
– Suddenly, everyone involved in corporate governance is
an accountant – or, at least, accountable.
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• Sarbanes-Oxley and the Clean-up of Toxic
Financial Reporting
– Characteristics of the Legislation
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•
•
•
Comprehensive
Systemic
Highly Prescription
Expensive!
– Example of Sarbane-Oxley’s Replacement of SelfRegulation with Detailed Official Standard-Setting:
The PCAOB and Sections 103 and 404
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• Public Company Accounting Oversight Board
– Established to oversee accounting profession
– Covering auditing, quality control, ethics
• Establishes or adopts auditing standards
• Issues quality control standards
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–
–
–
–
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Monitoring ethics and independence
Consulting on audit issues
Supervision, hiring, training
Client acceptance and continuance
Internal inspections
2nd partner reviews
• Sanctions for poor supervision
• Seven year working paper retention
– Rules for reporting on management’s assessment of Internal Controls
(Section 404)
– Registration requirements
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New “Early Warning” Standards
• The PCAOB Auditing Standard No. 2 frames the auditing
engagement concerning internal controls as an audit, not
merely a review or other limited exercise.
• Standard No. 2 requires auditors to deliver two controlrelated opinions – one opinion on management’s assertions
concerning control effectiveness, and a separate opinion on
the auditor’s own assessment of whether a company is
maintaining effective internal control over financial
reporting.
• The result is that auditors will now provide a total of three
opinions: one opinion on the financial statements and two
opinions concerning internal controls.
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•
“Material Weaknesses” versus “Significant Deficiencies”
– Material weakness in controls is a particularly severe form of significant
deficiency. Significant deficiencies pose consequential risks for financial statement
reliability, while material weaknesses pose material risks.
•
•
•
•
Auditors are required to disclose and explain “material weaknesses” publicly,
but need only bring “significant deficiencies” to the attention of management
and audit committees.
Whether a significant deficiency amounts to a material weakness depends on
the possibility that a financial misstatement could result. This depends on both
the likelihood and magnitude, measured using various factors.
Standard No. 2 specifically provides that ineffective audit committees can be
treated as a significant deficiency at minimum, and possibly as a material
weakness.
Is this not a conflict or an “independence” issue itself: how can an audit firm
audit the audit committee that it reports to and that evaluates its performance
and continued engagement?
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The Future of Sarbanes-Oxley
– Coming Soon: To a Self-Regulatory Body Near You
• NY Stock Exchange reforms
– Coming Soon to a Not-for-Profit Entity Near You
• Non-profit Integrity Act of 2004
• Independent audit required for charities with annual gross
revenues of $2 million.
• Must also have audit committees.
– Coming Soon to a Government-Supported Enterprise
Near You
• $9 billion restatement by Fannie Mae
• Senior officers out
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– Coming Soon to a Government Unit Near You?
– Employee pension fund accounting will probably be a
major focus, both for corporate and governmental
entities.
• Remaining corporate defined-benefit plans are underfunded by
$450 billion.
• State employee retirement plan liabilities exceed assets by
$366 billion.
– The ultimate cure: continued education and
training in Sarbanes-Oxley compliance for
corporate staff, executives, directors and audit
committees.
• But don’t expect all A’s!
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Issues for the Real Estate
Professional
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Internal Issues
• Is your employer or parent company a publiclytraded company? If so:
– Review its SEC SOX compliance filings – you should
assume your competitors and clients will be doing that
review.
– Confirm that if you want to book your commission on
the date of full execution of the lease, your commission
agreements state that the commission is earned upon
execution of the lease, and payable on the traditional
basis, e.g. the first half is payable upon removal of any
contingencies and the second half is payable upon the
lease commencement date.
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– The auditors will be reading every lease to confirm that
the accounting for the public brokerage company takes
into account precisely what the leases require, such as
the execution of a lease commencement date letter as a
condition to occupancy.
– If there is an inconsistency between what the lease say
and what the commission agreement says, you will
need to have a “variance letter” prepared and executed
by the landlord, the tenant and the broker bringing the
listing agreement into precise alignment with the lease
language.
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• Your hard work in achieving state and local
incentives for your publicly traded clients needs to
be rigorously documented and tracked in order to
rationalize the leasing acquisition and disposition
decisions of your clients, because all of its real
estate costs drive the decision of the corporate real
estate executive as to location, and those costs
need to be accurately analyzed and assessed.
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• The immediate impact of Section 404 of SOX is
that it requires company officers to accept
responsibility for the accuracy of the information
presented in financial reports as reviewed by the
SEC. The CFO and CEO will look to you to
support their reports regarding real estate
decisions with the most accurate data and process
justification you can generate. Failure to
accurately provide SEC-related data will expose
the company and its CEO and CFO to substantial
liability from those who rely on that data,
including shareholders.
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• Real estate officers of your publicly traded clients
need to be prepared by you to certify the accuracy
of the reports and methodologies used to derive
these numbers, since accounting and finance rely
on them to correctly portray, at any given point in
time, the company’s financial position. Incorrect
or inaccurate information provided by the real
estate department could have serious implications
for the company.
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• The relationships of your publicly traded
clients to their vendors will be audited and
thus must be carefully documented with
evidence of the basis for selection of such
vendors, including real estate brokerage.
Expect that listing and commission
agreements will become more formal and
will need to comply with SOX.
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• You should prepare to compete for your share of
what is sure to become a major increase in the
outsourcing of the real estate accounting function
and other business processes in order to increase
efficiency and allocate risk with respect to such
activities. Expect the centralization of the real
estate process at your publicly traded clients.
Strive to qualify to be a part of these processes.
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External Issues
• Your property owner clients should be reviewing SOX
compliance filings of prospective tenants who are publicly
traded companies.
• Look for areas of concern as to the company’s viability and
suitability as a tenant.
• These clients tend to be large occupiers of space, and if their
condition is shaky, a bankruptcy or other problem can cause
significant losses for the Property Owner.
• SOX gives you more and more reliable information on which to
base leasing terms and acceptance.
• As the agent for these owners, you may have a professional duty
to review these materials, or at least advise your clients of their
availability for review. You need to know what these filings are,
what they contain, and how to get access to them.
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External Issues
• Your prospective tenants should be reviewing the SOX
compliance filings of the prospective landlords for signs of
corporate weakness that could signal a future sale of their
office buildings.
• More importantly, real estate professionals should do this
review of their own clients to look for signs of company
weakness (thin capitalization, poor debt/equity ratios,
significant losses) which may hurt your client’s prospects
at securing A-list space – you should figure that the
landlord is reviewing, and/or demanding this information
from your clients, so you should make review of it a part
of your initial client review process.
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Public v. Private Ownership
• At present, SOX applies only to publicly
traded companies. This is not likely to
remain so limited. Prudence suggests that
conducting a SOX like review of records of
privately held companies will be the norm
in the future, and that legislative calls to
expand SOX to private companies are
likely.
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