The SEC has adopted rules to require each SEC reporting company to disclose in its annual SEC filing the determination of its board of directors as to whether or not the company has at least one "audit committee financial expert" serving on its audit committee; if not, why not; and if so, the name of such expert and whether or not the person is independent of management.

The disclosure called for by the new rules will be required in annual reports for fiscal years ending after July 15, 2003.

A. Definition of "Audit Committee Financial Expert"

The instructions to Item 401(h) of Regulation S-K define the term "audit committee financial expert" to mean a person who has the following attributes:

• an understanding of generally accepted accounting principles and financial statements;
• the ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves;
• experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the registrant's financial statements, or experience actively supervising one or more persons engaged in such activities;
• an understanding of internal controls and procedures for financial reporting; and
• an understanding of audit committee functions.

An audit committee financial expert must possess all five attributes included in the definition of audit committee financial expert. The expert must have acquired such attributes through any one or more of the following:

• education and experience as a principal financial officer, principal accounting officer, controller, public accountant or auditor or experience in one or more positions that involve the performance of similar functions;
• experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions;
• experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or
• other relevant experience (a brief description of which must be disclosed if it is the basis for the person being considered an audit committee financial expert).

According to the adopting release, the term "active supervision" means more than the mere existence of a traditional hierarchical reporting relationship between supervisor and those being supervised. Rather, it means that a person engaged in active supervision participates in, and contributes to, the process of addressing, albeit at a supervisory level, the same general types of issues regarding preparation, auditing, analysis or evaluation of financial statements as those addressed by the person or persons being supervised. The supervisor should also have experience that has contributed to the general expertise necessary to prepare, audit, analyze or evaluate financial statements that is at least comparable to the general expertise of those being supervised. A principal executive officer should not be presumed to qualify. A principal executive officer with considerable operations involvement, but little financial or accounting involvement, likely would not be exercising the necessary active supervision.

Previous service on a company's audit committee will not by itself "grandfather" a person as an audit committee financial expert under the definition. Similarly, the fact that a person has experience as a public accountant or auditor, or a principal financial officer, controller or principal accounting officer or experience in a similar position does not, by itself, justify a determination that the person is an audit committee financial expert.

In addition to determining that a person possesses an appropriate degree of knowledge and experience, the SEC has stated that the board must ensure that it names an audit committee financial expert who embodies the highest standards of personal and professional integrity. In this regard, the SEC has stated that a board should consider any disciplinary actions to which a potential expert is, or has been, subject in determining whether that person would be a suitable audit committee financial expert.

B. Disclosure Requirements

The adopted rules add a new Item 401(h) to Regulation S-K to require reporting companies to disclose in their annual reports:

• whether the board of directors has determined that there is at least one audit committee financial expert serving on the company's audit committee;
• if so, the name of the audit committee financial expert and whether the financial expert is "independent" and if not, an explanation of why he or she is not; and
• if the company does not have an audit committee financial expert serving on its audit committee, the company must disclose that fact and explain why it has no audit committee financial expert.

Because the required new disclosure is included in Part III of Form 10-K, companies may include the required disclosure in their annual meeting proxy statement and incorporate it by reference into its Form 10-K.

Each company must determine whether or not it has at least one audit committee financial expert. A company cannot satisfy its obligation by merely claiming that its board has not yet made a determination as to whether or not its audit committee includes an audit committee financial expert. Furthermore, it would not be appropriate for a company to disclose that it does not have an expert on its audit committee if the board has determined that such an expert serves on the audit committee.

The rules permit, but do not require, a company to disclose that it has more than one audit committee financial expert on its audit committee. Therefore, once a company's board determines that a particular audit committee member qualifies as an audit committee financial expert, it may, but is not required to, determine whether additional audit committee members also qualify as experts.

The new rules require disclosure as to whether or not the identified audit committee financial expert is independent of management. As adopted, the new rules define independence with reference to Item 7(d)(3)(iv) of Schedule 14A, which in turn relies on the listing standards of the New York Stock Exchange, American Stock Exchange and Nasdaq. As previously advised, all members of the audit committee must be independent of the company by some time after January 1, 2004. Accordingly, there may be a period where the audit committee financial expert need not be independent.

In response to a number of comments urging the SEC to clarify that identification of an audit committee financial expert will not increase or decrease his or her duties, obligations or potential liabilities as an audit committee member, the SEC has included a safe harbor in the new audit committee disclosure rules to clarify that:

• a person who is determined to be an audit committee financial expert will not be deemed an "expert" for any other purpose as a result of being designated or identified as an audit committee financial expert;
• the designation or identification of a person as an audit committee financial expert does not impose on such person any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such person as a member of the audit committee; and
• the designation or identification of a person as an audit committee financial expert does not affect the duties, obligations or liability of any other member of the audit committee.

Effective Date and Transition. The SEC has provided a limited transition period for complying with the audit committee financial expert disclosure requirements. Companies must comply with the audit committee financial expert disclosure requirements in their annual reports for fiscal years ending on or after July 15, 2003.

The foregoing is meant to be a summary only. As with any discussion of the law, certain exceptions may apply to specific situations. Please call Ted Tashlik or Martin Goldwyn to discuss any specific matters.