New England Biz Law Update
As in-house counsel, your goal in establishing or brushing-up your company’s “code of conduct” or “code of ethics” should be more than minimum compliance with Sarbanes-Oxley or stock exchange rules.
Regardless of whether your company is a publicly traded company, “best practices” go beyond what is required by recent changes to SEC and stock exchange rules.
For some companies, such codes of conduct have been in place for many years, creating meaningful, institutionalized standards of business conduct, with clear guidance for directors, officers and employees and mechanisms for encouraging compliance. Perhaps the existence of such codes has helped these companies to avoid the abuses that have given rise to recent regulations mandating codes of ethics.
However, this is not about merely parroting the requirements of a government agency or the listing requirements of an exchange. It is about recognizing that having a functioning code is a sound business practice and an integral part of the foundation of a sound business. You can make this happen by recognizing that drafting a code of ethics or code of conduct is about creating a process and not merely creating a form
The term “code of ethics” is often seen as more limited than a “code” or a “guide” to business conduct. For the purpose of this article, the term “code of ethics” is limited to the minimum specific requirements promulgated by the SEC and those stock exchanges that have them, discussed below, and the term “Code” encompasses a broader guide to business conduct.
The Code As A Legal Mandate
Though the value of a well-crafted “code of ethics” process is not limited to publicly traded companies, the regulatory landscape for public companies now requires them. The minimum requirements, if your company is subject to them, are relatively simple to state and will vary slightly depending on the exchange on which your company’s stock is traded.
For many public companies, “codes of ethics” are now mandated for fiscal years ending after July 15, 2003 by the Securities & Exchange Commission’s final rules implementing Section 406 of the Sarbanes-Oxley Act (“SOA”).
For companies with exchange-traded securities, compliance with the more specific “code of ethics” requirements of the principal stock exchanges will be required six months after SEC approval is published in the Federal Register. Expanding on the legislative directive of SOA Section 406, the SEC’s final rules on a “code of ethics” can be summarized as requiring a set of written standards, reasonably designed to deter wrongdoing, as well as to promote:
(i) honest and ethical conduct (including the ethical handing of actual or apparent conflicts of interest);
(ii) full, fair, accurate, timely and understandable disclosure in all materials filed with the SEC and in other public communications;
(iii) compliance will government laws, rules and regulations;
(iv) prompt reporting to appropriate persons with sufficient status to the engender respect of violations of law and of the code of ethics pursuant to a system prescribed in the code itself; and
(v) accountability for adherence to the code of ethics.
The rules also mandate that changes to the code of ethics and waivers thereof, both explicit and implicit, be prominently disclosed on a Form 8-K or, if certain website public notice requirements are met, on the company’s website.
The SEC has quite wisely concluded that the code of ethics should vary from company to company and that each company itself determine its provisions independently. For this reason, no specific formula or draft text is provided.
Stock Exchanges Weigh In
The principal stock exchanges also have developed “code of ethics” standards as amendments to their respective listing requirements. The proposed amendments to listing requirements of the New York Stock Exchange (NYSE) are illustrative. They can be found at www.nyse.com/pdfs/amend1-04-09-03.pdf. (See also Securities and Exchange Commission, Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto by the New York Stock Exchange, Inc. Relating to Corporate Governance http://www.sec.gov/rules/sro/34-47672.htm (listed April 11, 2003))
Each listed company must disclose a code of ethics applicable to its directors, officers and employees on the company’s website that addresses seven specific topics, in addition to any topics the individual company determines are necessary. The seven topics for which coverage is mandated can be summarized as follows:
Other exchanges have similar rules for codes of ethics and no doubt this guidance will be refined in the coming months. See, e.g., Nasdaq and Amex proposed rules, which can be found, respectively, at www.nasdaq.com/about/SR-NASD-2002-139-Amendment1.pdf and www.amex.com. But, as noted above, the most useful code is one that encompasses a process that recognizes the unique circumstances of your company and become a part of its day-to-day business culture.
The Code Of Conduct As A Process
A well-crafted code is developed by internal dialogue among directors and officers, and, as appropriate, people deeper in the organization, such as managers, supervisors and employees.
While many aspects of the code must be top-down, to be functional the code and its procedures must be embraced at every level of the organization. Some key features will aid such acceptance.
An imperative from the top. The code must be given the highest priority by the board of directors and senior management to assure that it is taken seriously and forms the basis of everything that the company does and stands for. This requires tailoring your code to the specific needs, circumstances and culture of your company. Its importance can be conveyed in the code itself or through an introductory communication from the highest levels in the company.
Summary Statement or Principles. Sometimes the code will cover a very broad range of subjects and may cross reference rules and policies located in other guidance, such as an employee handbook. For some companies, a summary of the principal ethics rules is helpful, with examples that help address practical issues that can arise in day-to-day affairs.
Guidance and Compliance. The main body of a well-crafted code should provide meaningful guidance and assure compliance and enforcement. These functions are often reflected in two separate segments in the body of the material – a segment dealing with specific rules, policies and guidance (with practical examples), and a segment dealing with the mechanics for compliance and enforcement (and, where appropriate in the circumstances, training).
Substantive Guidance. The substantive areas covered will vary dramatically from company to company, though every code should address, at minimum, the following:
Reporting and Follow-up
The code should state that the company is committed to the highest standards of business conduct.
To insure this, all employees must be encouraged to report violations of laws, rules, regulations, the code and company policies generally. Additionally, any employee who is in doubt about the best course of action in a particular situation should be encouraged to seek guidance from the company through channels spelled out in the code.
If an employee does not believe it appropriate or is not comfortable approaching his or her supervisor or other superiors about his or her concerns or complaint, then he or she should be encouraged to contact the human resources department, the corporate compliance committee or any of its members (including the general counsel), or the committee of the board comprised of independent members, where available.
All communications should be appropriately investigated, and kept as confidential as possible. A separate reporting procedure should be available for the confidential and anonymous submission of concerns regarding questionable accounting or auditing matters or internal controls.
Any such concerns may be reported directly to the audit committee of the board of directors of the company. No employees acting in good faith will be subject to discipline for providing information concerning suspected violations of law or company policy.
Mechanisms to encourage compliance should include an annual certification to be made by every director, officer and employee that they have again read and understand the code and are in compliance with it. Some certifications add an attestation that they are not aware of any ongoing violations of the Code that have not been reported.
There will be occasions when there is a need to make an exception or waive a provision of the code. For public companies, a specific procedure may be mandated by the SOA regulations or exchange listing requirements. The key is that there be a process for approving and disclosing such matters and that there be a standard applied to assure consistency.
Sabino (“Rod”) Rodriguez III is a partner at Day, Berry & Howard, practicing from the firm’s offices in Stamford, Conn. A past chair of the firm’s business law department, Rod advises boards of directors and senior management on matters of corporate governance, business strategy and executive compensation, especially in tax sensitive matters in domestic and cross border transactions. Rod can be reached at [email protected].
