Accounting, Patriot Laws Raise Concern for Telcos -- Public and Private

Channel Partners

March 1, 2003

7 Min Read
Accounting, Patriot Laws Raise Concern for Telcos -- Public and Private

Posted: 3/2003

Accounting, Patriot Laws Raise
Concern for Telcos — Public and Private

By Stanley M. Gorinson and Neil
D. Falis

Michael K. Powell, chairman of the
Federal Communications Commission, recently signaled the commission’s intent to
relax existing regulations, making it easier for telecommunications companies to
expand. For example, Powell has made clear his desire to roll back regulations
that prevent telecommunications companies from entering new lines of business.
Likewise, effective Jan. 1, the commission removed certain spectrum limitations
to which wireless carriers were subject.

This trend toward deregulation may,
over time, lead to increased partnerships in the telecom industry, through
mergers, joint ventures or otherwise, as companies have greater flexibility to
offer consumers and business customers a single package of services that
traditionally have been purchased separately. However, while the relaxation of
FCC regulations may remove certain speed bumps for growing telecom companies,
other recently enacted legislation could create new potholes and, in some cases,
virtual roadblocks for telecom industry players attempting to expand. In
particular, telecom companies should consider recently implemented provisions
under the Sarbanes-Oxley Act of 2002 and the USA Patriot Act.


Sarbanes-Oxley, enacted in July 2002
partly in response to recent bankruptcies and financial misstatements of telecom
carriers such as WorldCom Inc., subjects public companies to myriad disclosure
requirements and requires them to implement a series of internal policies and
procedures. While most of the act’s provisions directly cover only publicly
traded companies, various provisions also will significantly impact private
businesses. This may be particularly true for telecom firms, which may be
subject to a higher standard of conduct after the relatively large number of
recent industry-related scandals.

First, many of the provisions under
Sarbanes-Oxley are likely to become standards for "best practices" for
both public and private companies. In particular, lenders, investors and other
stakeholders may require private firms to comply with certain provisions of the
act, such as its required financial disclosures, audit committee interaction
with accountants and implementation of codes of conduct, even if such compliance
is not legally required. In addition, the corporate governance standards
implemented by both private and public companies are likely to be compared to
those affected by their industry competitors. As a result, even private
companies may feel increasing pressure to adopt reforms implemented by their
public company rivals.

Further, under existing securities
laws, when a public company acquires a private target, the public company may be
required to file financial statements of the private company (assuming certain
asset or income tests are met). Under Sarbanes-Oxley, each public company CEO
and CFO is required to certify financial statements filed by the issuer; for
example, that they fairly present the financial condition of the company.

In the context of a potential
telecom acquisition, CEOs and CFOs may be required to certify financial
statements which include private telecom company operations, including
certifications for periods during which the acquiring company did not own the
private firm and where those officers were not involved in the preparation of
the private company’s financial statements.

Accordingly, public company
acquirers likely will conduct much more comprehensive diligence of a target’s
financial disclosure before effecting the transaction. This diligence likely
will include an assessment of the target’s management team, a review of internal
controls (and any significant deficiencies in their design or operation which
could adversely impact disclosure of financial information) and an evaluation of
the level of aggressiveness of the target’s accounting policies. It also could
include meetings with the people involved in the target’s compilation of
financial data and require targets to make representations and warranties
concerning internal controls, disclosure controls and procedures and other
financial disclosure issues, along with related indemnification provisions.


The USA Patriot Act, the short name
for the statute formally titled the "Uniting and Strengthening America
Providing Appropriate Tools to Intercept Terrorism (USA PATRIOT Act) of
2001," strengthens the U.S. government’s ability to combat terrorism and
prevent and detect money laundering activities.

Among other items, the act:

  • provides federal law enforcement officials with greater authority to gather and share evidence, particularly in the area of wire and electronic communications;

  • creates new federal crimes, increases the penalties for existing federal crimes and adjusts existing federal criminal procedure, particularly with respect to acts of terrorism; and

  • modifies immigration law, increasing the ability of the federal government to prevent terrorists from entering the country and to detain foreign terrorists.

Certain provisions of the act went
into effect immediately, while others became effective more recently.

Telecom companies, of course,
quickly have become familiar with the Patriot Act’s requirements in the law
enforcement area, as federal officials increasingly seek to intercept voice and
data communications. However, the act sets out other requirements which over
time may have unanticipated impacts on various types of businesses, including
telecommunications firms.

Title III of the Patriot Act,
"International Money Laundering and Anti-Terrorist Financing Act of
2001," imposes various new obligations on "financial
institutions," a term defined quite broadly to encompass a wide variety of
companies throughout the economy. For example, loan or finance companies,
operators of credit card systems, telegraph companies, travel agents and any
other business designated by the government through regulation whose cash
transactions have a high degree of usefulness in criminal, tax or regulatory
matters, are designated as "financial institutions."

That designation imposes significant
obligations, including the requirement to establish a written
anti-money-laundering program, which, at a minimum, includes:

  • development of internal anti-money laundering policies, procedures and controls designed to detect and prevent money laundering;

  • designation of an internal compliance officer who will assure day-to-day compliance with the program;

  • an ongoing employee training program, under which employees must be educated about the applicable legal requirements, acceptable record-keeping measures, and the identification and handling of suspicious transactions or money laundering activities; and

  • an independent audit function to monitor the program.

The Patriot Act also requires
financial institutions to implement "reasonable procedures" to verify
the identity of any person seeking to open an account, to maintain records of
information used to verify a person’s identity and to consult lists of known or
suspected terrorists or terrorist organizations.

The applicability of the Patriot Act
to telecommunications providers depends on how a particular company runs its
business. For example, if a telephone company provides financing for CPE or
other types of equipment through its own affiliate, it may be deemed a
"loan or finance company" under the act, which would subject it to the
obligations discussed above. On the other hand, if equipment purchases are
instead financed through an independent third party, the telephone company would
not be subject to the act directly, but could still be required to comply with
its record-keeping obligations to allow that independent third party to comply.
Thus, any company with affiliates engaged, directly or indirectly, in any line
of business listed as a "financial institution" either in the Bank
Secrecy Act or by regulation may be swept into the Patriot Act’s requirements.

If a business is covered by the act
as a nontraditional "financial institution," noncompliance can prove
costly. For example, the failure to comply with regulations issued under the
Patriot Act can result in civil penalties of $25,000 per day, or a maximum of
$250,000 per day for willful criminal violations. Given the complexity of the
Patriot Act and the severe penalties for noncompliance, many companies that
traditionally would not be considered "financial institutions"
nevertheless have developed programs to comply with the act.

now is not the time for telecommunications companies to rejoice in deregulation
of the industry. Instead, firms will continue to grapple with increasingly broad
and ambiguous rules, in an environment where the risks of noncompliance may be
greater than ever.

Neil D. Falis, top, and Stanley
M. Gorinson are partners in the Corporate Group of Kilpatrick Stockton LLP.
Falis’ securities practice includes the counseling of public companies and their
officers and directors on disclosure and reporting requirements, including
advice on the effects and implications of the Sarbanes-Oxley Act of 2002 and
related NYSE and Nasdaq regulations. Gorinson concentrates his practice in
litigation and business law with a particular emphasis on antitrust and
telecommunications matters.



Federal CommunicationsCommission

Kilpatrick Stockton LLP

WorldCom Inc.


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