The Objectivist Ethics

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THE OBJECTIVIST ETHICS

by Ayn Rand
Paper delivered by Ayn Rand at the University of Wisconsin Symposium
on “Ethics in Our Time”in Madison, Wisconsin, on February 9, 1961.
Since I am to speak on the Objectivist Ethics, I shall begin by quoting its
best representative— John Galt, in Atlas Shrugged:
“Through centuries of scourges and disasters, brought about by your
code of morality, you have cried that your code had been broken, that
the scourges were punishment for breaking it, that men were too weak
and too selfish to spill all the blood it required. You damned man, you
damned existence, you damned this earth, but never dared to question
your code. . . . You went on crying that your code was noble, but human
nature was not good enough to practice it. And no one rose to ask the
question: Good?— by what standard?
“You wanted to know John Galt’
s identity. I am the man who has asked
that question.
“Yes, this is an age of moral crisis. . . . Your moral code has reached its
climax, the blind alley at the end of its course. And if you wish to go on
living, what you now need is not to return to morality . . . but to discover
it.”
What is morality, or ethics?It is a code of values to guide man’ s choices
and actions— the choices and actions that determine the purpose and
the course of his life. Ethics, as a science, deals with discovering and
defining such a code.
The first question that has to be answered, as a precondition of any
attempt to define, to judge or to accept any specific system of ethics, is:
Why does man need a code of values?
Let me stress this. The first question is not: What particular code of
values should man accept?The first question is: Does man need values
at all— and why?
Is the concept of value, of “good or evil”an arbitrary human invention,
unrelated to, underived from and unsupported by any facts of reality— or
is it based on a metaphysical fact, on an unalterable condition of man’ s
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existence?(I use the word “metaphysical”to mean: that which pertains

to reality, to the nature of things, to existence.) Does an arbitrary human
convention, a mere custom, decree that man must guide his actions by
a set of principles— or is there a fact of reality that demands it?Is ethics
the province of whims: of personal emotions, social edicts and mystic
revelations— or is it the province of reason?Is ethics a subjective
luxury— or an objective necessity?
In the sorry record of the history of mankind’ s ethics— with a few rare,
and unsuccessful, exceptions— moralists have regarded ethics as the
province of whims, that is: of the irrational. Some of them did so
explicitly, by intention— others implicitly, by default. A “whim”is a desire
experienced by a person who does not know and does not care to
discover its cause.
No philosopher has given a rational, objectively demonstrable, scientific

answer to the question of why man needs a code of values. So long as
that question remained unanswered, no rational, scientific, obj ective
code of ethics could be discovered or defined. The greatest of all
philosophers, Aristotle, did not regard ethics as an exact science;he
based his ethical system on observations of what the noble and wise
men of his time chose to do, leaving unanswered the questions of: why
they chose to do it and why he evaluated them as noble and wise.
Most philosophers took the existence of ethics for granted, as the given,
as a historical fact, and were not concerned with discovering its
metaphysical cause or objective validation. Many of them attempted to
break the traditional monopoly of mysticism in the field of ethics and,
allegedly, to define a rational, scientific, nonreligious morality. But their
attempts consisted of trying to justify them on social grounds, merely
substituting society for God.
The avowed mystics held the arbitrary, unaccountable “will of God”as

the standard of the good and as the validation of their ethics. The
neomystics replaced it with “the good of society,”thus collapsing into
the circularity of a definition such as “the standard of the good is that
which is good for society.”This meant, in logic— and, today, in
worldwide practice— that “society”stands above any principles of ethics,
since it is the source, standard and criterion of ethics, since “the good”
is whatever it wills, whatever it happens to assert as its own welfare and
pleasure. This meant that “society”may do anything it pleases, since
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“the good”is whatever it chooses to do because it chooses to do it.

And— since there is no such entity as “society,”since society is only a
number of individual men— this meant that some men (the majority or
any gang that claims to be its spokesman) are ethically entitled to
pursue any whims (or any atrocities) they desire to pursue, while other
men are ethically obliged to spend their lives in the service of that
gang’ s desires.
This could hardly be called rational, yet most philosophers have now
decided to declare that reason has failed, that ethics is outside the
power of reason, that no rational ethics can ever be defined, and that in
the field of ethics— in the choice of his values, of his actions, of his
pursuits, of his life’
s goals— man must be guided by something other
than reason. By what?Faith— instinct— intuition— revelation— feeling—
taste— urge— wish— whim. Today, as in the past, most philosophers
agree that the ultimate standard of ethics is whim (they call it “arbitrary
postulate”or “subjective choice”or “emotional commitment”)-and the
battle is only over the question of whose whim: one’ s own or society’s or
the dictator’ s or God’s. Whatever else they may disagree about, today’ s
moralists agree that ethics is a subj ective issue and that the three things
barred from its field are: reason— mind— reality.
If you wonder why the world is now collapsing to a lower and ever lower
rung of hell, this is the reason.
If you want to save civilization, it is this premise of modern ethics— and

of all ethical history— that you must challenge.
To challenge the basic premise of any discipline, one must begin at the
beginning. In ethics, one must begin by asking: What are values?Why
does man need them?
“Value”is that which one acts to gain and/or keep. The concept “value”
is not a primary;it presupposes an answer to the question: of value to
whom and for what?It presupposes an entity capable of acting to
achieve a goal in the face of an alternative. Where no alternative exists,
no goals and no values are possible.
I quote from Galt’ s speech: “There is only one fundamental alternative
in the universe: existence or nonexistence— and it pertains to a single
class of entities: to living organisms. The existence of inanimate matter
is unconditional, the existence of life is not: it depends on a specific
course of action. Matter is indestructible, it changes its forms, but it

cannot cease to exist. It is only a living organism that faces a constant
alternative: the issue of life or death. Life is a process of self-sustaining
and self-generated action. If an organism fails in that action, it dies;its
chemical elements remain, but its life goes out of existence. It is only
the concept of ‘ Life’that makes the concept of ‘ Value’possible. It is only
to a living entity that things can be good or evil.”
To make this point fully clear, try to imagine an immortal, indestructible
robot, an entity which moves and acts, but which cannot be affected by
anything, which cannot be changed in any respect, which cannot be
damaged, injured or destroyed. Such an entity would not be able to
have any values;it would have nothing to gain or to lose;it could not
regard anything as for or against it, as serving or threatening its welfare,
as fulfilling or frustrating its interests. It could have no interests and no
goals.
Only a living entity can have goals or can originate them. And it is only a
living organism that has the capacity for self-generated, goal-directed
action. On the physical level, the functions of all living organisms, from
the simplest to the most complex— from the nutritive function in the
single cell of an amoeba to the blood circulation in the body of a man—
are actions generated by the organism itself and directed to a single
goal: the maintenance of the organism’ s life.1
An organism’ s life depends on two factors: the material or fuel which it

needs from the outside, from its physical background, and the action of
its own body, the action of using that fuel properly. What standard
determines what is proper in this context?The standard is the
organism’ s life, or: that which is required for the organism’
s survival.
No choice is open to an organism in this issue: that which is required for
its survival is determined by its nature, by the kind of entity it is. Many
variations, many forms of adaptation to its background are possible to
an organism, including the possibility of existing for a while in a crippled,
disabled or diseased condition, but the fundamental alternative of its
existence remains the same: if an organism fails in the basic functions
required by its nature— if an amoeba’ s protoplasm stops assimilating
food, or if a man’ s heart stops beating— the organism dies. In a
fundamental sense, stillness is the antithesis of life. Life can be kept in
existence only by a constant process of self-sustaining action. The goal
of that action, the ultimate value which, to be kept, must be gained

through its every moment, is the organism’ s life.
An ultimate value is that final goal or end to which all lesser goals are
the means— and it sets the standard by which all lesser goals are
evaluated. An organism’ s life is its standard of value: that which furthers
its life is the good, that which threatens it is the evil.
Without an ultimate goal or end, there can be no lesser goals or means:
a series of means going off into an infinite progression toward a
nonexistent end is a metaphysical and epistemological impossibility. It is
only an ultimate goal, an end in itself, that makes the existence of
values possible. Metaphysically, life is the only phenomenon that is an
end in itself: a value gained and kept by a constant process of action.
Epistemologically, the concept of “value”is genetically dependent upon
and derived from the antecedent concept of “life.”To speak of “value”
as apart from “life”is worse than a contradiction in terms. “It is only the
concept of ‘ Life’that makes the concept of ‘ Value’possible.”
In answer to those philosophers who claim that no relation can be

established between ultimate ends or values and the facts of reality, let
me stress that the fact that living entities exist and function necessitates
the existence of values and of an ultimate value which for any given
living entity is its own life. Thus the validation of value judgments is to
be achieved by reference to the facts of reality. The fact that a living
entity is, determines what it ought to do. So much for the issue of the
relation between “is”and “ought.”
Now in what manner does a human being discover the concept of
“value”?By what means does he first become aware of the issue of
“good or evil”in its simplest form?By means of the physical sensations
of pleasure or pain. Just as sensations are the first step of the
development of a human consciousness in the realm of cognition, so
they are its first step in the realm of evaluation.
The capacity to experience pleasure or pain is innate in a man’ s body;it
is part of his nature, part of the kind of entity he is. He has no choice
about it, and he has no choice about the standard that determines what
will make him experience the physical sensation of pleasure or of pain.
What is that standard?His life.
The pleasure-pain mechanism in the body of man— and in the bodies of
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all the living organisms that possess the faculty of consciousness—

serves as an automatic guardian of the organism’s life. The physical
sensation of pleasure is a signal indicating that the organism is pursuing
the right course of action. The physical sensation of pain is a warning
signal of danger, indicating that the organism is pursuing the wrong
course of action, that something is impairing the proper function of its
body, which requires action to correct it. The best illustration of this can
be seen in the rare, freak cases of children who are born without the
capacity to experience physical pain; such children do not survive for
long; they have no means of discovering what can injure them, no
warning signals, and thus a minor cut can develop into a deadly
infection, or a major illness can remain undetected until it is too late to
fight it.
Consciousness—for those living organisms which possess it—is the
basic means of survival.
The simpler organisms, such as plants, can survive by means of their
automatic physical functions. The higher organisms, such as animals
and man, cannot: their needs are more complex and the range of their
actions is wider. The physical functions of their bodies can perform
automatically only the task of using fuel, but cannot obtain that fuel. To
obtain it, the higher organisms need the faculty of consciousness. A
plant can obtain its food from the soil in which it grows. An animal has to
hunt for it. Man has to produce it.
A plant has no choice of action; the goals it pursues are automatic and
innate, determined by its nature. Nourishment, water, sunlight are the
values its nature has set it to seek. Its life is the standard of value
directing its actions. There are alternatives in the conditions it
encounters in its physical background—such as heat or frost, drought or
flood—and there are certain actions which it is able to perform to
combat adverse conditions, such as the ability of some plants to grow
and crawl from under a rock to reach the sunlight. But whatever the
conditions, there is no alternative in a plant’s function: it acts
automatically to further its life, it cannot act for its own destruction.
The range of actions required for the survival of the higher organisms is
wider: it is proportionate to the range of their consciousness. The lower
of the conscious species possess only the faculty of sensation, which is
sufficient to direct their actions and provide for their needs. A sensation
is produced by the automatic reaction of a sense organ to a stimulus

from the outside world; it lasts for the duration of the immediate
moment, as long as the stimulus lasts and no longer. Sensations are an
automatic response, an automatic form of knowledge, which a
consciousness can neither seek nor evade. An organism that
possesses only the faculty of sensation is guided by the pleasure-pain
mechanism of its body, that is: by an automatic knowledge and an
automatic code of values. Its life is the standard of value directing its
actions. Within the range of action possible to it, it acts automatically to
further its life and cannot act for its own destruction.
The higher organisms possess a much more potent form of

consciousness: they possess the faculty of retaining sensations, which
is the faculty of perception. A “perception” is a group of sensations
automatically retained and integrated by the brain of a living organism,
which gives it the ability to be aware, not of single stimuli, but of entities,
of things. An animal is guided, not merely by immediate sensations, but
by percepts. Its actions are not single, discrete responses to single,
separate stimuli, but are directed by an integrated awareness of the
perceptual reality confronting it. It is able to grasp the perceptual
concretes immediately present and it is able to form automatic
perceptual associations, but it can go no further. It is able to learn
certain skills to deal with specific situations, such as hunting or hiding,
which the parents of the higher animals teach their young. But an
animal has no choice in the knowledge and the skills that it acquires; it
can only repeat them generation after generation. And an animal has no
choice in the standard of value directing its actions: its senses provide it
with an automatic code of values, an automatic knowledge of what is
good for it or evil, what benefits or endangers its life. An animal has no
power to extend its knowledge or to evade it. In situations for which its
knowledge is inadequate, it perishes—as, for instance, an animal that
stands paralyzed on the track of a railroad in the path of a speeding
train. But so long as it lives, an animal acts on its knowledge, with
automatic safety and no power of choice: it cannot suspend its own
consciousness—it cannot choose not to perceive—it cannot evade its
own perceptions—it cannot ignore its own good, it cannot decide to
choose the evil and act as its own destroyer.
Man has no automatic code of survival. He has no automatic course of
action, no automatic set of values. His senses do not tell him
automatically what is good for him or evil, what will benefit his life or
endanger it, what goals he should pursue and what means will achieve
them, what values his life depends on, what course of action it requires.
His own consciousness has to discover the answers to all these
questions—but his consciousness will not function automatically. Man,
the highest living species on this earth—the being whose
consciousness has a limitless capacity for gaining knowledge—man is
the only living entity born without any guarantee of remaining conscious
at all. Man’s particular distinction from all other living species is the fact
that his consciousness is volitional.
Just as the automatic values directing the functions of a plant’s body are
sufficient for its survival, but are not sufficient for an animal’s—so the
automatic values provided by the sensory-perceptual mechanism of its
consciousness are sufficient to guide an animal, but are not sufficient
for man. Man’s actions and survival require the guidance of conceptual
values derived from conceptual knowledge. But conceptual knowledge
cannot be acquired automatically.
A “concept” is a mental integration of two or more perceptual concretes,

which are isolated by a process of abstraction and united by means of a
specific definition. Every word of man’s language, with the exception of
proper names, denotes a concept, an abstraction that stands for an
unlimited number of concretes of a specific kind. It is by organizing his
perceptual material into concepts, and his concepts into wider and still
wider concepts that man is able to grasp and retain, to identify and
integrate an unlimited amount of knowledge, a knowledge extending
beyond the immediate perceptions of any given, immediate moment.
Man’s sense organs function automatically; man’s brain integrates his
sense data into percepts automatically; but the process of integrating
percepts into concepts—the process of abstraction and of concept-
formation—is not automatic.
The process of concept-formation does not consist merely of grasping a
few simple abstractions, such as “chair,” “table,” “hot,” “cold,” and of
learning to speak. It consists of a method of using one’s consciousness,
best designated by the term “conceptualizing.” It is not a passive state
of registering random impressions. It is an actively sustained process of
identifying one’s impressions in conceptual terms, of integrating every
event and every observation into a conceptual context, of grasping
relationships, differences, similarities in one’s perceptual material and of
abstracting them into new concepts, of drawing inferences, of making
deductions, of reaching conclusions, of asking new questions and

discovering new answers and expanding one’s knowledge into an ever-
growing sum. The faculty that directs this process, the faculty that works
by means of concepts, is: reason. The process is thinking.
Reason is the faculty that identifies and integrates the material provided
by man’s senses. It is a faculty that man has to exercise by choice.
Thinking is not an automatic function. In any hour and issue of his life,
man is free to think or to evade that effort. Thinking requires a state of
full, focused awareness. The act of focusing one’s consciousness is
volitional. Man can focus his mind to a full, active, purposefully directed
awareness of reality—or he can unfocus it and let himself drift in a
semiconscious daze, merely reacting to any chance stimulus of the
immediate moment, at the mercy of his undirected sensory-perceptual
mechanism and of any random, associational connections it might
happen to make.
When man unfocuses his mind, he may be said to be conscious in a
subhuman sense of the word, since he experiences sensations and
perceptions. But in the sense of the word applicable to man—in the
sense of a consciousness which is aware of reality and able to deal with
it, a consciousness able to direct the actions and provide for the survival
of a human being—an unfocused mind is not conscious.
Psychologically, the choice “to think or not” is the choice “to focus or
not.” Existentially, the choice “to focus or not” is the choice “to be
conscious or not.” Metaphysically, the choice “to be conscious or not” is
the choice of life or death.
Consciousness—for those living organisms which possess it—is the

basic means of survival. For man, the basic means of survival is reason.
Man cannot survive, as animals do, by the guidance of mere percepts.
A sensation of hunger will tell him that he needs food (if he has learned
to identify it as “hunger”), but it will not tell him how to obtain his food
and it will not tell him what food is good for him or poisonous. He cannot
provide for his simplest physical needs without a process of thought. He
needs a process of thought to discover how to plant and grow his food
or how to make weapons for hunting. His percepts might lead him to a
cave, if one is available—but to build the simplest shelter, he needs a
process of thought. No percepts and no “instincts” will tell him how to
light a fire, how to weave cloth, how to forge tools, how to make a
wheel, how to make an airplane, how to perform an appendectomy, how

to produce an electric light bulb or an electronic tube or a cyclotron or a
box of matches. Yet his life depends on such knowledge—and only a
volitional act of his consciousness, a process of thought, can provide it.
But man’s responsibility goes still further: a process of thought is not
automatic nor “instinctive” nor involuntary—nor infallible. Man has to
initiate it, to sustain it and to bear responsibility for its results. He has to
discover how to tell what is true or false and how to correct his own
errors; he has to discover how to validate his concepts, his conclusions,
his knowledge; he has to discover the rules of thought, the laws of logic,
to direct his thinking. Nature gives him no automatic guarantee of the
efficacy of his mental effort.
Nothing is given to man on earth except a potential and the material on
which to actualize it. The potential is a superlative machine: his
consciousness; but it is a machine without a spark plug, a machine of
which his own will has to be the spark plug, the self-starter and the
driver; he has to discover how to use it and he has to keep it in constant
action. The material is the whole of the universe, with no limits set to the
knowledge he can acquire and to the enjoyment of life he can achieve.
But everything he needs or desires has to be learned, discovered and
produced by him—by his own choice, by his own effort, by his own
mind.
A being who does not know automatically what is true or false, cannot
know automatically what is right or wrong, what is good for him or evil.
Yet he needs that knowledge in order to live. He is not exempt from the
laws of reality, he is a specific organism of a specific nature that
requires specific actions to sustain his life. He cannot achieve his
survival by arbitrary means nor by random motions nor by blind urges
nor by chance nor by whim. That which his survival requires is set by
his nature and is not open to his choice. What is open to his choice is
only whether he will discover it or not, whether he will choose the right
goals and values or not. He is free to make the wrong choice, but not
free to succeed with it. He is free to evade reality, he is free to unfocus
his mind and stumble blindly down any road he pleases, but not free to
avoid the abyss he refuses to see. Knowledge, for any conscious
organism, is the means of survival; to a living consciousness, every “is”
implies an “ought.” Man is free to choose not to be conscious, but not
free to escape the penalty of unconsciousness: destruction. Man is the
only living species that has the power to act as his own destroyer—and
that is the way he has acted through most of his history.
What, then, are the right goals for man to pursue? What are the values
his survival requires? That is the question to be answered by the
science of ethics. And this, ladies and gentlemen, is why man needs a
code of ethics.
Now you can assess the meaning of the doctrines which tell you that
ethics is the province of the irrational, that reason cannot guide man’s
life, that his goals and values should be chosen by vote or by whim—
that ethics has nothing to do with reality, with existence, with one’s
practical actions and concerns—or that the goal of ethics is beyond the
grave, that the dead need ethics, not the living.
Ethics is not a mystic fantasy—nor a social convention—nor a
dispensable, subjective luxury, to be switched or discarded in any
emergency. Ethics is an objective, metaphysical necessity of man’s
survival—not by the grace of the supernatural nor of your neighbors nor
of your whims, but by the grace of reality and the nature of life.
I quote from Galt’s speech: “Man has been called a rational being, but
rationality is a matter of choice—and the alternative his nature offers
him is: rational being or suicidal animal. Man has to be man—by choice;
he has to hold his life as a value—by choice; he has to learn to sustain
it—by choice; he has to discover the values it requires and practice his
virtues—by choice. A code of values accepted by choice is a code of
morality.”
The standard of value of the Objectivist ethics—the standard by which
one judges what is good or evil—is man’s life, or: that which is required
for man’s survival qua man.
Since reason is man’s basic means of survival, that which is proper to
the life of a rational being is the good; that which negates, opposes or
destroys it is the evil.
Since everything man needs has to be discovered by his own mind and
produced by his own effort, the two essentials of the method of survival
proper to a rational being are: thinking and productive work.
If some men do not choose to think, but survive by imitating and
repeating, like trained animals, the routine of sounds and motions they
learned from others, never making an effort to understand their own
work, it still remains true that their survival is made possible only by
those who did choose to think and to discover the motions they are
repeating. The survival of such mental parasites depends on blind
chance; their unfocused minds are unable to know whom to imitate,
whose motions it is safe to follow. They are the men who march into the
abyss, trailing after any destroyer who promises them to assume the
responsibility they evade: the responsibility of being conscious.
If some men attempt to survive by means of brute force or fraud, by
looting, robbing, cheating or enslaving the men who produce, it still
remains true that their survival is made possible only by their victims,
only by the men who choose to think and to produce the goods which
they, the looters, are seizing. Such looters are parasites incapable of
survival, who exist by destroying those who are capable, those who are
pursuing a course of action proper to man.
The men who attempt to survive, not by means of reason, but by means
of force, are attempting to survive by the method of animals. But just as
animals would not be able to survive by attempting the method of
plants, by rejecting locomotion and waiting for the soil to feed them—so
men cannot survive by attempting the method of animals, by rejecting
reason and counting on productive men to serve as their prey. Such
looters may achieve their goals for the range of a moment, at the price
of destruction: the destruction of their victims and their own. As
evidence, I offer you any criminal or any dictatorship.
Man cannot survive, like an animal, by acting on the range of the

moment. An animal’s life consists of a series of separate cycles,
repeated over and over again, such as the cycle of breeding its young,
or of storing food for the winter; an animal’s consciousness cannot
integrate its entire lifespan; it can carry just so far, then the animal has
to begin the cycle all over again, with no connection to the past. Man’s
life is a continuous whole: for good or evil, every day, year and decade
of his life holds the sum of all the days behind him. He can alter his
choices, he is free to change the direction of his course, he is even free,
in many cases, to atone for the consequences of his past—but he is not
free to escape them, nor to live his life with impunity on the range of the
moment, like an animal, a playboy or a thug. If he is to succeed at the
task of survival, if his actions are not to be aimed at his own destruction,
man has to choose his course, his goals, his values in the context and
terms of a lifetime. No sensations, percepts, urges or “instincts” can do
it; only a mind can.
Such is the meaning of the definition: that which is required for man’s
survival qua man. It does not mean a momentary or a merely physical
survival. It does not mean the momentary physical survival of a mindless
brute, waiting for another brute to crush his skull. It does not mean the
momentary physical survival of a crawling aggregate of muscles who is
willing to accept any terms, obey any thug and surrender any values, for
the sake of what is known as “survival at any price,” which may or may
not last a week or a year. “Man’s survival qua man” means the terms,
methods, conditions and goals required for the survival of a rational
being through the whole of his lifespan—in all those aspects of
existence which are open to his choice.
Man cannot survive as anything but man. He can abandon his means of
survival, his mind, he can turn himself into a subhuman creature and he
can turn his life into a brief span of agony—just as his body can exist for
a while in the process of disintegration by disease. But he cannot
succeed, as a subhuman, in achieving anything but the subhuman—as
the ugly horror of the antirational periods of mankind’s history can
demonstrate. Man has to be man by choice—and it is the task of ethics
to teach him how to live like man.
The Objectivist ethics holds man’s life as the standard of value—and his
own life as the ethical purpose of every individual man.
The difference between “standard” and “purpose” in this context is as
follows: a “standard” is an abstract principle that serves as a
measurement or gauge to guide a man’s choices in the achievement of
a concrete, specific purpose. “That which is required for the survival of
man qua man” is an abstract principle that applies to every individual
man. The task of applying this principle to a concrete, specific
purpose—the purpose of living a life proper to a rational being—belongs
to every individual man, and the life he has to live is his own.
Man must choose his actions, values and goals by the standard of that
which is proper to man—in order to achieve, maintain, fulfill and enjoy
that ultimate value, that end in itself, which is his own life.
Value is that which one acts to gain and/or keep—virtue is the act by
which one gains and/or keeps it. The three cardinal values of the
Objectivist ethics—the three values which, together, are the means to
and the realization of one’s ultimate value, one’s own life—are: Reason,
Purpose, Self-Esteem, with their three corresponding virtues:
Rationality, Productiveness, Pride.
Productive work is the central purpose of a rational man’s life, the

central value that integrates and determines the hierarchy of all his
other values. Reason is the source, the precondition of his productive
work—pride is the result.
Rationality is man’s basic virtue, the source of all his other virtues.
Man’s basic vice, the source of all his evils, is the act of unfocusing his
mind, the suspension of his consciousness, which is not blindness, but
the refusal to see, not ignorance, but the refusal to know. Irrationality is
the rejection of man’s means of survival and, therefore, a commitment
to a course of blind destruction; that which is anti-mind, is anti-life.
The virtue of Rationality means the recognition and acceptance of
reason as one’s only source of knowledge, one’s only judge of values
and one’s only guide to action. It means one’s total commitment to a
state of full, conscious awareness, to the maintenance of a full mental
focus in all issues, in all choices, in all of one’s waking hours. It means a
commitment to the fullest perception of reality within one’s power and to
the constant, active expansion of one’s perception, i.e., of one’s
knowledge. It means a commitment to the reality of one’s own
existence, i.e., to the principle that all of one’s goals, values and actions
take place in reality and, therefore, that one must never place any value
or consideration whatsoever above one’s perception of reality. It means
a commitment to the principle that all of one’s convictions, values,
goals, desires and actions must be based on, derived from, chosen and
validated by a process of thought—as precise and scrupulous a
process of thought, directed by as ruthlessly strict an application of
logic, as one’s fullest capacity permits. It means one’s acceptance of
the responsibility of forming one’s own judgments and of living by the
work of one’s own mind (which is the virtue of Independence). It means
that one must never sacrifice one’s convictions to the opinions or
wishes of others (which is the virtue of Integrity)-that one must never
attempt to fake reality in any manner (which is the virtue of Honesty)-
that one must never seek or grant the unearned and undeserved,
neither in matter nor in spirit (which is the virtue of Justice). It means
that one must never desire effects without causes, and that one must
never enact a cause without assuming full responsibility for its effects—
that one must never act like a zombie, i.e., without knowing one’s own
purposes and motives—that one must never make any decisions, form
any convictions or seek any values out of context, i.e., apart from or
against the total, integrated sum of one’s knowledge—and, above all,
that one must never seek to get away with contradictions. It means the
rejection of any form of mysticism, i.e., any claim to some nonsensory,
nonrational, nondefinable, supernatural source of knowledge. It means
a commitment to reason, not in sporadic fits or on selected issues or in
special emergencies, but as a permanent way of life.
The virtue of Productiveness is the recognition of the fact that
productive work is the process by which man’s mind sustains his life,
the process that sets man free of the necessity to adjust himself to his
background, as all animals do, and gives him the power to adjust his
background to himself. Productive work is the road of man’s unlimited
achievement and calls upon the highest attributes of his character: his
creative ability, his ambitiousness, his self-assertiveness, his refusal to
bear uncontested disasters, his dedication to the goal of reshaping the
earth in the image of his values. “Productive work” does not mean the
unfocused performance of the motions of some job. It means the
consciously chosen pursuit of a productive career, in any line of rational
endeavor, great or modest, on any level of ability. It is not the degree of
a man’s ability nor the scale of his work that is ethically relevant here,
but the fullest and most purposeful use of his mind.
The virtue of Pride is the recognition of the fact “that as man must
produce the physical values he needs to sustain his life, so he must
acquire the values of character that make his life worth sustaining—that
as man is a being of self-made wealth, so he is a being of self-made
soul.” (Atlas Shrugged.) The virtue of Pride can best be described by
the term: “moral ambitiousness.” It means that one must earn the right
to hold oneself as one’s own highest value by achieving one’s own
moral perfection—which one achieves by never accepting any code of
irrational virtues impossible to practice and by never failing to practice
the virtues one knows to be rational—by never accepting an unearned
guilt and never earning any, or, if one has earned it, never leaving it
uncorrected—by never resigning oneself passively to any flaws in one’s
character—by never placing any concern, wish, fear or mood of the
moment above the reality of one’s own self-esteem. And, above all, it
means one’s rejection of the role of a sacrificial animal, the rejection of

any doctrine that preaches self-immolation as a moral virtue or duty.
The basic social principle of the Objectivist ethics is that just as life is an
end in itself, so every living human being is an end in himself, not the
means to the ends or the welfare of others—and, therefore, that man
must live for his own sake, neither sacrificing himself to others nor
sacrificing others to himself. To live for his own sake means that the
achievement of his own happiness is man’s highest moral purpose.
In psychological terms, the issue of man’s survival does not confront his
consciousness as an issue of “life or death,” but as an issue of
“happiness or suffering.” Happiness is the successful state of life,
suffering is the warning signal of failure, of death. Just as the pleasure-
pain mechanism of man’s body is an automatic indicator of his body’s
welfare or injury, a barometer of its basic alternative, life or death—so
the emotional mechanism of man’s consciousness is geared to perform
the same function, as a barometer that registers the same alternative by
means of two basic emotions: joy or suffering. Emotions are the
automatic results of man’s value judgments integrated by his
subconscious; emotions are estimates of that which furthers man’s
values or threatens them, that which is for him or against him—lightning
calculators giving him the sum of his profit or loss.
But while the standard of value operating the physical pleasure-pain
mechanism of man’s body is automatic and innate, determined by the
nature of his body—the standard of value operating his emotional
mechanism, is not. Since man has no automatic knowledge, he can
have no automatic values; since he has no innate ideas, he can have
no innate value judgments.
Man is born with an emotional mechanism, just as he is born with a
cognitive mechanism; but, at birth, both are “tabula rasa.” It is man’s
cognitive faculty, his mind, that determines the content of both. Man’s
emotional mechanism is like an electronic computer, which his mind has
to program—and the programming consists of the values his mind
chooses.
But since the work of man’s mind is not automatic, his values, like all his
premises, are the product either of his thinking or of his evasions: man
chooses his values by a conscious process of thought—or accepts
them by default, by subconscious associations, on faith, on someone’s

authority, by some form of social osmosis or blind imitation. Emotions
are produced by man’s premises, held consciously or subconsciously,
explicitly or implicitly.
Man has no choice about his capacity to feel that something is good for
him or evil, but what he will consider good or evil, what will give him joy
or pain, what he will love or hate, desire or fear, depends on his
standard of value. If he chooses irrational values, he switches his
emotional mechanism from the role of his guardian to the role of his
destroyer. The irrational is the impossible; it is that which contradicts the
facts of reality; facts cannot be altered by a wish, but they can destroy
the wisher. If a man desires and pursues contradictions—if he wants to
have his cake and eat it, too—he disintegrates his consciousness; he
turns his inner life into a civil war of blind forces engaged in dark,
incoherent, pointless, meaningless conflicts (which, incidentally, is the
inner state of most people today).
Happiness is that state of consciousness which proceeds from the

achievement of one’s values. If a man values productive work, his
happiness is the measure of his success in the service of his life. But if
a man values destruction, like a sadist—or self-torture, like a
masochist—or life beyond the grave, like a mystic—or mindless “kicks,”
like the driver of a hotrod car—his alleged happiness is the measure of
his success in the service of his own destruction. It must be added that
the emotional state of all those irrationalists cannot be properly
designated as happiness or even as pleasure: it is merely a moment’s
relief from their chronic state of terror.
Neither life nor happiness can be achieved by the pursuit of irrational
whims. Just as man is free to attempt to survive by any random means,
as a parasite, a moocher or a looter, but not free to succeed at it
beyond the range of the moment—so he is free to seek his happiness in
any irrational fraud, any whim, any delusion, any mindless escape from
reality, but not free to succeed at it beyond the range of the moment nor
to escape the consequences.
I quote from Galt’s speech: “Happiness is a state of non-contradictory
joy—a joy without penalty or guilt, a joy that does not clash with any of
your values and does not work for your own destruction. . . . Happiness
is possible only to a rational man, the man who desires nothing but
rational goals, seeks nothing but rational values and finds his joy in
nothing but rational actions.”
The maintenance of life and the pursuit of happiness are not two
separate issues. To hold one’s own life as one’s ultimate value, and
one’s own happiness as one’s highest purpose are two aspects of the
same achievement. Existentially, the activity of pursuing rational goals
is the activity of maintaining one’s life; psychologically, its result, reward
and concomitant is an emotional state of happiness. It is by
experiencing happiness that one lives one’s life, in any hour, year or the
whole of it. And when one experiences the kind of pure happiness that
is an end in itself—the kind that makes one think: “This is worth living
for”—what one is greeting and affirming in emotional terms is the
metaphysical fact that life is an end in itself.
But the relationship of cause to effect cannot be reversed. It is only by

accepting “man’s life” as one’s primary and by pursuing the rational
values it requires that one can achieve happiness—not by taking
“happiness” as some undefined, irreducible primary and then attempting
to live by its guidance. If you achieve that which is the good by a
rational standard of value, it will necessarily make you happy; but that
which makes you happy, by some undefined emotional standard, is not
necessarily the good. To take “whatever makes one happy” as a guide
to action means: to be guided by nothing but one’s emotional whims.
Emotions are not tools of cognition; to be guided by whims—by desires
whose source, nature and meaning one does not know—is to turn
oneself into a blind robot, operated by unknowable demons (by one’s
stale evasions), a robot knocking its stagnant brains out against the
walls of reality which it refuses to see.
This is the fallacy inherent in hedonism—in any variant of ethical
hedonism, personal or social, individual or collective. “Happiness” can
properly be the purpose of ethics, but not the standard. The task of
ethics is to define man’s proper code of values and thus to give him the
means of achieving happiness. To declare, as the ethical hedonists do,
that “the proper value is whatever gives you pleasure” is to declare that
“the proper value is whatever you happen to value”—which is an act of
intellectual and philosophical abdication, an act which merely proclaims
the futility of ethics and invites all men to play it deuces wild.
The philosophers who attempted to devise an allegedly rational code of
ethics gave mankind nothing but a choice of whims: the “selfish” pursuit
of one’s own whims (such as the ethics of Nietzsche)—or “selfless”
service to the whims of others (such as the ethics of Bentham, Mill,
Comte and of all social hedonists, whether they allowed man to include
his own whims among the millions of others or advised him to turn
himself into a totally selfless “shmoo” that seeks to be eaten by others).
When a “desire,” regardless of its nature or cause, is taken as an ethical
primary, and the gratification of any and all desires is taken as an
ethical goal (such as “the greatest happiness of the greatest number”)—
men have no choice but to hate, fear and fight one another, because
their desires and their interests will necessarily clash. If “desire” is the
ethical standard, then one man’s desire to produce and another man’s
desire to rob him have equal ethical validity; one man’s desire to be free
and another man’s desire to enslave him have equal ethical validity; one
man’s desire to be loved and admired for his virtues and another man’s
desire for undeserved love and unearned admiration have equal ethical
validity. And if the frustration of any desire constitutes a sacrifice, then a
man who owns an automobile and is robbed of it, is being sacrificed, but
so is the man who wants or “aspires to” an automobile which the owner
refuses to give him—and these two “sacrifices” have equal ethical
status. If so, then man’s only choice is to rob or be robbed, to destroy or
be destroyed, to sacrifice others to any desire of his own or to sacrifice
himself to any desire of others; then man’s only ethical alternative is to
be a sadist or a masochist.
The moral cannibalism of all hedonist and altruist doctrines lies in the
premise that the happiness of one man necessitates the injury of
another.
Today, most people hold this premise as an absolute not to be
questioned. And when one speaks of man’s right to exist for his own
sake, for his own rational self-interest, most people assume
automatically that this means his right to sacrifice others. Such an
assumption is a confession of their own belief that to injure, enslave, rob
or murder others is in man’s self-interest—which he must selflessly
renounce. The idea that man’s self-interest can be served only by a
non-sacrificial relationship with others has never occurred to those
humanitarian apostles of unselfishness, who proclaim their desire to
achieve the brotherhood of men. And it will not occur to them, or to
anyone, so long as the concept “rational” is omitted from the context of
“values,” “desires,” “self-interest” and ethics.

The Objectivist ethics proudly advocates and upholds rational
selfishness—which means: the values required for man’s survival qua
man—which means: the values required for human survival—not the
values produced by the desires, the emotions, the “aspirations,” the
feelings, the whims or the needs of irrational brutes, who have never
outgrown the primordial practice of human sacrifices, have never
discovered an industrial society and can conceive of no self-interest but
that of grabbing the loot of the moment.
The Objectivist ethics holds that human good does not require human
sacrifices and cannot be achieved by the sacrifice of anyone to anyone.
It holds that the rational interests of men do not clash—that there is no
conflict of interests among men who do not desire the unearned, who
do not make sacrifices nor accept them, who deal with one another as
traders, giving value for value.
The principle of trade is the only rational ethical principle for all human
relationships, personal and social, private and public, spiritual and
material. It is the principle of justice.
A trader is a man who earns what he gets and does not give or take the
undeserved. He does not treat men as masters or slaves, but as
independent equals. He deals with men by means of a free, voluntary,
unforced, uncoerced exchange—an exchange which benefits both
parties by their own independent judgment. A trader does not expect to
be paid for his defaults, only for his achievements. He does not switch
to others the burden of his failures, and he does not mortgage his life
into bondage to the failures of others.
In spiritual issues—(by “spiritual” I mean: “pertaining to man’s
consciousness”)—the currency or medium of exchange is different, but
the principle is the same. Love, friendship, respect, admiration are the
emotional response of one man to the virtues of another, the spiritual
payment given in exchange for the personal, selfish pleasure which one
man derives from the virtues of another man’s character. Only a brute
or an altruist would claim that the appreciation of another person’s
virtues is an act of selflessness, that as far as one’s own selfish interest
and pleasure are concerned, it makes no difference whether one deals
with a genius or a fool, whether one meets a hero or a thug, whether
one marries an ideal woman or a slut. In spiritual issues, a trader is a

man who does not seek to be loved for his weaknesses or flaws, only
for his virtues, and who does not grant his love to the weaknesses or
the flaws of others, only to their virtues.
To love is to value. Only a rationally selfish man, a man of self-esteem,
is capable of love—because he is the only man capable of holding firm,
consistent, uncompromising, unbetrayed values. The man who does not
value himself, cannot value anything or anyone.
It is only on the basis of rational selfishness—on the basis of justice—

that men can be fit to live together in a free, peaceful, prosperous,
benevolent, rational society.
Can man derive any personal benefit from living in a human society?
Yes—if it is a human society. The two great values to be gained from
social existence are: knowledge and trade. Man is the only species that
can transmit and expand his store of knowledge from generation to
generation; the knowledge potentially available to man is greater than
any one man could begin to acquire in his own lifespan; every man
gains an incalculable benefit from the knowledge discovered by others.
The second great benefit is the division of labor: it enables a man to
devote his effort to a particular field of work and to trade with others who
specialize in other fields. This form of cooperation allows all men who
take part in it to achieve a greater knowledge, skill and productive return
on their effort than they could achieve if each had to produce everything
he needs, on a desert island or on a self-sustaining farm.
But these very benefits indicate, delimit and define what kind of men
can be of value to one another and in what kind of society: only rational,
productive, independent men in a rational, productive, free society.
Parasites, moochers, looters, brutes and thugs can be of no value to a
human being—nor can he gain any benefit from living in a society
geared to their needs, demands and protection, a society that treats him
as a sacrificial animal and penalizes him for his virtues in order to
reward them for their vices, which means: a society based on the ethics
of altruism. No society can be of value to man’s life if the price is the
surrender of his right to his life.
The basic political principle of the Objectivist ethics is: no man may
initiate the use of physical force against others. No man—or group or
society or government—has the right to assume the role of a criminal

and initiate the use of physical compulsion against any man. Men have
the right to use physical force only in retaliation and only against those
who initiate its use. The ethical principle involved is simple and clear-
cut: it is the difference between murder and self-defense. A holdup man
seeks to gain a value, wealth, by killing his victim; the victim does not
grow richer by killing a holdup man. The principle is: no man may obtain
any values from others by resorting to physical force.
The only proper, moral purpose of a government is to protect man’s

rights, which means: to protect him from physical violence—to protect
his right to his own life, to his own liberty, to his own property and to the
pursuit of his own happiness. Without property rights, no other rights are
possible.
I will not attempt, in a brief lecture, to discuss the political theory of

Objectivism. Those who are interested will find it presented in full detail
in Atlas Shrugged. I will say only that every political system is based on
and derived from a theory of ethics—and that the Objectivist ethics is
the moral base needed by that politico-economic system which, today,
is being destroyed all over the world, destroyed precisely for lack of a
moral, philosophical defense and validation: the original American
system, Capitalism. If it perishes, it will perish by default, undiscovered
and unidentified: no other subject has ever been hidden by so many
distortions, misconceptions and misrepresentations. Today, few people
know what capitalism is, how it works and what was its actual history.
When I say “capitalism,” I mean a full, pure, uncontrolled, unregulated
laissez-faire capitalism—with a separation of state and economics, in
the same way and for the same reasons as the separation of state and
church. A pure system of capitalism has never yet existed, not even in
America; various degrees of government control had been undercutting
and distorting it from the start. Capitalism is not the system of the past;
it is the system of the future—if mankind is to have a future.
For those who are interested in the history and the psychological
causes of the philosophers’ treason against capitalism, I will mention
that I discuss them in the title essay of my book For the New
Intellectual.
The present discussion has to be confined to the subject of ethics. I
have presented the barest essentials of my system, but they are

sufficient to indicate in what manner the Objectivist ethics is the morality
of life—as against the three major schools of ethical theory, the mystic,
the social, the subjective, which have brought the world to its present
state and which represent the morality of death.
These three schools differ only in their method of approach, not in their
content. In content, they are merely variants of altruism, the ethical
theory which regards man as a sacrificial animal, which holds that man
has no right to exist for his own sake, that service to others is the only
justification of his existence, and that self-sacrifice is his highest moral
duty, virtue and value. The differences occur only over the question of
who is to be sacrificed to whom. Altruism holds death as its ultimate
goal and standard of value—and it is logical that renunciation,
resignation, self-denial, and every other form of suffering, including self-
destruction, are the virtues it advocates. And, logically, these are the
only things that the practitioners of altruism have achieved and are
achieving now.
Observe that these three schools of ethical theory are anti-life, not
merely in content, but also in their method of approach.
The mystic theory of ethics is explicitly based on the premise that the
standard of value of man’s ethics is set beyond the grave, by the laws
or requirements of another, supernatural dimension, that ethics is
impossible for man to practice, that it is unsuited for and opposed to
man’s life on earth, and that man must take the blame for it and suffer
through the whole of his earthly existence, to atone for the guilt of being
unable to practice the impracticable. The Dark Ages and the Middle
Ages are the existential monument to this theory of ethics.
The social theory of ethics substitutes “society” for God—and although it
claims that its chief concern is life on earth, it is not the life of man, not
the life of an individual, but the life of a disembodied entity, the
collective, which, in relation to every individual, consists of everybody
except himself. As far as the individual is concerned, his ethical duty is
to be the selfless, voiceless, rightless slave of any need, claim or
demand asserted by others. The motto “dog eat dog”—which is not
applicable to capitalism nor to dogs—is applicable to the social theory of
ethics. The existential monuments to this theory are Nazi Germany and
Soviet Russia.
The subjectivist theory of ethics is, strictly speaking, not a theory, but a
negation of ethics. And more: it is a negation of reality, a negation not
merely of man’s existence, but of all existence. Only the concept of a
fluid, plastic, indeterminate, Heraclitean universe could permit anyone to
think or to preach that man needs no objective principles of action—that
reality gives him a blank check on values—that anything he cares to
pick as the good or the evil, will do—that a man’s whim is a valid moral
standard, and that the only question is how to get away with it. The
existential monument to this theory is the present state of our culture.
It is not men’s immorality that is responsible for the collapse now
threatening to destroy the civilized world, but the kind of moralities men
have been asked to practice. The responsibility belongs to the
philosophers of altruism. They have no cause to be shocked by the
spectacle of their own success, and no right to damn human nature:
men have obeyed them and have brought their moral ideals into full
reality.
It is philosophy that sets men’s goals and determines their course; it is

only philosophy that can save them now. Today, the world is facing a
choice: if civilization is to survive, it is the altruist morality that men have
to reject.
I will close with the words of John Galt, which I address, as he did, to all
the moralists of altruism, past or present: “You have been using fear as
your weapon and have been bringing death to man as his punishment
for rejecting your morality. We offer him life as his reward for accepting
ours.”
“The Objectivist Ethics,” copyright The Virtue of Selfishness © 1961

by Ayn Rand, renewed © 1985, by Ayn Rand. Used by permission of
Dutton Signet, a division of Penguin Group (USA), Inc. Reproduction in
any form without permission prohibited.
1. When applied to physical phenomena, such as the automatic

functions of an organism, the term “goal-directed” is not to be
taken to mean “purposive” (a concept applicable only to the
actions of a consciousness) and is not to imply the existence of
any teleological principle operating in insentient nature. I use the
term “goal-directed,” in this context, to designate the fact that the

automatic functions of living organisms are actions whose nature
is such that they result in the preservation of an organism’s life. ↩
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THE CORPORATE EXECUTIVE BOARD COMPANY
Turning Ethics into Outcomes

Three Steps to Build “Integrity Capital,” Manage
Risk, and Drive Performance
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Senior executives face
a “perfect storm” of
THE CHALLENGING SITUATION
increasing regulations,
operational complexity, An Increasingly Complex Environment Facing Executives
and internal pressures.
■ Implication: Executives must

look beyond traditional
approaches to succeed. 1. Busier Regulators— 2. Higher Employee Exposure—
■ 83% of your peers expect more regulations ■ Greater access to sensitive company data and
in more regions around the world. more channels through which that data might
leak
■ 86% of your peers expect an increase
in the scope of regulatory enforcement. ■ 72% of your peers expect these trends to
increase.
3. Increasing Operational Complexity— 4. Intense Pressure from an Anxious Board—
■ Company growth depends on new products, ■ Senior executives are faced with—and exert—
technologies, increasing number of partner increased pressure for greater risk assurances.
companies, and expanded geographic reach. ■ 83% of your peers expect the pressure
■ 85% of your peers expect the complexity to increase.
to increase.
Source: 2011 survey of more than 1,000 auditors, General Counsel, compliance and ethics officers, and risk managers.
From the CORPORATE EXECUTIVE BOARD COMPANY
www.executiveboard.com
© 2011 The Corporate Executive Board Company.

All Rights Reserved. GCR1095911SYN
3
In this complex
environment, potential
THE OPPORTUNITY COST OF POOR COMMUNICATION
loss or reduced timeliness
of information reduces
corporate ability to
properly identify risks Speed with Which Material, Negative Corporate Reporting Bad News or Negative Feedback
News Reaches Executive Teams Amount of Corporate Earnings at Stake Before
and avoid strategic
Reporting
missteps.
37.8%
■ On average, employees
would forego $1 million < $100 K 11.2%
33.6%
to $10 million in company
earnings to avoid reporting
bad news or negative $100 K–
feedback. 30.1%
< $1 Million
19.6%
■ Recent survey work by our
company’s Finance and 1 Million–
30.8%
Strategy Practice shows that < $10 Million
9.1%
58.7% of employees do not
share bad news and negative
feedback because they fear $10 Million–
< $100 Million
16.8%
it will negatively impact their
careers. Always Frequently Sometimes Rarely
Promptly Promptly Promptly Promptly
$100 Million– 5.6%

< $1 Billion
≥ $1 Billion 5.6%
n = 143 responses from Finance and Strategy executives. n = 143 responses from Finance and Strategy executives.


4
A high integrity culture
significantly influences
DUAL BENEFITS OF “INTEGRITY CAPITAL”
both risk-management
systems and business Impact of a High Integrity Corporate Culture
outcomes.
■ While it is likely that business Corporate Culture

performance and corporate
culture both, to some
degree, drive the other, it
is clear that cultures where
Risk Management Business Performance
employees freely speak up
to honest, respectful senior
leaders improve employee
productivity, increase the Lower Improved Risk Higher Better Strategic Improved
flow of new ideas, and better Compliance Detection Employee Management Business
avoid risk-management Misconduct CELC research Productivity Corporate Performance
CELC research finds that Joint CELC and Executive Board CELC data
pitfalls.
finds that employees in CLC Human research reveals analysis finds
employees in higher integrity Resources that companies positive
higher integrity cultures are research finds with strong correlations
cultures are more likely that managers openness of between
67% less likely to report who exhibit communication business
to observe noncompliance corporate deliver performance
significant and operational values can shareholder and specific
instances failures than improve returns 5% aspects of
of business employees in employees’ higher than corporate
misconduct than lower integrity performance their peers. culture.
employees in cultures. by 12%.
lower integrity
cultures.
Companies with cultures that value transparency around key

ethics and compliance issues have high “Integrity Capital.”


5
Top quartile companies
outperformed the bottom
COMPANIES WITH LONG-TERM TOTAL SHAREHOLDER
quartile companies by
more than 16 percentage
RETURNS ALSO HAVE HIGH INTEGRITY SCORES
points in 10-year total
shareholder return. Difference in 10-Year Total Shareholder Return for Bottom and Top Quartile of 48 Companies
8.8%
Bottom Quartile of Integrity Index
Top Quartile of Integrity Index
Culture as Competitive Advantage?

While promoting a culture of integrity
may not always be a high corporate
(7.4%) priority, failure to properly engage with
employees represents a strategic (as well as
compliance) risk that threatens long-term
competitive advantage.
Correlation (r) = 0.58
Significance level of Correlation: P-value < 0.01
n = 48.


6
Employee perceptions
about organisational
QUESTION #1: WHY DOES ORGANISATIONAL
justice explain the
vast majority of their
JUSTICE MATTER?
perceptions about the
ethical culture of their Culture of Integrity
Illustrative
company.
2008 2009
■ CEB data indicate there

is a big gap between how
managers and non-managers
view the company’s efforts
in dealing with unethical
behavior.
Definition
Employees’ degree of agreement
74% that:
■ Their company responds quickly 73%
Organisational and consistently to verified or Organisational
proven unethical behavior. Justice
Justice ■ Unethical behavior is not
Drivers tolerated in their department.
of a Culture
of Integrity
What the Numbers Mean

Addressing
■ Clarity of Expectations
■ Comfort Speaking Up
organisational justice is
the most effective way to impact 26% ■ Department Climate 27%
ethical culture.
■ Direct Manager Leadership All Other Integrity
All Other Integrity ■ Openness of Communication
Components Components
■ Tone at the Top

n = 172,593 employees from 2008; n = 65,683 from 2009.
9
Fostering a stronger
culture can have a
QUESTION #2: HOW DOES INTEGRITY VARY ACROSS
dramatic impact on
local misconduct levels
THE COMPANY?
and reporting rates.
Impact of Culture on Misconduct and Reporting Rates
Findings from Alpha Company1
■ The Consequences of
Culture on Risk Profiles:
Company-Level Results
– Organisations with higher Actual RiskClarity Data
integrity index scores
Integrity Index = 5.59
have significantly fewer
observed instances of Observation Rate = 18%
misconduct. Reporting Rate = 50%
– Organisations with higher 17 Business Units
integrity index scores
have significantly higher
reporting rates when
misconduct is observed.
Highest Integrity Lowest Integrity
Business Unit Business Unit
Management Management
Integrity Index = 6.21 Integrity Index = 5.40
Observation Rate = 7% Observation Rate = 20%
Reporting Rate = 75% Reporting Rate = 46%
What the Numbers Mean
For every 10,000 Non-Management Non-Management
employees at a typical Integrity Index = 5.82 Integrity Index = 5.15
company, a total of 1,840 Observation Rate = 29%
Observation Rate = 13%
individuals may observe
Reporting Rate = 50% Reporting Rate = 39%
misconduct. However,
a single low-scoring
business unit may hold
twice as many misconduct
observations as a business
unit with a high Integrity
Index score. 1 Pseudonym.


10
On average, barely one-
half of managers feel
QUESTION #3: ARE MANAGERS SET UP FOR SUCCESS?
prepared to respond to
employee concerns. Q: Do You Feel Prepared to Address Employees Reports or Concerns of Misconduct?
Responses from Managers at Gamma Company1 Versus Benchmark
■ Managers receive training

from their company typically 53% Gamma Company
due to a regulatory need; Benchmark
a significant subset of
39%
managers do not believe
they have received training
and do not feel prepared to
respond to questions.
Yes
n = 829.
Q: How Much Ethics and Compliance Training Have You Received?

Responses from Managers at Gamma Company Versus Benchmark
35% Gamma Company
Benchmark
10%
Managers Indicating They Received

No Ethics and Compliance Related Training
From the CORPORATE EXECUTIVE BOARD COMPANY 1 Pseudonym.


11
Four key leadership
competencies that drive
DEFINING ETHICAL LEADERSHIP
a culture of integrity and
reduce the likelihood of Leadership Competencies
misconduct. Highlighted Terms Indicate Competencies That Actually Drive a Culture of Integrity and Reduce the Likelihood
of Misconduct
Role model for proper business conduct

Setting an appropriate ethical tone
Honesty and integrity
Clearly communicating expectations
Skill in managing the company
Taking action on verified unethical conduct
Commitment to diversity
Intelligence
Accepting responsibility for successes and failures
Friendliness and approachability

Passion to succeed
Treating direct reports the same
Respecting and trusting employees
Recognising and rewarding achievement
Encouraging employee development

Accurately evaluating employee performance
Listening carefully to the opinions of others

Defending direct reports
Valuing work–life balance

Reputation within the company
Ethical Leadership
The Corporate Executive board defines "Ethical Leadership" as those managerial attributes which inspire employees to deliver
high-performance results against business objectives while embodying the values of the organisation.
Research has found that four demonstrated behaviors are most likely to have the strongest correlation with ethical leadership:
■ Honesty and integrity
■ Taking action on verified unethical conduct
From the CORPORATE EXECUTIVE BOARD COMPANY ■ Respecting and trusting employees
■ Listening carefully to the opinions of others
12
FROM INSIGHT TO ACTION
How the Corporate Executive Board Can Help You to Build Integrity Capital in Your Organisation
Building Organisational Justice Creating Local Relevance Developing Ethical Leaders
Take appropriate action to ensure that Define local cultural goals and priorities to Create effective training to ensure that
employees feel comfortable raising evaluate progress towards creating a culture managers are prepared to appropriately
ethical concerns. of integrity. handle employee concerns.
Products and Services Products and Services Products and Services
Tailor and deploy our “Voice Your Concerns” Deploy our training programmes for Learn practical tips and guidelines from
training module. dispelling employee myths. our Manager Leadership Training Guide.
View our “Employee FAQs” to address Apply our recommendations on tailoring View our “Building Trust with Employees”
speaking up and reporting concerns. training for local relevance. presentation to create or update your
own.
See how other companies have encouraged View our proven best practice examples Learn from peer experiences on
employees to speak up through proven best on creating policies and procedures to onboarding and assessing managers
practice case studies. localize company standards. on compliance and ethics criteria.
Learn from your peers on integrating

integrity-related criteria into traditional
performance reviews.
Features
Proven Best Research Peer Decision and Executive Advisory Live and Online
Practices and Insights Benchmarks Diagnostic Tools Networking Support Learning Events


13
Assess your company’s
ethical culture and
RISKCLARITY: A CORPORATE INTEGRITY SERVICE
preemptively identify FOR SENIOR FINANCE, STRATEGY, LEGAL, AND COMPLIANCE EXECUTIVES
cultural risks before
they lead to compliance
failures. Act Today and Learn
from Your Peers
Almost 58% of employees at your peer companies do not share bad
news and negative feedback because they fear it will negatively
impact their careers. What are your employees not telling you? ~525,000
The Corporate Executive Board’s RiskClarity is an employee survey Participating Employees
and suite of services that enables your company to do the following:
~130
■ Identify cultural weak spots that present increased risk—and
Participating Companies
missed strategic opportunities—for your organisation.
■ Benchmark your results against hundreds of thousands of 20%
employees across the globe. of the Fortune 100
■ Analyse your findings by business unit and management level.
~115
■ Determine clear, actionable solutions to assess and improve
Countries Represented
your corporate culture.
Across Six Continents
“[RiskClarity, formerly
named The Cultural Why RiskClarity Is Different
Diagnostic survey] has
allowed our company to identify
some underlying cultural issues Guaranteed Established and extensive Developed in collaboration
that our risk assessment process Data Quality peer dataset based on four with member companies and
had not uncovered. It also years of research academics
provided information to business
Comprehensive Paper and online survey tool Customised data cuts by
owners regarding where they
Data Collection including simple, easy-to- seniority, function and business
should target limited resources
Tool follow instructions unit, and geography
for increased training and
controls.” Custom Reports Custom benchmarking report Continued implementation
Chief Compliance Officer and Support with detailed analysis support from your advisory team
Health Care Services Company


14
CEB’S CORPORATE INTEGRITY SUPPORT
Audit Director Roundtable Compliance and Ethics Leadership Council General Counsel Roundtable
■ Audit Planning ■ Programme Management ■ Legal Risk Management

■ Internal Controls ■ Policies and Procedures ■ Outside Counsel Management
■ Continuous Monitoring ■ Training and Communication ■ Records Management
■ Data Analytics ■ Corporate Culture and Compliance ■ Department Management and Effectiveness
■ Talent Management ■ Compliance Risk Management ■ Corporate Governance
Additional Offerings
RiskClarity: A Corporate Integrity Service Legal Leadership Academy
■ Quickly create an effective channel to ■ Offers intensive training sessions for legal
see “bad news” before it goes public department staff
and becomes costly. ■ Builds individual skills in key areas such
■ Begin changing the culture to yield as business partnering and effective
fewer incidents. communications
■ Determine clear, actionable solutions ■ Cultivates team development
to mitigate risk. and professional engagement


15
THE CORPORATE EXECUTIVE BOARD COMPANY

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Ethics Issues In Business Page 2 of 3
cooled his heels in a Federal penitentiary where he’

ll spend 24years getting creative with
an orange j
umpsuit.
While most of us won’

t ever defraud the public on such a grand scale,we all engage in
some degree of rule-bending. Then the scope and severity of that bending increase as
additional considerations are met:
1. The action won’ t cause any immediate or obvious harm,or the impact would be
very removed/abstracted from the cheater. (I know the material,I j
ust don’
t test
well;it’
s okay if I get the answers in advance).
2. The action or potential impact is seen as deserved in any way. (My company
doesn’t pay me what I’ m worth,so it’s only fair that I should accept kickbacks from
my vendors,etc.). This Robin Hood/Che Guevara argument is especially powerful
because it turns immoral behavior into justifiabl e retribution.
3. Finally,we’re FAR more inclined to cheat when there’ s a low likelihood of getting
caught. We’ ll do a lot of very unsavory things if we’
re sure no one will find out.
Clearly we don’ t mind being dishonest,we j ust don’t want to be seen as
dishonest.
It’
s good to know that there are at least a few natural valves for controlling our darker
impulses. But we can see how a creative personality may be better equipped to build a
convincing rationale for improving their condition through unethical means.
The Cartman Effect
After dining on academia,I decided to cleanse my palette with a little South Park.
Ironically,the show had Cartman in a ‘Stand and Deliver’situation –upside down and
backward,of course. In the Edward James Almos role (complete with comb-over and
thickglasses),Eric was trying to convince a classroom full of Hispanic kids that they
needed to cheat on an upcoming test. ‘
How else do you thinkwhite people have gotten
ahead in everything?They CHEAT!’The show was zeroed in on a videotaping scandal
with the New England Patriots. But a number of recent college athletics scandals and the
Occupy Wall Street events made this a nicely-timed rerun.
We all know that South Parkis j

ust a raunchy,deliberately inflammatory cartoon.
However,this piece of subtext is resonating on a large scale right now:Those in power
have an unwarranted or ill-gotten advantage over the little guy. Cheating simpl
ylevel
s
the pl
aying fiel
d.
As an ethical business leader,the last thing you need is a bunch of Robin Hoods and
Che Guevaras (or Eric Cartmans)running amokin your operation. How are you
addressing this kind of thinking?
Ethics in Business:Real world implications
Realize this is first-and-foremost an excellent communication opportunity. Bring your

Creatives backfrom the DarkSide and get them engaged in problem-solving. Challenge:
Show everyone that they are real stakeholders in the success of the organization.
Get a few of your crackerj

ackmarketing specialists to design an internal campaign
around your Open Door policy –we’
re actively promoting transparency,enforcing our
policies at every level,and showing real appreciation to those who come forward to help.
Remember the third rul
e ofrul
e-bending:People are far less likely to engage in
questionable behavior when there’
s a high likelihood of getting caught. Find ways of
saying “we’
re watching”without actually saying “we’
re watching.”
Then make sure that you have the systems in place with sufficient fail-safes at every level
to ensure that issues are getting documented and handled effectively. When your people
feel heard and see consistent behavior in their leadership,they are more inclined to
contribute to an ethical workenvironment.
http:/
blog/
28/
2012
Ethics Issues In Business Page 3of 3
Business Ethics Webinar
Have you ever worried that pushing your

employees for results may increase the
use of unethical means to achieve stated
goals?How can you change the
organizational climate in order to
encourage ethical behavior?New research
shows that productivity goals may increase
unethical behavior but that subtle symbols,
posters,and slogans may workto increase
ethical mindfulness.
Checkout our archived webinar to learn about new research that shows that productivity
goals may increase unethical behavior,and the tactics you can use to increase ethical
mindfulness in a competitive workplace.
About the Author
With a life-long love of the arts and music,Julie’

s professional career
can best be described as a Creative Evangelist. Her message:
Principles of good design and creativity are not j
ust for Marketing.
They need to be pulled up and applied across the entire
organizational strategy. In short,good design is good for business.
Prior to j
oining the EthicsPoint team in 2010,Julie spent 12years
running her own creative agency. Her workcan be found in
thousands of campaigns around the world for clients like adidas,Nike,Tektronix,and
Stanford Hospital & Clinics. When she’
s not turning business owners into aficionados,
Julie is a passionate foodie,published poet and essayist,and she plays a mean
tambourine.
@ ethicspoint + ethicspoint + news +
©EthicsPoint 2012 Privacy Policy Safe Harbor Terms Site Map Contact Us
http:/
blog/
28/
2012
In re Inv. Adviser Codes of Ethics, Release No. 2256 (2004)
Release No. 2256 (S.E.C. Release No.), Release No. 26492, Release No. IA
- 2256, Release No. IC - 26492, 83 S.E.C. Docket 828, 2004 WL 1488752
17 CFR Parts 270, 275 and 279
S.E.C. Release No.

Investment Advisers Act of 1940
Investment Company Act of 1940
SECURITIES AND EXCHANGE COMMISSION (S.E.C.)
INVESTMENT ADVISER CODES OF ETHICS
File No. S7- 04- 04

RIN 3235-AJ08
July 2, 2004
*1 AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
SUMMARY: The Securities and Exchange Commission is adopting a new rule and related rule amendments under the
Investment Advisers Act of 1940 that require registered advisers to adopt codes of ethics. The codes of ethics must set forth
standards of conduct expected of advisory personnel and address conflicts that arise from personal 0trading by advisory
personnel. Among other things, the rule requires advisers' supervised persons to report their personal securities transactions,
including transactions in any mutual fund managed by the adviser. The Commission is also adopting amendments to rule 17j-1
to conform certain provisions to the new rule. The rule and rule amendments are designed to promote compliance with fiduciary
standards by advisers and their personnel.
DATES: Effective Date: August 31, 2004. Compliance Date: January 7, 2005.
FOR FURTHER INFORMATION CONTACT: Robert L. Tuleya, Attorney-Adviser, or Jennifer Sawin, Assistant Director,
at 202-942-0719, Office of Investment Adviser Regulation, Division of Investment Management, Securities and Exchange
Commission, 450 Fifth Street, NW, Washington, DC 20549-0506.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission (“Commission” or “SEC”) is adopting (i)
rule 204A-1 [17 CFR 275.204A-1] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (“Advisers Act” or “Act”); (ii)
amendments to rule 204-2 [17 CFR 275.204-2] and Form ADV [17 CFR 279.1] under the Advisers Act; and (iii) amendments
to rule 17j-1 [17 CFR 270.17j-1] under the Investment Company Act of 1940 [15 U.S.C. 80a] (“Company Act”). 1
EXECUTIVE SUMMARY
I. BACKGROUND
II. DISCUSSION
A. Standards of Conduct and Compliance with Laws
B. Protection of Material Nonpublic Information
C. Personal Securities Trading

1. Personal Trading Procedures
© 2012 Thomson Reuters. No claim to original U.S. Government Works. 1

2. “Access Persons” Subject to the Reporting Requirements
3. Initial and Annual Holdings Reports
4. Quarterly Transaction Reports
5. Exceptions From Reporting Requirements
6. Reportable Securities
D. Initial Public Offerings and Private Placements
E. Reporting Violations
F. Educating Employees About the Code of Ethics
G. Adviser Review and Enforcement
*2 H. Recordkeeping
I. Amendment to Form ADV
J. Amendments to Rule 17j-1
III. EFFECTIVE DATE
IV. COST-BENEFIT ANALYSIS
V. EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL FORMATION
VI. PAPERWORK REDUCTION ACT
VII. FINAL REGULATORY FLEXIBILITY ANALYSIS
VIII. STATUTORY AUTHORITY
TEXT OF RULES AND FORM AMENDMENTS
EXECUTIVE SUMMARY
The Commission is adopting new rule 204A-1 under the Advisers Act to require registered investment advisers to adopt codes
of ethics. The rule requires an adviser's code of ethics to set forth standards of conduct and require compliance with federal
securities laws. Codes of ethics must also address personal trading: they must require advisers' personnel to report their personal
securities holdings and transactions, including those in affiliated mutual funds, and must require personnel to obtain pre-approval
of certain investments. The Commission is amending the Advisers Act recordkeeping rule to require advisers to keep copies
of their codes of ethics and records relating to the code. The Commission is also amending the client disclosure requirements
under Part II of Form ADV to require advisers to describe their codes of ethics to clients.

I. BACKGROUND
In January of this year, we proposed to require every adviser registered with us to adopt and enforce a written code of ethics
applicable to its supervised persons. 2 Our proposal was designed to prevent fraud by reinforcing fiduciary principles that must
govern the conduct of advisory firms and their personnel. The proposal was part of a package of regulatory initiatives with
which we have responded to a number of recent enforcement actions against advisers or their personnel alleging violations of
their fiduciary obligations to clients, including mutual fund clients. 3
Advisers' codes would be required to contain provisions reminding employees of their obligations to clients as well as provisions
requiring reporting of personal securities transactions and holdings. In order to ensure that advisers' employees are made aware
of their firms' standards, advisers would have to obtain (and keep) a written acknowledgement from each supervised person
confirming that he or she received a copy of the code of ethics and any amendments. While the code of ethics would have to
contain certain minimum provisions, our proposal left advisers with substantial flexibility to design individualized codes that
would best fit the structure, size and nature of their advisory businesses.
We received 44 comment letters in response to our proposal. Most commenters supported requiring advisers to have written
codes of ethics, and supported the flexibility that our proposal offered. Today, we are adopting new rule 204A-1 with certain
changes that respond to commenters' recommendations.
II. DISCUSSION
A. Standards of Conduct and Compliance with Laws
Rule 204A-1 requires each adviser's code of ethics to set forth a standard of business conduct that the adviser requires of all
its supervised persons. 4 The rule does not require the adviser to adopt a particular standard, but the standard chosen must
reflect the adviser's fiduciary obligations and those of its supervised persons, and must require compliance with the federal
securities laws. 5
*3 This provision, which we are adopting as proposed, establishes only a minimum requirement. Advisers are free to set higher
standards for their employees, such as those established by professional or trade groups. 6 Of course, any other code adopted
for use must meet the minimum requirements of the rule, or be supplemented to meet the minimum requirements. 7
We urge advisers to take great care and thought in preparing their codes of ethics, which should be more than a compliance
manual. Rather, a code of ethics should set out ideals for ethical conduct premised on fundamental principals of openness,
integrity, honesty and trust. A good code of ethics should effectively convey to employees the value the advisory firm places
on ethical conduct, and should challenge employees to live up not only to the letter of the law, but also to the ideals of the
organization. 8
B. Protection of Material Nonpublic Information
We proposed to require codes of ethics to prevent access to material nonpublic information about the adviser's securities
recommendations, and client securities holdings and transactions by individuals who do not need the information to perform
their duties. 9 Commenters supported our objective of controlling access to information as a first line of defense against misuse,
but noted that it may be impractical to segregate employees, particularly in smaller firms that have limited office space. We are
not requiring this provision in the code of ethics, but remind advisers that they must maintain and enforce policies and procedures
to prevent the misuse of material nonpublic information, 10 which we believe includes misuse of material nonpublic information
about the adviser's securities recommendations, and client securities holdings and transactions. 11 Advisers' duty of care also

requires that they safeguard this sensitive information. 12 Advisers should carefully consider how to control dissemination of
sensitive information both within their organizations and outside them.
C. Personal Securities Trading
Each adviser's code of ethics must require an adviser's “access persons” to periodically report their personal securities
transactions and holdings to the adviser's chief compliance officer or other designated persons. 13 The code of ethics must
also require the adviser to review those reports. 14 Reviewing these reports will allow advisers as well as the Commission's
examination staff to identify improper trades or patterns of trading by access persons. The reports are modeled largely on those
required by rule 17j-1 under the Company Act. 15
1. Personal Trading Procedures
As discussed in more detail below, while rule 204A-1 requires advisers' codes of ethics to contain provisions requiring access
persons to report securities transactions and holdings, it does not require advisers to adopt many of the detailed prophylactic
measures common to many codes. 16 Commenters agreed with this approach, which we took to accommodate the vast
differences among advisory firms registered with us and the variety of risks associated with employee securities transactions.
Advisory firms that have already adopted codes of ethics, however, commonly include many of the following elements, or
address the following issues, which we believe that all advisers should consider in crafting their own procedures for employees'
personal securities trading. 17
*4 • Prior written approval before access persons can place a personal securities transaction (“pre-clearance”). 18
• Maintenance of lists of issuers of securities that the advisory firm is analyzing or recommending for client transactions, and
prohibitions on personal trading in securities of those issuers.
• Maintenance of “restricted lists” of issuers about which the advisory firm has inside information, and prohibitions on any
trading (personal or for clients) in securities of those issuers.
• “Blackout periods” when client securities trades are being placed or recommendations are being made and access persons are
not permitted to place personal securities transactions. 19
• Reminders that investment opportunities must be offered first to clients before the adviser or its employees may act on them,
and procedures to implement this principle. 20
• Prohibitions or restrictions on “short-swing” trading and market timing. 21
• Requirements to trade only through certain brokers, or limitations on the number of brokerage accounts permitted.
• Requirements to provide the adviser with duplicate trade confirmations and account statements.
• Procedures for assigning new securities analyses to employees whose personal holdings do not present apparent conflicts of
interest. 22
2. “Access Persons” Subject to the Reporting Requirements

Under rule 204A-1, the adviser's code must require certain supervised persons, called “access persons,” to report their personal
securities transactions and holdings. 23 An access person is a supervised person who has access to nonpublic information
regarding clients' purchase or sale of securities, is involved in making securities recommendations to clients or who has access
to such recommendations that are nonpublic. 24 A supervised person who has access to nonpublic information regarding the
portfolio holdings of affiliated mutual funds is also an access person. 25
We are adopting the definition of “access person” as proposed. Some commenters suggested that we adopt a narrower definition
covering only those employees who actually obtained nonpublic information, the approach rule 17j-1 takes for mutual fund
advisers. 26 Others suggested that all advisory employees be covered. 27 Our approach takes the middle course. It treats as
access persons employees who are in a position to exploit information about client securities transactions or holdings, and thus
provides the adviser with a tool to protect its clients.
Access persons will include portfolio management personnel and, in some organizations, client service representatives who
communicate investment advice to clients. These employees have information about investment recommendations whose effect
may not yet be felt in the marketplace; as such, they may be in a position to take advantage of their inside knowledge.
Administrative, technical, and clerical personnel may also be access persons if their functions or duties give them access to
nonpublic information. Organizations in which employees have broad responsibilities, and where information barriers are few,
may see a larger percentage of their staff subject to the reporting requirements. In contrast, organizations that keep strict controls
on sensitive information may have fewer access persons. 28
*5 In many advisory firms, directors, officers and partners will also be access persons. Rule 204A-1, as proposed, contains a
presumption that, if the firm's primary business is providing investment advice, then all of its directors, officers and partners
are access persons. 29 Commenters supported this approach rather than rule 17j-1's special rules and revenue-based test for
advisory firms “primarily engaged” in a business other than advising funds or advisory clients. 30
3. Initial and Annual Holdings Reports
The code of ethics must require a complete report of each access person's securities holdings, at the time the person becomes an
access person and at least once a year thereafter. 31 Commenters supported these reporting requirements, which are similar to
those required by rule 17j-1. 32 The holdings reports must be current as of a date not more than 45 days prior to the individual
becoming an access person (initial report) or the date the report is submitted (annual report). We had proposed to require initial
holdings reports to be current as of the date the individual becomes an access person, and annual reports to be current within 30
days prior to submission, but many commenters told us these requirements were not flexible enough to allow access persons
to use brokerage statements as the basis of their reports. 33
4. Quarterly Transaction Reports
The code of ethics must require quarterly reports of all personal securities transactions by access persons, which are due no
later than 30 days after the close of the calendar quarter. 34 The code of ethics may excuse access persons from submitting
transaction reports that would duplicate information contained in trade confirmations or account statements that the adviser
holds in its records, provided the adviser has received those confirmations or statements not later than 30 days after the close
of the calendar quarter in which the transaction takes place. 35
We have not adopted a requirement we proposed that would have required access persons that had no personal securities
transactions during the quarter to submit a report confirming the absence of transactions. Commenters argued that reports

confirming absence of transactions were unnecessary and burdensome, particularly when the adviser was relying on transaction
records received from the access person's broker-dealer during the course of the quarter.
5. Exceptions From Reporting Requirements
Rule 204A-1 permits three exceptions to personal securities reporting. No reports are required:
• With respect to transactions effected pursuant to an automatic investment plan. 36
• With respect to securities held in accounts over which the access person had no direct or indirect influence or control. 37
• In the case of an advisory firm that has only one access person, so long as the firm maintains records of the holdings and
transactions that rule 204A-1 would otherwise require be reported. 38
6. Reportable Securities
*6 Access persons must submit holdings and transaction reports for “reportable securities” in which the access person has,
or acquires, any direct or indirect beneficial ownership. 39 An access person is presumed to be a beneficial owner of securities
that are held by his or her immediate family members sharing the access person's household. 40
Rule 204A-1 treats all securities 41 as reportable securities, with five exceptions designed to exclude securities that appear to
present little opportunity for the type of improper trading that the access person reports are designed to uncover: 42
• Transactions and holdings in direct obligations of the Government of the United States. 43
• Money market instruments - bankers' acceptances, bank certificates of deposit, commercial paper, repurchase agreements and
other high quality short-term debt instruments. 44
• Shares of money market funds. 45
• Transactions and holdings in shares of other types of mutual funds, unless the adviser or a control affiliate acts as the investment
adviser or principal underwriter for the fund. 46
• Transactions in units of a unit investment trust if the unit investment trust is invested exclusively in unaffiliated mutual
funds. 47
The rule thus requires access persons to report shares of mutual funds advised by the access person's employer or an affiliate,
and is designed to help advisers (and our examiners) identify abusive trading by personnel with access to information about
a mutual fund's portfolio. 48
D. Initial Public Offerings and Private Placements
The code of ethics must require that access persons obtain the adviser's approval before investing in an initial public offering
(“IPO”) or private placement. 49 Most individuals rarely have the opportunity to invest in these types of securities; an access
person's IPO or private placement purchase therefore raises questions as to whether the employee is misappropriating an
investment opportunity that should first be offered to eligible clients, or whether a portfolio manager is receiving a personal

benefit for directing client business or brokerage. 50 Advisory firms with only one access person would not be required to have
that access person pre-clear these investments. 51 We are adopting this provision as proposed. 52
E. Reporting Violations
Under rule 204A-1, each adviser's code of ethics must require prompt internal reporting of any violations of the code. 53
Violations must be reported to the adviser's chief compliance officer. An investment adviser can choose to have supervised
persons report violations to either the chief compliance officer or to other persons designated in the code of ethics. But an
advisory firm that designates someone other than the chief compliance officer to receive reports of code violations from
supervised persons must have procedures requiring that the chief compliance officer also receives reports periodically of all
violations. We caution advisers, however, that it is incumbent on them to create an environment that encourages and protects
supervised persons who report violations. Advisers should consider how they can best prevent retaliation against someone who
reports a violation; many advisers may choose to permit anonymous reporting, others may decide that retaliation constitutes a
further violation of the code, and still others may find other methods to ensure that concerned employees feel safe to speak freely.
*7 We are not, as some commenters suggested, adopting a system of fines or other penalties for violations of a code of ethics,
nor are we requiring codes of ethics to include a discussion of penalties. We note, however, that many advisers do so, so that
employees have a meaningful understanding of the importance of the code and of the consequences of violating it. 54
F. Educating Employees About the Code of Ethics
Under rule 204A-1, an adviser's code of ethics must require the adviser to provide each supervised person with a copy of
the code of ethics and any amendments. 55 The code must also require each supervised person to acknowledge, in writing,
his receipt of those copies. 56 While some commenters opposed this requirement, most who addressed it were supportive.
Some commenters went further, and recommended we mandate that advisers educate employees as to the code of ethics. An
investment adviser's procedures for informing its employees about its code of ethics are critical to obtaining good compliance
and avoiding inadvertent violations of the code. Although we do not believe it is necessary to require employee education as an
element of codes of ethics, we expect most advisory firms will ensure that their employees have received adequate training on
the principles and procedures of their codes. Many firms that have already implemented codes of ethics hold periodic orientation
or training sessions with new and existing employees to remind them of their obligations under the code; others may require
employees to certify that they have read and understood the code of ethics, and require annual recertification that the employee
has re-read, understands and has complied with the code. We are not mandating any of these procedures, but they are among
best practices for advisers.
G. Adviser Review and Enforcement
Rule 204A-1 requires that advisers maintain and enforce their codes of ethics. 57 We expect that the adviser's chief compliance
officer, or persons under his authority, will have primary responsibility for enforcing the adviser's code of ethics. 58 Enforcement
of the code must include reviewing access persons' personal securities reports. 59 As discussed below, we are not adopting the
proposed requirement that records of these reports be maintained in an accessible electronic database. However, we question
seriously whether a larger investment advisory firm will be able adequately to review such reports manually or on paper. Review
of personal securities holding and transaction reports should include not only an assessment of whether the access person
followed any required internal procedures, such as pre-clearance, but should also compare the personal trading to any restricted
lists; assess whether the access person is trading for his own account in the same securities he is trading for clients, and if
so whether the clients are receiving terms as favorable as the access person takes for himself; periodically analyze the access
person's trading for patterns that may indicate abuse, including market timing; investigate any substantial disparities between
the quality of performance the access person achieves for his own account and that he achieves for clients; and investigate any

substantial disparities between the percentage of trades that are profitable when the access person trades for his own account
and the percentage that are profitable when he places trades for clients.
H. Recordkeeping
*8 We are amending rule 204-2 under the Advisers Act to reflect new rule 204A-1. Because the codes of ethics will
already cover personal securities transaction and holdings reports, we have been able to simplify rules 204-2(a)(12) and (13)
significantly. 60 As amended, rule 204-2(a)(12) requires advisers to keep copies of their code of ethics, records of violations
of the code and actions taken as a result of the violations, and copies of their supervised persons' written acknowledgment of
receipt of the code. As discussed earlier, rule 204A-1 requires prompt internal reporting of violations of the code of ethics, 61 but
we are not requiring advisers to keep records of these whistleblower reports. 62 Commenters have persuaded us that requiring
these records could have a chilling effect on employees' willingness to report violations, particularly in smaller organizations.
Rule 204-2(a)(13), as amended, covers records of access persons' personal trading. It requires advisers to keep a record of the
names of their access persons, the holdings and transaction reports made by access persons, and records of decisions approving
access persons' acquisition of securities in IPOs and limited offerings.
We proposed, but are not requiring, records of access persons' personal securities reports (and duplicate brokerage confirmations
or account statements in lieu of those reports) to be maintained electronically in an accessible computer database. Commenters
were concerned that the requirement would be unduly burdensome and would require them to input large quantities of data
manually. Although we are not adopting this requirement, as discussed above, we have strong expectations that most advisers
will need to maintain these records electronically in order to meet their responsibilities to review these records and monitor
compliance with their codes.
The standard retention period required for books and records under rule 204-2 is five years, in an easily accessible place, the first
two years in an appropriate office of the investment adviser. 63 Advisers must maintain the records required under amended
rule 204-2(a)(12) and (13) for this standard period, subject to special holding requirements for certain categories of records as
specified in amended rule 204-2(a)(12) and (13). Codes of ethics must be kept for five years after the last date they were in effect.
Supervised person acknowledgements of the code must be kept for five years after the individual ceases to be a supervised
person. 64 Similarly, the list of access persons must include every person who was an access person at any time within the past
five years, even if some of them are no longer access persons of the adviser. 65
I. Amendment to Form ADV
We are amending Part II of Form ADV, as proposed, to require advisers to describe their codes of ethics to clients and, upon
request, to furnish clients with a copy of the code of ethics. 66 This disclosure will serve two functions: first, it will help clients
understand the adviser's ethical culture and standards, how the adviser controls sensitive information and what steps it has taken
to prevent employees from misusing their inside positions at clients' expense. Clients will be able to select advisers whose
ethical commitment meets their expectations. Second, disclosure will act as sunlight, encouraging advisers to implement more
effective procedures by exposing them to view, and encouraging advisers to adhere strictly to the procedures they disclose. 67
J. Amendments to Rule 17j-1
*9 As proposed, we are revising a provision of rule 17j-1 to state that no report would be required under rule 17j-1 “to the
extent that” the report would duplicate information required under the Advisers Act recordkeeping rules. 68 Currently, the rule
contains an exception only if “all of” the information in the report would duplicate information required to be recorded under
Advisers Act rules. The reports we are requiring under the Advisers Act are not identical to those required under rule 17j-1,
and this amendment avoids unnecessary duplication.

In the proposing release, we also requested comment whether, to the extent rule 204A-1 as adopted differed from rule 17j-1, we
should make conforming changes to rule 17j-1. With limited exception, commenters addressing this issue expressed a desire
to keep the rules as parallel as possible and suggested that rule 17j-1 be modified in some respects. We are persuaded that four
changes should be made to rule 17j-1. First, rule 17j-1 as amended provides that the information in initial and annual holdings
reports must be current as of a date no more than 45 days prior to the individual becoming an access person under the rule
(initial holdings report), or submitting the report (annual holdings report). 69 Second, quarterly transaction reports will be due
no later than 30 days after the close of the quarter, rather than 10 days as currently provided. 70 Third, quarterly transaction
reports need not be submitted with respect to transactions effected pursuant to an automatic investment plan. 71
Fourth, we are revising the definition of “access person.” 72 Under the amended rule, an access person includes an advisory
person of a fund or its investment adviser. We are eliminating the revenue-based test for determining whether an investment
adviser's primary business is advising funds and other advisory clients. Advisers with other primary businesses used this test
to exclude certain of their officers, directors and general partners from being considered access persons under the rule. We are
replacing the revenue-based test with the same legal presumption we are adopting in new rule 204A-1 — that directors, officers
and general partners are presumed to be access persons if the firm's primary business is investment advisory. 73
III. EFFECTIVE DATE
The effective date of the new rule and amendments is August 31, 2004. Advisers must comply with the new rule and rule
amendments by January 7, 2005. By this compliance date, each adviser must have adopted its code of ethics and be prepared
to maintain and enforce it. In addition to fundamentals such as articulating its chosen standards of conduct, each adviser's
preparation will necessarily include identifying its access persons, providing a copy of the code of ethics to each supervised
person and receiving their acknowledgement. Also by January 7, 2005, each adviser must have an initial holdings report from
each access person, and must arrange for the submission of quarterly transaction reports. Access persons' personal securities
transaction reports for the calendar quarter ended March 31, 2005 will be due no later than April 30, 2005. Until advisers begin
to comply with new rule 204A-1, the amendments to rule 204-2, and the amendments to Form ADV Part II, they must continue
to comply with the personal securities transaction recordkeeping requirements of our current rule 204-2(a)(12) and (13).
IV. COST-BENEFIT ANALYSIS
*10 The Commission is sensitive to the costs and benefits resulting from our rules. The new rule we adopt today requires
investment advisers to establish, maintain, and enforce codes of ethics for their supervised persons. These codes of ethics
must establish standards of business conduct reflecting the fiduciary obligations of the adviser and its personnel and impose
personal securities reporting measures designed to prevent access persons from abusing information about clients' securities
transactions. We are also adopting related recordkeeping and client disclosure amendments under the Advisers Act and
conforming amendments under the Company Act. 74
In our Proposing Release, we carefully analyzed the costs and benefits of our proposed rule and amendments and requested
comment regarding the costs and benefits. Most commenters supported requiring advisers to have written codes of ethics,
although several commenters expressed reservations at the potential costs of the proposed electronic recordkeeping requirement
for personal securities transactions. Only one commenter specifically addressed our cost-benefit analysis.
We are adopting the rule and amendments substantially as proposed, with some revisions in response to comments, including
elimination of the proposed electronic recordkeeping requirement for personal securities transactions. We believe our original
analyses regarding the benefits and costs of the rule and amendments remain accurate. Most of the benefits and costs under the
new rule and amendments, however, are not quantifiable.

A. Benefits
Codes of ethics under new rule 204A-1 should benefit advisory clients as well as advisory firms. The codes will impress upon
advisers' supervised persons the significance of the fiduciary aspects of their professional responsibilities, formulating these
into standards of conduct to which their employers will hold these individuals accountable. Codes of ethics will also be an
important part of advisers' efforts to prevent fraudulent personal trading by their supervised persons. As a result, these codes
increase investor protection by forestalling supervised persons from engaging in misconduct that defrauds clients. In addition,
the Form ADV amendments, which require advisers to describe their codes of ethics to clients and to furnish copies to clients
upon request, put clients in a better position to evaluate whether their advisers' codes of ethics meet their expectations. If a client
is not confident that an advisory firm has taken appropriate measures to prevent its personnel from placing their own interests
ahead of their clients' interests, the client will be able to seek a different adviser whose measures he approves.
Rule 204A-1 will reinforce existing measures that require investment advisers to guard against employee misconduct. It goes
beyond section 204A of the Advisers Act, which focuses on policies and procedures to prevent misuse of material nonpublic
information by advisory firm personnel. Rule 204A-1 expands advisers' policies to address other situations in which such
personnel could potentially benefit at the expense of firm clients. It also goes beyond Company Act rule 17j-1, which focuses
on fraud in connection with securities held or to be acquired by an investment company advised by an adviser. Rule 204A-1
expands advisers' policies to address advisory personnel's holdings and transactions in shares of investment companies managed
by the adviser. Codes of ethics will also assist advisers in meeting their obligations under Advisers Act rule 206(4)-7 to adopt
policies and procedures reasonably designed to prevent their supervised persons from violating the Advisers Act.
*11 Rule 204A-1 will benefit investment advisers by renewing their attention to their fiduciary and other legal obligations,
and by increasing their vigilance against inappropriate behavior by employees. This may have the effect of diminishing the
likelihood that their firms will be embroiled in securities violations, Commission enforcement actions, and private litigation.
For an adviser, the potential costs associated with a securities law violation may consist of much more than merely the fines or
other penalties levied by the Commission or civil liability. The reputation of an adviser may be significantly tarnished, resulting
in lost clients. Advisers may be denied eligibility to advise funds. 75 In addition, advisers could be precluded from serving in
other capacities. 76
Our revision of advisers' recordkeeping obligations for personal securities transactions will also benefit investment advisers.
The amended rules are easier to understand than the complex provisions currently contained in Advisers Act rule 204-2(a)(12)
and (13). The requirement that advisers maintain information about their access persons' personal securities transactions will
enable firms to detect trading patterns that may indicate abuse. 77 In addition, the requirement that each access person provide
initial and annual holdings reports allows investment advisers to better monitor conflicts that may arise when an access person
participates in investment decisions involving securities the access person holds in his or her portfolio, and to assess whether
access persons are filing accurate quarterly transaction reports.
B. Costs
The new rule and amendments will result in some additional costs for advisers. It is possible that advisers may pass these costs
along to their clients in the form of advisory fees. 78 Advisers, however, are already required to maintain various policies and
procedures that would constitute core elements of their codes of ethics, and therefore many of these costs are already reflected
in fees clients currently pay. Advisers are required, under section 204A of the Advisers Act, to maintain and enforce written
policies and procedures reasonably designed to prevent the firm or its employees from misusing material nonpublic information.
Also, the approximately 1,500 advisers who advise registered investment companies currently have codes of ethics to prevent
their “access persons” from abusing their access to information about the fund's securities trading, pursuant to Company Act
rule 17j-1. 79 In addition, advisers are required under Advisers Act rule 206(4)-7 to adopt policies and procedures reasonably

designed to prevent their supervised persons from violating the Advisers Act. Accordingly, we believe requiring written codes
of ethics will impose few new costs on advisers.
Similarly, our rule to require access persons to report personal securities transactions should cause only minor cost increases.
Advisers are already required to maintain records of their advisory representatives' personal securities transactions on a quarterly
basis under Advisers Act rules 204-2(a)(12) and (13). The additional reporting required of access persons under our new rule
— an annual report of securities holdings — should impose only minor additional costs. 80 Because most SEC-registered
investment advisers have so few employees, we believe the cost of these additional reports will be minor. As of December 2003,
49% of investment advisers registered with us reported that they had five or fewer non-clerical employees, and another 18%
reported that they had only six to ten non-clerical employees. 81 The majority of larger SEC-registered advisers are already
subject to Company Act rule 17j-1 because they advise investment companies, and consequently obtain annual reports from
their “access persons” that contain virtually the same information as would be required under our proposals. These larger firms
are also in a position to limit the number of supervised persons subject to the reporting requirements, by imposing stringent
controls on who obtains access to client securities information.
*12 Many commenters expressed concern regarding the cost of the proposed requirement that advisers maintain records
of personal securities transactions electronically. The Commission is not adopting the proposed electronic recordkeeping
requirement.
One commenter stated that significant costs would result from the new rule's requirement that advisers review supervised
persons' securities holdings and transaction reports to monitor them for abuses. The Commission recognizes that advisers will
experience costs in conducting their review. The benefits to investors and to advisory firms themselves in terms of improved
detection and prevention of abuses will, however, justify these costs. Moreover, the incremental cost imposed by the new rule
in this regard is diminished to the extent that advisers should already be conducting such a review. An adviser's fiduciary duty
of loyalty to its clients may require it to take steps to protect clients from such abuses by the adviser's personnel, and section
204A of the Advisers Act requires the adviser to enforce its policies and procedures designed to prevent misuse of material
nonpublic information.
We expect only minor cost increases from the new requirement that access persons obtain their advisers' approval before
investing in an initial public offerings or private placements. Our experience administering the same requirement under
Company Act rule 17j-1 has been that such proposals are infrequent, even at larger advisory firms. We also believe that our new
requirement that advisers describe their codes of ethics to clients in their Form ADV and provide copies on request will impose
only minor cost increases. We expect few clients will request a copy of the code, and that the cost to provide it will be minimal.
V. EFFECTS ON COMPETITION, EFFICIENCY AND CAPITAL FORMATION
Section 202(c) of the Advisers Act [15 U.S.C. 80b-2(c)] mandates that the Commission, when engaging in rulemaking that
requires it to consider or determine whether an action is necessary or appropriate in the public interest, to consider, in addition
to the protection of investors, whether the action will promote efficiency, competition, and capital formation.
As discussed above, rule 204A-1 requires investment advisers to adopt codes of ethics applicable to their supervised persons.
These codes of ethics must establish standards of business conduct reflecting the fiduciary obligations of the adviser and its
personnel and impose personal securities reporting measures designed to prevent access persons from abusing their access
to information about clients' securities transactions. We expect that the proposed rule may indirectly increase efficiency by
forestalling supervised persons from engaging in misconduct that defrauds clients and harms the advisory firm, or by facilitating
the adviser's early intervention to protect its clients. In addition, the existence of an industry-wide code of ethics requirement may
enhance efficiency further by encouraging third parties to create new informational resources and guidance to which industry
participants can refer in establishing and improving their codes.

*13 Since the rule applies equally to all registered advisers, we do not anticipate that it introduces any competitive
disadvantages. We expect that the rule may indirectly foster capital formation by bolstering investor confidence. To the extent
that investors know that advisory firms have taken measures designed to prevent their supervised persons. from placing their
interests ahead of their clients' interests, clients are more likely to make assets available through advisers for investment in
the capital markets.
VI. PAPERWORK REDUCTION ACT
As we discussed in the Proposing Release, the new rule and rule and form amendments contain “collection of information”
requirements within the meaning of the Paperwork Reduction Act of 1995. 82 These collections of information are mandatory.
One of the collections of information is new. The title of this new collection is “Rule 204A-1,” which the Commission submitted
to the Office of Management and Budget (“OMB”) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The
OMB has approved this collection under control number 3235-0596 (expiring on March 31, 2007). The other collections of
information take the form of amendments to currently approved collections titled “Rule 204-2,” under OMB control number
3235-0278, and “Form ADV,” under OMB control number 3235-0049. The Commission also has submitted the amendments
to these collections to the OMB for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The OMB has approved
these collections under control numbers 3235-0278 (expiring on July 31, 2007) and 3235-0049 (expiring on July 31, 2007),
respectively. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information
unless it displays a currently valid control number.
The collection of information under rule 204A-1 is necessary to establish standards of business conduct for supervised persons
of investment advisers and to facilitate investment advisers' efforts to prevent fraudulent personal trading by their supervised
persons. The collection of information is mandatory. The respondents are investment advisers registered with us, and certain of
their supervised persons who must submit reports of their personal trading activities to their firms. These investment advisers
use the information collected to control and assess the personal trading activities of their supervised persons. Responses to
the reporting requirements will be kept confidential to the extent each investment adviser provides confidentiality under its
particular practices and procedures.
The collection of information under rule 204-2 is necessary for the Commission staff to use in its examination and oversight
program. This collection of information is mandatory. The respondents are investment advisers registered with us. Responses
provided to the Commission in the context of its examination and oversight program are generally kept confidential. 83 The
records that an adviser must keep in accordance with rule 204-2 must generally be retained for not less than five years. 84
*14 The collection of information under Form ADV is necessary to provide advisory clients and prospective clients with
information about an adviser's code of ethics. This collection of information is mandatory. The respondents are investment
advisers registered with us. Clients of these investment advisers use the information collected to assess measures the adviser
has taken to prevent its supervised persons from placing their own interests ahead of the adviser's clients' interests. Responses
to the disclosure requirements are not kept confidential.
A. Rule 204A-1
Rule 204A-1 requires SEC-registered investment advisers to establish a written code of ethics for their supervised persons. 85
We estimated in the Proposing Release that each adviser would spend six hours annually, on average, documenting its code
of ethics, taking into consideration that investment advisers currently maintain policies and procedures that can be the basis
for their code of ethics and that advisers to investment companies already have fully developed codes of ethics. Based on our
estimate in the Proposing Release that 8,019 advisers would incur the burden, the burden estimate for establishing a written
code of ethics was 48,114 hours. 86

Rule 204A-1 also requires each adviser's code of ethics to include provisions under which the adviser provides each supervised
person with a copy of the code of ethics and any amendments, and obtains written acknowledgment of receipt from the
supervised person. Based on our estimates that, on average, each investment adviser has 100 supervised persons, 87 will hire
5 new supervised persons each year, and each adviser will amend their codes once every other year, that advisers will have to
provide a copy of their codes of ethics and obtain an acknowledgment of receipt 55 times each year. 88 We further estimated in
the Proposing Release that it will take an investment adviser 0.05 hours on average for each iteration, for an annual burden of
2.75 hours per adviser and a total burden of 22,052.25 hours for all advisers related to informing supervised persons of adviser
codes of ethics. 89
Lastly, rule 204A-1 also requires each adviser's code of ethics to include provisions under which the adviser's “access persons”
report their personal securities transactions and holdings to the adviser. 90 To estimate the annual paperwork burden stemming
from this requirement we relied on the following assumptions: (1) advisers would treat all their non-clerical employees as
access persons; (2) advisers have, on average, 84 non-clerical employees; 91 (3) initial and annual holdings reports will take
0.7 hours on average; and (4) quarterly transaction reports will take 0.6 hours on average annually. 92 Using these assumptions,
we estimated in the Proposing Release that the total annual burden hours for all access persons under the proposed would be
875,675 hours. 93
One significant amendment to rule 204A-1 that addressed commenters concerns materially reduces the paperwork burden
on advisers. Because we are no longer requiring access persons to make quarterly reports when they do not have securities
transactions, we are thus adopting rule 204A-1 with revised paperwork collection requirements. Accordingly, our estimate of
the total annual burden for rule 204A-1 in the Proposing Release of 945,841.25 hours is reduced to 743,762.25 hours. 94
B. Rule 204-2
*15 In the Proposing Release, we estimated that the amendments to rule 204-2 would result in an approximate 10% net
decrease from the currently approved annual aggregate collection of information burden. 95 Eliminating the requirement that
advisers retain records relating to the personal securities transactions of advisory representatives reduces the annual average
burden of the rule, 96 while the new recordkeeping requirements under the amendments to rule 204-2 add to the burden, as
does the increase of 229 advisers registered with us. 97
Many commenters objected to the proposed requirement to require advisers to maintain access person reports electronically.
The amended rule does not include this requirement, but this amendment does not change the information collection burden
estimate. 98 Our total hour burden estimate for the collection of information under rule 204-2 remains 1,537,883.8 burden hours,
as we estimated in our proposal. 99
C. Form ADV
In the proposing release, we estimated that the amendments to Form ADV (requiring advisers to describe their codes of ethics
and furnish a copy upon request) would increase the annual collection burden under Form ADV by 6.95 hours per adviser. 100
One trade group commenter recommended that we allow web site posting of the code of ethics in lieu of furnishing a copy
upon request. We do not believe that web access is universal at this time so we are adopting amendments to Form ADV without
change and, accordingly, our total burden hour estimate remains at 102,653 burden hours. 101
VII. FINAL REGULATORY FLEXIBILITY ANALYSIS

The Commission proposed new rule 204A-1 and amendments to rule 204-2 and Form ADV under the Advisers Act, and
amendments to rule 17j-1 under the Company Act, in a release on January 20, 2004 (“proposing release”). An Initial Regulatory
Flexibility Analysis (“IRFA”) was published in the proposing release. No comments were received specifically on the IRFA.
The Commission has prepared the following Final Regulatory Flexibility Analysis (“FRFA”) in accordance with 5 U.S.C. 604,
regarding rule 204A-1 and amendments to rule 204-2 and Form ADV under the Advisers Act and amendments to rule 17j-1
under the Company Act.
A. Need for the Rule and Amendments
Sections I and II of this Release describe the background and reasons for the new rule and rule amendments. As we discussed
in detail above, the rule and amendments are designed to promote compliance with fiduciary standards by advisers and their
personnel.
B. Significant Issues Raised by Public Comment
The Commission received 44 letters from commenters in response to the proposing release. Commenters supported the proposal.
As discussed in Section II of this Release, the Commission is adopting the new rule and rule amendments substantially as
proposed with some changes to respond to commenters' suggestions. Commenters opposed a proposed requirement that advisers
keep records of access persons' personal securities reports electronically in an accessible database, and the Commission is not
adopting this provision of the proposal. The Commission specifically requested comments with respect to the IRFA, but did
not receive any comments specifically concerning the IRFA.
C. Small Entities Subject to Rule
*16 The new rule and rule amendments under the Advisers Act apply to all advisers registered with the Commission,
(and the amendments to rule 17j-1 apply to all investment companies) including small entities. In developing the new rule
and amendments, we have considered their potential effect on small entities. Under Commission rules, for purposes of the
Regulatory Flexibility Act, an investment adviser generally is a small entity if it: (i) has assets under management having a total
value of less than $25 million; (ii) did not have total assets of $5 million or more on the last day of its most recent fiscal year;
and (iii) does not control, is not controlled by, and is not under common control with another investment adviser that has assets
under management of $25 million or more, or any person (other than a natural person) that had $5 million or more on the last
day of its most recent fiscal year. 102 The Commission estimates that approximately 570 SEC-registered investment advisers
are small entities that are affected by the new rules and rule amendments. 103
For purposes of the Regulatory Flexibility Act, a registered investment company (“fund”) is a small business or small
organization (collectively, “small entity”) if the fund, together with other funds in the same group of related investment
companies, has net assets of $50 million or less as of the end of its most recent fiscal year. 104 The Commission estimates
that approximately 204 registered investment companies are small entities. 105 As discussed in Section II of this Release, the
amendments to rule 17j-1 (i) allow advisers to rely on a reporting exception in the rule if the adviser already maintains duplicate
information under records required by certain Advisers Act rules, (ii) exempt certain transactions from required reporting, and
(iii) replace with a legal presumption a revenue-based test for the primary business of the adviser. Whether the amendments to
rule 17j-1 affect small entities depends on whether the small entities rely on the reporting exception or use the exemption, and
whether the small entity is primarily engaged in the business of advising investment companies or other advisory clients.
D. Projected Reporting, Recordkeeping, and Other Compliance Requirements
The amendment to Form ADV imposes a new reporting requirement on advisers, requiring that they make an additional
disclosure statement in their brochures describing their codes of ethics and noting that copies of the codes are available from

the adviser upon request. Although new rule 204A-1 and the other rule amendments under the Advisers Act impose no other
new reporting requirements on registered advisers themselves, the new rule requires advisers' codes of ethics to impose a new
reporting requirement on advisers' access persons by requiring certain new personal securities holdings and transaction reports.
One rule amendment under the Company Act exempts certain personal securities transactions from existing quarterly reporting
requirements.
*17 The new rule and rule amendments create certain new recordkeeping and compliance requirements. The rule amendments
impose new recordkeeping requirements by requiring that advisers maintain certain records pertaining to their codes of ethics
and requirements of such codes (including records of personal securities holdings and transaction reports). 106 The new rule
imposes new compliance requirements by requiring that SEC-registered investment advisers adopt codes of ethics, obtain
written acknowledgments of their supervised persons' receipt of copies of the code and any amendments, review personal
securities holdings and transaction reports filed by their access persons, and pre-approve investments by their access persons
in IPOs and limited offerings.
Small entities registered with the Commission as investment advisers are for the most part subject to these new reporting,
recordkeeping and compliance requirements to the same extent as larger advisers. With regard to reporting of securities
holdings and transactions and to pre-approvals of certain investments, however, certain small advisers, possibly including
some that are small entities, are not subject to the new requirements. Additionally, we anticipate that most advisers will very
rarely need to address violations to their codes of ethics and, similarly, should infrequently be asked by an access person to
consider pre-approval of an investment in an IPO or limited offering. Small advisers will likely deal with violations or IPO
and limited offering pre-approvals on an even more limited scale due to the smaller size of their operations. Furthermore,
it is important to note that some of the new reporting, recordkeeping and compliance requirements replace, clarify or
simplify existing requirements to which advisers, including those that are small entities, are already subject. To the extent
that such requirements clarify or simplify existing requirements, the rule and amendments may actually alleviate reporting,
recordkeeping, or compliance burdens on advisers, including those that are small entities.
E. Agency Action to Minimize Effect on Small Entities
The Regulatory Flexibility Act directs the Commission to consider significant alternatives that would accomplish the stated
objective, while minimizing any significant adverse impact on small entities. 107 In connection with the new rule and rule
amendments, the Commission considered the following alternatives: (a) the establishment of differing compliance or reporting
requirements or timetables that take into account the resources available to small entities; (b) the clarification, consolidation,
or simplification of compliance and reporting requirements under the rule for such small entities; (c) the use of performance
rather than design standards; and (d) an exemption from coverage of the rule, or any part thereof, for such small entities.
With respect to the first alternative, the Commission believes that the flexibility built into the rules adequately addresses different
compliance and reporting requirements. The Commission is not prescribing uniform codes of ethics, but gives each adviser
the flexibility to design its own code in light of the firm's size and operational structure, and the particular types of conflicts
encountered by the firm in connection with its business and clients. The amendments to rule 204-2 permit the use of brokerage
confirmations and statements in lieu of separate reports, at the firm's option.
*18 With respect to the second alternative, the Commission believes that clarification, consolidation, or simplification of the
compliance and recordkeeping requirements under the rule for small entities unacceptably compromises the investor protections
of the rule. Rule 204A-1 sets out minimum requirements for advisers' codes of ethics, which are designed to promote compliance
with fiduciary standards by advisers and their personnel. Eliminating some or all of these requirements would potentially impede
achievement of that objective. Similarly, in establishing the categories of records to be retained under amendments to rule
204-2, the records described by the rule are necessary for the Commission to evaluate advisers' compliance with rule 204A-1
as part of the Commission's inspection program.

With respect to the third alternative, the Commission believes that the compliance and reporting requirements contained in the
new rule and rule amendments already appropriately use performance standards instead of design standards. The rule enumerates
few elements required for codes of ethics, allowing all firms, including small firms, to tailor the remainder of their codes of
ethics to the nature and scope of their business. Rule 204A-1 does not specify what standard of conduct an adviser must require
of its supervised persons, but requires only that the adviser articulate a standard in its code of ethics. Similarly, the rule does
not specify which supervised persons should have access to nonpublic information about client recommendations, trading and
holdings, and does not prohibit or restrict personal securities transactions by access persons, but requires only that access persons
report their personal securities trading and holdings to the adviser. Furthermore, the recordkeeping requirements under rule
204-2 do not specify the means by which an adviser must keep records to demonstrate its compliance with the rule.
Finally, with respect to the fourth alternative, the Commission notes that the rule exempts advisers with only one access person
from personal securities reporting and pre-clearance of investments in IPOs and private placements. The codes of ethics are
designed to promote advisers' fulfillment of their fiduciary duty to clients and to guard against personal securities trading by
advisers' access persons that may be contrary to clients' interests. Because the protections of the Advisers Act are intended to
apply equally to clients of both large and small advisory firms, it would be inconsistent with the purposes of the Advisers Act
to exempt small entities further from the rule and rule amendments or to specify different requirements for small entities.
VIII. STATUTORY AUTHORITY
We are adopting amendments to rule 17j-1 pursuant to our authority set forth in sections 17(j) and 38(a) of the Investment
Company Act [15 U.S.C. 80a-17(j) and 80a-37(a)] and sections 206(4) and 211(a) of the Advisers Act [15 U.S.C. 80b-4 and
80b-11(a)].
*19 We are adopting amendments to rule 204-2 pursuant to our authority set forth in sections 204 and 206(4) of the Advisers
Act [15 U.S.C. 80b-4 and 80b-6(4)].
We are adopting rule 204A-1 pursuant to our authority set forth in sections 202(a)(17), 204A, 206(4) and 211(a) of the Advisers
Act [15 U.S.C. 80b-2(a)(17), 80b-4a, 80b-6(4) and 80b-11(a)].
We are adopting amendments to Form ADV under section 19(a) of the Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a)
and 28(e)(2) of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and 78bb(e)(2)], section 319(a) of the Trust Indenture
Act of 1939 [15 U.S.C. 77sss(a)], section 38(a) of the Investment Company Act of 1940 [15 U.S.C. 78a-37(a)], and sections
203(c)(1), 204, and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1), 80b-4, and 80b-11(a)].
TEXT OF RULES AND FORM AMENDMENTS
List of Subjects in 17 CFR Parts 270, 275 and 279
Investment companies, Reporting and recordkeeping requirements, Securities.
For reasons set forth in the preamble, Title 17, Chapter II of the Code of Federal Regulations is amended as follows:
PART 270 — RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for Part 270 continues to read in part as follows:
AUTHORITY:15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-39, unless otherwise noted.
*****

2. Section 270.17j-1 is amended by:

a. Revising paragraph (a)(1)(i);
b. Revising paragraph (a)(2)(i);
c. Adding new paragraph (a)(11);
d. Revising the introductory text of paragraphs (d)(1)(i), (d)(1)(ii), and (d)(1)(iii);
e. Revising paragraph (d)(2)(iv); and
f. Adding new paragraph (d)(2)(vi).
The additions and revisions to read as follows:
§ 270.17j-1 Personal investment activities of investment company personnel.
*20 (a) ***
(1) ***
(i) Any Advisory Person of a Fund or of a Fund's investment adviser. If an investment adviser's primary business is advising
Funds or other advisory clients, all of the investment adviser's directors, officers, and general partners are presumed to be Access
Persons of any Fund advised by the investment adviser. All of a Fund's directors, officers, and general partners are presumed
to be Access Persons of the Fund.
*****
(2) ***
(i) Any director, officer, general partner or employee of the Fund or investment adviser (or of any company in a control
relationship to the Fund or investment adviser) who, in connection with his or her regular functions or duties, makes, participates
in, or obtains information regarding, the purchase or sale of Covered Securities by a Fund, or whose functions relate to the
making of any recommendations with respect to such purchases or sales; and
*****
(11) Automatic Investment Plan means a program in which regular periodic purchases (or withdrawals) are made automatically
in (or from) investment accounts in accordance with a predetermined schedule and allocation. An Automatic Investment Plan
includes a dividend reinvestment plan.
*****
(d) ***
(1) ***

(i) Initial Holdings Reports. No later than 10 days after the person becomes an Access Person (which information must be
current as of a date no more than 45 days prior to the date the person becomes an Access Person):
*****
(ii) Quarterly Transaction Reports. No later than 30 days after the end of a calendar quarter, the following information:
*****
(iii) Annual Holdings Reports. Annually, the following information (which information must be current as of a date no more
than 45 days before the report is submitted):
*****
(2) ***
(iv) An Access Person to an investment adviser need not make a separate report to the investment adviser under paragraph
(d)(1) of this section to the extent the information in the report would duplicate information required to be recorded under §
275.204-2(a)(13) of this chapter.
*****
(vi) An Access Person need not make a quarterly transaction report under paragraph (d)(1)(ii) of this section with respect to
transactions effected pursuant to an Automatic Investment Plan.
PART 275 — RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
3. The general authority citation for Part 275 is revised to read in part as follows:
AUTHORITY:15 U.S.C. 80b-2(a)(11)(F), 80b-2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless otherwise
noted.
*21 *****
4. Section 275.204-2 is amended by revising paragraphs (a)(12), (a)(13), and (e)(1) to read as follows:
§ 275.204-2 Books and records to be maintained by investment advisers.
(a) ***
(12)(i) A copy of the investment adviser's code of ethics adopted and implemented pursuant to § 275.204A-1 that is in effect,
or at any time within the past five years was in effect;
(ii) A record of any violation of the code of ethics, and of any action taken as a result of the violation; and
(iii) A record of all written acknowledgments as required by § 275.204A-1(a)(5) for each person who is currently, or within
the past five years was, a supervised person of the investment adviser.

(13)(i) A record of each report made by an access person as required by § 275.204A-1(b), including any information provided
under paragraph (b)(3)(iii) of that section in lieu of such reports;
(ii) A record of the names of persons who are currently, or within the past five years were, access persons of the investment
adviser; and
(iii) A record of any decision, and the reasons supporting the decision, to approve the acquisition of securities by access persons
under § 275.204A-1(c), for at least five years after the end of the fiscal year in which the approval is granted.
*****
(e)(1) All books and records required to be made under the provisions of paragraphs (a) to (c)(1)(i), inclusive, and (c)(2) of this
section (except for books and records required to be made under the provisions of paragraphs (a)(11), (a)(12)(i), (a)(12)(iii),
(a)(13)(ii), (a)(13)(iii), (a)(16), and (a)(17)(i) of this section), shall be maintained and preserved in an easily accessible place
for a period of not less than five years from the end of the fiscal year during which the last entry was made on such record, the
first two years in an appropriate office of the investment adviser.
*****
5. Section 275.204A-1 is added to read as follows:
§ 275.204A-1 Investment adviser codes of ethics.
(a) Adoption of code of ethics. If you are an investment adviser registered or required to be registered under section 203 of the
Act (15 U.S.C. 80b-3), you must establish, maintain and enforce a written code of ethics that, at a minimum, includes:
(1) A standard (or standards) of business conduct that you require of your supervised persons, which standard must reflect your
fiduciary obligations and those of your supervised persons;
(2) Provisions requiring your supervised persons to comply with applicable federal securities laws;
(3) Provisions that require all of your access persons to report, and you to review, their personal securities transactions and
holdings periodically as provided below;
(4) Provisions requiring supervised persons to report any violations of your code of ethics promptly to your chief compliance
officer or, provided your chief compliance officer also receives reports of all violations, to other persons you designate in your
code of ethics; and
*22 (5) Provisions requiring you to provide each of your supervised persons with a copy of your code of ethics and any
amendments, and requiring your supervised persons to provide you with a written acknowledgment of their receipt of the code
and any amendments.
(b) Reporting requirements.
(1) Holdings reports. The code of ethics must require your access persons to submit to your chief compliance officer or other
persons you designate in your code of ethics a report of the access person's current securities holdings that meets the following
requirements:
(i) Content of holdings reports. Each holdings report must contain, at a minimum:

(A) The title and type of security, and as applicable the exchange ticker symbol or CUSIP number, number of shares, and
principal amount of each reportable security in which the access person has any direct or indirect beneficial ownership;
(B) The name of any broker, dealer or bank with which the access person maintains an account in which any securities are held
for the access person's direct or indirect benefit; and
(C) The date the access person submits the report.
(ii) Timing of holdings reports. Your access persons must each submit a holdings report:
(A) No later than 10 days after the person becomes an access person, and the information must be current as of a date no more
than 45 days prior to the date the person becomes an access person.
(B) At least once each 12-month period thereafter on a date you select, and the information must be current as of a date no more
than 45 days prior to the date the report was submitted.
(2) Transaction reports. The code of ethics must require access persons to submit to your chief compliance officer or other
persons you designate in your code of ethics quarterly securities transactions reports that meet the following requirements:
(i) Content of transaction reports. Each transaction report must contain, at a minimum, the following information about each
transaction involving a reportable security in which the access person had, or as a result of the transaction acquired, any direct
or indirect beneficial ownership:
(A) The date of the transaction, the title, and as applicable the exchange ticker symbol or CUSIP number, interest rate and
maturity date, number of shares, and principal amount of each reportable security involved;
(B) The nature of the transaction (i.e., purchase, sale or any other type of acquisition or disposition);
(C) The price of the security at which the transaction was effected;
(D) The name of the broker, dealer or bank with or through which the transaction was effected; and
(E) The date the access person submits the report.
(ii) Timing of transaction reports. Each access person must submit a transaction report no later than 30 days after the end of
each calendar quarter, which report must cover, at a minimum, all transactions during the quarter.
*23 (3) Exceptions from reporting requirements. Your code of ethics need not require an access person to submit:
(i) Any report with respect to securities held in accounts over which the access person had no direct or indirect influence or
control;
(ii) A transaction report with respect to transactions effected pursuant to an automatic investment plan;
(iii) A transaction report if the report would duplicate information contained in broker trade confirmations or account statements
that you hold in your records so long as you receive the confirmations or statements no later than 30 days after the end of the
applicable calendar quarter.

(c) Pre-approval of certain investments. Your code of ethics must require your access persons to obtain your approval before
they directly or indirectly acquire beneficial ownership in any security in an initial public offering or in a limited offering.
(d) Small advisers. If you have only one access person (i.e., yourself), you are not required to submit reports to yourself or to
obtain your own approval for investments in any security in an initial public offering or in a limited offering, if you maintain
records of all of your holdings and transactions that this section would otherwise require you to report.
(e) Definitions. For the purpose of this section:
(1) Access person means:
(i) Any of your supervised persons:
(A) Who has access to nonpublic information regarding any clients' purchase or sale of securities, or nonpublic information
regarding the portfolio holdings of any reportable fund, or
(B) Who is involved in making securities recommendations to clients, or who has access to such recommendations that are
nonpublic.
(ii) If providing investment advice is your primary business, all of your directors, officers and partners are presumed to be
access persons.
(2) Automatic investment plan means a program in which regular periodic purchases (or withdrawals) are made automatically
in (or from) investment accounts in accordance with a predetermined schedule and allocation. An automatic investment plan
includes a dividend reinvestment plan.
(3) Beneficial ownership is interpreted in the same manner as it would be under § 240.16a-1(a)(2) of this chapter in determining
whether a person has beneficial ownership of a security for purposes of section 16 of the Securities Exchange Act of 1934
(15 U.S.C. 78p) and the rules and regulations thereunder. Any report required by paragraph (b) of this section may contain
a statement that the report will not be construed as an admission that the person making the report has any direct or indirect
beneficial ownership in the security to which the report relates.
(4) Federal securities laws means the Securities Act of 1933 (15 U.S.C. 77a-aa), the Securities Exchange Act of 1934 (15
U.S.C. 78a - mm), the Sarbanes-Oxley Act of 2002 (Pub. L. 107-204, 116 Stat. 745 (2002)), the Investment Company Act of
1940 (15 U.S.C. 80a), the Investment Advisers Act of 1940 (15 U.S.C. 80b), Title V of the Gramm-Leach-Bliley Act (Pub. L.
No. 106-102, 113 Stat. 1338 (1999), any rules adopted by the Commission under any of these statutes, the Bank Secrecy Act
(31 U.S.C. 5311 - 5314; 5316 - 5332) as it applies to funds and investment advisers, and any rules adopted thereunder by the
Commission or the Department of the Treasury.
*24 (5) Fund means an investment company registered under the Investment Company Act.
(6) Initial public offering means an offering of securities registered under the Securities Act of 1933 (15 U.S.C. 77a), the issuer
of which, immediately before the registration, was not subject to the reporting requirements of sections 13 or 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)).
(7) Limited offering means an offering that is exempt from registration under the Securities Act of 1933 pursuant to section
4(2) or section 4(6) (15 U.S.C. 77d(2) or 77d(6)) or pursuant to §§ 230.504, 230.505, or 230.506 of this chapter.
(8) Purchase or sale of a security includes, among other things, the writing of an option to purchase or sell a security.

(9) Reportable fund means:
(i) Any fund for which you serve as an investment adviser as defined in section 2(a)(20) of the Investment Company Act of 1940
(15 U.S.C. 80a-2(a)(20)) (i.e., in most cases you must be approved by the fund's board of directors before you can serve); or
(ii) Any fund whose investment adviser or principal underwriter controls you, is controlled by you, or is under common control
with you. For purposes of this section, control has the same meaning as it does in section 2(a)(9) of the Investment Company
Act of 1940 (15 U.S.C. 80a-2(a)(9)).
(10) Reportable security means a security as defined in section 202(a)(18) of the Act (15 U.S.C. 80b-2(a)(18)), except that it
does not include:
(i) Direct obligations of the Government of the United States;
(ii) Bankers' acceptances, bank certificates of deposit, commercial paper and high quality short-term debt instruments, including
repurchase agreements;
(iii) Shares issued by money market funds;
(iv) Shares issued by open-end funds other than reportable funds; and
(v) Shares issued by unit investment trusts that are invested exclusively in one or more open-end funds, none of which are
reportable funds.
PART 279 — FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF 1940
6. The authority citation for Part 279 continues to read as follows:
AUTHORITY: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1, et seq.
7. Form ADV (referenced in § 279.1) is amended by:
In Part II, at the end of Item 9 add “Describe, on Schedule F, your code of ethics, and state that you will provide a copy of your
code of ethics to any client or prospective client upon request.”
*25 Note: The text of Form ADV does not and this amendment will not appear in the Code of Federal Regulations.
By the Commission.
Margaret H. McFarland
Deputy Secretary
Footnotes
1 Unless otherwise noted, when we refer to rule 17j-1 or any paragraph of the rule, we are referring to 17 CFR 270.17j-1 of the Code
of Federal Regulations in which the rule is published, and when we refer to rule 204-2 or any paragraph of the rule, we are referring
to 17 CFR 275.204-2 of the Code of Federal Regulations in which the rule is published.
2 Investment Adviser Codes of Ethics, Investment Advisers Act Release No. 2209 (Jan. 20, 2004) [69 FR 4040 (Jan. 27, 2004)].

3 See, e.g., In the Matter of Strong Capital Management, Inc., Investment Advisers Act Release No. 2239 (May 20, 2004) (“Strong”)
(adviser disclosed material nonpublic information about fund portfolio holdings to hedge fund, and permitted own chairman and
hedge fund to engage in undisclosed market timing of funds managed by adviser); In the Matter of Massachusetts Financial Services
Co., Investment Advisers Act Release No. 2213 (Feb. 5, 2004) (2 senior executives of adviser permitted undisclosed market
timing in certain funds in the complex managed by the adviser); In the Matter of Alliance Capital Management, L.P., Investment
Advisers Act Release No. 2205 (Dec. 18, 2003) (“Alliance”) (disclosure of material nonpublic information about certain mutual fund
portfolio holdings permitted favored client to profit from market timing); In the Matter of Robert T. Littell and Wilfred Meckel,
Investment Advisers Act Release No. 2203 (Dec. 15, 2003) (portfolio manager of hedge fund made misrepresentations to investors
and potential investors concerning performance, management oversight, and risk management practices); In the Matter of Zion
Capital Management LLC and Ricky A. Lang, Investment Advisers Act Release No. 2200 (Dec. 11, 2003) (“Zion”) (adviser favored
an advisory account in which he had an interest, allocating profitable trades to this account while allocating numerous unprofitable
trades to another client); In the Matter of George F. Fahey, Investment Advisers Act Release No. 2196 (Nov. 24, 2003) (president
of investment adviser made misrepresentations to clients as to risk of investment strategy and value of investments); In the Matter
of Putnam Investment Management LLC, Investment Advisers Act Release No. 2192 (Nov. 13, 2003) (“Putnam”) (adviser failed to
reasonably supervise employees who market timed funds managed by the adviser and failed to disclose their timing activities); In
the Matter of Wendell D. Belden, Investment Advisers Act Release No. 2191 (Nov. 6, 2003) (associate of adviser defrauded clients
by misleading them about their investment options and the security of their invested principal and by investing their money in a
manner calculated to enrich himself at their expense); In the Matter of James Patrick Connelly, Jr., Investment Advisers Act Release
No. 2183 (Oct. 16, 2003) (adviser's vice chairman permitted more than a dozen clients to market time certain funds in the complex
managed by the adviser in exchange for stable. investments in other funds in the complex); In the Matter of Marshall E. Melton and
Asset Management & Research, Inc., Investment Advisers Act Release No. 2151 (Jul. 25, 2003) (investment adviser made material
misrepresentations to its clients to induce them to invest their funds in limited liability companies controlled by adviser's principal).
4 Rule 204A-1(a)(1).
5 Rule 204A-1(a)(1) and (2).
6 Many professional and trade organizations, such as the Financial Planning Association, the Association for Investment Management
and Research, the Certified Financial Planner Board of Standards, the Investment Counsel Association of America, and the American
Institute of Certified Public Accountants, have developed professional codes of ethics or model codes for their members' use.
7 While advisers are also free to structure their codes as best fits their organizations, an adviser using multi-document codes should
ensure that all parts are integrated and understandable, so it is clear to supervised persons that these documents constitute the firm's
code of ethics.
8 See joint comment letter from the Ethics Resource Center and Thelen Reid & Priest LLP (Apr. 6, 2004) (available from the
Commission's public reference room in File No. S7-04-04).
9 Proposed rule 204A-1(a)(3).
10 Section 204A [15 U.S.C. 80b-4a]. Advisers' required procedures under section 204A usually also contain a summary of insider trading
law and procedures for determining whether information has become public. These may be distinct from the adviser's section 204A
procedures to guard against misuse of material nonpublic information about client recommendations, trading, and holdings. Many
advisers may choose to integrate their section 204A procedures into their codes, but they are not required to do so.
11 See, e.g., Strong, supra note 3 (adviser that released nonpublic information about fund portfolio holdings to select market timers
violated section 204A); Alliance, supra note 3 (adviser that released, to select market timers, material nonpublic information
concerning portfolio holdings of fund managed by the adviser violated section 204A); Putnam, supra note 3 (adviser whose portfolio
manager traded on nonpublic information regarding portfolio holdings and transactions of fund managed by the adviser violated
section 204A).
12 As we noted in our proposing release, the obligation to safeguard sensitive client information would not preclude the adviser from
providing necessary information to, for example, persons providing services to the adviser or the account such as brokers, accountants,
custodians, and fund transfer agents, or in other circumstances when the client consents. In addition, if the adviser has supervised
persons who are also associated persons of a broker-dealer, self-regulatory organization rules may require the broker-dealer to have
certain information about the adviser's client accounts. Two commenters noted that, under certain circumstances, NASD rule 3040
requires the broker-dealer to supervise its registered representatives' activities for advisory accounts.
13 Rule 204A-1(a)(3). We are not suggesting that the chief compliance officer must personally review all reports. In addition, we expect
most advisers will designate another individual to review personal securities reports submitted by the chief compliance officer.
14 Rule 204A-1(a)(3).
15 Rule 17j-1 requires that fund advisers adopt written codes of ethics and have procedures in place to prevent their personnel from
abusing their access to information about the fund's securities trading, and requires “access persons” to submit reports periodically

containing information about their personal securities holdings and transactions. Rule 17j-1(c)(1) and (d) under the Investment
Company Act. Most funds, and therefore most fund advisers, must have codes of ethics under rule 17j-1. Money market funds and
funds that invest only in certain non-covered securities, however, are not required to adopt codes of ethics under rule 17j-1. Rule
17j-1(c)(1)(i). As of May 1, 2004, approximately 1500 advisers, or 18 percent of the firms registered with us, reported that they
manage fund portfolios.
16 For example, pre-clearance of personal securities transactions, see infra note 18 and accompanying text, is mandated to some degree
in most advisory firms that have adopted a code of ethics.
17 In addition to personal securities transaction procedures, the following is a list of other provisions that many advisers include in
codes of ethics, and that advisers should consider when deciding what to include in their own codes: Limitations on acceptance of
gifts; limitations on the circumstances under which an access person may serve as a director of a publicly traded company; detailed
identification of who is considered an access person within the organization; and procedures for the firm and its compliance personnel
to review periodically the code of ethics as well as to review reports made pursuant to it.
18 In some organizations, all personnel must pre-clear all trades with the firm's compliance personnel. In other firms, only access persons
must pre-clear, or only certain types of transactions must be pre-cleared. Some advisers have begun using compliance software to pre-
clear personal trades on an automated basis, rather than have compliance personnel process the requests. Pre-clearance procedures
may also identify who has authority to approve a trade request, the length of time an approval is valid, and procedures for revoking an
approval, as well as procedures for verifying post-trade reports or duplicate confirmations against the log of pre-clearance approvals.
19 Advisers may use blackout periods to guard against employees trading ahead of clients or on the same day as clients' trades are placed.
See In the Matter of Roger Honour, Investment Advisers Act Release No. 1527 (Sept. 29, 1995). Prohibiting personal trading at the
same time as client trading can also serve as a measure to prevent employees from allocating trades in a manner that defrauds clients.
See, e.g., In the Matter of Nicholas-Applegate Capital Management, Investment Advisers Act Release No. 1741 (Aug. 12, 1998)
(adviser's senior trader placed personal trades alongside trades for employee plan, allocating profitable trades to his personal account
and unprofitable ones to the employee plan's account); SEC v. Moran, 922 F.Supp. 867 (S.D.N.Y. 1996) (advisory principal allocated
shares to his family and personal accounts even though additional shares would need to be purchased for client accounts on the
following day at higher prices). The Commission has previously indicated its approval of blackout periods for advisory personnel. See
Report of the Securities and Exchange Commission on the Public Policy Implications of Investment Company Growth (1966) (“PPI
Report”) at 196 (noting with approval that the staff's 1962-63 Special Study of the Securities Markets had concluded that all funds and
advisers should have policies precluding certain insiders from buying and selling securities at the same time as a fund they manage).
20 In several of our enforcement cases involving personal trading, advisory personnel took investment opportunities for themselves (or
for an account in which they had an interest) instead of for clients, even where the investment became available only because of the
client's other securities purchases. See In the Matter of Joan Conan, Investment Advisers Act Release No. 1446 (Sept. 30, 1994); In
the Matter of Kemper Financial Services, Inc., Investment Advisers Act Release No. 1494 (June 6, 1995).
21 Advisers that prohibit short-term trading generally mandate disgorgement of any profits if an employee effects a short-term trade.
22 Initial and annual holdings reports will facilitate an adviser's assessment of whether an individual's personal securities holdings
present a conflict of interest.
23 Rule 204A-1(a)(3). Section 202(a)(25) of the Advisers Act [15 U.S.C. 80b-2(a)(25)] defines “supervised person.” An adviser's
supervised persons are its partners, officers, directors (or other persons occupying a similar status or performing similar functions)
and employees, as well as any other persons who provide advice on behalf of the adviser and are subject to the adviser's supervision
and control.
24 Rule 204A-1(e)(1).
25 Id. A supervised person would not be an access person solely because he has nonpublic information regarding the portfolio holdings
of a client that is not an investment company. The individual is unlikely to be able to exploit that information in any way that would
benefit himself.
26 Rule 17j-1 includes individuals as access persons only if they make, participate in, or obtain information regarding, the purchase and
sale of the fund's securities, or if their functions relate to the making of any recommendations for such transactions. Rule 17j-1(a)
(1)(i), 17j-1(a)(2)(i).
27 While the definition of “access person” under rule 204A-1 will not require all employees to submit personal securities transaction
reports, some firms may elect to require reporting from all personnel. This approach, while not required, offers certainty as to whether
reports are required from a given individual.
28 As proposed, persons who are not “supervised persons” of the adviser would not be access persons. This represents a change from
the current adviser recordkeeping rule, rule 204-2(a)(12). Commenters supported the change.
29 Rule 204A-1(e)(1)(ii).

30 Rule 17j-1(a)(1)(i)(A) and (B). See also current rule 204-2(a)(13)(iii)(D). Today we are also adopting parallel changes to 17j-1 to
remove this revenue-based test. See infra Section II.J of this Release.
31 Rule 204A-1(b)(1).
32 Rule 17j-1(d)(1)(i) and (iii). As under rule 17j-1, an access person can satisfy the initial or annual holdings report requirement by
timely filing and dating a copy of a securities account statement listing all their securities holdings, if the statement provides all
information required by the rule and the code of ethics. Similarly, if a supervised person has previously provided such statement
to the adviser, or has previously been reporting or supplying brokerage confirms for all securities transactions and the adviser has
maintained them as a composite record containing all the requisite information, the access person can satisfy the initial or annual
holdings report requirement by timely confirming the accuracy of the statement or composite in writing. See Personal Investment
Activities of Investment Company Personnel, Investment Company Act Release No. 23958 (Aug. 20, 1999) [64 FR 46821 (Aug.
27, 1999)] (“Rule 17j-1 1999 Adopting Release”), at n. 34. The rule would not, however, permit an access person to avoid filing
an initial or annual holdings report simply because all information has been provided over a period of time in various transaction
reports. One reason for requiring a holdings report is so that the adviser's compliance personnel and our examiners have ready access
to a “snapshot” of the access person's holdings and are not required to piece the information together from transaction reports.
33 We modeled our proposal on requirements in rule 17j-1. We are today adopting amendments to these requirements in rule 17j-1 to
conform them to rule 204A-1. See infra Section II.J of this Release.
34 Rule 204A-1(b)(2). In response to comments, we extended the deadline from the 10-day deadline we had proposed, and we have
made similar changes to rule 17j-1. See infra Section II.J of this Release.
35 The rule does not require all of the information required in a transaction report to appear in the duplicate trade confirmation or
account statement. That is, some of the required information could appear in the confirmation or statement, and the remainder could
be submitted by access persons in their reports.
36 Rule 204A-1(b)(3)(ii). However, any transaction that overrides the pre-set schedule or allocations of the automatic investment plan
must be included in a quarterly transaction report. We are also adopting a parallel exception under rule 17j-1. See infra Section II.J
of this Release.
37 Rule 204A-1(b)(3)(i).
38 Rule 204A-1(d). We had proposed this exception for firms that have only one supervised person, because that individual would
otherwise be required to make reports to himself; commenters suggested that we should extend to firms with one access person,
because these are still essentially one-man shops. We agree that a sole proprietor who has a clerical assistant or bookkeeper for
his business should still be able to use this exception so long as that employee is not also an access person. These small advisers
would still be subject to the other provisions of the rule, including the requirements to adopt a code of ethics and safeguard material
nonpublic client information.
39 Rule 204A-1(b)(1)(i)(A) and (b)(2)(i). Rule 204A-1 provides that beneficial ownership is to be interpreted in the same manner as for
purposes of rule 16a-1(a)(2) under the Securities Exchange Act of 1934 in determining whether a person has beneficial ownership
of a security for purposes of section 16 of that Act. Rule 204A-1(e)(3). This is the same as the standard under rule 17j-1. Rule 17j-1
1999 Adopting Release, supra note 32. It is also the standard used under our current adviser recordkeeping rule. See rule 204-2(a)
(12)(iii)(B). Rule 204A-1, again like rule 17j-1, provides that any required report may contain a disclaimer of beneficial ownership
by the person making the report.
40 Rule 16a-1(a)(2)(ii)(A) [17 CFR 240.16a-1(a)(2)(ii)(A)].
41 The term “security” is defined in section 2(a)(18) of the Act. [15 US 80b-2(a)(18)].
42 Rule 204A-1(e)(10). No investment adviser is required to take advantage of these exceptions; an adviser is free to require its access
persons to report their holdings and transactions in all securities, notwithstanding these exceptions.
43 Rule 204A-1(e)(10)(i).
44 Rule 204A-1(e)(10)(ii). We have interpreted “high quality short-term debt instrument” to mean any instrument having a maturity at
issuance of less than 366 days and which is rated in one of the highest two rating categories by a Nationally Recognized Statistical
Rating Organization, or which is unrated but is of comparable quality. Personal Investment Activities of Investment Company
Personnel and Codes of Ethics of Investment Companies and Their Investment Advisers and Principal Underwriters, Investment
Company Act Release No. 21341 (Sept. 8, 1995) [60 FR 47844 (Sept. 14, 1995)] (proposing amendments to rule 17j-1) at n. 66.
45 Rule 204A-1(e)(10)(iii).
46 Rule 204A-1(e)(9) and (10)(iv). Transactions and holdings in shares of closed-end investment companies would be reportable
regardless of affiliation. The exception extends only to open-end funds registered in the U.S.; therefore, transactions and holdings
in offshore funds would also be reportable.
47 Rule 204A-1(e)(10)(v). This exception is aimed at variable insurance contracts that are funded by insurance company separate
accounts organized as unit investment trusts. Such separate accounts typically are divided into subaccounts, each of which invests

exclusively in shares of an underlying open-end fund. Commenters suggested that these investments be excepted to the same extent
as the underlying open-end funds.
48 Portfolio managers' short-term trading in fund shares has been an issue in our recent enforcement actions. See, e.g., Putnam, supra
note 3.
49 Rule 204A-1(c).
50 See, e.g., In the Matter of Monetta Financial Services, Inc., Robert S. Bacarella, and Richard D. Russo, Investment Advisers Act
Release No. 2136 (Jun. 9, 2003) (investment adviser to mutual funds improperly allocated IPO shares in which funds could have
invested to certain access persons of the funds without adequate disclosure or approval); In the Matter of Ronald V. Speaker and
Janus Capital Corporation, Investment Company Act Release No. 22461 (Jan. 13, 1997) (portfolio manager made a profit on same
day purchase and sale of debentures in which fund could have invested, and failed to disclose transactions to the fund or obtain prior
consent of the fund); U.S. v. Ostrander, 999 F.2d 27 (2d Cir. 1993) (affirming conviction of portfolio manager for accepting unlawful
compensation where she purchased privately offered warrants of a company whose securities she acquired for the fund).
51 Rule 204A-1(d). Firms with only one access person are generally one-person operations. It would make little sense to require the
individual to pre-clear investments with himself. See supra note 38.
52 Advisers that elect to prohibit their access persons from investing in IPOs and private placements would not have to include this
pre-clearance provision.
53 Rule 204A-1(a)(4). We adopted a similar provision under section 406 of the Sarbanes-Oxley Act. See Disclosure Required by Sections
406 and 407 of the Sarbanes-Oxley Act of 2002, Securities Act Release No. 8177 (Jan 23, 2003) [68 FR 5109 (Jan. 31, 2003)].
54 Our understanding is that penalties for violations vary from one firm to another, and depend on the type of violation involved.
Employees may be required to cancel trades, disgorge profits or sell positions at a loss, and may face internal reprimands, fines,
or firing.
55 Rule 204A-1(a)(5).
56 Id. These written acknowledgements may be made electronically.
57 Rule 204A-1(a). Some firms may, in their code, reserve the right to waive compliance with certain of the code's provisions. Of
course, if a code provision is required by new rule 204A-1 (or by rule 17j-1), the advisory firm cannot waive a supervised person's
compliance with that provision.
58 Advisers to investment companies must provide the investment company's board of directors with an annual report describing any
issues arising under the code of ethics. See rule 17j-1(c)(2)(ii). Such annual report must include a discussion of any material violations
of the code and whether any waivers that might be considered important by the board were granted during the period.
59 Rule 204A-1(a)(3).
60 Currently, these sections lay out fairly complex requirements for the information that an adviser must keep regarding personal
securities transactions of “advisory representatives,” which include the adviser's personnel, directors, officers and partners.
61 See supra note 53.
62 An adviser could, for example, record the facts and circumstances surrounding a violation of the code, but omit mention of the
employee who brought the problem to the adviser's attention.
63 Rule 204-2(e) (retention period of five years from the end of the fiscal year during which the last entry was made on such record).
64 One commenter suggested that the acknowledgement be kept only for five years after it was made. We are not adopting this suggestion,
because it could mean that an adviser would have no records of acknowledgement from long-term employees.
65 In addition, records supporting decisions to approve access persons' acquisitions of IPOs or private placements must be retained for
at least five years after the end of the fiscal year in which the approval is granted.
66 We are amending Item 9 of Form ADV Part II, which asks whether the adviser or a “related person” (that is, a person that controls the
adviser, is controlled by the adviser, or is under common control with the adviser) participates or has an interest in client transactions.
In April 2000, we proposed a new version of Part 2 that called for a narrative disclosure brochure, and which moved this disclosure
topic to Item 10.
67 An investment adviser that disclosed its policies and procedures but then materially deviated from them may be subject to action
under section 206 of the Advisers Act.
68 Rule 17j-1(d)(2)(iv).
69 Rule 17j-1(d)(1)(i) and (iii).
70 Rule 17j-1(d)(1)(ii).
71 Rule 17j-1(d)(2)(vi).
72 Rule 17j-1(a)(1)(i).
73 In addition, the directors, officers and general partners of a fund are presumed to be. access persons of the fund.

74 We are adopting amendments to rule 204-2, the recordkeeping rule under the Advisers Act, to address documentation of advisers'
compliance with rule 204A-1. We are also amending Part II of Form ADV, which specifies certain information investment advisers
must disclose to their clients, to require advisers to include a discussion of their codes of ethics and make copies available to clients
upon request. We are adopting amendments. to rule 17j-1, the code of ethics rule under the Company Act, to conform certain of its
provisions to those in new rule 204A-1.
75 Section 9(a) of the Investment Company Act [15 U.S.C. 80a-9(a)] prohibits a person from serving as an adviser to a fund if, within
the past 10 years, the person has been convicted of certain crimes or is subject to an order, judgment, or decree of a court prohibiting
the person from serving in certain capacities with a fund, or prohibiting the person from engaging in certain conduct or practice.
76 See, e.g., 29 U.S.C. 1111(a) (prohibiting a person from acting in various capacities for an employee benefit plan, if within the past 13
years, the person has been convicted of, or has been imprisoned as a result of, any crime described in section 9(a)(1) of the Investment
Company Act [15 U.S.C. 80a-9(a)(1)]).
77 Although the Commission is not adopting the proposed requirement that advisers maintain these records electronically, as previously
noted we have strong expectations that most advisers will need to maintain these records electronically in order to meet their
responsibilities to review these records and monitor compliance with their codes.
78 We understand, however, that many advisers have already adopted codes of ethics for their firm and their employees. We are unaware
whether these firms charge higher advisory fees than firms that have not yet adopted codes of ethics.
79 Based on our records of information submitted to us by investment advisers in Part 1 of Form ADV through December 10, 2003,
approximately 1,500 advisers report that they manage portfolios for investment companies.
80 The Commission is not adopting its proposal to require quarterly reports indicating that no transactions were effected.
81 This is based on Form ADV data (under Item 5.A of Part 1A) submitted to us by 8,019 SEC-registered investment advisers through
December 9, 2003.
82 44 U.S.C. 3501 to 3520.
83 See section 210(b) of the Advisers Act [15 U.S.C. 80b-10(b)].
84 See rule 204-2(e) [17 CFR 275.204-2(e)].
85 Rule 204A-1(a).
86 8,019 advisers x 6 hours = 48,114 total annual hours.
87 This estimate is based on each adviser having on average 84 non-clerical and 16 clerical employees.
88 Over any two-year period, 100 copies of amendments in year 1 + 10 copies of complete code for new supervised persons in year 1
through 2 = 110 copies, divided by 2 years = 55 copies.
89 0.05 hours per copy x 55 copies per year = 2.75 hours. 2.75 hours x 8,019 investment advisers = 22,052.25 hours total.
90 Rule 204A-1(a)(3).
91 This average is based on Form ADV data that asks for the total number of employees. We believe this estimate overstates the typical
number of access persons for an adviser, since the data is skewed significantly higher by the largest (in terms of number of employees)
100 advisers.
92 We estimated in the Proposing Release that quarterly transaction reports would take 0.6 hours per access person. In a change from
the proposed rule, the adopted rule does not require quarterly reports for any quarter in which the access person makes no security
transactions. In the Proposing Release, we assumed for purposes of estimating access person reporting that access persons would
typically file transaction reports indicating no transactions in 3 out of the 4 quarters. Thus we have reduced by half the amount of
time allocated for access person transaction reporting, as discussed below.
93 (0.7 hours holdings report + 0.6 hours transactions report) x (84 access persons x 8,019 investment advisers) = 875,675 hours.
94 Eliminating these quarterly reports decreases the burden of quarterly transaction reporting on access persons from 0.6 hours to 0.3
hours, or a total of 202,079 hours (0.3 hours x 84 access persons x 8,019 advisers = 202,079). Our revised total burden is as follows:
48,114 hours by advisers to record their codes of ethics + 673,596 hours for reporting by access persons + 22,052.25 hours for advisers
to deliver copies of codes and amendments = 743,762.25.
95 Prior to the adoption of the amendments herein, the approved annual aggregate information collection burden was 1,651,324.2 hours
(based on 7,790 advisers) or 211.98 hours per firm for rule 204-2.
96 In the Proposing Release we estimated that the reduction would be 25.2 hours per firm (0.3 hours per access person to record the
transactions x 84 access persons per firm). This results in a reduction on a per firm basis to 186.78 hours (211.98 - 25.2).
97 The new recordkeeping obligations under the rule include the maintenance of access person holding and quarterly transaction reports,
retention of the codes of ethics, supervised person acknowledgments, records of the names of the firm's access persons, records of
any violation of the codes of ethics and any action taken, and records of any decision under rule 204A-1 to permit an access person
to invest in an initial public offering or private placement. In the Proposing Release we estimated that these new collections would

add 5 hours on average per adviser to the annual hour burden of the rule. This results in a per firm annual burden estimate of 191.78
hours (186.78 + 5).
98 In the Proposing Release, we estimated no incremental burden in connection with the proposed requirement for advisers to maintain
access person reports electronically. We estimated advisory firms would be able to use their existing computer software, taking
transaction data electronically from the same broker-dealers that advisory firms use to obtain electronic information about client
transactions.
99 191.78 hours per adviser x 8,019 advisers = 1,537,883.8 hours.
100 0.25 hours preparing a description of the code of ethics + 6.7 hours responding to requests for copies of the code of ethics (based on
a 10% request rate by the 670 average number of clients per adviser and 0.1 hours for delivery).
101 (0.25 hours + 6.7 hours) x 8,019 advisers =55,732 hours. 46,921 hours (existing total) + 55,732 hour increase = 102,653 hours.
102 17 CFR 275.0-7(a).
103 This estimate is based on the information submitted by SEC-registered advisers in Part 1A of Form ADV as of May 1, 2004.
104 17 CFR 270.0-10.
105 This estimate, which is current as of December 2003, is derived from analyzing information from Form N-SAR and various databases
including Lipper. Some or all of these entities may contain multiple series or portfolios. If a registered investment company is a small
entity, the portfolios or series it contains are also small entities.
106 These records are: copies of the codes of ethics, records of violations of the codes of ethics, records of personal securities transactions
and holdings reports, records of persons subject to reporting under the codes of ethics, records of decisions relating to approvals
of investments in IPOs or limited offerings, and records of supervised person acknowledgments of the code of ethics. Advisers are
generally required to retain these records for five years.
107 5 U.S.C. 603(c).
Release No. 2256 (S.E.C. Release No.), Release No. 26492, Release No. IA
- 2256, Release No. IC - 26492, 83 S.E.C. Docket 828, 2004 WL 1488752
End of Document © 2012 Thomson Reuters. No claim to original U.S. Government Works.

MANAGING ETHICAL RISK
THE SECURITIES INDUSTRY AND THE LAW
By
Larry Alan Bear and
Rita Maldonado-Bear
Stern School of Business
New York University*
ABSTRACT
We examine the interplay of markets, ethics and law, and rising demand for
ethical behavior in a market driven society coping with the promise and peril of
rapid technological innovation. We analyze the market affecting role of our
Common Law/Rule of Law System, its adaptability to social need and resultant
legal and regulatory action promoting adherence to the spirit as well as the letter
of the law. We provide examples of manager and firm harm from sanctions
imposed despite adherence to “the rules.” Finally, we discuss competitive
market/common law interplay in the coming era of the genome.
*
Larry A. Bear Tisch Hall 305, 44 W 4th St. Suite 301, New York, NY 10012 Phone (212) 998-0049 Fax (212)
995-4230 <lbear@stern.nyu.edu>
Rita Maldonado-Bear Tisch Hall 903, 44 W 4th St. Suite 9-190, New York, NY 10012 Phone (212) 998-0360 Fax
(212)995-4233 <rmaldona@stern.nyu.edu>We want to express our gratitude to our editor Professor Connel
Fullenkamp for the invaluable editorial help and encouragement that he provided throughout the entire editorial
process.
Page 1
INTRODUCTION
…a major asset of our nation (is) the integrity of our financial system.
Trust is a principle of central importance to all effective financial systems.
Our system is strong and vibrant in large part because we demand that
financial institutions participating in our markets operate with
integrity…When confidence in the integrity of a financial institution is
shaken, or its commitment to the honest conduct of business is in doubt,
public trust erodes and the entire system is weakened.
– Alan Greenspan
Testimony before a U.S. Senate Committee, November 27, 1995
In the United States today, both the law and the regulators are demanding an increasing
attention to ethical behavior on the part of firms participating in our domestic capitalist system.
This is, in substantial measure, due to our society’s need for, and rising expectation of, such
behavior in the face of the rising power of competitive markets in the life of the body politic.
In Part I of this paper, we propose to explain why and how our Common Law/Rule of
Law system allows for effective legal and regulatory responses to social demand and, in essence,
promotes adherence to the spirit of the law in addition to the letter of the law. In the process, we
will give examples of specific legal and regulatory responses in our time to unethical market
behavior illustrating both the insufficiency, and clear inefficiency, of mere compliance with
existing rules. In Part II of this paper we intend to confront the extraordinary demands being
made upon the law and the regulators, in our Rule of Law system, to honor society’s needs and
expectations relative to trust, integrity and overall fairness in competitive markets in the face of
rapid, and often bewildering technological development. We will focus at this point on the
unique adaptability of the common law process, in order to suggest how our legal and financial
systems might best adapt to this new century in cyberspace. In our Conclusion, we will note
briefly the applicability of our analysis of the markets-ethics-law process in securities markets, to
Page 2
another technology driven, market-related development in our time---a challenge to the law and
to regulators so severe as to involve the possibility of substantive change in the fundamental
nature of our society.
I. The Common Law/Rule of Law System and Its Response to Some Questionable Securities
Markets Behavior
The United States legal system has its roots in the Constitution of the United States. As
the protector of constitutional values, the legal system is both values-based and adaptable to
change in the interpretation of those values. Adaptability is key to maintaining the integrity of
the original constitutional contract.
Our constitutional values, due process and separation of church and state, for example,
are permanent at base, but they are not immutable. Such values set forth in the Constitution, as
reinterpreted, but never rejected by the citizenry in succeeding generations1, are the foundation
upon which our society is built, and by means of which it functions as it does. And property
rights, the freedom to contract, and access to an independent judiciary are examples of the
fulfillment of these values. Upholding these values is an obligation, and our financial
institutions, no less the citizenry in general, are bound to meet that obligation or risk turning the
Constitution into mere pieces of paper2. However, the practical, workable shape these values
assume, and how they are both protected and enforced, is determined by a free, democratic
citizenry in succeeding generations under changing conditions.
The Rule of Law in a Constitutional Democracy must function as the Constitution does:
its practical, workable shape must be subject to change under changing conditions. The end of
the Rule of Law is always to strengthen and uphold the values inherent in the original contract—
by assuring that we and our institutions, including the financial, fulfill our obligations to uphold
those values as well.
Our Rule of Law functions through a process remarkably well suited to the task. That
process is “The Common Law.” The common law system originated in England and was
adopted in the United States. The majority of western nations utilize a different legal process,
based upon a comprehensive set of written statutes referred to collectively as a Civil Law Code.
The answers to legal questions must proceed from what is within the Code, not from outside it.
Page 3
The individual statutes can be changed. But until they are, they govern all cases. The following
quote illustrates how the common law system differs from a Civil Law Code system:
Our common law is different. It is generally derived from principles rather than rules; it does not
consist of absolute, fixed and inflexible rules, but rather of broad and comprehensible principles
based on justice, reason and common sense. Its principles have been determined by the social
needs of the community and have changed with changes in such needs. These principles are
susceptible to new conditions, interests, relations and usages as the progress of society may
require.3
Judges make the common law. But they must observe two very important requirements
while doing so. First, they must honor stare decisis which means literally that they must honor
the laws that have already been laid down in very similar cases. But stare decisis is not
inviolable. What judges who wish to depart from precedent must do is elucidate very carefully
good cause to repudiate it. And they are subject to reversal by a higher (appellate) court.
Second, judges must reduce all their opinions to writing, so that they are on the record as to
reasoning and result. At the trial level there is a full transcript. All appellate opinions are printed
and available for reading in law libraries and, more recently, on the Internet. These two
requirements assure a satisfactory measure of stability in the law so that people and organizations
might have guidance on how to act in legally-related situations.
There are plenty of statutes passed in the United States at the Federal and State level, as
well as allied regulations. Nevertheless, our basic body of law is common law based, and the
principle of incorporating change when necessary permeates our legal process. The common
law, in actuality, is neither loose nor unduly broad for reasons we will soon detail. However, it is
certainly more changeable than is civil law. Free, competitive market managers in the United
States neglect that reality at their peril, as we hope to demonstrate.
Only Congress can create federal law, and state legislatures state law; however, since no
legislative body could possibly deal with every request for bank mergers, or drug releases, or
spectrum licenses, nor maintain oversight over all industries, they pass legislation appointing
administrative agencies to do so, called enabling legislation. This legislation, to put it succinctly,
sets out priorities and ground rules. The administrative agency then fleshes them out.4 In the
face of the large delegations of power to administrative agencies, where lies the common law
concern about carefully, but necessarily, taking into account in decision-making the social needs
conceptions and concerns of the body politic? That concern, too, lies within the purview of the
Page 4
administrative agency—within the bounds of their congressional mandate. Thus agencies, such
as the SEC, deal not only with what brokerage houses and investment banks do in fact (their
actual conduct), but with what they ought to do (their ethical conduct) as well.
In sum, we emphasize that in our United States constitutional society, we are involved in
a constant attempt to preserve those values that cannot be allowed ever to change. We do so by
re-interpreting and reshaping them through our Common Law/Rule of Law process to make them
meaningful in a current social context. The values are the ends, the process the means to achieve
those ends.
We proceed now to some securities market activities that illustrate the key corollary here:
underlying business values such as fairness, integrity, transparency and trustworthiness should
not be allowed to change either, although the shape they assume in the current social,
technological context certainly may change. The nature of the changes, one might argue, can
best be determined by markets and market players. A serious problem there, however, lies in a
general market player belief that rules are rules, and playing strictly by them is all the market
player is required to do. Consider the following quotation:
As an anonymous participant in financial markets, I never had to weigh the social
consequences of my actions…I felt justified in ignoring them on the grounds that I was
playing by the rules…(this) makes it all the more important that the rules that govern markets
should be properly formulated. The anonymous participant can ignore moral, political and
social considerations, but if we look at financial markets from the standpoint of society, we
cannot leave such considerations out. Although we are justified in playing by the rules, we
ought to be concerned with the rules by which we play.5
The preceding quotation from one of the most influential players in the world financial
markets raises two issues. Is it true that all participants in U.S. securities markets are “justified”
in playing by the rules even with the knowledge that they are thereby causing social harm? And
if participants do believe and act upon that “justification”, how then are they to manifest their
“concern” about “ignoring moral, political and social considerations” and the social harm they
have caused? Ought they to lobby legislators to force them to be ethical?
George Soros, the source of the quotation, has actually shown his concern very clearly by
being a very active personal participant in, and major financial contributor to, many positive
socio-political endeavors. Our purpose here is not to fault him, but to challenge his dichotomy:
that it is “right” to simply play by the rules regardless of any and all political, social, and ethical
consequences to anyone, anywhere; however, at the same time, players must be concerned,
Page 5
outside the game, with the nature of such rules as produce morally, politically and socially
unacceptable results.
This ethical compartmentalization is not acceptable generally in its determination that
behavior demonstrably dangerous to the welfare of others is demanded by business necessity, and
protected by rules which were made (or neglected to be made) by representatives of those
actually harmed. As a matter of principle, shifting the blame for destructive behavior onto the
alleged proxies of those destroyed, is unacceptable outside of markets. For example, terrorist
actions against innocent civilians, which the terrorists justify by reference to the active policies of
the civilians’ own governments, are in turn destructive of the aspirations of the terrorists’
peoples. Certainly the dichotomy is unacceptable in a democratic republic where basic values
representing the citizenry’s choices about how it wishes to live and be governed, are required to
be enforced by a socially adaptable Common Law/Rule of Law. One’s duty to those values is not
waived while one is engaged in the market game, precisely because how that game is played
deeply affects the content of those values.
We also oppose another part of Soros’ statement, which says that in the fiercely
competitive struggle for profits “playing by the rules” is all that can be asked of any participant,
or that ethical behavior beyond the rules will cause the actor to be smashed by others who steer
clear of ethical action. Our contrary assertion is twofold. First, given the nature and makeup of
our common law, any securities market manager who does steer clear of ethical action is not only
headed for serious personal trouble, but may well be taking his firm, his stockholders, and even
the reputation of his industry down with him. Second, we are convinced that ethical and socio-
political insights and skills should be required of every manager with authority to act for his firm
in securities markets operations. Such insights and skills are intimately related to the value of the
firm, as the following examples help to show.
The Federal Sentencing Guidelines

Until very recently, the idea of holding corporations themselves criminally liable for illegal
actions of their employees was subject to much criticism.6 The actual record regarding corporate
conviction for crime shows that prior to the late 1980s and the early 1990s, very few cases were
even brought to court. Those that were, were targeted at small companies, not larger, publicly
Page 6
held companies with actively traded stock.7 The situation changed drastically in 1991, the year in
which a major tool for punishing corporations – “Chapter 8” – became the law of the land.
In 1984, Congress passed The Sentencing Reform Act.8 That law set up a Federal Sentencing
Commission charged with developing guidelines to deal with three basic problems: disparity in
sentencing for federal crimes, uncertainty in sentencing, and an unjust lack of focus on white
collar crime. Some judges, academics and lawyers were critical of the sentencing law for various
reasons, but it was declared constitutional in 1989.9
Initially, the sentencing guidelines did not deal with organizations. But they went beyond
natural persons, focusing on organizational white collar crime, in 1989 amendments which were
sent to Congress in 1991. A new chapter was then added to The Federal Sentencing Guidelines:
“Chapter 8: The Sentencing of Organizations.” That chapter, with all of its provisions, became
effective on November 1, 1991.10 Now organizations themselves could be held responsible for
violations of any federal law. There are some 3,000 or so federal laws available for breaking,
involving securities, commercial banking, anti-trust, defrauding the government, and many more.
The operational market areas covered by the Federal Sentencing Guidelines are broad. Forty-six
separate categories of offenses are listed under broad headings; for example, “commercial bribery
and kickbacks” is one of six general offenses listed under “Offenses Involving Property.” Each
offense arises out of a particular area of market operations covered by federal law, as stated
above.11
Chapter 8 is evidence of official government recognition of an important ethical reality: that
much of the illegal action of an organization’s employees arises out of the corporate culture
within which they function. This is the organizational link to white collar crime. A definition of
“corporate culture is to be found in this organizational statement:
Our corporate culture…is the sum total of what we believe and think, how we work together
as colleagues and how we conduct ourselves as individuals. It is the way we treat our clients,
our shareholders, our neighbors and the public in general.
It is who we are. And while our corporate culture is by nature indefinable, it begins and ends
with certain principles that underlie our success as a business and as individuals. Our future
growth and prosperity depend on our continued commitment to these principles and our ability
to instill them in others.12
The current government focus on who and what we are – our behavior and the content of our
corporate character – is but one example of corporate responsibility going beyond “the rules.”
The Federal Sentencing Guidelines, according to Deputy Attorney General Eric Holder “enables
Page 7
the government to address and be a force for positive change of corporate culture, (to) alter
corporate behavior, and (to) prevent, discover and punish white collar crime.”13
The Federal Sentencing Guidelines have two distinguishing characteristics. First, they
provide very specific penalties for specified violations. Judges must apply these penalties and no
others, unless their reasons for deviation are fully explained and justified, in writing; for
example, deviation may be allowed on prosecutor recommendations because of the unusual
extent of cooperation and assistance by the defendant. There are very few justifications for
departing from the Guidelines. Second, the penalty system for organizations is based upon a
government commitment to a process best referred to as the carrot and the stick. Penalties are
adjusted upward or downward within the mandated categories depending upon the steps the
organization has taken, prior to the legal infraction, to avoid criminal conduct, and the
cooperation with the government the organization has evidenced once an infraction has taken
place. Some attention is also given to the involvement or non-involvement of high level
organization personnel in the infraction.
Figure 1 lists offense levels on the left. They are based on the government’s harm priorities.
Minor offenses are ranked at 6 or less; more serious ones, such as certain anti-trust offenses, can
be ranked as high as 38 and above. The dollar fines are shown in the right hand column: as little
as $5,000 for a minor one, $72,500,000 for a very serious one.
Because of the carrot and stick approach embedded in the Guidelines, a level 38 infraction
would not be likely to result in exactly $72,500,000. That figure would probably be adjusted up
or down. The direction of the adjustment would be determined by several factors, particularly
those set out in the second characteristic discussed above. Past infractions of federal law are also
taken into consideration. All those elements are, together, the basis for what is referred to as the
organizational “culpability score.” The culpability score ranges from a low fraction up to 4. If a
particular corporate crime is at level 38 or above, and the culpability score is at 4, the total fine
for that one infraction then would be $290,000,000, an amount calculated to send a clear and
convincing message. Conversely, there are actions the corporation might have taken that would
mitigate the
Page 8
Figure 1 CORPORATE FINES
Offense Level Amount

6 or less $5,000
7 $7,500
8 $10,000
9 $15,000
10 $20,000
11 $30,000
12 $40,000
13 $60,000
14 $85,000
15 $125,000
16 $175,000
17 $250,000
18 $350,000
19 $500,000
20 $650,000
21 $910,000
22 $1,200,000
23 $1,600,000
24 $2,100,000
25 $2,800,000
26 $3,700,000
27 $4,800,000
28 $6,300,000
29 $8,100,000
30 $10,500,000
31 $13,500,000
32 $17,500,000
33 $22,000,000
34 $28,500,000
35 $36,000,000
36 $45,500,000
37 $57,500,000
38 or more $72,500,000
Page 9
offense level, say down to 28. Given an insignificant “culpability score,” the total penalty could
be, say, $10,000,000 rather than $290,000,000, a rather significant savings.
One major before-the-fact mitigator is the existence within the organization of “an effective
program to prevent and detect violations of the law.” There are 10 elements that make up such a
program, and they are contained in the Guidelines manual—a publication with which all
corporate compliance officers are intimately acquainted. The elements encompass compliance
standards and procedure; oversight by high level personnel; due care in delegating authority;
effective communication of the program within the company and steps taken to achieve
compliance. Included here is a “reporting system” employees might use without fear of
retaliation, to encourage whistleblowing. There are other elements, but the key is to have the
organizational efforts so focused on prevention and detection as to constitute “due diligence.”14
Of course, the government cannot force any private employee into having such a program as
described before the fact. But after the fact, in addition to the severe, unmitigated penalties that
could be levied against the firm, a program can then be forced upon it. This brings us to the
supreme organizational punishment, not listed in Figure 1. It is called “Probation.”
Organizations, in practice, go to very great lengths to avoid it, even agreeing to pay high dollar
fines. An organization placed on probationary status for serious infractions will be forced to put
“an effective program” in place; could be assigned an overseer appointed by the government to
remain on site for a specified period of time to watch over the new program and even more
general corporate activity; will have to make books and records available to the government on
demand; and will be held to making all penalty payments in full and on time.
The Guidelines apply to all infractions of federal law subsequent to November 1, 1991. They
are, to our knowledge, the only such body of law in the world focused on corporate behavior and
calculated to motivate the maintenance of a corporate culture that actively promotes lawful and
ethical behavior. The word “ethics” does not appear specifically in Chapter 8. However, on the
ground, in actual practice, government regulators are very much affected by the presence, or the
absence, of a corporate code of ethics which actually provides support for the corporate
compliance program.15 The reason for this practical ethics requirement has been stated succinctly
by the author of the most important legal treatise extant on compliance programs and the
organizational sentencing guidelines:
The dynamic nature of business crime also suggests that no compliance program can truly be
effective if it neglects the broader subject of ethics. With laws (or the interpretation of laws)
Page 10
subject to change on little notice, ethical reasoning and instincts can act as an all-important
safety net. A purely legalistic approach, by contrast, may ill serve not only ethics, but
compliance itself. A limited approach may also be unsatisfying to many employees as well as
to others in a company’s community-such as customers.16
The Organizational Sentencing Guidelines, however, do not substitute the corporate offender
for the individual offender. The complete Federal Sentencing Guidelines punish both, severely.
In fact, corporate punishments can be mitigated when, in a timely fashion, the corporation
cooperates with the government by self-reporting its offenses and discloses to the government all
pertinent information sufficient for law enforcement personnel to identify the individuals
responsible for the criminal conduct. In other words, employees who continue to believe that
they are acting properly as long as what they do satisfies the prevailing corporate behavior
standard (“meet that bottom line if you want to succeed, no matter what”) are in for a rude
awakening and serious personal punishment when that same corporation suddenly hangs them
out to dry. Jail time is very often their fate.
The Federal Sentencing Guidelines pose enormous risks for business and for individuals
when the rules are broken and make very clear as well, that ethical behavior beyond specific legal
requirements plays an important role in how, when, and to what extent the sanctions attached to
those rules are applied. The Soros dichotomy would hardly hold up here, either for the firm or
for the individual.
In 1999, in addition to bargained and settled organizational cases under the Guidelines, 255
organizations were sentenced under Chapter 8, a 15.9% increase from 1998. Fines were imposed
on 200 organizations. The sentenced organizations pled guilty in 91.4% of the cases; 8.2% were
convicted after trial. One defendant pleaded nolo contendere. As in 1998, fraud was the most
frequent offense committed by an organization. The highest fine in 1999 was $500,000,000.17
Some 56,000 individual defendants were reported to the Commission under the Guidelines in
1999, up from some 51,000 in 1998. The second most frequently applied of the guidelines,
behind drug trafficking, was that pertaining to the crime of fraud.18
It only remains to be pointed out that neither the Federal Sentencing Guidelines, nor any
other legislative responses to societal concerns about unethical market behavior are “civil law”
responses. They are the legal result of a common law process whose basic purpose is to eschew
the civil law function of reducing all behavior to inviolate rules.19
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While many securities firms have run afoul of the Sentencing Guidelines in such areas as
insider trading and other forms of fraud, such as the Salomon Brothers traders’ attempt to corner
the Treasury Bond Market, we complete this section of the paper with some examples of
seemingly within-the-rules behavior of securities firms specifically, which raise ethical issues
and legal issues as well. We also note how in some cases these practices are triggering the
common law process discussed above.
IPO “Spinning” and Special Commissions

In the world of Wall Street “spin desks” (as of 1997):
Many investment banks silently allocate chunks of hot new stocks to the personal brokerage
accounts they hold for corporate executives and venture capitalists – “spinning” or “flipping” the
shares on the day of the IPO for quick profits – in an apparent bid for business from the executive
firms…’At its extreme an IPO is priced Wednesday. Thursday morning you call 25 venture
capitalists and say: “by the way, XYZ just went public at 15. It’s now 30. You just sold your
allocation at 29 ½. I hope you’re happy.’20
Should this kind of spinning be looked at as a quid pro quo? If so, the executive who takes
the profit has to deal with the issue of breach of fiduciary duty. Fiduciary duty posits a very
special relationship between principal and agent. One aspect is that the fiduciary has an
affirmative duty not to profit by virtue of his position as a fiduciary; another is an affirmative
duty to disclose to the principal any and all information in his possession that bears upon any
decision the principal is to make. Both duties are inconsistent with taking spin money as, say, a
chief financial officer of X Company, or helping to decide on using the spin profits’ investment
bank to underwrite X Company’s new stock issue.
Many firms who spun and then “flipped” IPO stock for major firms’ officers (turned it over
quickly for a profit) had been preventing lesser customers of the firm, who manage to get a small
piece of an IPO, from “flipping” the very same stock. The method used was to inform all of the
firm’s brokers that if their regular customers do not retain their stock for 20 or 30 or however
many days, then the broker loses his commission on the original sale.
The “spin” broker’s refrain is of course, “everybody does it and they always have.”
Inevitably, one of society’s message bearers, in this case in the form of the Wall Street Journal,
exposes the practice to the light of day for all those in and out of the game to see, and with easily
perceivable distaste. The “justice, reason and common sense” of the common law process is set
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in motion, and the SEC is now investigating the process. State securities regulators have also
come down heavily on spinning as a “dishonest and unethical business practice” that puts the
firm’s brokers in direct contravention with the financial interests of their customers.
Massachusetts regulators have charged brokerage firms with wrongdoing here and stated that
“requiring firms to abandon (these) policies is one of the more severe sanctions we will
impose.”21 It would be overstating the case to say that spinning is now extinct. However, if not
abandoned, spinning is down by a considerable degree. And those who insist on playing that
game are now opened up to lawsuits, in which the “rules” will be no defense.
Finally, in connection with IPOs, there is the issue of just how broker-dealers make
allocations of these (at least, formerly) “hot” stock issues. The “rules” would seem to have been
clear: how broker-dealers allocate IPOs, or any stock issues, is strictly their business. But it is
now alleged that in order to obtain shares of hot IPOs, some investors paid hefty stock trading
commissions, well above the going rate, to particular broker dealers. According to the SEC, this
might be interpreted as commercial bribery -–a whole new slant on the good old “rules,” and a
clear response to strong ethical concerns. If, in fact, the mass of consumers were frozen out of
hot issues because hefty commission agreements were key to obtaining the money-tree IPO
issues, social concern is clearly warranted. Whether or not the SEC can prove direct connection
between fee and allocation is not necessarily the issue: tons of documents have been
subpoenaed, United States and New York City prosecutors are investigating and the securities
industry has suffered another blow to its already damaged image.22 Clearly, there is a sizeable
group of Wall Street defendants, former employees and sensitized working managers who have,
quite recently, observed at close hand this example of the common law process at work. There
are two other examples:
“Soft Dollar” Services

Investment managers often get an array of services from many brokerage firms to whom they
give their business. It has even been estimated that the soft dollar brokerage business accounts
for as much as 40% of all stock trading.23 Soft dollars are certainly not all unethical. Some of the
higher commissions (soft dollars) paid to brokers result in an investment manager being provided
with valuable extras, including independent research such as stock reports and data feeds, which
do not come automatically with purchase and sale execution. That is not a kickback from the
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broker; rather, it is a return for the higher commission paid. However, investment managers
rarely inform their clients that they are actually paying higher than normal broker fees, nor,
certainly, what they are getting in return. This becomes a problem when the broker returns part
of the excess fee in the form of payment for new top-of-the-line furniture for the manager’s
office.
The result of public exposure to the soft dollar phenomenon was an 18 month sweep of 250
investment advisors and 7 broker-dealers by the SECs Office of Compliance. The concern of
Chairman Levitt went beyond excessive commission rates to such areas as the overtrading of
accounts, and inferior execution by less efficient brokers to satisfy a soft dollar obligation. These
are unethical behaviors, failing the test of fundamental fairness to one’s customers. Subsequent
to the compliance report, the SEC moved to tighten up section 28(e) of the securities laws, which
does not prohibit soft dollars per se. Full disclosure to clients is the watchword now and, in the
case of the $5.5 trillion dollar mutual fund business, better disclosure to investment advisors’
boards.
Securities “Clearing Firms” and Responsibility For Activities of Their Customers

Clearing firms are trade processors. They are large brokerage houses which are hired by
smaller firms, called introducing brokers, to execute trades for them, maintain client records,
send out trade confirmations and monthly statements and also settle the smaller firm’s
transactions. By this clearing firm arrangement, the introducing broker is able to use the cachet of
the powerful, well-known firm, and the powerhouse firm is able to make a tremendous amount of
money. The clearing firm requires introducing firms to put up a deposit, usually some $250,000.
It also levies a “ticket charge” of $10 to $25 on each trade it conducts for the introducing broker.
It also charges interest, usually 1% per month, on margin loans it makes to these customers.24
Since 1982, when commissions were deregulated, clearing firms have not had legally
determined oversight responsibilities for their introducing brokers. The operating principle has
been to provide the service and earn the money for any introducing broker who hasn’t yet been
thrown out of the business. The ethical character of the still-in-operation introducing firm was
not regarded as the business of the clearing firm in any way; that is, no rule existed stating that it
was.
Page 14
Then A.R. Baron & Co., an introducing broker to its clearing broker, Bear Stearns & Co.,
went bankrupt. Baron was also charged by the Manhattan (New York City) District Attorney
with being a criminal enterprise that defrauded investors out of 75 million dollars. Bear Stearns,
whose clearing operations represented more than 25% of its multi-billion dollar business in
recent years,25 came under fire in connection with the A.R. Baron debacle. Bear Stearns cleared
for Baron in 1995, when Baron’s credit was so bad it was unable to qualify for a corporate
gasoline credit card. In that same year, Baron paid $1.5 million in fines in an NASD settlement
where it was alleged that it executed trades for customers at unfair and unreasonable prices. By
the end of that same year, Baron’s capital fell below the regulatory minimum. Additionally, a
Baron customer notified Bear Stearns of unauthorized trading in its accounts. Bear Stearns
simply referred the matter back to Baron. In October of 1995, Bear Stearns injected $1.1 million
of its own money into A.R. Baron to keep it afloat when its capital once more fell below the
statutory minimum. The SEC ordered Baron to halt all operations in May, 1996. It filed for
bankruptcy two months later, and less than a year after that came under formal investigation by
the Manhattan District Attorney.26
By early June of 1997, the NYSE and NASD had their officials meet with several clearing
firm officials. One firm, Oppenheimer & Co., announced plans to stop processing trades for any
introducing broker client accused by regulators of charging excess commissions.27 Bear Stearns’
position was that a clearing broker had neither access to, nor control over, any introducing
broker, and if subjected to customer claims, might well get out of the business altogether.28 The
SEC then let Bear Stearns know it was preparing to consider making civil securities fraud
charges against it, with attendant Sentencing Guidelines penalties if the U.S. Attorney went
further with criminal charges. A settlement was reached, with Bear Stearns agreeing to pay a
fine, and restitution to A.R. Baron customers of $25 million. The agreement apparently was that
Bear Stearns “contributed to” A.R. Baron’s activities—something short of “aiding and abetting”
fraud. Bear Stearns' senior executive in charge of its billion dollar a year clearing business,
Richard Harriton, later resigned.29
The key question here is not why Wall Street firms would accept no responsibility for
introducing brokers actions for a long time; rather it is how could a major investment bank fail to
see changes blowing in the wind? Hubris may well be part of the answer. But an argument
could be made that Bear Stearns’ admittedly strong compliance culture (nobody here is allowed
Page 15
to actually break the law), did not focus on ethical sensitivity at all. The notion that all action
still legal is per se ethical and beyond punishment, is not true in fact. What is true in fact is that
the Common Law/Rule of Law system assigns basic duties of care to those who are paid to
provide skilled services to others for a fee. And the definition and application of these duties are
susceptible to change – “to new conditions, interests, relations and usages as the progress of
society may require.”30 As between the consumer and Bear Stearns, the duty to take due care to
be informed about the behavior of the introducing broker, and to act responsibly (that is,
ethically) to avoid harm, ought to be upon Bear Stearns, and any other clearing broker.
II. The Common Law/Rule of Law System, Securities Markets Behavior, and the Technology
Explosion
Online trading is a coverall term for securities transactions entered into and completed on the
Internet using computer processes. The advent of online trading has already changed the
structure of the securities industry. According to recent data, more than 6.3 million U.S.
households had online trading accounts as of April, 1999.31 Online transactions in 1998 rose
from less than 11% of total stock trades in the first quarter to 13% in the fourth quarter. Given
that 400 billion shares of stock were traded on U.S. exchanges in 1998 (and far more since then),
that percentage constitutes a lot of cyberspace transactions. And according to The Wall Street
Journal (1999) the top 10 trading firms control over 91% of the total business.32
The advent of online trading has also changed the nature of the broker-client relationship.
Prior to 1997, technological inefficiencies in the market had provided only fast acting
professionals in possession of equipment and access to data with the opportunity for rapid daily
profits. Then came the NASDAQ bid-ask (point) spread collusion scandal, which had two
important results. First, the many brokerage firms allegedly involved in maintaining wider point
spreads in order to heighten profits paid out more than $1 billion in settlements. More important,
new NASDAQ Trading Rules were put into effect, providing greater data access to non-
professionals through more prominent display of their stock orders on the NASDAQ system.
Day trading could now become a game for everyone.
Many customers trade on the Internet much as they would on the ground: with a broker’s
advice, or data provided by his or her firm, with an eye toward risk tolerance, present financial
position, ultimate investment goals, and some substantive information on the companies in which
Page 16
they invest. But there are also “day traders,” whose goal is immediate profit. They often know
nothing at all about the company whose shares they buy and sell, other than the direction in
which they and their industry as a whole perhaps have been moving. And trading as they do
several times in a day, they may well lose sight of their current financial position.
The question now, put simply, is the following: given the changing nature of broker-client
relationships in cyberspace, what are, and what ought to be, the rules in this awesome new game?
Beyond that lies an even more difficult question: what new shape might this game assume –
perhaps shapes would be more realistic – and what are we to do about rules then?
It might be argued that we are in a brave new world in securities trading now, where the true
ethic is “assumption of the risk”: we are all fully responsible for our choices, win or lose, and
broker-dealer duty does not go beyond performing all mechanical functions with some
reasonable degree of care.
An ethic calling for the consumer’s full and complete assumption of the risk is no ethic at all.
It is nothing more than an excuse for intransigence by those who would argue for a right to be
paid highly for their expertise, in the face of a disappearing correspondent duty. And to negate
meaningful duty to investors in the presence of technological leaps would be to argue that
constitutional values are now outmoded—perhaps, even, that now is the time for a new,
electronic constitution.
This is a less than convincing argument to us. While we have no ability to predict the future
of securities markets in cyberspace, we are able to extend to cyberspace the issues already giving
rise to questions of law and regulation. Our position is that the Rule of Law will prevail, even on
the Internet. If it does not, competitive markets as we know them now will cease to exist, and
meaningful discussions on the issue of securities will be limited to self-defense and survival.
This is not to say that our basic constitutional values will not take new workable, practical legal
and regulatory shapes that cannot now be foreseen. But if private property rights and the sanctity
of contracts are to prevail, so must fundamental fairness to the free citizens of a democracy.
Outside of cyberspace, where almost all of us still live and conduct our business, there are
legal and ethical constructs for promoting proper behavior in broker-client relations. All
stockbrokers, mainly because of the asymmetry of information that exists between the buyer and
seller of securities, have some form of legal duty to every single client. The extent of that legal
duty depends on two central factors: the nature of the service relationship between the parties
Page 17
with regard to the transaction being done, and the extent of the information asymmetry between
them.
A broker receiving a simple buy order from a sophisticated client has a duty to that client.
But it is limited to the quality of execution only: proper timing and price. How that stock
performs is the client’s risk, not the broker’s. At the other end of the scale is the elderly widow,
completely lacking in market experience, who comes to a broker for advice on how to invest her
nest egg which is now $250,000 in bank CDs. Even here the broker’s duty may not be at the
level of fiduciary; however, the broker had better get a lot of information on this widow’s
preferences, risk profile, total assets and the like before making his investment recommendations.
The duty of care here is far higher than to our first client. And if the broker is handling a
“discretionary” account in which she has full authority to buy and sell for the client’s portfolio
according to the broker’s best judgement only, with no need for permission to make specific
trades, then the broker’s duty is fiduciary, and that is a very high duty indeed.
Given the varying duties of care on the ground then, how ought the law and the regulators
deal with these duties in cyberspace; that is, online? An investor choosing to invest online with
the advice and assistance of a broker is entitled to broker duties of care equal to any on-the-
ground transaction. For example, the New York Stock Exchange requires that brokers know
their clients’ overall goals, risk preferences and time horizon before they execute an order,
whether they recommend the particular transaction or they do not. This is referred to as the
“suitability” rule. The NASD holds brokers firmly to a suitability rule when the seller has
recommended the transaction, and is considering enlarging the duty to all transactions in
cyberspace. To what level of legal duty, exactly, should an online broker, lacking the normal on
the ground client relationship, be held? How about on-the-ground brokers operating in
cyberspace as well? Is their level of duty different?
A sizable percentage of arbitration cases in which customer-buyers prevail are based
presently on “unsuitable” investment grounds. In the face of any meaningful market retreat, the
ethical and legal issues of “knowing” and “suitability” could bring about an intolerable load of
damage claims.
It is difficult to contemplate a brokerage firm of any kind of making money for themselves in
the absence of any duty to act in their clients’ best interests and in an informed fashion.
Certainly, what is reasonable in cyberspace may require different suitability rules depending upon
Page 18
the nature of the relationship; however, whether it be mandatory pre-trading customer
information filing, trade blocking for particular customers of specified risky investments, or
something else, some duty of suitability must be implied, even in cyberspace, in a form dictated
by two things: first, the presence of transparency, honesty, and non-misleading behavior—the
hallmarks of the fairness and trustworthiness value; and second, reasonable accommodation to
the new structure and function of existing technology. As long as we continue to live under a
Constitutional value system upheld by the Rule of Law through the Common Law adaptability
process, we will find ways to efficiently utilize technology in an out of cyberspace, without
negating meaningful duties of care owed to the public by market managers and those they
supervise. If technology is allowed to pull beyond the Rule of Law, we might survive that event
as well—but not as residents of a constitution-based, democratic republic.
There are many issues to be faced in the new world of technology driven securities markets in
addition to that of the broker-dealer duties of care to investors. Much of this burden will fall, as
it has in the past, on the regulators. Regulators seeking to ensure the continued development of
the wealth creating function on the one hand, and the fairness and integrity and safety of the
markets on the other, are faced with a formidable task in a cyberspace with, as yet, indefinable
dimensions. In the face of technology developing exponentially, how does one keep one’s legal
and ethical bearings? The editor of a Wall Street magazine put the problem for regulators
somewhat in perspective:
Regulators are having as tough a time as everybody else trying to figure out what their new
priorities should be. We all need to move more carefully-There’s too much at stake from the
livelihood of market makers to the health of the nation’s economy.33
We argue that there are three general, but crucial considerations that relate to the coming
regulatory task in the securities market area. First, technology driven market change has outrun
our capacity to comprehend fully the meaning of what has already happened in our securities
markets, much less what ought to be happening in the future. Second, we face great difficulties
in doing cost benefit analysis regarding individual regulations in the presence of conflicts
between efficient markets and democratic values. Finally, we must continue to deal with the
reality of both politician and regulator conflict of interest, and self-regulating organization
conflicts as well.
To begin at the beginning: while our regulators do not truly understand the present or future
state of securities markets, they must act as if they really did. Questions of fairness, efficiency
Page 19
and safety must be faced since, every day, trillions of dollars, marks, pounds, euros, francs, yen
and such continue to change hands in various ways all around the world with some effect, surely,
on “the public interest.” And in addition, tremendous numbers of players feel justified in arguing
that public interest is irrelevant to them on the ground that they are playing by the existing rules.
Any argument that we should forgo all regulation, let the market sort everything out for itself
until equilibrium is reached, and in the meantime, “c’est la guerre,” is nothing short of
preposterous.
How, then, to proceed realistically in the whirlwind? We suggest utilizing a sensible general
approach to working in the face of uncertainty:34 regulators ought first to examine where current
securities markets changes appear to be taking us. They are pointed in the direction of rapid
institutional and product development, and diffused delivery systems, surely. These changes
create unique opportunities for creating wealth—and for increasing worldwide competition, and
risk as well.
As an example of such a change, we focus on one final development: the stock exchanges
themselves are in the process of changing their forms and possibly their responsibilities. We
have reached the stage where a four year old computerized stock trading service (an ECN or
“electronic communications network”) has applied to the SEC to become a brand new stock
exchange,35 and many other ECNs are waiting in the wings to apply as well. The SEC is studying
the issue, and could well grant such an application. In 1999, the SEC rule referred to as “Reg
ATS” took effect, which allows alternative trading systems to become stock exchanges. That
regulation is focused on the probability that ECNs would be good for market efficiency by dint of
rapid innovation and lowered transaction costs.
How should these cyberspace stock exchanges be regulated? And by whom? Should they
largely regulate themselves as self-regulating organizations? To what duties must they hold
themselves? SEC market regulators know the truth of one market exchange expert’s recent
remark:
This is not a revolution.
It’s an earthquake36
It must be pointed out that the three major exchanges (NASDAQ and the American Stock
Exchange being combined, however) are not unaware of the challenges they are facing. Since
ECN financial ownership, currently, comes from sources dependent on NYSE listing and
Page 20
liquidity, that exchange is less immediately threatened than NASDAQ-ASE. Nevertheless, the
NYSE is seriously contemplating becoming a for-profit company selling its own shares to the
public. The focus is on removing the existing, entrenched power structure that holds back
change, and creating a sizeable pool of funds with which to buy, most likely, ECNs themselves.
The NASD is also contemplating spinning NASDAQ off as a private for-profit company and
selling shares to the public as well.37
Fragmented securities markets, such as are suggested by the ECNs, must surely point
regulators in the direction of conflicts of interest. Best execution and best price, for example,
from a brokerage-owned ECN, may not be forthcoming. One might also ask whether a publicly
owned NYSE, with self-regulating powers, could be truly dependable and fair to all customers in
the face of the Wall Street imperative to make as much money for its owners, right now, as
possible without breaking current law.38 These conflicts emphasize the need to consider “which
entities should be allowed to own which others” equally with “how best to police conflicts of
interests in an unfettered ownership market.” One might answer that there’s no need to worry
about exchange operators since self-regulating organizations and the market itself will take care
of all serious funny business. That answer represents, at best, the triumph of hope over
experience.
Self-regulating organizations have, of late, shown disturbing weaknesses. In addition to the
NASD lapse, 1999 saw the securities industry’s number one SRO-the New York Stock Exchange
– publicly chastised for oversight failures. What the NYSE missed was the existence of illegal
trading on the floor of the exchange. Floor brokers executing orders in an account were allegedly
sharing profits from that account as well. Four NYSE floor brokers also pleaded guilty in a
federal court to a conspiracy to place trades to benefit themselves and not their customers. The
result of an SEC investigation was the institution, by the NYSE, of several new regulatory
initiatives, including a system that will enable the exchange to reconstruct any trade or cancelled
trade from beginning to end.39
It does not belittle the generally careful and laudable oversight of the NYSE and the NASD to
note the possibility that when oversight problems do arise, they could be related to an overly
protective watcher stance with a bit too much regard paid to the interests of the watched rather
than their customers.
Page 21
As previously mentioned, there are, of course, other issues to be faced relative to how law
and regulators ought to respond to securities markets and expanding technology issues. They are,
for the most part, however, more complicated aspects of issues that are faced on the ground
already: determining the costs and benefits of any regulatory action; dealing with regulator turf
issues (how do we prevent overlap and internecine regulator warfare), especially after the repeal
of Glass-Steagall, when banks, brokers and insurance folk will be combining, even in
cyberspace; and finally, dealing far more forthrightly than we have to date with the issue of what
internal regulator conflicts of interest interfere with proper regulatory functions.40
Dealing with these three issues, even in the absence of cyberspace technology has not been –
and still is not – easy. Competing scientific, political, economic and public social concerns, such
as those regarding environmental policy, must be considered and weighed constantly, and
judicial and regulatory responses fashioned, albeit in a manner and at a pace that would certainly
unsettle civil code adherents. Our trump card has always been an established culture of public
interest protection arising out of our Rule of Law and its Common Law adaptability process.
And will continue to be, even in cyberspace, as long as our original constitutional contract is
observed.41
III. Conclusion
We have attempted, in this paper, to show how our Common Law/Rule of Law system
allows for effective legal and regulatory responses to social demand and, in essence, promotes
adherence to the spirit, as well as to the letter, of the law. And we have argued that this socio-
legal process demands ethical behavior often beyond the boundaries of rules, which, if lacking on
the part of securities firms and their managers, could cause great harm to these managers, to their
firms, and to the body politic.
Maintaining this law and regulatory system in the face of rapid technological
development will be ever more difficult, but ever more essential, if we are to protect and preserve
the Constitutional value system upon which we all depend for safety, growth and fulfillment,
whether as individuals or as business firms. This is true in terms of financial markets certainly,
but not in terms of financial markets alone.
Recognizing and acting on the reality that our market behavior must be ethics-based as
well as rules-based, and that our legal and regulatory system must continue to promote that
Page 22
behavior, is imperative, surely, in the face of the scientific technology based genetic revolution as
well. Many competitive markets, commercial and investment banking, brokerage, insurance and
health care markets particularly, are already becoming involved in genetics based commercial
activity. Here now, or coming relatively soon, are such areas as genetic testing for predisposition
to genetic disease; gene therapy focused on present disease states (somatic therapy); gene
“therapy” focused on “normal” states (germ cell therapy) encompassing everything from the
choice of physical and perhaps mental characteristics of one’s offspring, to the act of cloning
humans. Much human progress is in the offing but much danger is there as well.
Competitive markets, science, religion, and society itself will demand decisions requiring
both human and governmental action beyond anything ever dreamed of as little as 50 years ago.
How we as a Constitutional, Rule of Law society resolve the rules and ethical “ought tos” in
terms of our behavior in securities markets, genetics markets, and others, could go very far
toward determining not just the financial and economic, but the moral shape of humanity as well
in the 21st Century and beyond. It would be presumptuous of us to state unequivocally that the
awesome promise of 21st century genomics could never be overshadowed by technological and
market driven genetic engineering, much closer to dreadful gene tuning eugenics than to good
health; or that a profusion of competing stock exchanges, or presently unforeseen institutional
combinations, and trading methodologies of incredible volume and speed, could not bring about
a weakening of duties of care and consumer protections as would have us functioning under an
eventually intolerable burden of social and financial risk. And this is to name but two of many
possible, if not probable, technological, financial and natural science advances that could present
our nation with the dazzling promise of human betterment – and the reality of wrenching,
negative, socio-political, democracy-denying change.
Maximum Liberty and Justice, in the face of Minimum morality, is impossible. And law
alone cannot change that reality. However, with what we believe is a realistic view of our
nation’s past and present, we have great confidence that we will, in our future, extract far more of
the good than of the bad from science, from technology and from our competitive market system.
The story is told of Benjamin Franklin leaving Independence Hall in Philadelphia after the
delegates’ work was completed, and being asked by an anxious matron, “Well, Sir, what sort of
government do I have now?” And Franklin replying : “A Republic, Madam, if you can keep it.”
Page 23
Well, we have kept it—with some moral lapses, to be sure. We are a democratic republic, not
a Utopia. But there is, in our body politic, an imbedded values system arising out of the original
constitutional contract. We are not a minimum morality nation.
What we have tried to do in this article is to set out what we believe to be an essential
ingredient in the preservation of that value system, particularly in the face of a total change
dynamic greater than we have ever seen before, a dynamic which cannot help but challenge our
democratic institutions. That essential ingredient is our Rule of Law, upheld through our
Common Law process. It is an adaptable process that evaluates and acts upon the essential
fairness of individual and institutional behavior—what it ought to be, as well as upon present,
strictly rule-based conduct set out at some earlier time. The Common Law/Rule of Law process
exerts a powerful demand for integrity on the part of individuals and surely market institutions,
for behavior that is trustworthy, fair and public confidence building.
We believe that examples we have given in Parts I and II of this paper model the effectiveness
over time of this “essential ingredient.” They should help to assure us that, if we all do our part
to strengthen and preserve it, our Rule of Law will allow us to incorporate the benefits of
progress while retaining our essential commitment to Liberty and Justice for all.
Page 24
References
Bear, L. and Maldonado-Bear, R., 1994. Free Markets, Finance, Ethics and Law. Prentice-Hall,
Upper Saddle River.
Buckman, R., 1999. Firm Pegs Accounts in On Line Trading at 3.7 Million. The Wall Street
Journal, March 25, B10.
Casey, J. L., 1997. Values Added: Making Ethical Decisions in the Financial Marketplace.
University Press of America, Lanham.
Dugan, I.J., 1999. In Bull Market, the Urge to Gamble Is Rising; Popularity of 'Day Trading'
Poses Questions of Risk, Regulation. Washington Post, February 2, A1.
Gasparino, C., 1999. Bear Stearns’ Richard Harriton Is Likely To Step Down as Part of Pact
with SEC. The Wall Street Journal, July 7, A6.
Gifis, S., 1991. Law Dictionary, 3rd edition. Barons, New York.
Henriques, D.B., 1999. Can Wall St.'s Old Guards Cope With the New Trading? New York
Times, May 12, C1.
Holder, E., 2000. U.S. Dept. of Justice Memorandum (1999), as modified 3/9/2000.
http:11www.usdvj.gov./criminal/fraud/policy/Changingcorps.
Hughes, B., 1999. International Futures: Choices in the Face of Uncertainty, 3rd edition.
Westview,
Ip, G., 1999. Trading Places: The Stock Exchanges, Long Static, Suddenly Are Roiled by
Page 25
Change --- ECNs, Internet Prod NYSE And Others to Consider Radical Steps Like IPOs. The
Wall Street Journal, July 27, A1.
Ip, G., and M. Schroeder, 1999a. SEC Likely to Criticize Big Board—Settlement Expected in
Floor Trading Case. The Wall Street Journal, June 29, C1.
Ip, G., and M. Schroeder, 1999b. SEC Assails Oversight Lag at Big Board. The Wall Street
Journal, June 30, A3.
Jackall, R., 1988. Moral Mazes: The World of Corporate Managers. Oxford Univ. Press, New
York.
Kane, E., 1997. Ethical Foundations of Financial Regulation. Journal of Financial Services
Research 12, 51-74 .
Kaplan et al., 1998. Living With the organizational Guidelines, in: Buchanan et al., Cases and
Materials In Markets, Ethics and Law. Simon and Schuster, New York.
Morgenson, G., 1999a. Humbled By the Company He Kept. New York Times, July 4, C1.
Morgenson, G., 1999b. Not to Seem Cranky But What’s the Big Rush? New York Times,
August 29, C1.
Paine, L., 1997. Cases In Leadership, Ethics and Organizational Integrity. Irwin, New York.
Pulliam, S., R. Smith and C. Gasparino, 2000. SEC Intensifies Inquiry Into Commissions for
Hot IPOs. The Wall Street Journal, December 3, C1.
Page 26
Schlegal, Q. K., 1990. Just Deserts for Corporate Criminals. Northeastern University Press,
Boston.
Siconolfi, M., 1997a. Bear Stearns Takes Stand On Clearing. The Wall Street Journal,
September 26 C1.
Siconolfi, M., 1997b. Heat Rises On Wall Street ‘Clearing Operations’. The Wall Street Journal,
June 17, C1.
Siconolfi, M., 1997c. The Spin Desk: Underwriters Set Aside IPO Stock for Officials of
Potential Customers. The Wall Street Journal, November 12, A1.
Siconolfi, M., 1998. Massachusetts Nears Pact in IPO Probe. The Wall Street Journal, December
3, C1.
Sloan, A., 1999. A Long Season of Wall Street Weirdness. Newsweek, September 13, 43-44.
Smith, R., 1999. Bear Stearns Could Settle Clearing Case. The Wall Street Journal, June 23, C1.
Soros, G., 1998. The Crisis of Global Capitalism (Open Society Endangered). Public Affairs,
New York.
Sunstein, C.R., 1997. Free Markets and Social Justice. Oxford University Press, New York.
Taylor, J., 1995. SEC Wants Investment Managers to Tell Clients More About ‘Soft
Dollar’Services. The Wall Street Journal, February 15, A6.
Page 27
United States Sentencing Commission, 1998. Federal Sentencing Guideline Manual.
United States Sentencing Commission, 2000. 1999 Annual Report. The Commission,
Washington, D.C.
The Wall Street Journal, 1999. The On Line Lineup. The Wall Street Journal, June 14, R6.
Page 28
Footnotes
1
With one important exception: the abandonment of the original concession to slavery-a value
well disposed of, and specifically replaced by the prohibition of slavery (13th Amendment, 1865),
and the protection of basic constitutional rights in the face of any state attempt to abridge or deny
them (14th Amendment, 1868).

2
That situation has been the lot of many nations around the world who have had several
incarnations of such pieces of paper, without ever effecting through them a value system capable
of producing and sustaining a Rule of Law—to the great detriment of their financial systems, one
might add.
3
Gifis (1991), page 82, citing the judge in 37 N.W.2d 543, 547.
4
For example, Congress has never defined “insider trading,” leaving it up to the SEC and the
courts to define it within the broad, statutory limits.

5
Soros (1998), pages 196-197.
6
See Schlegal (1990), especially Chapter 1.
7
See Bear and Maldonado-Bear (1994), pp. 406-407.
8
Public Law 98-473, now codified in various sections of 18 U.S.C. and 28 U.S.C. (1988).
9
Mistretta v U.S., 109 S. Ct. 647 (1989).
10
The Sentencing Guidelines Manual, Section 8, intro. Cmt. (1998). “Organizations” is defined
as including every possible combination: corporations, partnerships, unions, trusts, pension
funds, etc.
11
Sentencing Guideline, note 17, supra at Section 8A 1.2, “Commentary” and section 3(K) 1-7
(iii), “Application Notes.”
Page 29
12
From The Merrill Lynch Principles, reprinted in Casey, (1997) pages 232-235. See also Jackall
(1988) for corporate culture’s clear effect upon the actions of individuals functioning within it.
13
U.S. Dept. of Justice Memorandum (1999), as modified 3/9/2000.
14
See Kaplan et al., Compliance Programs and the Corporate Sentencing Guidelines (Clark,
Boardman, Callahan, 1994 at section 3.19).

15
From the authors’ personal contacts with U.S. Government officials attached to the Securities
and Exchange Commission, the Office of the U. S. Attorney for the Southern District of New
York and the Division of Procurement of the Navy Department.

16
Kaplan et al., “Living With the organizational Guidelines,” Buchanan et al., Cases and
Materials In Markets, Ethics and Law (Simon and Schuster, 1998). See also Paine (1997), pages
91-97.
17
United States Sentencing Commission (2000), 1999 Annual Report, Chapter Five, pages 45-47.
More than one offense can exceed the $290,000,000 figure cited in the text.
18
United States Sentencing Commission (2000), pages 42, 44.
19
See Kaplan et al at fn .15, supra.
20
Siconolfi (1997c).
21
All quotes are contained in Siconolfi (1998).
22
See Pulliam, Smith, and Gasparino (2000).
23
Taylor (1995).
24
The figures are from a table in Morgenson (1999a).
25
Smith (1999).
26
The Bear Stearns story is fully and dramatically detailed in Morgenson (1999a).
27
Siconolfi (1997b).
Page 30
28
Siconolfi (1997a).
29
See Gasperino (1999). Mr. Harriton has also issued a public defense of his actions based on
two arguments: first, he was playing by the (then current) rules and there’s nothing wrong with
that; and second, the SEC also knew Baron was doing wrong and they did nothing, either,
encouraging him to remain as Baron’s clearing firm. See “Fraud at Bear Stearns? Two
Views,”the Wall Street Journal, September 1, 1999 at page A26. Harriton’s first argument is not
likely to help him, but the second argument is interesting if it’s 100% accurate.
30
See fn. 2, supra.
31
Henriques (1999) offers the Securities Industry Association, Credit Suisse First Boston and the
SEC as sources for her figures; Buckman (1999), at 3.7 million, cites Forrester Research for her
figures. In her story, however, another analyst is cited as using the figure of 7.3 million on line
accounts with Charles Schwab and Fidelity Investments claiming 5.5 million just between them.
Dugan (1999) claims that “one in 4 trades is executed on line.” The bottom line seems to be that
nobody seems to know for sure exactly how many on line accounts exist, or how much total
trading (money) they account for. But one answer surely must be: a lot!
32
The Wall Street Journal (1999). The 10 trading firms, listed in order of market share, from
27.9% for #1 to 1.3% for #10 are: Charles Schwab; E*Trade; Waterhouse Securities; Datek
Securities; Ameritrade; DLJ Direct; Discover Brokerage Direct; Suretrade; and National
Discount Brokers.
33
John Byrne, editor of The Trader, quoted in Henriques (1999).
34
Hughes (1999).
Page 31
35
The applicant is Island ECN. Some 19 other ECNs are waiting in the wings, including a “super
ECN” formed by a Bloomberg subsidiary and ITG. An excellent examination of the fast
changing stock markets landscape is Ip (1999b).

36
Professor Robert A. Schwartz, quoted in Henriques (1999).
37
G, Ip, note 67, supra. See also Sloan (1999).
38
See Morgenson (1999b).
39
See Ip and Shroeder (1999a, 1999b).
40
Regulator responsibility is a subject of enormous importance, not sufficiently related to in
academia. One who has done so both forcefully and well is Kane (1997).
41
On thrashing out environmental cost-benefit issues, see Bear and Maldonado-Bear (1994),
pages 138-156. See also Sunstein (1997), Chapter 10. And on the issue of judicial control of
regulatory overreaching, see Board of Governors of the Federal Reserve System v. Dimension
Financial Corp. et. al., 474 U.S. 361 (Supreme Court of the United States, 1986).
Page 32
Federal Securities Law Reporter, Disclosure Required by Sections
404, 406 and 407 of the Sarbanes-Oxley Act of 2002. Securities Act
Release No. 8177. Exchange Act Release No. 47235. January 23,
2003., Securities and Exchange Commission, (Jan. 23, 2003)
Click to open document in a browser
Disclosure Required by Sections 404, 406 and 407 of the Sarbanes-Oxley Act of 2002.
Securities Act Release No. 8177. Exchange Act Release No. 47235. January 23, 2003. Release in full text.
Exchange Act: Reports: Disclosures: Sarbanes-Oxley Act.– The SEC adopted rule changes to require
specific disclosures in Exchange Act filings. The rules are intended to implement provisions of the Sarbanes-
Oxley Act. As adopted, companies will be required to 1) make disclosures concerning the identity and
independence of financial experts serving on the company's audit committee and 2) disclose whether they
have adopted a code of ethics that covers their principal executive officers and senior financial officers. The
SEC is also requesting additional comments regarding the appropriate treatment of foreign private issuers in
light of the proposed rules on audit committees under Section 301 of the act. The rule changes are effective
30 days after publication in the Federal Register. Companies must comply with the code of ethics disclosure
requirements in their annual reports for fiscal years ending on or after July 15, 2003. Companies, other than
small business issuers, must comply with the audit committee financial expert disclosure requirements in
their annual reports for fiscal years ending on or after July 15, 2003. Small business issuers must comply
with the audit committee financial expert disclosure requirements in their annual reports for fiscal years
ending on or after December 15, 2003.
See ¶23,047, ¶23,608D and ¶23,609, "Exchange Act—Registration; Reports" Division, Volume 3, ¶25,150
and ¶25,151, "Exchange Act—Broker-Dealer Regulation" division, Volume 4, ¶29,701, ¶29,801, ¶31,001,
¶31,031, ¶31,041, ¶31,101, ¶31,131 and ¶32,291, "Exchange Act—Forms" division, Volume 5, ¶69,101,
"Accounting Rules—Regulation S-X" division, Volume 6, ¶70,701, "Regulation S-B" division, Volume 7, and
¶71,001, "Regulation S-K" division, Volume 7.
Action: Final rule; request for comment.
Summary: We are adopting rules and amendments requiring companies, other than registered investment
companies, to include two new types of disclosures in their annual reports filed pursuant to the Securities
Exchange Act of 1934. First, the rules require a company to disclose whether it has at least one “audit
committee financial expert” serving on its audit committee, and if so, the name of the expert and whether
the expert is independent of management. A company that does not have an audit committee financial
expert must disclose this fact and explain why it has no such expert. Second, the rules require a company
to disclose whether it has adopted a code of ethics that applies to the company's principal executive officer,
principal financial officer, principal accounting officer or controller, or persons performing similar functions.
A company disclosing that it has not adopted such a code must disclose this fact and explain why it has not
done so. A company also will be required to promptly disclose amendments to, and waivers from, the code of
ethics relating to any of those officers. These rules implement the requirements in Sections 406 and 407 of
the Sarbanes-Oxley Act of 2002. We also request additional comments regarding the appropriate treatment
of foreign private issuers in light of our proposed rules implementing Section 301 of the Act.
Dates:Effective Date: March 3, 2003. Comment Date: Comments regarding treatment of certain foreign
private issuers should be received on or before February 18, 2003.
Compliance Dates: Companies must comply with the code of ethics disclosure requirements promulgated
under Section 406 of the Sarbanes-Oxley Act in their annual reports for fiscal years ending on or after July
15, 2003. They also must comply with the requirements regarding disclosure of amendments to, and waivers
from, theirethics codes on or after the date on which they file their first annual report in which the code of
ethics disclosure is required. Companies, other than small business issuers, similarly must comply with the
audit committee financial expert disclosure requirements promulgated under Section 407 of the Sarbanes-
Oxley Act in their annual reports for fiscal years ending on or after July 15, 2003. Small business issuers
©2012 Wolters Kluwer. All rights reserved.

1
must comply with the audit committee financial expert disclosure requirements in their annual reports for
fiscal years ending on or after December 15, 2003.
Addresses: To help us process and review your comments more efficiently, comments should be sent
by hard copy or e-mail, but not by both methods. Comments sent by hard copy should be submitted in
triplicate to Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 450 Fifth Street,
NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following e-mail
address: rule-comments@sec.gov. All comment letters should refer to File No. S7-40-02; if e-mail is used,
this file number should be included in the subject line. Comment letters will be available for inspection and
copying in the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549-0102.
Electronically submitted comment letters will be posted on the Commission's Internet Web Site (http://
1
www.sec.gov).
For Further Information Contact: Ray Be, Special Counsel, N. Sean Harrison, Special Counsel, or
Kim McManus, Attorney-Advisor, Division of Corporation Finance, at (202) 942-2910, or with respect to
accounting issues, Michael Thompson, Professional Accounting Fellow, Office of Chief Accountant, at (202)
942-4400, U.S. Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549.
2 3
Supplementary Information: We are adopting amendments to Form 8-K, Form 10-K, Form 10-KSB,
4 5 6 7 8
Form 20-F and Form 40-F under the Securities Exchange Act of 1934, Regulation S-B, and
9
Regulation S-K.
I. Background
The strength of the U.S. financial markets depends on investor confidence. Recent events involving
allegations of misdeeds by corporate executives, independent auditors and other market participants have
10
undermined that confidence. In response to this threat to the U.S. financial markets, Congress passed,
11
and the President signed into law, the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), which
effects sweeping corporate disclosure and financial reporting reform.
This release is one of several that the Commission is required to issue to implement provisions of the
Sarbanes-Oxley Act. In this release, we adopt rules to implement the following two provisions of the
Sarbanes-Oxley Act:
• Section 407, which directs us to adopt rules: (1) requiring a company to disclose whether its
audit committee includes at least one member who is a financial expert; and (2) defining the
term “financial expert”; and
• Section 406, which directs us to adopt rules requiring a company to disclose whether it has
adopted a code of ethics for its senior financial officers, and if not, the reasons therefor, as
well as any changes to, or waiver of any provision of, that code of ethics.
We received over 200 comment letters in response to our release proposing requirements to implement
12
Sections 404, 406 and 407 of the Sarbanes-Oxley Act. These comment letters came from corporations,
professional associations, accountants, law firms, analysts, consultants, academics, investors and others.
In general, the commenters favored the objectives of the proposed new requirements. Investors generally
supported the manner in which we proposed to achieve these objectives and, in some cases, urged us to
require additional disclosure from companies. Many other commenters, however, thought that we were
requiring more disclosure than necessary to fulfill the mandates of the Sarbanes-Oxley Act and suggested
modifications to the proposals. We have reviewed and considered all of the comments on the proposals. The
adopted rules reflect many of these comments—we discuss our conclusions with respectto each topic and
related comments in more detail throughout the release. We believe that the new rules and amendments are
in the public interest and consistent with the protection of investors.
The Proposing Release also included requirements to implement Section 404 of the Act, relating to internal
control reports and auditor attestations of those reports. We will set forth the final rules to implement
Section 404 in a separate adopting release to be issued at a later date. The Sarbanes-Oxley Act does not
mandate that we issue final rules to implement Section 404 by a specific date. In addition, in the Proposing

2
Release, we proposed to defer effectiveness of those rules so that they would apply only to companies
whose fiscal years end on or after September 15, 2003 to allow the Public Company Accounting Oversight
Board sufficient time to adopt standards for attestation engagements, and to allow companies and auditors
sufficient time to prepare for imposition of the new requirements.
We also will set forth the rules to implement the requirements of Sections 406 and 407 of the Sarbanes-
Oxley Act with respect to registered investment companies in a subsequent release. We expect to consider
13
implementing these requirements at the same time that we consider adopting proposed Form N-CSR
to be used by registered management investment companies to file certified shareholder reports with the
Commission under Section 302 of the Sarbanes-Oxley Act.
II. Discussion
A. Audit Committee Financial Experts
1. Title of the Expert
In the Proposing Release, we solicited comment as to whether we should use the term “financial expert”
in our rules consistent with its use in Section 407 of the Sarbanes-Oxley Act, or whether a different term
such as “audit committee financial expert” would be more appropriate. A number of commenters expressed
a concern that neither the term “financial expert” nor “audit committee financial expert” accurately reflects
the required experience and expertise of the type of expert contemplated by Section 407 and our proposed
rules. Some noted that many of the key characteristics included in our proposed definition of a financial
expert relate to the expert's accounting knowledge and experience in an accounting or auditing position.
One commenter therefore recommended that we use the term “audit committee accounting expert.” Other
suggested terms included “accounting expert,” “audit committee member financial lead” and “financially
proficient director.”
We agree that the term “financial” may not completely capture the attributes referenced in Section 407, given
the provision's focus on accounting and auditing expertise and the fact that traditional “financial” matters
extend to capital structure, valuation, cash flows, risk analysis and capital-raising techniques. Furthermore,
several recent articles on the proposals have noted that many experienced investors and business leaders
with considerable financial expertise would not necessarily qualify as financial experts under the proposed
14
definition. We have decided to use the term “audit committee financial expert” in our rules implementing
15
Section 407 instead of the term “financial expert.” This term suggests more pointedly that the designated
person has characteristics that are particularly relevant to the functions of the audit committee, such as: a
thorough understanding of the audit committee's oversight role, expertise in accounting matters as well as
understanding of financial statements, and the ability to ask the right questions to determine whether the
company's financial statements are complete and accurate. The new rules include a definition of the term
16
“audit committee financial expert.”
2. Disclosure of the Number and Names of Audit Committee Financial Experts
A substantial number of commenters opposed our proposal to require a company to disclose the number and
names of the persons that the company's board determined to be audit committee financial experts. Some
were opposed on the ground that our proposed rules exceeded the mandates of the Sarbanes-Oxley Act.
17
Much of the opposition stemmed from a fear that the designation of an audit committee financial expert
may inappropriately suggest that the expert bears greater responsibility, and therefore is subject to a higher
degree of liability, foraudit committee decisions than other audit committee members. Some commenters
thought that identification of the audit committee financial expert in the company's annual report would
exacerbate that problem and discourage qualified persons from serving as such experts.
We have modified the proposals that would have required disclosure of the number and names of audit
committee financial experts serving on a company's audit committee to more closely track the language used
in Section 407 of the Sarbanes-Oxley Act. Under the rules that we are adopting, a company must disclose
that its board of directors has determined that the company either:

3
• has at least one audit committee financial expert serving on its audit committee; or
• does not have an audit committee financial expert serving on its audit committee.
A company disclosing that it does not have an audit committee financial expert must explain why it does not
have such an expert. We continue to believe that disclosure of the name of the audit committee financial
expert is necessary to benefit investors and to carry out the purpose of Section 407. Therefore, under the
final rules, if a company discloses that it has an audit committee financial expert, it also must disclose the
expert's name. We believe that, in general, omission of the expert's name ultimately would not result in the
expert's identity remaining non-public. To the extent that there are liability concerns, we believe that they are
best addressed by our inclusion of a safe harbor in our rules, as discussed below.
The final 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. Every company subject to
the audit committee disclosure requirements would, however, have to determine whether or not it has at
least one audit committee financial expert; a company will not satisfy the new disclosure requirements by
stating that it has decided not to make a determination or by simply disclosing the qualifications of all of its
audit committee members. Furthermore, if the company's board determines that at least one of the audit
committee members qualifies as an expert, the company must accurately disclose this fact. It will not be
appropriate for a company to disclose that it does not have an audit committee financial expert if its board
has determined that such an expert serves on the audit committee.
3. Disclosure of Independence of Audit Committee Financial Experts
We proposed to require a company to disclose whether its audit committee financial expert is independent
of management. A number of commenters opposed this disclosure requirement as unnecessary, noting
that Section 301 of the Sarbanes-Oxley Act mandates the Commission to direct the self-regulatory
organizations to prohibit the listing of any company that does not require all of its audit committee members
to be independent. However, not all Exchange Act reporting companies are listed on a national securities
18
exchange or association. We believe that investors in these companies would be interested in knowing
whether the audit committee financial expert is independent of management. Therefore, the final rules
require a company to disclose whether the person or persons identified as the audit committee financial
expert is independent of management.
In the proposing release, we defined “independent” by reference to Section 10A(m)(3) of the Exchange Act.
19
Several commenters noted that this reference may cause some confusion because the securities laws
20
include different definitions of the term “affiliated,” which is part of the definition used in Section 10A(m)(3).
Therefore, to provide clarity, the final rules refer to the definition of “independent” used in Item 7(d)(3)(iv) of
21 22
Schedule 14A. This revision ensures that the term “independent” is used consistently in our rules.
4. Definition of “Audit Committee Financial Expert”
a. Proposed Definition of the Term “Financial Expert”
We proposed to define the term “financial expert” to mean a person who has, through education and
experience as a public accountant, auditor, principal financial officer, controller or principal accounting officer,
of a company that, at the time the person held such position, was required to file reports pursuant to Section
13(a) or 15(d) of the Exchange Act, or experience in one or more positions that involve the performance of
similar functions (or that results, in the judgment of the company's board of directors, in the person's having
23
similar expertise and experience), the following attributes:
(1) An understanding of generally accepted accounting principles and financial statements;
(2) Experience applying such generally accepted accounting principles in connection with
the accounting for estimates, accruals, and reserves that are generally comparable to the
estimates, accruals and reserves, if any, used in the registrant's financial statements;
(3) Experience preparing or auditing financial statements that present accounting issues that
are generally comparable to those raised by the registrant's financial statements;

4
(4) Experience with internal controls and procedures for financial reporting; and
(5) An understanding of audit committee functions.
In addition, the proposed rule would have provided guidance to companies by providing a list of factors to be
considered in making that evaluation, including:
• The level of the person's accounting or financial education, including whether the person has
earned an advanced degree in finance or accounting;
• Whether the person is a certified public accountant, or the equivalent, in good standing, and
the length of time that the person actively has practiced as a certified public accountant, or
the equivalent;
• Whether the person is certified or otherwise identified as having accounting or financial
experience by a recognized private body that establishes and administers standards in
respect of such expertise, whether that person is in good standing with the recognized
private body, and the length of time that the person has been actively certified or identified
as having this expertise;
• Whether the person has served as a principal financial officer, controller or principal
accounting officer of a company that, at the time the person held such position, was required
to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act, and if so, for how long;
• The person's specific duties while serving as a public accountant, auditor, principal financial
officer, controller, principal accounting officer or position involving the performance of similar
functions;
• The person's level of familiarity and experience with all applicable laws and regulations
regarding the preparation of financial statements that must be included in reports filed under
Section 13(a) or 15(d) of the Exchange Act;
• The level and amount of the person's direct experience reviewing, preparing, auditing or
analyzing financial statements that must be included in reports filed under Section 13(a) or
15(d) of the Exchange Act;
• The person's past or current membership on one or more audit committees of companies
that, at the time the person held such membership, were required to file reports pursuant to
Section 13(a) or 15(d) of the Exchange Act;
• The person's level of familiarity and experience with the use and analysis of financial
statements of public companies; and
• Whether the person has any other relevant qualifications or experience that would assist
him or her in understanding and evaluating the registrant's financial statements and other
financial information and to make knowledgeable and thorough inquiries whether:
o The financial statements fairly present the financial condition, results of
operations and cash flows of the company in accordance with generally accepted
accounting principles; and
o The financial statements and other financial information, taken together,
fairly present the financial condition, results of operations and cash flows of the
company.
b. Comments on Proposed Definition
The proposed definition of the term “financial expert” proved to be the most controversial aspect of the
proposals - more commenters remarked on it than on any other topic addressed by the proposed rules. Most
of the commenters thought that the proposed definition was too restrictive. Several expressed concern that
many companies, especially small ones, would have a difficult time attracting an audit committee member
who would qualify as an expert under the proposed definition. Some of the corporate commenters were
of the view that they already have exemplary audit committees, despite the fact that none of their current
members would meet our proposed definition of an expert. A few complained that companies may have to
sacrifice the diversity of their boards and nominate directors who satisfy the audit committee financial expert
definition even if the company does not believe that these directors are best-suited for the position.

5
Furthermore, several commenters debated the merits of defining an audit committee financial expert as a
person with strong accounting credentials, given that an audit committee member's role is one of oversight,
rather than direct involvement in the company's accounting functions, and suggested that the emphasis on
technical accounting expertise in the definition was misplaced. A few commenters further argued that it is
unnecessary to have a financial expert serving on the audit committee because audit committee members
should have the discretion to retain experts with specific financial expertise as they deem necessary or
appropriate.
Other commenters asserted that the proposed definition was more restrictive than necessary to satisfy
Congressional intent - they noted that Section 407 of the Sarbanes-Oxley Act requires us, in defining
the term “financial expert,” only to “consider” whether a person has, through education and experience
as a public accountant, auditor, principal financial officer, comptroller, principal accounting officer, or
24
similar position, the four attributes specified in the Act. These commenters argued that in light of
the Congressional directive only to consider the four attributes, our proposed definition did not need to
incorporate all of them, or even any of them. Some commenters believed that a single member of the audit
committee should not have to possess all of the required financial expert attributes so long as the members
of the audit committee collectively possess these attributes. Others suggested various permutations such as
requiring the financial expert to have the first and fifth attributes in our proposed definition, but only two of the
other three attributes.
Many commenters criticized specific provisions of the proposed financial expert definition as being too
narrow. In particular, many commenters asserted that our proposed requirement that an expert have
direct experience preparing or auditing financial statements was greatly, and needlessly, restrictive.
Other commenters were concerned that the requirement that a person have had experience with financial
statements presenting issues generally comparable to those raised by the company's financial statements
might have anti-competitive effects if we interpreted this requirement to mean that a financial expert would
need previous experience with financial statements of other companies in the same industry.
Several commenters sought clarification regarding the relevant body of generally accepted accounting
principles, in particular for financial experts of foreign private issuers. Other commenters expressed concern
over the possible lack of potential financial experts that would be knowledgeable about accounting for
estimates and reserves in specific industries, such as the insurance and oil industries.
Numerous additional commenters were concerned that the proposed definition was too restrictive regarding
the means by which a person could acquire the required expertise to qualify as a financial expert. They
suggested that a requirement that an expert have experience as a public accountant, auditor, principal
financial officer, controller, principal accounting officer or in a similar position, would severely limit the
number of persons qualified to be financial experts. Some believed that there are a substantial number
of highly qualified persons who have sufficient knowledge and experience to effectively and competently
perform the activities required of a financial expert, but do not have experience in one of the listed positions.
They questioned the relevance of the means by whicha person acquires the necessary expertise, so long as
the person in fact has such expertise.
c. Final Definition of “Audit Committee Financial Expert”
The final rules define an audit committee financial expert as 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.
25
Under the final rules, a person must have acquired such attributes through any one or more of the following:

6
(1) 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;
(2) Experience actively supervising a principal financial officer, principal accounting officer,
controller, public accountant, auditor or person performing similar functions;
(3) Experience overseeing or assessing the performance of companies or public accountants
with respect to the preparation, auditing or evaluation of financial statements; or
26
(4) Other relevant experience.
d. Discussion of Significant Modifications to the Proposed Definition of “Financial Expert”
We have made several changes to our proposed definition of a financial expert. As already discussed, we
have decided to use the term audit committee financial expert rather than financial expert in the final rules.
We also have reorganized the components of the definition to make it easier to read and to emphasize,
by including them in the first part of the definition, the attributes that an audit committee financial expert
must possess. The second part of the definition discusses the means by which a person must acquire
the necessary attributes. We also have eliminated the proposed instruction listing several factors that
a company's board of directors should consider in evaluating the education and experience of an audit
committee financial expert candidate.
Proposed attributes of a financial expert.
i. The financial expert must have an understanding of generally accepted accounting
principles and financial statements.
We are adopting this attribute substantially as proposed. However, in response to comments, we have added
an instruction to clarify that, with respect to foreign private issuers, the audit committee financial expert's
understanding must be of the generally accepted accounting principles used by the foreign private issuer
27
in preparing its primary financial statements filed with the Commission. Our rules require foreign private
issuers that do not prepare their primary financial statements in accordance with U.S. generally accepted
accounting principles to include a reconciliation to those principles in the financial statements that they file
with the Commission. Although an understanding of reconciliation to U.S. generally accepted accounting
principles would be helpful, we believe that the proper focus of audit committee financial expertise is on the
principles used to prepare the primary financial statement. We also are sensitive to the fact that requiring
an audit committee financial expert to possess expertise relating to U.S. generally accepted accounting
principles could burden foreign private issuers who use home country accounting principles or international
accounting standards to prepare their primary financial statements.
ii. The financial expert must have experience applying such generally accepted accounting
principles in connection with the accounting for estimates, accruals and reserves that are
generally comparable to the estimates, accruals and reserves, if any, used in the registrant's
financial statements.
Several commenters were concerned that potential audit committee financial experts wouldnot have
experience with the unique and complex accounting for estimates, accruals and reserves in certain
industries, such as the insurance industry, unless they have had direct previous experience in these
industries. The commenters further noted that there could be a very limited pool of audit committee financial
expert candidates available with such experience that would not have ties to a competitor within the same
industry. In light of these comments, we have revised this attribute by eliminating the clause “that are
generally comparable to the estimates, accruals and reserves, if any, used in the registrant's financial
statements.” We also have revised this attribute to state that the audit committee financial expert must
have the ability to assess the general application of generally accepted accounting principles in connection
with the accounting for estimates, accruals and reserves, rather than stating that the expert must have
28
experience applying these principles. We believe that this description of the attribute better satisfies the
intent of the statute and better reflects the role to be played by audit committees. We recognize that the
pool of persons possessing the highly specialized technical knowledge that some thought the proposals
necessitated may be so small that a substantial percentage of companies in certain industries would be

7
compelled to disclose that they could not retain an expert without recruiting a person associated with
a competitor. We do not intend for the new requirements to lead to such a result. An audit committee
financial expert must be able to assess the general application of generally accepted accounting principles
in connection with accounting for estimates, accruals and reserves. This general attribute provides the
necessary background for an audit committee when addressing more detailed industry-specific standards or
other particular topics. Experience with such detailed standards or topics is not a necessary attribute of audit
committee financial expertise.
iii. The financial expert must have experience preparing or auditing financial statements that
present accounting issues that are generally comparable to those raised by the registrant's
financial statements.
The majority of commenters who thought that the proposed definition of “financial expert” was too restrictive
focused on this attribute. We are convinced by the weight of the comments that the proposed requirement
that an expert have direct experience preparing or auditing financial statements could impose an undue
burden on some companies, especially small companies, that desire to have an audit committee financial
expert. We also are persuaded by commenters' arguments that persons who have experience performing
in-depth analysis and evaluation of financial statements should not be precluded from being able to qualify
as audit committee financial experts if they possess the other four necessary attributes of an expert. We
therefore have broadened this attribute by requiring an audit committee financial expert to have experience
29
“preparing, auditing, analyzing or evaluating” financial statements.
We believe that our revisions properly capture the clear intent of the statute that an audit committee financial
expert must have experience actually working directly and closely with financial statements in a way that
provides familiarity with the contents of financial statements and the processes behind them. We also believe
that our revisions appropriately broaden the group of persons who are eligible to be audit committee financial
experts. We recognize that many people actively engaged in industries such as investment banking and
venture capital investment have had significant direct and close exposure to, and experience with, financial
statements and related processes. Similarly, professional financial analysts closely scrutinize financial
statements on a regular basis. Indeed, all of these types of individuals often hold positions that require them
to inspect financial statements with a healthy dose of skepticism. They therefore would be well prepared
to diligently and zealously question management and the company's auditor about the company's financial
statements. Effective audit committee members must have both the ability and the determination to ask the
right questions. Therefore, we have broadened this attribute to include persons with experience performing
extensive financial statement analysis or evaluation.
We also are convinced by commenters that a potential audit committee financial expert should be considered
to possess this attribute by virtue of his or her experience actively supervising a person who prepares,
audits, analyzes or evaluates financial statements. The term “active supervision” means more than the
mere existence of a traditional hierarchical reporting relationship between supervisor and those being
supervised. Rather, we mean 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. We also mean that the supervisor shouldhave 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 principle 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. Active
participation in, and contribution to, the process, albeit at a supervisory level, of addressing financial and
accounting issues that demonstrates a general expertise in the area would be necessary.
Finally, we are retaining, with clarification, the requirement that an audit committee financial expert have
experience with financial statements that present accounting issues that are “generally comparable” to those
raised by the registrant's financial statements. We do not intend for this phrase to imply that a person must
have previous experience in the same industry as the company that is evaluating the person as a potential
audit committee financial expert, or that the person's experience must have been with a company subject
to the Exchange Act reporting requirements. We therefore have modified the requirement to focus on the

8
breadth and level of complexity of the accounting issues with which the person has had experience. We
think that a company's board of directors will make the necessary assessment based on particular facts
and circumstances. In making its assessment, the board should focus on a variety of factors such as the
size of the company with which the person has experience, the scope of that company's operations and
the complexity of its financial statements and accounting. We do not believe that familiarity with particular
financial reporting or accounting issues, or any other narrow area of experience should be dispositive.
iv. A financial expert must have experience with internal controls and procedures for financial
reporting.
30
We are substituting the term “understanding” for the term “experience.” In our view, it is necessary that
the audit committee financial expert understand the purpose, and be able to evaluate the effectiveness, of
a company's internal controls and procedures for financial reporting. It is important that the audit committee
financial expert understand why the internal controls and procedures for financial reporting exist, how
they were developed, and how they operate. Previous experience establishing or evaluating a company's
internal controls and procedures for financial reporting can, of course, contribute to a person's understanding
of these matters, but the attribute as rephrased properly focuses on the understanding rather than the
experience.
v. A financial expert must have an understanding of audit committee functions.
31
We are adopting this attribute as proposed.
Means of obtaining expertise.
We have revised the audit committee financial expert definition to state that a person must have acquired the
five necessary attributes through any one or more of the following:
32
In response to commenters' remarks, we have eliminated the proposed requirement that an audit committee
financial expert must have gained the relevant experience with a company that, at the time the person
held such position, was required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act.
Many private companies are contractually required to prepare audited financial statements that comply
with generally accepted accounting principles. In addition, a potential expert may have gained relevant
experience at a foreign company that is publicly traded in its home market but that is not registered under the
Exchange Act.
We have added a provision in response to comments that experience overseeing or assessing the
performance of companies or public accountants with respect to the preparation, auditing or evaluation
of financial statements can provide a person with in-depth knowledge and experience of accounting and
financial issues. For example, certain individuals serving ingovernmental, self-regulatory and private-sector
bodies overseeing the banking, insurance and securities industries work on issues related to financial
statements on a regular basis. We believe that such experience can constitute a very useful background for
an audit committee financial expert.
In addition, we have revised the last provision of this part of the proposed definition. The original proposal
stated that a person who had not served in one of the specified positions alternatively could have acquired
the relevant attributes and experience in a position that results, in the judgment of the board of directors, in
the person's having similar expertise and experience. The final rules state simply that a person may acquire
the necessary attributes of an audit committee financial expert through other relevant experience, and no
longer require the company to disclose the basis for the board's determination that a person has “similar

9
expertise and experience.” We also have eliminated the reference to the judgment of the board with respect
to this provision because, as explicitly stated in the audit committee financial expert disclosure requirement,
the board must make all determinations as to whether a person qualifies as an expert. Therefore, this
reference is redundant.
This revision permitting a person to have “other relevant experience” recognizes that an audit committee
financial expert can acquire the requisite attributes of an expert in many different ways. We do believe that
this expertise should be the product of experience and not, for example, merely education. Under the final
rules, if a person qualifies as an expert by virtue of possessing “other relevant experience,” the company's
33
disclosure must briefly list that person's experience.
Proposed factors to be considered in evaluating the education and experience of a financial expert.
The proposed definition of “financial expert” included a non-exclusive list of qualitative factors for a
company's board to consider in assessing audit committee financial expert candidates. These factors
focused on the breadth and level of a potential audit committee financial expert's experience, understanding
and involvement in relevant activities, including the person's length of experience in relevant positions, and
the types of duties held by such person in those positions. We believe that the board should consider all the
available facts and circumstances, including but certainly not limited to, qualitative factors of the type that
we had identified, in its determination. Some commenters were concerned that some boards would use the
list as a mechanical checklist rather than as guidance to be used in considering a person's knowledge and
experience as a whole. In light of these comments, the definition does not include this list.
The fact that a person previously has served on an audit committee does not, by itself, justify the board of
directors in “grandfathering” that 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 the board
of directors in deeming the person to be an audit committee financial expert. In addition to determining that
a person possesses an appropriate degree of knowledge and experience, 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, 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.
Requirement that an audit committee financial expert possess all five required attributes.
We are not convinced by comments stating that an audit committee financial expert should not have to
possess all of the attributes included in our definition. Although Congress did not explicitly require us to
incorporate all of the attributes listed in Section 407 of the Sarbanes-Oxley Act, it also did not limit us to
consideration of those attributes. Congress obviously considered each of the listed attributes to be important.
A definition of “audit committee financial expert” that leaves the meaning of the term entirely to the judgment
of the board of directors would be highly subjective and could constitute an abrogation of our responsibilities
under Section 407.
The Sarbanes-Oxley Act clearly was intended to enhance corporate responsibility by effecting significant
change; its purpose was not to perpetuate the status quo. Therefore, while many companies likely will
be able to determine that they already have an audit committee financial expert serving on their audit
committees, we believe that the fact that some companies will not be able to draw this conclusion unless
they are able to attract a new director with the requisite qualifications is consistent with the Act.
Moreover, the Sarbanes-Oxley Act did not contemplate that a company could disclose thatit has an audit
committee financial expert by virtue of the fact that the audit committee members collectively possess all
of the attributes of an expert; the statute directs us to issue rules to require a company to disclose whether
or its audit committee is comprised of “at least one member” who is a financial expert. Due to the statute's
use of this specific language, there is no doubt that Congress had in mind individual experts and did not
contemplate a “collective” expert. We note, however, that it would be appropriate under the final rules for a
company disclosing that it does not have an audit committee financial expert to explain the aspects of the
definition that various members of the committee satisfy.
5. Safe Harbor from Liability for Audit Committee Financial Experts

10
Several commenters urged us to clarify that the designation or identification of an audit committee financial
expert will not increase or decrease his or her duties, obligations or potential liability as an audit committee
member. A few recommended a formal safe harbor from liability for audit committee financial experts.
34
Unlike the provisions of the Act that impose substantive requirements, the requirements contemplated
by Section 407 are entirely disclosure-based. We find no support in the Sarbanes-Oxley Act or in related
legislative history that Congress intended to change the duties, obligations or liability of any audit committee
member, including the audit committee financial expert, through this provision.
In the proposing release, we stated that we did not believe that the mere designation of the audit committee
financial expert would impose a higher degree of individual responsibility or obligation on that person. Nor
did we intend for the designation to decrease the duties and obligations of other audit committee members
or the board of directors. We continue to believe that it would adversely affect the operation of the audit
committee and its vital role in our financial reporting and public disclosure system, and systems of corporate
governance more generally, if courts were to conclude that the designation and public identification of an
audit committee financial expert affected such person's duties, obligations or liability as an audit committee
member or board member. We find that it would be adverse to the interests of investors and to the operation
of markets and therefore would not be in the public interest, if the designation and identification affected the
duties, obligations or liabilities to which any member of the company's audit committee or board is subject.
To codify this position, we are including a safe harbor in the new audit committee disclosure item to clarify
that:
• A person who is determined to be an audit committee financial expert will not be deemed
an “expert” for any purpose, including without limitation for purposes of Section 11 of the
35
Securities Act, as a result of being designated or identified as an audit committee
financial expert pursuant to the new disclosure item;
• The designation or identification of a person as an audit committee financial expert pursuant
to the new disclosure item 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 board of directors in the absence of such designation or
identification; and
• The designation or identification of a person as an audit committee financial expert pursuant
to the new disclosure item does not affect the duties, obligations or liability of any other
36
member of the audit committee or board of directors.
This safe harbor clarifies that any information in a registration statement reviewed by the audit committee
financial expert is not “expertised” unless such person is acting in the capacity of some other type of
traditionally recognized expert. Similarly, because the audit committee financial expert is not an expert
37
for purposes of Section 11, he or she is not subject to a higher level of due diligence with respect to
any portion of the registration statement as aresult of his or her designation or identification as an audit
committee financial expert.
In adopting this safe harbor, we wish to emphasize that all directors bear significant responsibility. State law
generally imposes a fiduciary duty upon directors to protect the interests of a company's shareholders. This
duty requires a director to inform himself or herself of relevant facts and to use a “critical eye” in assessing
38
information prior to acting on a matter. Our new rule provides that whether a person is, or is not, an audit
committee financial expert does not alter his or her duties, obligations or liabilities. We believe this should be
the case under federal and state law.
6. Determination of a Person's Status as an Audit Committee Financial Expert
The Sarbanes-Oxley Act does not explicitly state who at the company should determine whether a person
qualifies as an audit committee financial expert. We believe that the board of directors in its entirety, as the
most broad-based body within the company, is best-equipped to make the determination. We think that it is
appropriate that any such determination will be subject to relevant state law principles such as the business
judgment rule.
7. Location of Audit Committee Financial Expert Disclosure

11
The Sarbanes-Oxley Act expressly states that companies must include the financial expert disclosure in their
periodic reports required pursuant to Section 13(a) or 15(d) of the Exchange Act. The final rules that we are
adopting require companies to include the new disclosure in their annual reports on Forms 10-K, 10-KSB,
20-F or 40-F. The requirement to provide the new audit committee disclosure item is included in Part III of
Forms 10-K and 10-KSB, enabling a domestic company that voluntarily chooses to include this disclosure in
its proxy or information statement to incorporate this information by reference into its Form 10-K or 10-KSB
if it files the proxy or information statement with the Commission no later than 120 days after the end of the
39
fiscal year covered by the Form 10-K or 10-KSB.
Although some commenters recommended that we require companies to include the audit committee
financial expert disclosure in their proxy and information statements, registration statements and quarterly
reports, as well as in their annual reports, we are not convinced that the benefits to investors would exceed
the costs to companies of requiring this disclosure in additional documents or on a more frequent basis.
8. Change in Item Number

We proposed to designate the audit committee financial expert disclosure requirement as new Item 309
40
of Regulations S-K and S-B. However, existing Item 401 seems to be a more logical location for this
requirement. Item 401 currently requires, among other things, a brief description of the business experience
of each director. Therefore, we are designating the new disclosure item as Item 401(h) of Regulation S-K
and Item 401(e) of Regulation S-B. The new item specifies that a company may choose to include the audit
committee financial expert disclosure in its proxy or information statement if the company incorporates such
41
information into its annual report as permitted by the instructions to Forms 10-K and 10-KSB.
B. Code of Ethics
1. Code of Ethics Disclosure Requirements
a. Proposed Disclosure Requirements
Section 406 of the Sarbanes-Oxley Act directs us to issue rules requiring a company that is subject to the
reporting requirements of Section 13(a) or 15(d) of the Exchange Act to disclose whether or not the company
has adopted a code of ethics for its senior financial officers that applies to the company's principal financial
officer and controller or principal accounting officer, or persons performing similar functions. The Act further
directs us to require companies that have not adopted such a code of ethics to explain why they have not
done so. In addition to requiring the disclosure mandated by Section 406, we proposed rules to require
disclosure as to whether the company has a code of ethics that applies to its principal executive officer.
b. Commenters' Remarks
Some of the commenters thought that the required disclosure should be limited to a statement indicating
whether the company has a code of ethics that applies to its senior financial officers, and if not, why not.
Others stated that it was appropriate to expand the requirements of the Sarbanes-Oxley Act to also require
a company to disclose whether it has a code of ethics that applies to its principal executive officer. A few
commenters thought that we should extend the requirement even further to require a company to state
whether it has a code of ethics that applies to other individuals, such as directors, all executive officers, and
the company's employees generally.
After considering the comments, we continue to think that it is appropriate and consistent with the purposes
of the Sarbanes-Oxley Act to extend the scope of our rules under Section 406 to include a company's
principal executive officer, as proposed. It seems reasonable to expect that a company would hold its chief
executive officer, an official superior to the company's senior financial officers, to at least the same standards
of ethical conduct to which it holds its senior financial officers. Some commenters who are investors
confirmed that they not only have an interest in knowing whether a company holds its senior financial officers
to certain ethical standards, but whether the company holds its principal executive officer to ethical standards
as well.

12
c. Final Disclosure Requirements
The final rules require a company to disclose whether it has adopted a code of ethics that applies to the
registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or
persons performing similar functions. If the company has not adopted such a code of ethics, it must explain
42
why it has not done so.
2. Definition of the Term “Code of Ethics”

a. Proposed Definition
We proposed to define the term “code of ethics” to mean written standards that are reasonably designed to
43
deter wrongdoing and to promote:
(1) Honest and ethical conduct, including the ethical handling of actual or apparent conflicts
of interest between personal and professional relationships;
(2) Avoidance of conflicts of interest, including disclosure to an appropriate person or
persons identified in the code of any material transaction or relationship that reasonably
could be expected to give rise to such a conflict;
(3) Full, fair, accurate, timely, and understandable disclosure in reports and documents that
a company files with, or submits to, the Commission and in other public communications
made by the company;
44
(4) Compliance with applicable governmental laws, rules and regulations;
(5) The prompt internal reporting to an appropriate person or persons identified in the code
of violations of the code; and
(6) Accountability for adherence to the code.
The second, fifth and sixth prongs of this proposed definition were broader than the requirements specified
by Section 406 of the Sarbanes-Oxley Act, but were intended to supplement the requirements contained in
the Act.
b. Commenters' Remarks
We received several comments on the proposed definition of a code of ethics. Some commenters
recommended that we make the code of ethics cover more issues or general topics than proposed. Some of
these recommendations identified very specific topics that the code of ethics should address. These topics
included matters such as: personal participation in initial public offerings, the reporting of any items of value
received as a result of the officer's position with the company, and change of control transactions.
c. Final Definition of “Code of Ethics” The final rule defines the term “code of ethics” as written standards
that are reasonably designed to deter wrongdoing and to promote:
• Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of
interest between personal and professional relationships;
• Full, fair, accurate, timely, and understandable disclosure in reports and documents that a
registrant files with, or submits to, the Commission and in other public communications made
by the registrant;
• Compliance with applicable governmental laws, rules and regulations;
• The prompt internal reporting to an appropriate person or persons identified in the code of
45
violations of the code; and
• Accountability for adherence to the code.
46
We eliminated the component of the definition requiring the code to promote the avoidance of conflicts
of interest, including disclosure to an appropriate person or persons identified in the code of any material
transaction or relationship that reasonably could be expected to give rise to such a conflict, because the
conduct addressed by this component already is addressed by the first prong of the proposed definition,
requiring honest and ethical conduct and the ethical handling of actual and apparent conflicts of interest.

13
We are not adopting commenters' suggestions that we set forth additional ethical principles that the code
of ethics should address. We continue to believe that ethics codes do, and should, vary from company to
company and that decisions as to the specific provisions of the code, compliance procedures and disciplinary
measures for ethical breaches are best left to the company. Such an approach is consistent with our
disclosure-based regulatory scheme. Therefore, the rules do not specify every detail that the company must
address in its code of ethics, or prescribe any specific language that the code of ethics must include. They
further do not specify the procedures that the company should develop, or the types of sanctions that the
company should impose, to ensure compliance with its code of ethics. We strongly encourage companies
to adopt codes that are broader and more comprehensive than necessary to meet the new disclosure
requirements.
We have added an instruction to the code of ethics disclosure item indicating that a company may have
separate codes of ethics for different types of officers. The instruction also clarifies that the provisions of the
company's code of ethics that address the elements listed in the definition and apply to those officers may
be part of a broader code that addresses additional issues and applies to additional persons, such as all
47
executive officers and directors of the company.
3. Filing of Ethics Code as an Exhibit

We proposed to require a company to file a copy of its ethics code as an exhibit to its annual report. We
received several comment letters stating that the rules should not include this requirement. A common
ground for objection was that some codes are extremely lengthy and therefore would be difficult to file
electronically on our EDGAR system. Some also asserted that ethics codes may contain a significant amount
of detailed information that would not be of particular interest to investors.
We are not entirely persuaded by the commenters that we should not require a company disclosing that
it has a code of ethics that applies to its principal executive officer and senior financial officers to make
those provisions of the code available. However, more flexibility seems appropriate in light of the fact that
many companies already post their codes on their websites. We therefore are adopting rules that will allow
companies to choose between three alternative methods of making their ethics codes publicly available.
First, a company may file a copy of its code of ethics that applies to the registrant's principal executive
officer, principal financial officer, principal accounting officer or controller, or persons performing similar
48
functions and addresses the specified elements as an exhibit to its annual report. Alternatively, a
company may post the text of its code of ethics, or relevant portion thereof, on its Internet website, provided
however, that a company choosing this option also must disclose its Internet address and intention to
49
provide disclosure in this manner in its annual report on Form 10-K, 10-KSB, 20-F or 40-F. As another
alternative, a company may provide an undertaking in its annual report on one of these forms to provide a
50
copy of its code of ethics to any person without charge upon request.
If a company is complying with this disclosure item in its annual report, inclusion of the company's website
address in the annual report will not, by itself, include or incorporate by reference the information on the
company's website into the annual report, unless the company otherwise acts to incorporate the information
51
by reference. Also, we understand that a company may have multiple websites that it uses for various
purposes, such as investor relations, product information and business-to-business activities. We intend the
requirement to disclose the company's website address to mean the website the company normally uses for
its investor relations functions.
4. Location of the Code of Ethics Disclosure A company will have to include the new code of ethics
disclosure in its annual report filed on Form 10-K, 10-KSB, 20-F or 40-F.
5. Form 8-K or Internet Disclosure Regarding Changes to, or Waivers from, the Code of Ethics Section
406(b) of the Sarbanes-Oxley Act directs us to require a company to make “immediate disclosure” on Form
8-K or via Internet dissemination of any change to, or waiver from, the company's code of ethics for its senior
financial officers. Consistent with this mandate, and in keeping with our decision to also require a company to
disclose whether its principal executive officer is subject to a code of ethics, we are adding an item to the list
of Form 8-K triggering events to require disclosure of:

14
• The nature of any amendment to the company's code of ethics that applies to its principal
executive officer, principal financial officer, principal accounting officer or controller, or
52
persons performing similar functions; and
• The nature of any waiver, including an implicit waiver, from a provision of the code of ethics
granted by the company to one of these specified officers, the name of the person to whom
53
the company granted the waiver and the date of the waiver.
Only amendments or waivers relating to the specified elements of the code of ethics and the specified
officers must be disclosed. This clarification is intended to allow and encourage companies to retain broad-
based business codes. For example, if a company has a code of ethics that applies to its directors, as well
as its principal executive officer and senior financial officers, an amendment to a provision affecting only
directors would not require Form 8-K or Internet disclosure.
A company choosing to provide the required disclosure on Form 8-K must do so within five business days
54
after it amends its ethics code or grants a waiver. As an alternative to reporting this information on Form
8-K, a company may use its Internet website as a method of disseminating this disclosure, but only if it
55
previously has disclosed in its most recently filed annual report on Form 10-K or 10-KSB:
• its intention to disclose these events on its Internet website, and
• its Internet website address.
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The commenters were mixed in their reaction to our proposal to permit Internet disclosure of changes and
waivers of the code of ethics in lieu of a Form 8-K filing. Some commenters did not believe that Internet
disclosure would provide sufficiently broad dissemination. Others believed that such disclosure would be
sufficient. The final rules retain the Internet disclosure option because the language in Section 406(b) of the
Sarbanes-Oxley Act clearly indicates that Congress intended companies to have this option.
Several commenters remarked on the proposal to require a company to disclose ethics waivers. A number
of these suggested that we provide guidance as to the meaning of the terms “waiver” and “implicit waiver.”
In response, the final rules define the term “waiver” as theapproval by the company of a material departure
57
from a provision of the code of ethics. They define the term “implicit waiver” as the registrant's failure to
take action within a reasonable period of time regarding a material departure from a provision of the code of
58 59
ethics that has been made known to an executive officer, as defined in Rule 3b-7, of the registrant.
C. Foreign Private Issuers and Request for Comments

We included foreign private issuers within the scope of the proposed rules implementing both Sections
406 and 407 of the Sarbanes-Oxley Act. Some commenters requested that we exempt foreign private
issuers from the application of these rules on the ground that the rules would overlap or conflict with the
audit committee requirements and corporate governance code of ethics provisions in the issuers' home
jurisdictions. Other commenters stated that, for the sake of simplicity, any rule requiring a company, whether
foreign or domestic, to disclose whether its audit committee financial expert is independent should reflect the
standard of independence set forth in the rules that we will adopt to implement Section 301 of the Sarbanes-
Oxley Act.
We have determined to include foreign private issuers within the scope of the final rules implementing
Sections 406 and 407. Their inclusion comports both with the plain language of the above statutory sections,
which applies broadly to issuers, as well as with the overarching purpose of the Sarbanes-Oxley Act, which
is to restore investor confidence in U.S. financial markets, regardless of the origin of the market participants.
Accordingly, like a domestic issuer, a foreign private issuer will have to disclose whether it has an audit
committee financial expert in its Exchange Act annual report. Because foreign private issuers are not subject
to Regulation S-K, however, we have amended Forms 20-F and 40-F to require the audit committee financial
60
expert disclosure.
We agree with the commenters that urged us to adopt an independence standard for the required audit
committee financial expert disclosure that will be the same as that embodied in the rules to be adopted under

15
Section 301 of the Sarbanes-Oxley Act. Accordingly, we intend to revise the Section 407 rules to reflect the
61
independence standard eventually adopted and set forth in the rules implementing Section 301.
In the interim, we believe that it is not appropriate or necessary at this time to require foreign private issuers
62
to disclose whether their audit committee financial experts are independent. Unlike domestic issuers,
foreign private issuers currently are not required to disclose whether their audit committee members are
63
independent. Imposing the independence disclosure requirement immediately may compel a foreign
private issuer to disclose that its expert is not independent under our definition even though there has been
no prior context in which that issuer has been required to consider our definition of the term. In addition,
immediate imposition of our current definition of “independent” would require foreign private issuers to
familiarize themselves with rules which we expect to revise within one annual reporting period. Such
imposition may be unfair to foreign private issuers. Therefore, the final rules do not require a foreign private
issuer to disclose whether its audit committee financial expert is independent. However, we reiterate that in
conjunction with the adoption of our rules under Section 301, which will apply to foreign private issuers, we
intend to amend Forms 20-F and 40-F to require such disclosure.
In the release implementing Section 301, we propose a special accommodation for certain audit committee
requirements for foreign private issuers with a board of auditors or statutory auditors under home country
legal or listing provisions, subject to certain conditions. Specifically, foreign private issuers with boards of
auditors or similar bodies or statutory auditors meeting the requirements of our proposals would be exempt
from the requirements regarding the independence of audit committee members. We request comment
on whether the disclosure requirements related to audit committee financial experts should apply to such
issuers. To the extent they should apply to such issuers, should the requirements apply to the board of
auditors or similar body? Should we apply different standards or disclosure requirements for such issuers?
For example, should audit committeefinancial experts of such issuers be subject to the same disclosure
requirement regarding independence as other foreign private issuers? One of the proposed requirements
for the listing exemption would be that home country legal or listing provisions set forth standards for the
independence of such board or body. Should we permit these issuers to use those independence standards
for their independence disclosure?
Like a domestic issuer, under the adopted Section 406 rules, a foreign private issuer will have to provide the
new code of ethics disclosure in its Exchange Act annual report. However, in contrast to a domestic issuer,
a foreign private issuer will not have to provide in a current report “immediate disclosure” of any change to,
or waiver from, the company's code of ethics for its senior financial officers and principal executive officer.
Instead, we are adopting as proposed the requirement that a foreign private issuer disclose any such change
64
or waiver that has occurred during the past fiscal year in its Exchange Act annual report. This differing
treatment reflects the fact that, unlike domestic Exchange Act reporting companies, reporting foreign private
65
issuers do not have any specific interim or current disclosure requirements mandated by the Commission.
The adopted revisions to Forms 20-F and 40-F do state, however, that a foreign private issuer may disclose
any change to or waiver from the code of ethics obligations of its senior officers on a Form 6-K or its Internet
66
website. We strongly encourage foreign private issuers to use these alternative means of disclosure in
the interest of promptness.
D. Asset-Backed Issuers
In several of our releases implementing provisions of the Sarbanes-Oxley Act, including the Proposing
67
Release, we have noted the special nature of asset-backed issuers. Because of the nature of these
entities, such issuers are subject to substantially different reporting requirements. Most significantly, asset-
backed issuers generally are not required to file the financial statements that other companies must file.
Also, such entities typically are passive pools of assets, without an audit committee or board of directors
or persons acting in a similar capacity. Accordingly, we are excluding asset-backed issuers from the new
disclosure requirements.
E. Transition Periods

16
We received numerous comments urging us to adopt transition periods for compliance. Commenters noted
that some companies desiring audit committee financial experts and codes of ethics that meet the definitions
included in the new rules may need some time to adjust. Several commenters asserted that no special
transition periods were necessary because the new rules only require disclosure. They noted that a company
that has no audit committee financial expert or code of ethics would not be at risk of non-compliance with
our rules as long as it makes appropriate disclosure. However, we recognize that a company that does
not have an audit committee financial expert or a code of ethics that complies with these new definitions
may be harmed by having to disclose these facts even if the company intends to obtain such expert or
code. Therefore, we have decided to provide a limited transition period. Companies must comply with the
code of ethics disclosure requirements promulgated under Section 406 of the Sarbanes-Oxley Act in their
annual reports for fiscal years ending on or after July 15, 2003. They also must comply with the requirements
regarding disclosure of amendments to, and waivers from, their ethics codes on or after the date on which
they file their first annual report in which disclosure of their code of ethics is required. Companies, other
than small business issuers, similarly must comply with the audit committee financial expert disclosure
requirements promulgated under Section 407 of the Sarbanes-Oxley Act in their annual reports for fiscal
years ending on or after July 15, 2003. Recognizing that smaller businesses may have the greatest difficulty
attracting qualified audit committee financial experts, small business issuers must comply with the audit
committee financial expert disclosure requirements in their annual reports for fiscal years ending on or after
December 15, 2003.
III. Paperwork Reduction Act

The amendments contain “collection of information” requirements within the meaning of the Paperwork
Reduction Act of 1995 (“PRA”). We published a notice requesting comment on the collection of information
requirements in the Proposing Release, and we submitted requests to the Office of Management and Budget
(“OMB”) for approval in accordance with thePRA. These requests are pending before the OMB.
The titles for the collection of information are “Form 10-K,” “Form 10-KSB,” “Form 20-F,” “Form 40-F” and
“Form 8-K.” An agency may not conduct or sponsor, and a person is not required to respond to, a collection
of information unless it displays a currently valid OMB control number.
Form 10-K (OMB Control No. 3235-0063) prescribes information that a registrant must disclose annually to
the market about its business. Form 10-KSB (OMB Control No. 3235-0420) prescribes information that a
“small business issuer” as defined under our rules must disclose annually to the market about its business.
Form 20-F (OMB Control No. 3235-0288) prescribes information that a foreign private issuer must disclose
annually to the market about its business. Form 40-F (OMB Control No. 3235-0381) prescribes information
that certain Canadian issuers must disclose annually to the market about their businesses. Form 8-K (OMB
Control No. 3235-0060) prescribes information about significant events that a registrant must disclose on a
current basis. Form 8-K also may be used, at a registrant's option, to report any events that the registrant
deems to be of importance to shareholders. Additionally, companies may use the form to disclose the
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nonpublic information required to be disclosed by Regulation FD.
A. Summary of Amendments
The amendments require two new types of disclosure that must be included in Form 10-K, Form 10-KSB,
Form 20-F and Form 40-F. A domestic company may, at its discretion, provide the new disclosures in its
proxy or information statement on Schedule 14A or 14C and incorporate those disclosures by reference into
its annual report. These new disclosure items require a company to disclose the following:
• Whether it has at least one “audit committee financial expert” serving on its audit committee,
and if so, the name of the expert and whether the expert is independent of management. A
company that does not have an audit committee financial expert must disclose this fact and
explain why it has no such expert.
• Whether it has adopted a code of ethics that applies to the company's principal executive
officer, principal financial officer, principal accounting officer, controller, or persons
performing similar functions. A company disclosing that it has not adopted such a code must
disclose this fact and explain why it has not done so. A company also will be required to

17
promptly disclose amendments to, and waivers from, the code of ethics relating to any of
those officers.
None of these amendments requires a company to have an audit committee financial expert or a code of
ethics.
B. Summary of Comment Letters and Revisions to Proposals

We requested comment on the PRA analysis contained in the proposing release. Several commenters
asserted that the benefits of a rule requiring a company to file its code of ethics do not justify the costs.
In response to those comments, the final rules provide for two additional means by which a company
may make copies of its code of ethics available to the public. Instead of filing the code, the rules permit
a company to either post its code of ethics on the company's website if it discloses in its annual report
that it intends to do so or to include a written undertaking in its annual report to provide any person with
a copy of the code of ethics free of charge upon request. We include in this PRA analysis an adjustment
to reflect the added disclosure required if a company intends to post its ethics code on its website and by
the undertaking if a company elects to make copies available to the public without charge upon request.
The purpose of these new disclosures is to provide flexibility for companies in making their codes of ethics
available to the public and to ensure that interested investors will be able to obtain a copy of the code of
ethics if the company does not otherwise make the code publicly accessible. At the same time, we assume
that companies will choose the least burdensome means of providing the information.
Although we have made several other modifications to the proposals, they will not affect our estimates of
the burden imposed on companies by the new disclosure requirements. These modifications clarify the
definitions of certain terms, such as “audit committee financial expert” and “code of ethics,” used in the new
disclosure items. Although the revision to the audit committee financial expert definition may increase the
number of persons who would qualify as an audit committee financial expert, it will not affect the amount of
disclosure necessary under the disclosure items. The change to the code of ethics definition similarly will
not affect the amount of disclosure required under the new rules. Therefore, we do not believe that these
changes affect our previous estimates of the burden on registrants associated with these new disclosure
items.
C. Burden Estimates
All Form 10-K, 10-KSB, 20-F and 40-F respondents will be subject to the new audit committee financial
expert and code of ethics disclosure requirements. In the Proposing Release, we estimated that the total
burden imposed by the new disclosure items that we are adopting would be one burden hour per year per
registrant, of which 75%, or ¾hour, would be borne by the company internally and 25%, or ¼hour, would
69
be borne externally by outside counsel retained by the company at a cost of $300 per hour. We also
estimated in the Proposing Release that preparation of a Form 8-K to report changes to, or waivers from,
provisions of the code of ethics would impose a burden of 5 hours per form. We estimated that a company
will file such a report once every three years. This results in an estimate of 1 2/3hours per company per year,
of which 75%, or 1 ¼hours would be borne by the company internally and 25%, or 5/12of an hour, would be
reflected as an outside counsel cost of $300 per hour.
The new disclosures required when a company elects to post its code of ethics on its website or to undertake
to provide copies to persons upon request will result in an additional one or two sentences in the company's
annual report. We estimate that this disclosure will add a burden of 6 minutes, or 0.1 hour, per year per
company choosing the posting or undertaking option. We do not have data to accurately estimate the
number of companies that will make such elections. However, we believe that a significant number of
companies currently make their ethics codes available to the public on their websites. Therefore, we estimate
that 75% of companies subject to the requirements will choose to disclose this information on their websites.
We further estimate that 10% of companies will choose to undertake to offer copies of its code of ethics upon
request. Compliance with the revised disclosure requirements is mandatory. Responses to the disclosure
requirements will not be kept confidential.
IV. Costs and Benefits

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The Sarbanes-Oxley Act requires us to adopt the new audit committee financial expert and code of ethics
disclosure requirements. These changes will affect all companies reporting under Section 13(a) and 15(d)
of the Exchange Act, including foreign private issuers and small business issuers. We recognize that these
requirements will result in costs as well as benefits and that they will have an effect on the economy.
A. Benefits
One of the main goals of the Sarbanes-Oxley Act is to improve investor confidence in the financial markets.
These rules are intended to achieve the Act's goals by providing greater transparency as to whether an audit
committee financial expert serves on a company's audit committee and whether the company's principal
executive officer and senior financial officers are subject to ethical standards. By increasing transparency
regarding key aspects of corporate activities and conduct, the proposals are designed to improve the
quality of information available to investors. Greater transparency should assist the market to properly value
securities, which in turn should lead to more efficient allocation of capital resources.
The new rules require a company to disclose the name of the audit committee financial expert serving on the
audit committee and whether that person is independent of management if the company discloses that it has
a financial expert. Investors should benefit from this disclosure by being able to consider it when reviewing
currently required disclosure about all directors' past business experience and making voting decisions.
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The new rules also require a company to make copies of its code of ethics available to investors.
This requirement will allow investors to better understand the ethical principles that guide executives of
companies in which they invest.
B. Costs
The new disclosure items require companies to make disclosure about two matters. First, a company must
disclose whether it has at least one “audit committee financial expert” serving on its audit committee, and
if so, the name of the expert and whether the expert is independent of management. A company that does
not have an audit committee financial expert must disclose this fact and explain why it has no such expert.
Second, a company must disclose whether it has adopted a code of ethics that applies to the company's
principal executive officer and senior financial officers. A company disclosing that it has not adopted such
a code must disclose this fact and explain why it has not done so. A company also will be required to
promptly disclose amendments to, and waivers from, the code of ethics relating to any of those officers.
This information will be readily available to the company. For purposes of the Paperwork Reduction Act, we
estimated these burdens to be $7,760,000.
As stated above, in limited instances, the new rules require more disclosure than mandated by the
Sarbanes-Oxley Act. For example, we expect that companies will incur added costs to disclose the name of
the audit committee financial expert, to disclose whether that person is independent and to file or otherwise
make available copies of their codes of ethics to investors. Companies electing to disclose changes in, and
waivers from, their codes of ethics via their websites in lieu of publicly filing such disclosure on Form 8-K
must disclose this election in their annual reports.
The added burden associated with the requirements to name the audit committee financial expert and
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disclose whether the audit committee financial expert is independent should be minimal. We have added
a safe harbor provision to clarify that we do not intend to increase or decrease the current level of liability
of audit committee members, or the audit committee member determined to be the expert, by requiring
disclosure as to whether an audit committee financial expert serves on the audit committee. We also do not
think that the requirement to name the audit committee financial expert should affect the expert's potential
liability as an audit committee member.
Several commenters noted that a company may incur costs if it has to disclose that it does not have an
audit committee financial expert on its audit committee. For example, a negative market reaction to this type
of disclosure could hamper a company's ability to raise capital. In response to commenters' remarks, we
have broadened the definition of the term “audit committee financial expert” so that more individuals will be
able to qualify under the definition. For example, the final rules allow persons with experience preparing,
auditing, analyzing or evaluating financial statements, or active supervision over those activities, to qualify.

19
The proposals only permitted those with experience preparing or auditing financial statements to qualify as
experts. Similarly, we have broadened the permissible means by which a person may acquire the requisite
expertise. For example, we have added a clause that would permit a person to have acquired the attributes
through experience overseeing or assessing the performance of companies or public accountants with
respect to the preparation, auditing or evaluation of financial statements. We have also added a clause that
allows a person to acquire the attributes through other relevant experience. While more companies will be
able to disclose that they have an audit committee financial expert under the revised definition, we believe
that definition still is consistent with the Act's objective to require an Exchange Act reporting company to
disclose whether it has a person with a high level of financial expertise on its audit committee.
With respect to the code of ethics provisions, a number of commenters stated that the benefits of filing
copies of the code of ethics do not justify the anticipated costs. They argued that some companies have
long codes which would be expensive to file. Moreover, many details in those codes may not be material to
investors. They argued that it should be sufficient for a company to disclose whether it has a code satisfying
the definition of the term “code of ethics” in our rule. Recognizing that a number of companies currently post
copies of their code of ethics on their websites, we have revised the rule to provide two alternatives to the
filing requirement. A company may either post its code of ethics on its website if it discloses that it intends
to do so in its annual report or undertake in its annual report to provide investors with a copy of its code of
ethics upon request. These alternatives should allow issuers to choose the most cost efficient method to
meet the new requirements. We believe that these additional requirements benefit investors, impose minimal
burden on companies, and are consistent with the objectives of the Sarbanes-Oxley Act.
V. Effect on Efficiency, Competition and Capital Formation

72
Section 23(a)(2) of the Exchange Act requires us, when adopting rules under the Exchange Act, to
consider the impact that any new rule would have on competition. In addition, Section 23(a)(2) prohibits
us from adopting any rule that would impose a burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act.
73 74
Section 2(b) of the Securities Act and Section 3(f) of the Exchange Act require us, when engaging in
rulemaking where we are required to consider or determine whether an action is necessary or appropriate
in the public interest, to consider, in addition to the protection of investors, whether the action will promote
efficiency, competition, and capital formation. The purpose of the amendments is to increase transparency
of certain aspects of a company's corporate governance. This should improve the ability of investors to
make informed investment and voting decisions. Informed investor decisions generally promote market
efficiency and capital formation. As noted above, however, the new disclosure items could have certain
indirect consequences, which could adversely impact a company's ability to raise capital. The possibility
ofthese effects and their magnitude if they were to occur are difficult to quantify.
Much of the new disclosure required by the final rules discussed in this release is explicitly mandated by the
Sarbanes-Oxley Act. The new disclosure items are intended to increase transparency as to whether an audit
committee financial expert serves on a company's audit committee and whether the company has a code
of ethics that applies to its principal executive officer and senior financial officers. We anticipate that these
disclosures will enhance the proper functioning of the capital markets by giving investors greater insight
into certain aspects of a company's corporate governance activities. These enhancements should, in turn,
increase the competitiveness of companies participating in the U.S. capital markets. However, because only
companies subject to the reporting requirements of Sections 13 and 15 of the Exchange Act must make the
disclosures, competitors not subject to those reporting requirements potentially could gain an informational
advantage.
We requested comment on whether the proposed amendments, if adopted, would impose a burden on
competition or, conversely, promote efficiency, competition and capital formation. A number of commenters
expressed concern that the definition of the term “audit committee financial expert” may have anti-
competitive effects. Specifically, they were concerned that the definition was so narrow that it might
cause some companies, desiring to have an expert on their board, to recruit persons associated with a
competitor. In response to these comments, we have clarified that this provision does not require the audit
committee financial expert to have experience with issuers in the same industry as the company, or that the

20
person's experience must have been with a company subject to the Exchange Act reporting requirements.
Rather, we have included this provision to focus on the level of sophistication of the accounting issues with
which the person has had experience. We think that a company's board of directors will have to make the
sophistication assessment based on particular facts and circumstances.
Other commenters expressed concern that the definition was so narrow that many companies would
have trouble finding audit committee financial experts. They also feared that disclosure of the fact that a
company does not have an audit committee financial expert could trigger an adverse market reaction. We
have attempted to expand the definition of “audit committee financial expert” without sacrificing the quality
of knowledge and experience required of such an expert. We believe that the revised definition, though
expanded, is consistent with the purposes of the Act.
Commenters also expressed concern that requiring disclosure of the names of audit committee financial
experts would further hamper their efforts to find qualified persons willing to serve on their audit committees
as experts by exposing such persons to increased liability. In response to these comments, we have
created a safe harbor from liability for audit committee financial experts. This safe harbor states that an audit
committee financial expert is not deemed an expert for any purpose, including for purposes of Section 11
of the Securities Act, which imposes, in private actions, a liability standard that is more strict than typically
imposed by the anti-fraud provisions of the Securities Act and the Exchange Act. In addition, the safe harbor
states that a person's potential liability as a director does not change as a result of being designated an
audit committee financial expert. That person will be subject to the same duties, obligations and liability to
which he or she would have been subject, absent such designation. The safe harbor also clarifies that the
designation of an audit committee financial expert does not affect the duties, obligations and liability of other
directors and audit committee members.
VI. Final Regulatory Flexibility Analysis

This Final Regulatory Flexibility Analysis has been prepared in accordance with 5 U.S.C. §603. It relates to
revisions to Exchange Act Form 8-K, Form 10-K, Form 10-KSB, Form 20-F, Form 40-F, Regulation S-K and
Regulation S-B.
A. Need for, and Objectives of, the Amendments

We are adopting these disclosure requirements to comply with the mandate of, and fulfill the purposes
underlying the provisions of, the Sarbanes-Oxley Act of 2002. The new disclosure items are intended
to enhance investor confidence in the fairness and integrity of the securities markets by increasing
transparency as to whether a company has an audit committee financial expert on its audit committee and
whether a company has adopted a code of ethics that applies to its principal executive officer and senior
financial officers. We believe that these rules will help investors to understand and assess certain aspects of
a company's corporate governance.
B. Significant Issues Raised by Public Comment

The Initial Regulatory Flexibility Analysis, or IRFA, appeared in the Proposing Release. We requested
comment on any aspect of the IRFA, including the number of small entities that would be affected by the
proposals, the nature of the impact, how to quantify the number of smallentities that would be affected and
how to quantify the impact of the proposals.
A number of commenters expressed concern that small business issuers, including small entities, would
be particularly disadvantaged by the proposed definition of “audit committee financial expert,” which they
thought was too restrictive. Commenters believed that such entities may be more likely to be unable to
attract qualified persons to serve on their audit committees and that a higher percentage of small companies
than large companies would be compelled to state that they had no audit committee financial expert. They
suggested that this problem would be exacerbated for companies whose operations are primarily conducted
in relatively small geographic regions in which such expertise may not be available.
C. Small Entities Subject to the New Disclosure Requirements

21
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The new disclosure items affect issuers that are small entities. Exchange Act Rule 0-10(a) defines
an issuer, other than an investment company, to be a “small business” or “small organization” if it had
total assets of $5 million or less on the last day of its most recent fiscal year. We estimate that there are
approximately 2,500 issuers, other than investment companies, that may be considered small entities. The
new disclosure items apply to any small entity that is subject to Exchange Act reporting requirements.
D. Projected Reporting, Recordkeeping, And Other Compliance Requirements
The new disclosure items require companies to disclose information as to whether an audit committee
financial expert serves on the company's audit committee and whether the company has adopted a code
of ethics that applies to its principal executive officer and senior financial officers. All small entities that
are subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act are subject to
these disclosure requirements. Because reporting companies already file the forms being amended, no
additional professional skills beyond those currently possessed by these filers are necessary to prepare
the new disclosure. We expect that these new disclosure items will increase costs incurred by small
entities by requiring them to compile and report new information. In addition, to the extent that some small
entities may have difficulty attracting qualified audit committee financial experts, disclosure that they have
no audit committee financial expert may have a negative impact on the market price of their securities.
We have calculated for purposes of the Paperwork Reduction Act that each company, including a small
entity, would be subject to an added annual reporting burden of approximately 2.1 hours and an estimated
annual average cost of approximately $206 for disclosure assistance from outside counsel as a result of
the amendments. These burden estimates reflect only the burden and cost of the required collection of
information. They do not reflect any potential burden or cost associated with recruitment of a qualified audit
committee financial expert or creation of a code of ethics, neither of which is required by our rules.
E. Agency Action to Minimize Effect on Small Entities and Significant Alternatives
The Regulatory Flexibility Act directs the Commission to consider significant alternatives that would
accomplish the stated objective, while minimizing any significant adverse impact on small entities. In
connection with the new disclosure items, we considered the following alternatives: (a) the establishment of
differing compliance or reporting requirements or timetables that take into account the resources available
to small entities; (b) the clarification, consolidation, or simplification of the reporting requirements for small
entities; (c) the use of performance rather than design standards; and (d) an exemption from coverage of the
requirements, or any part thereof, for small entities.
We believe that different compliance or reporting requirements for small entities would interfere with the
primary goal of increasing transparency of corporate governance. Although we generally believe that an
exemption for small entities from coverage of the new disclosure requirements is not appropriate and
would be inconsistent with the policies underlying the Sarbanes-Oxley Act, we have provided a deferred
compliance date for small business issuers, including those that constitute small entities, with respect to the
76
required audit committee financial expert disclosures. Under the adopted rules, small business issuers
need not make such disclosure until they file their annual reports for fiscal years ending December 15, 2003
or later. This deferral provides a small business issuer that does not currently have an audit committee
member that would qualify as an audit committee financial expert under the new definition with more time
to identify and recruit one. We note in this regard that our rules do not require any company to have an
auditcommittee financial expert serving on its audit committee; they only require disclosure of whether such
an expert serves on the company's audit committee.
As explained in this release, we also have significantly expanded the definition of the term “audit committee
financial expert” for all companies. Several commenters noted that small businesses, in particular, would
have difficulty attracting qualified persons. By expanding the definition, the rules increase the pool of
available experts and ease the burden for all companies, including small entities, interested in recruiting
qualified persons.
Also, we have revised our proposed requirement that all companies, including small entities, must file a
copy of their code of ethics as an exhibit to their annual reports. As stated in the release, the adopted rules
provide three different alternatives for a company to make its code of ethics publicly available. This revision
allows companies to choose the least burdensome alternative.

22
We believe that the new disclosure requirements are clear and straightforward. The new rules require
only brief disclosure. Therefore, it does not seem necessary to develop separate requirements for small
entities. Similarly, we believe that applying a different definition of “audit committee financial expert” in a
rule applicable only to small entities would not be appropriate. The final rules clarify that factors such as the
complexity of a company's business and the accounting issues involved in a company's financial statements
affect the level of experience and understanding that an audit committee financial expert should have.
Because small entities tend to have less complex businesses and accounting issues than large companies,
the definition provides significant flexibility to small entities. We have used design rather than performance
standards in connection with the new disclosure items because we want this disclosure to appear in a
specific type of disclosure filing so that investors will know where to find the information. We do not believe
that performance standards for small entities would be consistent with the purpose of the new rules.
VII. Statutory Basis

We are adopting amendments to Securities Exchange Act Form 10-K, Form 10-KSB, Form 20-F, Form
40-F, Form 8-K, Regulation S-B and Regulation S-K pursuant to Sections 5, 6, 7, 10, 17, 19 and 28 of the
Securities Act, as amended, Sections 12, 13, 15, 23 and 36 of the Securities Exchange Act, as amended,
and Sections 3(a), 406 and 407 of the Sarbanes-Oxley Act of 2002.
TEXT OF THE PROPOSED AMENDMENTS

List of Subjects
17. CFR Part 228
Reporting and recordkeeping requirements, Securities, Small businesses.

17. CFR Parts 229 and 249
Reporting and recordkeeping requirements, Securities. For the reasons set out above, we amend title 17,
chapter II of the Code of Federal Regulations as follows:
PART 228 - INTEGRATED DISCLOSURE SYSTEM FOR SMALL BUSINESS ISSUERS
1. The authority citation for Part 228 is revised to read as follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 77z-3, 77aa(25), 77aa(26), 77ddd,
77eee, 77ggg, 77hhh, 77jjj, 77nnn, 77sss, 78 l, 78m, 78n, 78o, 78u-5, 78w, 78 ll, 78mm, 80a-8,
80a-29, 80a-30, 80a-37 and 80b-11.
*****
Section 228.401 is also issued under secs. 3(a) and 407, Pub. L. No. 107-204, 116 Stat. 745. Section
228.406 is also issued under secs. 3(a) and 406, Pub. L. No. 107-204, 116 Stat. 745. 2. Amend §228.401 by
adding paragraph (e) to read as follows:
§228.401 (Item 401) Directors, Executive Officers, Promoters and Control Persons. * * * * *
(e) Audit committee financial expert. (1)(i) Disclose that the small business issuer's board of directors has
determined that the small business issuer either:
(A) Has at least one audit committee financial expert serving on its audit committee; or
(B) Does not have an audit committee financial expert serving on its audit committee.
(ii) If the small business issuer provides the disclosure required by paragraph (e)(1)(i)(A) of this Item, it must
disclose the name of the audit committee financial expert and whether that person is independent, as that
term is used in Item 7(d)(3)(iv) of Schedule 14A (240.14a-101 of this chapter) under the Exchange Act.
(iii) If the small business issuer provides the disclosure required by paragraph (e)(1)(i)(B) of this Item, it must
explain why it does not have an audit committee financial expert.
Instruction to paragraph (e)(1) of Item 401 If the small business issuer's board of directors has determined
that the small business issuer has more than one audit committee financial expertserving on its audit

23
committee, the small business issuer may, but is not required to, disclose the names of those additional
persons. A small business issuer choosing to identify such persons must indicate whether they are
independent pursuant to Item 401(e)(1)(ii).
(2) For purposes of this Item, an audit committee financial expert means a person who has the following
attributes:
(i) An understanding of generally accepted accounting principles and financial statements;
(ii) The ability to assess the general application of such principles in connection with the
(iii) 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 small
business issuer's financial statements, or experience actively supervising one or
more persons engaged in such activities; (iv) An understanding of internal controls and
procedures for financial reporting; and
(v) An understanding of audit committee functions. (3) A person shall have acquired such
attributes through:
(i) 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;
(ii) Experience actively supervising a principal financial officer, principal accounting
officer, controller, public accountant, auditor or person performing similar functions;
(iii) Experience overseeing or assessing the performance of companies or public
accountants with respect to the preparation, auditing or evaluation of financial
statements; or
(iv) Other relevant experience.
(4) Safe Harbor
(i) A person who is determined to be an audit committee financial expert will not be deemed an expert for any
purpose, including without limitation for purposes of section 11 of the Securities Act of 1933 (15 U.S.C. 77k),
as a result of being designated or identified as an audit committee financial expert pursuant to this Item 401.
(ii) The designation or identification of a person as an audit committee financial expert pursuant to this Item
401 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 board of directors
in the absence of such designation or identification.
(iii) The designation or identification of a person as an audit committee financial expert pursuant to this Item
401 does not affect the duties, obligations or liability of any other member of the audit committee or board of
directors.
Instructions to Item 401(e)
1. The small business issuer need not provide the disclosure required by this Item 401(e) in a proxy or
information statement unless that small business issuer is electing to incorporate this information by
reference from the proxy or information statement into its annual report pursuant to general instruction E(3)
to Form 10-KSB.
2. If a person qualifies as an audit committee financial expert by means of having held a position described
in paragraph (e)(3)(iv) of this Item, the small business issuer shall provide a brief listing of that person's
relevant experience. Such disclosure may be made by reference to disclosures required under paragraph (a)
(4) of this Item 401 (§229.401(a)(4) or this chapter).
3. In the case of a foreign private issuer with a two-tier board of directors, for purposes of this Item 401(e),
the term board of directors means the supervisory or non-management board. Also, in the case of a foreign
private issuer, the term generally accepted accounting principles in paragraph (e)(2)(i) of this Item means the

24
body of generally accepted accounting principles used by that issuer in its primary financial statements filed
with the Commission.
4. A small business issuer that is an Asset-Backed Issuer (as defined in §240.13a-14(g) and §240.15d-14(g)
of this chapter) is not required to disclose the information required by this Item 401(e).
5. Following the effective date of the first registration statement filed under the Securities Act (15 U.S.C. 77a
et seq.) or Securities Exchange Act (15 U.S.C. 78a et seq.) by a small business issuer, the small business
issuer or successor issuer need not make the disclosures required by this Item in its first annual report filed
pursuant to Section 13(a) or 15(d) (15 U.S.C. 78m(a) or 78o(d)) of the Exchange Act after effectiveness.
3. Add §228.406 to read as follows: §228.406 (Item 406) Code of ethics.
(a) Disclose whether the small business issuer has adopted a code of ethics that applies to the small
business issuer's principal executive officer, principal financial officer, principal accounting officer or
controller, or personsperforming similar functions. If the small business issuer has not adopted such a code
of ethics, explain why it has not done so.
(b) For purposes of this Item 406, the term code of ethics means written standards that are reasonably
designed to deter wrongdoing and to promote:
(2) Full, fair, accurate, timely, and understandable disclosure in reports and documents
that a small business issuer files with, or submits to, the Commission and in other public
communications made by the small business issuer;
(4) The prompt internal reporting of violations of the code to an appropriate person or
persons identified in the code; and
(c) The small business issuer must:
(1) File with the Commission a copy of its code of ethics that applies to the small business
issuer's principal executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions, as an exhibit to its annual report;
(2) Post the text of such code of ethics on its Internet website and disclose, in its annual
report, its Internet address and the fact that it has posted such code of ethics on its Internet
website; or
(3) Undertake in its annual report filed with the Commission to provide to any person without
charge, upon request, a copy of such code of ethics and explain the manner in which such
request may be made.
(d) If the small business issuer intends to satisfy the disclosure requirement under Item 10 of Form 8-K
regarding an amendment to, or a waiver from, a provision of its code of ethics that applies to the small
business issuer's principal executive officer, principal financial officer, principal accounting officer or
controller, or persons performing similar functions and that relates to any element of the code of ethics
definition enumerated in paragraph (b) of this Item by posting such information on its Internet website,
disclose the small business issuer's Internet address and such intention.
Instructions to Item 406.
1. A small business issuer may have separate codes of ethics for different types of officers. Furthermore,
a code of ethics within the meaning of paragraph (b) of this Item may be a portion of a broader document
that addresses additional topics or that applies to more persons than those specified in paragraph (a). In
satisfying the requirements of paragraph (c), a small business issuer need only file, post or provide the
portions of a broader document that constitutes a code of ethics as defined in paragraph (b) and that apply to
the persons specified in paragraph (a).
2. If a small business issuer elects to satisfy paragraph (c) of this Item by posting its code of ethics on its
website pursuant to paragraph (c)(2), the code of ethics must remain accessible on its website for as long as

25
the small business issuer remains subject to the requirements of this Item and chooses to comply with this
Item by posting its code on its website pursuant to paragraph (c)(2).
3. A small business issuer that is an Asset-Backed Issuer (as defined in §240.13a-14(g) and §240.15d-14(g)
of this chapter) is not required to disclose the information required by this Item.
4. Amend §228.601 by:
a. Removing the “reserved” designation for exhibit (14) and adding “Code of ethics” in its
place in the Exhibit Table;
b. Removing “N/A” corresponding to exhibit (14) under all captions in the Exhibit Table;
c. Adding an “X” corresponding to exhibit (14) under the caption “Exchange Act Forms”, “8-
K” and “10-KSB” in the Exhibit Table; and
d. Adding the text of paragraph (b)(14).
The revisions and additions read as follows:
§228.601 (Item 601) Exhibits.
*****
(b) Description of exhibits. * * *
(14) Code of ethics. Any code of ethics, or amendment thereto, that is the subject of the disclosure required
by Item 406 of Regulation S-B (§228.406) or Item 10 of Form 8-K (§249.308 of this chapter), to the extent
that the small business issuer intends to satisfy the Item 406 or Item 10 requirements through filing of an
exhibit.
*****
PART 229 - STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES ACT OF 1933,
SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND CONSERVATION ACT OF 1975 -
REGULATION S-K
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2, 77z-3, 77aa(25), 77aa(26), 77ddd,
77eee, 77ggg, 77hhh, 77iii, 77jjj, 77nnn, 77sss, 78c, 78i, 78j, 78 l, 78m, 78n, 78o, 78u-5, 78w, 78 ll
(d), 78mm, 79e, 79n, 79t, 80a-8, 80a-29, 80a-30, 80a-31(c), 80a-37, 80a-38(a) and 80b-11, unless
otherwise noted.
*****
Section 229.401 is also issued under secs. 3(a) and 407, Pub. L. No. 107-204, 116 Stat. 745. Section
229.406 is also issued under secs. 3(a) and 406, Pub. L. No. 107-204, 116 Stat. 745. Section 229.601 is
also issued under secs. 3(a) and 406, Pub. L. No. 107-204, 116 Stat. 745. 6. Amend §229.401 by adding
paragraph (h) to read as follows:
§229.401 (Item 401) Directors, executive officers, promoters and control persons.
*****
(h) Audit committee financial expert. (1)(i) Disclose that the registrant's board of directors has determined
that the registrant either:
(A) Has at least one audit committee financial expert serving on its audit committee; or
(B) Does not have an audit committee financial expert serving on its audit committee.
(ii) If the registrant provides the disclosure required by paragraph (h)(1)(i)(A) of this Item, it must disclose the
name of the audit committee financial expert and whether that person is independent, as that term is used in
Item 7(d)(3)(iv) of Schedule 14A (240.14a-101 of this chapter) under the Exchange Act.
(iii) If the registrant provides the disclosure required by paragraph (h)(1)(i)(B) of this Item, it must explain why
it does not have an audit committee financial expert.
Instruction to paragraph (h)(1) of Item 401

26
If the registrant's board of directors has determined that the registrant has more than one audit committee
financial expert serving on its audit committee, the registrant may, but is not required to, disclose the names
of those additional persons. A registrant choosing to identify such persons must indicate whether they are
independent pursuant to Item 401(h)(1)(ii).
(2) For purposes of this Item, an audit committee financial expert means a person who has the following
attributes:
(i) An understanding of generally accepted accounting principles and financial statements;
(ii) The ability to assess the general application of such principles in connection with the
(iii) Experience preparing, auditing, analyzing or evaluating financial statements that present
(iv) An understanding of internal controls and procedures for financial reporting; and
(v) An understanding of audit committee functions.
(3) A person shall have acquired such attributes through:
(i) Education and experience as a principal financial officer, principal accounting officer,
(ii) Experience actively supervising a principal financial officer, principal accounting officer,
(iii) Experience overseeing or assessing the performance of companies or public
accountants with respect to the preparation, auditing or evaluation of financial statements; or
(iv) Other relevant experience.
(4) Safe Harbor
(i) A person who is determined to be an audit committee financial expert will not be deemed an expert for any
purpose, including without limitation for purposes of section 11 of the Securities Act of 1933 (15 U.S.C. 77k),
as a result of being designated or identified as an audit committee financial expert pursuant to this Item 401.
(ii) The designation or identification of a person as an audit committee financial expert pursuant to this Item
401 does not impose on such person any duties, obligations or liability that are greater than the duties,
(iii) The designation or identification of a person as an audit committee financial expert pursuant to this Item
401 does not affect the duties, obligations or liability of any other member of the audit committee or board of
directors.
Instructions to Item 401(h)
1. The registrant need not provide the disclosure required by this Item 401(h) in a proxy or information
statement unless that registrant iselecting to incorporate this information by reference from the proxy or
information statement into its annual report pursuant to general instruction G(3) to Form 10-K.
2. If a person qualifies as an audit committee financial expert by means of having held a position described
in paragraph (h)(3)(iv) of this Item, the registrant shall provide a brief listing of that person's relevant
experience. Such disclosure may be made by reference to disclosures required under paragraph (e) of this
Item 401 (§229.401(e) or this chapter).
3. In the case of a foreign private issuer with a two-tier board of directors, for purposes of this Item 401(h),
the term board of directors means the supervisory or non-management board. Also, in the case of a foreign
private issuer, the term generally accepted accounting principles in paragraph (h)(2)(i) of this Item means the
body of generally accepted accounting principles used by that issuer in its primary financial statements filed
with the Commission.

27
4. A registrant that is an Asset-Backed Issuer (as defined in §240.13a-14(g) and §240.15d-14(g) of this
chapter) is not required to disclose the information required by this Item 401(h).
7. Add §229.406 to read as follows:
§229.406 (Item 406) Code of ethics.

(a) Disclose whether the registrant has adopted a code of ethics that applies to the registrant's principal
executive officer, principal financial officer, principal accounting officer or controller, or persons performing
similar functions. If the registrant has not adopted such a code of ethics, explain why it has not done so.
(b) For purposes of this Item 406, the term code of ethics means written standards that are reasonably
a registrant files with, or submits to, the Commission and in other public communications
made by the registrant;
(c) The registrant must:
(1) File with the Commission a copy of its code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal accounting officer or controller,
or persons performing similar functions, as an exhibit to its annual report;
website; or
(d) If the registrant intends to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an
amendment to, or a waiver from, a provision of its code of ethics that applies to the registrant's principal
similar functions and that relates to any element of the code of ethics definition enumerated in paragraph (b)
of this Item by posting such information on its Internet website, disclose the registrant's Internet address and
such intention.
Instructions to Item 406.
1. A registrant may have separate codes of ethics for different types of officers. Furthermore, a code of ethics
within the meaning of paragraph (b) of this Item may be a portion of a broader document that addresses
additional topics or that applies to more persons than those specified in paragraph (a). In satisfying the
requirements of paragraph (c), a registrant need only file, post or provide the portions of a broader document
that constitutes a code of ethics as defined in paragraph (b) and that apply to the persons specified in
paragraph (a).
2. If a registrant elects to satisfy paragraph (c) of this Item by posting its code of ethics on its website
pursuant to paragraph (c)(2), the code of ethics must remain accessible on its website for as long as the
small business issuer remains subject to the requirements of this Item and chooses to comply with this Item
by posting its code on its website pursuant to paragraph (c)(2).
3. A registrant that is an Asset-Backed Issuer (as defined in §240.13a-14(g) and §240.15d-14(g) of this
chapter) is not required to disclose the information required by this Item.
8. Amend §229.601 by:

28
a. Removing the “reserved” designation for exhibit (14) and adding “Code of ethics” in its
place in the Exhibit Table;
b. Removing “N/A” corresponding to exhibit (14) under all captions in the Exhibit Table;
c. Adding an “X” corresponding to exhibit (14) under the caption “Exchange Act Forms”, “8-
K” and “10-K” in the Exhibit Table; and
d. Adding the text of paragraph (b)(14).
The revisions and additions read as follows:
§229.601 (Item 601) Exhibits.
*****
(b) Description of exhibits. * * *
(14) Code of ethics. Any code of ethics, or amendment thereto, that is the subject of the disclosure required
by Item 406 of Regulation S-K (§229.406) or Item 10 of Form 8-K (§249.308 of this chapter), to the extent
that the registrant intends to satisfy the Item 406 or Item 10 requirements through filing of an exhibit.
*****
PART 249 - FORMS, SECURITIES EXCHANGE ACT OF 1934

Authority: 15 U.S.C. 78a et seq., unless otherwise noted.
Section 249.220f is also issued under secs. 3(a), 302, 404 and 407, Pub. L. No. 107-204, 116 Stat. 745.
Section 249.240f is also issued under secs. 3(a), 302, 404 and 407, Pub. L. No. 107-204, 116 Stat. 745.
Section 249.308 is also issued under 15 U.S.C. 80a-29 and secs. 3(a), 302 and 404, Pub. L. No. 107-204,
116 Stat. 745.
*****
Section 249.310 is also issued under secs. 3(a), 302, 407, Pub. L. No. 107-204, 116 Stat. 745.
Section 249.310b is also issued under secs. 3(a), 302, 407, Pub. L. No. 107-204, 116 Stat. 745.
*****
10. Amend Form 8-K (referenced in §249.308) by:
a. Revising General Instruction B.1.; and
b. Adding Item 10.
The revision and addition read as follows:
Note—The text of Form 8-K does not, and this amendment will not, appear in the Code of
Federal Regulations.
Form 8-K
Current Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
*****
General Instructions
*****
B. Events to Be Reported and Time for Filing of Reports

1. A report on this form is required to be filed upon the occurrence of any one or more of the events specified
in Items 1-4, 6 and 10 of this form. A report of an event specified in Items 1-3 is to be filed within 15 calendar

29
days after the occurrence of the event. A report of an event specified in Item 4, 6 or 10 is to be filed within
5 business days after the occurrence of the event; if the event occurs on a Saturday, Sunday, or holiday
on which the Commission is not open for business then the 5 business day period shall begin to run on
and include the first business day thereafter. A report on this form pursuant to Item 8 is required to be filed
within 15 calendar days after the date on which the registrant makes the determination to use a fiscal year
end different from that used in its most recent filing with the Commission. A registrant either furnishing a
report on this form under Item 9 or electing to file a report on this form under Item 5 solely to satisfy its
obligations under Regulation FD ( 17 CFR 243.100 and 243.101) must furnish such report or make such
filing in accordance with the requirements of Rule 100(a) of Regulation FD ( 17 CFR 243.100(a)). A report
on this form pursuant to Item 11 is required to be filed not later than the date prescribed for transmission of
the notice to directors and executive officers required by Rule 104(b)(2) of Regulation BTR (§245.104(b)(2)
of this chapter).
*****
Information to Be Included in the Report

*****
Item 10. Amendments to the Registrant's Code of Ethics, or Waiver of a Provision of the Code of
Ethics.
(a) The registrant must briefly describe the nature of any amendment to a provision of its code of ethics
that applies to the registrant's principal executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions and that relates to any element of the code of
ethicsdefinition enumerated in Item 406(b) of Regulations S-K and S-B (§229.406(b) and §228.406(b) of this
chapter).
(b) If the registrant has granted a waiver, including an implicit waiver, from a provision of the code of
ethics to one of these officers or persons that relates to one or more of the items set forth in Item 406(b) of
Regulations S-K and S-B (§229.406(b) and §228.406(b) of this chapter), the registrant must briefly describe
the nature of the waiver, the name of the person to whom the waiver was granted, and the date of the
waiver.
(c) The registrant does not need to provide any information pursuant to this Item if it discloses the required
information on its Internet website within five business days following the date of the amendment or waiver
and the registrant has disclosed in its most recently filed annual report its Internet address and intention to
provide disclosure in this manner. If the registrant elects to disclose the information required by this Item
through its website, such information must remain available on the website for at least a 12-month period.
Following the 12-month period, the registrant must retain the information for a period of not less than five
years. Upon request, the registrant must furnish to the Commission or its staff a copy of any or all information
retained pursuant to this requirement.
Instructions.
1. The registrant does not need to disclose technical, administrative or other non-substantive amendments to
its code of ethics.
2. For purposes of this Item:
a. The term “waiver” means the approval by the registrant of a material departure from a
provision of the code of ethics; and
b. The term “implicit waiver” means the registrant's failure to take action within a reasonable
period of time regarding a material departure from a provision of the code of ethics that has
been made known to an executive officer, as defined in Rule 3b-7 (§240.3b-7 of this chapter)
of the registrant.
*****
11. Amend Form 20-F (referenced in §249.220f) by:
a. Redesignating Item 16 as Item 16A, adding text to Item 16A and adding Item 16B;

30
b. Redesignating paragraph 11 of “Instructions as to Exhibits” as paragraph 12; and
c. Adding new paragraph 11 to “Instructions as to Exhibits.”
The additions and revisions read as follows:
Note: The text of Form 20-F does not, and this amendment will not, appear in the Code of Federal
Regulations.
FORM 20-F
*****
Item 16A. Audit committee financial expert.

(a)(1) Disclose that the registrant's board of directors has determined that the registrant either:
(i) Has at least one audit committee financial expert serving on its audit committee; or
(ii) Does not have an audit committee financial expert serving on its audit committee.
(2) If the registrant provides the disclosure required by paragraph (a)(1)(i) of this Item, it must disclose
the name of the audit committee financial expert.
(3) If the registrant provides the disclosure required by paragraph (a)(1)(ii) of this Item, it must explain why it
does not have an audit committee financial expert.
Instruction to paragraph (a) of Item 16A:
of those additional persons.
(b) For purposes of this Item, an “audit committee financial expert” means a person who has the following
attributes:
(2) The ability to assess the general application of such principles in connection with the
(3) Experience preparing, auditing, analyzing or evaluating financial statements that present
(4) An understanding of internal controls and procedures for financial reporting; and
(c) A person shall have acquired such attributes through:
(d) Safe Harbor
(1) A person who is determined to be an audit committee financial expert will not be deemed an “expert” for
any purpose, including without limitation for purposes of section 11 of the Securities Act of 1933 (15 U.S.C.
77k), as a result of being designated or identified as an audit committee financial expert pursuant to this Item
16A.

31
(2) The designation or identification of a person as an audit committee financial expert pursuant to this Item
16A does not impose on such person any duties, obligations or liability that are greater than the duties,
(3) The designation or identification of a person as an audit committee financial expert pursuant to this Item
16A does not affect the duties, obligations or liability of any other member of the audit committee or board of
directors.
Instructions to Item 16A:
1. Item 16A applies only to annual reports, and does not apply to registration statements, on
Form 20-F.
2. If a person qualifies as an audit committee financial expert by means of having held a
position described in paragraph (c)(4) of this Item, the registrant shall provide a brief listing of
that person's relevant experience. Such disclosure may be made by reference to disclosures
required under Item 6.A.
3. In the case of a foreign private issuer with a two-tier board of directors, for purposes of this
Item 16A, the term “board of directors” means the supervisory or non-management board.
Also, the term “generally accepted accounting principles” in paragraph (b)(1) of this Item
means the body of generally accepted accounting principles used by the foreign private
issuer in its primary financial statements filed with the Commission.
4. A registrant that is an Asset-Backed Issuer (as defined in §240.13a-14(g) and
§240.15d-14(g) of this chapter) is not required to disclose the information required by this
Item 16A.
Item 16B. Code of Ethics.
(a) Disclose whether the registrant has adopted a code of ethics that applies to the registrant's principal
(b) For purposes of this Item 16B, the term “code of ethics” means written standards that are reasonably
website; or
(d) The registrant must briefly describe the nature of any amendment to a provision of its code of ethics that
applies to the registrant's principal executive officer, principal financial officer, principal accounting officer
or controller, or persons performing similar functions and that relates to any element of the code of ethics

32
definition enumerated in Item 16B(b), whichhas occurred during the registrant's most recently completed
fiscal year.
(e) If the registrant has granted a waiver, including an implicit waiver, from a provision of the code of ethics
to one of the officers or persons described in Item 16B(a) that relates to one or more of the items set forth in
Item 16B(b) during the registrant's most recently completed fiscal year, the registrant must briefly describe
the nature of the waiver, the name of the person to whom the waiver was granted, and the date of the
waiver.
Instructions to Item 16B:
1. Item 16B applies only to annual reports, and does not apply to registration statements, on
Form 20-F.
2. A registrant may have separate codes of ethics for different types of officers. Furthermore,
a “code of ethics” within the meaning of paragraph (b) of this Item may be a portion of a
broader document that addresses additional topics or that applies to more persons than
those specified in paragraph (a). In satisfying the requirements of paragraph (c), a registrant
need only file, post or provide the portions of a broader document that constitutes a “code of
ethics” as defined in paragraph (b) and that apply to the persons specified in paragraph (a).
3. If a registrant elects to satisfy paragraph (c) of this Item by posting its code of ethics on
its website pursuant to paragraph (c)(2), the code of ethics must remain accessible on its
website for as long as the registrant remains subject to the requirements of this Item and
chooses to comply with this Item by posting its code on its website pursuant to paragraph (c)
(2).
Item.
5. The registrant does not need to provide any information pursuant to paragraphs (d)
and (e) of this Item if it discloses the required information on its Internet website within
five business days following the date of the amendment or waiver and the registrant has
disclosed in its most recently filed annual report its Internet address and intention to provide
disclosure in this manner. If the registrant elects to disclose the information required by
paragraphs (d) and (e) through its website, such information must remain available on the
website for at least a 12-month period. Following the 12-month period, the registrant must
retain the information for a period of not less than five years. Upon request, the registrant
must furnish to the Commission or its staff a copy of any or all information retained pursuant
to this requirement.
6. The registrant does not need to disclose technical, administrative or other non-substantive
amendments to its code of ethics.
7. For purposes of this Item 16B:
a. The term “waiver” means the approval by the registrant of a material departure
from a provision of the code of ethics; and
b. The term “implicit waiver” means the registrant's failure to take action within a
reasonable period of time regarding a material departure from a provision of the
code of ethics that has been made known to an executive officer, as defined in
Rule 3b-7 (§240.3b-7 of this chapter), of the registrant.
*****
Instructions As To Exhibits
*****
11. Any code of ethics, or amendment thereto, that is the subject of the disclosure required by Item 16B of
Form 20-F, to the extent that the registrant intends to satisfy the Item 16B requirements through filing of an
exhibit.
*****

33
12. Amend Form 40-F (referenced in §249.240f) by adding paragraphs (8) and (9) to General Instruction B to
read as follows.
Note: The text of Form 40-F does not, and this amendment will not, appear in the Code of Federal
Regulations.
FORM 40-F
*****
GENERAL INSTRUCTIONS
*****
B. Information To Be Filed on this Form.

*****
(8)(a)(1) Disclose that the registrant's board of directors has determined that the registrant either:
(i) Has at least one audit committee financial expert serving on its audit committee; or
(ii) Does not have an audit committee financial expert serving on its audit committee.
(2) If the registrant provides the disclosure required by paragraph (8)(a)(1)(i) of this General Instruction
B, it must disclose the name of the audit committee financial expert.
(3) If the registrant provides the disclosure required by paragraph (8)(a)(1)(ii) of this General Instruction B, it
must explain why it does not have an audit committee financial expert.
Note to paragraph (8)(a) of General Instruction B:
of those additional persons.
(b) For purposes of paragraph (8) of General Instruction B, an “audit committee financial expert” means a
person who has the following attributes:
(2) The ability to assess the general application of such principles in connection with the
(3) Experience preparing, auditing, analyzing or evaluating financial statements that present
(4) An understanding of internal controls and procedures for financial reporting; and
(c) A person shall have acquired such attributes through:
(d) Safe Harbor

34
(1) A person who is determined to be an audit committee financial expert will not be deemed an “expert” for
any purpose, including without limitation for purposes of section 11 of the Securities Act of 1933 (15 U.S.C.
77k), as a result of being designated or identified as an audit committee financial expert pursuant to this
paragraph (8) of General Instruction B.
(2) The designation or identification of a person as an audit committee financial expert pursuant to this
paragraph (8) of General Instruction B 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 board of directors in the absence of such designation or identification.
(3) The designation or identification of a person as an audit committee financial expert pursuant to this
paragraph (8) of General Instruction B does not affect the duties, obligations or liability of any other member
of the audit committee or board of directors.
Notes to Paragraph (8) of General Instruction B:
1. Paragraph (8) of General Instruction B applies only to annual reports, and does not apply
to registration statements, on Form 40-F.
2. If a person qualifies as an audit committee financial expert by means of having held
a position described in paragraph (8)(c)(4) of General Instruction B, the registrant shall
provide a brief listing of that person's relevant experience. Such disclosure may be made
by reference to disclosures in the annual report relating to the business experience of that
director.
3. In the case of a foreign private issuer with a two-tier board of directors, for purposes
of this paragraph (8) of General Instruction B, the term “board of directors” means the
supervisory or non-management board. Also, the term “generally accepted accounting
principles” in paragraph (8)(b)(1) of General Instruction B means the body of generally
accepted accounting principles used by the foreign private issuer in its primary financial
statements filed with the Commission.
(9)(a) Disclose whether the registrant has adopted a code of ethics that applies to the registrant's principal
(b) For purposes of this paragraph (9) of General Instruction B, the term “code of ethics” means written
standards that are reasonably designed to deter wrongdoing and to promote:
website; or

35
(d) The registrant must briefly describe the nature of any amendment to a provision of its code of ethics that
applies to the registrant's principal executive officer, principal financial officer, principal accounting officer
or controller, or persons performing similar functions and that relates to any element of the code of ethics
definition enumerated in paragraph (9)(b) of General Instruction B, which has occurred during the registrant's
most recently completed fiscal year. File a copy of the amendment as an exhibit to the annual statement.
(e) If the registrant has granted a waiver, including an implicit waiver, from a provision of the code of ethics
to one of the officers or persons described in paragraph (9)(a) that relates to one or more of the items set
forth in paragraph (9)(b) of General Instruction B during the registrant's most recently completed fiscal year,
the registrant must briefly describe the nature of the waiver, the name of the person to whom the waiver was
granted, and the date of the waiver.
Notes to paragraph (9) of General Instruction B:
1. Paragraph (9) of General Instruction B applies only to annual reports, and does not apply
to registration statements, on Form 40-F.
2. A registrant may have separate codes of ethics for different types of officers. Furthermore,
a “code of ethics” within the meaning of paragraph (9)(b) of this General Instruction may
be a portion of a broader document that addresses additional topics or that applies to more
persons than those specified in paragraph (9)(a). In satisfying the requirements of paragraph
(9)(c), a registrant need only file, post or provide the portions of a broader document that
constitutes a “code of ethics” as defined in paragraph (9)(b) and that apply to the persons
specified in paragraph (9)(a).
3. If a registrant elects to satisfy paragraph (9)(c) of this General Instruction by posting its
code of ethics on its website pursuant to paragraph (9)(c)(2), the code of ethics must remain
accessible on its website for as long as the registrant remains subject to the requirements of
this paragraph (9) of General Instruction B and chooses to comply with this paragraph (9) of
General Instruction B by posting its code on its website pursuant to paragraph (9)(c)(2).
5. The registrant does not need to provide any information pursuant to paragraphs (9)(d) and
(9)(e) of General Instruction B if it discloses the required information on its Internet website
within five business days following the date of the amendment or waiver and the registrant
has disclosed in its most recently filed annual report its Internet address and intention to
provide disclosure in this manner. If the registrant elects to disclose the information required
by paragraphs (9)(d) and (9)(e) of General Instruction B through its website, such information
must remain available on the website for at least a 12-month period. Following the 12-month
period, the registrant must retain the information for a period of not less than five years.
Upon request, the registrant must furnish to the Commission or its staff a copy of any or all
information retained pursuant to this requirement.
6. The registrant does not need to disclose technical, administrative or other non-substantive
amendments to its code of ethics.
7. For purposes of this paragraph (9) of General Instruction B:
a. The term “waiver” means the approval by the registrant of a material departure
from a provision of the code of ethics; and
b. The term “implicit waiver” means the registrant's failure to take action within a
reasonable period of time regarding a material departure from a provision of the
code of ethics that has been made known to an executive officer, as defined in
Rule 3b-7
(§240.3b-7 of this chapter), of the registrant.

36
*****
13. Amend Form 10-K (referenced in §249.310) by revising Item 10 in Part III to read as follows: Note—The
text of Form 10-K does not, and this amendment will not, appear in the Code of Federal Regulations.
Form 10-K
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
*****
PART III
*****
Item 10. Directors and Executive Officers of the Registrant. Furnish the information required by Items
401, 405 and 406 of Regulation S-K (§§229.401, 229.405 and 229.406 of this chapter).
*****
14. Amend Form 10-KSB (referenced in §249.310b) by revising Item 9 in Part III to read as follows:
Note—The text of Form 10-KSB does not, and this amendment will not, appear in the Code of
Federal Regulations.
Form 10-KSB
[]
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
*****
PART III
*****
Item 9. Directors and Executive Officers of the Registrant.

Furnish the information required by Items 401, 405 and 406 of Regulation S-B (§§228.401, 228.405, and
228.406 of this chapter).
*****
By the Commission.
Margaret H. McFarland
Deputy Secretary
January 23, 2003
Footnotes
1 We do not edit personal information, such as names or electronic mail addresses, from electronic
submissions. You should submit only information that you wish to make available publicly.
2 17 CFR 249.308.
3 17 CFR 249.310.
4 17 CFR 249.310b.
5 17 CFR 249.220f.
6 17 CFR 249.240f.
7 15 U.S.C. §78a et seq.
8 17 CFR 228.10et seq.

37
9 17 CFR 229.10et seq.
10 See, for example, John Waggoner and Thomas A. Fogarty, "Scandals Shred Investors' Faith: Because
of Enron, Andersen and Rising Gas Prices, the Public Is More Wary Than Ever of Corporate America,"
USA Today, May 5, 2002, and Louis Aguilar, "Scandals Jolting Faith of Investors," Denver Post, June
27, 2002.
11 Pub. L. 107-204, 116 Stat. 745 (2002).
12 Release No. 33-8138 (October 22, 2002) [67 FR 66208] ( "Proposing Release").
13 See Release No. IC-25723 (Aug. 30, 2002) [67 FR 57298].
14 See Andrew R. Sorkin, "Back to School, but This One Is for Top Corporate Officials," NY Times,
Sept. 3, 2002, Cassell Bryan-Low, "Defining Moment for SEC: Who is a financial expert," Wall Street
Journal, Dec. 9, 2002, and Geoffrey Colvin, "Sarbanes & Co. Can't Want This: Under Reform Law, Alan
Greenspan Would Not Qualify as a Board's Financial Expert," Fortune, Dec. 30, 2002.
15 Throughout this release, we will refer to both "audit committee financial experts" and "financial experts"
as appropriate in a particular context. For example, when discussing statutory provisions, we will
continue to refer to financial experts. For purposes of the discussions in this release, the meanings of
these terms are identical.
16 See new Item 401(h)(2) of Regulation S-K, Item 401(e)(2) of Regulation S-B, Item 16A(b) of Form 20-F,
and paragraph (8)(b) of General Instruction B to Form 40-F.
17 The Sarbanes-Oxley Act required only that we adopt rules requiring disclosure of whether a company
had at least one financial expert on its audit committee, and if not, the reasons why.
18 As we note in our recent release proposing rules to implement Section 301 of the Sarbanes-Oxley Act,
there are only 7,250 listed companies out of a total of approximately 17,000 reporting companies. See
Release No. 33-8173 (Jan. 8, 2003).
19 15 U.S.C. §78j-1(m)(3).
20 For example, Section 2(a)(3) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(3)) defines
an "affiliated person" as, among other things, any person owning with power to vote five percent of the
outstanding voting securities of an entity. Rule 405 ( 17 CFR 230.405) under the Securities Act defines
an "affiliate" as a person that controls or is controlled by, or is under common control with a specified
person.
21 17 CFR 240.101. That item currently relies on the definitions of "independent" in the listing standards of
the New York Stock Exchange, the American Stock Exchange and the NASD. Under Section 10A(m) of
the Exchange Act (as amended by Section 301 of the Sarbanes-Oxley Act), we recently proposed rules
directing the national securities exchanges and national securities associations to prohibit the listing of
any security of an issuer that, among other things, does not have an independent audit committee as
that term is used in Section 10A(m)(3). See Release No. 33-8173 (Jan. 8, 2003). As a result of those
proposals, the current references in Item 7(d)(3)(iv) of Schedule 14A may be amended. See id.
22 For domestic issuers, the audit committee independence standard is found in new Regulation S-K Item
401(h)(1)(ii) ( 17 CFR 229.401(h)(1)(ii)) and Regulation S-B Item 401(e)(1)(ii) ( 17 CFR 228.401(e)
(1)(ii)). See Part II.C, below for further discussion of the audit committee financial expert disclosure
requirements for foreign issuers.
23 The proposed definition would have broadened the types of persons listed in Section 407 of the
Sarbanes-Oxley Act as qualified to serve as experts by enabling the board of directors to conclude that
a person is a financial expert if, in lieu of having experience as a public accountant, auditor, principal
financial officer, principal accounting officer, or controller, or experience in a position involving the
performance of similar functions, the person has experience in a position that results, in the judgment
of the board of directors, in the person having similar expertise and experience. Under the proposals, if
the board made such a determination, the company would have been required to disclose the basis for
that determination.
24 The attributes listed in Section 407 of the Sarbanes-Oxley Act include:
(1) an understanding of generally accepted accounting principles and financial statements;

38
(2) experience in: (a) the preparation or auditing of financial statements of generally comparable
issuers; and (b) the application of such principles in connection with the accounting for estimates,
accruals, and reserves;
(3) experience with internal accounting controls; and
(4) an understanding of audit committee functions.
25 See new Item 401(h)(2) of Regulation S-K, Item 401(e)(2) of Regulation S-B, Item 16A(b) of Form 20-F
and paragraph (8)(b) of General Instruction B to Form 40-F.
26 See new Item 401(h)(3) of Regulation S-K, Item 401(e)(3) of Regulation S-B, Item 16A(c) of Form 20-F
and paragraph (8)(c) of General Instruction B to Form 40-F.
27 See new Instruction 3 to Item 401(h) of Regulation S-K, Item 401(e) of Regulation S-B, Instruction 3 to
Item 16A of Form 20-F, and Note 3 to paragraph (8) of General Instruction B to Form 40-F.
28 See new Item 401(h)(2)(ii) of Regulation S-K, Item 401(e)(2)(ii) of Regulation S-B, Item 16A(b)(2) of
Form 20-F and paragraph (8)(b)(2) of General Instruction B to Form 40-F.
29 See new Item 401(h)(2)(iii) of Regulation S-K, Item 401(e)(2)(iii) on Regulation S-B, Item 16A(b)(3) of
30 See new Item 401(h)(2)(iv) of Regulation S-K, Item 401(e)(2)(iv) on Regulation S-B, Item 16A(b)(4) of
31 See new Item 401(h)(2)(v) of Regulation S-K, Item 401(e)(2)(v) on Regulation S-B, Item 16A(b)(5) of
32 See new Item 401(h)(3) of Regulation S-K, Item 401(e)(3) on Regulation S-B, Item 16A(c) of Form 20-F
and paragraph (8)(c) of General Instruction B to Form 40-F.
33 See new Instruction 2 to Item 401(h) of Regulation S-K, Item 401(e) of Regulation S-B and Item 16A of
Form 20-F and Note 2 to paragraph (8) of General Instruction B to Form 40-F.
34 For example, the Sarbanes-Oxley Act requires the Commission to direct the self-regulatory
organizations by rule to mandate the independence of all audit committee members of companies listed
on national securities exchanges and associations. See Section 301 of the Sarbanes-Oxley Act. As
another example, Section 402 of the Sarbanes-Oxley Act prohibits certain loans made by companies to
their directors and executive officers.
35 15 U.S.C. §77k.
36 See new Item 401(h)(4) of Regulation S-K, Item 401(e)(4) of Regulation S-B, Item 16A(d) of Form
20-F and paragraph (8)(d) of General Instruction B to Form 40-F. Although other audit committee
members may look to the audit committee financial expert as a resource on certain issues that arise,
audit committee members should work together to perform the committee's responsibilities. The safe
harbor provides that other audit committee members may not abdicate their responsibilities.
37 Section 11 of the Securities Act imposes liability for material misstatements and omissions in a
registration statement, but provides a defense to liability for those who perform adequate due diligence.
The level of due diligence required depends on the position held by a defendant and the type of
information at issue. Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968). The
type of information can be categorized as either "expertised," which means information that is prepared
or certified by an expert who is named in the registration statement, or "non-expertised." Similarly, a
defendant can be characterized either as an "expert" or a "non-expert."
38 See, for example, Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
39 See General Instruction E(3) to Form 10-KSB [ 17 CFR 249.310b] and General Instruction G(3) to
Form 10-K [ 17 CFR 249.310].
40 We had proposed to add new items to Forms 20-F and 40-F as well. Those item numbers have not
changed.
41 See new Instruction 1 to Item 401(h) of Regulation S-K and Item 401(e) of Regulation S-B.
42 See new Items 406(a) of Regulation S-K, and S-B, Item 16B(a) of Form 20-F and paragraph (9)(a) of
General Instruction B to Form 40-F.

39
43 The Sarbanes-Oxley Act Section 406(c) definition of the term "code of ethics" does not include the
phrase "to deter wrongdoing" that we have incorporated into proposed Item 406 of Regulations S-K and
S-B, but we think that it is appropriate to expand the definition in this manner. Although codes of ethics
typically are designed to promote high standards of ethical conduct, they also generally seek to instruct
those to whom they apply as to improper or illegal conduct or activity and to prohibit such conduct or
activity.
44 We proposed to add "laws" to this prong of the proposed definition. The Sarbanes-Oxley Act Section
406(c) definition refers only to compliance with applicable governmental rules and regulations.
45 Although the company retains discretion to determine the identity of the appropriate person or persons,
such person should not be involved in the matter giving rise to the violation. Furthermore, we believe
the person identified in the code should have sufficient status within the company to engender respect
for the code and the authority to adequately deal with the persons subject to the code regardless of
their stature in the company.
46 See new Items 406(b) of Regulation S-K, and S-B, Item 16B(b) of Form 20-F and paragraph (9)(b) of
General Instruction B to Form 40-F.
47 See Instruction 1 to Items 406 of Regulations S-K and S-B, Instruction 2 to Item 16B of Form 20-F and
Note 2 to paragraph (9) of General Instruction B to Form 40-F.
48 See new Item 601(b)(14) of Regulations S-K and S-B. Although Section 406 of the Sarbanes-Oxley Act
does not state that our rules must require a company to file a copy of the code of ethics as an exhibit to
its annual report, some investors likely will be interested in examining the actual code itself, given that
codes are likely to vary significantly from one company to another.
49 See new Item 406(c)(2) of Regulations S-K and S-B, Item 16B(c)(2) of Form 20-F and paragraph
(9)(c)(2) of General Instruction B to Form 40-F. We note that the NYSE haswith the Commission
arule changeSection 19(b)(1) of the Exchange[15 U.S.C. 78s(b)(1)]if adopted, would require listed
companies to adopt codes of ethics andthem on their internet websites.See(pending before the
Commission).Therefore, this alternative would be consistent with the proposals of the NYSE,
minimizing unnecessary duplication.
50 See new Item 406(c)(3) of Regulations S-K and S-B, Item 16B(c)(3) of Form 20-F and paragraph (9)(c)
(3) of General Instruction B to Form 40-F.
51 In Release No. 33-7856 (Apr. 28, 2000) [65 FR 25843], we provided interpretive guidance on the effect
of including a website address in other situations. We are not changing that guidance for those other
situations.
52 The new rule includes an instruction clarifying that a company need not disclose technical,
administrative or other non-substantive amendments to the code of ethics. See Instruction 1 to new
Item 10 of Form 8-K, Instruction 6 to Item 16B of Form 20-F, and Note 6 to paragraph (9) of General
Instruction B to Form 40-F.
53 See new Form 8-K Item 10. In Release No. 33-8106 (June 17, 2002) [67 FR 42914], we proposed to
reorganize and renumber the Form 8-K items as part of our Form 8-K proposals. In anticipation of such
change, we had proposed to designate this item as Item 5.05. Because we are adopting it before we
consider adoption of the reorganization of Form 8-K, we are designating this new item as Item 10 under
the existing Form 8-K numbering system.
54 We initially proposed a two business day filing period to be consistent with the accelerated Form 8-K
filing deadlines that we proposed in Release No. 33-8106. Because we have not yet adopted those
proposals, the five business day period will serve as an interim deadline for an Item 10 Form 8-K. The
five business day period is the shorter of the two existing Form 8-K deadlines. When we address the
Form 8-K proposals, we will consider whether to shorten the Item 10 deadline to two business days.
55 See new Item 406(b) of Regulations S-K and S-B. Because investors may not expect these disclosures
to be made on the company's website in lieu of a Form 8-K filing, we are requiring a company to
provide investors with advance notice that it may choose to use this option to avoid confusion.
56 If a company elects to disclose this information on its website, it must do so within the same five-
business day period as required for a Form 8-K that includes this type of disclosure. In addition, a

40
company electing to provide disclosure in this manner must make the disclosure available on its
website for at least 12 months after it initially posts the disclosure. Although a company may remove
information from its website after the 12-month posting period, the company must retain this disclosure
for a period of not less than five years and make it available to the Commission or its staff upon
request. New Item 10(c) of Form 8-K.
57 See Instruction 3.a. to new Item 10 of Form 8-K.
58 17 CFR 240.3b-7.
59 See Instruction 3.b. to new Item 10 of Form 8-K.
60 See new Item 16A of Form 20-F and new paragraph (8) to General Instruction B of Form 40-F.
61 See proposed Exchange Act Rule 10A-3 set forth in Release No. 33-8173 (Jan. 8, 2003).
62 A domestic company must disclose whether its audit committee financial expert is independent under
the existing definition of independence in Item 7 of Schedule 14A. Upon the expected revision of that
item, a domestic company must disclose whether its audit committee financial expert is independent
under the new definition of independence.
63 Foreign private issuers generally are exempt from the requirements of Regulation 14A, including Item
7(d) of Schedule 14A which requires disclosure of whether audit committee members are independent.
See 17 CFR 240.3a12-3(b).
64 See Release No. 33-8138, the text before and after n. 84.
65 Instead, a foreign private issuer must file under cover of Form 6-K copies of all information that it:
makes or is required to make public under the laws of its jurisdiction of incorporation, domicile or
organization; files or is required to file under the rules of any stock exchange; or distributes or is
required to distribute to its security holders. See General Instruction B to Form 6-K.
66 See new Item 16B to Form 20-F and new paragraph (9) to General Instruction B of Form 40-F.
67 The term "asset-backed issuer" is defined in Exchange Act Rules 13a-14(g) and 15d-14(g) [ 17 CFR
240.13a-14(g) and 240.15d-14(g)].
68 17 CFR 243.100-103.
69 Estimates regarding burden within the company, for third party services, and for professional costs
were obtained by contacting a number of law firms and other persons regularly involved in completing
the forms.
70 See Item 401 of Regulations S-K and S-B ( 17 CFR 229.401 and 228.401).
71 This added burden is included in the Paperwork Reduction Act estimate discussed above.
72 15 U.S.C. §78w(a)(2).
73 15 U.S.C. §77b(b).
74 15 U.S.C. §78c(f).
75 17 CFR 240.0-10(a).
76 Item 10 of Regulation S-B ( 17 CFR 228.10) defines a small business issuer as a company that has
revenues of less than $25 million, is a U.S. or Canadian issuer, is not an investment company, and has
a public float of less than $25 million. Also, if it is a majority owned subsidiary, the parent corporation
also must be a small business issuer. Rule 0-10 of the Exchange Act ( 17 CFR 240.10) defines a small
entity for purposes of the Regulatory Flexibility Act as a company that, on the last day of its most recent
fiscal year, had total assets of $5 million or less.

41
Industry Groups Weigh In On New Ethics Standard - Stay Ahead of Your Clients | Dow Jones Page 1 of 2
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Stay Ahead of Your Clients
Industry Groups Weigh In On New Ethics Standard

Thursday, September 2, 2010 by the Editors of Dow Jones Newswires
By SUZANNE BARLYN
Many trade and other interest groups waited until Monday's deadline to offer comments to the Securities and Exchange Join Us On...
Commission on its new study of a possible single standard for broker-dealers and investment advisers who provide
personalized advice to retail investors. A summary of some key points made by six major groups follows.
Securities Industry and Financial Markets Association (SIFMA): Supports a new uniform standard that places clients' interests
first, is "clearly defined" and "business-model neutral," according to the letter by Sifma's general counsel, Ira D. Hammerman.
The group, which represents Wall Street's largest brokerages, argued that the standard should allow the industry to continue to Search This Blog
offer the same products and services that are currently available. Broker-dealers and investment advisers should manage
conflicts of interest by providing individual investors with a full disclosure that is simple and clear.
Investment Adviser Association (IAA): Advocates broker-dealers and investment advisers both be held to the fiduciary standard
of care established under the Investment Advisers Act of 1940. This requires that investment advisers act in the best interests Subscribe to this blog
of clients and place client interests before their own. IAA, which represents more than 475 SEC-registered investment adviser
firms, urged the SEC "to avoid efforts to weaken or water down the Advisers Act fiduciary standard." In its letter from executive That's an RSS feed. Just click on it
director David Tittsworth, it disagreed with brokerage industry arguments that the strict standard would disrupt business and to receive content updates.
reduce choice for investors.
Financial Services Institute (FSI): Supports a "clearly stated universal fiduciary standard of care" that includes "plainly About the Financial Adviser Blog
articulated" conduct rules and effective disclosures for customers, according to Dale Brown, president and chief executive of Produced by the editors of Dow Jones
FSI, which represents independent broker dealers. Applying the Advisers Act fiduciary standard to the broker-dealer world is Newswires, the Dow Jones Financial
"fraught with difficulty," he wrote. Recommends "balanced" regulatory supervision of both investment advisers and broker- Adviser blog provides an inside view into
dealers, including a self-regulatory organization for investment advisers, which are presently policed by the SEC. The group is the important issues affecting financial
concerned about increased compliance costs being passed to customers. advisers, brokers, wealth managers and
their clients. The Financial Adviser blog
National Association of Insurance and Financial Advisors (Naifa): The group, which aims to "protect and promote" the role of
provides insight into the major wealth
insurance in financial planning, says their advisers would be subject to duplicate requirements if held to the Advisers Act
management issues, including strategies
fiduciary standard. "This is wholly unnecessary," wrote Susan Waters, Naifa chief executive, since brokers are already subject
for taxes and estates, philanthropy,
to regulations that provide substantial investor safeguards. Advisers already routinely provide disclosures to customers who, in
investing, practice management, financial
many cases, don't read them, she wrote.
planning and personal finance. The
North American Securities Administrators Association (Nasaa): Broker-dealers and investment advisers should both be held to Financial Adviser blog features lead editor
the Advisers Act fiduciary standard, wrote Denise Voigt Crawford, NASAA president and Texas Securities Commissioner and Kevin Noblet and the reporting team of
the group's president elect, David Massey, who also serves as North Carolina Deputy Securities Administrator. The current Dow Jones Adviser in New York and
standard of suitability represents a "material gap" in regulation because it doesn't require brokers to place clients' interests London, along with contributions by
ahead of their own. Nasaa, a group of state securities regulators, says the benefits of a stricter standard will outweigh the costs. leading industry voices.
Contact us at djadviser@dowjones.com.
Financial Planning Coalition (FPC): Supports applying the Advisers Act fiduciary standard to all advisers. The current standard For more information on Dow Jones
of suitability is inferior, it says, because it allows brokers to recommend a range of products to clients, including those that are products covering financial advisers and
"most highly remunerative." The group, representing three financial planning organizations, says a fiduciary standard won't limit wealth managers, click here.
customer access to investment advice, since the number of advisers, including brokers, is increasing. It opposes tailoring a
standard to accommodate business models.
Suzanne Barlyn writes Compliance Watch, a column that focuses on compliance and regulatory issues affecting financial
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SEC Speech: The Role of Compliance and Ethics in Risk Management (Carlo V. di Florio; October 17, 2011) Page 1 of 9
Home | Previous Page
Speech by SEC Staff:

The Role of Compliance and Ethics in Risk Management
by
Carlo V. di Florio
Director, Office of Compliance Inspections and Examinations1
NSCP National Meeting

October 17, 2011
Thank you for inviting me to speak at this event. The work you all do is
incredibly important, and we appreciate and respect your critical
contributions to investor protection and market integrity. Today I would like
to address two related topics that are growing in importance: the
heightened role of ethics in an effective regulatory compliance program,
and the role of both ethics and compliance in enterprise risk management.
The views that I express here today are of course my own and do not
necessarily reflect the views of the Commission or of my colleagues on the
staff of the Commission.
In the course of discussing these two topics, I would like to explore with
you the following propositions:
1. Ethics is fundamental to the securities laws, and I believe ethical

culture objectives should be central to an effective regulatory
compliance program.
2. Leading standards have recognized the centrality of ethics and have

explicitly integrated ethics into the elements of effective compliance
and enterprise risk management.
3. Organizations are making meaningful changes to embraced this trend

and implement leading practices to make their regulatory compliance
and risk management programs more effective.
Ethics and the Federal Securities Laws
The debate about how law and ethics relate to each other traces all the way
back to Plato and Aristotle. I am not the Director of the Office of Legal
Philosophy, so I won’t try to contribute to the received wisdom of the ages
on this enormous topic,2 except to say that for my purposes today, the
question really boils down to staying true both the spirit and the letter of
the law.
Framed this way, ethics is a topic of enormous significance to anyone

whose job it is to seek to promote compliance with the federal securities
laws. At their core, the federal securities laws were intended by Congress to
http://www.sec.gov/news/speech/2011/spch101711cvd.htm 11/28/2012
be an exercise in applied ethics. As the Supreme Court stated almost five

decades ago,
[a] fundamental purpose, common to [the federal securities]…

statutes, was to substitute a philosophy of full disclosure for the
philosophy of caveat emptor and thus to achieve a high
standard of business ethics in the securities industry…. “It
requires but little appreciation . . . of what happened in this
country during the 1920's and 1930's to realize how essential it
is that the highest ethical standards prevail” in every facet of
the securities industry.3
Of course, what has happened through the financial crisis I believe is yet
another reminder of the fundamental need for stronger ethics, risk
management and regulatory compliance practices to prevail. Congress has
responded once again, as it did after the Great Depression, with landmark
legislation to raise the standards of business ethics in the banking and
securities industries.
The manner in which the federal securities laws are illuminated by ethical
principles was well illustrated by the Study on Investment Advisers and
Broker-Dealers that the Commission staff submitted to Congress earlier this
year pursuant to Section 913 of the Dodd-Frank Act (“913 Study”).4 As
described in the 913 study, in some circumstances the relationship is
explicit, such as the requirement that each investment adviser that is
registered with the Commission or required to be registered with the
Commission must also adopt a written code of ethics. These ethical codes
must at a minimum address, among other things, a minimum standard of
conduct for all supervised persons reflective of the adviser’s and its
supervised persons’ fiduciary obligations.5
In other circumstances, an entire body of rules is based implicitly on ethical

precepts. This is the case with the rules adopted and enforced by FINRA
and other self-regulatory organizations, which “are grounded in concepts of
ethics, professionalism, fair dealing, and just and equitable principles of
trade,” giving the SROs authority to reach conduct that may not rise to the
level of fraud.6 This has empowered FINRA and other SROs to, for example,
not require proof of scienter to establish a suitability obligation,7 to develop
rules and guidance on fair prices, commissions and mark-ups that takes
into account that what may be “fair” (or reasonable) in one transaction
could be “unfair” (or unreasonable) in another,8 and to require broker-
dealers to engage in fair and balanced communications with the public,
disclose conflicts of interest, and to undertake a number of other duties.9 In
addition to approving rules grounded on these ethical precepts, the
Commission has also sustained various FINRA disciplinary actions utilizing
FINRA’s authority to enforce “just and equitable principles of trade,” even
where the underlying activity did not involve securities, such as actions
involving insurance , tax shelters, signature forgery, credit card fraud,
fraudulent expense account reimbursement, etc.10
Other ethical precepts are derived from the antifraud provisions of the
federal securities laws. The “shingle” theory, for example, holds that by
virtue of engaging in the brokerage business a broker-dealer implicitly
represents to those with whom it transacts business that it will deal fairly
with them. When a broker-dealer takes actions that are not fair to its
customer, these must be disclosed to avoid making the implied

representation of fairness not misleading. A number of duties and conduct
regulations have been articulated by the Commission or by courts based on
the shingle theory.11
Another source by which ethical concepts are transposed onto the federal
securities laws is the concept of fiduciary duty. The Supreme Court has
construed Section 206(1) and (2) of the Investment Advisers Act as
establishing a federal fiduciary standard governing the conduct of
advisers.12 This imposes on investment advisers “the affirmative duty of
‘utmost good faith, and full and fair disclosure of all material facts,’ as well
as an affirmative obligation to ‘employ reasonable care to avoid
misleading’” clients and prospective clients. As the 913 Study stated,
Fundamental to the federal fiduciary standard are the duties of

loyalty and care. The duty of loyalty requires an adviser to
serve the best interests of its clients, which includes an
obligation not to subordinate the clients’ interests to its own. An
adviser’s duty of care requires it to “make a reasonable
investigation to determine that it is not basing its
recommendations on materially inaccurate or incomplete
information.”13
While broker-dealers are generally not subject to a fiduciary duty under the
federal securities laws, courts have imposed such a duty under certain
circumstances, such as where a broker-dealer exercises discretion or
control over customer assets, or has a relationship of trust and confidence
with its customer.14 The 913 Study, of course, explores the principle of a
uniform fiduciary standard.
Concepts such as fair dealing, good faith and suitability are dynamic and
continue to arise in new contexts. For example, the Business Conduct
Standards for Securities-Based Swap Dealers (SBSDs”) and Major Security-
Based Swap Participants (“MSBSPs”), required by Title VII of the Dodd-
Frank Act and put out for comment last summer, include proposed
elements such as
l a requirement that communications with counterparties are made in a

fair and balanced manner based on principles of fair dealing and good
faith;
l an obligation to disclosure to a counterparty material information

about the security-based swap, such as material risks, characteristics,
incentives and conflicts of interest; and
l a determination by SBSDs that any recommendations that they make

regarding security-based swaps are suitable for their counterparties.
Of course the Business Conduct Standards have not been finalized, but the
requirements of Title VII requiring promulgation of these rules, as well as
the content of the rules as proposed, illustrate that ethical concepts
continue to be a touchstone for both Congress and the Commission in
developing and interpreting the federal securities laws.
The Relationship Between Ethics and Enterprise Management.
Ethics is not important merely because the federal securities laws are
grounded on ethical principles. Good ethics is also good business. Treating
customers fairly and honestly helps build a firm’s reputation and brand,
while attracting the best employees and business partners. Conversely,
creating the impression that ethical behavior is not important to a firm is
incredibly damaging to its reputation and business prospects. This, of
course, holds true equally for individuals, and there are plenty of
enforcement cases that tell the story of highly talented and successful
individuals who were punished because they violated their ethical and
compliance responsibilities.
Another way of saying this is that a corporate culture that reinforces ethical
behavior is a key component of effectively managing risk across the
enterprise. As the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) put it, in articulating its well-established standards of
Internal Control and Enterprise Risk Management:
An entity’s strategy and objectives and the way they are

implemented are based on preferences, value judgments, and
management styles. Management’s integrity and commitment
to ethical values influence these preferences and judgments,
which are translated into standards of behavior. Because an
entity’s good reputation is so valuable, the standards of
behavior must go beyond mere compliance with the law.
Managers of well-run enterprises increasingly have accepted the
view that ethics pays and ethical behavior is good business.15
In the wake of the financial crisis, enterprise risk management is a rapidly

evolving discipline that places ethical values at the heart of good
governance, enterprise risk management and compliance. For example,
organizations such as COSO, the Ethics Resource Center (ERC), the Open
Compliance and Ethics Guidelines (OCEG) and the Ethics & Compliance
Officer Association (ECOA) have developed detailed guidance, from the
board room to business units and key risk, control and compliance
departments, on implementation of effective enterprise risk management
systems. Industry and sector specific guidance has flowed from these
general standards. As COS notes, integrity and ethical values are the pillars
of an effective compliance culture.
The effectiveness of enterprise risk management cannot rise

above the integrity and ethical values of the people who create,
administer, and monitor entity activities. Integrity and ethical
values are essential elements of an entity’s internal
environment, affecting the design, administration, and
monitoring of other enterprise risk management components.16
Nowhere should this be more true than in financial services firms today,
which depend for their existence on public trust and confidence to a unique
degree. Expectations are rising around the world for a stronger culture of
ethical behavior at financial services firms of all types and sizes. As the
Basle Committee on Banking Supervision recently stated:
A demonstrated corporate culture that supports and provides

appropriate norms and incentives for professional and
responsible behaviour is an essential foundation of good
governance. In this regard, the board should take the lead in

establishing the “tone at the top” and in setting professional
standards and corporate values that promote integrity for itself,
senior management and other employees.17
As the standards for ethical behavior continue to evolve, your firms’ key
stakeholders – shareholders, clients and employees will increasingly expect
you to meet or exceed those standards.
In my first speech here at the SEC I outlined ten elements I believe make
an effective compliance and ethics program. These elements reflect the
compliance, ethics and risk management standards and guidance noted
above. They also reflect the U.S. Federal Sentencing Guidelines (FSG),
which were revised in 2004 to explicitly integrate ethics into the elements
of an effective compliance and ethics program that would be considered as
mitigating factors in determining criminal sentences for corporations. These
elements include:
l Governance. This includes the board of directors and senior

management setting a tone at the top and providing compliance and
ethics programs with the necessary resources, independence,
standing, and authority to be effective. NEP staff have begun meeting
with directors, CEOs, and senior management teams to better
understand risk and assess the tone at the top that is shaping the
culture of compliance, ethics and risk management.
l Culture and values. This includes leadership promoting integrity and

ethical values in decision-making across the organization and
requiring accountability.
l Incentives and rewards. This includes incorporating integrity and

ethical values into performance management systems and
compensation so the right behaviors are encouraged and rewarded,
while inappropriate behaviors are firmly addressed.
l Risk management. This includes ensuring effective processes to

identify, assess, mitigate and manage compliance and ethics risk
across the organization.
l Policies and procedures. This includes establishing, maintaining and

updating policies and procedures that are tailored to your business,
your risks, your regulatory requirements and the conflicts of interest
in your business model.
l Communication and training. This includes training that is tailored to

your specific business, risk and regulatory requirements, and which is
roles-based so that each critical partner in the compliance process
understands their roles and responsibilities.
l Monitoring and reporting. This includes monitoring, testing and

surveillance functions that assess the health of the system and report
critical issues to management and the board.
l Escalation, investigation and discipline. This includes ensuring there

are processes where employees can raise concerns confidentially and
anonymously, without fear of retaliation, and that matters are
effectively investigated and resolved with fair and consistent
discipline.
l Issues management. This includes ensuring that root cause analysis

is done with respect to issues that are identified so effective
remediation can occur in a timely manner.
l An on-going improvement process. This includes ensuring the

organization is proactively keeping pace with developments and
leading practices as part of a commitment to a culture of ongoing
improvement.
In addition to the effective practices above, the NEP has also seen firms
that have focused on enhancing regulatory compliance programs through
effective integration of ethics principles and practices. These include
renaming the function and titles to incorporate ethics explicitly; elevating
the dialogue with senior management and the board; implementing core
values and business principles to guide ethical decision-making; integrating
ethics into key leadership communications; and introducing surveys and
other mechanisms to monitor the health of the culture and identify
emerging risks and issues.
The Relationship of Compliance and Ethics with Enterprise Risk

Management.
We can expand the discussion above beyond compliance and ethics to

address enterprise risk management and risk governance more broadly.
These same program elements, and ethics considerations, are equally
critical, but the scope of risks expands beyond regulatory risk to also
include market, credit and operational risk, among others. The roles and
responsibilities also expand to include risk management, finance, internal
audit and other key risk and control functions. Whether we’re talking about
compliance and ethics or we’re talking about ERM, it is important to clarify
fundamental roles and responsibilities across the organization. .
1. The business is the first line of defense responsible for taking,

managing and supervising risk effectively and in accordance with the
risk appetite and tolerances set by the board and senior management
of the whole organization.
2. Key support functions, such as compliance and ethics or risk

management, are the second line of defense. They need to have
adequate resources, independence, standing and authority to
implement effective programs and objectively monitor and escalate
risk issues.
3. Internal Audit is the third line of defense and is responsible for

providing independent verification and assurance that controls are in
place and operating effectively.
4. Senior management is responsible for reinforcing the tone at the top,

driving a culture of compliance and ethics and ensuring effective
implementation of enterprise risk management in key business
processes, including strategic planning, capital allocation,
performance management and compensation incentives.
5. The board of directors (if one exists in the organization) is responsible

for setting the tone at the top, overseeing management and ensuring
risk management, regulatory, compliance and ethics obligations are

met.
While compliance and ethics officers play a key role in supporting effective
ERM, risk managers in areas such as investment risk, market risk, credit
risk, operational risk, funding risk and liquidity risk also play an important
role. As noted above, the board, senior management, other risk and control
functions, the business units and internal audit also play a critical role in
ERM. As ERM matures as a discipline, it is critical that these key functions
work together in an integrated coordinated manner that supports more
effective ERM. Understanding and managing the inter-relationship between
various risks is a central tenet of effective ERM. One needs only reflect on
the financial crisis to understand how the aggregation and inter-relationship
of risks across various risk categories and market participants created the
perfect storm. ERM provides a more systemic risk analysis framework to
proactively identify, assess and manage risk in today’s market
environment.
OCIE Considerations
As I discussed earlier, there is an ethical component to many of the federal

securities laws. When NEP staff examines, for example, an investment
adviser’s adherence to its fiduciary obligations, or a broker-dealer’s
effective development, maintenance and testing of its compliance program,
our examiners are looking at how well firms are meeting both the letter and
spirit of these obligations. In addition, our examiners certainly examine
specific requirements for ethical processes, such as business conduct
standards.
There is another way in which the ethical environment within a firm matters
to us. As you know, our examination program has greatly increased its
emphasis on risk-based examinations. How we perceive a registrant’s
culture of compliance and ethics informs our view of the risks posed by
particular entities. In this regard we have begun meeting boards of
directors, CEOs and senior management to share perspectives on the key
risks facing the firm, how those risks are being managed and the
effectiveness of key risk management, compliance, ethics and control
functions. It provides us an opportunity to emphasize the critical
importance of compliance, ethics, risk management and other key control
functions, and our expectation that these functions have sufficient
resources, independence, standing and authority to be effective in their
roles. These dialogues also provide us an opportunity to assess the tone at
the top that is shaping the culture of compliance, ethics and risk
management in the firm. If we believe that a firm tolerates a nonchalant
attitude toward compliance, ethics and risk management, we will factor that
into our analysis of which registrants to examine, what issues to focus on,
and how deep to go in executing our examinations.
Finally, I would end by sharing with you that we are also embracing these
leading practices. We recently created our own program around compliance
and ethics. For the first time, we have a dedicated team focused on
strengthening and monitoring how effectively we adhere to our own
examination standards. We are in the process of finalizing our first Exam
Manual, which we set forth all of our key policies and standards in one
manual. We have also established a senior management committee with
oversight responsibility for compliance, ethics and internal control. On the
risk management front, we are also making good progress. We have

recruited individuals with expertise and established a senior management
oversight committee here as well. In short, we are also committing
ourselves to a culture of ongoing improvement and leading practices.
Conclusion
Thank you for inviting me to speak here today. I hope that my remarks will
be helpful to you and help you to perform your critical compliance functions
more effectively. I invite your feedback, whether regarding the points that I
made, or the points that you think I missed. I now invite your questions.
1 The Securities and Exchange Commission, as a matter of policy, disclaims

responsibility for any private statements by its employees.
2
For a deeper plunge into the relationship between law and ethics, a classic
exchange on this subject can be found in Positivism and the Separation of
Law and Morals, H.L.A. Hart, 71 Harvard L. Rev. 529 (1958) and Positivism
and Fidelity to Law: A Reply to Professor Hart, L.L. Fuller, 71 Harvard L.
Rev. 630 (1958).
3
SEC v. Investment Research Bureau, Inc., 375 U.S. 180, 186-87 (1963),
quoting Silver v. New York Stock Exchange, 373 U.S. 341,366 (1963).
4 Study on Investment Advisers and Broker-Dealers as Required by Section

913 of the Dodd-Frank Wall Street Reform Act (January 2011) at 62
(available at http://www.sec.gov/news/studies/2011/913studyfinal.pdf)
(“913 Study”).
5
Advisers Act Section 204A, and Advisers Act Rule 204A-1.
6
913 Study at 51.
7 Id.
8 Id. at 66.
9 Id. at 52.
10 Id. at 52-53 and cases cited therein.
11
Id. at 51, citing Guide to Broker-Dealer Registration (April 2008),
available at http://www.sec.gov/divisions/marketreg/bdguide.htm.
12SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963);
913 Study at 21.
13
Id. at 22 (quoting Concept Release on the U.S. Proxy System,
Investment Advisers Act Release No. 3052 (July 14, 2010) at 119.
14 Id. at 54 and cases cited therein.
15
Enterprise Risk Management- Integrated Framework, Committee of
Sponsoring Organizations of the Treadway Commission (September 2004)
at 29.
16 Id. at 29-30.
17Basel Committee on Banking Supervision, Principles for Enhancing

Corporate Governance (October 2010) at 8.
http://www.sec.gov/news/speech/2011/spch101711cvd.htm
Home | Previous Page Modified: 11/07/2011
§8B2.1. EFFECTIVE COMPLIANCE AND ETHICS PROGRAM, U.S.S.G. § 8B2.1...
U.S.S.G. § 8B2.1 (11/1/11)
United States Sentencing Commission

Guidelines Manual
*1 Effective November 1, 1987, Including Amendments Effective January 1, 1988 through November 1, 2011 a
Chapter Eight - Sentencing of Organizations
Part B - Remedying Harm from Criminal Conduct, and Effective Compliance and Ethics Program
2. Effective Compliance and Ethics Program
§8B2.1. EFFECTIVE COMPLIANCE AND ETHICS PROGRAM
(a) To have an effective compliance and ethics program, for purposes of subsection (f) of §8C2.5 (Culpability Score) and
subsection (b)(1) of §8D1.4 (Recommended Conditions of Probation - Organizations), an organization shall--
(1) exercise due diligence to prevent and detect criminal conduct; and
(2) otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with the
law.
Such compliance and ethics program shall be reasonably designed, implemented, and enforced so that the program is generally
effective in preventing and detecting criminal conduct. The failure to prevent or detect the instant offense does not necessarily
mean that the program is not generally effective in preventing and detecting criminal conduct.
(b) Due diligence and the promotion of an organizational culture that encourages ethical conduct and a commitment to
compliance with the law within the meaning of subsection (a) minimally require the following:
(1) The organization shall establish standards and procedures to prevent and detect criminal conduct.
(2) (A) The organization's governing authority shall be knowledgeable about the content and operation of the compliance and
ethics program and shall exercise reasonable oversight with respect to the implementation and effectiveness of the compliance
and ethics program.
(B) High-level personnel of the organization shall ensure that the organization has an effective compliance and ethics program,
as described in this guideline. Specific individual(s) within high-level personnel shall be assigned overall responsibility for the
compliance and ethics program.
(C) Specific individual(s) within the organization shall be delegated day-to-day operational responsibility for the compliance and
ethics program. Individual(s) with operational responsibility shall report periodically to high-level personnel and, as appropriate,
to the governing authority, or an appropriate subgroup of the governing authority, on the effectiveness of the compliance and
ethics program. To carry out such operational responsibility, such individual(s) shall be given adequate resources, appropriate
authority, and direct access to the governing authority or an appropriate subgroup of the governing authority.
(3) The organization shall use reasonable efforts not to include within the substantial authority personnel of the organization
any individual whom the organization knew, or should have known through the exercise of due diligence, has engaged in
illegal activities or other conduct inconsistent with an effective compliance and ethics program.
*2 (4) (A) The organization shall take reasonable steps to communicate periodically and in a practical manner its standards
and procedures, and other aspects of the compliance and ethics program, to the individuals referred to in subparagraph (B)
by conducting effective training programs and otherwise disseminating information appropriate to such individuals' respective
roles and responsibilities.

(B) The individuals referred to in subparagraph (A) are the members of the governing authority, high-level personnel, substantial
authority personnel, the organization's employees, and, as appropriate, the organization's agents.
(5) The organization shall take reasonable steps--

(A) to ensure that the organization's compliance and ethics program is followed, including monitoring and auditing to detect
criminal conduct;
(B) to evaluate periodically the effectiveness of the organization's compliance and ethics program; and
(C) to have and publicize a system, which may include mechanisms that allow for anonymity or confidentiality, whereby the
organization's employees and agents may report or seek guidance regarding potential or actual criminal conduct without fear
of retaliation.
(6) The organization's compliance and ethics program shall be promoted and enforced consistently throughout the
organization through (A) appropriate incentives to perform in accordance with the compliance and ethics program; and (B)
appropriate disciplinary measures for engaging in criminal conduct and for failing to take reasonable steps to prevent or
detect criminal conduct.
(7) After criminal conduct has been detected, the organization shall take reasonable steps to respond appropriately to the
criminal conduct and to prevent further similar criminal conduct, including making any necessary modifications to the
organization's compliance and ethics program.
(c) In implementing subsection (b), the organization shall periodically assess the risk of criminal conduct and shall take
appropriate steps to design, implement, or modify each requirement set forth in subsection (b) to reduce the risk of criminal
conduct identified through this process.
Commentary
Application Notes:
1. Definitions.--For purposes of this guideline:
“Compliance and ethics program” means a program designed to prevent and detect criminal conduct.
“Governing authority” means the (A) the Board of Directors; or (B) if the organization does not have a Board of Directors,
the highest-level governing body of the organization.
“High-level personnel of the organization” and “substantial authority personnel” have the meaning given those terms in the
Commentary to §8A1.2 (Application Instructions - Organizations).
“Standards and procedures” means standards of conduct and internal controls that are reasonably capable of reducing the
likelihood of criminal conduct.
*3 2. Factors to Consider in Meeting Requirements of this Guideline.--

(A) In General.--Each of the requirements set forth in this guideline shall be met by an organization; however, in determining
what specific actions are necessary to meet those requirements, factors that shall be considered include: (i) applicable
industry practice or the standards called for by any applicable governmental regulation; (ii) the size of the organization;
and (iii) similar misconduct.

(B) Applicable Governmental Regulation and Industry Practice.--An organization's failure to incorporate and follow
applicable industry practice or the standards called for by any applicable governmental regulation weighs against a finding
of an effective compliance and ethics program.
(C) The Size of the Organization.--

(i) In General.--The formality and scope of actions that an organization shall take to meet the requirements of this guideline,
including the necessary features of the organization's standards and procedures, depend on the size of the organization.
(ii) Large Organizations.--A large organization generally shall devote more formal operations and greater resources in meeting
the requirements of this guideline than shall a small organization. As appropriate, a large organization should encourage small
organizations (especially those that have, or seek to have, a business relationship with the large organization) to implement
effective compliance and ethics programs.
(iii) Small Organizations.--In meeting the requirements of this guideline, small organizations shall demonstrate the same degree
of commitment to ethical conduct and compliance with the law as large organizations. However, a small organization may meet
the requirements of this guideline with less formality and fewer resources than would be expected of large organizations. In
appropriate circumstances, reliance on existing resources and simple systems can demonstrate a degree of commitment that,
for a large organization, would only be demonstrated through more formally planned and implemented systems.
Examples of the informality and use of fewer resources with which a small organization may meet the requirements of this
guideline include the following: (I) the governing authority's discharge of its responsibility for oversight of the compliance and
ethics program by directly managing the organization's compliance and ethics efforts; (II) training employees through informal
staff meetings, and monitoring through regular “walk-arounds” or continuous observation while managing the organization;
(III) using available personnel, rather than employing separate staff, to carry out the compliance and ethics program; and
(IV) modeling its own compliance and ethics program on existing, well-regarded compliance and ethics programs and best
practices of other similar organizations.
(D) Recurrence of Similar Misconduct.--Recurrence of similar misconduct creates doubt regarding whether the organization
took reasonable steps to meet the requirements of this guideline. For purposes of this subparagraph, “similar misconduct”
has the meaning given that term in the Commentary to §8A1.2 (Application Instructions - Organizations).
*4 3. Application of Subsection (b)(2).--High-level personnel and substantial authority personnel of the organization shall
be knowledgeable about the content and operation of the compliance and ethics program, shall perform their assigned duties
consistent with the exercise of due diligence, and shall promote an organizational culture that encourages ethical conduct and
a commitment to compliance with the law.
If the specific individual(s) assigned overall responsibility for the compliance and ethics program does not have day-to-day
operational responsibility for the program, then the individual(s) with day-to-day operational responsibility for the program
typically should, no less than annually, give the governing authority or an appropriate subgroup thereof information on the
implementation and effectiveness of the compliance and ethics program.
4. Application of Subsection (b)(3).--

(A) Consistency with Other Law.--Nothing in subsection (b)(3) is intended to require conduct inconsistent with any Federal,
State, or local law, including any law governing employment or hiring practices.
(B) Implementation.--In implementing subsection (b)(3), the organization shall hire and promote individuals so as to ensure
that all individuals within the high-level personnel and substantial authority personnel of the organization will perform their
assigned duties in a manner consistent with the exercise of due diligence and the promotion of an organizational culture that
encourages ethical conduct and a commitment to compliance with the law under subsection (a). With respect to the hiring or

promotion of such individuals, an organization shall consider the relatedness of the individual's illegal activities and other
misconduct (i.e., other conduct inconsistent with an effective compliance and ethics program) to the specific responsibilities
the individual is anticipated to be assigned and other factors such as: (i) the recency of the individual's illegal activities and
other misconduct; and (ii) whether the individual has engaged in other such illegal activities and other such misconduct.
5. Application of Subsection (b)(6).--Adequate discipline of individuals responsible for an offense is a necessary component of
enforcement; however, the form of discipline that will be appropriate will be case specific.
6. Application of Subsection (b)(7).--Subsection (b)(7) has two aspects.
First, the organization should respond appropriately to the criminal conduct. The organization should take reasonable steps,
as warranted under the circumstances, to remedy the harm resulting from the criminal conduct. These steps may include, where
appropriate, providing restitution to identifiable victims, as well as other forms of remediation. Other reasonable steps to
respond appropriately to the criminal conduct may include self-reporting and cooperation with authorities.
Second, the organization should act appropriately to prevent further similar criminal conduct, including assessing the
compliance and ethics program and making modifications necessary to ensure the program is effective. The steps taken should
be consistent with subsections (b)(5) and (c) and may include the use of an outside professional advisor to ensure adequate
assessment and implementation of any modifications.
*5 7. Application of Subsection (c).--To meet the requirements of subsection (c), an organization shall:
(A) Assess periodically the risk that criminal conduct will occur, including assessing the following:
(i) The nature and seriousness of such criminal conduct.
(ii) The likelihood that certain criminal conduct may occur because of the nature of the organization's business. If, because
of the nature of an organization's business, there is a substantial risk that certain types of criminal conduct may occur, the
organization shall take reasonable steps to prevent and detect that type of criminal conduct. For example, an organization
that, due to the nature of its business, employs sales personnel who have flexibility to set prices shall establish standards and
procedures designed to prevent and detect price-fixing. An organization that, due to the nature of its business, employs sales
personnel who have flexibility to represent the material characteristics of a product shall establish standards and procedures
designed to prevent and detect fraud.
(iii) The prior history of the organization. The prior history of an organization may indicate types of criminal conduct that it
shall take actions to prevent and detect.
(B) Prioritize periodically, as appropriate, the actions taken pursuant to any requirement set forth in subsection (b), in order
to focus on preventing and detecting the criminal conduct identified under subparagraph (A) of this note as most serious,
and most likely, to occur.
(C) Modify, as appropriate, the actions taken pursuant to any requirement set forth in subsection (b) to reduce the risk of
criminal conduct identified under subparagraph (A) of this note as most serious, and most likely, to occur.
Background: This section sets forth the requirements for an effective compliance and ethics program. This section responds
to section 805(a)(2)(5) of the Sarbanes-Oxley Act of 2002, Public Law 107-204, which directed the Commission to review and
amend, as appropriate, the guidelines and related policy statements to ensure that the guidelines that apply to organizations
in this chapter “are sufficient to deter and punish organizational criminal misconduct.”
The requirements set forth in this guideline are intended to achieve reasonable prevention and detection of criminal conduct
for which the organization would be vicariously liable. The prior diligence of an organization in seeking to prevent and detect

criminal conduct has a direct bearing on the appropriate penalties and probation terms for the organization if it is convicted
and sentenced for a criminal offense.
Historical Note: Effective November 1, 2004 (see Appendix C, amendment 673). Amended effective November 1, 2010
(see Appendix C, amendment 744); November 1, 2011 (see Appendix C, amendment 758).
Footnotes
a Incorporating amendments effective January 15, 1988; June 15, 1988; October 15, 1988; November 1, 1989; November 1, 1990;
November 1, 1991; November 27, 1991; November 1, 1992; November 1, 1993; September 23, 1994; November 1, 1994; November
1, 1995; November 1, 1996; May 1, 1997; November 1, 1997; November 1, 1998; May 1, 2000; November 1, 2000; December 16,
2000; May 1, 2001; November 1, 2001; November 1, 2002; January 25, 2003; April 30, 2003; October 27, 2003; November 1, 2003;
November 5, 2003; November 1, 2004; October 24, 2005; November 1, 2005; March 27, 2006; September 12, 2006; November 1,
2006, November 1, 2007, November 1, 2008, November 1, 2009, November 1, 2010, and November 1, 2011.
End of Document © 2012 Thomson Reuters. No claim to original U.S. Government Works.

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existence?(I use the word “metaphysical”to mean: that which pertains

No philosopher has given a rational, objectively demonstrable, scientific

The avowed mystics held the arbitrary, unaccountable “will of God”as

“the good”is whatever it chooses to do because it chooses to do it.

If you want to save civilization, it is this premise of modern ethics— and

course of action. Matter is indestructible, it changes its forms, but it

An organism’ s life depends on two factors: the material or fuel which it

of that action, the ultimate value which, to be kept, must be gained

In answer to those philosophers who claim that no relation can be

all the living organisms that possess the faculty of consciousness—

is produced by the automatic reaction of a sense organ to a stimulus

The higher organisms possess a much more potent form of

A “concept” is a mental integration of two or more perceptual concretes,

deductions, of reaching conclusions, of asking new questions and

Consciousness—for those living organisms which possess it—is the

wheel, how to make an airplane, how to perform an appendectomy, how

Man cannot survive, like an animal, by acting on the range of the

Productive work is the central purpose of a rational man’s life, the

means one’s rejection of the role of a sacrificial animal, the rejection of

them by default, by subconscious associations, on faith, on someone’s

Happiness is that state of consciousness which proceeds from the

But the relationship of cause to effect cannot be reversed. It is only by

“values,” “desires,” “self-interest” and ethics.

one marries an ideal woman or a slut. In spiritual issues, a trader is a

It is only on the basis of rational selfishness—on the basis of justice—

society or government—has the right to assume the role of a criminal

The only proper, moral purpose of a government is to protect man’s

I will not attempt, in a brief lecture, to discuss the political theory of

have presented the barest essentials of my system, but they are

It is philosophy that sets men’s goals and determines their course; it is

“The Objectivist Ethics,” copyright The Virtue of Selfishness © 1961

1. When applied to physical phenomena, such as the automatic

term “goal-directed,” in this context, to designate the fact that the

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Turning Ethics into Outcomes

■ Implication: Executives must

3. Increasing Operational Complexity— 4. Intense Pressure from an Anxious Board—

© 2011 The Corporate Executive Board Company.

$100 Million– 5.6%

From the CORPORATE EXECUTIVE BOARD COMPANY

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■ While it is likely that business Corporate Culture

Companies with cultures that value transparency around key

From the CORPORATE EXECUTIVE BOARD COMPANY

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Bottom Quartile of Integrity Index

Top Quartile of Integrity Index

Culture as Competitive Advantage?

From the CORPORATE EXECUTIVE BOARD COMPANY

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■ CEB data indicate there

What the Numbers Mean

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From the CORPORATE EXECUTIVE BOARD COMPANY

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■ Managers receive training

Q: How Much Ethics and Compliance Training Have You Received?

35% Gamma Company

Managers Indicating They Received

From the CORPORATE EXECUTIVE BOARD COMPANY 1 Pseudonym.

© 2011 The Corporate Executive Board Company.

Role model for proper business conduct