1 © sten erik hakanson 2007 the sarbanes – oxley act of 2002 and intellectual asset management....

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© Sten Erik Hakanson 2007

The Sarbanes – Oxley Act of 2002

and

Intellectual Asset Management.

How a well designed and run Intellectual Asset Management System assures

compliance with that challenging congressional mandate.

2© Sten Erik Hakanson 2007

The Sarbanes – Oxley act (SOX) of 2002 was passed in the wake of catastrophic business failures at the likes of Enron, WorldCom, Tyco and Adelphia.

The corporate officers, board members and accountants of these companies;

♦ Enriched themselves at the expense of their employees and

the investing public.

♦ Used phony accounting tricks to cover up their misdeeds

and

losses.

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SOX now imposes comprehensive duties on publicly traded companies. They must have control systems in place to insure;

♦ Accurate reporting of financial data.

♦ That the company is run efficiently, ethically and in a

manner that best achieves their stated goals.

♦ That management is timely informed of events that

could have a material impact on the business.

♦ That company value is preserved.


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SOX sections most relevant to IP management;

302 404 409 906


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Section 302 – Requires that the CEO and CFO:

1. Certify that the annual and quarterly SEC (10K and 10Q) reports do not;

A. Contain any untrue statements of material fact.

B. Omit a material fact that would render the reports misleading.

2. Certify that the reports fairly present in all material respects the financial condition and results of operations.

3. Are responsible for establishing and maintaining internal controls.

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Section 404 – The CEO and CFO in their annual report to the SEC, must:

1. State their responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and

2. Include their assessment, as of the end of the most recent fiscal year of their company, of the effectiveness of its internal control structure and procedures relative to financial reporting.

The assessment of the CEO and CFO of their company’s internal control structures and procedures must be reviewed and attested to by the registered accounting firm that prepares the independent audit report for the company.


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Section 409 – REAL TIME ISSUER DISCLOSURES- Companies reporting to the SEC must quickly disclose to the public information concerning material changes in theirfinancial condition or operations. Examples include:

1. Termination of a Material Agreement.2. Bankruptcy or Receivership.3. Departure of Directors or Principal Officers4. Election of Directors.5. Appointment of Principal Officers.6. Material Modifications to Rights of Security Holders.7. Loss of key Patent?8. Sued for patent infringement?


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Section 906 – CRIMINAL PENALTIES.

1. Each periodic report filed by a company with the SEC shall be accompanied by a written statement by its CEO and CFO certifying that it:

1. Fully complies with all SEC requirements, and2. Fairly represent the company’s financial condition and results of

operation.

2. A CEO or CFO that certifies such a report knowing it does not comport with SEC requirements shall be;

1. Fined not more than $1,000,000, or2. Imprisoned not more than 10 years, or both.

3. A CEO or CFO that willfully certifies such a report knowing it does not comport with SEC requirements shall be;

1. Fined not more than $5,000,000, or 2. Imprisoned not more than 20 years, or both.


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Basic SOX Acronyms.

SEC – The Securities and Exchange Commission oversees and regulates all publicly traded companies and is charged with the implementation and enforcement of SOX.

GAAS – Generally Accepted Auditing Standards. A set of systematic guidelines used by auditors when conducting audits on a company's finances to ensure the accuracy, consistency and verifiability of the auditor’s actions and reports.

GAAP – Generally Accepted Accounting Principals uniform minimum standards of, and guidelines for, financial accounting and

reporting.


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FASB – The Federal Accounting Standards Board is a private entity that sets national accounting standards under the auspices of the SEC. The FASB determines GAAP.

AICPA – The American Institute of Certified Public Accountants is a private CPA organization that developed the GAAS and also provides input to the FASB regarding GAAP. PCAOB – The Public Company Accounting Oversight Board is a non-profit corporation created by SOX to oversee and regulate the auditing firms providing auditing services to public companies. All auditing firms providing such services must be registered with the PCAOB. The board has investigative and enforcement authority under SOX over these firms.


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COSO – The Committee of Sponsoring Organizations of the Treadway Commission is a nonprofit commission that in 1992 established a common definition of internal control and created a framework for evaluating the effectiveness of internal controls. Used relative to SOX 302.

Auditing Standard No. 2 (AS2)- An audit system adopted by the PCAOB for use by registered external auditors for use relative to audits of financial statements and controls over financial reporting pertaining to SOX 404.


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SAS 70 (the Statement on Auditing Standards No. 70, developed by the AICPA) defines the standards an auditor must use in assessing the quality of the internal controls of a contracted service organization (CSO). CSO’s are businesses that provide outsourced financially related services. Service organization examples:

♦ payroll providers ♦ benefits providers ♦ insurance claims processors

SAS 70 audit performed by ICPA (Independent Certified Public Accountant)


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PCAOBS. 404

SEC

FASB

AS2 GAAPGAAS

AICPA

External Auditor

Company

COSOS.302

Some Accounting Interrelationships

CSO

ICPA

SAS 70

Sec. 404


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PCAOB

Company

Board of Directors

CEO-CFO

Audit Committee

Control and Disclosure Functions

Purchasing - Sales - Engineering - HR

Shipping - Legal - IS - Manufacturing

Internal Auditors

External Auditors

PCAOB Company Auditing Details


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1. A method of complying with SOX relative to the management of IP assets, the steps comprising:

a. identifying and inventorying all IP assets,b. determining a value for the IP assets, c. establishing procedures to identify and protect new IP,d. establishing further procedures to preserve existing

IP and extract maximum value there from,e. putting controls in place to identify and minimize risks to IP value,f. ensuring management is made aware of risks to IP

value so that such risk can reported quickly,g. monitoring and auditing all management controls and

procedures to ensure they are all functioning properly.


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The “method” of this preceding claim example describes precisely what is achieved with a well designed and fully implemented Intellectual Asset Management system.

The following condensed outline, roman numerals I-IX, of an IAM design and implementation course offered through Optimum IP, Inc., provides some background of the structure and function of an IAM system.


http://www.poptimumipinc.com/

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I. Identifying Patent Protectable Subject Matter and Obtaining Patent Protection.

A. Implementing a Patent Disclosure Process. B. Understanding and optimizing the IP

protection/prosecution processes.


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II. Competitive Intelligence.

A. Identifying and listing all company IP.B. Identifying and listing all competitive IP.C. Analyzing that information to understand

1. relative strengths and weaknesses.2. industry trends.

D. Instituting a monthly industry awareness update procedure.

1. Patent searching techniques/process.2. Review of non-patent information sources.


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III. Infringement.

A. Establishing procedures for avoiding Infringement Of Others. B. Establishing procedures for Identifying Infringement By Others.


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IV. Working With Others.

A. Understanding the co-development process. B. Resolving IP Ownership issues. C. How to In-License.

1. Finding licensable technology to fill a need. 2. Negotiating a favorable license agreement.

D. Handling technology submissions from outside parties.


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V. The IP Portfolio as Income Source.

A. Out-Licensing. 1. How to identify patents and draft patent

applications with out-licensing potential.2. Licensing the competition.


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VI. Communication.

A. A successful program of IAM requires a business environment that nurtures creativity and that encourages collaborative problem solving.

1. Inventor/Engineer recognition. 2. Using the internet to facilitate

employee communication and problem solving.

3. Being inclusive of all personnel.


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VII. IP and Valuation.

A. Establishing a Book Value: 1. The “Cost” Value. 2. The “Income” Value. 3. The “Market” Value. 4. Assumption Based Valuation Techniques.

B. Understand the valuation problems and limitations with each technique.

C. No standard valuation system for IP has been developed.


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VIII. How to Make IP Related Decisions Reliably and Accurately.

A. How to database IP and important IP due dates. B. Using a decisional flow diagram for simplifying maintenance fee payment decisions. C. Establishing relative and potential Industry value – a shorthand technique for assisting in IP related decisions. D. Have methods for capturing employee know how.


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IX. Forming and Staffing an Internal IAM Team.

A. Identify team members. B. Creating an IAM team reporting structure. C. Defining team and individual responsibilities.


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Additional Discussion about IP Valuation.

The aspect of an IAM system that is the most problematic involves the valuation of IP assets. SOX provides no guidance as to IP valuation and currently there exists little in the way of official guidelines as to how to accomplish that task - other than two statements issued by the FASB dealing with acquired assets.

1. FASB Statement No. 141 – Concerns the valuation of all assets including intangible assets resulting from an

acquisition or combination.2. FASB Statement No. 142 – Concerns annual intangible

asset fair value measurement.


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Unfortunately, there are no current national standards for determining intangible asset value.

There are a number of private companies that purport to have systems for such valuations. However, their ability to yield consistent results as between them for any given company is probably questionable.

A standard system for IP valuation has yet to evolve and will involve the cooperation of the public and private sector and a “Darwinian” selection of best techniques developed by both.


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The lack of generally accepted guidelines concerning the valuation of IP is odd given that:

♦ Approximately 70 to 80% of the value of publicly traded companies is comprised of intangible

assets, and ♦ IP is currently not very accurately or completely reflected on balance sheets.

Thus, in order to meet the general thrust of Sox to insure more complete and accurate information regarding company finances and condition, the greatest opportunity for improvement will necessarily involve the development and application of better IP valuation metrics.


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The most vexing valuation problems concern IP properties where the value is indeterminate and/or contingent. Examples include:

♦ Patent applications. (parent/ continuation/ divisional)

♦ Issued patent not supporting a current product.

♦ R&D activities. ♦ Know how/workforce expertise. ♦ Ability of a patent portfolio to prevent

infringement.


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SOX IP Disclosure Dilemma.

SOX requires accurate disclosure of company value. However, there is no requirement per se to compromise a competitive position by reporting confidential business information.

♦ If close to patent application publication – disclose. ♦ Disclose what is sufficient for investors and the SEC, e.g.

the value of a trade secret not how it works. ♦ The need for secrecy will ultimately have to be balanced

against the economic benefit of more complete IP valuation reporting.


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Part of the problem regarding the lack of nationally recognized accounting standards for intangibles is due to the fact that any numbers generated have to, at least in part, be based on assumptions about future events.

It is currently thought by the SEC that the numbers arrived at are not “hard” enough to provide any meaningful insight.

On the other hand, the European and Asian markets are doing a better job of quantifying IP.


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The major problem with IP valuation – inability to accurately predict the future!


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So, is this your client’s fate under SOX if they are not omniscient?


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It is highly doubtful that a lack of ability to divine the future will form the basis of a guilty verdict in a criminal trial!

Clearly, the possibility of a criminal penalty is “uncomfortable” to say the least, however no one will be convicted of a crime under SOX unless:

♦ They committed financial fraud,♦ They did so intentionally, and♦ Those facts are proven beyond a reasonable doubt.


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Fortunately, there is no requirement under SOX, or certainly by the SEC, to perform IP valuations for which no national guidelines exist. However, and regardless of the requirements of SOX, US companies need to do a better job of identifying and valuing their intangibles so that their full value is established in order to provide them:

♦ Better access to capital.♦ Higher market capitalization.♦ A stronger competitive position.


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Many smaller/non publicly traded businesses have voluntarily adopted some of the Sarbanes-Oxley “best practices”. The reasons include:

♦ To benefit from improved governance and internal controls.

♦ Better ability to obtain loans. ♦ Be more attractive as an acquisition prospect to a

publicly traded company. ♦ Be more attractive to potential investors should

they decide to go public. ♦ Make it easier “mechanically” to go public. ♦ Obtain better insurance rates for officer liability. ♦ Easier to defend company practices in court..


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Due diligence can be defined as:

The performance of an act or acts in accordance with recognized and established standards of care.

Due diligence is not always legally required; rather it can be performed voluntarily simply to insure best practices and optimal results.

Not following accepted standards of care will always increase the chance of errors as well as amplify the risk of exposure to legal liability.


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The accepted standard of care relative to IP is to have in place a fully functioning IAM system integrated into essentially all business management operations.

♦ Without a well implemented and properly functioning IAM system in place, companies run a much greater risk of making bad or inaccurate decisions about their IP.

♦ Failing to follow firmly established IAM principles can lead to civil and criminal

liability.

♦ With an IAM system in place, responses to changed circumstances can be made more quickly and accurately.


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In addition to limiting SOX liability, and IAM system can help prevent the mishandling of IP assets, which can give rise to:

♦ Shareholder Liability.

Shareholders can sue for mismanagement resulting in a loss of their stock value. These actions can be based on a failure to extract maximum value from the IP portfolio.

♦ Licensee Liability.

A licensee need not breach its patent license agreement in order to bring an action challenging the validity of a covered patent. (Medimmune v. Genentech et al., 549 U.S. ___ (2007) .


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We can fairly conclude that not havingan IAM system in place is not a viable option, and therefore, everyone involved in IP development and management,and especially company executives, must:

♦ Have a strong knowledge of the various types of IP protection, i.e. patents, trademarks, copyrights etc.,

♦ Understand the process of protection for each. ♦ Understand all aspects of the company IAM system or at least the parts relevant to their job function.


IAM

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In sum, good reasons to institute an IAM system, include:

♦ It satisfies the “controls” requirement of Sarbanes-Oxley. The valuation problems relative to IP will have to work themselves out over time.

♦ To optimize your financial performance.

♦ To be better able to rapidly respond to changed circumstances.

♦ To avoid the potential legal consequences of not putting a comprehensive IP control system in place.


1 © sten erik hakanson 2007 the sarbanes – oxley act of 2002 and intellectual asset management....

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sten erik hakanson

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