History of Sarbanes Oxley and the Reasons for Enactment Virginia Knight Student ID: 6892460166 Accounting Capstone Senior Seminar in Accounting ACC 499006016Spring 2009 Submitted to: Professor Tee Thein June 19, 2009 Abstract: In 2002 the Sarbanes-Oxley Act was passed. This is a mandatory act that all organizations, large and small, must comply with. This legislation introduced major changes to the regulation of financial practice and corporate governance. There are eleven titles to the Sarbanes-Oxley Act. The act is named after its main architect, Representative Michael Oxley and Senator Paul Sarbanes.
Former President Bush is quoted saying that it is intended to “deter and punish corporate and accounting fraud and corruption, ensure justice for wrongdoers, and protect the interest of workers and shareholders”. Table of Contents: Page Abstract. . . . . . . . . . . . . . . . . . . .. .2 Chapter 1 . . . . . . . . . . . . . . . . . . . . . 5 Introduction. . . . . . . . . . . . . . . . . 5 Chapter 2. . . . . . . . . . . . . . . . . . . . . . 7 Eleven Titles of SOX . . . . . . . . . . . . . . 7 1. PCAOB . . . . . . . . . . . . . . . . . . . . . . 7 2. Auditor Independence. . . . . . . . . . . . . . . 8 3. Corporate Responsibility . . . . . . . . . . . . 8 4. Enhanced Financial Disclosures . . . . . . . . . . 9 5. Analyst Conflicts of Interest . . . . . . . . . . . 9 6. Commission Resources and Authority . . . . . . . . . 10 7. Studies and Reports . . . . . . . . . . . . . . . . 10 8. Corporate and Criminal Fraud Accountability . . . . 10 9. White Collar Crime Penalty Enhancement . . . . . . . 11 10. Corporate Tax Returns . . . . . . . . . . . . . . . 11 11. Corporate Fraud Accountability . . . . . . . . . . . 11 Chapter 3 . . . . . . . . . . . . . . . . . . . . . . 13 An Accountant’s View . . . . . . . . . . . . . . 13 Internal Control Scorecard . . . . . . . . . . . 17 Chapter 4 . . . . . . . . . . . . . . . . . . . . . . 18 Summary and Conclusion . . . . . . . . . . . . . . 18 Research File Memorandum . . . . . . . . . . . . . . . 19 Communication Memorandum . . . . . . . . . . . . . . . 21 References . . . . . . . . . . . . . . . . . . . . . . 22 CHAPTER 1 Introduction President George W. Bush signed the Sarbanes-Oxley Act into law on July 30, 2002. At that time he called it “the most far-reaching” business regulation reform since the days of Franklin Delano Roosevelt. The Sarbanes-Oxley Act (often shortened to SOX) was born of reaction and despair.
The public and business communities were reeling from a series of high profile cases of corporate corruption and failure when congress embraced this act. SOX is legislation enacted in response to the Enron and WorldCom financial scandals to protect shareholders and the general public from accounting errors and fraudulent practices. The Securities and Exchange Commission (SEC) sets deadlines for compliance and publishes rules on the requirements. Sarbanes-Oxley does not specify how a business should store records, but rather which records should be stored and for how long.
SOX was designed following the outbreak of corporate scandals and bankruptcies to restore investor confidence. It has been described as “the most sweeping and significant change in securities law since the 1930’s. SOX is a wide-ranging complex statute that amended United States securities law in significant ways”. The passage of Sarbanes-Oxley was met with criticisms and concerns; some of which has continued through the present. There have been numerous and far-reaching effects due to SOX on the accounting professions with new regulations regarding auditing and consulting.
An invitation only on-line survey named Oversight Systems 2004 surveyed 222 financial executives. “Seventy-nine percent of those surveyed reported having ‘significantly stronger’ or ‘somewhat stronger’ internal controls because of SOX. Seventy-four percent reported realizing a benefit from SOX compliance”. In December of 2004 CFO. com and RevenueRecognition. com also conducted a survey of 220 business leaders. “The results noted a distinct difference between companies that had reached compliance with SOX and those that had not. ” CHAPTER 2 Eleven Titles of SOX
The objective of the eleven titles of the Sarbanes-Oxley Act is to ensure that auditors remain independent; corporations and auditors are accountable to the public for the numbers they publish; an independent body governs financial reporting processes; sufficient measures are in place to deter fraudulent activity; financial activities are transparent enough to allow fraud detection to occur; and if fraud is detected, someone is held responsible. Public Company Accounting Oversights Board Section 101 of the Sarbanes-Oxley Act establishes the Public Company Accounting Oversights Board (PCAOB).
The Board consists of five financially-literate members that are appointed for five-year terms. Three of these members must not be a CPA currently nor have been one in the past. The other two members must be, previously or currently, a certified public accountant. The main focus of this Board is (1) to register along with discipline accounting firms that prepare audit reports on companies that are public; (2) conduct inspections and/or investigations of registered accounting firms that audit public companies; and (3) establish audit and accounting standards.
Auditor Independence Sections 201, 203 and 204 outline the responsibilities of the accounting firms. These responsibilities include prohibiting any public accounting firm from providing any services that do not have to do with auditing while they are auditing that firm; making sure the reviewing partner and lead auditor rotate off of the audit every 5 years; and confirming that auditors report all critical accounting policies and practices to the firm’s audit committee. Corporate Responsibility
Section 301 of SOX requires a formation of an audit committee that is independent and competent. It is required that each member of this committee be a member of the Board of Directors of the firm and be “independent”. The term “independent” is defined as “not receiving, other than for service on the board, any consulting, advisory, or other compensatory fee from the issuer, and as not being an affiliated person of the issuer, or any subsidiary thereof. ” Enhanced Financial Disclosures
Title IV’s Section 404 is often considered one of the most significant aspects of SOX along with one of the most costly provisions to implement. While Title IV regulates some of the accounting practices such as off-balance sheet transactions and personal loans to executives, Section 404 makes it mandatory for auditors to submit an annual management report. This gauges the efficacy of a company’s internal controls. There is also a second report that is mandatory that is required from management and auditors that assesses these controls. Analyst Conflicts of Interest
The fifth title of the Sarbanes-Oxley Act reviews the possible conflicts of interest that may face securities analysts when they interact with publicly traded companies. This section contains rules specifically designated to “foster greater public confidence in securities research, and to protect the objectivity and independence of securities analysts”. Commission Resources and Authority Through Title VI of SOX the appropriation funds for the SEC are increased. This allows a hiring increase as it gives the SEC the authority to censure advisors and stock brokers or deny them to practice.
Section 603 also gives the courts the authority to prohibit the offering of penny stocks. Studies and Reports Title VII is regarding various studies to be done by the Government Accountability Office. These are described in Section 701: GAO Study and Report Regarding Consolidation of Public Accounting Firms; Section 702: Commission study and report regarding credit rating agencies; Section 703: Study and report on violators and violations; Section 704: Study of Enforcement Actions; and Section 705: Study of Investment Banks. Corporate and Criminal Fraud Accountability
This section of SOX extends “whistleblower protection” and mandates criminal penalties for certain acts taken against the employee by the employer. This makes it illegal for firms to punish whistle-blowers in any way. This Act also requires auditors to maintain “all audit or review work papers” for five years. White Collar Crime Penalty Enhancement In Title IX enhances sentencing guidelines for mail and wire fraud from 5 years to 10. This also gives the SEC the authority to ask the court to freeze any extraordinary payments.
Also this now mandates that it is a crime for tampering with corporate financial reports or impeding an official proceeding. Corporate Tax Returns Section 1001: Sense of the Senate Regarding the Signing of Corporate Tax Returns by Chief Executive Officers makes it mandatory that the CEO of a company must sign the Federal income tax return for the corporation. Corporate Fraud Accountability The following describes Sections 1102, 1103 and 1105 of Title XI: “Section 1102: Tampering With a Record or Otherwise Impeding an Official Proceeding – Makes it a crime for any person to corruptly alter, destroy, utilate, or conceal any document with the intent to impair the object’s integrity or availability for use in an official proceeding or to otherwise obstruct, influence or impede any official proceeding is liable for up to 20 years in prison and a fine. Section 1103: Temporary Freeze Authority for the Securities and Exchange Commission – The SEC is authorized to freeze the payment of an extraordinary payment to any director, officer, partner, controlling person, agent or employee of a company during an investigation of possible violations of securities laws.
Section 1105: Authority of the Commission to Prohibit Persons from Serving as Officers or Directors – The SEC may prohibit a person from serving as an officer or director of a public company if the person has committed securities fraud. ” CHAPTER 3 An Accountant’s View of SOX Kimberly R. Huntley, Senior Financial Analyst for HONEYWELL in Greer, SC comments on her involvement with Sarbanes-Oxley. “One of the biggest complaints about Sarbanes-Oxley is that it requires extra work from not only finance but all departments of the company to insure that all internal controls are in place.
SOX allows the public and stockholders to feel secure in that another ENRON or WorldCom won’t happen again. I have worked for two public companies at different times during my accounting career. Each of these companies were at different stages of the Sarbanes-Oxley compliance process. The first company was working to develop their internal controls scorecard and have it implemented in time for the newly passed Sarbanes-Oxley Act. The development of this scorecard required a person from IT, Finance, HR, Engineering, Supply Chain, and Manufacturing.
Controls and process maps had to be in place for all aspects of the business. While I wasn’t the person responsible for writing the initial controls, I was given the task of taking the controls and testing them not for only my plant but for all plants within our product group. Fixed assets were tested for proper paperwork including the appropriate signatures of approval for the expenditures. If the expenditure was approved for $100,000, the total cost of buying the asset, installing it, and turning it on could not exceed the $100,000 by more than five percent.
If it did, then it would require an addendum to the original documentation and signed off on again. Some other controls put in place were over accounts receivable. One of the tests was to see if a duplicate invoice could be entered into the system. This was to help ensure the integrity of revenue. A test from HR was to see if I could change in the system my pay rate. IT has its own set of controls. Only certain people should have access to the entire system. All systems should be backed up daily and stored in a safe place in case of a natural disaster.
Putting all of the controls in place took time. All of the leadership team had to be in agreement with the controls and the wording. The controls also had to be easily understood by someone from outside the industry including the outside auditors. Most importantly, the controls had to completely objective and easily testable. It took me 2 weeks to test all of the controls for 5 different plants. I had to supply a complete report to the leadership team and to our auditors. In the initial testing, some of the controls were edited for better clarity and some changed to be more objective.
These controls are still in place and the company has continued to use them. Sarbanes-Oxley is not just for publicly traded companies but used in many large private companies as well. It helps people feel secure that the financial statements are accurate. Even CEO’s of private companies report to a Board of Directors. That board wants to be comfortable that the information they are given is true and accurate. All auditors will audit the internal controls of their clients regardless if it is private or publicly held.
Many companies complain about the cost of implementing and maintaining Sarbanes-Oxley controls. Most accountants frown at the mention of SOX. Unfortunately, it is a necessary evil. Some companies have several full-time people on staff devoted entirely to maintaining Sarbanes-Oxley controls. My current company has a Sarbanes-Oxley team. Each site also has a person who is responsible for testing those Sarbanes-Oxley controls quarterly and reporting those back to the corporate office. Thankfully it is only quarterly because it takes a few days to get through the testing of the controls. Below is a copy of her work internal controls scorecard: [pic] CHAPTER 4 Summary and Conclusion The Sarbanes-Oxley Act can be considered one of the most far-reaching set of government-enforced rules. One point of further research that may be suggested is what impact the Board will have on the status and power of power of private sector standard-setting in the future. This would include the FASB. In effect on the corporate world, Sarbanes-Oxley is one of the most important pieces of legislation in recent years. The intervention was much needed in the area of corporate responsibility.
The implications of SOX not only restore investor confidence, but also confidence in the accounting profession. Because of Sarbanes-Oxley, companies have changed the way they develop their business strategies and invest in IT resources. June 19, 2009 Research File Memorandum Prepared by Virginia Knight Subject: Sarbanes-Oxley Act Background: SOX was a reaction to corporate scandals and lack of investor confidence. Some of the main corporations involved were Enron and MCI. There was intense competition and pressure, along with conflicts of interest.
Poor practices led to poor reporting and mismanagement. Statement of Research Problem: By consensus, auditing had been working poorly, and increasingly so. Plausible Alternatives: The most important, and most promising, part of Sarbanes-Oxley was the creation of a unique institution to oversee and regulate auditing, the Public Company Accounting Oversight Board (PCAOB). Proposed Solution: In section 404, the law also created new disclosure-based incentives for firms to spend money on internal controls, above increases that would have occurred after the corporate scandals of the early 2000s.
In exchange for these higher costs, which have already fallen substantially, Sarbanes-Oxley promises a variety of long-term benefits. Investors will face a lower risk of losses from fraud and theft, and benefit from more reliable financial reporting, greater transparency, and accountability. Public companies will pay a lower cost of capital, and the economy will benefit because of a better allocation of resources and faster growth. Explanation and documentation: Sarbanes-Oxley remains a work in progress.
Section 404 in particular was implemented very aggressively, but reformers should push for continued improvements in its implementation, by PCAOB, rather than for repeal of the legislation itself. Other Issues and Additional Concerns: Some argue that the new regulations are too strict or misdirected, and others propose amending the law for greater clarification of information and ease of the public obtaining such information. It is understood that the new regulations have resulted in increased expense, time, and liability of auditing companies.
SOX has not only affected the regulatory environment of the accounting profession, but extends to the legal profession as well. This is accomplished by Section 307, which requires counsel to report material state and federal violations, as well as breaches of fiduciary duty, with attendant liability for failure to comply. June 19, 2009 Virginia Knight Accounting Capstone Communication Memorandum To Whom It May Concern: Corporate, along with individual security stands in the center of the Sarbanes Oxley Act summary.
New criminal and civil penalties were announced for security violations. Also a new system of certification of internal audit efforts was set. Auditors from outside the system have been granted more access to company data with the new auditor independence provision. There is also an increased disclosure of compensation methods and systems, especially for upper management, comprised in the Sarbanes Oxley Act. The result of SOX has had both a positive and negative impact. This has led to discussions on expanding the scope of it.
Congress is examining the reporting of privately held companies and is also reviewing options to expand to nonprofit companies to reduce scandals. Local, along with State governments are revising policies and possibly legislation to require activity reporting. The process for improvements for future compliance should focus on financial reporting along with risk identification and assessment. Internal audits along with IT oversight and operations should also be monitored. Please feel free to contact me for any additional information needed. Sincerely, Virginia Knight
REFERENCES Sarbanes-Oxley: Overview of Current Issues and Concerns An Article by Parles, Lisa McCauley-O’Sullivan (2007) Retrieved from http://www. entreprenuer. com Shining the Light on the Sarbanes-Oxley Act Retrieved on June 17, 2009 from http://www. grgc. com Introduction to Sarbanes-Oxley Retrieved on June 9, 2009 from http://www. sarbanes-oxley-forum. com Provisions of the Sarbanes-Oxley Act Retrieved on June 6, 2009 from http://thecaq. aicpa. org Interview with Kimberly R. Huntley, Senior Financial Analyst for HONEYWELL in Greer, SC John C. Coates IV