The Sarbanes-Oxley Act of 2002 was enacted in the wake of a series of high profile corporate scandals. It established a series of requirements that affect corporate governance in the U.S. and influenced similar laws in many other countries. The law required, along with many other elements, that:
- The Public Company Accounting Oversight Board (PCAOB) is established to regulate the auditing profession, which had been self-regulated prior to the law. Auditors are responsible for reviewing the financial statements of corporations and issuing an opinion as to their reliability.
- The Chief Executive Officer (CEO) and Chief Financial Officer (CFO) attest to the financial statements. Prior to the law, CEO’s had claimed in court they hadn’t reviewed the information as part of their defense.
- Board audit committees have members that are independent and disclose whether or not at least one is a financial expert, or reasons why no such expert is on the audit committee.
- External audit firms cannot provide certain types of consulting services and must rotate their lead partner every 5 years. Further, an audit firm cannot audit a company if those in specified senior management roles worked for the auditor in the past year. Prior to the law, there was the real or perceived conflict of interest between providing an independent opinion on the accuracy and reliability of financial statements when the same firm was also providing lucrative consulting services.
The U.S. Securities and Exchange Commission (SEC) administers the act, which sets deadlines for compliance and publishes rules on requirements. The Sarbanes-Oxley Act was enacted in response to a series of high-profile financial scandals that occurred in the early 2000s at companies including Enron, WorldCom and Tyco that rattled investor confidence. The act, drafted by U.S. Congressmen Paul Sarbanes and Michael Oxley, was aimed at improving corporate governance and accountability.
Sarbanes-Oxley Compliance
Compliance with the legislation need not be a daunting task. Like every other regulatory requirement, it should be addressed methodically, via proper analysis and study. Also like other regulatory requirements, some sections of the act are more pertinent to compliance than others. To assist those seeking to meet the demands of this act, the following are the six main areas of the Act:
- Oversight Board: The Public Company Accounting Oversight Board was created to oversee the audit of public companies. This board sets standards and rules for audit reports. All accounting firms that audit public companies must register with the Oversight Board. It also inspects, investigates, and enforces compliance from these registered firms.
- Auditor Independence: Auditors now have a list of non-audit services they can’t perform during an audit. The Act also imposes a one-year waiting period for audit firm employees who leave an accounting firm to become an executive for a former client. In addition, the former firm must wait one year before performing any audit services for the new employer.
- Greater Financial Disclosures: Transactions and relationships that are off-balance sheet but that may affect financial status now must be disclosed. Personal loans from a corporation to its executives are now largely prohibited. Annual reports must include a report stating the management is responsible for the internal control structure and procedures for financial reporting.
- Conflict of Interest Disclosures for Analysts: Conflict of interest disclosures now need to be made by research analysts who make public appearances or offer research reports. These disclosures need to contain certain information about the company that is the subject of the appearance or report. The analyst has to report whether he or she holds any securities in the company or received corporate compensation. Brokers and dealers have to disclose if the public company is a client.
- Corporate and Criminal Fraud Accountability: Altering, destroying, concealing or falsifying records or documents with the intent to influence a federal investigation or bankruptcy case is subject to fines and up to 20 years imprisonment. New audit work papers must be retained for five years. Any person who knowingly defrauds shareholders of publicly traded companies is subject to fines or imprisonment.
- Attorneys’ Responsibilities: There are now minimum standards of professional conduct for attorneys representing public companies before the SEC. These include a rule requiring an attorney to report securities violations to the CEO.
