Corporate and Accounting Reform Legislation Signed Into Law
Legislation that will fundamentally change the way
public companies do business and how the accounting profession performs its
statutorily required audit function was signed by President Bush on July 30,
2002. The Sarbanes-Oxley Act of 2002 (Pub. Law No. 107-204) is intended to address systemic and
structural weaknesses that have been revealed in recent months and that show
failures of audit effectiveness and a breakdown in corporate financial and
broker-dealer responsibility.
The Act establishes a comprehensive framework to
modernize and reform the oversight of public company auditing, improve quality
and transparency in financial reporting by those companies, and strengthen the
independence of auditors. It promotes competition among service providers,
enhances accurate investor decision-making throughout the capital markets, and
seeks to correct shortcomings that have threatened the reputation of those
markets for integrity.
Title I creates a public company accounting oversight
board. The board is empowered to set auditing, quality control, and ethics
standards, to inspect registered accounting firms, to conduct investigations,
and to take disciplinary actions. As a check on the board's power, its decisions
are subject to oversight and review by the SEC. This will be a strong,
independent, and full-time oversight board with broad authority to regulate
auditors of public companies, set auditing standards, and investigate violations
of accounting practices.
Up until now, there has been reliance on self-policing
of the audit process, private auditing and accounting standards setting, and,
for the most part, private disciplinary measures. But questionable accounting
practices and corporate failures have raised serious questions about this
private oversight system.
For the first time, the Act creates a truly
independent accounting oversight board, staffed with objective, unbiased
overseers, who can enforce rules and prosecute violators without having to vet
their decisions elsewhere. Unlike the Public Oversight Board, which depended on
fees from the very auditors it was meant to regulate, this new board will be
funded by mandatory fees paid by all public companies. The Act also provides for
a new, improved FASB, giving it for the first time full financial independence
from the accounting industry.
Title II strengthens auditor independence from
corporate management by limiting the scope of consulting services that auditors
can offer their public company audit clients. This works to prevent auditors
from controlling the entire financial reporting system at an individual company
by both designing the internal audit system, and then purporting to offer an
unbiased external audit.
The Act applies only to public companies that are
required to report to the SEC. It says plainly that state regulatory authorities
should make independent determinations of the proper standards and should not
presume that the Act's standards apply to small- and medium-sized accounting
firms that do not audit public companies.
Titles III and IV of the Act enhance the
responsibility of public company directors and senior managers for the quality
of the financial reporting and disclosure made by their companies. Title V seeks
to limit and expose to public view possible conflicts of interest affecting
securities analysts. Title VI increases the SEC's annual authorization from $481
million to $776 million and extends the SEC's enforcement authority. Title VII
of the bill mandates studies of accounting firm concentration, the role of
credit rating agencies, investment banks, and aiding and abetting
The Act provides for a strong public company audit
committee that would be directly responsible for the appointment, compensation,
and oversight of the work of the public company auditors, which makes it clear
that the primary duty of the auditors is to the public company's board of
directors and the investing public, and not to the managers. Audit committee
members must be independent from company management.
The Act will stiffen the resolve and oversight of
audit committees by requiring, among other provisions, that all committee
members be independent and that they be given funds to hire independent counsel
and other advisers. The Act requires that the audit committee develop procedures
for addressing complaints concerning auditing issues and also that they put in
place procedures for employee whistleblowers to submit their concerns regarding
accounting.
Sarbanes-Oxley prohibits insider trades during pension
fund blackout periods. Thus, you cannot have officers and directors free to sell
their shares while the majority of the employees of the company are required to
hold theirs.
On enhanced financial disclosures, the measure
requires that public companies must disclose all off-balance-sheet transactions
and conflicts. Also, pro forma disclosures must be done in a way that is not
misleading and be reconciled with a presentation based on generally accepted
accounting principles. More companies are doing these pro forma disclosures, and
Congress feels they are not accurately reflecting the financial conditions of
the company.
The Act requires very prompt disclosure of insider
trades, which are to be reported by the second day following any transaction.
The SEC is authorized to establish a different reporting timetable when the
two-day period is not feasible.
The Act deals with analyst conflicts of interest. It
prevents investment banking staff from supervising research analysts or clearing
their reports and prohibits analysts from distributing research reports about a
company they are underwriting. There is also a provision to protect analysts
from retaliation for making unfavorable stock recommendations.
On corporate misconduct, the Act presents a number of
new provisions to deter wrongdoing. For the first time, CEOs and CFOs would have
to certify that company financial statements fairly present the company's
financial condition. If a misleading financial statement later resulted in a
restatement, the CEO and CFO would have to forfeit and return to the company any
bonus, stock, or stock option compensation received in the twelve months
following the misleading financial report. It would be unlawful for any company
officer or director to attempt to mislead or coerce an auditor. The Act would
also require auditors to discuss specific accounting issues with the company's
audit committee, which will not only increase the understanding of the company's
board of directors, but also prevent directors from later claiming they were not
informed about the company's accounting practices. The Act would also enable the
SEC to remove unfit officers and directors from office and bar them from holding
any future position at a public company.
The Act establishes a new crime of securities fraud,
with a tough 25-year jail sentence. It breaks the corporate code of silence by
providing, for the first time, federal protection for corporate whistleblowers
who report fraud to the authorities or testify at trial. It closes loopholes and
toughens penalties for shredding documents. It requires audit documents to be
preserved for five years and provides tough criminal penalties for their
destruction. It protects victims the right to recoup their losses by preventing
fraud artists from hiding in bankruptcy or concealing their crime and using
unfair statute of limitations to hide.
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