Corporate Governance - USACorporate Governance - USA
Sarbanes-Oxley ActSarbanes-Oxley Act “SOX” “SOX”
Lecture 15&16Lecture 15&16ByByAbdur Rashid MirzaAbdur Rashid MirzaUniversity of LahoreUniversity of Lahore
Enduring UnderstandingEnduring Understanding
The Sarbanes-Oxley Act was enacted to The Sarbanes-Oxley Act was enacted to establish new or enhanced standards for establish new or enhanced standards for U.S. public company boards, Management, U.S. public company boards, Management, and public accounting firms.and public accounting firms.
Essential QuestionsEssential Questions
Why was the Sarbanes-Oxley Act Why was the Sarbanes-Oxley Act needed?needed?
How does the Sarbanes-Oxley Act How does the Sarbanes-Oxley Act protect stockholders and institutions?protect stockholders and institutions?
ObjectivesObjectives
Describe the events that caused the Describe the events that caused the passing of the Sarbanes-Oxley Act.passing of the Sarbanes-Oxley Act.
Relate the Sarbanes-Oxley Act to Relate the Sarbanes-Oxley Act to accounting.accounting.
Explain the goals of the Sarbanes-Oxley Explain the goals of the Sarbanes-Oxley Act.Act.
Describe each of the 11 titles of the Describe each of the 11 titles of the Sarbanes-Oxley Act.Sarbanes-Oxley Act.
What is SOX?What is SOX?
Also known as the Public Company Also known as the Public Company Accounting Reform and Investor Accounting Reform and Investor Protection Act of 2002Protection Act of 2002
Created by US Senator Paul Sarbanes (D-Created by US Senator Paul Sarbanes (D-Maryland) and US Congressman Michael Maryland) and US Congressman Michael Oxley (R-Ohio) Oxley (R-Ohio)
Signed into law July 30, 2002Signed into law July 30, 2002 Most dynamic securities legislation since Most dynamic securities legislation since
the Securities and Exchange Acts of the Securities and Exchange Acts of
1933 and 19341933 and 1934
Purpose of SOXPurpose of SOX
Establish new or enhanced Establish new or enhanced standards for U.S. public company standards for U.S. public company boards, management, and public boards, management, and public accounting firmsaccounting firms
Relation to AccountingRelation to Accounting
Bad accounting procedures, both Bad accounting procedures, both intentional and non-intentional, led to the intentional and non-intentional, led to the collapse and subsequent investigation of collapse and subsequent investigation of several large companiesseveral large companies
Public outrage led Congress to pass Public outrage led Congress to pass SOX to regulate audits of public company SOX to regulate audits of public company accounting procedures and hopefully accounting procedures and hopefully prevent false financial reportsprevent false financial reports
Relation to Accounting, Relation to Accounting, continued…continued…
Companies that do not follow standard Companies that do not follow standard accounting procedures may use methods accounting procedures may use methods that mislead investors about the financial that mislead investors about the financial health of the company. health of the company.
These practices range from just unethical These practices range from just unethical to illegal. to illegal.
Why was SOX passed?Why was SOX passed?
Failure of Boards of Directors and executives Failure of Boards of Directors and executives to double-check financial recordsto double-check financial records
Intentional misrepresentation of financial statusIntentional misrepresentation of financial status Loans from major banks to risky companies Loans from major banks to risky companies
hurt bank investors and encouraged others to hurt bank investors and encouraged others to make risky investments in those companiesmake risky investments in those companies
Misrepresentation of company earnings Misrepresentation of company earnings caused stockholders to make seemingly good caused stockholders to make seemingly good investments that cost them large sums of investments that cost them large sums of moneymoney
Why was SOX passed?, Why was SOX passed?, continued…continued…
Auditor conflicts of interestAuditor conflicts of interest Some auditing firms provided consulting Some auditing firms provided consulting
services to the companies they audited. services to the companies they audited. Proper auditing procedures, such as challenging Proper auditing procedures, such as challenging
a company’s accounting procedures, could a company’s accounting procedures, could damage the client relationship under the damage the client relationship under the consulting agreement. consulting agreement.
This caused bad accounting practices and This caused bad accounting practices and misrepresentation of financial information to go misrepresentation of financial information to go unchecked, leading to the collapse of several unchecked, leading to the collapse of several companies, like Enron, Worldcom, Healthsouth companies, like Enron, Worldcom, Healthsouth and Tyco.and Tyco.
Causes of Sarbanes-OxleyCauses of Sarbanes-Oxley
HeadlinesHeadlines
Audience QuizAudience Quiz
The Problem for Corporate America
Deficit
Audience QuizAudience Quiz
The TRUST deficitThe extraordinary loss of
trust in corporations and their leaders
Goals of SOXGoals of SOX
Regain public confidence in marketsRegain public confidence in markets Improve corporate governanceImprove corporate governance Increase executive accountability Increase executive accountability Increase efforts to Increase efforts to prevent, detect,
investigate and remediate fraud and misconduct
Title I – Public Company Title I – Public Company Accounting Oversight BoardAccounting Oversight Board
Created as a non-profit organization to oversee audits Created as a non-profit organization to oversee audits of public companiesof public companies
Under the authority of the Securities Exchange Under the authority of the Securities Exchange Commission (SEC)Commission (SEC)
Comprised of 5 appointed members w/ a max of 2 CPA’sComprised of 5 appointed members w/ a max of 2 CPA’s Duties:Duties:
Register existing public accounting firms Register existing public accounting firms which prepare audits for publicly traded which prepare audits for publicly traded companies companies
Audit the auditors Audit the auditors Establish and amend rules and standards (in Establish and amend rules and standards (in
cooperation with other standard setters)cooperation with other standard setters) Try and penalize registered public Try and penalize registered public
accounting firms who fail to comply with the accounting firms who fail to comply with the rulesrules
Title II – Auditor Title II – Auditor IndependenceIndependence
Prohibits registered public accounting Prohibits registered public accounting firms from performing non-audit services firms from performing non-audit services for companies they auditfor companies they audit
Prevents conflicts of interestPrevents conflicts of interest
Title III – Corporate Title III – Corporate ResponsibilityResponsibility
CEOs and CFOs must certify accuracyCEOs and CFOs must certify accuracy Surrender bonuses and profits if information Surrender bonuses and profits if information
is misrepresentedis misrepresented
Title IV – Enhanced Title IV – Enhanced Financial DisclosuresFinancial Disclosures
Forbids most personal loans to chief Forbids most personal loans to chief executivesexecutives
Disclosure of code of ethics for senior Disclosure of code of ethics for senior financial officersfinancial officers
Disclosure of members of company audit Disclosure of members of company audit committeecommittee Should include at least one financial expertShould include at least one financial expert
Title V – Analyst Conflicts Title V – Analyst Conflicts of Interestof Interest
Requires registered securities Requires registered securities associations to adopt rules that prevent associations to adopt rules that prevent conflicts of interestconflicts of interest Ex: Recommendations of analysts in Ex: Recommendations of analysts in
research reportsresearch reports
Title VI – Commission Title VI – Commission Resources and AuthorityResources and Authority
Increased SEC budget to $780 millionIncreased SEC budget to $780 million $98 million used to hire 200 employees to $98 million used to hire 200 employees to
oversee auditorsoversee auditors
SEC has the authority to investigate and SEC has the authority to investigate and punish violators of security lawpunish violators of security law
Title VII – Studies and Title VII – Studies and ReportsReports
US Comptroller General US Comptroller General (The (The Comptroller Comptroller General of the United StatesGeneral of the United States is the director of is the director of the the Government Accountability Office ( (GAOGAO, , formerly known as the General Accounting Office formerly known as the General Accounting Office to conduct a study about the consolidation of to conduct a study about the consolidation of public accounting firms)public accounting firms)
Also conduct investigation of security law Also conduct investigation of security law violations in the cases of Enron, violations in the cases of Enron, WorldCom, etc. WorldCom, etc.
Title VIII – Corporate and Title VIII – Corporate and Criminal Fraud AccountabilityCriminal Fraud Accountability
To knowingly create, destroy, or manipulate To knowingly create, destroy, or manipulate documents or impede federal investigations documents or impede federal investigations is considered a crimeis considered a crime
Punishment = Fines, maximum 20 years in Punishment = Fines, maximum 20 years in prison, or bothprison, or both
Audit reports should be kept for 5 yearsAudit reports should be kept for 5 years Whistleblower protectionWhistleblower protection Dishonest or illegal activities (Dishonest or illegal activities (misconduct) occurring in a ) occurring in a
government departmentgovernment department
Title IX – White-collar Crime Title IX – White-collar Crime Penalty EnhancementsPenalty Enhancements
CEOs and CFOs must certify that CEOs and CFOs must certify that financial statements are accurate financial statements are accurate representations of the company’s representations of the company’s conditioncondition
Punishment = Max $5 million fine and/or Punishment = Max $5 million fine and/or max 20 year punishmentmax 20 year punishment
SEC may ban anyone convicted of a SEC may ban anyone convicted of a security crime from holding an executive security crime from holding an executive position at a public companyposition at a public company
Title X – Corporate Tax Title X – Corporate Tax ReturnsReturns
Federal income tax returns must be Federal income tax returns must be signed by the Chief Executive Officer signed by the Chief Executive Officer (CEO) of the company(CEO) of the company
Title XI – Corporate Fraud Title XI – Corporate Fraud AccountabilityAccountability
Destroying/altering evidence or otherwise Destroying/altering evidence or otherwise obstructing securities fraud proceedings obstructing securities fraud proceedings may be punished with a fine and/or up to may be punished with a fine and/or up to 20 years in prison20 years in prison
SEC may freeze payments to accused SEC may freeze payments to accused individualsindividuals
Any revenge to whistleblowers is subject Any revenge to whistleblowers is subject to fines and/or 10 years imprisonmentto fines and/or 10 years imprisonment
SummarySummary
The Sarbanes-Oxley Act of 2002 was passed The Sarbanes-Oxley Act of 2002 was passed to regain public confidence in the stock market to regain public confidence in the stock market following a string of major accounting fraud following a string of major accounting fraud cases involving public companies. cases involving public companies.
A plan to accomplish this objective is outlined A plan to accomplish this objective is outlined in 11 titles, which:in 11 titles, which: Prohibit conflicts of interestProhibit conflicts of interest Increase corporate accountabilityIncrease corporate accountability Increase accounting transparencyIncrease accounting transparency Form an oversight board to enforce the new rulesForm an oversight board to enforce the new rules
Exam QuestionsExam Questions
1.1. The Sarbanes-Oxley Act was passed in:The Sarbanes-Oxley Act was passed in:a. 1935b. 1974c. 1999d. 2002
2.2. What events led to the passing of SOX?What events led to the passing of SOX?a. Collapse of the auto industrya. Collapse of the auto industryb. A string of accounting scandals at public b. A string of accounting scandals at public companiescompaniesc. Great Depressionc. Great Depressiond. Discrimination in the accounting professiond. Discrimination in the accounting profession
Exam Questions, Exam Questions, continued…continued…
3.3. What government institution was established by SOX to oversee What government institution was established by SOX to oversee auditors?auditors?AnswerAnswer
4.4. The Public Company Accounting and Oversight Board is under The Public Company Accounting and Oversight Board is under the authority of:the authority of:a. North Atlantic Treaty Organization (NATO)a. North Atlantic Treaty Organization (NATO)b. Food and Drug Administration (FDA)b. Food and Drug Administration (FDA)c. Securities Exchange Commission (SEC)c. Securities Exchange Commission (SEC)d. US Treasuryd. US Treasury
5.5. Name 4 titles of the Sarbanes-Oxley Act.Name 4 titles of the Sarbanes-Oxley Act.AnswerAnswer
Exam Questions, Exam Questions, continued…continued…
6.6. According to Title X, who should sign the company tax return?According to Title X, who should sign the company tax return?a. Chief Executive Officer (CEO)a. Chief Executive Officer (CEO)b. President of External Accounting Firmb. President of External Accounting Firmc. Chief Financial Officer (CFO)c. Chief Financial Officer (CFO)d. Company’s Head of Accountingd. Company’s Head of Accounting
7.7. What events involving major public companies led to the What events involving major public companies led to the passing of SOX?passing of SOX?a. Intentional misrepresentation of company financial recordsa. Intentional misrepresentation of company financial recordsb. Auditor conflicts of interestb. Auditor conflicts of interestc. Risky loans from banks based on false earningsc. Risky loans from banks based on false earningsd. all of the aboved. all of the above
Exam Questions, Exam Questions, continued…continued…
8.8. What is the criminal penalty for violation of SOX?What is the criminal penalty for violation of SOX?a. life in prisona. life in prisonb. fines and/or maximum 20 years in prisonb. fines and/or maximum 20 years in prisonc. maximum 5 years in prisonc. maximum 5 years in prisond. tax increased. tax increase
9.9. True/False: Under SOX, auditors are not allowed to True/False: Under SOX, auditors are not allowed to provide non-audit services (consulting) to the provide non-audit services (consulting) to the companies they audit.companies they audit.
10.10. True/False: SOX does not apply to privately held True/False: SOX does not apply to privately held companies.companies.
Effects of Sarbanes-OxleyEffects of Sarbanes-Oxley
If you’re a criminal –If you’re a criminal –
the risks of doing businessthe risks of doing businessabsolutely have increasedabsolutely have increased
Crimes/PenaltiesCrimes/Penalties
•• Created new federal crimesCreated new federal crimes
•• Enacted whistleblower protection and cause of Enacted whistleblower protection and cause of actionaction
Increased criminal penalties for mail/wire fraudIncreased criminal penalties for mail/wire fraud Restricted bankruptcy discharge of securities Restricted bankruptcy discharge of securities
liabilitiesliabilities Lowered threshold officer/director barsLowered threshold officer/director bars Lengthened statute of limitations for securities Lengthened statute of limitations for securities
fraudfraud Gave SEC power to freeze assetsGave SEC power to freeze assets
Senate InvestigationSenate InvestigationEffects of Sarbanes-OxleyEffects of Sarbanes-Oxley
●● Auditors Auditors
●● Securities analystsSecurities analysts
●● Government agenciesGovernment agencies
●● Board of DirectorsBoard of Directors
●● Credit rating agenciesCredit rating agencies
●● Financial institutionsFinancial institutions
Effects of Sarbanes-OxleyEffects of Sarbanes-Oxley
AuditorsAuditors•• Enacted auditor independence Enacted auditor independence
requirementsrequirements
•• Gave guidance to state regulatory Gave guidance to state regulatory authoritiesauthorities
Made it unlawful to mislead public Made it unlawful to mislead public company auditorscompany auditors
Effects of Sarbanes-OxleyEffects of Sarbanes-Oxley
Securities Analysts/Government Securities Analysts/Government AgenciesAgencies
•• Regulation mandated by SOXRegulation mandated by SOX
•• SEC budget increasedSEC budget increased
•• SEC required to review public company’s SEC required to review public company’s filings more oftenfilings more often
““Real time” disclosureReal time” disclosure
Effects of Sarbanes-OxleyEffects of Sarbanes-Oxley
Boards of DirectorsBoards of Directors
•• CEO/CFO certificationsCEO/CFO certifications•• Bonus restrictionsBonus restrictions•• professional conduct rulesprofessional conduct rules•• Enhanced reporting requirementsEnhanced reporting requirements•• Loan prohibitionsLoan prohibitions•• Internal controls attestationsInternal controls attestations•• Codes of ethicsCodes of ethics•• Audit committee requirements (including “audit Audit committee requirements (including “audit
committee financial experts”) and disclosurescommittee financial experts”) and disclosures
Effects of Sarbanes-OxleyEffects of Sarbanes-Oxley
Credit Rating AgenciesCredit Rating Agencies SEC required by SOX to study Credit Rating SEC required by SOX to study Credit Rating
AgenciesAgencies ““Congressional Response” from October 7, 2002 Congressional Response” from October 7, 2002
responseresponse
Investment BanksInvestment Banks GAO required by SOX to study investment banksGAO required by SOX to study investment banks ““Congressional Response” from January 2, 2003 Congressional Response” from January 2, 2003
reportreport
Corporate Scandal - Corporate Scandal - EducationEducation
Some commentators have noted the Some commentators have noted the education level of some of those education level of some of those
involved in some corporate scandals:involved in some corporate scandals:
““How could a Harvard MBA behave so How could a Harvard MBA behave so unethically?”unethically?”
Corporate Scandal - Corporate Scandal - EducationEducation
There’s no relation between education There’s no relation between education and human decencyand human decency
““You can be a Ph.D and an S.O.B.”You can be a Ph.D and an S.O.B.”
Justice Oliver Wendell HolmesJustice Oliver Wendell Holmes
So - What So - What ReallyReally Got Us Got Us Here?Here?
It’s not their M.B.A.It’s not their M.B.A.
It’s their DNAIt’s their DNA
Moral DNAMoral DNAIn my mind, the most important thing that a Board of
Directors should do is determine the elements that must be embedded in the company's moral DNA…It should be the
foundation on which the Board builds a corporate culture based on a philosophy of high ethical standards and accountability. This culture should penetrate every level
of the organization and influence all of the board's decisions including the selection of a CEO and the senior management team who will ultimately ensure that the
company's operations reflect its philosophy.
William DonaldsonFormer SEC ChairmanRemarks made to the Economic Club of New YorkMay 8, 2003
What’s SOX Got To Do What’s SOX Got To Do With It?With It?
Three separate sections of SOX (805, Three separate sections of SOX (805, 905 and 1104) address the US Federal 905 and 1104) address the US Federal Sentencing Guidelines (the “Guidelines”)Sentencing Guidelines (the “Guidelines”)
Guidelines amended in 2004 to change Guidelines amended in 2004 to change references from “Compliance” programs references from “Compliance” programs to “to “EthicsEthics and Compliance Programs” and Compliance Programs”
Boards given direct oversight Boards given direct oversight responsibilityresponsibility
US Sentencing Guideline US Sentencing Guideline RevisionsRevisions““Good corporate citizens have been Good corporate citizens have been incorporating ethical standards into their incorporating ethical standards into their compliance programs for a number of years, compliance programs for a number of years, and recent legislation, such as [SOX], has and recent legislation, such as [SOX], has adopted ethics as a guiding principle.”adopted ethics as a guiding principle.”
Commission Vice Chair Ruben Castillo Commission Vice Chair Ruben Castillo stated “A good corporate citizen must first stated “A good corporate citizen must first and foremost operate ethically.”and foremost operate ethically.”
Corporate Culture and Corporate Culture and PerformancePerformance
““Corporate Ethics: Right Makes Corporate Ethics: Right Makes Might”Might”
Avoiding scandal isn’t the only reason to observe Avoiding scandal isn’t the only reason to observe a stringent code of conduct. Doing the right thing a stringent code of conduct. Doing the right thing also generates more tangible dividendsalso generates more tangible dividends
Business WeekBusiness Week
April 11, 2002April 11, 2002
The Present and Future The Present and Future SolutionSolution
Not in the lawsNot in the laws
The limit of the law is not the test of right and The limit of the law is not the test of right and wrongwrong
People who do their job and do the right thingPeople who do their job and do the right thing