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Introduction
The collapse of Enron and WorldCom, as well as other well-publicized
financial debacles, have led to an unprecedented level of attention paid to corporate governance, financial disclosure, and auditing issues.
These conditions warranted US legislators to take a strong action to
tighten the belts of erring corporates. In wake of the above
conditions American Congress presented Sarbanes Oxley Act, 2002 to
the President on July, 2002 after passing it in the senate by a
99-0 vote and in the house by a 423-3 margin. President Bush
signed the Sarbanes Oxley Act, 2002 into law the morning of July
30 2002.
This Act is named after its primary architects, Senator Paul Sarbanes
and Representative Michael Oxley. The Act deal with issues of auditor
independence, corporate responsibility, enhanced financial disclosures,
conflicts of interest, and corporate accountability, among other things. The Act also establishes a Public Company Accounting Oversight Board.
Sarbanes Oxley Act, 2002 directly affects the following
1. Certified Public Accountants of Publicly traded companies
2. Publicly traded companies their employees, officers and owners
including holders of more than 10% of the outstanding common shares.
3. Attorneys who work for or have publicly traded companies as their
clients
4. Brokers, dealers, investment bankers and financial analyst who work
for publicly traded companies.
Sarbanes Oxley Act, 2002 (SOA) provides for the following.
ESTABLISHMENT OF PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB) Sec
101
The SOA provides for establishment of PCAOB consisting of five members.
This Board is subject to oversight by Securities Exchange Commission,
USA. The Board will oversea the audit of Publicly Traded Companies.
Every CPA or a CPA firm, auditing publicly traded companies have to
register himself/themselves with PCAOB.
Beginning 180 days after the SEC determination, it will be unlawful for
any firm that is not registered with the Board to prepare or issue, or
to participate in the preparation or issuance of, any audit report with
respect to any issuer.
PUBLIC COMPANY AUDIT COMMITTEE Sec 301/407
The SOA provides for constitution of Audit Committee responsible for
appointment, compensation and oversight of the work of independent
auditors. Members of the Audit Committee should be members of the Board
of Directors of the Company and must be independent, meaning he/she must not accept any consulting, advisory or other compensatory fees from the issuer company; however he/she may draw sitting fees. Member of Audit
Committee must also not be affiliated to subsidiary of the issuer Company. This Audit Committee is charged with the responsibility of
establishing, reviewing the procedure for the receipt, treatment of
accounts, internal control or auditing complaints received by the issuer from the interested/effected parties. On January 9,
2003, the Securities and Exchange Commission had released proposed rules under the Sarbanes-Oxley Act of 2002 (the Act) to strengthen the
independence and authority of the audit committees of listed companies.
AUDITOR REPORTS- Sec 204
The SOA requires that registered public accounting firms should report
directly to issuers Audit Committee:
all critical accounting policies and practices to be used;
all alternative treatments of financial information within GAAP that have been discussed with management, ramifications of the use of such
alternative treatments, and the treatment preferred by the registered
public accounting firm; and other material written communication between the registered public
accounting firm and management, such as any management letter or
schedule of unadjusted differences.
CONFLICTS OF INTEREST- Sec 206
The SOA provides that registered public accounting firm may not perform
any audit service for an issuer if the CEO, CFO, controller, chief
accounting officer or any person serving in an equivalent position was
employed by such firm and participated in any capacity in the audit of
that issuer during the one-year period preceding the date of the initiation of the audit.
AUDIT PARTNER ROTATION- Sec 203
The SOA provides for rotation of lead audit partner and partner reviewing the audit every five years. However note should be taken of
the fact that rotation of Audit firm is not. ****
INDEPENDENT AUDIT Sec 201
CPA or CPA firms auditing publicly traded companies are also prohibited
from providing services outside the scope of practice of auditors.
Prohibited services include:
1. Bookkeeping or other services related to the accounting records or
financial statements of the audit client;
2. Financial information systems design and implementation;
3. Appraisal or valuation services, fairness opinions, or contribution-in-kind reports;
4. Actuarial services;
5. Internal audit outsourcing services;
6. Management functions or human resources;
7. Broker or dealer, investment adviser, or investment banking services;
8. Legal services and expert services unrelated to the audit;
9. Any other service that the Board determines, by regulation, is
impermissible.
However note should be taken of the fact that CPA/ CPA firms may continue to provide tax services such as tax planning, tax management or
other permitted non audit services provided such services are pre-approved by the issuers Audit Committee . The issuer Company must
disclose approval of permitted non audit services in its periodic reports.
AUDIT RECORDS SEC
The SOA requires any accountant who conducts an audit of a public company's securities under section 10A of the Securities Exchange Act of 1934 to maintain all audit or review work papers for 5 years from the
end of the fiscal period relating to such audit. Penalties for a willful violation of such laws, rules or regulations pertaining to the
destruction of corporate audit records include fines, imprisonment up
to 10 years or both
CEOS & CFOS REQUIRED TO AFFIRM FINANCIALS- Sec 302
The SOA requires CEO and Principal Finance Officer to certify that: the signing officer has reviewed the report; based on the officer's knowledge, the report does not contain any
untrue statement of a material fact or omit to state a material fact in
order to make the statements made not misleading, in light of the circumstances under which the statements were made;
based on the officer's knowledge, the financial statements (and all other information contained in the report) fairly present in all
material respects the financial condition and results of operations of
the issuer for the periods presented; the signing officers are responsible for establishing and maintaining
internal controls and other matters relating to such internal controls; the signing officers have disclosed to the auditors and the audit
committee any fraud involving management (or other employees who have a
significant role in internal controls) and significant deficiencies
regarding internal controls if any ; and the signing officers have indicated in the report whether or not there
were significant changes in internal controls or other factors that
could significantly affect internal controls after the date of their
evaluation.
PENALTY FOR WRONG CERTIFICATION Sec 304
The SEC's rules are effective now. If an issuer is required to restate
its financials due to the material noncompliance , "as a result of
misconduct", of CEO or CFO with any financial reporting requirement
under the securities laws, then such CEO and CFO will have to reimburse
the issuer for:
1. any bonuses (or other incentive-based or equity-based compensation)
received by that person from the issuer during the 12-month period
following the first public issuance or filing (whichever occurs first)
with the SEC of the financial document embodying such financial reporting requirement and
2. any profits realized from the sale of securities of the issuer during that 12-month period. This would include performance-driven salary
increases, cash or stock bonuses and profits from stock option exercises.However SEC is empowered to exempt any person from this forfeiture rule
in appropriate cases. Point noteworthy is that the SOA does not define
Misconduct and it limits its approach to misconduct by CEO & CFO only .
PENSION FUND BLACKOUT PERIOD /INSIDER TRADING Sec 306/403
Directors and Executives Officers are prohibited from dealing in equity
securities of the issuer company during pension fund blackout period.
The issuer is obliged to forfeit any profits realised by such directors
or executive officers during such period.
Its the responsibility of the Issuer to notify directors and executive
officers, as well as the SEC, of such blackout periods. In the event of
a pension plan blackout, a public company must provide notification to
the SEC on a Form 8-K filed no later than the date on which the company
notifies its directors and executive officers The Act further provides that SEC is required to frame rules not later
than April 26, 2003 directing national securities exchanges and associations to prohibit the listing of any security of an issuer does
not comply with this new requirement. For these purposes, a blackout period is defined generally to include
any period of more than three consecutive business days during which the
ability of at least 50% of the participants or beneficiaries under all
individual account plans maintained by the issuer to trade in issuers
equity securities held in such an individual account plan is temporarily
suspended by the issuer or a plan fiduciary. Changes in equity ownership (i.e., stock purchases, sales, option grants
and option exercises) by directors, officers, and 10% beneficial owners must be reported by the end of the second business day following the
transaction date.
FINANCIAL DISCLOSURES- Sec 401 /409
All 10 K ( Annual Filing) , 10 Q ( Quarterly Filing ) with the SEC must
disclose all material off balance sheet transactions, arrangements,
obligations ( including contingent liability) , relationship of the
issuer with unconsolidated entities and other relationship that may
have a material effect on the issuers present or future financial condition, proforma financial information in any report filed with the
SEC or in any public release must not contain any misleading or misstatement or omit material fact necessary to make the financial
information not misleading. Such information must be reconcilable with
the financial conditions and operating results prepared under US GAAP.
This provision plugs the advantage enjoyed by the corporate of excluding
various types of negative financial data from press releases to create
more positive pro forma results.
BAN ON LOAN TO DIRECTORS AND EXECUTIVE- Sec 402
Section 402 of SAO prohibits US and foreign Companies with Securities
traded in the US from making or arranging from third parties any type of
personal loan to directors or executive directors. It appears that
existing loans are not affected but material modification or renewal of
loan and arrangement of existing loans are banned. However, credit and
charge cards issued by businesses to their employees, margin loans for
personal securities brokerage accounts held by brokerage employees, and
loans by financial institutions to their employees that are regulated by
the Federal Reserve are exempted One point to be noted is that exemption applies only to broker dealers
registered with the SEC, thereby excluding most Non US broker dealer.
Thus exceptions provided in Section 402 are very narrow covering only
loans made in the ordinary course of business and at market rates by the
issuer who are financial institution or otherwise in the business of
consumer lending.
POWER TO BAR OFFICERS AND DIRECTORS- Sec 305
The SOA empower the SEC to permanently bar persons from serving as a
director or officer of a public company in an administrative proceeding
before the SEC. This power of barring a person from serving as a director or officer of a public Company was previously only entrusted toa federal district court.
RESPONSIBILITY OF ATTORNEYS - Sec 307
The Attorneys dealing with the publicly traded Companies are required to report evidence of material violation of securities law or breach of
fiduciary duty ( or similar violation) by the issuer or any agent of
the issuer to the Chief Counsel or CEO and if the Counsel or CEO does
not appropriately respond to the evidence, the attorney must report the
evidence to the audit committee, another committee composed entirely
of independent directors, or the board of directors. These requirements
will drastically change the relationship between Directors / officers of
public companies and legal counsel.
SECURITIES ANALYST REQUIREMENTS Sec 501
The SOA provides that Brokers and dealers of securities should not
retaliate or threaten to retaliate against an analyst employed by the
broker or dealer as a result of an adverse, negative or unfavorable
research report on a public company. The SOA further provides that
Securities analysts and brokers or dealers should disclose conflicts of
interest, such as:
(a) Whether the analyst has investments or debt in the company it is
reporting on;
(b) Whether any compensation received by the broker, dealer or analyst
is appropriate in the public interest and consistent with the protection
of investors;
(c) Whether an issuer has been a client of the broker or dealer; and
(d) Whether the analyst received compensation with respect to a research report based on investment banking revenues.
NO DISCHARGE IN BANKRUPTCY- SEC 803
Section 803 of the SOA provides that debts arising from judgments or
settlements in civil and criminal securities fraud proceedings, including common law fraud in connection with the purchase or sale of a
security, cannot be discharged in bankruptcy.
MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS- Sec 403
The SOA requires each annual report of an issuer must contain an "internal control report", which shall:
(1) state the responsibility of management for establishing and
maintaining an adequate internal control structure and procedures for
financial reporting; and
(2) contain an assessment, as of the end of the issuer's fiscal year, of the effectiveness of the internal control structure and procedures of
the issuer for financial reporting
PENALITIES
1. For alteration, destruction, concealment of any records with the
intent of obstructing a federal investigation then penalty could a fine
and/or up to 10 years imprisonment
2. Anyone who knowingly executes, or attempts to execute, a scheme to
defraud a purchaser of securities then penalty could be fine and/or up
to 5 years imprisonment
3. Any CEO or CFO who recklessly violates his or her certification of
the companys financial statements then penalty could be fine of up to $1,000,000
and/or up to 10 years imprisonment
4. Any CEO or CFO who willfully violates his or her certification of the companys financial statements then penalty would be fine of up to $5
million and/or up to 20 years imprisonment penalty would be
5. Two or more persons who conspire to commit any offense against or to
defraud the U.S. or its agencies then penalty could be fine and/or up to
10 years imprisonment
6. Any person who corruptly alters, destroys, conceals, etc., any
records or documents with the intent of impairing the integrity of the
record or document for use in an official proceeding then penalty would
be fine and/or up to 20 years imprisonment.
7. In case of Mail and wire fraud penalty could be upto 10 years
imprisonment
Conclusion:
The SOA increases accountability standards for directors, officers,
auditors, securities analysts and legal counsel involved in the financial markets. Senator Paul Sarbanes has brought forward legislation that could have
far-reaching implications for worldwide audits. The SOA Act leaves the
issues of board independence, expensing of stock options, untouched. For
private companies, the impact is less noticeable since the SOA is
targeted specifically at public companies. The SOA does not distinguish
between US and non-US issuers; it applies to all companies with a listing in the US. Companies cannot retaliate against an employee for
providing information or assisting in US fraud investigations.
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Sarbanes and Oxleys Act 2002
Of USA
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author can be reached at: paras_acs@yahoo.co.in /
