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Sarbanes-Oxley was created to improve quality and transparency in financial reporting, independent audits, and accounting services for public companies. On July 30, 2002, the Sarbanes Oxley Act (also known as SOX) was signed into law by President George W. Bush. The Sarbanes Oxley Act of 2002 is a federal law that set new or improved standards for all U.S. public company boards, management and public accounting firms. Covered in the eleven titles are additional corporate board responsibilities, auditing requirements and criminal penalties. This essay reviews the implications of the Sarbanes Oxley Act on the accounting profession.
President George W. Bush signed the Sarbanes Oxley Act into law on July 30, 2002. This law set new and enhanced standards for public companies and the boards, management and accounting firms. The Sarbanes Oxley Act also brought about considerable changes to the financial reporting and auditing practices of public companies. The act holds top executives for these companies personally responsible for the financial data and its timeliness, with non-compliance having criminal consequences (Trivoli, 2004).
The Sarbanes Oxley Act, it also known as SOX. SOX created a new agency. It introduce in financial market is the "Public Company Accounting Oversight Board" (PCAOB). It is providing to oversee the auditors of public companies. The PCAOB is overseen by the Securities and Exchange Commission (SEC) and consists of five full-time members. The main job of the PCAOB is to "oversee and investigate the audits and auditors of public companies". Two of the five members must be or must have been CPAs, while the other three members must not be or cannot have been CPAs. Accounting firms who audit public companies are required to register with the PCAOB and pay registration and annual fees (facultyfiles, 2002).
In addition to the creation of the PCAOB to oversee the auditors, SOX mandated a set of internal procedures designed to ensure accuracy in disclosure of the finances of public companies. SOX placed more responsibility for the accuracy of financial reports on the top executives. According to Section 302 of the Sarbanes Oxley Act, CEOs and CFOs were required to personally certify quarterly and annual financial statements (FindLaw, 2002). Officers were required to accept responsibility for reported figures in addition to having timely deadlines met.
The Sarbanes Oxley Act also stressed stiff penalties for both noncompliances as well as for retaliation against whistleblowers. Section 802 specified fines up to as much as five million dollars and up to twenty years imprisonment, or both. Section 1107 mentions fines and up to ten years imprisonment for any harmful actions retaliated toward whistleblowers (FindLaw, 2002).
External auditors (only those registered with the Public Company Accounting Oversight Board) were required to review these financial statements and issue opinions on the accuracy
of the financial reports and whether effective internal control was maintained in regards to financial reporting. The requirement of the external auditors reporting professional opinion regarding the internal control and the accuracy of the financial reports added considerable cost to all companies, as this verification is time consuming and requires a huge amount of effort.
Many arguments have come up regarding whether the cost is justified in the results. "SEC appropriations for 2003 were increased to $77.6 billion. $98 million of the funds were to be used to hire an additional 200 employees to provide enhanced oversight of auditors and audit services required by the Federal securities laws". During the financial crisis in November of 2008, Newt Gingrich asked Congress to repeal Sarbanes Oxley. Congressman Ron Paul was one to argue that SOX was an unnecessary and costly government intrusion, placing American corporations at a competitive disadvantage with foreign firms.
Even though SOX found opposition by some, more were eager to see the positive results prevail. "Smart companies recognize that Sarbanes-Oxley presents an opportunity to improve management and increase efficiency", according to the Trivoli Group (2004). The goal in enacting SOX was to place accountability for the reported figures and reduce the inaccuracy of financial reports to stockholders, thereby minimizing the unnecessary risks associated with public companies.
The multi-thousand crore Satyam scandal that was uncovered early this morning led to a heavy sell-off on the benchmark as well as sectoral indices. The Nifty has broken 2900 mark during the day while the Sensex closed below 10,000 level. B Ramalinga Raju, the outgoing chairman of Satyam, admitted to cooking up figures in the Satyam balance sheet. The abortive Matyas deal last month that brought the company much bad press was also aimed to cover his tracks.
The Satyam scam is the biggest one after Harshad Mehta and Ketan Parekh. This news has hammered the stock a lot, which touched a new 52-week low of 30.80. It has seen a drop of 77.51% to Rs 40.25, at close. There were pending buy orders of 288,984 shares, with no sellers available in the stock. It has traded with volumes of 330,058,513 shares, an increase of 966.06% compared to its 5-day average of 30,960,602 shares.
In the days following the Enron and WorldCom scandals, private companies are starting to feel the pressure of complying with the Sarbanes-Oxley Act of 2002. Currently requirements of the act that apply to private companies include the following:
1) Criminal Liability for Document Destruction, 2) Increased Penalties for Securities Fraud, 3) Increased Liability for White Collar Crimes, 4) Liability for Retaliation against Whistle-Blowers and 5) Notice of Defined Benefit Plan Blackout Periods (Titus, 2003).
According to Koehn and Del Vecchio (2004), private companies are being pressured by potential acquirers to show compliance with internal control documentation and processes because of the financial liability they could assume for the private companies they acquire (p. 36). The banking industry is applying pressure on private companies as well. Katz (2003) cites an example of a Chicago bank that is requiring CFOs and CEOs to certify financial statements in their loan agreements with private companies (p.105). Other banks are considering similar measures such as requiring internal-control sign offs. Pressures for private companies to comply are reaching the state and federal level also. Katz (2003) mentions the proposal of the state attorney general of New York to require the CFOs and CEOs of nonprofit organizations to verify annual reports (p. 105). A federal judge has also suggested that board members and executives of private firms be held at higher standards than public companies. In a decision against five former directors and officers of Trace International for concealing reckless spending by the company's CEO, Judge Robert Sweet stated that "given the lack of public accountability present in a closely held private corporation, it is arguable that such officers and directors owe a greater duty to corporations and [their] shareholders" (Katz, 2005, p.105). Hill and Gambaccini (2004) makes reference to the U.S. General Accounting Office mandate that all companies planning to compete for federal government contracts must be compliant to the degree applicable, regardless of the company's status, i.e. public or private (p.56). Because of the aftermath of corporate scandals, diverse factions are examining the way private companies conduct themselves.
Outsiders are not the only sources of pressure. Koehn and Del Vecchio (2004) suggest that customers, lenders, investors and accountants are turning up the heat on managers (p. 36). As a result of Sarbanes-Oxley, organizational and investor confidence are on the rise once again, and many internal sources are of aware of the benefits. By reconstructing the way they do business, private industries will be in the position to reap the benefits of Sarbanes-Oxley.
Potential Benefits of Sarbanes-Oxley for Private Businesses
There is a school of thought that exists about the benefits of compliance with the Sarbanes-Oxley Act and private business. Molin and Adams (2004) believe that "private companies who adopt the Act's corporate compliance procedures can better position themselves to seek and maintain key business relationships, such as relationships with lenders and insurance companies" (p.1). They continue their view by acknowledging the value future stakeholders will recognize in private companies that are willing to go the extra mile with SOX. Titus (2003) argues that private companies planning for an IPO should consider becoming Act-compliant:
Many provisions of the Act apply as soon as a company files a registration statement under the Securities Act of 1933, even if the
registration statement is subsequently withdrawn. Advance planning for companies contemplating such a filing is critical. Underwriters expect that well run private companies have anticipated Sarbanes-Oxley and implemented steps to ensure compliance prior to the time the registration statement is filed with the SEC (Titus, 2003, p.1).
Further arguments for the benefits of compliance include limiting exposure to lawsuits, gaining qualified board members, future acquisition by public companies and potential state legislation calling for compliance (Molin & Adams, 2004, p1.).
The benefits of compliance far outweigh the risks. As stated previously, the cost of compliance is expensive. Private companies must look introspectively when making the decision to line up with Sarbanes-Oxley. The biggest question should not be can we afford to comply, but rather, can we afford not to?
Where do we go from here?
Once private companies decide to move forward with Sarbanes-Oxley they may not know what path to take. Several authors have established guidelines for these weary companies. Molin and Adams (2004) provide the following suggestions:
(1) Create an independent board of directors, including placing independent directors on the audit committee and compensation committee.
(2) Review and periodically re-evaluate the internal accounting controls procedures of the company.
(3) Create a code of corporate ethics.
(4) Separate professional services. (p.2)
Hill and Gambaccini (2004) and Titus (2003) provide similar suggestions for a private company who is progressing toward the height and depth of the Sarbanes-Oxley Act.
As private companies look toward the future, implementation of the Sarbanes-Oxley will be imperative to their success. Enron and WorldCom taught the world a lesson. As a result of their actions, Congress developed one of the toughest pieces of legislation targeted to U.S. Securities Law since 1934. Public companies have come under scrutiny since the development of the act; however, private companies have managed to just "get by". Now as the benefits of SOX began to surface, private companies are feeling the pressure from without and within. The message is clear that reform is here to stay. Now it is time for private companies to assess the potential of compliance for their so that they may reap the rewards of this valuable piece of legislation.