Sarbanes Oxley Act 2002 was enacted by the U.S. Government jointly sponsored by Democratic and Republican parties named after their senators Sarbanes and Oxley respectively echoing the sentiments of all stakeholders in the aftermath of big corporate frauds of Enron, Global Crossing and World com to name a few. As the corporate frauds were perpetrated with the connivance of auditors of the public limited companies, the act called SOX for short, has come down heavily up on the Auditors and Directors. This paper is aimed at briefly outlining of how SOX has changed corporate governance affecting auditors by changing the working of their firms, their audit practice and impacting their audit clients of publicly listed companies in the U.S. both U.S and non-U.S having their debt or equity securities registered with SEC under Securities Exchange Act of 1934. SOX establishes new provisions and changes existing law considerably. The enactment provides for an enhanced audit committee responsibility and auditor oversight, prior approval for non-audit services by the auditor, and disclosure of non-audit services of the auditor.
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CEOs and CFOs have to certify the accuracy of their companies’ annual and quarterly reports without any misleading statements besides assuming responsibility for properly evaluated internal controls. A ban has been imposed on directors and executives to avail new personal loans from their companies except certain regular consumer loans.
Section 301 of SOX prohibits listing of security of any company with SEC that does not have an audit committee complying with the provisions therein. The audit committee members should be independent. The director who is the audit committee member is considered independent only if he has not received any direct or indirect compensation from the company or its subsidiaries other than as a director. He ca not also act as an affiliated person which means acting directly or indirectly through intermediaries. A safe harbor not being an executive officer of the company or a shareholder owning 10% or more shares with voting rights is not considered as controlling the company.
This audit committee is responsible for hiring company’s independent auditor and fixing their remuneration. This committee should oversee the auditor’s work involving preparation or issue of audit reports and related works and also sorting out differences between the management and the auditor in respect of financial reporting. If the audit committee has any financial expert who is independent as stipulated above, his/her name must be disclosed by the company. If there is no financial expert in the audit committee, reason must be furnished by the committee. The financial expert must have the following attributes.
“An understanding of GAAP and financial statements. The ability to assess the general application of such principles in the accounting for estimates, accruals, and reserves. Experience preparing, auditing, analyzing, or evaluating financial statements that present a complexity of accounting issues that is generally comparable in breadth and level to the complexity of issues that the company’s financial statements can reasonably be expected to raise or experience actively supervising one or more persons engaged in such activities An understanding of internal control for financial reporting. An understanding of audit committee functions.
The audit committee financial expert must also have acquired the required attributes through any of the following: Education and experience as a principal financial officer, principal accounting officer, controller, public accountant, or auditor or experience in one or more positions that involve the performance of similar functions Experience actively supervising a principal financial officer, principal accounting officer, controller, public accountant, or auditor or person performing similar functions Experience overseeing or assessing the performance of companies or public accountants for the preparation, auditing, or evaluation of financial statements Other relevant experience.” (Guy 2003)
Section 302 of the Act dealing with corporate responsibility requires that periodic statutory financial reports should certify that signatories have reviewed the reports, that it does not include any material untrue statements, omissions or misleading statements, that financial statements fairly present prevailing financial condition and results in all material aspects and tat the signatories are in charge of internal controls evaluated in the previous 90 days. Deficiencies if any, in the internal control and information on fraud involving employees and changes in the internal controls having negative impact. ( soxclaw.com)
The auditor who conducts audit of the company as approved by the Audit committee shall not perform specified non-audit services concurrently. The auditors should be changed once in five years. There must be one year cooling-off time for an employee or employees of the audit firm to join the company they audited as CEO, CFO or Chief Accounting Officer. The corporate personnel are also prohibited from influencing, coercing, manipulating an accountant of the audit firm engaged in the audit of their company. All auditing firms engaged in auditing of listed companies should enlist with the newly formed Public Accounting Oversight Board wihin 180 days of the Board coming into being. Section 409 stipulates real time disclosure on ‘a rapid and current basis.
The disclosure relates to the following 11 items in Form 8K.. “execution or termination of a material agreement not in the ordinary course of business; termination or reduction of a business relationship with a customer which constitutes a specified portion of revenues; creation of a direct or contingent material financial obligation; events triggering a direct or contingent material financial obligation (i.e., default or acceleration of an obligation); exit activities such as material write-offs and restructuring charges; any material impairment; any change in a rating agency decision, issuance of a credit watch or change in company outlook; movement of securities from one exchange or quotation system to another, delisting of securities, failure to comply with a listing standard; conclusion or notice that security holders should no longer rely on previously issued financial statements or audit report; and any material limitation regarding employee benefit, retirement or stock ownership plans. ”(Orrick 2002)
Material off-balance sheet items and dealings with unconsolidated entities or other persons must be also reported in all annual and quarterly reports having a bearing on “current or future financial position of the company, changes in financial condition, results of operation, liquidity, capital expenditures , capital resources or significant components of revenues or expenses.” (Orrick 2002)
Section 802 stipulates a maximum 20 years imprisonment for knowledge of alteration, destruction, mutilation, concealment, cover up or falsification of a record or document with an intention to defeat a federal investigation or influence a bankruptcy case with or without fines.. Section 904 of the Act increases the penalties for criminal violations of ERISA from up to $5,000 and/or one year in prison to up to $100,000 and/or ten years in prison. For other than natural persons, it increases the penalty from up to $100,000 to up to $500,000. Attempts and Conspiracies. Section 902 of the Act makes attempts and conspiracies to commit offences under the white collar criminal laws contained in the U.S. Code
Under the same section there is a punishment of maximum 10 years with fines for knowing and wilful violation of a new audit working paper retention requirements. Section 1102 stipulates a maximum punishment of 20 years with fines for corrupt alteration, destruction, mutilation or concealment of a record or document in order to impair it’s integrity or availability for a proceeding. “Section 807 of the Act creates an additional federal felony, subject to fines and/or up to 25 years imprisonment, for knowingly executing or attempting to execute a scheme or artifice to defraud a person in connection with any security of a public company; or to obtain by means of fraud any money or property in connection with the purchase or sale of any security of a public company.
The Act also increase criminal penalties for several existing white collar crimes Increased Criminal Penalties Under the Exchange Act. Section 1106 of the Act increases the penalty for wilful violations of the Exchange Act from up to $1 million and/or ten years in prison to up to $5 million and/or 20 years in prison. For other than natural persons, it increases the penalty from up to $2.5 million to up to $25 million Mail and Wire Fraud. Section 903 of the Act increases the maximum prison terms of mail and wire fraud from five to 20 years” (Orrick.2002)
As seen above, the stipulations are of high standard and are punishments are exemplary that Sarbanes-Oxley Act has been a trend setter in the accounting world. In Australia similar enactment called CLERP 9 has also followed suit. Though critics say that advantages of the new provisions are lesser than the damages it is causing to the auditing and accounting profession, it is hoped that in due course of time, these damages will disappear and auditing profession will rise like a phoenix.
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