Running head: SARBANES-OXLEY ACT OF 2002 AND DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT
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SARBANES-OXLEY ACT OF 2002 AND DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT
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Sarbanes-Oxley Act of 2002 and Dodd-Frank Wall Street Reform and Consumer Protection Act
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Following the collapse of Enron, WorldCom, Arthur Andersen, and Tyco, corporate names became synonymous with greed and scandal and the public lost confidence in the market. On July 30, 2002, the Sarbanes-Oxley Act of 2002, SOX was signed into law in response to these corporate scandals (Simon, 2009). Later on, in the fall of the 2008 financial crisis of severity and scale not seen in generations, President Obama, in 2010, signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Lee, 2010). These two Acts were intended to protect the consumer, bring the confidence back into the public, and prevent another financial crisis from ever happening again. However, both the SOX and Dodd-Frank have been received differently by different stakeholders. There are those who believe that the two Acts are landmark legislations as they protect the investors and the consumers while there are those who believe that the two Acts are over-burdensome and anti-competitive.
The Sarbanes-Oxley was enacted in 2002 following the collapse of high-profile corporations following widespread omissions and misstatements in the financial statements of public companies. The Act has six main provisions. The first provision is the oversight board. This provision created the Public Company Accounting Oversight Board whose main function was to audit the public companies (Simon, 2009). The board is tasked with setting the rules and standards for the audit reports. The board also carries outs investigations, inspections, and enforce compliances to the registered audit firms.
The second provision of the Act refers to auditor independence. The auditors have a list of non-audit services that they cannot perform when conducting an audit. The Act impose a waiting period of one year to those audit employees who leave an audit firm to become executives of a former client. Furthermore, the audit firm will have to wait for an additional one-year period before they can be able to perform any audit services for such a client (Hanna, 2014). This to make sure that an executive does not have an influence on the audit work.
The third main provision of SOX is greater financial disclosures. The Act requires that those transactions that are off the balance sheet but have a potential to affect the firm’s financial status must be disclosed(Hanna, 2014).For instance, a court case that would have a material impact on the financial statements of the firm if the case is ruled against the firm should be revealed. Loans to the executives are prohibited(Simon, 2009).In addition, the annual reports should include a statement indicating the management is responsible for the internal procedures and structures for the financial reporting.
The Act also calls for the disclosure of conflict of interest. Any accounting professional carrying out an assurance work on the company must disclose any conflict of interest that might exist(Hanna, 2014). The accounting professionals should disclose whether they hold any securities in the company before any assurance work is done. The dealers and brokers are required to disclose if the company in question is a client(Simon, 2009).Failure to make this disclosureleadsto penalties to the professional.
The Act also provides for criminal fraud and corporate responsibility. SOX states that destroying, concealing, altering or falsifying of the documents or records with an intent of influencing a bankruptcy case or a federal investigation is subject to up 20 years imprisonment and fines(Hanna, 2014). In addition, the audit working papers need to be retained for a period of at least five years. This is to make sure that if theneed arises, the audit papers can be referred to as evidence. In addition, any individuals who willfully defrauds any shareholder of a public company is subject to imprisonment and fines.
The other provision of the SOX is the attorneys’ responsibility. The Act provides minimum standards for the professional conduct of the attorneys who represent the public companies before the Securities and Exchange Commission. The attorneys are required to report to the SEC on the violations of the executives(Simon, 2009).Failure to do so attracts penalties.
The SOX also requires that the financial reports should contain acertification that the financial statements have been audited. In addition, the management should declare that the financial statements do not contain material misstatements or omissions. The management should also certify that they are responsible for the internal control and should do an evaluation on them and report on them within 90 days. In addition, any significant alterations in the internal control or any other change that might affect adversely the internal controls (Hanna, 2014).This is intended to make sure that the internal controls in the company are adequate and constantly reviewed to represent the changes in the market(Simon, 2009). It is important for internal controls of the corporation to be sound with a weak internal control system, there will be increased thechance of fraud and error in the financial reports which may result in the collapse of the corporation leading to losses to the investors.
On the other hand, the Dodd-Frank Act was signed into law by President Obama in 2010 (Lee, 2010). The Act was written following the 2008 financial crisis. The Dodd-Frank Act was a pioneer for the major overhaul of the regulations that were governing the US financial system. Dodd-Frank was intended to prevent the likelihood of another financial crisis occurring. The Act put very strict rules on the activities undertaken by the financial institutions so as to better protect the consumers. Dodd-Frank has six main provisions.
The first provision of Dodd-Frank is the Volker Rule. The Volker rules prevent the commercial banks from taking part in speculative activities as well as proprietary trading so as to make aprofit. In other words, the Volker Rule limits the commercial banks from investing in private equity funds and hedge funds (Miller, 2012). This is because such investments played a major role in the 2008 financial crisis. These investments made the banks experience very large losses placing the depositor’s money at a very big risk
The second major provision of Dodd-Frank is the creation of the Consumer Financial Protection Bureau, CFPB. CFPB was established to be an independent financial bodyso as to oversee the consumer finance markets which includes the student’s loans, mortgages, and credit cards (Miller, 2012). The CFPB has the authority to make rules, enforce consumer protection laws, supervise certain financial companies, as well as other measures. The CFPB also educates the consumers on the on the matters involving taking control of their finances so as to they can better understand their finances (Lee, 2010).
The other provision of Dodd-Frank is the capital and liquidity requirements. The Fed set new standards to guide the amount, as well as the time of capital commercial banks, needs to have so as to maintain the depositor’s funds (Gramm, 2015).The largest financial institutions which included the Citibank and Goldman Sachs were required to hold 9.5% of their assets in the liquid capital to make sure that they have enough cash to meet the depositors’ demands (Miller, 2012).
The other provision of the Dodd-Frank is the creation of the Financial Stability Oversight Council and designations, FSOC. The FSOC is composed of the heads as well as the deputies in the Treasury Department. The council is tasked with identifying and the monitoring of the risks facing the financial institutions. Its initial and most important responsibility is the designating of the systematically important financial institution (Miller, 2012).
Dobb-Frank Act also gave the SEC authority to regulate the over-the-counter trading derivatives (Gramm, 2015). In addition, the clearing houses were to reduce the overall risk in the market by making sure that the traders deposit collaterals and also monitoring the creditworthiness of the firms that were engaged in the derivative trade. In addition, the clearing houses were to have a strong capital base so as to make sure that it can pay if a firm defaults meeting its obligations.
Finally, the Dodd-Frank Act provides for the big to fail mantra and the living wills. The Act gave Federal Deposit Insurance Corporation the ability, as an alternative to bankruptcy, to wind down any large and failing financial institution. Large financial institutions also have a requirement to create living wills. These are details plans that explain the institutions are going to manage their own failure, if it happens, without having to contaminate the entire financial system (Miller, 2012).
These two Acts have faced contrasting opinions from different stakeholders. There are those who support the Acts and there are those who does not support the Acts. The proponents of the SOX argue that the Act protects the investors from the possibility of creative accounting by the corporations. The Act makes the management be responsible for the financial reporting, as a result, the public will not have to suffer losses. The proponents believe that this Act has been instrumental in preventing high profile corporate failures as a result of management fraud. In addition, the Act has been instrumental in bringing back the public confidence into the corporations and the investors can make their investment without having to worry that the corporation might collapse (Hanna, 2014).
Furthermore, the proponents of SOX believe that the Act has been very instrumental improving the market liquidity (Simon, 2009). The implementation of the SOX requirements has been closely related to the significant improvement in the market liquidity. The mandatory SOX requirement improvement market liquidity by pushing down information asymmetry that had been observed before. All the market players have equal access to the information and as a result are willing to participate in the market. In addition, market liquidity has also improved due to the reduction in the in the adverse selection part of the trading costs. The proponents also argue that the closer the corporations are to compliance of SOX the more liquid the corporation is this.
The proponents of Dodd-Frank Act argues that the Act will prevent the economy from having to experience another financial crisis like the one experienced in 2008 (Lee, 2010). They argue that the Act protects the consumers from the abuses that contributed to the 2008 financial crisis. The Act repairs the financial regulatory system that was principle to the financial crisis. The financial regulation system was fragmented and allowed a big portion of the financial sector to operate with very little if any oversight. The proponents believe that the Act has been instrumental in protecting the consumers by putting strict regulations on the financial institutions. They believe that the Act has been very instrumental in preventing another financial crisis. These new rules will be able to build a safer and more stable financial system. This is a big foundation for a lasting job creation and economic growth.
Those against SOX are particularly against section 404 which requires thecreation of very extensive policies as well as controls within corporations as to secure, process, document and verify material information in dealing with the financial results of a company (Hanna, 2014). The secure requires that the corporations should file SEC an internal control report which is intended to state the management’s responsibilities for implementing adequate procedures needed for financial reporting. The critics of the Act argue that the cost of implementation is so high which greatly affects the company’s bottom line. There are those who argue that the cost of implementation for smaller businesses is even higher than the large businesses. Therefore, those against the SOX believes that the cost of implementation outweighs its benefits.
Even though SOX does not specifically require firms to install information technology, in practice, to comply with the requirements of SOX it requires intensive implementation of IT services. This is necessary so as to comply with the reporting requirements (Raphael, 2006). In addition, the cost of doing business for the non-US firms that are listed on the US stock exchange has been very high. As a result, many foreign corporations have been considering not being listed on the U.S. stock market. Some firms have even specifically cited that the compliance costs brought about SOX is the main reason for why they are opting not to list their share in the United States. Many of these corporations are opting to list on the London Stock Exchange which has far fewer regulations and therefore lesser compliance cost as compared to the United States. In addition, many U.S. investors are willing to invest in foreign firms outside the U.S. This is contributing to the killing of the United States corporations in addition to reducing the amount of foreign firms willing to invest in the United States.
On the other hand, the critics of Dodd-Frank believes that the Act harms the competitiveness of the United States banks as compared to the other foreign banks. In addition, in order for the firm to comply with the provisions of the Act, they feel extremely burdened by the regulatory requirements. The Act burdens the community banks and other smaller financial institutions even though this smaller institution did not play any part in the financial crisis. In addition, the high capital reserve requirements mean that banks need to hold a big percentage of their assets in cash. This decreases the amount that the banks can hold as marketable security. Thisaffects the role that banks plays as bond market markers. As a result, the prospective buyers have a hard time in finding of the counter-sellers. Since the prospective sellers find it difficult to find buyers, it has a potential of hurting economic growth (Gramm, 2015).
Other critics of Dodd-Frank points out that it is not its massive regulatory burden that is most dangerous. They believe that its most costly and dangerous effects are its arbitrary power and the uncertainty that theAct has created through the obliteration of the rule of law. This has had an effect of adversely affecting the economic growth in addition to imperiling the freedom of corporations. The other critics are concerned with the fact that the risky behavior from the corporations will be transferred to the other institutions that are less regulated. Furthermore, other critics believe that there is a heightened and growing anxiety in the industry that the increased regulation is leading to illiquidity in the financial markets.
Due to the criticismof Dodd-Frank, in January 2015, the Congress, led by the Republicans, passed a legislation to ease off some of the banking regulations adopted by the Dodd-Frank. The legislation would delay by two years the requirement for banks to sell off the collateralized loan obligations, relax regulations on derivatives, excused some of theprivate equity firms from registering with SEC, and allow some of the small corporations to omit their historical financial information from their filings (Weisman, 2015). As a result, financial institutions have more time to ensure compliance of the Dodd-Frank.
How the Democrats did not take the changes to Dodd-Frank well. The Democrats let by Senator Elizabeth Warren and President Obama feels that a line need to be drawn against the legislations that would erode Dodd-Frank (Weisman, 2015). The Democrats feel that Dodd-Frank is necessary as it helps to prevent the kinds of excessive taking of financial risks that had led to the worst recession ever experienced in more than 70 years. Such recession left many Americans without jobs and billions of dollars were lost as well. They believe that such changes have only served to benefit Wall Street as well as other narrow special interest groups at the expense of the US public.
As a CPA, I believe that the two Acts, SOX, and Dodd-Frank, were necessary. Even though they place some burdens on the corporations that affect their competitiveness, I believe that they are necessary to prevent the management from defrauding the investors. Dodd-Frank, in particular, is very instrumental in avoiding another financial crisis. The public is supposed to be protected because they normally don’t have access to privileged information that the executives have. The Acts also prevents the management from using such information to benefit themselves at the expense of the public. The Dobb-Frank prevents the financial institutions from taking excessive risks that end up in big losses for the public and leading to the loss of confidence in the financial system. It is only fair that the executives be compelled to provide more relevant information to the public to help them make informed decisions. As a CPA, I fully support the SOX Act and the Dodd-Frank Act.
As a person, just any other member of the public, feel that both Dodd-Frank and SOX are necessary as they protect my interests as an investor. I can be able to invest without having to worry that my money may get lost. Every member of the public needs to be protected by the greed of the executives in the corporations. Personally, I can choose to invest in corporations because I know that I am protected by SOX and Dodd-Frank. Therefore, despite the criticism that the two Acts have faced, I believe that no further changes should be made because they will lose their ability to protect the members of the public. The financial crisis that was observed in 2008 may recur causing more losses to the public.
The Sarbanes-Oxley Act of 2002 was enacted in 2002 following the collapse of high-profile corporations including Enron and WorldCom. The Act was intended to prevent the management from defrauding the investors and bring back public confidence in the corporations. Later in 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. This was in the aftermath of the 2008 financial crisis. Dodd-Frank was intended to prevent such a crisis from happening ever again. The two Acts have been a success so far but not without any opposition. Of course, there are those who support the Acts as they protect the public. On the hand, there are those who believe that the Act is laying so much burden on the corporations and therefore limiting their competitiveness. As a CPA, these Acts are necessary as they serve to protect the interests of the public who are normally innocent and stand to lose a lot due to the fraud or negligence of the management.
References
Gramm, P. (2015). Dodd-Frank’s Nasty Double Whammy. WSJ. Retrieved 26 September 2016,
from http://www.wsj.com/articles/dodd-franks-nasty-double-whammy-1437692851
Hanna, J. (2014). The Costs And Benefits Of Sarbanes-Oxley. Forbes.com. Retrieved 26
September 2016, from
http://www.forbes.com/sites/hbsworkingknowledge/2014/03/10/the-costs-and-benefits-
of-sarbanes-oxley/#32c217c2776d
Lee, J. (2010). President Obama Signs Wall Street Reform: “No Easy Task”. whitehouse.gov.
Retrieved 26 September 2016, from
https://www.whitehouse.gov/blog/2010/07/21/president-obama-signs-wall-street-reform-
no-easy-task
Miller, S. (2012). 6 major provisions of Dodd-Frank. Fin. Retrieved 26 September 2016, from
https://fin.plaid.com/articles/major-provisions-of-the-wall-street-reform-and-consumer
Raphael, K. (2006). Feature Articles – Increased Criticism for Sarbanes-Oxley. TransLegal.
Retrieved 28 September 2016, from https://www.translegal.com/feature-
articles/increased-criticism-for-sarbanes-oxley
Simon, D. (2009). Corporate Accountability: A Summary of the Sarbanes-Oxley Act.
legalzoom.com. Retrieved 26 September 2016, from
https://www.legalzoom.com/articles/corporate-accountability-a-summary-of-the-
sarbanes-oxley-act
Weisman, J. (2015). House Passes Legislation to Ease Some Dodd-Frank Financial Rules.
Nytimes.com. Retrieved 26 September 2016, from
http://www.nytimes.com/2015/01/15/business/house-passes-measure-to-ease-some-dodd-
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