Sarbanes-Oxley Act a.k.a.

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Sarbanes-Oxley Act a.k.a. SOX
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Enduring Understanding

• The Sarbanes-Oxley Act was enacted to establish
  new or enhanced standards for U.S. public company
  boards, management, and public accounting firms.

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Essential Questions

• Why was the Sarbanes-Oxley Act needed?
• How does the Sarbanes-Oxley Act protect
  stockholders and institutions?

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Objectives

• Describe the events that caused the passing of
  the Sarbanes-Oxley Act.
• Relate the Sarbanes-Oxley Act to accounting.
• Explain the goals of the Sarbanes-Oxley Act.
• Describe each of the 11 titles of the
  Sarbanes-Oxley Act.

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What is SOX?

• Also known as the Public Company Accounting
  Reform and Investor Protection Act of 2002
• Created by US Senator Paul Sarbanes (D-Maryland)
  and US Congressman Michael Oxley (R-Ohio)
• Signed into law July 30, 2002
• Most dynamic securities legislation since the
  Securities and Exchange Acts of 1933 and 1934

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Purpose of SOX

• Establish new or enhanced standards for U.S.
  public company boards, management, and public
  accounting firms

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Relation to Accounting

• Bad accounting procedures, both intentional and
  non-intentional, led to the collapse and
  subsequent investigation of several large
  companies
• Public outrage led Congress to pass SOX to
  regulate audits of public company accounting
  procedures and hopefully prevent false financial
  reports

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Relation to Accounting, continued

• Companies that do not follow standard accounting
  procedures may use methods that mislead investors
  about the financial health of the company.
• These practices range from just unethical to
  illegal.

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Why was SOX passed?

• Failure of Boards of Directors and executives to
  double-check financial records
• Intentional misrepresentation of financial status
• Loans from major banks to risky companies hurt
  bank investors and encouraged others to make
  risky investments in those companies
• Misrepresentation of company earnings caused
  stockholders to make seemingly good investments
  that cost them large sums of money

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Why was SOX passed?, continued

• Auditor conflicts of interest
• Some auditing firms provided consulting services
  to the companies they audited.
• Proper auditing procedures, such as challenging a
  companys accounting procedures, could damage the
  client relationship under the consulting
  agreement.
• This caused bad accounting practices and
  misrepresentation of financial information to go
  unchecked, leading to the collapse of several
  companies, like Enron.

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Goals of SOX

• Regain public confidence in markets
• Improve corporate governance
• Increase executive accountability
• Increase efforts to prevent, detect, investigate
  and remediate fraud and misconduct

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Title I Public Company Accounting Oversight
Board

• Created as a non-profit organization to oversee
  audits of public companies
• Under the authority of the Securities Exchange
  Commission (SEC)
• Comprised of 5 appointed members w/ a max of 2
  CPAs
• Duties
• Register existing public accounting firms which
  prepare audits for publicly traded companies
• Audit the auditors
• Establish and amend rules and standards (in
  cooperation with other standard setters)
• Try and penalize registered public accounting
  firms who fail to comply with the rules

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Title II Auditor Independence

• Prohibits registered public accounting firms from
  performing non-audit services for companies they
  audit
• Prevents conflicts of interest

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Title III Corporate Responsibility

• CEOs and CFOs must certify accuracy
• Forfeit bonuses and profits if information is
  misrepresented

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Title IV Enhanced Financial Disclosures

• Forbids most personal loans to chief executives
• Disclosure of code of ethics for senior financial
  officers
• Disclosure of members of company audit committee
• Should include at least one financial expert

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Title V Analyst Conflicts of Interest

• Requires registered securities associations to
  adopt rules that prevent conflicts of interest
• Ex Recommendations of analysts in research
  reports

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Title VI Commission Resources and Authority

• Increased SEC budget to 780 million
• 98 million used to hire 200 employees to oversee
  auditors
• SEC has the authority to investigate and punish
  violators of security law

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Title VII Studies and Reports

• US Comptroller General to conduct a study about
  the consolidation of public accounting firms
• Also conduct investigation of security law
  violations in the cases of Enron, WorldCom, etc.

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Title VIII Corporate and Criminal Fraud
Accountability

• To knowingly create, destroy, or manipulate
  documents or impede federal investigations is
  considered a felony
• Punishment Fines, maximum 20 years in prison,
  or both
• Audit reports should be kept for 5 years
• Whistleblower protection

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Title IX White-collar Crime Penalty Enhancements

• CEOs and CFOs must certify that financial
  statements are accurate representations of the
  companys condition
• Punishment Max 5 million fine and/or max 20
  year sentence
• SEC may ban anyone convicted of a security crime
  from holding an executive position at a public
  company

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Title X Corporate Tax Returns

• Federal income tax returns must be signed by the
  Chief Executive Officer (CEO) of the company

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Title XI Corporate Fraud Accountability

• Destroying/altering evidence or otherwise
  obstructing securities fraud proceedings may be
  punished with a fine and/or up to 20 years in
  prison
• SEC may freeze payments to accused individuals
• Any retaliation to whistleblowers is subject to
  fines and/or 10 years imprisonment

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Summary

• The Sarbanes-Oxley Act of 2002 was passed to
  regain public confidence in the stock market
  following a string of major accounting fraud
  cases involving public companies.
• A plan to accomplish this objective is outlined
  in 11 titles, which
• Prohibit conflicts of interest
• Increase corporate accountability
• Increase accounting transparency
• Form an oversight board to enforce the new rules

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Review Questions

• 1. The Sarbanes-Oxley Act was passed in
• a. 1935
• b. 1974
• c. 1999
• d. 2002
• 2. What events led to the passing of SOX?
• a. Collapse of the auto industry
• b. A string of accounting scandals at public
  companies
• c. Great Depression
• d. Discrimination in the accounting profession

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CORRECT!
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Review Questions, continued

• What government institution was established by
  SOX to oversee auditors?
• Answer
• 4. The Public Company Accounting and Oversight
  Board is under the authority of
• a. North Atlantic Treaty Organization (NATO)
• b. Food and Drug Administration (FDA)
• c. Securities Exchange Commission (SEC)
• d. US Treasury
• Name 4 titles of the Sarbanes-Oxley Act.
• Answer

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• Public Company Accounting Oversight Board (PCAOB)

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• Titles
• Public Company Accounting Oversight Board
• Auditor Independence
• Corporate Responsibility
• Enhanced Financial Disclosures
• Analyst Conflicts of Interest
• Commission Resources and Authority
• Studies and Reports
• Corporate and Criminal Fraud Accountability
• White-collar Crime Penalty Enhancements
• Corporate Tax Returns
• Corporate Fraud Accountability

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Review Questions, continued

• 6. According to Title X, who should sign the
  company tax return?
• a. Chief Executive Officer (CEO)
• b. President of External Accounting Firm
• c. Chief Financial Officer (CFO)
• d. Companys Head of Accounting
• What events involving major public companies led
  to the passing of SOX?
• a. Intentional misrepresentation of company
  financial records
• b. Auditor conflicts of interest
• c. Risky loans from banks based on false
  earnings
• d. all of the above

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Review Questions, continued

• 8. What is the criminal penalty for violation of
  SOX?
• a. life in prison
• b. fines and/or maximum 20 years in prison
• c. maximum 5 years in prison
• d. tax increase
• 9. True/False Under SOX, auditors are not
  allowed to provide non-audit services
  (consulting) to the companies they audit.
• 10. True/False SOX does not apply to privately
  held companies.

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