Title: Regulatory Bodies, Standard Setters, and Best Practices
1Regulatory Bodies, StandardSetters, and Best
Practices
2Chapter Objectives
- Understand the roles and responsibilities of
regulators and standard setters. - Provide an overview of fundamental provisions
of SOX and their impacts. - Provide an overview of the evaluation of SOX
(cost and benefits). - Understand why the SEC was established.
- Provide an overview of the primary functions of
the PCAOB. - Become familiar with the role of the FASB and
its activities. - Provide an overview of the GASB.
- Understand the challenges facing the IFAC.
- Identify the primary responsibilities of the
Committee of European Securities Regulators. - Understand the role and authority of the state
attorney general. - Be aware of how state laws affect corporate
governance. - Be aware of the role of courts in corporate
governance. - Become familiar with corporate governance
listing standards and best practices.
3Key Terms
- Accounting and Auditing Enforcement Releases
(AAERS) - Accounting Regulatory Committee (ARC)
- Administrative law judges
- American Bar Association (ABA)
- American Institute of Certified Public
Accountants (AICPA) - Anticontractarianists
- Blackout period
- California Public Employees Retirement System
(CalPERS) - Committee of European Securities Regulators
(CESR) - Contractarianists
- Council of Institutional Investors (CII)
- European Financial Reporting Advisory Group
(EFRAG) - Generally accepted accounting principles (GAAP)
- generally accepted accounting standards (GAAS)
- Government Accounting Standards Board (GASB)
- International Accounting Standards Board (IASB)
- investment protection principles (IPPs)
- Investor Task Force
- Office of Risk Assessment
4Regulations
- Regulations are aimed at protecting the investors
and creating an environment for organizations to
conduct their affairs in the utmost ethical,
legal, and competent manner. - Regulations are typically enacted in response to
specific crises and concerns or protection needed
due to the failure of market based correction
mechanisms. Adequate regulation creates a balance
between reducing the likelihood of recurrence of
the crisis and the imposed enforcement and
compliance costs. Underregulation is when
adequate rules are not in place to ensure
long-term improvements and stability.
5Sarbanes Oxley Act of 2002
- Was enacted in July 2002 in response to the
economic downturn of the early 2000s, several
years of steady decline in the capital markets
and numerous high-profile financial scandals. - The fundamental provisions of SOX can be
categorized into the following five categories
(1) corporate governance (2) financial
reporting (3) audit functions (4) federal
securities law enforcement and (5) others (e.g.,
legal counsel, financial analysts).
6SOX provisions
- Influence on corporate governance (1) auditors,
analysts, and legal counsel who were not
traditionally considered as components of
corporate governance are now brought into the
realm of internal governance as the gatekeepers,
(2) the legal status and fiduciary duties of
directors and officers, particularly the audit
committee and CEO, have been enhanced
significantly, (3) certain aspects of state
corporate law were preempted and federalized.
(e.g. Section 404 of SOX prohibits loans to
directors and officers, whereas state law permits
such loan), (4) SOX is considered a process whose
impact on improving the effectiveness of
corporate governance will continue for years to
come.
7SOX provisions
- Financial reporting provisions of SOX and
SEC-related rules are - 1. Certification of financial statements and
internal controls by CEOs and CFOs - 2. Disclosure of off balance sheet transactions
- 3. Disclosure pertaining to the use of non-GAAP
financial measures - 4. Disclosure of material current events
affecting companies - 5. Mandatory internal control reporting by
management - 6. A study of principles-based accounting
standards - 7. Convergence of accounting standards
- 8. Recognition of an adequate funding for the
FASB as an accounting standard-setting body - 9. Oversight function of the FASB by the SEC.
8SOX provisions
- Provisions of SOX and SEC-related rules
addressing audit functions are - 1. Creation of the PCAOB to regulate public
accounting firms practice before the SEC - 2. Adoption of new rules related to auditor
independence - 3. Establishment of auditing standards in guiding
auditors to improve audit quality - 4. Issuance of new rules related to improper
influence on auditors - 5. Issuance of new rules pertaining to retention
of records and audit evidence relevant to reviews
and audits of financial statements - 6. Establishment of quality control standards to
protect investors from receiving misleading
financial information - 7. Oversight function of the PCAOB by the SEC
- 8. Attestation of and report on ICFR
9SOX provisions
- SOX empowered the SEC to better enforce federal
securities laws to improve public trust and
investor confidence in the capital markets. SOX
enabled the SEC to use various means to bring
enforcement actions against corporate wrongdoers,
sanction them, obtain penalties and disgorgement,
and compensate injured investors. - The following SEC-related rules address the
conduct of gatekeepers other than directors,
management, and auditors - 1. Rules governing research analysts potential
conflicts of interest - 2. Rules regarding standards of conduct for
attorneys practicing before the SEC - 3. Rules pertaining to rating agencies
- 4. Rules concerning mutual and hedge funds
- 5. Rules pertaining to investment banks
10SOX Global Reach
- Several provisions of SOX have been adopted in
countries worldwide, which lends credibility to
SOX and its intended purpose of protecting
investors. - Adopted provisions by other countries, including
Australia, Canada, China, India, and Mexico, are
executive certification of financial statements,
mandatory audit committees consisting of all
independent directors, creation of standard
setting bodies similar to the PCAOB in regulating
the auditing profession, the rotation of audit
partners and audit firms, and executive
certification of ICFR without requiring an audit
opinion.
11Securities and Exchange Commission
- The SEC has four divisions
- 1) Division of Corporate Finance, which oversees
corporate disclosure of public information by
reviewing registration statements for newly
offered securities, annually audited and
quarterly reviewed filings (Forms 10-K and 10-Q) - 2) Division of Market Regulations, which
establishes and maintains standards for fair,
orderly, and efficient capital markets by
regulating the major securities market
participants, including broker/dealer firms and
self-regulatory organizations (SROs) such as
stock exchanges and the NASD - 3) Division of Investment Management, which
oversees and regulates the investment management
industry and administers securities laws relevant
to investment companies (e.g., mutual funds) and
investment advisors - 4) Division of Enforcement, which investigates
possible violations of securities laws,
recommends actions either in a federal court or
before an administrative law judge, negotiates
settlements on behalf of the commission, and
publishes accounting and auditing enforcement
releases (AAERs).
12Securities and Exchange Commission
- The SEC is regarded as an independent agency
created by Congress to protect investor
interests. - (Securities Act of 1933 and the Securities
Exchange Act of 1934) - Sec Enforcement Actions
13Public Company Oversight Board
- Section 101 of SOX authorizes the establishment
of the PCAOB to oversee the audit of public
companies under the SEC jurisdiction. - Congress authorized the PCAOB to fund its
expenses by imposing a fee on all public
companies determined in proportion to their
market capitalizations and registration fees
received from public accounting firms. - PCAOB .
- The PCAOB has appointed a standing advisory group
(SAG) of thirty members with expertise in
accounting, auditing, corporate governance,
investments, and corporate finance to assist in
carrying out its standard-setting
responsibilities.
14Public Company Oversight Board (Cont)
- PCAOB responsibilities
- Prepare its budget and manage its operation.
- Register both U.S. and non-U.S. public accounting
firms auditing U.S. public companies. - Inspect registered public accounting firms.
- Establish auditing, quality control, and ethics
standards for registered public accounting firms. - Enforce compliance with applicable laws and
regulations. - Investigate registered public accounting firms.
- Impose sanctions for violations.
- Hold roundtables addressing emerging issues
affecting the functions and performance of
registered public accounting firms to obtain the
views of interested parties, including accounting
firms, public companies, investor groups,
standard setters, and academicians. - Take initiatives in addressing auditing in a
small business environment. - Perform other duties or functions as deemed
necessary.
15Public Company Oversight Board (Cont)
- PCAOB rule-making process looks like the
following schema
16Federal Sentencing Guidelines For Organizations
- In 1984, Congress created the U.S. Sentencing
Commission (USSC) with the authority to issue
guidelines for punishing organizations, including
companies that have committed federal crimes. - The revised guidelines are expected to have a
significant impact on the effectiveness of
corporate governance by requiring - companies to establish and maintain an effective
compliance program - boards of directors to accept accountability to
ensure compliance throughout the company - companies to assign high-level individuals (e.g.,
executives) to oversee the companys compliance
program.
17American Institute of Certified Public Accountants
- The AICPA is a national professional association
of more than 330,000 CPAs in public practice,
industry, government, and academia. - In the post-Enron and SOX era, the AICPA has
introduced 6 leadership roles - Standard-setting role of obtaining greater
involvement of users of financial statements in
setting auditing standards - Fraud prevention and detection liaison role
- Research role in promoting academic research in
such areas as fraud prevention - Educational role of developing training programs
aimed at combating fraud - Financial reporting role of working with other
standard setters to improve quality, reliability,
and transparency of business and financial
reporting - Corporate governance role to improve corporate
governance and internal control systems.
18Financial Accounting Standards Board
- The SEC has delegated its accounting
standard-setting authority to the FASB to issue
authoritative Statements of Financial Accounting
Standards (SFAS) for the measurement,
recognition, and reporting of - business transactions and economic events and the
preparation of their financial statements. - Traditional Financial Statements KPIs
-
- Sec Rules to allow foreign companies to file
their statements using IFRS without
reconciliation to U.S. GAAP.
19Government Accounting Standards Board (GASB)
- GASB, in April 2005, issued its Concept Statement
No. 3, Communication Methods in General Purpose
External Financial Reports that Contain Basic
Financial Statements. Concept Statement No. 3
provides - A conceptual framework for determining
communication methods for improving the
presentation of financial reports of governmental
entities, - criteria for each communication method,
- a hierarchy for their use.
20International Federation of Accountants
- Challenges facing IFAC are finding ways to
improve the credibility of the accounting
profession worldwide, establishing globally
accepted accounting and auditing standards, and
developing global corporate governance guiding
principles. - \
- These challenges require IFAC to quickly move
toward the global convergence of both accounting
and auditing standards issued by a variety of
standard-setting bodies such as the FASB, AICPA,
PCAOB, and IASB.
21Committee of European Securities Regulators
- The EC established the Committee of European
Securities Regulators (CESR) to ensure efficient
functioning of the European capital market. - In May 2004, the SEC and CESR released a joint
statement that specifies the terms of reference
for future cooperation and coordination between
the two bodies. - The primary objectives of such cooperation are
to (1) identify and address emerging risks in
the EU and U.S. markets at an early stage (2)
discuss potential regulatory projects to
facilitate converging ways of addressing common
issues and (3) set priorities for discussion and
collaboration between the two bodies, including
market structure issues, the role and
responsibility of credit rating agencies and
analysts, and mutual fund regulation.
22State Influence on Corporate Governance.
Corporate Governance and Courts.
- State laws generally affect corporate governance
by setting requirements for companies directors
and officers. There is no uniform body of
corporate law in the United States because each
state is allowed to establish its own model. - The judicial process and court decisions in
several landmark cases have affected the
structure of corporate governance in the United
States. Many of the court cases have led to
increased accountability and liability for a
companys board of directors. -
23Corporate Governance and Self-Regulatory
Organizations
- By establishing listing standards for their
listed companies, SROs including stock exchanges
can also influence corporate governance. - List of self-regulatory organizations
24Best Practices
- The effectiveness of corporate governance depends
on compliance with state and federal statutes and
listing standards, as well as best practices
recommended by investor activists and
professional organizations. - Best practices of corporate governance are these
of The Conference Board, American Law Institute
(ALI), American Bar Association (ABA),
institutional investors, Council of Institutional
Investors, National Association of Corporate
Directors, Business Roundtable, Public Pension
Funds and etc. - Best practices can be used as benchmarks to
determine the best way to improve business
processes and corporate governance by following
the means by which leading organizations achieve
excellence performance.
25Conclusion
- Compliance with applicable laws, regulations,
rules, and standards is essential to the
efficiency and integrity of the capital markets,
the effectiveness of corporate governance, and
the reliability of financial reports. - The fundamental provisions of SOX can be
categorized into the following five categories
(1) corporate governance (2) financial
reporting (3) audit functions (4) federal
securities law enforcement and (5) others (e.g.,
legal counsel, financial analysts). - The SEC was established to protect investor
interests and was given the responsibility for
issuing financial reporting standards. - SOX directs the SEC to issue rules in
implementing its provisions pertaining to
corporate governance, financial reporting, audit
activities, and others. - Section 101 of SOX authorizes the establishment
of the PCAOB as an independent, nongovernmental,
not-for-profit organization to oversee the audits
of public companies under SEC jurisdiction.
26Conclusion
- The PCAOBs primary functions are to (1)
register public accounting firms that audit
public companies (2) inspect the registered
public accounting firms on a regular basis (3)
establish auditing, attestation, ethics, quality
control, and independence standards and (4)
conduct investigations and disciplinary
proceedings. - The PCAOB ended several decades of
self-regulation and peer reviews for registered
public accounting firms because both domestic and
foreign public accounting firms that prepare or
issue audit reports must now register with the
PCAOB. - The AICPA has introduced many initiatives in the
post-SOX era to improve public trust in the
accounting profession and public accounting
firms. - FASB has been the designated private sector
not-for-profit organization for promulgating
standards of financial accounting and reporting
since 1973.