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SARBANES-OXLEY ACT OVERVIEW

August 23, 2010

Team One I2MBA11

Jeanetta Brown, Chris Caro, Brian Ignatowski, Matt Johnson, Bobby Reeder

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Sarbanes-Oxley Act

Passed in July 2002 by a House vote of 423-3 and a Senate vote of 99-0

Also known as the “Public Company Accounting Reform and Investor Protection Act of 2002”

Frequently called SOX or Sarbox

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Why Sarbanes-Oxley Act?

Federal law passed in response to a number of major corporate and accounting scandals (Enron, Tyco International, WorldCom).

Ex: WorldCom overstated its earnings by $72 billion dollars over 5 quarters; Enron execs receiving large bonuses based on company performance while draining the pension funds.

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Sarbanes-Oxley Act

The scandals resulted in a decline in the public’s trust in accounting and corporate reporting practices.

Congress decided to “be the hero” by stepping in and passing new law F-A-S-T.

The Corporate and Auditing Accountability, Responsibility, and Transparency Act was ‘in the works’ when Sen. Sarbanes and Rep. Oxley stepped in with a more comprehensive, tougher law for accounting and reporting oversight.

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Who enforces SOX?

Public Company Accounting Oversight Board (PCAOB)

Securities and Exchange Commission

Intended to be somewhat Self-Regulating

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SOX

The Act contains 11 Titles (sections) and is very wide reaching.Imposed on Accounting Firms, Audit Firms,

Public Company Board of Directors, and Public Company Management

Addresses oversight, auditor independence, corporate governance, enhanced financial disclosure, enhanced ‘insider’ disclosure, professional conduct for attorneys, accountants, and executive management, etc.

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Definitions / Key Components

Public Company - Traded on a stock exchange, has a board of directors, investors and management, required to file periodic financial statements (10-K, 10-Q) with the SEC

Audit Committee – sub-committee of a public company’s board of directors

Auditors – Accounting firm/company who audits public company’s financial records for SEC filings and attests to their accuracy

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Definitions / Key Components

Internal vs. Independent AuditorInsider – Director, officer, >10% shareholder, or

other person with access to material, non-public information about a Company

Independent Board Member – member not receiving any consulting, advisory, or other compensatory fee from the company, other than for service on the board, and not being an affiliated person of the company, or any subsidiary thereof

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Wow. Where do we start??

Section 101-109: Creation of PCAOBEstablished to oversee the audits of public companies

Sets forth composition of the Board (5 members)

All public accounting firms must register with the Board

Board must create auditing ‘standards’, conduct inspections/investigations, enforce compliance with SOX, and establish a budget

SEC is to oversee the Board and can give the Board additional duties / responsibilities

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Major Sections of SOX: REPORTING

Upgraded Disclosures KEY to SOXExecutive Management Certifications –

Certify that all financial info contained in company filings materially reflects company’s financial position (302)

Enhanced disclosures of off-balance sheet transactions, pro forma financial info, and material correcting adjustments (401)

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REPORTING

Management takes responsibility for and assesses the effectiveness of internal controls and procedures (404)

Rules for ‘real time’ disclosures of material changes in financial conditions or operations, including early time for company filings (409)Additional 8K filing requirementsTiming for public disclosures shortened

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Major Sections of SOX: ROLES

Strengthened Corporate Governance KEY to SOXIncrease communications between auditor

and Audit Committee on accounting policies and practices (204)

Audit Committee now made up of only independent directors, directly responsible for selecting auditor, can have independent advisors (lawyers, accountants) reporting to Audit Committee (301)

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ROLES

Prohibits Company loans to Executive Officers and Directors (402) No more personal piggybank Conflict of Interest Provision

Company must disclose its make up and financial expertise on Audit Committee (407)Committee members must meet certain

qualifications/criteria and must have at least one financial “expert”

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Major Sections of SOX: CONDUCT

Expanded Insider Accountability KEY to SOXUnlawful for Director/Officer to manipulate or

mislead any independent auditor (303)Prohibits Insider trading during blackout dates

(306)Accelerated reporting of trades by Insiders to

“within two business days” (403)Form 4 reporting

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CONDUCT

Company must publicly disclose Code of Ethics/Conduct and keep on website (406)

Unlawful to retaliate against Whistleblowers who provide evidence of fraud or non-compliance with the Act (806)

Professional Conduct Standards for Attorneys working for/with Public Companies (307)“Up the Chain” reporting

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Major Sections of SOX: ENFORCEMENT

Increased Oversight KEY to SOXAll public accounting firms must register, pay

fees, and supply info to PCAOB (101, 102)

PCAOB to conduct investigations into audit company compliance (104)

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ENFORCEMENT

Independent Auditor to attest to the assessments made by management in reference to internal controls (404)Auditors have to verify accurate and

effectiveness of internal controls and managements testing thereof

Expanded SEC review of 10-Ks and 10-Qs at least once every 3 years for every company (408)

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Major Sections of SOX: RELATIONSHIPS

Heightened Auditor Independence KEY to SOXProhibits ‘independent’ auditors from

providing 9 specific non-audit services (201)Examples: investment banking, valuation

opinions, legal services, tax services

Requires Pre-Approval by Audit Committee of all services provided by independent auditor (202)

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RELATIONSHIPS

Requires a lead auditor and reviewing audit partner rotation every 5 years (203)Theory is that changing auditors every so often

puts a ‘fresh pair of eyes’ on a company’s financials

Requires “cooling off” period of one year before an employee of an audit firm can be hired into executive positions with the audited company (206)

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Major Sections of SOX:PENALTIES

Broadened Sanctions KEY to SOXForfeiture of bonuses or profits on the sale of

securities by CEO or CFO if restatement in financial disclosures occurs due to material non-compliance with SOX (304)

Increased (and heavily enforced) criminal penalties for CEO/CFO who certifies a financial or tax filing in bad faith (906)Up to $5M fine and up to 20 yrs in prison or both.

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PENALTIES

Longer Statute of Limitations for private securities fraud lawsuits

Increased Criminal PenaltiesExtends prison term for “knowingly defrauding” to 25 yrsCreates criminal penalties for destroying audit-related docs

before record retention time period expiresAmends US Sentencing Guidelines related to white-collar

crimes, securities fraud, and accounting fraud

Makes it more ‘personal’ to those committing the fraud/crimes

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Internal Controls

Two certifications as to internal controls implemented by SOXCivil penaltiesCriminal penalties

Sec 302 mandates a set of internal procedures to ensure accurate financial disclosure.

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INTERNAL CONTROLS

The signing officer must certify 1.) that he/she is responsible for establishing and

maintaining internal controls, and 2.) that she/he has designed the internal controls to ensure

that material information relating to the company is made known to the officers particularly during the period in which a periodic report is being prepared

The officer must have “evaluated the effectiveness of the company’s internal controls within 90 days prior to the report” and have “presented in the report conclusions about the effectiveness of the internal controls based on the evaluation”

Adds significant personal responsibility and liability to CEO/CFO for their company’s public financial reports

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INTERNAL CONTROLS

Additionally, outside auditors must attest to management’s internal controls assessment (i.e. do they agree?)

Major challenges: Controls within IT systems

Electronic data management, electronic document retention, and key operational processes kept on IT systems

Implementation Costs

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Future of SOX

Widely criticized for its far-reaching effectsMaking some sectors significant money

(attorneys, CPAs, SOX consultants), BUT those same sectors are taking on significant liability

Cost to business high, but comfort to investors also high

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Future of SOX

The result:

SOX IS NOT GOING ANYWHERE!!

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Many CPAs have become affectionate towards SOX

Watch the Singing CPA in the You Tube video below

http://www.youtube.com/watch?v=n2ylBKOURtw&feature=player_embedded ¹

Future of SOX

¹ Steven Zelin, (12 July 2007), Singing CPA Sings Happy Birthday to Sarbanes-Oxley . YouTube. http://www.youtube.com/watch?v=n2ylBKOURtw&a.

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Resources for more detail on SOX

www.legalarchiver.org/soa.htm = Full text of the statute

SEC websiteSOX compliance personnelCorporate Legal Departments