Sarbanes_Oxley

SARBANES - OXLEY November 13, 2012 Introduction The Sarbanes-Oxley Act (SOX) was signed into law in July 2002 with the goal of improving the scope of declared information and the rectitude of financial statements of U.S. publicly traded companies through increasing their reporting standards, the implementation of independent audits, and the institution of steep penalties for corporate executives who submit fallacious filings (Botes, 2012). These actions provide increased investor assurance of the accuracy of public financial filings through improving their reliability and breadth of disclosure (Botes, 2012). The following report shows how the Act has impacted outside independent audit firms, the accuracy of public company financial statements and the cost of capital for public companies. The report further discusses the main advantages and disadvantages of the law, what changes should be made to it, and why the legislation cannot guarantee the accuracy of public company financial statements despite the attention CEOs and CFOs are paying to the law. Outside Independent Audit Firms Under SOX independent audit firms perform audit reviews of financial filings, in accordance with the Generally Accepted Accounting Principles (GAAP), and under the direction of the Public Company Oversight Accounting Board (PCOAB), in order to assure the disclosure and accuracy of financial filings (Livingstone, 2003; Botes, 2012). Botes notes these reviews provide a uniform platform for sound financial reporting and act as a deterrent of fraudulent accounting practices (2012). She also stated the PCOAB, under the direction of the SEC, administers regulations and sets principles of accounting standards known as Generally Accepted Accounting Standards or GAAS (2012). Audit firms are inspected by the PCOAB, with their frequency determined by the number of audits conducted by the independent firm (American Institute of CPAs, 2012). The American Institute of CPAs reports that PCOAB provides oversight monitoring of compliance with accounting standards and for conflicts of interest between the auditing firm and the publically traded company (2012). SOX specifies that the audit firm submit a statement to the PCOAB affirming that their relationship with the company is free from conflicts of interest (American Institute of CPAs, 2012). SOX specifies firms are prohibited from performing additional accounting and consulting duties due to the conflicts of interest these duties would impose (Botes, 2012). Audit firms are selected by and report to the company’s audit committee (Center for Audit Quality, n.d). Botes reports the audit process entails a review of the company’s internal control practices, the quality of accounting policies and practices, and a review of unusual transactions and top managerial financial decisions (2012). The American Institute of CPAs reports the audit committee acts as a liaison between the audit firm and top corporate management during discussions regarding audit findings (2012). They also report the independent auditors “shall disclose all material off-balance sheet transactions" and "other relationships" with "unconsolidated entities"’ in order to provide financial transparency for investors. In addition audit findings are reported to the CEO and CFO, who attests to their accuracy by signing a statement of validation within the SEC financial statement filings. The role of the independent audit firm is to provide an unbiased review of the publicly traded company’s financial statements, their internal audit process, their accounting policies and procedures, report findings to the company management, and provide assurance that the accounting practices are performed according to GAAP. The Accuracy of Public Company Financial Statements and the Cost of Capital for Public Companies The implementation of SOX works to reform the reporting of financial statements and to ensure the accuracy of financial statements of U.S. publicly traded companies by creating reliable financial controls, through improving the accuracy of the financial statements and requiring both independent auditors and management to attest to the validity of the statements (Kaserer, Mettler, & Obernberger 2011). SOX serves to identify poor accounting practices and fraudulent reporting techniques which could result in a misstatement of financial reports (Bisoux, 2005) Compliance with SOX standards is often costly (Kaserer et., al. 2011). Not only is there a cost associated with conforming to SOX standards but many companies choose to hire consultants to make sure they have achieved and maintain compliance (Bisoux, 2005). Companies must now set aside resources to pay for auditors and to maintain internal operating processes. Direct costs associated with SOX are accounting and audit fees, documentation services, and fees associated with the audit committees with the most evident costs being the accounting and auditing fees (Kaserer et., al. 2011). SOX has placed greater focus on internal accounting controls within a company. (Bisoux, 2005) Many companies do not have an internal audit department and those who do state that they are looking outside the company to perform some of the work in order to meet the requirements as set forth in SOX (Kaserer et., al 2011). Another cost is that of the audit documentation requirements as well as the verification of the financial statements (Bisoux, 2005). Many companies are spending more to meet the criteria either by outsourcing or hiring more employees which adds to their overall cost of running their business (John & Marano, 2007). Boards of directors and audit committees are also increasing time and effort spent on achieving compliance (Kaserer, et., al 2011). Heads of companies are expected to have more input because they are the ones being held accountable if something is inaccurate (Bisoux, 2005) outside consulting fees are new expenses that companies need to take into consideration. SEC requirements specifically give audit committees the authority to take on independent counsel and advisors that they deem necessary to perform their duties and meet compliance requirements. Companies must prepare for the cost of meeting the requirements of SOX. Capital for public companies must be budgeted for meeting and complying with SOX so that no penalties are incurred. Initial compliance might seem costly for a public company but once they are met and maintained then companies will not be at risk for high penalties thereby saving them time, energy and money. The Main Advantages and Disadvantages of SOX SOX, has both advantages, intended to improve the assurance of sound accounting practice and reporting, and disadvantages, resulting from quickly crafted legislation formulated in the wake of recent accounting scandals (Botes, 2012). Botes notes one advantage is that the independent audit firm does not report directly to the firm’s CEO, instead reporting to the audit committee (2012). This allows the audit firm to not have undue influence placed upon them by the CEO who could override audit controls and terminate the firm for revealing findings considered erroneous or unfavorable to the company (Center for Audit Control, 2012). Botes notes another advantage is that the CEO and CFO must sign off on filed financial statements affirming their accuracy and can be held liable for inaccuracies (2012). The American Institute of CPAs review of SOX notes in addition to legal culpability the CEO and CFO are required to repay any bonus, incentive-based, or equity-based compensation received within a twelve month timeframe in which a financial restatement is issued (2012). Furthermore the authors note SOX created the formation of the PCOAB which reviews accounting practices, performs inspections of auditing quality controls, and establishes accounting standards. This oversight provides structure and a means for review of the independent auditors firms. The independent auditing firms are required to register with the PCOAB, which has authorization to assign disciplinary action to auditing firms. SOX requires independent auditors to work with the audit committee to discuss and resolve disagreements with company management (Keinath & Walo, 2009). Audit committees are required to have a financial expert as a member of their committee, which provides assurance of financial oversight within the audit committee itself (American Institute of CPAs, 2012). The audit committee acts as a liaison between management and the external independent auditor in the hiring of the independent audit firm and the oversight of the internal audit controls reviewed by the independent audit firm. SOX assigns penalties according to the ’34 Act for transgressors (Botes, 2012). According to the provisions summary of the legislation this includes threats of loss of compensation and threats of imprisonment for corporate executives or employees who commit fraudulent accounting practices (American Institute of CPAs, 2012). The legislation summary review also indicates disciplinary hearings can be held and sanctions can be assigned to transgressing audit firms. Despite the advantages SOX provides there are disadvantages to the legislation as well. One of the disadvantages is that the independent external auditors are not protected from being fired if they report a company’s poor or fraudulent accounting practices, or if they have disagreements with company management (Botes, 2012). Botes notes SOX does not provide a means of recourse for investors who are wronged through financial mismanagement (2012). In addition companies are burdened with the the additional expenses of improvements in their internal control accounting processes and any cost-benefit sustained from improved accounting practices can be subverted by executives or employees if they engage in corrupt practices or seek to override internal controls in order to commit fraud or unethical activities. What Changes Should be Made to SOX Although SOX was created as a way to reform unethical financial statement reporting, it is not without some faults. To begin with the Act is very complicated making it confusing for many companies to become and stay in compliance with the requirements. If companies don’t know or understand that they may be violating the act they can’t do anything to fix what is not in compliance. SOX imposes one size fits all requirements that can be unfair to small and mid-sized businesses that don’t have a lot of capital or resources to expend on becoming and staying compliant with the law. Relaxing some of the reporting and audit requirements for small to mid-size companies to ease the financial burden but still holding the companies accountable for fraudulent or misleading information that may arise is a good way to help the companies to become and stay in compliance with the law. Simplifying the law by making it shorter by removing redundant requirements is another way to help companies understand what is expected and required of them to be in compliance with the law. By simplifying the law and making it easier to understand money can be saved on having to hire attorneys and consultants to interpret what is required of each company. Making everything comprehendible makes it easier for companies to not violate the act either willingly or by mistake. By making the law easier to comply with and more cost effective for companies to comply with the requirements also encourages companies to go public. It also helps encourage international companies to come into the American job market making it profitable for all involved. The Sarbanes Oxley legislation has done great things to reform public company’s ways of reporting their financial status and is much needed but it is also important to understand that the corporate environment is ever changing so reforms are needed within the Act as well and to make compliance easy and enticing to all businesses no matter where they are located or whether they are big or small. Section B Legislation alone cannot guarantee the accuracy of public company financial statements. Many company heads report financial statements inaccurately because it benefits them. They reap large financial perks such as big bonuses and high salaries that can be accommodated if they don’t report their financial statements accurately. Legislation cannot diminish a person’s greed, it can however, hold those in charge accountable for their dishonest and unethical actions. The Sarbanes-Oxley Act doesn’t just require corporate CEOs, CFOs and Boards of Directors to a adopt a codes of ethics; it significantly raises the standards and requirements that each must meet. As a main focus on reform, the Act has stiffened the consequences for financial misconduct. Violations of the Act now carry bigger penalties such as jail time, and multi-million dollar fines. The article, “Introduction to SOX”, brings the reality of this to light by stating, in part, “The prospect of going to prison induces fear even in hard core crooked executives.” (UMUC, 2002). The Act extended the statute of limitations on securities fraud charges and ensures that victims of fraud receive monetary damage payments as well as it gives the SEC authority to freeze payments to anyone involved in the fraud during an investigation. Section 302 of SOX outlines what CEO’s and CFO’s are responsible for. They must certify in writing that the company’s financial statements are in compliance with the law and accurately report the company’s financial status. Gone are the days of “What you don’t know won’t hurt you” and in are the “Honesty is the best policy” way of thinking. CEOs and CFOs can no longer say that they weren’t aware of unethical practices within their company because they are held liable for those actions by way of having to certify accuracy of finances in writing. When you sign your name to authenticate accuracy, you are the one they are looking at when things don’t match up. Juries are more likely to convict and CEO’s and CFO’s are more likely to be held accountable because they have signed off on accuracy. If the statements are inaccurate and they know it why would they sign off on it. A second reason that CEOs and CFOs are paying close attention to SOX is because the ability to attract future funding relies heavily upon public opinion of the company in question. If there are misgivings as to the trustworthiness of key individuals or a lack of transparency in regards to its financial practices, a general feeling of mistrust will pervade the organization and create an atmosphere whereby investors will be extremely reluctant to invest. In addition, there is evidence that SOX itself has created an environment of caution as illustrated in an article by Kang, they assert that “…accelerated filers of Section 404 of the Act have become more cautious about investment” (Kang et. al., 2009) Funding is the lifeblood of any organization. Without it, there is no future planning, no new initiatives, no new jobs and no growth. CEOs & CFOs are evaluated by these benchmarks as well as others and current as well as prospective investors know this. Conclusion The Sarbanes-Oxley Act was put into legislation in order to restore integrity that had been compromised by improprieties within publicly traded companies. The effectiveness of the legislation is debatable in that some say it is too costly and inefficient where others argue the law has restored investor’s faith and confidence in publicly traded companies because it sets higher penalties for indiscretions. The changes that SOX has made enable companies to be accountable for their financial statement reporting and have made company officers and employees more ethical, truthful and reliable. Though some further changes should be made to the Act, and the legislation cannot guarantee the accuracy of public company financial statements, it is a good start because it requires companies and their officers to be held accountable to a high degree for unethical practices and financial statement reporting and it improves investor confidence in the financial reporting of the U.S. publicly traded companies within our free market economy. References American Institute of CPAs (2012). AICPA American Institute of CPAs: Summary of the provisions of the sarbanes-oxley act of 2002. Retreived from http://www.aicpa.org/InterestAreas/ForensicAndValuation/Resources/FraudPreventionDetectionResponse/Pages/Summary%20of%20the%20Provisions%20of%20the%20Sarbanes-Oxley%20Act%20of%202002.aspx. Bisoux, T (2005). 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