Sox_and_Its_Effect_on_the_American_Enconomy

Billy VanTreuren Dr. Miller Business Communications 12 April 2010 Sarbanes-Oxley and Its Effect On American Businesses In a world full of scandals and immoral acts, there was a need for change in the actions of businesses in terms of honesty and ethics. On July 20, 2002, the Sarbanes-Oxley Act was implemented to try to prevent future scandals from occurring. U.S. Senator Paul Sarbanes (D-Maryland) and U.S. Representative Michael G. Oxley (R-Ohio) constructed the act after realizing how companies were dishonestly conducting their businesses (Bainbridge 1-3). Many businesses were following the rules as expected, but corporations such as Enron and Tyco were involved with large scandals that ultimately cost shareholders billions of dollars. This new act placed regulations on businesses in terms of how they record their financial information, what kind of internal controls they use, and how they disclose financial information to the public. The Sarbanes-Oxley Act has demonstrated many positive effects on the American economy providing its ability to restore confidence among investors and create a more ethical and fair environment within the workplace. The Sarbanes-Oxley Act passed almost unanimously in the House and Senate. Within the act there are eleven sections or “titles,” stressing corporate compliance with governance and financial practice (SOX Summary). Section 401 of the Act states that “financial statements published by issuers are required to be accurate and presented in a manner that does not contain incorrect statements…” (SOX Summary). In addition to these financial statements, issuers are to include all balance sheets. Section 409 deals with the issue of disclosing false or incomplete information to the public. It states “Issuers are required to disclose to the public, on an urgent basis, information on material changes in their financial condition or operations. These disclosures are to be presented in terms that are easy to understand supported by trend and qualitative information of graphic presentations as appropriate” (SOX Summary). Although most companies were trustworthy and honest in terms of public disclosure, a few fell short of these expectations and created large financial scandals. The best example of such problems includes the Enron scandal in which investors were fed false information from the corporation, causing billions of dollars in losses. Enron was at one time a flourishing American energy corporation, known as one of the leading electricity and natural gas companies worldwide. Its reported net income in the year 2000 was $979 million (Enron Numbers) and its stock price reached an astonishing “$90 a share in the mid-2000s” (Benston, Bromwich, Litan, and Wagenhofer 23). When the scandal was revealed, the American economy took a large hit and people were in absolute shock. Shareholders lost a total of $63,101,519,000 (Enron Numbers) as a result of the scam, leaving many individuals and families with large debts. Directors of the company were receiving an average of $400,000 in cash and stock benefits prior to the unveiling of the scandal because of Enron’s manipulation of both the Texas and the California power markets (Enron Numbers). Investors quickly lost confidence in their investing activities and were very skeptical of where they put their money in the stock market. Americans now realized the problem that had been created as a result of poorly enforced financial regulations and accounting practices. The government needed to start from scratch and find a solution to this problem. Many people put their heads together and created what is now the Sarbanes Oxley Act; its sheer purpose to aid in the prevention of scandals, like that of Enron, from occurring in the future. SEC (Securities Exchange Commission) chairman at the time, Harvey Pitt, stated that “restoring investor confidence is the Number One goal” on his agenda (Bainbridge 19). Over 900 of the nation’s biggest corporations were forced to certify under oath that their corporate disclosures were not only accurate, but also complete. Congress was feeling the pressure from the American people for legislative action and in response, quickly acted. They generated numerous reform proposals that had never fully come into fruition and sent them to President Bush to sign (Bainbridge 19-20). SOX, as the Sarbanes-Oxley act is more commonly known, is built on existing legislation that apparently was not nearly enough to force our corporations to operate with honesty or ethical behavior. Many new disclosures are now mandated as a result of SOX, each with the hopes that companies will be required to provide the most accurate financial information to the public. For example, “explicit disclosure is required of off-balance-sheet and related-party transactions” (Bainbridge 28). The production of earnings statements are now required without any misleading content and they must also be paired with a presentation that complies with the GAAP or the Generally Accepted Accounting Principles. Also, “insider stock transactions now must be disclosed within two business days rather than at the end of each month” (Bainbridge 28). By doing so, both the government and the investors can keep a closer eye on how corporations are conducting themselves. In terms of ethics, SOX requires corporations to state whether or not they have a code of ethics for their managers and if not, they must have valid reasons as to why this is so. A code of ethics is clearly defined in Section 406 of SOX. Standards are to be set to promote “honest and ethical conduct” and “full, fair, accurate, timely, and understandable disclosure in the periodic reports” produced by the issuer (Executive Ethics). Within the code, companies are also to “promote the compliance with government rules and regulations” (Executive Ethics). On top of public disclosure regulations, numerous auditing, accounting, and internal controls were also implemented through the Act. After the passing of Sarbanes-Oxley, the American people began to see a new surge of legislation pushed through Congress as an immediate result. Originally, accounting within a company was mostly self-regulated before the implementation of SOX. The Act changed this concept of self-regulation and created the PCAOB or the Public Company Accounting Oversight Board. This group is specifically focuses on overseeing the accounting profession in an independent manner (Bainbridge 30). SOX also implemented multiple CEO and CFO rules for corporations. CEOs and CFOs are now required to “certify that the company’s SEC disclosure documents are free of material misrepresentations or omissions and that the financial statements therein fairly and accurately reflect the company’s financial and business condition” (Bainbridge 31). Failure to abide by these rules results in strict penalties for the CEOs and CFOs, who now hold primary responsibility for the “establishment, design, and maintenance” of the internal controls within a corporation (Bainbridge 31). There were certain types companies that were exempt from the policies created by SOX, however, like small businesses and “mom and pop” shops. Small businesses make up the core of the American economy, giving entrepreneurs an opportunity to chase the American dream. SOX does not affect those businesses that are considered “nonreporting companies” (companies that are exempt from reporting financial information to the SEC), which can be as small as a mom and pop shop and as large as a closely held corporation (Bainbridge 35). Only the companies that are traded on the public stock exchange are affected by Sarbanes-Oxley. This does not, however, mean that small public, publically traded companies do not exist. These smaller public businesses are affected disproportionately compared to the larger firms. A report found that the likelihood that a private firm will purchase a small public company “increased by 53 percent during the first year” of the implementation of SOX (Small Public Firms). This is because as a private firm, these small companies will no longer be subject to the rules and regulations of SOX. When they were previously publically traded, the smaller businesses suffered because of relatively large compliance costs. As for larger companies such as those included in the Fortune 500, compliance costs had skyrocketed. After the passing of SOX, people began to wonder whether or not the Act was worth the financial strain in placed upon American businesses. Enforcement of the rules and regulations implemented by SOX do not, however, come without a large price tag. The question then arises as to whether or not the benefits of the act will outweigh its compliance cost. Many would argue that SOX is not worth the cost required to comply with its provisions and that a large amount of money is being wasted through its compliance and enforcement. Section 404 requires companies to file management assertions and auditor attestations based on the effectiveness of internal controls. At the time of the implementation of the act, compliance with this provision alone could “exceed $4.6 million for each of the largest U.S. companies (companies with over $5 billion in revenues)” (D’Aquila) and for medium or smaller companies, the costs were projected to be an average of $2 per organization (D’Aquila). Another estimate by the Chicago consulting firm “The Johnsson Group” estimates that for Fortune 500 companies, SOX will add “$3 to $8 million in annual compliance costs” (Kahn). Many new jobs are also created within companies required to comply with SOX, as well as countless hours of internal work. According to one source, SOX has created an estimated “12,000 hours of internal work…3000 hours of external work…additional audit fees of $590,000” (D’Aquila). These costs and hours of extra work are required by each individual American company with revenues of less than $25 million and over $5 billion. Extra hours translate into extra pay within these businesses, which is arguably a large waste of money. At the higher ranks of the SOX complying companies, individuals such as CEOs and CFOs have been given more responsibilities as a result of the Act. After the Enron scandal, the SEC felt that it was necessary for the CEOs and CFOs of 947 large corporations to sign off on their respective company’s financial reports. SOX 302 requires that each principal executive as well as any officers involved in filing financial reports certify in each “quarterly and annual report” that everything stated is accurate and that no piece of information has been omitted” (9). This provision becomes part of the job requirements of the CEOs and CFOs, putting their jobs at risk if they fail to comply. As for the second half of SOX 302, a significant change in corporate practice is made. Specifically, this half of provision 302 “was designed to give CEOs and CFOs a potent stake in the internal controls processes” (Bainbridge 76). The internal controls therefore must be designed to make sure that information is shared from the company’s auditors to its CEO and CFO. CEOs and CFOs are also required to certify that the internal controls are effective by evaluating them within the ninety-day period before filing the financial report (Bainbridge 77). Section 906 of SOX creates new penalties to be assessed to anyone involved in the false certification of financial information (CEO and CFO Certification). These provisions will now potentially make a high-ranking businessmen think twice before they act dishonestly again; it could cost them their job. Sarbanes-Oxley has now been in effect for eight years, but it is arguable as to whether or not the Act is a success. In an interview with ex-representative Michael Oxley, he expresses his confidence in Sarbanes-Oxley. Mr. Oxley explains that even though the recent economic meltdown has hurt investor confidence once again, the economy could be in a much worse state if it was not for the accounting and financial regulations implemented by SOX (Benner). A member of the Public Company Accounting Oversight Board, or PCAOB, named Charles Niemeir claims that SOX is a large success for the investors of America (Farrell). He says, “Instead of the sky falling, it’s just the opposite. I see it as a clear, blue sky” (Farrell). Harvey Goldshmid, SEC commissioner from 2002 to 2005 added that, “We’re in much better shape today than we were prior to Sarbanes-Oxley…There was a real fear that the lack of trust in the markets could create long-term problems” (Farrell). This is exactly what Sarbanes-Oxley has created, investor confidence in the market. After the scandals of the 90s and 2000s were unveiled, Americans were skeptical about entering the stock market. Overall, the Sarbanes-Oxley Act has been a great success. The American economy has been influenced in a positive way as a result of the Act, restoring confidence to investors and making sure that businesses are acting ethically.