Sarbanas oxley act 2002


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Sarbanas oxley act 2002

  1. 1. Sarbanes-Oxley Act of 2002. by Dr.Rajesh Patel Director,nrv mba1/29/2012 10:55:29 PM 1 ,
  2. 2. The Sarbanes–Oxley Act of 2002, enacted July 30, 2002), alsoknown as the Public Company Accounting Reform and InvestorProtection Act (in the Senate) and Corporate and AuditingAccountability and Responsibility Act (in the House) and commonlycalled Sarbanes–Oxley, Sarbox or SOX, is a United States federal lawwhich set new or enhanced standards for all U.S. public companyboards, management and public accounting firms. It is named aftersponsors U.S. Senator Paul Sarbanes (D-MD) and U.S. RepresentativeMichael G. Oxley (R-OH). by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 2 ,
  3. 3. The bill was enacted as a reaction to a number of major corporate and accounting scandalsincluding those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom.These scandals, which cost investors billions of dollars when the share prices of affectedcompanies collapsed, shook public confidence in the nations securities markets. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 3 ,
  4. 4. The act contains 11 titles, or sections, ranging from additional corporate board responsibilitiesto criminal penalties, and requires the Securities and Exchange Commission (SEC) to implementrulings on requirements to comply with the law. Harvey Pitt, the 26th chairman of the SEC, ledthe SEC in the adoption of dozens of rules to implement the Sarbanes–Oxley Act. It created anew, quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, chargedwith overseeing, regulating, inspecting and disciplining accounting firms in their roles asauditors of public companies. The act also covers issues such as auditor independence,corporate governance, internal control assessment, and enhanced financial disclosure. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 4 ,
  5. 5. OutlinesSarbanes–Oxley contains 11 titles that describe specific mandates andrequirements for financial reporting. Each title consists of severalsections, summarized below. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 5 ,
  6. 6. •Public Company Accounting Oversight Board (PCAOB)Title I consists of nine sections and establishes the Public CompanyAccounting Oversight Board, to provide independent oversight of publicaccounting firms providing audit services ("auditors").It also creates acentral oversight board tasked with registering auditors, defining thespecific processes and procedures for compliance audits, inspecting andpolicing conduct and quality control, and enforcing compliance with thespecific mandates of SOX. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 6 ,
  7. 7. •Auditor IndependenceTitle II consists of nine sections and establishesstandards for external auditor independence, to limitconflicts of interest. It also addresses new auditorapproval requirements, audit partner rotation, andauditor reporting requirements. It restricts auditingcompanies from providing non-audit services (e.g.,consulting) for the same clients. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 7 ,
  8. 8. •Corporate ResponsibilityTitle III consists of eight sections and mandates that senior executives take individualresponsibility for the accuracy and completeness of corporate financial reports. It defines theinteraction of external auditors and corporate audit committees, and specifies the responsibilityof corporate officers for the accuracy and validity of corporate financial reports. It enumeratesspecific limits on the behaviors of corporate officers and describes specific forfeitures of benefitsand civil penalties for non-compliance. For example, Section 302 requires that the companys"principal officers" (typically the Chief Executive Officer and Chief Financial Officer) certify andapprove the integrity of their company financial reports quarterly.[4] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 8 ,
  9. 9. •Enhanced Financial DisclosuresTitle IV consists of nine sections. It describes enhanced reportingrequirements for financial transactions, including off-balance-sheettransactions, pro-forma figures and stock transactions of corporateofficers. It requires internal controls for assuring the accuracy offinancial reports and disclosures, and mandates both audits and reportson those controls. It also requires timely reporting of material changesin financial condition and specific enhanced reviews by the SEC or itsagents of corporate reports. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 9 ,
  10. 10. •Analyst Conflicts of InterestTitle V consists of only one section, which includesmeasures designed to help restore investorconfidence in the reporting of securities analysts. Itdefines the codes of conduct for securities analystsand requires disclosure of knowable conflicts of by Dr.Rajesh Patel Director,nrv mbainterest. 1/29/2012 10:55:29 PM , 10
  11. 11. •Commission Resources and AuthorityTitle VI consists of four sections and defines practices torestore investor confidence in securities analysts. It alsodefines the SEC’s authority to censure or bar securitiesprofessionals from practice and defines conditions underwhich a person can be barred from practicing as a broker, by Dr.Rajesh Patel Director,nrv mbaadvisor, or dealer. 1/29/2012 10:55:29 PM , 11
  12. 12. •Studies and ReportsTitle VII consists of five sections and requires the ComptrollerGeneral and the SEC to perform various studies and reporttheir findings. Studies and reports include the effects ofconsolidation of public accounting firms, the role of creditrating agencies in the operation of securities markets,securities violations and enforcement actions, and whetherinvestment banks assisted Enron, Global Crossing and othersto manipulate earnings and obfuscate true financialconditions. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 12 ,
  13. 13. •Corporate and Criminal Fraud AccountabilityTitle VIII consists of seven sections and is also referred to asthe “Corporate and Criminal Fraud Accountability Act of2002”. It describes specific criminal penalties formanipulation, destruction or alteration of financial recordsor other interference with investigations, while providingcertain protections for whistle-blowers. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 13 ,
  14. 14. •White Collar Crime Penalty EnhancementTitle IX consists of six sections. This section is also called the“White Collar Crime Penalty Enhancement Act of 2002.”This section increases the criminal penalties associated withwhite-collar crimes and conspiracies. It recommendsstronger sentencing guidelines and specifically adds failureto certify corporate financial Patel Director,nrv as a criminal offense. by Dr.Rajesh reports mba 1/29/2012 10:55:29 PM 14 ,
  15. 15. •Corporate Tax ReturnsTitle X consists of one section. Section 1001 statesthat the Chief Executive Officer should sign thecompany tax return. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 15 ,
  16. 16. •Corporate Fraud AccountabilityTitle XI consists of seven sections. Section 1101 recommendsa name for this title as “Corporate Fraud Accountability Act of2002”. It identifies corporate fraud and records tampering ascriminal offenses and joins those offenses to specificpenalties. It also revises sentencing guidelines andstrengthens their penalties. This enables the SEC to resort totemporarily freezing transactions or payments that have beendeemed "large" or "unusual". by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 16 ,
  17. 17. •Auditor conflicts of interest: Prior to SOX, auditing firms, the primaryfinancial "watchdogs" for investors, were self-regulated. They alsoperformed significant non-audit or consulting work for the companiesthey audited. Many of these consulting agreements were far morelucrative than the auditing engagement. This presented at least theappearance of a conflict of interest. For example, challenging thecompanys accounting approach might damage a client relationship,conceivably placing a significant consulting arrangement at risk,damaging the auditing firms bottom line. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 17 ,
  18. 18. Boardroom failures: Boards of Directors, specifically AuditCommittees, are charged with establishing oversightmechanisms for financial reporting in U.S. corporations on thebehalf of investors. These scandals identified Board memberswho either did not exercise their responsibilities or did nothave the expertise to understand the complexities of thebusinesses. In many cases, Audit Committee members werenot truly independent of management by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 18 ,
  19. 19. •Securities analysts conflicts of interest: The roles ofsecurities analysts, who make buy and sell recommendationson company stocks and bonds, and investment bankers, whohelp provide companies loans or handle mergers andacquisitions, provide opportunities for conflicts. Similar to theauditor conflict, issuing a buy or sell recommendation on astock while providing lucrative investment banking servicescreates at least the appearance Director,nrvconflict of interest. by Dr.Rajesh Patel of a mba 1/29/2012 10:55:29 PM 19 ,
  20. 20. •Inadequate funding of the SEC: The SECbudget has steadily increased to nearly doublethe pre-SOX level.[7] In the interview citedabove, Sarbanes indicated that enforcementand rule-making are more effective post-SOX. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 20 ,
  21. 21. •Banking practices: Lending to a firm sends signals toinvestors regarding the firms risk. In the case of Enron,several major banks provided large loans to the companywithout understanding, or while ignoring, the risks of thecompany. Investors of these banks and their clients were hurtby such bad loans, resulting in large settlement payments bythe banks. Others interpreted the willingness of banks to lendmoney to the company as an indication of its health andintegrity, and were led to invest in Enron as a result. Theseinvestors were hurt as well. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 21 ,
  22. 22. •Internet bubble: Investors had been stung in 2000by the sharp declines in technology stocks and to alesser extent, by declines in the overall market.Certain mutual fund managers were alleged to haveadvocated the purchasing of particular technologystocks, while quietly selling them. The lossessustained also helped create a general anger amonginvestors. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 22 ,
  23. 23. •Executive compensation: Stock option and bonus practices,combined with volatility in stock prices for even smallearnings "misses," resulted in pressures to manageearnings.[8] Stock options were not treated as compensationexpense by companies, encouraging this form ofcompensation. With a large stock-based bonus at risk,managers were pressured to meet their targets. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 23 ,
  24. 24. Analyzing the cost-benefits of Sarbanes–OxleyA significant body of academic research and opinion existsregarding the costs and benefits of SOX, with significantdifferences in conclusions. This is due in part to the difficultyof isolating the impact of SOX from other variables affectingthe stock market and corporate earnings.[9][10] Conclusionsfrom several of these studies and related criticism aresummarized below: by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 24 ,
  25. 25. Compliance costs•FEI Survey (Annual): Finance Executives International (FEI) provides anannual survey on SOX Section 404 costs. These costs have continued todecline relative to revenues since 2004. The 2007 study indicated that,for 168 companies with average revenues of $4.7 billion, the averagecompliance costs were $1.7 million (0.036% of revenue).[11] The 2006study indicated that, for 200 companies with average revenues of $6.8billion, the average compliance costs were $2.9 million (0.043% ofrevenue), down 23% from 2005. Cost for decentralized companies (i.e.,those with multiple segments or divisions) were considerably more thancentralized companies. Survey scores related to the positive effect ofSOX on investor confidence, reliability of financial statements, and fraudprevention continue to rise. However, when asked in 2006 whether thebenefits of compliance with Section 404 have exceeded costs in 2006,only 22 percent agreed.[12] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 25 ,
  26. 26. Benefits to firms and investors•Arping/Sautner (2010): This research paper analyzes whether SOXenhanced corporate transparency.[17] Looking at foreign firms that arecross-listed in the US, the paper indicates that, relative to a controlsample of comparable firms that are not subject to SOX, cross-listedfirms became significantly more transparent following SOX. Corporatetransparency is measured based on the dispersion and accuracy ofanalyst earnings forecasts.•Iliev (2007): This research paper indicated that SOX 404 indeed led toconservative reported earnings, but also reduced—rightly or wrongly—stock valuations of small firms.[18] Lower earnings often cause the shareprice to decrease. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 26 ,
  27. 27. •Skaife/Collins/Kinney/LaFond (2006): This research paper indicates that borrowingcosts are lower for companies that improved their internal control, by between 50 and150 basis points (.5 to 1.5 percentage points).[19]•Lord & Benoit Report (2006): Do the Benefits of 404 Exceed the Cost? A study of apopulation of nearly 2,500 companies indicated that those with no materialweaknesses in their internal controls, or companies that corrected them in a timelymanner, experienced much greater increases in share prices than companies that didnot.[20][21] The report indicated that the benefits to a compliant company in share price(10% above Russell 3000 index) were greater than their SOX Section 404 costs.•Institute of Internal Auditors (2005): The research paper indicates that corporationshave improved their internal controls and that financial statements are perceived to bemore reliable.[22] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 27 ,
  28. 28. Implementation of key provisionsSarbanes–Oxley Section 302: Disclosure controlsUnder Sarbanes–Oxley, two separate sections came into effect—one civil and the othercriminal. 15 U.S.C. § 7241 (Section 302) (civil provision); 18 U.S.C. § 1350 (Section 906)(criminal provision).Section 302 of the Act mandates a set of internal procedures designed to ensure accuratefinancial disclosure. The signing officers must certify that they are “responsible forestablishing and maintaining internal controls” and “have designed such internal controls toensure that material information relating to the company and its consolidated subsidiaries ismade known to such officers by others within those entities, particularly during the period inwhich the periodic reports are being prepared.” 15 U.S.C. § 7241(a)(4). The officers must“have evaluated the effectiveness of the company’s internal controls as of a date within 90days prior to the report” and “have presented in the report their conclusions about theeffectiveness of their internal controls based on their evaluation as of that date.” Id.. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 28 ,
  29. 29. Sarbanes–Oxley Section 303: Improper Influence on Conduct of Auditsa.Rules To Prohibit. It shall be unlawful, in contravention of such rules or regulationsas the Commission shall prescribe as necessary and appropriate in the publicinterest or for the protection of investors, for any officer or director of an issuer, orany other person acting under the direction thereof, to take any action tofraudulently influence, coerce, manipulate, or mislead any independent public orcertified accountant engaged in the performance of an audit of the financialstatements of that issuer for the purpose of rendering such financial statementsmaterially misleading. [2] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 29 ,
  30. 30. Sarbanes-Oxley Section 401: Disclosures in periodic reports (Off-balance sheet items)The bankruptcy of Enron drew attention to off-balance sheet instruments that were usedfraudulently. During 2010, the court examiners review of the Lehman Brothersbankruptcy also brought these instruments back into focus, as Lehman had used aninstrument called "Repo 105" to allegedly move assets and debt off-balance sheet tomake its financial position look more favorable to investors. Sarbanes-Oxley required thedisclosure of all material off-balance sheet items. It also required an SEC study andreport to better understand the extent of usage of such instruments and whetheraccounting principles adequately addressed these instruments; the SEC report wasissued June 15, 2005.[28][29] Interim guidance was issued in May 2006, which was laterfinalized.[30] Critics argued the SEC did not take adequate steps to regulate and monitorthis activity.[31] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 30 ,
  31. 31. Sarbanes–Oxley Section 404: Assessment of internal controlFurther information: SOX 404 top-down risk assessmentThe most contentious aspect of SOX is Section 404, which requires management and the externalauditor to report on the adequacy of the companys internal control on financial reporting (ICFR). This isthe most costly aspect of the legislation for companies to implement, as documenting and testingimportant financial manual and automated controls requires enormous effort.[32]Under Section 404 of the Act, management is required to produce an “internal control report” as partof each annual Exchange Act report. See 15 U.S.C. § 7262. The report must affirm “the responsibility ofmanagement for establishing and maintaining an adequate internal control structure and proceduresfor financial reporting.” 15 U.S.C. § 7262(a). The report must also “contain an assessment, as of the endof the most recent fiscal year of the Company, of the effectiveness of the internal control structure andprocedures of the issuer for financial reporting.” To do this, managers are generally adopting an internalcontrol framework such as that described in COSO. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 31 ,
  32. 32. Sarbanes–Oxley 404 and smaller public companiesThe cost of complying with SOX 404 impacts smaller companies disproportionately, asthere is a significant fixed cost involved in completing the assessment. For example,during 2004 U.S. companies with revenues exceeding $5 billion spent 0.06% ofrevenue on SOX compliance, while companies with less than $100 million in revenuespent 2.55%.[36]This disparity is a focal point of 2007 SEC and U.S. Senate action.[37] The PCAOB intendsto issue further guidance to help companies scale their assessment based on companysize and complexity during 2007. The SEC issued their guidance to management inJune, 2007.[34] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 32 ,
  33. 33. Sarbanes–Oxley Section 802: Criminal penalties forinfluencing US Agency investigation/proper administrationSection 802(a) of the SOX, 18 U.S.C. § 1519 states: “ Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both. ” by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 33 ,
  34. 34. Sarbanes–Oxley Section 906: Criminal Penalties for CEO/CFO financial statement certification§ 1350. Section 906 states: Failure of corporate officers to certify financial reports(a) Certification of Periodic Financial Reports.— Each periodic report containing financial statements filedby an issuer with the Securities Exchange Commission pursuant to section 13(a) or 15(d) of the SecuritiesExchange Act of 1934 (15 U.S.C. 78m (a) or 78o (d)) shall be accompanied bySection 802(a) of the SOX awritten statement by the chief executive officer and chief financial officer (or equivalent thereof) of theissuer.(b) Content.— The statement required under subsection (a) shall certify that the periodic reportcontaining the financial statements fully complies with the requirements of section 13(a) or 15(d) of theSecurities Exchange Act of [1] 1934 (15 U.S.C. 78m or 78o (d)) and that information contained in theperiodic report fairly presents, in all material respects, the financial condition and results of operationsof the issuer.(c) Criminal Penalties.— Whoever— (1) certifies any statement as set forth in subsections (a) and (b) ofthis section knowing that the periodic report accompanying the statement does not comport with all therequirements set forth in this section shall be fined not more than $1,000,000 or imprisoned not morethan 10 years, or both; or(2) willfully certifies any statement as set forth in subsections (a) and (b) of this section knowing that theperiodic report accompanying the statement does not comport with all the requirements set forth in thissection shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both. [3] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 34 ,
  35. 35. Sarbanes–Oxley Section 1107: Criminal penalties for retaliation againstwhistleblowersSection 1107 of the SOX 18 U.S.C. § 1513(e) states:[41]Criticism “ Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense, shall be fined under this title, imprisoned not more than 10 years, or both. ” by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 35 ,
  36. 36. CriticismCongressman Ron Paul and others such as former Arkansas governor Mike Huckabee have contended thatSOX was an unnecessary and costly government intrusion into corporate management that places U.S.corporations at a competitive disadvantage with foreign firms, driving businesses out of the United States. Inan April 14, 2005 speech before the U.S. House of Representatives, Paul stated, "These regulations aredamaging American capital markets by providing an incentive for small US firms and foreign firms toderegister from US stock exchanges. According to a study by a researcher at the Wharton Business School,the number of American companies deregistering from public stock exchanges nearly tripled during the yearafter Sarbanes–Oxley became law, while the New York Stock Exchange had only 10 new foreign listings in allof 2004. The reluctance of small businesses and foreign firms to register on American stock exchanges iseasily understood when one considers the costs Sarbanes–Oxley imposes on businesses. According to asurvey by Korn/Ferry International, Sarbanes–Oxley cost Fortune 500 companies an average of $5.1 millionin compliance expenses in 2004, while a study by the law firm of Foley and Lardner found the Act increasedcosts associated with being a publicly held company by 130 percent." [42] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 36 ,
  37. 37. PraiseFormer Federal Reserve Chairman Alan Greenspan praised the Sarbanes–Oxley Act: "I am surprised that the Sarbanes–Oxley Act, so rapidly developedand enacted, has functioned as well as it has...the act importantly reinforcedthe principle that shareholders own our corporations and that corporatemanagers should be working on behalf of shareholders to allocate businessresources to their optimum use.”[51]SOX has been praised by a cross-section of financial industry experts, citingimproved investor confidence and more accurate, reliable financialstatements. The CEO and CFO are now required to unequivocally takeownership for their financial statements under Section 302, which was notthe case prior to SOX. Further, auditor conflicts of interest have beenaddressed, by prohibiting auditors from also having lucrative consultingagreements with the firms they audit under Section 201. SEC ChairmanChristopher Cox stated in 2007: "Sarbanes–Oxley helped restore trust in by increasing accountability, speeding up reporting, and makingaudits more independent."[52] by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 37 ,
  38. 38. Legal challengesA lawsuit (Free Enterprise Fund v. Public Company Accounting Oversight Board) was filed in 2006 challengingthe constitutionality of the PCAOB. The complaint argues that because the PCAOB has regulatory powersover the accounting industry, its officers should be appointed by the President, rather than the SEC.[62]Further, because the law lacks a "severability clause," if part of the law is judged unconstitutional, so is theremainder. If the plaintiff prevails, the U.S. Congress may have to devise a different method of officerappointment. Further, the other parts of the law may be open to revision.[63][64] The lawsuit was dismissedfrom a District Court; the decision was upheld by the Court of Appeals on August 22, 2008.[65] JudgeKavanaugh, in his dissent, argued strongly against the constitutionality of the law.[66] On May 18, 2009, theUnited States Supreme Court agreed to hear this case.[67] On December 7, 2009, it heard the oralarguments.[68] On June 28, 2010, the United States Supreme Court unanimously turned away a broadchallenge to the law, but ruled 5–4 that a section related to appointments violates the Constitutionsseparation of powers mandate. The act remains "fully operative as a law" pending a process correction. by Dr.Rajesh Patel Director,nrv mba 1/29/2012 10:55:29 PM 38 ,
  39. 39. by Dr.Rajesh Patel Director,nrv mba1/29/2012 10:55:29 PM 39 ,
  40. 40. by Dr.Rajesh Patel Director,nrv mba1/29/2012 10:55:29 PM 40 ,
  41. 41. by Dr.Rajesh Patel Director,nrv mba1/29/2012 10:55:29 PM 41 ,