The Sarbanes-Oxley Act (SOX) was passed in 2002 in response to major corporate accounting scandals to increase transparency and accuracy in financial reporting. SOX established new or expanded standards for all U.S. public company boards, management, and public accounting firms. Key provisions addressed auditor independence, corporate governance, internal control assessment, and financial disclosure. SOX also strengthened criminal penalties for violation of securities law and increased criminal sentences for white-collar crimes like fraud.

1. 1 SARBANES-OXLEY ACT OVERVIEW August 23, 2010 Team One I2MBA11 Jeanetta Brown, Chris Caro, Brian Ignatowski, Matt Johnson, Bobby Reeder

2. 2 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

3. 3 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.

4. 4 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.

5. 5 Who enforces SOX? Public Company Accounting Oversight Board (PCAOB) Securities and Exchange Commission Intended to be somewhat Self-Regulating

6. 6 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.

7. 7 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

8. 8 Definitions / Key Components Internal vs. Independent Auditor Insider – 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

9. 9 Wow. Where do we start?? Section 101-109: Creation of PCAOB Established 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

10. 10 Major Sections of SOX: REPORTING Upgraded Disclosures KEY to SOX Executive 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)

11. 11 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 requirements Timing for public disclosures shortened

12. 12 Major Sections of SOX: ROLES Strengthened Corporate Governance KEY to SOX Increase 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)

13. 13 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”

14. 14 Major Sections of SOX: CONDUCT Expanded Insider Accountability KEY to SOX Unlawful 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

15. 15 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

16. 16 Major Sections of SOX: ENFORCEMENT Increased Oversight KEY to SOX All public accounting firms must register, pay fees, and supply info to PCAOB (101, 102) PCAOB to conduct investigations into audit company compliance (104)

17. 17 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)

18. 18 Major Sections of SOX: RELATIONSHIPS Heightened Auditor Independence KEY to SOX Prohibits ‘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)

19. 19 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)

20. 20 Major Sections of SOX:PENALTIES Broadened Sanctions KEY to SOX Forfeiture 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.

21. 21 PENALTIES Longer Statute of Limitations for private securities fraud lawsuits Increased Criminal Penalties Extends prison term for “knowingly defrauding” to 25 yrs Creates criminal penalties for destroying audit-related docs before record retention time period expires Amends US Sentencing Guidelines related to white-collar crimes, securities fraud, and accounting fraud Makes it more ‘personal’ to those committing the fraud/crimes

22. 22 Internal Controls Two certifications as to internal controls implemented by SOX Civil penalties Criminal penalties Sec 302 mandates a set of internal procedures to ensure accurate financial disclosure.

23. 23 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

24. 24 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

25. 25 Future of SOX Widely criticized for its far-reaching effects Making 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

26. 26 Future of SOX The result: SOX IS NOT GOING ANYWHERE!!

27. Many CPAs have become affectionate towards SOX Watch the Singing CPA in the You Tube video below 27 Future of SOX http://www.youtube.com/watch?v=n2ylBKOURtw&feature=player_embedded ¹ ¹ Steven Zelin, (12 July 2007), Singing CPA Sings Happy Birthday to Sarbanes-Oxley . YouTube. http://www.youtube.com/watch?v=n2ylBKOURtw&a.

28. 28 Resources for more detail on SOX www.legalarchiver.org/soa.htm = Full text of the statute SEC website SOX compliance personnel Corporate Legal Departments