Sarbanes-Oxley Act
SOX
Logan Cousins, Jordan Hensberger, Darren Kilby,
Emily Messer, Ben Sweger
● Auditing Conflicts of Interest
○ Prior to SOX, auditing firms were
self-regulated and many firms also
performed consulting work for firms
they audited
Pre-SOX Issues
● Boardroom mistakes
○ Executives either did not fulfill
responsibilities or were inadequately
prepared to understand the
complexities of the business
○ Audit committees not independent
of management
● Low funding from SEC
○ SEC was not putting enough money
into enforcement and rule-making
of financial reporting(Budget has
since doubled)
● Executive Stock Compensation
Pre-SOX Issues
(Cont’d)
○ High pressures to make earnings in
order for stock price to go up, and
therefore compensation to go up
○ Stock options not treated as
compensation expense, encouraging
use
● Troubled Bank Loans
○ Big banks loaned money to several
big name companies that appeared
to be doing well but weren’t
○ Led to investors being falsely led to
invest in failing companies
(Enron….)
Enron Scandal Background
● Energy company that also
provided financial/risk
management services to clients
● One of top 10 largest energy
companies in world in late
90’s/early 2000’s
● Stock price peaked at $90 in
August of 2000
● Top executives Ken Lay and
Jeffrey Skilling pocketed over
$100 million in combined
compensation in 2001 before...
Enron Scandal How did this
happen?
http://www.thebusinessowner.com/businessguidance/fraud-business-guidance/2013/07/the-fraudtriangle-2
Enron Scandal Downfall
● In August of 2001, then VP
Sherron Watkins alerts Ken Lay
about potential accounting issues
● In October of 2001, Enron
reported a loss of over $600
million
● By December 2001, Enron had
filed for bankruptcy and SEC
had already opened up formal
investigation into accounting
fraud at Enron
Enron Scandal Consequences
● Thousands of workers not only
lost jobs but had worthless stock
in pensions
● Investors lost over $60 billion
within a matter of days
● Complete lack of trust in
financial assurance of companies
● Downfall of Arthur Andersen
● SOX
Framework
● SOX only enforced on Publically
Traded Companies
● Created PCAOB – Public Company
Accounting Oversight Board
● The SEC -> PCAOB -> Public
Companies
● Audit Committee – Group selected from
company’s Board of Directors to focus on
audit process
Audit Committee
● SOX created strict rules for Audit
Committee’s of Public Companies:
○ Selects Independent Auditor
○ Oversight Financial Reporting process
○ Reviews SEC Filings (10-Q, 10-K, 8-K)
○ Oversee internal and external auditors
to limit risks
Code of Conduct
●
SOX forced public companies to create a
Code of Conduct
●
Code must be on company’s website or
in filings with SEC
●
Code must consist of:
○
Honest Behavior
○
Ethical actions during conflicts of
interest
○
Accurate financial disclosures
○
Compliance with all rules and
regulations
Document
Retention
●
SOX has implemented policies on how long
certain types of documents must be retained
for
●
Documents include electronic copies
●
Most documents have to be retained for at
least 7 years
●
Certain documents must be retained forever:
○
Stock ownership records
○
Bank statements
○
Training manuals
○
Contracts
•
•
Certification
Requirement
Required by the CEO and CFO of
publicly traded companies
Certify:
o Quarterly and annual reports
o Internal control functionality
o Inform Audit Committee and
outside auditors of material
weaknesses
o Inform Audit Committee and
outside auditors of any fraud
o Identify necessary changes in
internal controls
SOX
Disallowances
• Incentive-Based Compensation
o Claw-back provision
• Company Provided Loans
• Coercion
• Whistleblower Retaliation
o Protection
o Including: discharging,
demoting, suspending,
threatening, harassing, or in
any other manner
discriminating
PCAOB
Public Company Accounting Oversight
Board
• Overseen by the SEC
• Establish audit standards and
ethics rules
o Used ASB standards as
foundation
• Registration Process
o Application
o Approval
o Fees
• Inspection and Discipline of
CPA firms
•
•
Independence
•
•
•
AICPA Code of Conduct
Concurring Auditor Opinions
o Engagement
review/Concurring partner
o Evaluate engagement’s actions
Auditor Rotation
o Partner Rotation
o Audit Firm Rotation International
Waiting period
o Revolving door policy
o Cooling-off period
Performance of Nonaudit services
Impact on Other
Corporations
• High costs of compliance
associated with
o Internal control
o Increased legal fees
o Increased personal liability
obligations
• The burdens of the SOX have
forced many smaller public
companies to consider going
private.
•
Impact on Other
Service Lines
•
•
Accounting firms had to limit the
number of services they could
provide to one client
Tax services
o If a CPA firm also provides
audit services to a public client,
tax services must be preapproved by the client’s audit
committee
Advisory services are more in
demand to help companies
implement a SOX 404 compliance
plan to adhere to internal controls
requirements
Impact on
Privately Held
Companies
•
•
•
Recommended that Companies
thinking about going public should
adopt SOX governance practices
Lenders and investors are requesting
more detailed financial disclosures
because SOX has become a
benchmark at which every
company’s F/S will be measured
Private and non-profits have
adopted similar whistleblower
policies to public companies
Impact on
Investors
•
•
•
•
Risk management
Reduced fraud risk
Enhanced governance
Strengthened controls
All of these have resulted from
implementation of SOX
Their purpose: to strengthen investor
confidence.
• Sox has cut opportunities for
corporations to defraud institutional
and individual investors
The Economist. “Five years under the thumb.” (2007)
Five Years
Post-Sox
Negatives
• Estimated law costs exceed any benefits by
$1.4 trillion
• Firms have significantly reduced their
investment R&D and overall capital spending
• Firms are increasing their holdings of cash
• Successful whistleblowing by employees fell
(from 20.7% to 15.6% success rate)
Positives
• Serious frauds discovered by auditors rose to
about 50%
• Costs of complying with SOX are coming
down
Ten Years
Post-Sox
John Coates & Suraj Srinivasan. “Sox after Ten
Years: A Multidisciplinary Review.” (2014)
Negatives
• Only 32.4% of firms reported an internal
control weakness when it actually existed
• More companies “going dark” & fewer
IPOs in the 2000s
• Audit fees increased by 74-86% by 2006
Positives
• Other countries adopting SOX-like
regulations
• Lower tendency to meet forecasts by
managing earnings
SOX During
Financial Crisis:
Negative Effects
John Coates & Suraj Srinivasn. “Sox after Ten Years: A
Multidisciplinary Review.” (2014)
Was SOX effective during financial crisis?
Clean Audit Report
Failure/Bailout
Bear Sterns
January 28
March 14
Thornburg
February 27
March 4
Northern
Rock
July 25
September 14
US Bancorp
February 20
November 14
Conclusion:
Auditor’s may not been able to prevent financial
crisis, but definitely had the chance to warn
investors these companies were about to go under
SOX During
Financial Crisis:
Positive Effects
Evidence that suggest SOX improved
some banks’ situations
• Banks with fully independent
audit committees performed
better
• Bank with auditors who
specialized in banking were less
likely to fail
Questions?
The Economist. “Five years under the thumb.” (2007).
http://www.economist.com/node/9545905
Coates, John & Srinivasan, Suraj. Accounting Horizons, Forthcoming.
“Sox after Ten Years: A Multidisciplinary Review.” (2014).
http://ssrn.com/abstract=2379731
Klein, G. (2016). Ethics in Accounting: A Decision-Making Approach.
Hoboken, NJ:Wiley.
References
One Year Later, The Impact Of Sarbanes-Oxley. (n.d.). Retrieved
November 28, 2015, from
http://www.forbes.com/2003/07/22/cz_af_0722sarbanes.html
NACD Library. (n.d.). Retrieved November 27, 2015, from
https://www.nacdonline.org/Resources/Article.cfm?ItemNumber=564
Lowengrub, P. (2005, December 6). The Impact Of Sarbanes Oxley On
Companies, Investors, & Financial Markets. Retrieved November 28,
2015, from http://www.s-ox.com/dsp_getfeaturesdetails.cfm?cid=1141
Cushwaha, R. (2004, January 16). The Impact of Sarbanes-Oxley on
Corporate Tax Departments. Retrieved December 1, 2015, from
http://www.accountingweb.com/practice/practice-excellence/theimpact-of-sarbanes-oxley-on-corporate-tax-departments