Introduction.................................................................................................................................... 2
The Problem ................................................................................................................................... 3
Sarbanes-Oxley Act ........................................................................................................................ 5
PCAOB - Public Companies Oversight Board ....................................................................... 5
Section 101.............................................................................................................................. 5
Section 102.............................................................................................................................. 5
Section 103.............................................................................................................................. 6
Section 104.............................................................................................................................. 6
Section 105.............................................................................................................................. 7
Section 106.............................................................................................................................. 7
Section 107.............................................................................................................................. 7
Section 108.............................................................................................................................. 8
Section 109.............................................................................................................................. 8
Auditor Independence .............................................................................................................. 8
Section 201.............................................................................................................................. 8
Section 202.............................................................................................................................. 9
Section 203.............................................................................................................................. 9
Section 204.............................................................................................................................. 9
Section 205.............................................................................................................................. 9
Section 206............................................................................................................................ 10
Sections 207, 208, and 209 ................................................................................................... 10
Corporate Responsibility........................................................................................................ 10
Section 301............................................................................................................................ 10
Section 302............................................................................................................................ 11
Section 303, 304, 305, 306, 307, 308.................................................................................... 12
Enhanced Corporate Disclosures .......................................................................................... 12
Section 401............................................................................................................................ 12
Section 402............................................................................................................................ 13
Section 403............................................................................................................................ 13
Section 404............................................................................................................................ 13
Section 405............................................................................................................................ 14
Section 406............................................................................................................................ 14
Section 407............................................................................................................................ 14
Section 408............................................................................................................................ 14
Analyst Conflict of Interest .................................................................................................... 15
Section 501............................................................................................................................ 15
Commission Resources and Authority .................................................................................. 15
Section 601............................................................................................................................ 16
Section 602............................................................................................................................ 16
Section 603............................................................................................................................ 16
Section 604............................................................................................................................ 16
Studies and Reports ................................................................................................................ 17
Section 701............................................................................................................................ 17
Section 702............................................................................................................................ 17
Section 703............................................................................................................................ 18
Section 704............................................................................................................................ 18
Section 705............................................................................................................................ 18
Corporate and Criminal Fraud Accountability ................................................................... 18
Section 801............................................................................................................................ 18
Section 802............................................................................................................................ 18
Section 803............................................................................................................................ 19
Section 804............................................................................................................................ 19
Section 805............................................................................................................................ 19
Section 806............................................................................................................................ 19
Section 807............................................................................................................................ 20
White Collar Crime Penalty Enhancements ........................................................................ 20
Section 901............................................................................................................................ 20
Section 902............................................................................................................................ 20
Section 903............................................................................................................................ 20
Section 904............................................................................................................................ 20
Section 905............................................................................................................................ 21
Section 906............................................................................................................................ 21
Corporate Tax Returns .......................................................................................................... 21
Section 1001.......................................................................................................................... 21
Corporate Fraud and Accountability ................................................................................... 21
Section 1101.......................................................................................................................... 21
Section 1102.......................................................................................................................... 22
Section 1103.......................................................................................................................... 22
Section 1104.......................................................................................................................... 22
Section 1105.......................................................................................................................... 22
Section 1106.......................................................................................................................... 22
Section 1107.......................................................................................................................... 23
Conclusions .................................................................................................................................. 23
References .................................................................................................................................... 28
Appendix ....................................................................................................................................... 29
Exhibit 1 - PCAOB registration form ................................................................................... 30
Exhibit 2 - Sample internal control questionnaire - expenditure cycle.............................. 31
Exhibit 3 - Sarbanes-Oxley compliance timeline ................................................................. 32
1
Introduction
The Sarbanes-Oxley Act of 2002 (SOX) was created as corporate reform legislation in response
to corporate fraud from “several high profile companies, such as, Enron, WorldCom, Tyco
International, and Adelphia Communications” [The Good]. In the past few years we have seen
five out of ten of the largest bankruptcies in the history of the United States. The SarbanesOxley Act of 2002 added many and changed many existing provisions of the federal securities
laws. The Act is to establish governance and ethical business practices over public corporations,
auditors, attorneys, brokers, investment bankers, and financial analysts. “The principal
objectives of the Act are to strengthen and restore confidence in the accounting profession,
strengthen enforcement of the federal securities laws, improve the executive responsibility, and
improve disclosure and financial reporting [Guerra].
This legislation will change the interaction and accountabilities between corporate executives,
auditors, boards of directors, and securities analysts. The regulatory environment has changed
due to the SOX legislation with the introduction of the Public Company Accounting Oversight
Board (PCAOB). Changes in the CPA profession have seen a split in the service offerings it
provides to public clients and increased accountability due to a required increase in audit
evidence and knowledge of internal control. Management responsibilities and accountability
have increased regarding knowledge of corporate financial statements and corporate internal
controls. New criminal penalties have also been imposed through this legislation.
The government has enacted several legislative packages to solve the problems that plague
corporate America. Corporations have been required to comply with numerous laws and social
2
requirements regarding standards and ethical behavior. However, every decade America is
plagued with new corporate scandals. What is the problem, what is the Sarbanes-Oxley Act, and
how will this new legislation begin to resolve the conflicts that arise as corporations continue on
in the future?
The Problem
Corporate governance has been around for over a century in the United States. In 1890 the
Sherman Act was enacted to stop corporations from becoming monopolies. The Securities Act
of 1933 was created to “prohibit deceit, misrepresentations, and other fraud in the sale of
securities” [Wikipedia]. The 1934 Securities Exchange Act created the Securities and Exchange
Commission (SEC), and empowered the SEC with broad authority over registration of securities,
regulation of public companies, and to oversee brokerage firms, transfer agents, and clearing
agencies to ensure fair business practices in the United States” [Huddart]. In the 1960’s we saw
the price-fixing crisis, the 1970’s we saw the foreign payment crisis and the insider trading crisis,
and in the 1980’s the RICO prosecutions and defense procurement fraud [The Good]. One
answer to these crises included the creation of the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in 1985. The committee was established as an independent
private sector initiative, which studied causal factors that can lead to fraudulent financial
reporting. COSO undertook an extensive study of internal control to establish a common
definition of internal control for companies, public accounting firms, legislators and regulatory
agencies. This should have provided solid frameworks of internal control to manage the way
companies operate. However, COSO was not an authoritative body and its recommendations
were not consistently used and implemented. Self-regulation has not been effective. Additional
laws have been enacted in response to these crises, and many more which have not been
3
mentioned. The collapse of corporations like Enron and WorldCom, which caused billions of
dollars of losses to investors, led to public outcry for more government protection. The
seriousness of these corporate misdeeds is promulgated because involvement was not only of
corporate executives, but also boards of directors, securities analysts, and CPA firms. According
to SEC Commissioner Harvey J. Goldschmid, “The corporate and financial scandals of the
1990’s and early 2000’s are the most serious that have occurred in this country since the scandal
of the Great Depression” [Guerra].
How did this happen again?
There were several problems that led to the creation of the Sarbanes-Oxley Act of 2002.
Executive compensation is grossly disproportionate to corporate results. Management would
misrepresent true earnings and financial conditions in order to gain stock options or bonuses.
Management teams placed their personal interests above investor demand. Passive, nonindependent boards of directors were made up of members selected by the CEO or chairman of
the board. In one instance WorldCom’s Board of Director’s authorized a $6 billion bid for
Intermedia Communications with only 2 hours notice during a telephonically organized meeting.
Investment bankers and investment analysts presented biased or non-independent company
information focusing only on increasing their profits. No corporate executive would give
investment-banking business to a financial institution after one of their securities analysts just
trashed their stock value. Public accounting firms generated so much revenue from consulting
services from corporations that a conflict of interest arose during attestation services. Some
firms went so far as to obstruct justice by concealing activities or destroying evidence [Guerra].
4
Will SOX be enough regulation to stop corporate fraud? What are the intended or unintended
consequences due to the enactment of Sarbanes-Oxley? Will these new regulations stop the
unethical/illegal behaviors that been seen throughout the last five years or just make it more
difficult for honest corporations to continue on in the future?
Sarbanes-Oxley Act
PCAOB - Public Companies Accounting Oversight Board
The Public Accounting Oversight Board (The Board) came into existence with Title One of the
Sarbanes-Oxley Act.
Section 101
Section 101 created the PCAOB and its governing rules. There are five full-time members on
the Board, but only two are certified public accountants. The other three members are noncertified public accountants. The Securities and Exchange Commission selects the members,
with input from the Chairman of the Board of Governors of the Federal Reserve System and the
Secretary of the Treasury.
Section 102
Section 102 requires that any public accounting firm that prepares or issues an audit report must
complete an application to register with the PCAOB (Exhibit 1). Each firm also must file an
annual report in order to maintain a current record with the Board. An initial registration fee and
an annual fee are required with each application.
5
Section 103
Auditing standards, quality control and independence standards, and rules are defined in Section
103. Auditing standards include: retaining relevant documents that support the audit report for
not less than seven years, providing a second review by a partner not associated with the audit,
and identifying the scope of tests of internal control by the auditor. The quality control standards
reflect upon the auditors ethical and independence standards when issuing an audit report. The
auditor must not have consulted with the client regarding accounting and/or auditing issues. The
audit must be properly supervised and the public accounting firm must employ professional
employees who have been properly trained and who will continue to receive proper training
regarding accounting/auditing issues and problems.
Section 104
If a public accounting firm completes audit reports for more than 100 issuers, then according to
Section 104, they are to be inspected annually. If there are less than 100 issuers, the public
accounting firm will be inspected at least once every three years. The PCAOB will provide all
public accounting firms with an inspection report prior to the inspection. The PCAOB will
randomly select and review audits completed by the public accounting firm. Each review will
evaluate the quality control, documentation, and communications systems of the client and the
public accounting firm. The Board will look for any activity or procedure that is in violation of
the Act. If any violation is found it will be reported to the SEC and the correct State Regulatory
Commission. A full investigation will then be undertaken. The PCAOB’s final written report
will include any notes, as well as any correspondence from the public accounting firm. All
confidential information would be withheld from the public report.
6
Section 105
Section 105 allows the PCAOB to investigate and take disciplinary actions toward any firm that
is in violation of the Act. Penalties for violation include:
1. Temporary suspension or permanent revocation of registration,
2. Temporary or permanent suspension or bar of a person from further association with a
registered public accounting firm,
3. Temporary or permanent limitation on activities, functions, or operations of the firm or
person,
4. Civil monetary penalty:
a) Not more than $100,000 for a natural person or $2,000,000 for any other person; and
b) If intentional, not more than $750,000 for a natural person or $15,000,000 for any
other person,
5. Censure,
6. Required additional professional education or training, or
7. Any other appropriate sanction provided for in the rules of the PCAOB [United States].
Section 106
Foreign public accounting firms that issue audit reports for U.S. listed companies are treated as if
they are U.S. public accounting firms. Under certain circumstances the foreign firm may be
exempt from the Act or parts of the Act.
Section 107
Section 107 dictates that the SEC will approve and/or amend all rules proposed by the Board.
The SEC will only approve rules that are in compliance with the Act and all securities laws that
are in the best interest of the general public or to protect corporate investors. At any time the
SEC may remove a member of the Board if they are in violation of the Act, fail to follow the
rules of the Board, or fail to comply with the laws set forth by the SEC. Abuse of authority or
failure to comply and enforce standards could also result in a member’s removal.
7
Section 108
Accounting standards are established in Section 108. The Board is charged with “keeping
standards current in order to reflect changes in the business environment, the extent to which
international convergence on high quality accounting standards is necessary or appropriate in the
public interest and for the protection of investors” [United States]. The PCAOB is also required
to submit annually their audited financial statements to the SEC and make them available to the
public. Also in this section the SEC is instructed to complete an analysis on the effect of moving
from a rules-based accounting system to a principles-based system.
Section 109
Section 109 creates the funding components of the PCAOB. The Board is required to generate a
budget each year that is approved by the SEC. Registration and annual fees will offset expenses.
The fees will not exceed the budget expenses. A scholarship program for undergraduate and
graduate students, who are enrolled in an accredited accounting degree program, will be funded
by the monetary penalties assessed by the Board.
Auditor Independence
Title Two of the Sarbanes-Oxley Act addresses an auditor’s independence in nine sections.
Section 201
Section 201 states that it is illegal for a registered public accounting firm to complete an audit for
any issuer if the accounting firm has completed any non-audit services for the issuer. Non-audit
services include: bookkeeping/services related to accounting records or financial statements;
design and implementation of financial information systems; appraisal/valuation services,
8
fairness opinions, or contribution-in-kind reports; actuarial services; internal audit outsourcing
services; management or human resources functions; broker/dealer, investment adviser or
investment banking services; legal/expert services unrelated to the audit; and other services that
the Board determines are not appropriate [United States].
Section 202
The audit committee of the issuer must approve all auditing and non-auditing services of a
registered accounting firm. In addition, the audit committee is required to reveal to investors any
non-audit services that an accounting firm has been requested to complete.
Section 203
Section 203 focuses on audit partner rotation. The lead audit partner and the reviewing audit
partner cannot perform or review an audit for a period of more than five consecutive years.
Section 204
An auditor is required to report to the audit committee on a timely basis:
1. All critical accounting policies and practices to be used,
2. All alternative treatments of financial information within generally accepted accounting
principles that have been discussed with management officials of the issuer, ramifications of
the use of such alternative disclosures and treatments, and the treatment preferred by the
registered public accounting firm, and
3. Other material written communications between the registered public accounting firm and
the management of the issuer (i.e. management letter or schedule of unadjusted differences)
[United States].
Section 205
The audit committee of an issuer is created by the board of directors and is composed of
members of the board of directors. The audit committee is responsible for supervising their
9
accounting and financial reporting processes, as well as any audits completed on their financial
statements.
Section 206
Conflicts of interest are addressed in Section 206. A registered public accounting firm is
prohibited from completing an audit for an issuer if the issuer’s chief executive officer,
controller, chief financial officer, chief accounting officer, or any other person serving in an
equivalent position was employed by the accounting firm and had any role in the audit of the
issuer during the one-year period preceding the current audit [United States].
Sections 207, 208, and 209
Sections 207, 208, and 209 focus on important, but lesser known parts of the Act. Section 207
calls for the Comptroller of the General Accounting Office to conduct a study on the outcome of
the mandatory rotation of registered public accounting firms. This study is to be reviewed by the
Committee on Financial Services of the House of Representatives. Section 208 states that it is
against the law for a registered accounting firm to issue an audit report if they are not in
compliance with the Act and Section 209 mandates that each State’s regulatory commission
monitor the non-registered public accounting firms of that state.
Corporate Responsibility
The responsibilities of corporations are listed in the eight sections of Title 3 of the Act.
Section 301
Section 301 outlines the duties and responsibilities of the audit committee. As stated previously,
the audit committee is responsible for supervising the accounting and financial reporting
10
processes of the accounting firm; each board of director member is independent of the
accounting firm; and, each accounting firm reports directly to the audit committee. The
committee is also responsible for the accounting firm’s compensation. Procedures for the
receipt, retention, and treatment of complaints received by the issuer regarding accounting,
internal accounting controls, or auditing matters and the confidential, anonymous submission by
employees of the issuer of concerns regarding questionable accounting or auditing matters are
handled under the direction of the audit committee as well [United States].
Section 302
Financial report standards are noted in Section 302. The principal executive officer and the
principal financial officer are to certify that:
1. The signing officer has reviewed the report,
2. The report does not contain any untrue statements of material fact or omit to state a material
fact necessary in order to not make the statements misleading, based upon the officer’s
knowledge,
3. The financial statements, and other financial information included in the report, fairly present
in all material respects the financial condition and result of operations of the issuer as of and
for the time presented in the report, based upon the officer’s knowledge,
4. The signing officers are responsible for establishing and maintaining internal controls; have
designed such internal controls to ensure that material information relating to the issuer and
its consolidated subsidiaries is made known to such officers by others within those entities;
have evaluated the effectiveness of the issuer’s internal controls as of a date within 90 days
prior to the report; and have presented in the report their conclusions about the effectiveness
of their internal controls based on their evaluation as of that date,
5. The signing officers have disclosed to the issuer’s auditors and the audit committee all
significant deficiencies in the design or operation of internals controls and any fraud that
involves management or other employees who have a significant role in the issuer’s internal
controls, and
6. The signing officers have indicated in the report whether or not there were significant
changes in internal controls or in other factors that could significantly affect internal controls
[United States].
11
Section 303, 304, 305, 306, 307, 308
If an officer, in any manner, acts fraudulently or tries to pressure, influence, or misinform the
auditor then they have violated Section 303. If an accounting firm is required to complete a restatement of financial documents due to material non-compliance, the officer or officers will be
required to reimburse the company for any bonuses, equity-based compensation, or profits
received in the twelve months following the date of the initial audit report (Section 304). The
SEC can block an individual from working as director or officer of a company if that person has
broken any anti-fraud laws (Section 305). Also, directors and officers will not be able to
purchase, sell, acquire, or transfer any equity security of the company during any blackout period
(Section 306). Section 307 establishes rules of conduct for attorneys appearing or practicing
before the SEC. Attorneys are to report any material violation of securities law to the company’s
chief legal counsel or chief executive officer, and if not acted upon by legal counsel or the
executive officer, the attorney is required to report the infraction to the audit committee of the
board of directors. Section 308 instructs the SEC to complete a study of events over the last five
years to determine appropriate restitution methods for injured investors.
Enhanced Corporate Disclosures
Title 4 sets forth the requirements for corporate disclosures, conflicts of interest, and assessment
of internal controls.
Section 401
All corrective material adjusting entries in accordance with GAAP identified by a registered
public accounting firm shall be reflected in the financial statements. Disclosure will be made for
12
any off-balance sheet transactions that have a current or future effect on the financial condition
of company operations.
Section 402
All direct or indirect personal loans or extension of credit to executives are prohibited.
Section 403
Directors, officers and principal stockholders who own more than 10 percent of any class of
security must file a statement of ownership at the time of registration of the securities, within 10
days after ownership of securities, or after a change in ownership of securities. Disclosure
contents include the amount of all equity securities and ownership of the securities at the date of
filing the disclosure.
Section 404
Section 404 prescribes management’s assessment of internal controls. A company’s annual
report is required to include an internal control report of management that includes the following:
1. A statement of management’s responsibilities for establishing and maintaining adequate
internal controls and procedures for financial reporting;
2. Conclusions about the effectiveness of the company’s internal controls and procedures for
financial reporting based on management’s evaluation of those controls; and
3. A statement that the registered public accounting firm that prepared or issued the company’s
audit report relating to the financial statements included in the company’s annual report has
attested to, and reported on, management’s evaluation of the company’s internal controls and
procedures for financial reporting.
See Exhibit 2 for an example of questions to be answered regarding the expenditure cycle that
would facilitate management establishment of internal controls.
13
Section 405
Any investment company registered under Section 8 of the Investment Company Act of 1940 is
not subject to sections 401, 402 or 404 [United States].
Section 406
Section 406 requires that a company disclose its code of ethics for senior financial officers. If
the company has not adopted a corporate code of ethics then the company must disclose reasons
for not adopting a corporate code of ethics. Changes in an established code of ethics or any
waiver of the code to a corporate officer must be immediately disclosed on Form 8-K.
Section 407
A public company is required to have at least one member that is considered a “financial expert”
on its audit committee. A financial expert as defined by SOX is someone with the following
knowledge:
1. An understanding of generally accepted accounting principles and financial statements;
2. Experience in preparation of auditing of financial statements of generally comparable issuers
and the application of such principles in accounting for estimates, accruals, and reserves;
3. Experience with internal accounting controls; and
4. An understanding of audit committee functions [United States].
Section 408
Section 408 requires the SEC to review corporate financial statements. The review shall include:
1. Financial statements of companies that have issued material re-statements of financial
results;
2. Companies that experience significant volatility in stock price compared to other companies;
3. Companies with the largest market capitalism;
4. Emerging companies with disproportionate price to earnings ratios;
5. Companies whose operations significantly affect any material sector of the economy; and
6. Any other factors the commission considers relevant [United States].
14
Analyst Conflict of Interest
Title 5 addresses conflicts of interest regarding security analysts.
Section 501
This section has several requirements in order to maintain independence and objectivity of
research and dissemination of information to investors. Section 501 also created several rules
regarding analyst protection and disclosure requirements.
Three main issues surround analyst protection. First, analysts are not to be subject to “prepublication” clearance by anyone not directly responsible for investment research. Brokers or
dealers are not to threaten or retaliate against analysts for an adverse research report that could
cause negative consequences to the broker or dealer. Brokers or dealers involved with a public
offering are not to distribute research reports related to the issuance of the securities.
Regarding disclosure, brokers or dealers must disclose any conflicts of interest in the research
reports provided by securities analysts. Disclosures must include whether the securities analyst
has any debt or equity investments in the securities be reported on, whether the analyst, broker or
dealer has received compensation from the issuer of the security, whether the issuer of the
security has ever been a client of the broker or dealer and the types of services provided, and
whether the securities analyst has been paid for services rendered for the research report.
Commission Resources and Authority
Title 6 discloses the resources and the authority of the Securities and Exchange Commission.
15
Section 601
The SEC has been authorized for an appropriation of $776,000,000 for fiscal year 2003. The
funds appropriated for 2003 were as follows: $102,700,000 for salaries and benefits;
$108,400,000 for information technology, security enhancements, and recovery and mitigation of
terrorist attack activities; and $98,000,000 for additional manpower resources for additional
supervision of auditors and audit services.
Section 602
If anyone is found not to have qualifications to represent others, to be lacking in character or
integrity, has behaved unethically, or has willfully violated or aided in the violation of any of the
securities laws they can be censured by the SEC.
Negligent conduct includes any registered accounting firm not conducting itself within the
boundaries of professional accounting standards. Any repeat offense in violation of professional
accounting standards can warrant denial of practice before the SEC.
Section 603
The court may stop any person from dealing with a broker, dealer or issuer in the issuance of
penny stock offerings.
Section 604
Section 604 states that the SEC has the authority to suspend the right of any person to be
associated with a broker or dealer of securities. It also gives a State’s commission the authority
to supervise or examine banks, savings associations, or credit unions [United States].
16
Studies and Reports
Title 7 of the Sarbanes-Oxley Act identifies five studies that are to be undertaken by various
government entities.
Section 701
The General Accounting Office is requested to identify: why numerous public accounting firms
have consolidated since 1989 (which reduced the number of firms available to complete audits
for large corporations); the impact on domestic and international capital formation and securities
markets; and any resolutions to problems discovered (especially methods of increasing
competition among accounting firms who are able to complete audits for large corporations).
The study is also to include the impact on corporations due to the decrease in competition among
accounting firms. Issues that are to be addressed include high costs, poor quality of service, lack
of auditor independence, and choice of auditors. In addition, Federal and State regulations are to
be studied to determine their effect on competition.
Section 702
According to Section 702 credit rating companies are to be studied by the SEC. The SEC is to
research the role credit rating agencies play in evaluating issuers of securities and how much
weight investors place on that information. Additionally, the SEC is to determine if there are any
barriers to entry for new credit rating agencies and to information resources.
17
Section 703
The SEC is required to complete a study on the number of securities professionals who have
been in violation of any securities law, identify who they are, which law/laws were violated, how
many times multiple violations occurred, and what, if any, disciplinary actions were taken.
Section 704
Areas of reporting that are vulnerable to fraud or manipulation are to be investigated by the SEC
for the time period from 1997-2001. Recommendations to correct any areas are to be included in
the report.
Section 705
The General Accounting Office is to determine if investment bankers and financial advisors
encourage companies to alter financial records to hide the actual condition of the company.
Corporate and Criminal Fraud Accountability
Title 8 of the Sarbanes-Oxley Act creates amendments to the United States Code to focus on the
criminal activities addressed in the Act and sets forth penalties for violation of the Act.
Section 801
Corporate and Criminal Fraud Accountability Act of 2002
Section 802
If anyone knowingly alters, destroys, covers up, or falsifies records during the course of a
Federal investigation, that person will be fined and/or imprisoned for not more than 20 years. An
auditor is required to maintain audit work papers for a period of five years after the audit is
18
completed. If the papers are destroyed, the auditor will be fined and/or imprisoned for not more
than 10 years.
Section 803
Section 803 states that any debt that is the result of fraudulent practices cannot be discharged if
the corporation declares bankruptcy.
Section 804
The statute of limitations for securities fraud is set in Section 804. Action regarding securities
fraud must be taken by the earlier of:
1. 2 years after discovering facts that indicate a violation, or
2. 5 years after the violation.
Section 805
This section directs the United States Sentencing Commission to review and/or amend the
Federal Sentencing Guidelines based upon possible violations of the Act. The punishments are
to be severe enough to keep the violations from reoccurring.
Section 806
Section 806 prohibits companies from discharging, demoting, or discriminating against any
employee who provides information regarding conduct the employee believes is in violation of
securities laws or fraud statutes. If an employer is found to be in violation, they must reinstate
the employee at the same level; they must reimburse the employee for all back pay with interest;
and they must pay the employee’s court costs, reasonable attorney fees, and any other damages
determined to be a result of the actions taken against the employee.
19
Section 807
Anyone who knowingly or attempts to defraud anyone involved with the securities of the issuer
will be fined and/or imprisoned for not more than 25 years.
White Collar Crime Penalty Enhancements
The six sections of Title 9 of the Sarbanes-Oxley Act outline additional penalties for violation of
the Act.
Section 901
White-Collar Crime Penalty Enhancement Act of 2002
Section 902
Section 902 states that anyone who attempts to commit fraud will be treated as if they had
committed fraud.
Section 903
The maximum penalties for mail and wire fraud have been increased from 5 years to 20 years.
Section 904
The penalty for violating the Employee Retirement Income Act of 1974 has also been changed.
Imprisonment is now for period of 10 years instead of 1 year and the fine has increased from
$100,000 to $500,000.
20
Section 905
This section directs the United States Sentencing Commission to review and/or amend the
Federal Sentencing Guidelines related to white-collar crimes. Once more, the punishments are to
be severe enough to keep the violations from reoccurring.
Section 906
Section 906 mandates that all reports filed by the issuer to the SEC include a statement from the
CEO and the CFO. The statement must state that the information complies with the
requirements of SEC and that the information is a fair representation of the financial condition of
the issuer. Failure to comply will result in a fine of not more than $1,000,000 and/or
imprisonment of not more than 10 years. Willful failure to comply will result in a fine of not
more than $5,000,000 and/or imprisonment of not more than 20 years.
Corporate Tax Returns
Section 1001
The Federal income tax return of a corporation is to be signed by the CEO of that corporation.
Corporate Fraud and Accountability
Title 11 of the Sarbanes-Oxley Act contains 7 sections that specify additional fines and prison
sentences for those who violate the Act.
Section 1101
Corporate Fraud Accountability Act of 2002
21
Section 1102
Anyone who intentionally alters, destroys, or conceals information from and/or for an official
proceeding will be fined and/or imprisoned for not more than 20 years.
Section 1103
If the SEC suspects that an issuer will make special payments to any employee under
investigation, the SEC can petition a Federal district court to place the funds in an escrow
account for a period of 45 days.
Section 1104
The United States Sentencing Commission is required to review and/or amend the Federal
Sentencing Guidelines related to corporate fraud. Once again, the punishments are to be severe
enough to keep the violations from reoccurring and be consistent with other jail sentences and
fines.
Section 1105
Section 1105 allows the SEC to bar anyone from serving as a director or officer if that person has
violated the rules and regulations of this title.
Section 1106
The fines and penalties for an individual in violation of the SEC Act of 1934 include:
1. Maximum fine of $5,000,000, and
2. Imprisonment of not more than 20 years.
The fines and penalties for an individual in violation of the SEC Act of 1934 include:
1. Maximum fine of $25,000,000, and
2. Imprisonment of not more than 20 years.
22
Section 1107
Anyone who interferes with another person’s employment or livelihood, while that person is
providing information in regards to a violation, will be fined and/or imprisoned for not more than
10 years.
Conclusions
What have been the intended or unintended consequences due to the enactment of SarbanesOxley? Will SOX be enough regulation to stop corporate fraud?
Some of the intended consequences have been an increase in active participation by boards of
directors and audit committees; an increase in criminal action, fines and penalties against those
who do not comply with SOX; and an increase in internal control procedure documentation and
attestation to those internal controls. Studies completed by governmental entities have provided
insight into what and who facilitated the breakdown in corporate controls. Increases in salaries
and auditing costs also have been an intended consequence of SOX regulation, even though this
is not a welcome consequence for most corporations. An increase in corporate disclosure is
another intended consequence as well.
One of the issues cited as problematic was non-independence of boards of directors, audit
committees and public accounting firms. Section 404 of SOX required that the board of
directors take an active role in effecting the process of internal control within a company. 86%
of Enron’s board of directors was independent. A former dean of the Stanford Business School
and professor of accounting chaired Enron’s audit committee [Berlau]. Enron’s board of
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directors and audit committee should inherently have been considered independent and true
representatives of Enron’s shareholders; however, their performance showed this was not the
case. This was evident when Enron’s Chairman authorized a waiver of Enron’s code of ethics to
its CFO to participate in partnerships, which cost Enron millions of dollars. Section 406 will
also mitigate situations such as these due to forced disclosure of any waiver of corporate codes of
ethics.
How has SOX affected the way the audit committees and board of directors operate within a
company? According to a survey done by Deloitte and Touche, LLP, “before Sarbanes-Oxley,
11 of 66 companies surveyed met more than six times per year. Since the Act, 39 companies
have met that frequently. Before the Act, half of the companies surveyed met for one hour or
less. Since the Act, only 10% have met for such a short time” [Koehn]. In addition, as more and
more pressure is being placed upon the board of directors to comply with SOX, their workloads
have increased significantly. However, there have only been small increases in compensation for
members according to a study by PricewaterhouseCoopers. The study indicated that only 20%
of board members received increases, while 47% remained the same. Compensation for audit
committee members remained the same for 41% of the companies surveyed, while 22% received
increases. In order to have a competent board of directors and audit committee, compensation
levels will need to be increased to reflect the level of work required. Garrett Stauffer, leader of
PricewaterhouseCoopers’ US Corporate Governance Practices, sums this all up, “The new
regulations have increase the time demands for audit committee members even more than for
other directors. Directors generally are not serving on boards because of the pay. However, with
the time commitment for board’s service increasing, compensation for directors will have to
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reflect the amount of effort involved” [Collins]. This shows that audit committees are working
more to facilitate monitoring the internal control process due to the enactment of SarbanesOxley. However, a consequence to the increased involvement is an increase in salaries,
therefore, an increased cost of doing business.
Richard Scrushy, former HealthSouth CEO, is the first corporate executive to face charges under
the Act. He faces 85 charges, including conspiracy to commit fraud, filing false financial
statements, money laundering, and securities and wire fraud [Taub], which are in violation of
several sections of the Act. This is a giant step in proving that increased regulation and penalties
for non-compliance of regulation is making considerable leaps towards improving behavior
regarding fair reporting practices.
One study completed by the SEC identified 1596 securities professionals who were in violation
of any securities law from 1998-2001. Registered representatives and branch managers of
broker-dealers comprised the largest group offenders. At least four more studies will be
completed to help provide information regarding the lack of controls within various
organizations.
A major increase in disclosure is another consequence of SOX due to sections 401-406
compliance. This includes disclosure of all corrective material adjusting entries, management
assessment of internal controls, and disclosure its code of ethics for senior financial officers. If
the company has not adopted a corporate code of ethics then the company must disclose reasons
for not adopting a corporate code of ethics. According to the 2004 CPA Journal the size of
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annual reports, quarterly filings, and proxy statements has increased significantly. General
Electric’s latest report is 160 pages, double the previous year, Kodak’s annual report is 45%
larger and General Motor’s report is 28% larger.
One of the biggest increases in costs is due to Section 404 compliance, which requires increased
documentation for internal control processes and the registered audit firm’s attestation for that
internal control. According to The CPA Journal, the cost of SOX compliance personnel will
increase 266.7% and accounting personnel will increase 105.3% due to this regulation alone.
Audit fees are expected to increase from 25% to 33% [Kroehn].
There have been several unintended consequences due to SOX compliance. One effect has been
contraction in the audit market. Public accounting firms are required to be registered with the
PCAOB as a condition for providing attestation services to public companies. Due to
registration costs and increased liability insurance costs, training costs, and liability risk, more
firms are weighing the option of not becoming registered with the PCAOB.
There has also been an increase in corporate executive D&O insurance premiums. Insurance has
increased by as much as 100% to 400%. In addition, if a company has restated earnings some
insurance companies will drop coverage altogether for corporate executives.
An increase in accounting education has been one beneficial unintended consequence of the Act.
Educational institutions are seeing an increase in attendance for accounting courses. Universities
are also focusing more on classes related to fraud. With the increase in audit work needed for
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SOX compliance, hopefully, individuals will enter the profession with more refined course work
to match today’s accounting environment.
There has been an increased awareness of compliance levels that must be met. Corporate
executives, boards of directors, audit committee personnel, public accounting firms, and
securities analysts are all becoming aware of the accountability that exists with each of their
positions. It does seem that Sarbanes-Oxley will be very expensive to set up and maintain in the
years to come. However, is it as costly as the decline in stock market, the loss of jobs due to
downsizing and bankruptcies because of inaccurate financial reporting, and the creditor losses
due to bankruptcies? Is Sarbanes-Oxley the answer to all the problems that have inundated
corporations? Only time will tell.
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References
Berlau, John. “Sarbanes-Oxley is Business Disaster.” Insight on the News. 13-16
February 2004: 24-26.
Collins, Pet. “Sarbanes-Oxley Making Directors Work Harder.” 28 January 2004.
<http://srimedia.com/artman/publis/printer_728.shtml>
“The Good, the Bad, and Their Corporate Codes of Ethics: Enron, Sarbanes-Oxley, and the
Problems with Legislating Good Behavior.” Harvard Law Review, May 2003: 2123+.
Guerra, Jorge E. “The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate Governance
Process. Part 1: Overview.” 1 February 2001. <www.imaknowledge.org/sox>
Guerra, Jorge E. “The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate Governance
Process. Part 2: What Went Wrong? Who were the transgressors? Why did this happen
again?” 1 February 2001. <www.imaknowledge.org/sox>?
Guerra, Jorge E. “The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate Governance
Process. Part 3: What Needs to Be Done Now.” 1 February 2001.
<www.imaknowledge.org/sox>
Guerra, Jorge E. “The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate Governance
Process. Part 4: Sarbanes-Oxley - A Giant First Step In The Right Direction.” 1 February
2001. <www.imaknowledge.org/sox>
Huddart, Steven. Penn State Smeal College of Business. 15 March 2004.
<www.smeal.psu.edu/faculty/huddart/OptionGlossary/SecuritiesExchangeAct34.shtml>
Koehn, Jo Lynn and Stephen C. Del Vecchio. “Ripple Effects of the Sarbanes-Oxley Act.” The
CPA Journal. February 2004: 36+.
Stelzer, Irwin M. “The Corporate Scandals and American Capitalism.” Public Interest.
Winter 2004: 19+.
Taub, Stephen. “Scrushy to Challenge Sarbox.” 11 December 2003. <http://www.cfo.com
/Printarticle/0,5317,11519\C,00,html?f=options>
United States. Sarbanes-Oxley Act of 2002. 107th Congress, Second Session. Washington. 23
January 2002.
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<http://en.wikipedia.org/wiki/Securities_Act_of_1933>
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Appendix
29
Exhibit 1 - PCAOB registration form
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Exhibit 2 - Sample internal control questionnaire - expenditure cycle
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Exhibit 3 - Sarbanes-Oxley compliance timeline
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