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COMPLIANCE
& SOX
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SARBANES-OXLEY ACT
At Issue
 If the governance of the modern corporation
isn’t completely broken, it is going through a
severe crisis of confidence. At risk is the very
integrity of capitalism.
 Directors who fail to direct and CEOs who fail
at moral leadership are arguably the most
important challenge facing corporate America
today.
Business Week (May 6, 2002)
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SARBANES-OXLEY ACT
The Solution Starts At Home
 The recent corporate collapses have involved many
breakdowns: in ethics, in trust, in common sense,
to name a few. But perhaps the most troubling
breakdown is in corporate oversight.
 Directors, senior executives, and Wall Street
analysts all failed miserably by missing – or
concealing – danger signals until it was too late.
 Regulators will no doubt have plenty to say on the
issue, but the most zealous reformers should be
the companies themselves.
Fortune (May 27, 2002)
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CORPORATE GOVERNANCE
STANDARDS
 1900: NYSE requires distribution of annual reports
to stockholders
 1909: NYSE requires annual stockholders’ meeting
 1926: NYSE adopts “one share, one vote” standard
 1929: Stock market crash
 1932: Increased financial disclosure and
independent audits become mandatory
 1934: SEC is formed
 1955: Shareholder approval required for certain
corporate acquisitions
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CORPORATE GOVERNANCE
STANDARDS
 1968: AMEX publishes first guide establishing
listing standards
 1977: NYSE requires establishment of an audit
committee comprised of independent
directors
 1985: NASDAQ initiates its first corporate
governance listing standards
 1987: Treadway Commission (COSO) established
to define responsibilities of the auditor in
detecting and preventing fraud
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CORPORATE GOVERNANCE
STANDARDS
 1999: NYSE/AMEX/NASD adopt new rules based
on Blue Ribbon Committee on Improving the
Effectiveness of Audit Committees
 2002: Sarbanes-Oxley Act (July 30, 2002)
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SARBANES-OXLEY
Major Objectives
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Improve corporate governance
Reform public accounting (auditing)
Reform Wall Street practices
Attack insider trading and obstruction of
justice (document retention)
“Restore confidence in capital markets”
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SARBANES-OXLEY ACT
Major Provisions
 Title I:
Public Company Accounting
Oversight Board
 Title II: Auditor Independence
 Title III: Corporate Responsibility, Disclosure,
and Governance
 Title IV: Enhanced Financial Disclosures
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SARBANES-OXLEY ACT
Other Provisions
 Title V
 Title VI
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– Analyst Conflicts of Interest
– Commission (SEC) Resources
and Authority
Title VII – Studies and Reports
Title VIII – Corporate and Criminal
Fraud Accountability
Title IX – White-Collar Crime Penalty
Enhancements
Title X
– Corporate Tax Returns
Title XI - Corporate Fraud and Accountability
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PUBLIC COMPANY
ACCOUNTING OVERSIGHT BOARD
 Established by Sarbanes-Oxley
 Broad powers to regulate audits
and auditors of public companies
 Appointed by the SEC
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PCAOB
 Register public accounting firms
 Establish auditing standards
 Inspect registered public accounting
firms
 Conduct investigations and disciplinary
proceedings – with ability to sanction
auditors and audit firms
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AUDITOR INDEPENDENCE
 Prohibits certain “nonaudit services”
– Bookkeeping, financial systems design, appraisal or
valuation, actuarial, internal auditing outsourcing,
management or human resources, broker-dealer or
investment banking, others per PCAOB
 Audit committee must pre-approve all
auditing and non-auditing services
 Audit partner rotation
– Audit firm rotation was discussed
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AUDITOR INDEPENDENCE
 Audit Committee is directly responsible for
oversight of external auditors
 Auditor required to discuss
– All critical accounting policies and practices
– All alternative accounting and disclosure
treatments
– Other material written communications
 “Cooling – off” period
– CEO, CFO, Controller, etc.
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CORPORATE RESPONSIBILITY &
GOVERNANCE
 Audit Committee = independent directors
 Audit Committee has responsibility to appoint,
compensate, and oversee public accounting firm
performing the audit
 Audit Committee has responsibility to resolve
disagreements over financial reporting between
management and external auditors
 Audit Committee must establish “whistle-blower”
procedures
– New penalties for retaliation against them
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CORPORATE RESPONSIBILITY &
GOVERNANCE
 Requires executives and financial officers
(CEO & CFO) to certify financial reports are
accurate, complete and fairly presented
 Also must certify the state of internal controls
 Outlaws improperly influencing the auditor
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CORPORATE RESPONSIBILITY &
GOVERNANCE
 Reimbursement of bonuses and profits if
public was misled
 Removal of “substantial unfitness” standard
 Prohibits trading during a pension “blackout”
period
 Minimum standards for attorneys
– Both in-house and outside counsel
 Any reimbursed funds from guilty parties be
added to a fund for the benefit of victims
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ENHANCED FINANCIAL
DISCLOSURES
 Off-balance sheet arrangements and obligations
 Prohibits loans to executives and directors
 Insider trades within two business days
 Adoption of code of ethics for senior financial officers
and requirements
 Whether at least one member of the audit committee is
an “Audit Committee Financial Expert”
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ENHANCED FINANCIAL
DISCLOSURES
 Reconciliation of non GAAP revenue to most
directly comparable GAAP measure
 Requires management to establish and maintain
adequate internal controls and report annually
on:
– Management’s responsibility for such
– Effectiveness of such internal controls
 Assessment of internal controls by management
is to be subject of an attestation report by the
external auditor
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PRIVATE COMPANIES
Who Should Adopt SOX
 May soon go public
 Contemplating a combination with a
public company
 Large Not-for-profit entities
– Audit committees becoming common
 Significant absentee owners
 Creditors may require SOX
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PRIVATE COMPANIES
What parts of SOX?
 More than internal controls
 Independent audit committees
– “Financial expert”
– Compensation & funding of committee
– Approval of nonaudit services
 Certification of financial statements
 Codes of ethics
 Whistle-blower procedures and
protections
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CORPORATE AMERICA
After SOX
 Must have autonomous & vigorous audit committees
– “Take charge”
 Financial information is inherently judgmental
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Financial statements are NOT precise
Users must appreciate this fact
FMV reporting will increase volatility
Non-financial disclosures will become more important
Auditors’ opinions on overall “fairness” of statements
Financial reporting should be as clear and concise as
possible
Committee for Economic Development
March 28, 2006
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CORPORATE AMERICA
After SOX
Give SOX (esp. 404) a chance to work
– PCAOB has issued new guidelines
– Learning curve effects
 Excessive executive compensation can be
tamed by Compensation Committees
 Directors must be selected and appraised by
independent nominating committees
– Issue of Non-Executive Chair
– Direct nomination by shareholders
Committee for Economic Development
March 28, 2006