4th session:
Corporate Governance – Sarbanes Oxley
Performance Evaluation
IMSc in Business Administration
October-November 2008
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• Corporate Governance
– Sarbanes-Oxley
– “Five years under the thumb”
– Auditing Profession
• Financial Performance Measures
– Earnings per Share
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Sarbanes-Oxley
• The Sarbanes-Oxley Act of 2002, also known
as the Public Company Accounting Reform
and Investor Protection Act of 2002 and
commonly called SOX or Sarbox; is a United
States federal law signed into law on July 30,
2002 in response to a number of major
corporate and accounting scandals including
those affecting Enron, Tyco International,
Peregrine Systems and WorldCom.
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TITLE I - “Public Company
Accounting Oversight Board
(PCAOB)”
• PCAOB to provide independent oversight of
public accounting firms providing audit services
("auditors"). It also creates a central oversight
board tasked with registering auditors, defining
the specific processes and procedures for
compliance audits, inspecting and policing
conduct and quality control, and enforcing
compliance with the specific mandates of SOX.
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TITLE II - “Auditors
Independence”
• Establishes standards for external auditor
independence, to limit conflicts of interest. It
also addresses new auditor approval
requirements, audit partner rotation policy,
conflict of interest issues and auditor reporting
requirements. This title restricts auditing
companies from doing other kinds of business
apart from auditing with the same clients.
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TITLE III - “Corporate
Responsibility”
• This title mandates that senior executives take
individual responsibility for the accuracy and
completeness of corporate financial reports. It
enumerates specific limits on the behaviours of
corporate officers and describes specific forfeitures of
benefits and civil penalties for non-compliance. For
example, Section 302 implies that the company board
(Chief Executive Officer, Chief Financial Officer)
should certify and approve the integrity of their
company financial reports quarterly. This helps
establish accountability.
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TITLE IV - “Enhanced Financial
Disclosures”
• Title IV describes enhanced reporting requirements for
financial transactions, including off-balance sheet
transactions, pro-forma figures and stock transactions
of corporate officers. It requires internal controls for
assuring the accuracy of financial reports and
disclosures, and mandates both audits and reports on
those controls. It also requires timely reporting of
material changes in financial condition and specific
enhanced reviews by the SEC or its agents of corporate
reports.
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TITLE V - “Analyst Conflicts of
Interest”
• Title V defines the codes of conduct for
securities analysts and requires disclosure of
knowable conflicts of interest.
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TITLE VI - “Commission
Resources and Authority”
• Title VI defines the SEC’s authority to censure
or bar securities professionals from practice and
defines conditions under which a person can be
barred from practicing as a broker, adviser or
dealer.
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TITLE VII - “Studies and
Reports”
• Title VII is concerned with conducting research
for enforcing actions against violations by the
SEC registrants (companies) and auditors.
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TITLE VIII - “Corporate and
Criminal Fraud Accountability”
• Title VIII is also referred to as the “Corporate
and Criminal Fraud Act of 2002.” It describes
specific criminal penalties for fraud by
manipulation, destruction or alteration of
financial records or other interference with
investigations, while providing certain
protections for whistle-blowers.
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TITLE IX - “White Collar Crime
Penalty Enhancement”
• This section is also called the “White Collar
Crime Penalty Enhancement Act of 2002.” This
section increases the criminal penalties
associated with white-collar crimes and
conspiracies. It recommends stronger sentencing
guidelines and specifically adds failure to certify
corporate financial reports as a criminal offence.
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TITLE X - “Corporate Tax Returns”
• Title X consists of one section, which states that
the Chief Executive Officer should sign the
company tax return.
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TITLE XI - “Corporate Fraud
Accountability”
• Also known as “Corporate Fraud Accountability
Act of 2002” . It identifies corporate fraud and
records tampering as criminal offences and joins
those offences to specific penalties. It also
revises sentencing guidelines and strengthens
their penalties. This enables the SEC to
temporarily freeze large or unusual payments.
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The Certified Public Accountant and the
Auditor’s Opinion
• An audit is an examination of a company’s
transactions and the resulting financial
statements
• The auditor’s opinion describes the scope and
results of the audit and a judgment that the
financial statements prepared by management
are accurate
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Public Accounting Firms
• The four largest public accounting firms are
– Deloitte Touche Tohmatsu
– Ernst & Young
– KPMG International
– PricewaterhouseCoopers
• 97% of the firms listed on the NYSE are clients
of these four firms
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Public Accounting Firms
• Each firm has annual billings in excess of $1
billion
• All firms must follow generally accepted
accounting principles (GAAP)
– The broad concepts and detailed practices of
preparing and distributing financial statements
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Sarbanes-Oxley Act
• Established the Public Company Accounting Oversight
Board to regulate public accounting and to set
standards for audit procedures through the issuance of
generally accepted auditing standards (GAAS)
• Prohibits public accounting firms from providing audit
clients with certain non-audit services
• Requires rotation every 5 years of the lead audit or
coordinating partner and the reviewing partner on an
audit
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Sarbanes-Oxley Act
• Provides regulation of corporate governance
– Requiring boards to appoint an audit committee composed
only of “independent” directors
– Requiring CEOs and chief financial officers (CFOs) to
personally sign a statement certifying the appropriateness and
fairness of their companies’ financial statements
– Increasing criminal penalties for knowingly misreporting
financial information
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Professional Ethics
• Members of the AICPA must abide by a code of
professional conduct
• The Institute of Management Accountants has a code
of ethics for management accounts
• Auditors and management accountants have
professional responsibilities concerning competence,
confidentiality, integrity, and objectivity
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Professional Ethics
• Ethical standards are personal and depend on
the values of the individual
• A successful manager must recognize the ethical
dimensions of a situation and act with absolute
integrity
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Professional Ethics
• Despite the criticism of accounting ethics, accountants
were responsible for revealing the problems in many of
the recent corporate scandals
• Companies often rely on accountants to safeguard the
ethics of the company
• WorldCom and Enron whistle-blowers became two of
the three 2002 Persons of the Year in Time magazine
(Cynthia Cooper of Worldcom and Sherron Watkins of
Enron)
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