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Before the signing ceremony of the Sarbanes-Oxley Act, President George W. Bush meets with Senator Paul Sarbanes, Secretary of Labor Elaine Chao and other dignitaries in the Blue Room at the White House on July 30, 2002.
The Sarbanes-Oxley Act of 2002 (Pub.L. 107-204, 116 Stat. 745, enacted 2002-07-30), 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 enacted on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollars when the share prices of the affected companies collapsed, shook public confidence in the nation\'s securities markets. Named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH), the Act was approved by the House by a vote of 423-3 and by the Senate 99-0. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt." (Elisabeth Bumiller: "Bush Signs Bill Aimed at Fraud in Corporations", The New York Times, July 31, 2002, page A1).
The legislation establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms. It does not apply to privately held companies. The Act contains 11 titles, or sections, ranging from additional Corporate Board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law. Debate continues over the perceived benefits and costs of SOX. Supporters contend that the legislation was necessary and has played a useful role in restoring public confidence in the nation\'s capital markets by, among other things, strengthening corporate accounting controls. Detractors contend that SOX was an unnecessary and costly government intrusion into corporate management that places U.S. corporations at a competitive disadvantage vis-a-vis foreign firms.
The Act establishes a new quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, which is charged with overseeing, regulating, inspecting, and disciplining accounting firms in their roles as auditors of public companies. The Act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.
Sarbanes-Oxley contains 11 titles that describe specific mandates and requirements for financial reporting. Each title consists of several sections, summarized below.
Title I establishes the Public Company Accounting Oversight Board , 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. Title I consists of nine sections.
Title II consists of nine sections, 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. Section 201 of this title restricts auditing companies from doing other kinds of business apart from auditing with the same clients.
Title III mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors 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. Title III consists of eight sections.
Title IV consists of nine sections. It 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.
Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest.
Title VI consists of four sections and defines practices to restore investor confidence in securities analysts. It also 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.
Title VII consists of five sections. These sections 701 to 705 are concerned with conducting research for enforcing actions against violations by the SEC registrants (companies) and auditors. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations and enforcement actions, and whether investment banks assisted Enron, Global Crossing and others to manipulate earnings and obfuscate true financial conditions.
Title VIII consists of seven sections and it 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.
Title IX consists of two sections. 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 offense.
Title X consists of one section. Section 1001 states that the Chief Executive Officer should sign the company tax return.
Title XI consists of seven sections. Section 1101 recommends a name for this title as “Corporate Fraud Accountability Act of 2002” . It identifies corporate fraud and records tampering as criminal offenses and joins those offenses 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 neutrality of this section is disputed. Please see the discussion on the talk page. This section has been tagged since December 2007. |
A variety of complex factors created the conditions and culture in which a series of large corporate frauds occurred between 2000-2002. The spectacular, highly-publicized frauds at Enron (see Enron scandal), WorldCom, and Tyco exposed significant problems with conflicts of interest and incentive compensation practices. These frauds and others resulted in over U.S. $500 billion in market value declines. The analysis of their complex and contentious root causes contributed to the passage of SOX in 2002. Specific contributing factors and events included:Farrell, Greg. "America Robbed Blind." Wizard Academy Press: 2005
The House passed Rep. Oxley\'s bill (H.R. 3763) on April 25, 2002, by a vote of 334 to 90. The House then referred the "Corporate and Auditing Accountability, Responsibility, and Transparency Act" or "CAARTA" to the Senate Banking Committee with the support of President George W. Bush and the SEC. At the time, however, the Chairman of that Committee, Senator Paul Sarbanes (D-MD), was preparing his own proposal, Senate Bill 2673.
Senator Sarbanes’s bill passed the Senate Banking Committee on June 18, 2002, by a vote of 17 to 4. On June 25, 2002, WorldCom revealed it had overstated its earnings by more than $3.8 billion during the past five quarters (15 months), primarily by improperly accounting for its operating costs. Sen. Sarbanes introduced Senate Bill 2673 to the full Senate that same day, and it passed 97-0 less than three weeks later on July 15, 2002.
The House and the Senate formed a Conference Committee to reconcile the differences between Sen. Sarbanes\'s bill (S. 2673) and Rep. Oxley\'s bill (H.R. 3763). The conference committee relied heavily on S. 2673 and “most changes made by the conference committee strengthened the prescriptions of S. 2673 or added new prescriptions.” (John T. Bostelman, The Sarbanes-Oxley Deskbook § 2-31.)
The Committee approved the final conference bill on July 24, 2002, and gave it the name "the Sarbanes-Oxley Act of 2002." The next day, both houses of Congress voted on it without change, producing an overwhelming margin of victory: 423 to 3 in the House and 99 to 0 in the Senate. On July 30, 2002, President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt." (Elisabeth Bumiller: "Bush Signs Bill Aimed at Fraud in Corporations", The New York Times, July 31, 2002, page A1).
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A significant body of academic research and opinion exists regarding the costs and benefits of SOX, with significant differences in conclusions. This is due in part to the difficulty of isolating the impact of SOX from other variables affecting the stock market and corporate earnings.Economist Article - "Five Years Under the Thumb" Conclusions from several of these studies and related criticism are summarized below:
Some have asserted that Sarbanes-Oxley legislation has helped displace business from New York to London, where the Financial Services Authority regulates the financial sector with a lighter touch. In UK non statutory Combined Code of Corporate Governance play somewhat similar role to SOX. However, a greater amount of resources are dedicated to enforcement of securities laws in the UK than in the US -- see Howell E. Jackson & Mark J. Roe, “Public Enforcement of Securities Laws: Preliminary Evidence,” (Working Paper January 16, 2007). The Alternative Investment Market claims that its spectacular growth in listings almost entirely coincided with the Sarbanes Oxley legislation. In December 2006 Michael Bloomberg, New York\'s mayor, and Charles Schumer, a U.S. senator, expressed their concern.Bloomberg-Schumer report
The Sarbanes-Oxley Act\'s effect on Non-US companies cross-listed in the US is different on firms from developed and well regulated countries than on firms from less developed countries according to Kate Litvak.http://papers.ssrn.com/sol3/papers.cfm?abstract_id=876624 Companies from badly regulated countries benefit from better credit ratings by complying to regulations in a highly regulated country (USA) that is higher than the cost, but companies from developed countries only incur the cost, since transparency is adequate in their home countries as well. On the other hand, the benefit of better credit rating also comes with listing on other stock exchanges such as the London Stock Exchange. However, the administrative cost of SOX is considered a drag on the productivity of capital regardless of the rate at which it is borrowed, and it is the financial catastrophes caused by the 2000 bubble market and subsequent scandals that forced the federal reserve to flood money into the market via lower interest rates.[citation needed]
Under Sarbanes-Oxley, two separate certification sections came into effect—one civil and the other criminal. (Section 302) (civil provision); (Section 906) (criminal provision).
Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are “responsible for establishing and maintaining internal controls” and “have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared.” . The officers must “have evaluated the effectiveness of the company’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.” Id..
Moreover, under Section 404 of the Act, management is required to produce an “internal control report” as part of each annual Exchange Act report. See . The report must affirm “the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting.” . The report must also “contain an assessment, as of the end of the most recent fiscal year of the Company, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.” Id. To do this, managers are generally adopting an internal control framework such as that described in COSO.
Under both Section 302 and Section 404, Congress directed the SEC to promulgate regulations enforcing these provisions. (See Final Rule: Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Release No. 33-8238 (June 5,2003), available at http://www.sec.gov/rules/final/33-8238.htm.)
External auditors are required to issue an opinion on whether effective internal control over financial reporting was maintained in all material respects by management. This is in addition to the financial statement opinion regarding the accuracy of the financial statements. The requirement to issue a third opinion regarding management\'s assessment was removed in 2007.
The most contentious aspect of SOX is Section 404, which requires management and the external auditor to report on the adequacy of the company\'s internal control over financial reporting (ICFR). This is the most costly aspect of the legislation for companies to implement, as documenting and testing important financial manual and automated controls requires enormous effort.
Both management and the external auditor are responsible for performing their assessment in the context of a top-down risk assessment, which requires management to base both the scope of its assessment and evidence gathered on risk. Both the PCAOB and SEC recently issued guidance on this topic to help alleviate the significant costs of compliance and better focus the assessment on the most critical risk areas.
The recently released Auditing Standard No. 5PCAOB Auditing Standard No. 5 of the Public Company Accounting Oversight Board (PCAOB), which superseded Auditing Standard No 2., has the following key requirements for the external auditor:
The recently released SEC guidance SEC Interpretive Guidance is generally consistent with the PCAOB\'s guidance above, only intended for management.
The cost of complying with SOX 404 impacts smaller companies disproportionately, as there is a significant fixed cost involved in completing the assessment. For example, during 2004 U.S. companies with revenues exceeding $5 billion spent .06% of revenue on SOX compliance, while companies with less than $100 million in revenue spent 2.55%.SEC Advisory Cmte. Report - See charts on pages 33-34.
This disparity is a focal point of 2007 SEC and U.S. Senate action.Dodd-Shelby Amendment The PCAOB intends to issue further guidance to help companies scale their assessment based on company size and complexity during 2007. The SEC issued their guidance to management in June, 2007.[1]
The financial reporting processes of many companies depend to some extent on IT systems. Therefore, Information technology controls that specifically address financial risks may be within the scope of a SOX 404 assessment. Chief information officers are typically responsible for the IT organization and IT personnel may be directly involved in SOX compliance efforts.
The SOX 404 guidance requires the usage of an internal control framework, such as the COSO framework. The IT Governance Institute\'s "COBIT: Control Objectives of Information and Related Technology" is also used by many companies as a framework supporting IT SOX 404 efforts. However, there are certain aspects of COBIT that are outside the boundaries of Sarbanes-Oxley regulation. IT application controls (i.e., transaction processing controls) that address specific material misstatement risks are a critical part of the SOX 404 assessment. However, the extent of SOX testing to perform related to IT General Controls (ITGC) has been a topic of contention.SEC Comment Letter Summary By nature, ITGC have an indirect effect on financial statements. The 2007 SEC guidance states: "...management only needs to evaluate those ITGC that are necessary for the proper and consistent operation of other controls designed to adequately address financial reporting risks." ITGC efforts will likely be carefully scrutinized in light of the new guidance, which encourages focus on the most critical financial risks.
Section 802(a) of the SOX, states:
| “ | Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both. | ” |
Section 1107 of the SOX states:Stephen M. Kohn, Michael D. Kohn, and David K. Colapinto (2004). Whistleblower Law: A Guide to Legal Protections for Corporate Employees. Praeger Publishers. ISBN 0-275-98127-4
| “ | Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offence, shall be fined under this title, imprisoned not more than 10 years, or both. | ” |
Robert Schmidt and Thomas Walsh had significant leadership roles at Levi Strauss & Co. (LS&Co), as directors of the global tax department.Robert Schmidt and Thomas Walsh v. Levi Strauss & Co., et al, U.S. District Court , Case 5:04-cv-01026-RMW (Northern District of California 03/12/2004) While employed by LS&Co. in that capacity, they were instructed to withhold material documents from the IRS and to limit information to LS&Co.’s new auditor, KPMG. Schmidt and Walsh refused, advising their supervisors that they would not be a party to fraud. On December 10, 2002, LS&Co. summarily fired the two directors. LS&Co.’s termination of Schmidt and Walsh occurred approximately five days before KPMG arrived on site to conduct a comprehensive audit of the company. The trial in this litigation is scheduled to start March 31, 2008 in the US District Court in San Francisco, California.
Gerald R. Brookman was hired by LS&Co. on January 18, 2005 as an IMS/DB2 systems programmer at the company\'s Westlake, Texas IT facility, at a starting yearly salary of $85,000.Gerald R Brookman v. Levi Strauss & Co, U.S. Department of Labor , Case 2006-SOX-36 (Office of Administratrive Law Judges 11/14/2006) When the Sarbanes-Oxley Act (SOX) audit conducted by E&Y in 2Q05 revealed major deficiencies, senior LS&Co. management ordered Brookman and others to conceal these problems from KPMG. On October 20, 2005, Brookman and all six employees of the transportation department in the Little Rock, Arkansas nationwide distribution center were terminated. LS&Co.’s termination of Brookman and the "Little Rock Six" occurred approximately four days before KPMG arrived on site to conduct an audit. A civil RICO federal lawsuit has been filed against LS&Co. on behalf of Brookman, the "Little Rock Six", and 74 other LS&Co SOX whistleblowers who were terminated in 2005.
Detractors such as congressman Ron Paul contend that SOX was an unnecessary and costly government intrusion into corporate management that places U.S. corporations at a competitive disadvantage with foreign firms, driving businesses out of the United States. In an April 14, 2005 speech before the U.S. House of Representatives, Paul stated, "These regulations are damaging American capital markets by providing an incentive for small US firms and foreign firms to deregister from US stock exchanges. According to a study by the Wharton Business School, the number of American companies deregistering from public stock exchanges nearly tripled during the year after Sarbanes-Oxley became law, while the New York Stock Exchange had only 10 new foreign listings in all of 2004. The reluctance of small businesses and foreign firms to register on American stock exchanges is easily understood when one considers the costs Sarbanes-Oxley imposes on businesses. According to a survey by Kron/Ferry International, Sarbanes-Oxley cost Fortune 500 companies an average of $5.1 million in compliance expenses in 2004, while a study by the law firm of Foley and Lardner found the Act increased costs associated with being a publicly held company by 130 percent." Repeal Sarbanes-Oxley! Ron Paul, April 14, 2005
In a February 29, 2008 opinion column for WorldNetDaily, Ilana Mercer wrote, "The Sarbanes-Oxley Act of 2002, courtesy of the Republican Party, cost American companies upwards of $1.2 trillion. The capital flight it initiated caused the London Stock Exchange to become the new hub for capital markets." U.S. in the red and getting redder Ilana Mercer, February 29, 2008
Additional complaints have been documented in The Wall Street Journal:http://online.wsj.com/article/SB120398754592392261.html?mod=hps_us_at_glance_opinion
| “ | [Intended reform was among] the mistakes of Sarbanes-Oxley. "Reform" of the accounting industry ended up being a gold mine for the very auditing firms that Congress wanted to punish, as a few megafirms thrive in a more regulated market. | ” |
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