This article focuses on:-

What is SOX?

Background and

objective

Elements of the Act

Key Provisions

Indian Perspective

Success and Criticism

Exemptions under

JOBS Act, 2012

Takeaway

A Synopsis on

Sarbanes Oxley

Act, 2002

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What is Sarbanes Oxley Act?

The Sarbanes–Oxley Act of 2002 (‘SOX’ or

‘the Act’) is a United States federal law that

set new or expanded requirements for all

U.S. public company boards, management and public

accounting firms.

The Act contains eleven titles varying from

additional corporate board responsibilities to

criminal penalties, and requires the Securities

and Exchange Commission (SEC) to

implement rulings on requirements to obey

with the law.

The Act majorly covers issues such as auditor independence, corporate governance, internal

control assessment and enhanced financial disclosure.

Why it was named as Sarbanes-Oxley Act?

The Act is called Sarbanes-Oxley Act because it was sponsored by U.S. Senator Paul Sarbanes (D-

MD) and U.S. Representative Michael G. Oxley(R-OH).

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Background

A variety of complex factors created the

atmosphere in which a series of large

corporate frauds occurred between

2000–2002. The spectacular, highly

publicized frauds at Enron, WorldCom

and Tyco exposed significant problems

with conflicts of interest and incentive

compensation practices.

The US capital markets were shaken by

disclosure of financial misconduct at

numerous major companies. The

damage to investors, pensioners,

communities and markets was notable.

Corporate executives were behind the

bars. One of the nation’s largest

companies and one of the largest audit

firms were closed. Confidence in

financial markets was shaken to the

root.

The analysis of their complex and

debatable root causes contributed to the

passage of SOX in 2002.

Objective behind the Enactment

After, highly publicized frauds at Enron, WorldCom, and Tyco, public

started losing confidence in financial reporting.

So, in order to restore public confidence in the reliability of financial

reporting, to mandate strict reforms to improve financial disclosures from

corporations and to prevent accounting fraud, the US Senate and House of

Representatives passed the Sarbanes-Oxley Act of 2002, by votes of 99-0

and 423-3, respectively, sending it to President George W. Bush, who

signed the reform measure into law on July 30, 2002.

SOX intended to:-

Strengthen corporate governance,

Independent oversight of public company audits,

Strengthen audit committees,

Enhanced auditor independence,

Enhanced transparency,

Enhanced executive accountability,

Upgraded investor protection,

Internal control assessment,

Improved audit quality,

Increased reliability of financial reporting,

Enhanced financial disclosures, etc

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Elements of the Act

The Act is divided into 11 titles containing various

sections. These titles are as follows:-

PCAOB

Auditor Independence

Corporate Responsibility

Enhanced Financial Disclosures

Analyst Conflicts of Interest

Commission Resources and Authority

Studies and Reports

Corporate and Criminal Fraud Accountability

White Collar Crime Penalty Enhancement

Corporate Tax Returns

Corporate Fraud Accountability

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Title 1 (Section 101 to 109)

Public Company Accounting Oversight Board (PCAOB)

Sarbanes-Oxley’s foundation of the PCAOB, which ended more than 100 years of self-regulation at the federal level

by the public company audit profession, is possibly the most elementary change made by SOX.

PCAOB regulates audit firms, establishes auditing and ethics standards, investigates allegations, disciplines auditors

of public companies and conducts audit quality inspections for the purpose of identifying issues related to audit

quality.

Title II (Section 201 to 209)

Auditor Independence

It establishes standards for external auditor independence, to limit conflicts of interest.

It addresses new auditor approval requirements, auditor reporting requirements and audit partner rotation.

It also restricts auditing companies from providing non-audit services for the same clients including its affiliates.

Such services include bookkeeping, actuarial services, Legal services and expert services unrelated to the audit, etc.

Title III (Section 301 to 308)

Corporate Responsibility

It mandates that senior executives take individual responsibility for the accuracy and completeness of financial

reports.

For example, Section 302 requires the company's "principal officers" (typically the Chief Executive

Officer and Chief Financial Officer) to certify and approve the integrity of their company financial reports

quarterly.

Title IV (Section 401 to 409)

Enhanced Financial Disclosures

It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions,

pro-forma figures and stock transactions of corporate officers.

Adding to this, this title also requires timely reporting of material changes in financial condition and specific

enhanced reviews by the SEC or its agents of corporate reports.

Another important requirement of the title is that every annual report must contain a special report on internal

controls. Such controls must be established and maintained and then assessed every year.

Elements of the Act

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Title V (Section 501)

Analyst Conflicts of Interest

Securities analysts who recommend the purchase of securities to the public are addressed by Title V.

Financial and industry analysts played a large role in the financial scandals that brought down the economy.

Section 501 was inserted in SOX which determines the codes of conduct for securities analysts at broker and

dealer firms and requires disclosure of all possible conflicts of interest in each applicable research report.

This section concludes with a general provision which established "appropriate informational partitions" between

investment bankers and securities analysts in order to build a wall dividing the different divisions of the sell side

business of a bank.

Reason of such division is that the influence of investment bankers over securities analysts can make research

reports highly biased and inaccurate which could ultimately affect the quality rating of the security.

Title VI (Section 601 to 604)

Commission Resources and Authority

This title describes the authority of the commission to censure or deny any person the privilege of appearing

before the commission.

The commission may censure a person if they are found to have willfully violated a securities law or have

demonstrated improper professional conduct, which is defined as conduct deemed to be reckless, negligent, and

in violation of professional standards.

Title VII (Section 701 to 705)

Studies and Reports

This title mandates the research and publication of a number of studies and reports regarding the accounting

firms, credit rating agencies, investment banks, and past corporate malfeasance.

Title seven also designates a special study of investment banks and their role assisting companies with the

manipulation of earnings and "obfuscating their true financial condition."

The study aims to review not only the violation of securities law but the enforcement action that followed each

violation.

Elements of the Act

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Title VIII (Section 801 to 807)

Corporate and Criminal Fraud Accountability

It describes specific criminal penalties for manipulation, destruction or alteration of financial records or other

interference with investigations, while providing certain protections for whistle-blowers

Title IX (Section 901 to 906)

White Collar Crime Penalty Enhancement

This title 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 (Section 1001)

Corporate Tax Returns

It states that the Chief Executive Officer should sign the company tax return

Title XI (Section 1101 to 1107)

Corporate Fraud Accountability

It identifies corporate fraud and records tampering as criminal offenses and joins those offenses to specific

penalties.

It also revises sentencing guidelines and toughens their penalties.

It gives the SEC authority to temporarily freeze extraordinary payments to directors, officers, agents and

employees of a company during investigations of security law violations.

Elements of the Act

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Key Provisions of the Act

Section 302:

Disclosure controls

Section 303:

Improper influence on conduct of audits

Section 401:

Disclosures in periodic reports (Off-balance

sheet items)

Section 404:

Assessment of internal control

Section 802:

Criminal penalties for influencing US Agency

investigation/proper administration

Section 906:

Criminal Penalties for CEO/ CFO financial

statement certification

Section 1107:

Criminal penalties for retaliation against

whistleblowers

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Section 302: Disclosure controls

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".

Section 303: Improper influence on conduct of audits

It adopts rules to prohibit officers and directors of an issuer, and persons acting under the direction of an

officer or director, from taking any action to pressurize, manipulate, mislead, or fraudulently influence the

auditor of the issuer's financial statements for the purpose of rendering the financial statements materially

misleading.

Section 401: Disclosures in periodic reports (Off-balance sheet items)

Financial statements are published by issuers are required to be accurate and presented in a manner that does

not contain incorrect statements or admit to state material information. These financial statements shall also

include all material off-balance sheet liabilities, obligations or transactions.

The objective is transparent reporting and to determine whether generally accepted accounting principle or

other regulations result in open and meaningful reporting by issuers.

Key Provisions of the Act

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Section 404: Assessment of internal control

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 on financial reporting (ICFR).

Under Section 404 of the Act, management is required to produce an "internal control report" as part of each

annual Exchange Act report.

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."

The registered accounting firm shall, in the same report, attest to and report on the assessment on the

effectiveness of the internal control structure and procedures for financial reporting.

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.

Section 802: Criminal penalties for influencing US Agency investigation/proper

administration

This section imposes penalties of fines and/or up to 20 years imprisonment for altering, destroying, mutilating,

concealing, falsifying records, documents or tangible objects with the intent to obstruct, impede or influence a

legal investigation.

This section also imposes penalties of fines and/or imprisonment up to 10 years on any accountant who

knowingly and willfully violates the requirements of maintenance of all audit or review papers for a period of 5

years

Key Provisions of the Act

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Section 906: Criminal Penalties for CEO/CFO financial statement certification

Each periodic report containing financial statements filed by an issuer with the Securities Exchange

Commission pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 shall be accompanied

by a written statement by the chief executive officer and chief financial officer (or equivalent thereof) of the

issuer that : -

“The statement required under subsection (a) shall certify that the periodic report containing the financial

statements fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of

1934 and that information contained in the periodic report fairly presents, in all material respects, the financial

condition and results of operations of the issuer”.

Criminal Penalties

Whoever

(1) certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic report

accompanying the statement does not comport with all the requirements set forth in this section shall be fined

not more than $1,000,000 or imprisoned not more than 10 years, or both; or

(2) willfully certifies any statement as set forth in subsections (a) and (b) of this section knowing that the

periodic report accompanying the statement does not comport with all the requirements set forth in this

section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both.

Section 1107: Criminal penalties for retaliation against whistleblowers

Section 1107 of the SOX states:

“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 offense, shall be fined

under this title, imprisoned not more than 10 years, or both”.

Key Provisions of the Act

S.No Basis USA after SOX Indian Perspective

1 PCAOB Under SOX, PCAOB has been formulated which regulates audit firms, establishes auditing and ethics standards, investigates allegations, disciplines auditors of public companies and conducts audit quality inspections.

In India, the profession is regulated at the Central level by ICAI which derived its powers from enactment of The Chartered Accountants Act, 1949. But under Companies Act, 2013, an independent body (Similar to PCAOB) naming National Financial Reporting Authority (NFRA) is proposed to be constituted which is likely to replace some of the functions of the ICAI like standard setting and disciplinary functions.

2 Inspection Under the new Act, the Board has the power to periodically inspect the public accounting firm.

This is analogous to the provision of peer review mechanism in India.

3 Corporate Responsibility

Under section 302 and 404 of the Act, CEO and CFO, or persons performing similar functions of each company filing periodic reports to the Securities and Exchange Committee are required to certify that

The signing officer has reviewed the report, the report does not contain any untrue statement or omits a material fact and the financial statements present a fair view (Section 302)

In India, the financial statements are required to be signed by or on behalf on the Board of Directors of the company. Under Companies Act, the directors are also required to issue a directors report containing Director's Responsibility Statement which specifies the director’s responsibility in the preparation of the annual accounts, safe guarding the assets of the company and for preventing and detecting fraud and other irregularities, etc. The directors of the listed companies need to state in Directors’ Responsibility Statement that directors, had laid down Internal Financial Controls to be followed by the company and that such controls are adequate and operating effectively.

Indian Perspective

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SOX was implemented in USA and is applicable for all U.S. public company boards, management and

public accounting firms. Although the act is not applicable in India, but it affected Indian Accounting

profession indirectly. So, let us have a look on Indian perspective regarding changes made by SOX in USA.

The signing officer is responsible for establishing and maintaining internal controls for financial reporting (Section 404)

The directors of the unlisted companies need to state in Directors’ Responsibility Statement the details in respect of adequacy of Internal Financial Controls with reference to the financial statements.

4 Auditor’s Independence

Under the Act, it is unlawful for any person to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements.

Currently, there are no such clear provisions under the Indian statutes.

5 Penal Provisions for Auditors

The Act provides for sanctions on the auditing firms which include temporary or permanent revocation of the firm or the person associated with the firm, censure and civil monetary penalty. It also provides for a liberal view i.e., instead of award of punishment, as above, the member may be required to undergo required professional education and training.

Compared to above, in India, the Chartered Accountants Act, 1949 provides for censure or removal from the practice, permanently or for a particular period. There is no provision for imposition of civil monetary penalty

6 Second Partner Review and Partner Rotation

The Act provides for review of audit report by a concurring or a second partner and rotation of lead audit partner every 5 years.

Currently, there are no such clear provisions under the Indian statutes.

7

Enhanced Review of Periodic Disclosures by Issues

Under the Act, SEC is required to review the disclosures made by certain public companies falling in the criterion laid down by the Act.

ICAI has constituted a Financial Reporting Review Panel (FRRP) with the objective of reviewing the financial statements of certain enterprises. Currently, it is at evolving stage.

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Indian Perspective

Has SOX been Successful?

Has Sarbanes-Oxley failed? Not at all!

The law has made a massive difference, but not in the way you might think.

The impact of Sarbanes-Oxley isn’t necessarily found in the collective impact

of its substantive provisions. Rather, it is found in the profound way the law

has reshaped attitudes toward corporate governance, ethics and compliance.

Let we give you some quick reasons in support of its success.

1) It restored investor confidence.

2) It established the PCAOB, ending more than 100 years of self-

regulation by the accounting profession.

3) Increased Audit committee involvement.

4) It mandated independent audit committees and required issuers to

disclose whether a "financial expert" is on the audit committee.

5) It dealt with the conflicts of interest in the accounting profession by

prohibiting accounting firms from performing certain auditing and

consulting services for the same company the firm was auditing.

6) It increased corporate accountability and dealt with tone at the top

by requiring CEOs and CFOs to personally certify their companies'

financial statements.

7) Assessment of adequacy of the company's internal control on

financial reporting (ICFR)

8) It established whistleblower protections for employees of public

companies.

9) It required public companies to disclose off-balance sheet

arrangements in quarterly and annual financial reports to the SEC and

investors.

10) It restricted loans that public companies can make to officers and

directors. Page 15 of 18

Criticism Faced

The legislative intent behind SOX was to require that

all public firms be covered by its provisions.

After enactment of SOX, the business community has,

in very strident terms, repeatedly expressed concerns

for the costs incurred to comply with its requirements.

These communities said that the costs associated with

Sarbanes-Oxley are prohibitively high for small and

mid-sized companies that are trying to compete with

larger players, creating a barrier of entry for these

firms.

Due to numerous compliances and direct cost

associated with SOX, number of business houses:-

Decided to go private.

Started delisting their securities from US Stock

exchanges.

Announced decisions not to list on the US

exchange.

Decided to launch their IPO on foreign

exchanges in lieu of raising capital in the US

markets despite of being US domestic

companies.

This ultimately resulted in substantial loss of

investment opportunities in USA.

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Exemptions under JOBS Act, 2012

The JOBS Act1 coined the term of “Emerging Growth Company2” which are

exempted from:-

1) Complying with Section 404 for Assessment of internal control of

Sarbanes-Oxley Act. (Section 103 of JOBS Act)

2) Complying with any new accounting standard until such date that private

companies must comply, if such standard applies to private companies at

all. (Section 102 of JOBS Act).

3) Complying with any PCAOB rules requiring mandatory firm rotation or

auditor discussion and analysis (Section 104 of JOBS Act).

4) Complying with other new auditing standards unless the SEC determines

that the application of such standard is “necessary or appropriate in the

public interest, after considering the protection of investors and whether

the action will promote efficiency, competition, and capital formation”

(Section 104 of JOBS Act).

This provided relief to emerging companies from compliance of various costly and

complicated provisions of SOX.

1 JOBS Act i.e. Jumpstart Our Business Startups Act. is a law intended to encourage funding of

small businesses by easing various securities regulations. It was signed into law by President Barack

Obama on April 5, 2012.

2 An Emerging Growth Company is defined as an issuer with total gross revenues of under $1

billion (subject to inflationary adjustment by the SEC every five years) during its most recently

completed fiscal year. A company remains an EGC until the earlier of five years or:

• the last day of the fiscal year during which the issuer has total annual gross revenues in excess

of a $1 billion (subject to inflationary indexing);

• the last day of the issuer’s fiscal year following the fifth anniversary of the date of the first sale

of common equity securities of the issuer pursuant to an effective registration statement under

the Securities Act;

• the date on which such issuer has, during the prior three-year period, issued more than $1

billion in nonconvertible debt; or

• the date on which the issuer is deemed a “large accelerated filer.”

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Written by:-

Takeaway

The Sarbanes-Oxley Act is perhaps the most far-

reaching set of government-enforced rules.

SOX made profound effects on financial accounting

and auditing practices worldwide which inspired

various counties such as Canada and Japan who

adopted similar structure to SOX in form of C-SOX

and J-SOX respectively.

There is no question that the boards of directors,

corporate managers and external auditors have

changed their approach towards their

responsibilities.

In addition to this, greater efforts are being made to

ensure that timely and accurate financial information

is provided to investors.

Before concluding, we would offer our own

observation that the real key to achieving the great

potential of the Sarbanes-Oxley Act lies not with

SEC or the PCAOB, but with the dedicated and

serious efforts of businesses and their managers, who

probably have the most to gain from preserving the

reputation of markets.

Arpit Goel