Sarbanes-Oxley ActSOX

Logan Cousins, Jordan Hensberger, Darren Kilby, Emily Messer, Ben Sweger

Pre-SOX Issues

●Auditing Conflicts of Interest

○ Prior to SOX, auditing firms were self-regulated and many firms also performed consulting work for firms they audited

●Boardroom mistakes○ Executives either did not fulfill

responsibilities or were inadequately prepared to understand the complexities of the business

○ Audit committees not independent of management

●Low funding from SEC○ SEC was not putting enough

money into enforcement and rule-making of financial reporting(Budget has since doubled)

Pre-SOX Issues

(Cont’d)

●Executive Stock Compensation

○ High pressures to make earnings in order for stock price to go up, and therefore compensation to go up

○ Stock options not treated as compensation expense, encouraging use

●Troubled Bank Loans○ Big banks loaned money to

several big name companies that appeared to be doing well but weren’t

○ Led to investors being falsely led to invest in failing companies (Enron….)

Enron Scandal - Background

●Energy company that also provided financial/risk management services to clients

●One of top 10 largest energy companies in world in late 90’s/early 2000’s

●Stock price peaked at $90 in August of 2000

●Top executives Ken Lay and Jeffrey Skilling pocketed over $100 million in combined compensation in 2001 before...

Enron Scandal - How did this

happen?

http://www.thebusinessowner.com/business-guidance/fraud-business-guidance/2013/07/the-fraud-triangle-2

Enron Scandal - Downfall

●In August of 2001, then VP Sherron Watkins alerts Ken Lay about potential accounting issues

●In October of 2001, Enron reported a loss of over $600 million

●By December 2001, Enron had filed for bankruptcy and SEC had already opened up formal investigation into accounting fraud at Enron

Enron Scandal -

Consequences

●Thousands of workers not only lost jobs but had worthless stock in pensions

●Investors lost over $60 billion within a matter of days

●Complete lack of trust in financial assurance of companies

●Downfall of Arthur Andersen

●SOX

Framework●SOX only enforced on Publically

Traded Companies

●Created PCAOB – Public Company Accounting Oversight Board

●The SEC -> PCAOB -> Public Companies

Audit Committee

● Audit Committee – Group selected from company’s Board of Directors to focus on audit process

● SOX created strict rules for Audit Committee’s of Public Companies:

○ Selects Independent Auditor

○ Oversight Financial Reporting process

○ Reviews SEC Filings (10-Q, 10-K, 8-K)

○ Oversee internal and external auditors to limit risks

Code of Conduct

● SOX forced public companies to create a Code of Conduct

● Code must be on company’s website or in filings with SEC

● Code must consist of:

○ Honest Behavior

○ Ethical actions during conflicts of interest

○ Accurate financial disclosures

○ Compliance with all rules and regulations

Document Retention

● SOX has implemented policies on how long certain types of documents must be retained for

● Documents include electronic copies

● Most documents have to be retained for at least 7 years

● Certain documents must be retained forever:

○ Stock ownership records

○ Bank statements

○ Training manuals

○ Contracts

Certification Requirement

• Required by the CEO and CFO of publicly traded companies

• Certify:

o Quarterly and annual reports

o Internal control functionality

o Inform Audit Committee and outside auditors of material weaknesses

o Inform Audit Committee and outside auditors of any fraud

o Identify necessary changes in internal controls

SOX Disallowances

• Incentive-Based Compensation

o Claw-back provision

• Company Provided Loans

• Coercion

• Whistleblower Retaliation

o Protection

o Including: discharging, demoting, suspending, threatening, harassing, or in any other manner discriminating

PCAOB

• Overseen by the SEC

• Establish audit standards and ethics rules

o Used ASB standards as foundation

• Registration Process

o Application

o Approval

o Fees

• Inspection and Discipline of CPA firms

Public Company Accounting Oversight Board

Independence

• AICPA Code of Conduct

• Concurring Auditor Opinions

o Engagement review/Concurring partner

o Evaluate engagement’s actions

• Auditor Rotation

o Partner Rotation

o Audit Firm Rotation - International

• Waiting period

o Revolving door policy

o Cooling-off period

• Performance of Nonaudit services

Impact on Other

Corporations

• High costs of compliance associated with

o Internal control

o Increased legal fees

o Increased personal liability obligations

• The burdens of the SOX have forced many smaller public companies to consider going private.

Impact on Other Service

Lines

• Accounting firms had to limit the number of services they could provide to one client

• Tax serviceso If a CPA firm also provides

audit services to a public client, tax services must be pre-approved by the client’s audit committee

• Advisory services are more in demand to help companies implement a SOX 404 compliance plan to adhere to internal controls requirements

Impact on Privately Held

Companies

• Recommended that Companies thinking about going public should adopt SOX governance practices

• Lenders and investors are requesting more detailed financial disclosures because SOX has become a benchmark at which every company’s F/S will be measured

• Private and non-profits have adopted similar whistleblower policies to public companies

Impact on Investors

• Risk management• Reduced fraud risk• Enhanced governance• Strengthened controls All of these have resulted from implementation of SOX

Their purpose: to strengthen investor confidence. • Sox has cut opportunities for

corporations to defraud institutional and individual investors

Five Years Post-Sox

The Economist. “Five years under the thumb.” (2007)

Negatives• Estimated law costs exceed any

benefits by $1.4 trillion• Firms have significantly reduced their

investment R&D and overall capital spending

• Firms are increasing their holdings of cash

• Successful whistleblowing by employees fell (from 20.7% to 15.6% success rate)

Positives• Serious frauds discovered by auditors

rose to about 50%• Costs of complying with SOX are

coming down

Ten YearsPost-Sox

John Coates & Suraj Srinivasan. “Sox after Ten Years: A Multidisciplinary Review.” (2014)

Negatives• Only 32.4% of firms reported an

internal control weakness when it actually existed

• More companies “going dark” & fewer IPOs in the 2000s

• Audit fees increased by 74-86% by 2006

Positives• Other countries adopting SOX-like

regulations• Lower tendency to meet forecasts

by managing earnings

SOX During Financial

Crisis:Negative Effects

Was SOX effective during financial crisis?

Clean Audit Report

Failure/Bailout

Bear Sterns January 28 March 14

Thornburg February 27 March 4

Northern Rock

July 25 September 14

US Bancorp February 20 November 14

Conclusion:Auditor’s may not been able to prevent financial crisis, but definitely had the chance to warn investors these companies were about to go under

John Coates & Suraj Srinivasn. “Sox after Ten Years: A Multidisciplinary Review.” (2014)

SOX During Financial

Crisis:Positive Effects

Evidence that suggest SOX improved some banks’ situations• Banks with fully

independent audit committees performed better

• Bank with auditors who specialized in banking were less likely to fail

Questions?

References

The Economist. “Five years under the thumb.” (2007). http://www.economist.com/node/9545905

Coates, John & Srinivasan, Suraj. Accounting Horizons, Forthcoming. “Sox after Ten Years: A Multidisciplinary Review.” (2014). http://ssrn.com/abstract=2379731

Klein, G. (2016). Ethics in Accounting: A Decision-Making Approach. Hoboken, NJ:Wiley.

One Year Later, The Impact Of Sarbanes-Oxley. (n.d.). Retrieved November 28, 2015, from http://www.forbes.com/2003/07/22/cz_af_0722sarbanes.html

NACD Library. (n.d.). Retrieved November 27, 2015, from https://www.nacdonline.org/Resources/Article.cfm?ItemNumber=564

Lowengrub, P. (2005, December 6). The Impact Of Sarbanes Oxley On Companies, Investors, & Financial Markets. Retrieved November 28, 2015, from http://www.s-ox.com/dsp_getfeaturesdetails.cfm?cid=1141

Cushwaha, R. (2004, January 16). The Impact of Sarbanes-Oxley on Corporate Tax Departments. Retrieved December 1, 2015, from http://www.accountingweb.com/practice/practice-excellence/the-impact-of-sarbanes-oxley-on-corporate-tax-departments