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The
Sarbanes-Oxley Act and Global Companies
By
D. Manggala (October 1, 2004)
The information in this academic research report is not
intended to replace the expert legal, tax or accounting advice
available to business owners or others interested in this
topic. Each business situation represents a unique set of
circumstances requiring individual analysis for stay trained
professionals. Neither SOBA Research Reports, its publishers,
editors, writers, contributors nor staff will be held responsible
for any situation resulting from choices made by individual
business owners.
EXCUTIVE SUMMARY
The scandals of Enron, WorldCom and Tyco have made the congress
pass a new act that changes the accounting world and corporate
governance dramatically. The act is known as the Sarbanes-Oxley
Act of 2002. The dramatic changes created by this act and
the light speed of this act passed by the congress has raised
some concerns from people or organizations that affected by
the Act. This research report presents an overview of the
current status of the Sarbanes-Oxley Act. This research report
includes an explanation on the Act and the environment that
influences the Act such as social, economic, political and
technological issues. Based on some analysis, the stakeholders
affected by this act are discussed in this report and supported
with history and resources.
WHAT IS THE SARBANES-OXLEY ACT?
The Sarbanes-Oxley Act of 2002 refers to the Act that was
enacted by congress on July 30, 2002 in order “to protect
investors by improving the accuracy and reliability of corporate
disclosures made pursuant to the security laws and for other
purpose.”
This particular act wills applicable to all “issuers”
which current amount approximated at 15,000 public companies.
As explained in the Sec. 2 (7) of the act:“ The term
‘issuer’ means an issuer (as defined in section
3 of the Securities Exchange Act of 1934 (15 U.S.C 78c)),
the securities of which are registered under section 12 of
that Act (15 U.S.C 781), or that is required to file reports
under section 15(d) (15 U.S.C 78o(d)), or that files or has
filed a registration statement that has not yet become effective
under the Securities Act of 1933 (15 U.S.C 77a et seq.), and
that it has not withdrawn.”
The Sarbanes-Oxley Act is the most significant legislation
affecting the accounting profession since 1934, because now
it creates a new oversight board called the Public Company
Accounting Oversight Board (PCAOB). Furthermore, this act
also significantly increases criminal penalties for the violations
of the securities laws.
WHAT ARE THE ISSUES OF CONCERN?
The Chief Executive Officers (CEOs), Chief Financial Officers
(CFOs) of public companies, accounting and auditor firms,
lawyers, investors, the U.S and foreign companies (public
or private companies that plan to Issue Public Offering/IPO)
have three primary concerns about the Sarbanes-Oxley Act.
First, the creation of Public Company Accounting Oversight
Board and the new high standard required for both CEO and
CFO could restrict the entrepreneurship of corporate culture
which was the competitive advantage of the U.S companies from
its European counterparts. An excerpt from article in BusinessWeek
by Gary S. Baker provides a good description about this first
concern.
Moreover, an overly aggressive oversight board and the threat
of criminal prosecution to CEOs are likely to make U.S. business
leaders less flexible and more cautious. As a result, the
law could have a chilling effect on risk-taking by CEOs and
entrepreneurs--and that would weaken the business foundations
that have propelled the U.S. economy so far ahead of Europe's.
Second, the act could discourage the companies to go public
or to list their stock in the stock market; both for American
companies and especially foreign companies. The high standard
for being public companies (as well as the cost) will keep
small and private companies away from the securities market
due to the cost is too high compare to its benefit.
Third, the requirement of company’s lawyer to be “whistleblowers”
may conflicts with its profession value. By the new rule,
there is a requirement for corporate lawyers to report evidence
of fraud to general counsel or CEO or to the PCAOB which is
outsider to the company.
HISTORY
The corporate governance topics have been around since the
collapse of dotcom companies in the late 90s, but they have
become a public debate after a parade of corporate scandals
in last couple years. These two following excerpts provide
quite detail history of this act. The first excerpt is taken
from Practical Lawyer in December 2002.
IN RESPONSE TO the well-publicized failures of prominent corporations
such as Enron, Global Crossing, and WorldCom, our political
leaders and government officials have searched for ways to
restore investor confidence in our capital markets. They focused
on mechanisms to ensure that companies provide investors with
transparent, accurate information upon which to base investment
decisions. One of the favored approaches has been to require
corporate executives to certify the accuracy of their companies'
periodic reports and financial information filed with the
Securities and Exchange Commission (SEC) under the Securities
Exchange Act of 1934, 15 U.S.C. sec 78a et seq. (the Exchange
Act). The rush to impose this solution presented corporate
executives with a bewildering combination of proposed rules
and immediately effective, but differing, certification requirements:
* On June 14, 2002, the SEC proposed rules that would mandate
future certifications of Exchange Act reports by CEOs and
CFOs of publicly traded companies (June Proposal);
* On June 27,2002, the SEC issued an immediately effective
order imposing a one-time requirement on the CEOs and CFOs
of the largest United States publicly traded corporations
to certify certain past Exchange Act filings, including their
most recent annual report on Form 10-- K and their most recent
proxy statement (SEC Order). Most subject companies filed
these certifications on or before August 14, 2002;
* On July 30, 2002, the President signed into law the Public
Company Accounting Reform and Investor Protection Act of 2002,
unofficially, the "Sarbanes-Oxley Act of 2002,"
Pub. L. No. 107-204,116 Stat. 745 (the Act), which contained
two separate sections requiring executive certifications:
Section 906, effective immediately for all corporations, domestic
and foreign, that are required to file periodic reports pursuant
to the Exchange Act; and Section 302, covering the same companies
and to be implemented through rules promulgated by the SEC
to be effective no later than August 29, 2002;
* On August 27, 2002, the SEC adopted final rules, effective
August 29, 2002, (reported at 67 Fed. Reg. 57,276 (Sept. 9,2002))
implementing the certification requirements of Section 302
of the Act and adopting portions of its June Proposal that
had not been superseded by Section 302 (Section 302 Rules).
While the first excerpts above provide a kind of chronology,
the following excerpt from Michael Perino in St. John’s
Law Review Fall 2002 provides more on some backgrounds.
With an eye clearly on the Arthur Andersen document destruction
prosecution, Congress created three new obstruction-related
offenses, which appear in two different titles of the SOA
[Sarbanes Oxley Act]. Section 1102 of the SOA amends 18 U.S.C.
1512 to create a maximum twenty-year sentence for efforts
or attempts to tamper with records or otherwise obstruct official
proceedings. Section 802 of the SOA contains the other two
new obstruction statutes. Under new 18 U.S.C. 1519, individuals
that knowingly destroy, alter, or falsify records "with
the intent to impede, obstruct, or influence" a federal
investigation or bankruptcy proceeding are subject to fines
and potential imprisonment of up to twenty years. The second
provision relates to the destruction of corporate audit paper
and mandates accountants that conduct audits required under
the Securities Exchange Act of 1934 (the "Exchange Act")
to maintain all audit or review workpapers for five years.
Individuals that knowingly and willfully violate this requirement,
or any rule or regulation promulgated thereunder, are subject
to fines and potential imprisonment of up to ten years.
One of the more glaring examples of the SOA's drafting problems
is this document retention requirement. In Title One of the
SOA, Congress established a new self-regulatory organization
for the accounting industry-the Public Company Accounting
Oversight Board (the "Board"). In delegating authority
to the Board to establish accounting standards, the Act directs
the Board to require accountants to maintain audit workpapers
for seven, not five, years. Reading these provisions together
suggests that an auditor that willfully destroys workpapers
in years six and seven is only subject to disciplinary action
by the Board or enforcement action by the SEC, but not criminal
prosecution under this new provision. Of course the auditor
might, depending on the context, still be criminally liable
under existing obstruction provisions. And that is the pointlike
other recent federal crime legislation, these new crimes do
very little to criminalize conduct that was not already criminal.
To be sure, it is possible to read these provisions much more
broadly. Indeed, one could easily view them as significant
extensions of obstruction law. For example, new 1512(c) and
1519 allow actions against individuals that knowingly obstruct
justice, not just those who corruptly persuade or intimidate
others to do so. Second, unlike 1512, 1519 has no "official
proceeding" requirement. As a result, 1519 could cover
any document destruction involving any matter within the jurisdiction
of a federal agency. Senator Leahy, who was primarily responsible
for drafting 1519, has argued that it "imposes broad
prohibitions on evidence tampering" beyond those found
in current law.
THE ENVIRONMENT
After discussing the history of the Sarbanes-Oxley Act, it
is important to analyze the contemporary environmental issues
(social, economic, political and technological) that affects
or relates to the development of this act.
Social Issues
The most significant social issue related to this act is the
lost of public trust to the corporate behaviors in doing business.
There was no standard that control corporate executives and
their auditors as wells as legal advisers where that vacuum
of standard has created a series of corporate collapses. Public
trust to corporate behavior after the collapses of Enron or
WorldCom has been a big public debates in these years as appeared
in headlines of newspaper and magazines.
Economic Issues
Paul Atkins, one of commissioners of Securities Exchange Commission
(SEC), explains some economic issues in his remarks in University
of Cologne Germany in February 2003. He explained that the
market declined and large corporate failures have made politician
felt to take any action. The decline in the economy seen by
some politicians has something to do with low standard corporate
governance and business ethics. The other economic issue that
is also related to social issue is the loss of investor confidence
in the effect of scandals aftermath. Some politicians believe
a new regulation about corporate governance will build the
confidence again, that in the short and medium run will stimulate
the economic growth.
Political/Legal Issues
Currently, more than 53% of American household invest in the
securities market, so it is understandable that they need
some changes to improve the policy to protect investors. The
high percentages of household involvement in securities market
surely convince the politicians that the securities market
and companies financial statements must be regulated by a
new policy. There are some senses that this act is passed
just to show the publics that politicians have done something
about corporate governance in order to protect the household
investment in securities market. The following excerpt from
St. John’s Law Review describes that concerns.
Politicians with their eyes on November ballots may opt for
easy fixes that look good in thirty-second television commercials
rather than taking the time to analyze the merits of proposed
policy changes, a fact that one congressman candidly acknowledged.
Much of the Act simply follows headlines from Enron and other
corporate scandals, with little appreciation for whether those
headlines highlight systemic problems that need legislative
attention.
Technological Issues
There is a relationship between corporate problems and investor’s
realization of overcapacity in the telecom and high-technology.
In addition, some of corporate financial problems are due
to big spending in computer improvement due to fears of 2000
years (Y2K issue). The burst of dotcom and hi-tech companies
bubbles is one of the trigger that raise the need of new regulation
in securities market especially related to financial statement
and its verification.
THE STAKEHOLDERS
Chief Executive Officers (CEOs) and Chief Finance Officers
(CFOs) of Public Companies
The new regulation now requires the CEOs and CFOs to verify
the financial statements released by their companies and legally
responsible for any mistakes in those statements. This new
regulation surely will consume a large amount of time and
energy of CEOs and CFOs especially for big corporations. Many
CEOs and CFOs have expressed their reluctance following this
regulation, but they have to do them if they still want the
chairs. A commission by BusinessWeek and Deloitte Consulting
of survey from Research International over the 1,500 companies
indicates that 91% CFO feel job getting harder and 62% working
longer. Moreover, there is a growing tension between CFO and
CEO; 64% of CFOs say they're the leaders, while 47% of chief
executives think CEOs are. And surprisingly “the real
shocker was that nearly a third of the CFOs don't think that
the new rules enshrined in the Sarbanes-Oxley Act or imposed
by the SEC and other regulators make another Enron less likely.”
The requirements for CEOs and CFOs to comply with the certification
under Section 302 and 906 Rules are big issues. Because of
the confusing and time consuming procedures that may required
by the certification process, CEOs and CFOs of public companies
face many challenges in complying with the certification and
other requirements imposed by the Act.
Accounting/Auditor Firms
One of the most significant changes under the Act is the creation
of Public Company Accounting Oversight Board (PCAOB). This
board is responsible for “registering, inspecting, and
disciplining accounting firms and adopting rules governing
auditing quality control, ethics, independence and other standards
relating to the preparation of audit reports of issuers.”
These requirements are applicable for both US and non-US accountants.
The existence of this new board is a big change in accounting
profession because historically accountants and accounting
firms are self regulated. The GAAP (Generally Accepted Accounting
Principle) is just a generally accounting principle as implied
by its name. How the PCAOB will change the accounting standards
still in big question mark.
The other significant change is now every company is required
by the SEC to disclose if a company has an audit committee;
if not, it must explain its reason. This audit committee must
be independent from company management and responsible for
appointment, compensation and oversight of a company’s
outside auditor. For example, now an audit firm can’t
provide non-audit services for the same client.
Small Companies
Since the Congress passed the Sarbanes-Oxley Act, many small
and medium businesses decided to go private, because the increasing
cost of being public and regulatory burden created by that
new act. According to FactSet Mergerstat, a data tracker of
companies performance, there were 63 companies going private
a 34% increase from last year. Those small and medium companies
believe the cost and burden of being public are far exceed
the benefit of it, so that they consider to not bother with
the headache with all regulation and scrutiny if they were
public companies.
Foreign Companies
Foreign companies, both currently in U.S market and in planning
to be listed, are one of the big critics of the new regulation.
They can’t be neglected because they are significant.
At the NYSE, there are 470 non-U.S. companies listed, with
a combined global market cap of $3.8 trillion, or about 30%
of total exchange.
Big German companies, such as SAP, have raised their concern
about the conflict of this U.S regulation with German’s
regulation. For instance, under the act, the audit committee
must consist of members of the board directors. This regulation
has some conflicts with German two-tier board system; the
management board (Vorstand) and supervisory board (Aufsichtsrat).
There is no clear equivalent system between the U.S board
and German two-tier system.
Palenberg, et al., in International Financial Law Review (November
2002) explained more detail about the conflict.
It seems fairly clear that giving members of the management
board the role of independent (meaning non-management) supervisors
of the financial reporting functions of the company would
not make much sense. Among other things, the management board
is the executive body of the German stock corporation, with
comprehensive responsibility for the day-to-- day management
of the company. Under the German Stock Corporation Act (Aktiengesetz
or AktG), it is not possible to appoint outside non-executive
members to the management board. Accordingly, in a German
stock corporation, an audit committee function as envisaged
by the Act should really be performed by independent members
ofthe supervisory board.
Swiss, the country that is famous for its secretive banking
system, has a very big concern as described by the following
excerpt from Wall Street Journal.
"The problem," says Peter Bertschinger, international
partner of KPMG LLP, who works in Zurich, "is that the
Sarbanes-Oxley Act can force Swiss auditors to disclose information
about U.S.-listed Swiss companies that fall under the Swiss
penal code." For example, U.S. regulators might ask the
audit company of Swiss banks such as UBS AG or Credit Suisse
to provide it with bank customers' names and account numbers.
While the U.S. regulators' request is in compliance with the
Sarbanes-Oxley Act, divulging the information would be in
breach of the Swiss banking-secrecy law. If an auditor complies
with such a request from the U.S., he or she could face a
prison term of up to 10 years in Switzerland, Mr. Bertschinger
says.
Legal Communities
The legal communities, through the legal bar, view the requirement
under the Act as an assault on attorney-client privilege.
The Act requires the corporate lawyers to be whistle-blowers
if they found repeated financial misconducts and the company
refuses to fix it. In the case companies refuse to follow
the lawyers’ advices, the SEC requires the lawyers to
quit from their job in the process that now dubbed as “noisy
withdrawal.” As many as 77 law firms have made and send
a letter to SEC as a warning that the commission does not
has authority to impose that kind of rule.
SELECTED SARBANES-OXLEY ACT RESOURCES
There are varieties of resources available to those interested
in the Sarbanes-Oxley Act of 2002. Among them are the following
organizations, print and electronic contacts:
Academic Centers
Securities Exchange Commission website www.sec.gov
FindLaw www.findlaw.com
National Association
American Institute of Certified Public Accountants www.aicpa.org
Magazines
BusinessWeek (print edition) or online edition www.businessweek.com
Time Magazine (online) www.time.com
Online Resources
Proquest (from www.library.duq.edu)
Web Search Engine (www.google.com)
FOOTNOTES
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