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The Sarbanes-Oxley Act of 2002 established new or enhanced standards for all U.S. public company boards, management, and public accounting firms. It does not apply to privately held companies. abuses. Key Terms: Corporate Governance: Corporate governance is the system or framework of policies, customs and processes by which companies are directed, administered and controlled. It is based on the principle that companies are accountable for their actions. Transparency: A spirit of transparency means that companies willingly provide information needed by shareholders and other stakeholders to make decisions. Information is transparent when it provides the reader with a clear understanding of the company’s financial condition, results of operations, cash flows and other aspects of its business. Internal Controls are systems and processes that The law's purpose is to rebuild public trust in America's corporate sector, enforce good “corporate governance,” and prevent further corporate
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safeguard (protect) a company’s assets and resources, deter and detect errors, fraud and theft, ensure accurate and complete accounting data, produce reliable and timely financial and management information, and ensure adherence to its policies and plans.
Among the requirements of Sarbanes-Oxley are the following: Internal Controls: The Sarbanes Oxley Act requires that corporations maintain much better financial records and procedures than were required in the past. Among the requirements:
Corporations must establish a financial accounting framework that can generate financial reports that are readily verifiable with traceable source data. This source data must remain intact and cannot undergo undocumented revisions. Any revisions to financial or accounting software must be fully documented as to what was changed, why, by whom and when.
Corporations must submit an annual assessment of the effectiveness of their internal financial auditing controls to the Securities and Exchange Commission (SEC).
Each company's external auditors are required to audit and report on the internal control reports of management, in addition to the company’s financial statements.
• Company officers (generally the CEO and CFO) 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 is made known. Financial Reporting • Financial statements are required to be accurate and presented in a manner that does not contain incorrect statements or omit material information. These financial statements shall also include all material off-balance sheet liabilities, obligations or transactions.
• Companies are required to disclose to the public, on an urgent basis, information
on material changes in their financial condition or operations. These disclosures are to be presented in terms that are easy to understand, supported by trend and qualitative information or graphic presentations. • A company's chief executive and chief financial officer are accountable for the accuracy of filings with the Securities and Exchange Commission Auditing Firms: Prior to SOX, auditing firms, the primary financial "watchdogs" for investors, were selfregulated. They also performed significant non-audit or consulting work for the companies they audited. Many of these consulting agreements were far more lucrative (provided more income and profits) than the auditing engagement. This presented at least the appearance of a conflict of interest. For example, challenging the company's accounting approach might damage a client relationship, conceivably placing a significant consulting arrangement at risk, damaging the auditing firm's bottom line. Requirements under Sarbanes-Oxley include:
Auditing companies are prohibited from providing non-audit services (e.g., consulting) for the same clients that they are auditing, including bookkeeping and related services, financial systems design and implementation services, appraisal or valuation services, actuarial services, internal audit outsourcing and human resources and other managerial services.
The “Partner-in-Charge” of a company’s audit must be changed at least every 5 years. A new government agency was created to oversee, regulate and discipline accounting firms, called the Public Company Accounting Oversight Board, or PCAOB.
Employees who raise concerns or leak information about financial fraud in their company are now protected by federal laws. They may not be threatened or harassed by their employer, or fired in retaliation for providing the information.
Audit Committees must create systems and procedures for receiving anonymous employee concerns about financial improprieties.
What are the penalties for noncompliance with Sarbanes-Oxley? • Besides lawsuits and negative publicity, a corporate officer who does not comply or submits an inaccurate certification is subject to a fine up to $1 million and ten years in prison, even if done mistakenly.
If a wrong certification was submitted purposely, the fine can be up to $5 million and twenty years in prison.
Boards of Directors: The board has the obligation to understand, to evaluate, to exercise oversight, to review and approve corporate actions. Sarbanes-Oxley has introduced new standards of accountability on the board of directors for U.S. companies.
Boards of Directors, specifically Audit Committees, are charged with establishing oversight mechanisms for financial reporting in U.S. corporations on behalf of investors.
The role of the Audit Committee is enlarged and strengthened: Members of the Audit Committee must be independent Board members (not a member of the company’s management team).
One member must have accounting or financial management expertise.
All other members must be financially literate.
The Audit Committee is responsible for overseeing the company’s audit,
including selecting the auditing firm, determining its compensation, and resolving disagreements with management on financial reporting. Auditors report directly to the Audit Committee, not to management.
Audit committees must make certain that all groups involved in the
financial reporting and internal controls process understand their roles, gain input from the internal auditors, external auditors and outside experts when needed, and safeguard the overall objectivity of the financial reporting and internal controls processes.
Role of the Nominating/Corporate Governance Committee:
Members should be independent directors. It is responsible for shaping and overseeing all matters of corporate
governance for the corporation. • Role of the Compensation Committee
Members should be independent directors. They have the primary responsibility for ensuring that the compensation
programs, and values transferred to management through cash pay, stock, and stock-based awards, are fair and appropriate to attract, retain, and
motivate management, and are reasonable in view of company economics, and of the relevant practices of other, similar companies.
U.S. President's Corporate Fraud Task Force put out a Fact Sheet: President’s Corporate Fraud Task Force Marks Five Years of Ensuring Corporate Integrity that states 1,236 total corporate fraud convictions to date, including: • • • • 214 chief executive officers and presidents; 53 chief financial officers; 23 corporate counsels or attorneys; and 129 vice presidents
More than 50 defendants have been charged under new securities-fraud provisions of Sarbanes-Oxley (SOX). These corporate fraud charges brought over the five years have included • • • • • • • • • • securities fraud, insider trading, market manipulation, obstruction of justice, false statements, stock option backdating, conspiracy, money laundering, wire fraud, and violations of the Foreign Corrupt Practices Act [which required Internal Controls]
Investigations Initiated Prosecution Recommendations Indictments/Inform ation Sentenced Incarceration Rate Avg. Months to Serve
FY 200 5 102 115 69 51 80.4 % 23
FY 200 6 40 76 78 36 86.1 % 49
FY 2007 124 77 53 51 68.6 % 20
Report to the President – Corporate Fraud Task Force 2008
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