SARBANES-OXLEY ACT OF 2002

-Regulations Affecting Corporate Responsibility and

Its Disclosure-
 Sarbanes-Oxley Act of 2002(SOA-Act)
-Regulations Affecting Corporate Responsibility and
Its Disclosure-

• Outline of the project

– First Chapter- Reasons behind the SOA
– Second Chapter- General overview of major
provisions and critics about the Act
– Third Chapter- Focused on the responsibilities and
related disclosure requirements for companies`
executives & attorney’s by referring related SEC
Rules. In this chapter discussions about each of the
regulations are also provided.
Reasons Behind The Sarbanes-Oxley
– SOA was enacted soon after the significant corporate
scandals most popular ones are Enron and WorldCom,
– The environment triggering corporate scandals is provided
in the paper in summary;
• Take over movement, equity compensation linked
executives interest to the share price.
• Motivations to meet market expectations among
concerns.
• Long term bull market effect (1994-2000),
• Specifically, the reasons for failure of gatekeepers e.g.
auditors, lawyers, analyst… in the scandals. (deterrence,
bubble)
• Investors` position in that environment is also
considered.
Reasons Behind The Sarbanes-Oxley
Enron Case
–As a main model to enlighten the objectives of the SOA the
short timeline of Enron’s fall and the comments about the role
of participants provided.
•Enron when its stock price was $90 in August 2000, was
America’s 7th largest company,
•It went to chapter 11 (bankruptcy) on December 2,
2001, promptly after restating their financial reports, as
largest bankruptcy reorganization in American history, the
stock price at that time was 60 cents.
• The most highlighted event at the collapse of the Enron
is its relations with limited partnerships (Special Purpose
Entity- SPEs),
- Executives got personal gains being on both sides
(Fastow -CFO-more than $ 30 million)
- Enron failed to disclose the extent of these relations
(off-balance sheet and related party transaction)
Reasons Behind The Sarbanes-Oxley
Enron Case (Cont’d)

•Special Committee founded to investigate the events,

noted failures all levels of monitoring within the company
including board.
•The gatekeepers such as lawyers (Vinson & Elkins), rating
agencies severely criticized.
•Some investment banks after the event alleged aiding and
abetting the securities fraud.
•Enron’s both internal and outside auditor Arthur
Andersen, indicted to obstruction of justice, shredding of
Enron-related documents,
•The whistle-blower, vice president of Enron until resigned,
Sharon Watkins, letter to the top of Enron highly
emphasized by media.
Reasons Behind The Sarbanes-Oxley
Other Scandals way through legislation.
• March 2002- Enron demise followed by over 30 Enron
inspired bills and several regulatory responses from the SEC
and SRO ’s.

• June 25 2002, WorldCom confessed that it had overstated

its income by $3.8 billion, the announcement staggered
financial world because of the size and simplicity of
overstatement,

• On July 25 2002, SOA passed the Senate, President signed

into Law on July 30 2002.
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley

The Act has 11 titles can be summarized within;

•Foundation of Public Company Accounting Oversight Board
•Auditor independence provisions,
•A range of corporate governance measures,
•Expanded financial disclosure requirements,
•Analyst`s potential conflict of interest,
•Increase in SEC funding & enforcement power and direction
of various studies and reports,
•Criminal penalties & fraud.
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley
•Title I and II, regulates;
-Foundation of PCAOB-empowered to set auditing
quality, control and ethic standards, inspect registered
accountants, take disciplinary actions,
- Funding of FASB changed by providing full financial
independence from the accounting industry,
- Auditor independence from corporate management
supported by creating more separation between auditing and
consulting function,
•Title III and IV brought enclosed provisions about
responsibility of public company officers and lawyers for the
quality and accuracy of financial reporting, and some related
disclosure requirements, provided in detail in Chapter III.
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley

•Title IV cited provisions aiming to enhance financial disclosure;

-Off-balance sheet transactions- Sec. 401-As a direct response use of
Enron SPEs to keep liabilities off balance-sheet, SOA directs SEC to
prepare regulations requiring companies to disclose in their periodic
reports all material off balance-sheet information (including contingent
obligations),
-Pro Forma Disclosure- Requires SEC to adopt rules requiring the
companies to publish Pro Forma data with a reconciliation to comparable
data calculated according to GAAP.
-Required SEC prepare a study on SPEs,
-Enhanced SEC Review of Disclosure- Sec. 408.-SEC must systemically
review corporate filings at least once a three year. (Selection criterias
e.g. stock price volatility, large market capitalization…)
-Rapid Disclosure of Financial Change-Sec. 409-Disclosure of additional
information concerning material changes in financial conditions or
operations on a rapid and current basis.
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley

•Title V seeks to limit and expose to public possible conflict of interest

effecting securities analysts, in that respect; Sec. 501 of the Act obliged,
SEC or on the SEC’s direction exchanges, designed regulations;
-Restricting the pre-publication clearance of research or
recommendation by other staff,
-Limiting supervision and compensation of analysts to one other than
investment banking,
-Protects analysts from retaliation or threats.

•Title VI is related to SEC’s resources and authority and Title VII requires
some studies and reports to be conducted;
- Increased SEC funding;
-Codified SEC’s authority to censure and deny temporarily or
permanently preparing and practicing before,
-To reduce the migration of fraud, SEC was authorized to bar securities
industry employees barred from other financial sectors,
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley
Title VI is related to SEC’s resources and authority and Title
VII requires some studies and reports to be conducted;
-Required special studies;
-Sec. 701-Consolidation of public accounting firms
(Comptroller General)
-Sec. 702-Role of credit rating agency in the operation of
securities markets (SEC)
-Sec. 705-Role of investment bankers and financial advisers
in assisting public companies manipulation of their earnings
(GAO)
What Sarbanes-Oxley Brings
Major Provisions of Sarbanes-Oxley
SOA imposes new criminal penalties for fraud and other
wrongful act;
-Creates a new federal criminal violation, called securities
fraud, violation of this statue will be punishable by fine and
imprisonment upto 25 years,
-Strengthens the existing penalties of mail and wire fraud,
-Direct respond to Arthur Andersen`s shredding event,
creates new document destruction crime,
-Contains federal protection for whistle blowers when act
lawfully to disclose information,
-Increases statue of limitation in private lawsuits,
What Sarbanes-Oxley Brings
Critics of Sarbanes-Oxley
•An election year is not proper to overhaul a complicated area
like securities regulation.
•Simply follows headlines from Enron and others with little
appreciation for systemic problems
•The efforts of SEC and other SROs is not taken into account
by Congress.
•Little appreciation for markets` response to the scandals.
•Many provisions are simply delegations of authority to the
SEC to adopt rules, some of them involve the SEC or the other
SROs had already undertaken rulemaking initiatives.
•May cause long-term systemic harm to the competitiveness
of US capital markets.
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure
Audit Committees
Sec. 301-SEC Proposed Rule ”Standards Relating to Listed
Company Audit Committees”
•Sec. 301 requires the SEC to direct the exchanges and NASD to
prohibit the listing of securities of companies not complying with
certain audit committee requirements.
•Definition- A committee (or equivalent body) established by and
composed of members of an issuer’s board of directors to oversee
the accounting and financial reporting processes and audits of the
financial statements. If the issuer does not establish such a
committee, the entire board of directors serves in that capacity.
•The Responsibilities of Audit Committees cited as;
-Relationships to auditors
-Audit committee independence
-Authority and funding to hire advisers
-Procedures to address complaints regarding accounting, internal
accounting controls, or auditing matters
Audit Committees
•SEC rule details the audit committee responsibilities and add
some disclosure requirements to ensure the investors are
informed about the composition.
• Relationships to auditors- directly responsible for the
appointment, compensation, and oversight of the registered
audit firm’s work, including the resolution of disagreements
over financial reporting.
•Independence-Two criterias were set for the independence;
-Compensation-They can’t accept any consultation fee
other than for their service as a board member
-Affiliated person-Not being an affiliated person of the
issuer (controls the issuer or under common control)-(A safe
harbor provision defined for affiliated person definition by
Rule)
Audit Committees
•Authority and funding to hire advisor- For auditors and
other outside advisors funding will be determined by audit
committee.
•Procedures to handling complaints- Requires the audit
committee establish procedures for complaints of employees
and others, about accounting, internal control and audit.
(Anonyms also to make sure to enable whistle blowing)
•Some exemptions are also provided by Rule (IPO, holding
companies etc.),
• For foreign private issuers limited exemptions enabled
(permission for employee etc),
Audit Committees
•Exchanges’ Situation;
-SEC rule only sets a base line, exchanges expected to add information on
implementation and enforcement,
-Issuers must notify the exchanges or associations in case of material non-
compliance
-Exchanges expected to establish procedures for correcting problems and de-
listing
-Exchanges must adopt the rules’ provisions no later than the anniversary of
Final Rule.
Financial Expertise of Audit Committee Member
Sec. 407 –SEC Final Rule “Disclosure Required by Sec. 406 and 407 of Sarbanes-
Oxley Act
• Role of audit committee member requires financial expertise, the Sec. 407
directs SEC to issue Rules that require a company to disclose whether or not, and
if not, the reasons why not, the audit committee of that company is comprised of
at least one member who is a financial expert at annual reports.
•Rules had a detail definition for ‘audit committee financial expert’, regulating
attributes of financial expert, how it is expected to be acquired,
(Definition is among the controversial areas-whether have direct expertise at the
preparation of financial statements)
Audit Committees
Financial Expertise of Audit Committee Member
• A safe harbor generated by Rule: Mentioning this title do not impose
any additional duty, obligation or liability.
Discussions about Audit Committee Regulations
-Before the SOA exchanges had already have audit committee
requirements including their financial expertise. NYSE and NASDAQ has
already proposed changes to their corporate governance listing
requirements which is waiting for SEC approval.
-One of the benefits of SOA: Common regulation base for audit
committees (Financial expertise requirements used with a diverse
interpretation by exchanges)
-The financial expertise regulation do not include any penalty so its
efficiency is limited to the investors’ awareness to that kind of
information.
-Key issue for the effectiveness of new audit committee regulations is lied
in the exchanges attributes to the violations. Since before the SOA they
are unwilling to use delisting threat
Audit Committees
Discussions about Audit Committee Regulations

-The Rule’s exemptions for audit committee requirements for foreign

issuers is restricted when compared with the exchange’s listing rules in
the past, so the effect of these regulations to the competitiveness of the
US capital markets are among concerns,

-During the corporate scandals whistle blowers role for dissemination of

information about irregularities emphasized, the requirement for
establishing procedures for handling anonyms complaints is a result of
that. But its success is limited with the company’s approach towards
these cases.

-The recent decisions about the audit committee members (accepting

them as control person- e.g. Lernout&Hauspie) represent the increased
risk, new regulations can affect to find eligible audit committee members
because of increased risk. Safe harbor for audit committee financial
expert’s would be helpful.
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure
Professional Responsibility of Attorneys
Sec. 307 - SEC Final Rule “Implementation of Standard of Professional Conduct for
Attorneys”
•Reflecting the critics about the lawyers` role in scandals, Sec. 307 requires and gives
authority SEC to adopt rules establishing minimum standards of professional conduct for
attorneys appearing and practicing before the SEC
The Rule defines appearing and practicing before the SEC expansively including in-house
and outside attorneys (even advising an issuer to whether a statement required under the
securities laws or the SEC`s Rule)

•Up-To-Ladder Reporting
-Report evidence of a material violation of securities law or breach of a fiduciary duty or
similar violation by the company or one of its agents to the chief legal officer or the CEO of
the company.
-If they does not appropriately respond to the evidence, attorney must report the evidence
to the board’s audit committee or to another board committee comprised solely of directors
not employed directly or indirectly by the company or to the board of directors.

• Alternative procedure
-Rules establish a new term “Qualified Legal Compliance Committee” as an alternative to
the reporting evidence. Disclosure to QLCC relieves attorney’s reporting requirements
mentioned above.
-This committee has at least one member of the issuers audit committee or equivalent
committee of independent directors and two or more independent board members.
Professional Responsibility of Attorneys
Disclosure of Confidential Information
- Rules contains a “self-defense” exception to issuer confidentiality
- Allow an attorney to reveal to the SEC, without issuer consent,
confidential information related to the attorney’s representation of the
issuer to the extent he or she reasonably believes necessary to prevent
(e.g. a material violation by the issuer that is likely to cause substantial
injury to the issuer or investors)

•Rules do not create a private cause of action and that authority.

•Proposed rule required a lawyer to make a “noisy withdrawal” from

representing the company if the attorney sees evidence of fraud and the
company fails to react (As reporting to SEC his/her withdrawal "for
professional reasons.") SEC delayed the application
Professional Responsibility of Attorneys
Discussions on Professional Responsibility of Attorneys
•Sec. 307’s reporting up requirement is attempted to force attorneys as an information
intermediary
•This can affect attorney’s behavior in two ways;
-firstly causing lawyers to investigate potential corporate misconduct more vigorously.
-secondly bringing evidence of misconduct to the officers and the Board, so corporate
decision maker will be informed.
•Sec. 307 can provide a type of early warning system for independent directors, who are
not involved in day to day corporate operations much.
•The cost of the regulation can be threatening for the quality of information flow between
corporate attorneys and their clients.
•On the other hand to reduce the risk lawyers may choice over disclosure or decrease
incentive to become fully informed.
•Willingness of the employee to provide information to attorney can be affected.
•Regulations like noisy withdrawal may compromise a lawyers’ professional reputation.
Other managers will be unwilling to hire a lawyer who is known as a whistle blower.
•These Rules are likely to have a profound impact on attorney-client confidentiality rules.
•The debated noisy withdrawal requirements which SEC is proposed and delayed to apply
seem beyond the Sec. 307’s intention. This regulation can inhibit information flow between
customers and attorney.
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure
Corporate Responsibilities of Financial Reports
Sec. 302 – Sec Final Rule “Certification of Disclosure in Companies’
Quarterly and Annual Reports”

•Certification application starts with the order of SEC to 947 biggest

public companies. Then transferred to SOA.

•Sec. 302 regulates that SEC must adopt regulations, public company’s
principal executive officer and principal financial officer or person
performing similar functions certify each annual and quarterly report filed
under Section 13(a) or 15(d) of the Securities Exchange Act.

•The certifications pertain to the content of each report and to a

company’s system of controls designed to enable it to meet its periodic
disclosure obligations.

•Certifications must use the exact wording prescribed in the rules.

Corporate Responsibilities of Financial Reports

•The rules require these principal executive and financial officers to

certify that the report is accurate, complete, and fairly presented and to
take responsibility for maintaining and evaluating the issuer’s “disclosure
controls and procedures.”

•The officers have made required disclosures to the auditors and to the
audit committee about fraud and about significant deficiencies and
material weaknesses in internal controls.

•The officers must also affirm that they have disclosed their evaluations
for the effectiveness of the “disclosure controls and procedures” and must
indicate whether there have been significant changes in the internal
controls or in factors that might significantly change them.
Corporate Responsibilities of Financial Reports
Disclosure Controls and Procedures
•A new term established by SEC to ensure that information
required to be disclosed in reports is gathered, reported,
processed, summarized and disclose in a timely manner.
•Intended to enable the financial and non-financial
information required to meet its reporting obligations.
•Failure to maintain adequate disclosure controls and
procedures and review them, could be subject to SEC’s
action.
•In that way SEC is regulating the company’s disclosure
preparation procedures.
•SEC interpreted that this term is different from the internal
control.
Corporate Responsibilities of Financial Reports
Sec. 906 Certification

•In addition to Sec. 302 certification requirements, Sec. 906 of the Act
also requires a certification by the companies chief executive officer and
the financial officer accompany each period filed under Section 13(a) or
15(d) of the Securities Exchange Act of 1934 containing financial
statements.

•Providing that:
-The report fully complies with the requirements of reporting;
-The information in the report fairly presents in all material respects,
the financial condition and results of operations of the company,
•This certification requirement is effective immediately.
•Imposes criminal penalties of up to $1 million and/or ten years in prison
for knowingly filing a false certification, and up to $5 million and/or 20
years in prison for willfully filing a false certification.
Corporate Responsibilities of Financial Reports
Discussions on Corporate Responsibility

•Certification requirements Sec. 302 and Sec. 906 seems to

overlap.
•Both of them covers the certification of fair presentation of
financial conditions and results of operations of the company.
•Bringing two separate certification burden for officers, may be
interpreted as an evidence of the disorganized manner of the Act.
Using different officer terms is another evidence.
•CEO and CFO’s have been signing the annual reports. So before
the certification CEOs or CFOs that make knowingly false
certification would have been subject to prosecution for making
false statements.
•Primary certification is the one codified in Sec. 302 which is also
including the procedures to ensure the financial statements
accuracy. However only Sec. 906 certifications has criminal
provisions.
Corporate Responsibilities of Financial Reports
Discussions on Corporate Responsibility

•Certification requirements use fairly present clause not the GAAP

compliance requirement. So the certification statement is not limited to a
representation that the financial statements and other financial
information have been presented in accordance with GAAP.
•SEC’s view about disclosure in periodic reports would not be only
restricted with the GAAP compliance for financial statements resembles a
new perspective beyond the GAAP. It reflects intention of evolving the
principal based standards to rule based standards.
•The effect of fair presentation clause is concluded as codification of
Judge Friendly’s decision in United States v. Simon, which held that an
accountant could be convicted of securities fraud even if the accounting
practice at issue complied with GAAP. This can affect further cases
concept.
•CEOs and CFOs of the company’s would require downside certifications,
besides bringing new paperwork burden, can harm the trust in company
•Certification requirement may bring more conscience to the process of
report preparation.
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure
Management Assessment of Internal Control
SEC. 404-SEC Proposed Rule ‘Disclosure Required by Section 404, 406
and 407 of Sarbanes-Oxley Act of 2002”
•Definition
Controls that pertain to the preparation of financial statements for
external purposes that are fairly presented in conformity with GAAP
•Managements Internal Control Report
•Annual reports must include a report of management on internal
controls and procedures for financial reporting. Stating;
– The responsibility of management for establishing and
maintaining an adequate internal control structure and
procedures for financial reporting ,
– Contain an assessment, as of the end of the most recent fiscal
year of the issuer, of the effectiveness of the internal control
structure and procedures of the issuer for financial reporting.
•In addition external auditor attestation.
Management Assessment of Internal Control
•Rule proposes changes to certification requirements –every
periodic report include both evaluation of disclosure and
internal control.
Discussions on Assessment of Internal Control
•There is overlap between Act’s Sec. 302 and Sec. 404
requirements.
( SEC tried to differentiate them bringing a new concept as
disclosure control and procedures)
•Disclosure controls and procedures should entail some level
of internal controls review.
•Act’s two separate sections possess the same aim ‘effective
internal control procedures.’
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure

Compensation of CEOs and CFOs

Sec. 304-Forfeiture of Bonuses and Profits

In case an accounting restatement due to the material noncompliance, as
a result of misconduct, the CEO and CFO of the issuer shall reimburse the
issuer for:
•Any bonus or other incentive-based or equity based compensation
•Any profits realized from the sale of securities of the issuer
Sec. 402-Loans to Officers and Directors
• Makes unlawful for any issuer to arrange or to renew an extension of
credit, in the form of a personal loan to or for any director or executive
officer (Prohibits indirect compensation)
FASB’s and exchange’s proposals
Compensation of CEOs and CFOs

Discussions on Compensation

•Forfeiture required regardless of effect of restatement or whether

directly attributable to the misstatement of financial results.

•Cost inhibiting the CEO and CFO’s eager to make prompt disclosure of
non-compliances.

•‘Loans to officers and directors’ concept is ambiguous

•Types of indirect compensations can be created if there is an intention

for it.

•After these penalizing attempts compensation techniques can evolve

Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure

Officer Bar and Penalties

Sec. 305
•Replaces “substantial unfitness” standard for banning officer and
directors with an “unfitness” standard.
•Contains an equitable relief section
Sec. 1105
In any cease-and-desist proceeding, the SEC may order to prohibit officer
or director of any issuer with registered securities demonstrates unfitness
Discussions
-SEC has a lower standard and new administrative technique for banning
the officers
-Responsibility of the fraud for officers is also increased
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure

Fair Fund For Investors

Sec. 308
Disgorgement of profits ordered against those who have violated
securities laws, or any other funds collected as a result of the imposition
of penalties following securities laws violations, be added to a fund for
the benefit of the victims of the violations if the SEC so directs.

Discussions
-Civil money penalties can be distributed harmed investors-prior
forwarded to Treasury

-Utilization requires amendments to Act and enhanced collection

techniques (another spontaneous manner of the Act)
Regulations of Sarbanes-Oxley
Affecting Corporate Responsibility and Its Disclosure

Code of Ethics
Sec. 406-SEC Final Rule “Disclosures Required by Section 406
and 407 of Sarbanes-Oxley”
-Requires disclosure of whether they have adopted a code of ethics and
“of any change in, or waiver of” an issuer’s code of ethics in annual
reports.
Definition
-honest and ethical conduct
-Full fair, accurate timely disclosure in reports and documents,
-Compliance with laws, rules and regulations,
-Prompt reporting to violations,
Disclosure
-Made publicly available by exhibit to annual report, post internet web
site, by giving information in annual report give copy to any person
without charge
Code of Ethics
Waiver of Code of Ethics
•Required to promptly disclose any changes to, or waivers
of, the code of ethics on Form 8-K or on its Internet Web site
Discussion on Code of Ethics
•Has been used by companies for several years (Enron also
had a code of ethics).
•Only raise the level of ethical behavior if taken seriously and
enforced
•Provide information to investors on code of ethic but can
not guarantee or impose ethical behavior to officers.
THANK YOU FOR YOUR
PATIENCE