Sarbanes-Oxley Act
When the Enron scandal rocked the country back in 2001, we all knew that the world of business was about to change. With the passing of the Sarbanes-Oxley Act in 2002, this is exactly what happened.
In essence a compromise between two separate acts proposed by Sarbanes and Oxley, the SOX was brought about in large part because of the Enron scandal. According to President Bush, the Sarbanes-Oxley Act includes “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.”
Some of these reforms include things like the Public Company Accounting Oversight Board (PCAOB), evaluation and disclosure of the effectiveness of internal controls, independent auditors and auditor boards, employee protection, and enhanced penalties for intentional or accidental provision of false financial information. Basically, the Sarbanes-Oxley act protects us from Enron-like crimes.
How does this shield against white-collar-crime affect you? Fortunately, private corporations and companies worth less than $75 MM in market capitalization are not yet obligated to comply with everything in the SOX. However, any large publicly traded corporation in the US, any publicly traded foreign company trading in the US, and even any private companies that are preparing for their Initial Public Offering must comply with the SOX.
This, basically, is the SOX and what it means to you. However, a thorough knowledge of the SOX requires a much deeper look into the act.
The Public Company Accounting Oversight Board is a private sector, non-profit organization, a non-profit organization in which each of its five members makes about $500,000 a year. Each of these well-heeled members is appointed by the Securities and Exchange Commission and serves staggered five-year terms.
So now that we know what it is, what exactly does it do? The PCAOB is responsible for a number of things, such as registering accounting firms. This, of course, is not all. For $500,000 a year, members of the Public Company Accounting Oversight Board are also responsible for setting standards relating to the preparation of audit reports, conducting inspections of registered accounting firms, collecting support fees to fund the board, and basically doing anything, anywhere, that it thinks might promote high professional standards.
Who keeps this powerful organization in line? It turns out that, even though the Public Company Accounting Oversight Board is a private, non-profit organization, it is still our government who makes sure it doesn’t abuse its power. The PCAOB is directly answerable to the Securities and Exchange Commission (SEC). PCAOB decisions may be appealed to the SEC, which has the power to overturn PCAOB rules, inspect, and censor or remove PCAOB rules.
Internal controls are meant to increase the likelihood of company goals being met, as well as to diminish risks as much as possible. How exactly this happens is largely up to the higher-ranking executives, who either delegate certain responsibilities or take it upon themselves to ensure that the company runs smoothly and effectively.
In the case of a publicly traded company, the internal control over financial reporting must follow external regulations put down and enforced by the PCAOB. Specifically, sections 404 and 302 of the Sarbanes-Oxley Act established these regulations. After the law has been set down, external auditors are then brought in to test the internal controls.
But just what kinds of regulations are there? Mainly, the kinds that require a lot of paperwork. The CEO and corporate financial officer must review all financial reports and report anything wrong with the internal accounting controls. Basically, the CEO and CFO are responsible for these internal accounting controls, and they must ensure that the financial reports do not contain any misrepresentations. In addition, they must report any changes in internal accounting. All this must be done with auditors breathing down their necks. This brings us to the next question.
Yes, but there are restrictions. The reason should be obvious, but for the sake of clarity I will explain both why you can (and must) hire auditors, and why you can’t control them.
Put simply, the SOX doesn’t want to waste billions of dollars fighting white-collar crime. The answer to this predicament was to put the financial burden on the companies that the Act is keeping in line. It may seem cruel, but it works. The reason the auditors are on your payroll is that the money is spread out on everyone’s shoulders.
You may think that since you are paying the auditor, it means you are also controlling him or her. This is not the case. One of the provisions of the Sarbanes-Oxley act is auditor independence. Several regulations specifically put down in the SOX ensure that auditors are fair and accurate.
On top of all this, the SOX also requires that companies listed on the stock exchanges have fully independent audit committees. These committees watch over the relationship between the company and its auditor to ensure there is no foul play. This brings to mind another form of foul play that comes in the shape of a high-ranking executive trading off all his stocks...
Let’s look at a hypothetical situation for a moment. Say a fictitious company, “ComputerMart” is starting to slide into the abyss of bankruptcy. The devious and alert CEO knows this, so little by little, he begins trading away his stock in the company. Within a few months, it is all gone, and no one the wiser. The general public that owns stock in Computer Mart thinks they are still clinging to a vibrant and growing corporation. A few months later, the business hits the ground, and everyone loses thousands.
Now what if someone came along and told the CEO, “Hey, we want to see what you’re doing with your company’s stocks.” If the CEO was ethical, and didn’t believe in white-collar crime, he would say “sure.” However, up until the SOX, this wasn’t usually the case. This is why one of the provisions of the Sarbanes-Oxley Act is accelerated reporting of insider trading. When the CEO starts selling his company, the public will now know it.
A quick little side note involving the company’s money and high-ranking executives is the ban on personal loans. The Sarbanes-Oxley Act came right on the heels of the Enron scandal, so no one was feeling much faith in corporate executives at the time. This is why one of the provisions is also a ban on most personal loans.
Okay, so let’s say that our fictitious CEO knows about the Sarbanes-Oxley Act, and he is still trading away stocks in secret. You are one of his secretaries, and one day you stumble upon some computer records that say he is doing just that. Shocked that your boss is a white-collar criminal, you decide to blow the whistle. But wait a minute, you say, what about my job?
Well, ignoring the fact that the company is going down the drain anyway, you need look only as far as the Sarbanes-Oxley Act for protection. If your boss fires you, you only need to file a claim with the OSHA within 90 days to be reinstated. On top of this, you will be given back pay and benefits, compensatory damages, abatement orders, and reasonable attorney fees.
But just what is the OSHA? The Occupational Safety and Health Administration is responsible mainly for protecting workers. They have brought about changes like mandatory covers on all moving parts, permissible exposure levels, personal protective equipment, and process safety management. As you can see, much of the OSHA is identifying and eliminating occupational hazards, and is therefore mostly focused on hazardous occupations. However, fortunately for you and all other good whistleblowers out there, the OSHA will also protect you from vengeful bosses who’ve had the whistle blown on them.
Continuing along in our hypothetical situation, let’s say you’ve caught your boss red-handed, turned him in to the Public Company Accounting Oversight Board, and got your job back with the help of the OSHA. What next? What’s going to happen to your boss?
As it turns out, the fines for such a crime are enormous. Partly because it is such a nasty crime that affects so many people in so many ways, but also because the criminals usually have fatter wallets than your average mugger.
So what exactly does he get? It turns out that even if a corporate officer accidentally fails to comply with the Sarbanes-Oxley Act, he is risking a $1,000,000 fine and up to ten years in prison. While this may seem exorbitant, $1,000,000 hardly digs through even one of some of these officers’ bank accounts. This is where the ten-year prison sentence comes in. While a million-dollar fine may seem like chump change to some and an insurmountable mountain to others, ten years is ten years, no matter who you are.
If this all can happen to someone who accidentally goofed up, what would happen to our hypothetical boss, who intentionally didn’t comply with the SOX? For this white-collar crime, he is risking up to $5,000,000 in fines, and twenty years in prison. Considering the age of many of these CEOs, twenty years could well turn into life.
All this talk of life imprisonment and gigantic fines no doubt has a few of you sweating in your chairs, if you happen to be a corporate officer. So now you are finally ready to learn how to comply with the Sarbanes-Oxley Act. Unfortunately, Enron proved that corporations can’t be expected to simply act ethically, so you now have a number of hoops to jump through and paper trails to leave so that the PCAOB can make sure you aren’t a white-collared criminal.
As it turns out, simply listing what you need to do to comply with the Sarbanes-Oxley Act requires much more room than is provided here. However, there are many websites that do have such lists. A good example would be something like www.sarbanes-oxley-101.com.
This website also provides helpful links to three different types of software that will help you comply with the SOX. All this software helps you stay organized and leave an easily followed paper trail. Business Product Management software (BMP), Enterprise Resource Planning software (ERP), and Customer Relations Management (CRM) software all provide their own uses in complying with the Sarbanes-Oxley Act. However, these can be expensive, which is why it may be a good idea to do a little research on your own, and try to find out which type of software would help out the most. Which brings us to information technology.
So you’ve seen the light, have decided to turn away from white-collar crime, and want to know how much complying with the Sarbanes-Oxley Act is going to cost you. The simple fact is, it’s not cheap. For a fortune 500 company, the cost should be no problem. However, complying with all aspects of the Sarbanes-Oxley Act could take a serious chunk of change for some smaller companies.
In a survey done by the Financial Executives International, 217 companies with an income of more than $5 billion were surveyed during their first year of Sarbanes-Oxley compliance. This compliance was found to cost an average of $4.4 million.
Why the high price tag? Some of the cost can be attributed to having to update information systems to comply with control and reporting requirements. These systems must provide auditing capabilities, which many old systems do not have. Some companies are even forced to purchase entirely new systems to replace their old ones. This can run into big bucks and can be a pretty nasty blow to smaller companies. The other reason compliance with the Sarbanes-Oxley Act is costly is the high price of auditing, the payment for which comes directly from the corporation’s pocketbook.
Looking at all this, one may wonder just why the Sarbanes-Oxley Act passed with a 99-0 vote in the senate. For the answer, you need only look as far as Enron, WorldCom, Tyco International, and Peregrine Systems.