The Sarbanes-Oxley Act was signed into law on 30th July 2002, and introduced highly significant legislative changes to financial practice and corporate governance regulation. It introduced stringent new rules with the stated objective: "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws". Officially titled ‘the Public Company Accounting Reform and Investor Protection Act of 2002’, and commonly called SOX and Sarbox, it was named after its main architects, Senator Paul Sarbanes and Representative Michael Oxley, and came as result of a series of corporate financial scandals, such as Enron and WorldCom. Sarbanes-Oxley Act is considered the most significant change to federal securities laws in the United States since the New Deal. The Sarbanes-Oxley Act itself is organized into eleven titles, covering issues such as establishing a public company accounting oversight board, corporate responsibility, auditor independence, and enhanced financial disclosure, etc. Sections 302, 404, 401, 409, 802 and 906 are the most significant with respect to compliance and internal control;and section 404 seems to cause
most concern.The following is a rough summary of Sarbanes-Oxley act. Title one sets up the rules concerned with the establishment of the Public Company Accounting Oversight Board (PCAOB), and the Board’s
administrative provisions, duties and powers, Commission oversight of the Board, and funding. PCAOB is established to oversee the audit of public companies that are subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interests in the preparation of informative, accurate, and independent audit reports for companies. The Board operates as a nonprofit corporation. The Board shall have 5 members, two and only two members of which shall be or have been certified public accountants, provided that, if one of those two members is the chairperson, he or she may not have been a practicing certified public accountant for at least 5 years prior to his or her appointment to the Board. Each member of the Board shall serve on a full-time basis for no more than 2 terms, each term has 5 years. The main duties of the Board are to register public accounting firms, establish or adopt standards relating to the preparation of audit reports for issuers, conduct inspections of registered accounting firms, conduct investigations and disciplinary proceedings concerning, and impose appropriate sanctions upon registered accounting firms and associated persons, perform other duties or functions necessary
and enforce compliance with the SOX etc. One important requirement is that all the public accounting firms to prepare or issue, or to participate in the preparation or issuance of, any audit report with respect to any issuer have to register with the Board, including foreign public accounting firms. The funding of Board is composed of three elements: the budget, registration or annual fees received from registered public accounting firms, monetary penalties. Title two is concerned with auditor independence issue. Any registered accounting firm that performs for any issuer any audit service is prohibited from providing non-audit service for that issuer. Non-audit services include--- bookkeeping or other services related to the accounting records or financial statements of the audit client; financial information systems design and implementation; appraisal or valuation services, fairness opinions, or contribution-in-kind reports; actuarial services; internal audit outsourcing services; management functions or human resources; broker or dealer, investment adviser, or investment banking services; and legal services and expert services unrelated to the audit etc. All auditing services and non-audit services provided to an issuer shall be pre-approved by the audit committee of the issuer. And there is requirement of the mandatory 5-year audit partner rotation. It is unlawful for a registered public accounting firms to perform for an issuer audit services, if a chief executive officer, controller, chief financial officer, chief accounting officer or any person serving in an equivalent position for the issuer was employed by that registered independent public accounting firm and participated in any capacity in the audit of that issuer during the 1-year period preceding the date of the initiation of the audit.
Title three states the corporate responsibilities for financial reports. The principal executive or officers and the principal financial officer or officers, or persons performing similar functions, have to sign in each annual or quarter report to certify that the signing officer has reviewed the report and there are no untrue statements or omission of material fact that causes the statement misleading. The signing officer certifies that information in the report fairly present in all material respects the financial condition and results of operations of the issuer. The signing officer takes all the responsibilities for establishing and maintaining internal controls, and evaluates its effectiveness and presented the conclusion about the effectiveness in the report. The commission shall set up fair funds for investors who become victims in any
judicial or administrative action brought by the Commission. The resources of fair funds are from penalties and donations.
Title four enhances the financial disclosures of public companies. Periodic reports shall reflect all material correcting adjustments that have been identified by a registered public accounting firm, and disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons that may have a material current or future effect on the issuer. Each annual report shall contain an internal control report, which shall--- state the responsibility of management for establishing and maintaining an adequate internal control structure and procedure for financial reporting; and contain an assessment of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. With respect of internal control assessment, each registered public accounting firm that prepares or issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer. The Commission shall review disclosures made by issuers on a regular and systematic basis. Issuers shall not be reviewed less frequently than once every 3 years. Each issuer shall disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphic presentations.
Title five deals with the interest conflicts of analysts. In order to foster greater public confidence in securities research, and to protect the objectivity and independence of securities analysts, a registered securities association or national securities exchange shall adopt rules to assure that securities analysts are separated by appropriate informational partitions within the firm from the review, pressure, or oversight of those whose involvement in investment banking activities might potentially bias their judgment or supervision; require that a broker or dealer and persons employed by a broker or dealer who are involved with investment banking activities may not, directly or indirectly, retaliate against or threaten to retaliate against any securities analyst employed by that broker or dealer or its affiliates as a result of an adverse, negative, or otherwise unfavorable research report that may adversely affect that present or prospective investment banking relationship of the broker or dealer with the issuer that is the subject of the research
report; and define a period during which brokers or dealers who have participated, or are to participate, in a public offering of securities as underwriters or dealers should not publish or otherwise distribute research reports relating to such securities or to the issuer of such securities. Title six states the resources and authorities of the Commission. The Commission shall have enough funds appropriated to carry out the functions, powers and duties. The Commission has the authority to censure any person, or deny, temporarily or permanently, to any person the privilege of appearing or practicing before the Commission in any way, if that person is found performing improper professional conduct; and the Commission has the authority to bar or suspend the right of the person to be associated with a broker, dealer or investment adviser.
Title seven requires GAO to study the consolidation of public accounting firms , and investment banks; and requires the Commission to study credit rating agencies, violators and violations and the enforcement actions by the Commission. Both GAO and the Commission have to report the study results. Title eight may be cited as the “Corporate and Criminal Fraud Accountability Act of 2002”. This title sets up the rules for criminal penalties for altering documents. Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States, or in relation to or contemplation of any such matter or case, shall be fined, or imprisoned not more than 20 years, or both. Any accountant who conducts an audit of an issuer shall maintain all audit or review work papers for a period of 5 years, Whoever knowingly violates this rule will be fined or imprisoned not more than 10 years, or both. This title also provides protection for employees of publicly traded companies who provide evidence of corporate fraud. Title nine may be cited as the “White-Collar Crime Penalty Enhancement Act of 2002”. This title enhances the penalties on white-collar crimes. Any person who attempts or conspires to commit any offense under this title shall be subject to the same penalties as those prescribed for the offense, the commission of which was the object of the attempt or conspiracy. Chief executive officer and chief financial officer (or equivalent thereof) of the issuer shall certify with a written statement that periodic reports containing the financial statements fully complies with the
requirements of the Securities Exchange Act of 1934 and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. Whoever certifies any statement knowing that the periodic report accompanying the statement does not comport with all the requirements shall be fined not more than $1,000,000 or imprisoned not more than 10 years, or both. Whoever willfully certifies such statement will be fined not more than $5,000,000, or imprisoned not more than 20 years, or both.
Title ten requires that the Federal income tax return of a corporation should be signed by the chief executive officer of such corporation. Title eleven may be cited as the “Corporate Fraud Accountability Act of 2002”. This title designates SEC the authority to temporarily freeze the extraordinary payment to any director, officer, partner, controlling person, agent, or employee of a company during an investigation of possible violations of securities laws. SEC shall require the issuer to escrow those payments in an interest-bearing account for 45 days. Whoever tampers with a record or otherwise impedes an official proceeding shall be fined or imprisoned not more than 20 years or both. The Commission may issue an order to prohibit, conditionally or unconditionally, and permanently or for a period of time, any person who has violated the rules, from acting as an officer or director of any issuer, if the conduct of that person demonstrates unfitness to serve as an officer or director of any such issuer. Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the harmful employment or livelihood of any person, for providing to a law enforcement officer any truthful information, shall be fined or imprisoned not more than 10 years, or both.
From the summary of the Sarbanes-Oxley Act of 2002 above, we can see that the Act not only imposes additional disclosure requirements, but more importantly, proposes substantive corporate governance mandates, a practice that is unprecedented in the history of federal securities legislation. By requiring more oversight, imposing greater penalties for managerial misconduct, and dealing with potential conflicts of interest, the Act aims to prevent deceptive accounting and management misbehavior.
However, despite the claimed benefits of this Act, the business community has expressed substantial concerns about its costs, especially the compliance costs to the internal control rules from section 404. Whereas the out-of-
pocket compliance costs are generally considered significant, they are likely swamped by the opportunity costs SOX imposed on business, especially for smaller firms. A 2004 survey by Korn/Ferry International found that US businesses spent about $5.1 million on average complying with SOX in the first year, and according to EFI (Financial Executives International) survey, the average cost for Section 404 compliance was $2.9 million during fiscal year 2006, this drop is largely attributed to increased efficiencies, a positive learning curve, and technical systems and software rollouts. Large companies are able to absorb the expense and fold the compliance activity into their standard operating procedures, but smaller enterprises may not have a significant revenue base over which to spread the additional costs. The anticipated cost for small firms is $824,000 according to FEI survey, which will certainly become a very heavy financial burden on small firms. So the compliance date for firms with capitalization less than 75 million has been delayed several times to December 15, 2008 ( please see the appendix). Executives also complain that complying with the rules diverts their attention from doing business. Furthermore, the Act exposes managers and directors to greater litigation risks and stiffer penalties. CEOs allegedly will take less risky actions, consequently changing their business strategies and potentially reducing firm value.
On April 4, 2007, the Securities and Exchange Commission announced it will revisit some of SOX's rules. The primary focus will be the heavy financial costs of Section 404. In fact, the SEC's decision to revisit Section 404 appears to be a tacit acknowledgement that the high costs of complying with Section 404 may actually deprive some investors of information, as a growing number of smaller companies exit from the major stock exchanges to go private or list with services like the "Pink Sheets," an electronic quotation medium that is not subject to SOX disclosure requirements. Consequently, instead of providing more information to investors, these companies provide none. The Sarbanes-Oxley Act also has altered the flow of foreign listings across international exchanges. U.S. exchanges have experienced a decrease frequency of foreign listing following the Act. Many foreign companies, especially smaller and less profitable companies, prefer to list on LSE or other exchanges bypassing US high list and compliance costs.
Of course, SOX Act also has firm supporters, advocating that the passage of the Act has helped enhance the integrity of the capital markets and restore
investor confidence. There might be regulatory changes to SOX act, but whatever the changes are, the intention of the changes would be to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws.