1. Introduction....................................................................................................................................3 The Problem....................................................................................................................................4 Sarbanes-Oxley Act........................................................................................................................6PCAOB - Public Companies Accounting Oversight Board...................................................6Section 101...............................................................................................................................6Section 102...............................................................................................................................6Section 103...............................................................................................................................7Section 104...............................................................................................................................7Section 105...............................................................................................................................8Section 106...............................................................................................................................8Section 107...............................................................................................................................8Section 108...............................................................................................................................9Section 109...............................................................................................................................9Auditor Independence ..............................................................................................................9Section 201...............................................................................................................................9Section 202.............................................................................................................................10Section 203.............................................................................................................................10Section 204.............................................................................................................................10Section 205.............................................................................................................................10Section 206.............................................................................................................................11Sections 207, 208, and 209....................................................................................................11Corporate Responsibility.........................................................................................................11Section 301.............................................................................................................................11Section 302.............................................................................................................................12Section 303, 304, 305, 306, 307, 308.....................................................................................13Enhanced Corporate Disclosures...........................................................................................13Section 401.............................................................................................................................13Section 402.............................................................................................................................14Section 403.............................................................................................................................14Section 404.............................................................................................................................14Section 405.............................................................................................................................15Section 406.............................................................................................................................15Section 407.............................................................................................................................15Section 408.............................................................................................................................15Analyst Conflict of Interest.....................................................................................................16 Section 501.............................................................................................................................16Commission Resources and Authority...................................................................................16Section 601.............................................................................................................................17Section 602.............................................................................................................................17Section 603.............................................................................................................................17Section 604.............................................................................................................................17Studies and Reports.................................................................................................................18

2. Section 701.............................................................................................................................18Section 702.............................................................................................................................18Section 703.............................................................................................................................19Section 704.............................................................................................................................19Section 705.............................................................................................................................19Corporate and Criminal Fraud Accountability....................................................................19Section 801.............................................................................................................................19Section 802.............................................................................................................................19Section 803.............................................................................................................................20Section 804.............................................................................................................................20Section 805.............................................................................................................................20Section 806.............................................................................................................................20Section 807.............................................................................................................................21White Collar Crime Penalty Enhancements.........................................................................21 Section 901.............................................................................................................................21 Section 902.............................................................................................................................21 Section 903.............................................................................................................................21 Section 904.............................................................................................................................21 Section 905.............................................................................................................................22 Section 906.............................................................................................................................22Corporate Tax Returns...........................................................................................................22Section 1001...........................................................................................................................22Corporate Fraud and Accountability.....................................................................................22Section 1101...........................................................................................................................22Section 1102...........................................................................................................................23Section 1103...........................................................................................................................23Section 1104...........................................................................................................................23Section 1105...........................................................................................................................23Section 1106...........................................................................................................................23Section 1107...........................................................................................................................24 Conclusions ..................................................................................................................................24 References.....................................................................................................................................29 Appendix.......................................................................................................................................30Exhibit 1 - PCAOB registration form....................................................................................31Exhibit 2 - Sample internal control questionnaire - expenditure cycle...............................32Exhibit 3 - Sarbanes-Oxley compliance timeline..................................................................332 3. IntroductionThe Sarbanes-Oxley Act of 2002 (SOX) was created as corporate reform legislation in responseto corporate fraud from several high profile companies, such as, Enron, WorldCom, TycoInternational, and Adelphia Communications [The Good]. In the past few years we have seenfive out of ten of the largest bankruptcies in the history of the United States. The Sarbanes-Oxley Act of 2002 added many and changed many existing provisions of the federal securitieslaws. The Act is to establish governance and ethical business practices over public corporations,auditors, attorneys, brokers, investment bankers, and financial analysts. The principalobjectives of the Act are to strengthen and restore confidence in the accounting profession,strengthen enforcement of the federal securities laws, improve the executive responsibility, andimprove disclosure and financial reporting [Guerra].This legislation will change the interaction and accountabilities between corporate executives,auditors, boards of directors, and securities analysts. The regulatory environment has changeddue to the SOX legislation with the introduction of the Public Company Accounting OversightBoard (PCAOB). Changes in the CPA profession have seen a split in the service offerings itprovides to public clients and increased accountability due to a required increase in auditevidence and knowledge of internal control. Management responsibilities and accountabilityhave increased regarding knowledge of corporate financial statements and corporate internalcontrols. New criminal penalties have also been imposed through this legislation.The government has enacted several legislative packages to solve the problems that plaguecorporate America. Corporations have been required to comply with numerous laws and social3 4. requirements regarding standards and ethical behavior. However, every decade America isplagued with new corporate scandals. What is the problem, what is the Sarbanes-Oxley Act, andhow will this new legislation begin to resolve the conflicts that arise as corporations continue onin the future? The ProblemCorporate governance has been around for over a century in the United States. In 1890 theSherman Act was enacted to stop corporations from becoming monopolies. The Securities Actof 1933 was created to prohibit deceit, misrepresentations, and other fraud in the sale ofsecurities [Wikipedia]. The 1934 Securities Exchange Act created the Securities and ExchangeCommission (SEC), and empowered the SEC with broad authority over registration of securities,regulation of public companies, and to oversee brokerage firms, transfer agents, and clearingagencies to ensure fair business practices in the United States [Huddart]. In the 1960s we sawthe price-fixing crisis, the 1970s we saw the foreign payment crisis and the insider trading crisis,and in the 1980s the RICO prosecutions and defense procurement fraud [The Good]. Oneanswer to these crises included the creation of the Committee of Sponsoring Organizations of theTreadway Commission (COSO) in 1985. The committee was established as an independentprivate sector initiative, which studied causal factors that can lead to fraudulent financialreporting. COSO undertook an extensive study of internal control to establish a commondefinition of internal control for companies, public accounting firms, legislators and regulatoryagencies. This should have provided solid frameworks of internal control to manage the waycompanies operate. However, COSO was not an authoritative body and its recommendationswere not consistently used and implemented. Self-regulation has not been effective. Additionallaws have been enacted in response to these crises, and many more which have not been 4 5. mentioned. The collapse of corporations like Enron and WorldCom, which caused billions ofdollars of losses to investors, led to public outcry for more government protection. Theseriousness of these corporate misdeeds is promulgated because involvement was not only ofcorporate executives, but also boards of directors, securities analysts, and CPA firms. Accordingto SEC Commissioner Harvey J. Goldschmid, The corporate and financial scandals of the1990s and early 2000s are the most serious that have occurred in this country since the scandalof the Great Depression [Guerra].How did this happen again?There were several problems that led to the creation of the Sarbanes-Oxley Act of 2002.Executive compensation is grossly disproportionate to corporate results. Management wouldmisrepresent true earnings and financial conditions in order to gain stock options or bonuses.Management teams placed their personal interests above investor demand. Passive, non-independent boards of directors were made up of members selected by the CEO or chairman ofthe board. In one instance WorldComs Board of Directors authorized a $6 billion bid forIntermedia Communications with only 2 hours notice during a telephonically organized meeting.Investment bankers and investment analysts presented biased or non-independent companyinformation focusing only on increasing their profits. No corporate executive would giveinvestment-banking business to a financial institution after one of their securities analysts justtrashed their stock value. Public accounting firms generated so much revenue from consultingservices from corporations that a conflict of interest arose during attestation services. Somefirms went so far as to obstruct justice by concealing activities or destroying evidence [Guerra].5 6. Will SOX be enough regulation to stop corporate fraud? What are the intended or unintendedconsequences due to the enactment of Sarbanes-Oxley? Will these new regulations stop theunethical/illegal behaviors that been seen throughout the last five years or just make it moredifficult for honest corporations to continue on in the future? Sarbanes-Oxley Act PCAOB - Public Companies Accounting Oversight BoardThe Public Accounting Oversight Board (The Board) came into existence with Title One of theSarbanes-Oxley Act. Section 101Section 101 created the PCAOB and its governing rules. There are five full-time members onthe Board, but only two are certified public accountants. The other three members are non-certified public accountants. The Securities and Exchange Commission selects the members,with input from the Chairman of the Board of Governors of the Federal Reserve System and theSecretary of the Treasury. Section 102Section 102 requires that any public accounting firm that prepares or issues an audit report mustcomplete an application to register with the PCAOB (Exhibit 1). Each firm also must file anannual report in order to maintain a current record with the Board. An initial registration fee andan annual fee are required with each application. 6 7. Section 103Auditing standards, quality control and independence standards, and rules are defined in Section103. Auditing standards include: retaining relevant documents that support the audit report fornot less than seven years, providing a second review by a partner not associated with the audit,and identifying the scope of tests of internal control by the auditor. The quality control standardsreflect upon the auditors ethical and independence standards when issuing an audit report. Theauditor must not have consulted with the client regarding accounting and/or auditing issues. Theaudit must be properly supervised and the public accounting firm must employ professionalemployees who have been properly trained and who will continue to receive proper trainingregarding accounting/auditing issues and problems. Section 104If a public accounting firm completes audit reports for more than 100 issuers, then according toSection 104, they are to be inspected annually. If there are less than 100 issuers, the publicaccounting firm will be inspected at least once every three years. The PCAOB will provide allpublic accounting firms with an inspection report prior to the inspection. The PCAOB willrandomly select and review audits completed by the public accounting firm. Each review willevaluate the quality control, documentation, and communications systems of the client and thepublic accounting firm. The Board will look for any activity or procedure that is in violation ofthe Act. If any violation is found it will be reported to the SEC and the correct State RegulatoryCommission. A full investigation will then be undertaken. The PCAOBs final written reportwill include any notes, as well as any correspondence from the public accounting firm. Allconfidential information would be withheld from the public report.7 8. Section 105Section 105 allows the PCAOB to investigate and take disciplinary actions toward any firm thatis in violation of the Act. Penalties for violation include:1. Temporary suspension or permanent revocation of registration, 2. Temporary or permanent suspension or bar of a person from further association with aregistered public accounting firm, 3. Temporary or permanent limitation on activities, functions, or operations of the firm orperson, 4. Civil monetary penalty:a) Not more than $100,000 for a natural person or $2,000,000 for any other person; andb) If intentional, not more than $750,000 for a natural person or $15,000,000 for anyother person, 5. Censure, 6. Required additional professional education or training, or 7. Any other appropriate sanction provided for in the rules of the PCAOB [United States]. Section 106Foreign public accounting firms that issue audit reports for U.S. listed companies are treated as ifthey are U.S. public accounting firms. Under certain circumstances the foreign firm may beexempt from the Act or parts of the Act. Section 107Section 107 dictates that the SEC will approve and/or amend all rules proposed by the Board.The SEC will only approve rules that are in compliance with the Act and all securities laws thatare in the best interest of the general public or to protect corporate investors. At any time theSEC may remove a member of the Board if they are in violation of the Act, fail to follow therules of the Board, or fail to comply with the laws set forth by the SEC. Abuse of authority orfailure to comply and enforce standards could also result in a members removal. 8 9. Section 108Accounting standards are established in Section 108. The Board is charged with keepingstandards current in order to reflect changes in the business environment, the extent to whichinternational convergence on high quality accounting standards is necessary or appropriate in thepublic interest and for the protection of investors [United States]. The PCAOB is also requiredto submit annually their audited financial statements to the SEC and make them available to thepublic. Also in this section the SEC is instructed to complete an analysis on the effect of movingfrom a rules-based accounting system to a principles-based system. Section 109Section 109 creates the funding components of the PCAOB. The Board is required to generate abudget each year that is approved by the SEC. Registration and annual fees will offset expenses.The fees will not exceed the budget expenses. A scholarship program for undergraduate andgraduate students, who are enrolled in an accredited accounting degree program, will be fundedby the monetary penalties assessed by the Board. Auditor IndependenceTitle Two of the Sarbanes-Oxley Act addresses an auditors independence in nine sections. Section 201Section 201 states that it is illegal for a registered public accounting firm to complete an audit forany issuer if the accounting firm has completed any non-audit services for the issuer. Non-auditservices include: bookkeeping/services related to accounting records or financial statements;design and implementation of financial information systems; appraisal/valuation services,9 10. fairness opinions, or contribution-in-kind reports; actuarial services; internal audit outsourcingservices; management or human resources functions; broker/dealer, investment adviser orinvestment banking services; legal/expert services unrelated to the audit; and other services thatthe Board determines are not appropriate [United States]. Section 202The audit committee of the issuer must approve all auditing and non-auditing services of aregistered accounting firm. In addition, the audit committee is required to reveal to investors anynon-audit services that an accounting firm has been requested to complete. Section 203Section 203 focuses on audit partner rotation. The lead audit partner and the reviewing auditpartner cannot perform or review an audit for a period of more than five consecutive years. Section 204An auditor is required to report to the audit committee on a timely basis:1. All critical accounting policies and practices to be used, 2. All alternative treatments of financial information within generally accepted accountingprinciples that have been discussed with management officials of the issuer, ramifications ofthe use of such alternative disclosures and treatments, and the treatment preferred by theregistered public accounting firm, and 3. Other material written communications between the registered public accounting firm andthe management of the issuer (i.e. management letter or schedule of unadjusted differences)[United States]. Section 205The audit committee of an issuer is created by the board of directors and is composed ofmembers of the board of directors. The audit committee is responsible for supervising their10 11. accounting and financial reporting processes, as well as any audits completed on their financialstatements. Section 206Conflicts of interest are addressed in Section 206. A registered public accounting firm isprohibited from completing an audit for an issuer if the issuers chief executive officer,controller, chief financial officer, chief accounting officer, or any other person serving in anequivalent position was employed by the accounting firm and had any role in the audit of theissuer during the one-year period preceding the current audit [United States]. Sections 207, 208, and 209Sections 207, 208, and 209 focus on important, but lesser known parts of the Act. Section 207calls for the Comptroller of the General Accounting Office to conduct a study on the outcome ofthe mandatory rotation of registered public accounting firms. This study is to be reviewed by theCommittee on Financial Services of the House of Representatives. Section 208 states that it isagainst the law for a registered accounting firm to issue an audit report if they are not incompliance with the Act and Section 209 mandates that each States regulatory commissionmonitor the non-registered public accounting firms of that state. Corporate ResponsibilityThe responsibilities of corporations are listed in the eight sections of Title 3 of the Act. Section 301Section 301 outlines the duties and responsibilities of the audit committee. As stated previously,the audit committee is responsible for supervising the accounting and financial reporting11 12. processes of the accounting firm; each board of director member is independent of theaccounting firm; and, each accounting firm reports directly to the audit committee. Thecommittee is also responsible for the accounting firms compensation. Procedures for thereceipt, retention, and treatment of complaints received by the issuer regarding accounting,internal accounting controls, or auditing matters and the confidential, anonymous submission byemployees of the issuer of concerns regarding questionable accounting or auditing matters arehandled under the direction of the audit committee as well [United States]. Section 302Financial report standards are noted in Section 302. The principal executive officer and theprincipal financial officer are to certify that:1. The signing officer has reviewed the report, 2. The report does not contain any untrue statements of material fact or omit to state a materialfact necessary in order to not make the statements misleading, based upon the officersknowledge, 3. The financial statements, and other financial information included in the report, fairly presentin all material respects the financial condition and result of operations of the issuer as of andfor the time presented in the report, based upon the officers knowledge, 4. The signing officers are responsible for establishing and maintaining internal controls; havedesigned such internal controls to ensure that material information relating to the issuer andits consolidated subsidiaries is made known to such officers by others within those entities;have evaluated the effectiveness of the issuers internal controls as of a date within 90 daysprior to the report; and have presented in the report their conclusions about the effectivenessof their internal controls based on their evaluation as of that date, 5. The signing officers have disclosed to the issuers auditors and the audit committee allsignificant deficiencies in the design or operation of internals controls and any fraud thatinvolves management or other employees who have a significant role in the issuers internalcontrols, and 6. The signing officers have indicated in the report whether or not there were significantchanges in internal controls or in other factors that could significantly affect internal controls[United States]. 12 13. Section 303, 304, 305, 306, 307, 308If an officer, in any manner, acts fraudulently or tries to pressure, influence, or misinform theauditor then they have violated Section 303. If an accounting firm is required to complete a re-statement of financial documents due to material non-compliance, the officer or officers will berequired to reimburse the company for any bonuses, equity-based compensation, or profitsreceived in the twelve months following the date of the initial audit report (Section 304). TheSEC can block an individual from working as director or officer of a company if that person hasbroken any anti-fraud laws (Section 305). Also, directors and officers will not be able topurchase, sell, acquire, or transfer any equity security of the company during any blackout period(Section 306). Section 307 establishes rules of conduct for attorneys appearing or practicingbefore the SEC. Attorneys are to report any material violation of securities law to the companyschief legal counsel or chief executive officer, and if not acted upon by legal counsel or theexecutive officer, the attorney is required to report the infraction to the audit committee of theboard of directors. Section 308 instructs the SEC to complete a study of events over the last fiveyears to determine appropriate restitution methods for injured investors. Enhanced Corporate DisclosuresTitle 4 sets forth the requirements for corporate disclosures, conflicts of interest, and assessmentof internal controls. Section 401All corrective material adjusting entries in accordance with GAAP identified by a registeredpublic accounting firm shall be reflected in the financial statements. Disclosure will be made for13 14. any off-balance sheet transactions that have a current or future effect on the financial conditionof company operations. Section 402All direct or indirect personal loans or extension of credit to executives are prohibited. Section 403Directors, officers and principal stockholders who own more than 10 percent of any class ofsecurity must file a statement of ownership at the time of registration of the securities, within 10days after ownership of securities, or after a change in ownership of securities. Disclosurecontents include the amount of all equity securities and ownership of the securities at the date offiling the disclosure. Section 404Section 404 prescribes managements assessment of internal controls. A companys annualreport is required to include an internal control report of management that includes the following:1. A statement of managements responsibilities for establishing and maintaining adequateinternal controls and procedures for financial reporting; 2. Conclusions about the effectiveness of the companys internal controls and procedures forfinancial reporting based on managements evaluation of those controls; and 3. A statement that the registered public accounting firm that prepared or issued the companysaudit report relating to the financial statements included in the companys annual report hasattested to, and reported on, managements evaluation of the companys internal controls andprocedures for financial reporting. See Exhibit 2 for an example of questions to be answered regarding the expenditure cycle thatwould facilitate management establishment of internal controls.14 15. Section 405Any investment company registered under Section 8 of the Investment Company Act of 1940 isnot subject to sections 401, 402 or 404 [United States]. Section 406Section 406 requires that a company disclose its code of ethics for senior financial officers. Ifthe company has not adopted a corporate code of ethics then the company must disclose reasonsfor not adopting a corporate code of ethics. Changes in an established code of ethics or anywaiver of the code to a corporate officer must be immediately disclosed on Form 8-K. Section 407A public company is required to have at least one member that is considered a financial experton its audit committee. A financial expert as defined by SOX is someone with the followingknowledge:1. An understanding of generally accepted accounting principles and financial statements; 2. Experience in preparation of auditing of financial statements of generally comparable issuersand the application of such principles in accounting for estimates, accruals, and reserves; 3. Experience with internal accounting controls; and 4. An understanding of audit committee functions [United States]. Section 408Section 408 requires the SEC to review corporate financial statements. The review shall include:1. Financial statements of companies that have issued material re-statements of financialresults; 2. Companies that experience significant volatility in stock price compared to other companies; 3. Companies with the largest market capitalism; 4. Emerging companies with disproportionate price to earnings ratios; 5. Companies whose operations significantly affect any material sector of the economy; and 6. Any other factors the commission considers relevant [United States]. 15 16. Analyst Conflict of InterestTitle 5 addresses conflicts of interest regarding security analysts. Section 501This section has several requirements in order to maintain independence and objectivity ofresearch and dissemination of information to investors. Section 501 also created several rulesregarding analyst protection and disclosure requirements.Three main issues surround analyst protection. First, analysts are not to be subject to pre-publication clearance by anyone not directly responsible for investment research. Brokers ordealers are not to threaten or retaliate against analysts for an adverse research report that couldcause negative consequences to the broker or dealer. Brokers or dealers involved with a publicoffering are not to distribute research reports related to the issuance of the securities.Regarding disclosure, brokers or dealers must disclose any conflicts of interest in the researchreports provided by securities analysts. Disclosures must include whether the securities analysthas any debt or equity investments in the securities be reported on, whether the analyst, broker ordealer has received compensation from the issuer of the security, whether the issuer of thesecurity has ever been a client of the broker or dealer and the types of services provided, andwhether the securities analyst has been paid for services rendered for the research report. Commission Resources and AuthorityTitle 6 discloses the resources and the authority of the Securities and Exchange Commission. 16 17. Section 601The SEC has been authorized for an appropriation of $776,000,000 for fiscal year 2003. Thefunds appropriated for 2003 were as follows: $102,700,000 for salaries and benefits;$108,400,000 for information technology, security enhancements, and recovery and mitigation ofterrorist attack activities; and $98,000,000 for additional manpower resources for additionalsupervision of auditors and audit services. Section 602If anyone is found not to have qualifications to represent others, to be lacking in character orintegrity, has behaved unethically, or has willfully violated or aided in the violation of any of thesecurities laws they can be censured by the SEC.Negligent conduct includes any registered accounting firm not conducting itself within theboundaries of professional accounting standards. Any repeat offense in violation of professionalaccounting standards can warrant denial of practice before the SEC. Section 603The court may stop any person from dealing with a broker, dealer or issuer in the issuance ofpenny stock offerings. Section 604Section 604 states that the SEC has the authority to suspend the right of any person to beassociated with a broker or dealer of securities. It also gives a States commission the authorityto supervise or examine banks, savings associations, or credit unions [United States].17 18. Studies and ReportsTitle 7 of the Sarbanes-Oxley Act identifies five studies that are to be undertaken by variousgovernment entities. Section 701The General Accounting Office is requested to identify: why numerous public accounting firmshave consolidated since 1989 (which reduced the number of firms available to complete auditsfor large corporations); the impact on domestic and international capital formation and securitiesmarkets; and any resolutions to problems discovered (especially methods of increasingcompetition among accounting firms who are able to complete audits for large corporations).The study is also to include the impact on corporations due to the decrease in competition amongaccounting firms. Issues that are to be addressed include high costs, poor quality of service, lackof auditor independence, and choice of auditors. In addition, Federal and State regulations are tobe studied to determine their effect on competition. Section 702According to Section 702 credit rating companies are to be studied by the SEC. The SEC is toresearch the role credit rating agencies play in evaluating issuers of securities and how muchweight investors place on that information. Additionally, the SEC is to determine if there are anybarriers to entry for new credit rating agencies and to information resources.18 19. Section 703The SEC is required to complete a study on the number of securities professionals who havebeen in violation of any securities law, identify who they are, which law/laws were violated, howmany times multiple violations occurred, and what, if any, disciplinary actions were taken. Section 704Areas of reporting that are vulnerable to fraud or manipulation are to be investigated by the SECfor the time period from 1997-2001. Recommendations to correct any areas are to be included inthe report. Section 705The General Accounting Office is to determine if investment bankers and financial advisorsencourage companies to alter financial records to hide the actual condition of the company. Corporate and Criminal Fraud AccountabilityTitle 8 of the Sarbanes-Oxley Act creates amendments to the United States Code to focus on thecriminal activities addressed in the Act and sets forth penalties for violation of the Act. Section 801Corporate and Criminal Fraud Accountability Act of 2002 Section 802If anyone knowingly alters, destroys, covers up, or falsifies records during the course of aFederal investigation, that person will be fined and/or imprisoned for not more than 20 years. Anauditor is required to maintain audit work papers for a period of five years after the audit is19 20. completed. If the papers are destroyed, the auditor will be fined and/or imprisoned for not morethan 10 years. Section 803Section 803 states that any debt that is the result of fraudulent practices cannot be discharged ifthe corporation declares bankruptcy. Section 804The statute of limitations for securities fraud is set in Section 804. Action regarding securitiesfraud must be taken by the earlier of:1. 2 years after discovering facts that indicate a violation, or 2. 5 years after the violation. Section 805This section directs the United States Sentencing Commission to review and/or amend theFederal Sentencing Guidelines based upon possible violations of the Act. The punishments areto be severe enough to keep the violations from reoccurring. Section 806Section 806 prohibits companies from discharging, demoting, or discriminating against anyemployee who provides information regarding conduct the employee believes is in violation ofsecurities laws or fraud statutes. If an employer is found to be in violation, they must reinstatethe employee at the same level; they must reimburse the employee for all back pay with interest;and they must pay the employees court costs, reasonable attorney fees, and any other damagesdetermined to be a result of the actions taken against the employee.20 21. Section 807Anyone who knowingly or attempts to defraud anyone involved with the securities of the issuerwill be fined and/or imprisoned for not more than 25 years. White Collar Crime Penalty EnhancementsThe six sections of Title 9 of the Sarbanes-Oxley Act outline additional penalties for violation ofthe Act. Section 901White-Collar Crime Penalty Enhancement Act of 2002 Section 902Section 902 states that anyone who attempts to commit fraud will be treated as if they hadcommitted fraud. Section 903The maximum penalties for mail and wire fraud have been increased from 5 years to 20 years. Section 904The penalty for violating the Employee Retirement Income Act of 1974 has also been changed.Imprisonment is now for period of 10 years instead of 1 year and the fine has increased from$100,000 to $500,000.21 22. Section 905This section directs the United States Sentencing Commission to review and/or amend theFederal Sentencing Guidelines related to white-collar crimes. Once more, the punishments are tobe severe enough to keep the violations from reoccurring. Section 906Section 906 mandates that all reports filed by the issuer to the SEC include a statement from theCEO and the CFO. The statement must state that the information complies with therequirements of SEC and that the information is a fair representation of the financial condition ofthe issuer. Failure to comply will result in a fine of not more than $1,000,000 and/orimprisonment of not more than 10 years. Willful failure to comply will result in a fine of notmore than $5,000,000 and/or imprisonment of not more than 20 years. Corporate Tax Returns Section 1001The Federal income tax return of a corporation is to be signed by the CEO of that corporation. Corporate Fraud and AccountabilityTitle 11 of the Sarbanes-Oxley Act contains 7 sections that specify additional fines and prisonsentences for those who violate the Act. Section 1101Corporate Fraud Accountability Act of 2002 22 23. Section 1102Anyone who intentionally alters, destroys, or conceals information from and/or for an officialproceeding will be fined and/or imprisoned for not more than 20 years. Section 1103If the SEC suspects that an issuer will make special payments to any employee underinvestigation, the SEC can petition a Federal district court to place the funds in an escrowaccount for a period of 45 days. Section 1104The United States Sentencing Commission is required to review and/or amend the FederalSentencing Guidelines related to corporate fraud. Once again, the punishments are to be severeenough to keep the violations from reoccurring and be consistent with other jail sentences andfines. Section 1105Section 1105 allows the SEC to bar anyone from serving as a director or officer if that person hasviolated the rules and regulations of this title. Section 1106The fines and penalties for an individual in violation of the SEC Act of 1934 include:1. Maximum fine of $5,000,000, and 2. Imprisonment of not more than 20 years.The fines and penalties for an individual in violation of the SEC Act of 1934 include:1. Maximum fine of $25,000,000, and 2. Imprisonment of not more than 20 years.23 24. Section 1107Anyone who interferes with another persons employment or livelihood, while that person isproviding information in regards to a violation, will be fined and/or imprisoned for not more than10 years. ConclusionsWhat have been the intended or unintended consequences due to the enactment of Sarbanes-Oxley? Will SOX be enough regulation to stop corporate fraud?Some of the intended consequences have been an increase in active participation by boards ofdirectors and audit committees; an increase in criminal action, fines and penalties against thosewho do not comply with SOX; and an increase in internal control procedure documentation andattestation to those internal controls. Studies completed by governmental entities have providedinsight into what and who facilitated the breakdown in corporate controls. Increases in salariesand auditing costs also have been an intended consequence of SOX regulation, even though thisis not a welcome consequence for most corporations. An increase in corporate disclosure isanother intended consequence as well.One of the issues cited as problematic was non-independence of boards of directors, auditcommittees and public accounting firms. Section 404 of SOX required that the board ofdirectors take an active role in effecting the process of internal control within a company. 86%of Enrons board of directors was independent. A former dean of the Stanford Business Schooland professor of accounting chaired Enrons audit committee [Berlau]. Enrons board of 24 25. directors and audit committee should inherently have been considered independent and truerepresentatives of Enrons shareholders; however, their performance showed this was not thecase. This was evident when Enrons Chairman authorized a waiver of Enrons code of ethics toits CFO to participate in partnerships, which cost Enron millions of dollars. Section 406 willalso mitigate situations such as these due to forced disclosure of any waiver of corporate codes ofethics.How has SOX affected the way the audit committees and board of directors operate within acompany? According to a survey done by Deloitte and Touche, LLP, before Sarbanes-Oxley,11 of 66 companies surveyed met more than six times per year. Since the Act, 39 companieshave met that frequently. Before the Act, half of the companies surveyed met for one hour orless. Since the Act, only 10% have met for such a short time [Koehn]. In addition, as more andmore pressure is being placed upon the board of directors to comply with SOX, their workloadshave increased significantly. However, there have only been small increases in compensation formembers according to a study by PricewaterhouseCoopers. The study indicated that only 20%of board members received increases, while 47% remained the same. Compensation for auditcommittee members remained the same for 41% of the companies surveyed, while 22% receivedincreases. In order to have a competent board of directors and audit committee, compensationlevels will need to be increased to reflect the level of work required. Garrett Stauffer, leader ofPricewaterhouseCoopers US Corporate Governance Practices, sums this all up, The newregulations have increase the time demands for audit committee members even more than forother directors. Directors generally are not serving on boards because of the pay. However, withthe time commitment for boards service increasing, compensation for directors will have to 25 26. reflect the amount of effort involved [Collins]. This shows that audit committees are workingmore to facilitate monitoring the internal control process due to the enactment of Sarbanes-Oxley. However, a consequence to the increased involvement is an increase in salaries,therefore, an increased cost of doing business.Richard Scrushy, former HealthSouth CEO, is the first corporate executive to face charges underthe Act. He faces 85 charges, including conspiracy to commit fraud, filing false financialstatements, money laundering, and securities and wire fraud [Taub], which are in violation ofseveral sections of the Act. This is a giant step in proving that increased regulation and penaltiesfor non-compliance of regulation is making considerable leaps towards improving behaviorregarding fair reporting practices.One study completed by the SEC identified 1596 securities professionals who were in violationof any securities law from 1998-2001. Registered representatives and branch managers ofbroker-dealers comprised the largest group offenders. At least four more studies will becompleted to help provide information regarding the lack of controls within variousorganizations.A major increase in disclosure is another consequence of SOX due to sections 401-406compliance. This includes disclosure of all corrective material adjusting entries, managementassessment of internal controls, and disclosure its code of ethics for senior financial officers. Ifthe company has not adopted a corporate code of ethics then the company must disclose reasonsfor not adopting a corporate code of ethics. According to the 2004 CPA Journal the size of26 27. annual reports, quarterly filings, and proxy statements has increased significantly. GeneralElectrics latest report is 160 pages, double the previous year, Kodaks annual report is 45%larger and General Motors report is 28% larger.One of the biggest increases in costs is due to Section 404 compliance, which requires increaseddocumentation for internal control processes and the registered audit firms attestation for thatinternal control. According to The CPA Journal, the cost of SOX compliance personnel willincrease 266.7% and accounting personnel will increase 105.3% due to this regulation alone.Audit fees are expected to increase from 25% to 33% [Kroehn].There have been several unintended consequences due to SOX compliance. One effect has beencontraction in the audit market. Public accounting firms are required to be registered with thePCAOB as a condition for providing attestation services to public companies. Due toregistration costs and increased liability insurance costs, training costs, and liability risk, morefirms are weighing the option of not becoming registered with the PCAOB.There has also been an increase in corporate executive D&O insurance premiums. Insurance hasincreased by as much as 100% to 400%. In addition, if a company has restated earnings someinsurance companies will drop coverage altogether for corporate executives.An increase in accounting education has been one beneficial unintended consequence of the Act.Educational institutions are seeing an increase in attendance for accounting courses. Universitiesare also focusing more on classes related to fraud. With the increase in audit work needed for27 28. SOX compliance, hopefully, individuals will enter the profession with more refined course workto match todays accounting environment.There has been an increased awareness of compliance levels that must be met. Corporateexecutives, boards of directors, audit committee personnel, public accounting firms, andsecurities analysts are all becoming aware of the accountability that exists with each of theirpositions. It does seem that Sarbanes-Oxley will be very expensive to set up and maintain in theyears to come. However, is it as costly as the decline in stock market, the loss of jobs due todownsizing and bankruptcies because of inaccurate financial reporting, and the creditor lossesdue to bankruptcies? Is Sarbanes-Oxley the answer to all the problems that have inundatedcorporations? Only time will tell. 28 29. References Berlau, John. Sarbanes-Oxley is Business Disaster. Insight on the News. 13-16February 2004: 24-26.Collins, Pet. Sarbanes-Oxley Making Directors Work Harder. 28 January 2004.The Good, the Bad, and Their Corporate Codes of Ethics: Enron, Sarbanes-Oxley, and theProblems with Legislating Good Behavior. Harvard Law Review, May 2003: 2123+.Guerra, Jorge E. The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate GovernanceProcess. Part 1: Overview. 1 February 2001. Guerra, Jorge E. The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate GovernanceProcess. Part 2: What Went Wrong? Who were the transgressors? Why did this happenagain? 1 February 2001. ?Guerra, Jorge E. The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate GovernanceProcess. Part 3: What Needs to Be Done Now. 1 February 2001.Guerra, Jorge E. The Sarbanes-Oxley Act of 2002 and Evolution of the Corporate GovernanceProcess. Part 4: Sarbanes-Oxley - A Giant First Step In The Right Direction. 1 February2001. Huddart, Steven. Penn State Smeal College of Business. 15 March 2004.Koehn, Jo Lynn and Stephen C. Del Vecchio. Ripple Effects of the Sarbanes-Oxley Act. TheCPA Journal. February 2004: 36+.Stelzer, Irwin M. The Corporate Scandals and American Capitalism. Public Interest. Winter 2004: 19+.Taub, Stephen. Scrushy to Challenge Sarbox. 11 December 2003. United States. Sarbanes-Oxley Act of 2002. 107th Congress, Second Session. Washington. 23January 2002.Wikipedia Encyclopedia. 12 March 2004. 29 30. Appendix30 31. Exhibit 1 - PCAOB registration form 31 32. Exhibit 2 - Sample internal control questionnaire - expenditure cycle 32 33. Exhibit 3 - Sarbanes-Oxley compliance timeline33