MGT 4950: Business Policy Case Study: Sarbanes Oxley Act 2002 submit by: Sadia Naz User

ID:197532 Instructor : Dr. Kaup Mohammed Course : B.S. Honours- Madonna University Michigan State U.S.A. Specialization in Business

Date : 5th Dec 2011

Case Synopsis

Sarbanes-Oxley is a US law passed in 2002 to strengthen Corporate governance and restore investor confidence. Act was sponsored by US Senator Paul Sarbanes and US Representative Michael Oxley. Sarbanes-Oxley law passed in response to a number of major corporate and accounting scandals involving prominent companies in the United States. These scandals resulted in a loss of public trust in accounting and reporting practices. Legislation is wide ranging and establishes new or enhanced standards for all US public company Boards, Management, and public accounting firms. Sarbanes-Oxley law contains 11 titles, or sections, ranging from additional Corporate Board responsibilities to criminal penalties. Requires Security and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law. As far as compliance is concerned, the most important sections within these are often considered to be 302, 401, 404, 409, 802 and 906.

Sarbanes-Oxley Act Summary and Introduction

SarbanesOxley or SOX, is a United States Federal law enacted on July 30, 2002. It is named after Senator Paul Sarbanes and Representative Michael Oxley. The SOX of 2002 signed by the American President George W. Bush and considered to be the most far-reaching set of government implemented-laws. The bill was enacted as a reaction to a number of major Corporate & Accounting Scandals. It is the first effort after the collapse of Big Giant Enron, Tyco International, WorldCom etc. These scandals, cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the Security Market. SOX was created to make corporate executives more responsible for their companies financial statements. SOX requires companies to follow strict accounting practices to avoid large fines and, in some cases, prison sentences.

Brief Profile / History

The SarbanesOxley Act of 2002, also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and commonly called SarbanesOxley or SOX. SOX is a United Sates Federal Law enacted on July 30, 2002, which set new or enhanced standards for all U.S.Public Company boards, management and public accounting firms. It is named after sponsors U.S. Senator Paul Sarbanes and U.S. Representative Michael G Oxaley. who were its main architects, it also set a number of deadlines for compliance. SOX brought major amendments to the rules and regulations of financial procedures and corporate governance resulting in bringing about new responsibilities to the corporate government. When SOX was signed into law, it set new standards for financial reporting and accountability for the validity of those financial statements being reported. Corporate governance became mandatory. The bill significantly affects the regulation of accountants; imposes new responsibilities and liabilities on CEOs, CFOs and Boards of Directors; and extends criminal penalties, in terms of both fines and prison sentences, for corporate fraud, destruction of documents and impeding investigations.

Vision & Mission

Provides an overview of the requirements that are unclear for reporting entities. Focuses on improving the accurate and reliability of corporate disclosure to protect the investors. Inspects public companies annually for any possible violation of the professional and security standards and preparation of the audit report. Adopts tough new provisions proposed to prevent and punish corporate and accounting fraud and corruption. Threatens severe penalties for wrongdoers Safeguards the interests of workers and shareholders Strengthens the independence of firms that audit public companies Focuses on creation of new-disclosure based incentives for firms to spend money on internal controls

SOX Section Analysis

SarbanesOxley Section 302: Disclosure controls:Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. Sarbanes-Oxley Section 401: Disclosures in periodic reports:Sarbanes-Oxley required the disclosure of all material off-balance sheet items (bankruptcy of Enron drew attention to off balance sheet instruments that were used fraudulently). SarbanesOxley Section 404: Assessment of internal control:requires management and the external auditor to report on the adequacy of the company's internal control on financial reporting. SarbanesOxley Section 906: Criminal Penalties:Criminal Penalties for CEO/CFO for Misleading financial statement certification or or fraudulent report.

SOX Act Assessment

Timely disclosure of information Senior Officer certification Increased transparency Independence mandatory Mandatory SEC review New audit committee requirements Prohibition of loans or exchanges with senior management SOX allows SEC to impose greater criminal penalties for corporate crimes Creation of Public Company Accounting Oversight Board Newly defined analyst conflicts of interest rules Professional responsibility guidelines for attorneys Protection for whistleblowers

Sarbanes-Oxley Act Outline

11 titles that describe specific mandates and requirements of financial reporting.

Public Company Accounting Oversight Board (PCAOB) Auditor Independence Corporate Responsibility Enhanced Financial Disclosures Analyst Conflicts of Interest Commission Resources and Authority Studies and Reports Corporate and Criminal Fraud Accountability White Collar Crime Penalty Enhancement Corporate Tax Returns Corporate Fraud Accountability

Sarbanes Oxley Act Overview

Overview

Analyzing the cost-benefits of SarbanesOxley

Compliance costs

FEI Survey (Annual): Finance Executives International (FEI) provides an annual survey on SOX Section 404 costs. These costs have continued to decline relative to revenues since 2004. The 2007 study indicated that, for 168 companies with average revenues of $4.7 billion, the average compliance costs were $1.7 million (0.036% of revenue ).The 2006 study indicated that, for 200 companies with average revenues of $6.8 billion, the average compliance costs were $2.9 million (0.043% of revenue), down 23% from 2005. A 2011 SEC( Security & Exchange Commission ) study found that Section 404(b) compliance costs have continued to decline, especially after 2007 accounting guidance.

Continued..

Benefits to firms and investors

Arping/Sautner (2010): This research paper analyzes whether SOX enhanced corporate transparency.Looking at foreign firms that are cross-listed in the US, the paper indicates that, relative to a control sample of comparable firms that are not subject to SOX, cross-listed firms became significantly more transparent following SOX. Corporate transparency is measured based on the dispersion and accuracy of analyst earnings forecasts. Lord & Benoit Report (2006): Do the Benefits of 404 Exceed the Cost? A study of a population of nearly 2,500 companies indicated that those with no material weaknesses in their internal controls, or companies that corrected them in a timely manner, experienced much greater increases in share prices than companies that did not. The report indicated that the benefits to a compliant company in share price (10% above Russell 3000 index) were greater than their SOX Section 404 costs. Institute of Internal Auditors (2005): The research paper indicates that corporations have improved their internal controls and that financial statements are perceived to be more reliable.

Strategic Evaluation

Sarbanes Oxley Act Establishes new standards for Corporate Boards and Audit Committees. Sarbanes Oxley Act Establishes new accountability standards and criminal penalties for Corporate Management. Sarbanes Oxley Act Establishes new independence standards for External Auditors.

Criticism

Congressman Ron Paul and others such as former Arkansas governor Mike Huckabee have contended that SOX was an unnecessary and costly government intrusion into corporate management that places U.S. corporations at a competitive disadvantage with foreign firms, driving businesses out of the United States. A research study published by Joseph Piotroski of Stanford University and Suraj Srinivasan of Harvard Business School titled "Regulation and Bonding: Sarbanes Oxley Act and the Flow of International Listings" in the Journal of Accounting Research in 2008 found that following the act's passage, smaller international companies were more likely to list in stock exchanges in the U.K. rather than U.S. stock exchanges. During the financial crisis of 2007-2010, critics blamed SarbanesOxley for the low number of Initial Public Offerings (IPOs) on American stock exchanges during 2008. In November 2008,Newt Gingrich and co-author David W. Kralik called on Congress to repeal SarbanesOxley.

Praise

Former Federal Reserve Chairman Alan Greenspan praised the Sarbanes Oxley Act: "I am surprised that the SarbanesOxley Act, so rapidly developed and enacted, has functioned as well as it has...the act importantly reinforced the principle that shareholders own our corporations and that corporate managers should be working on behalf of shareholders to allocate business resources to their optimum use. The FEI 2007 study and research by the Institute of Internal Auditors (IIA) also indicate SOX has improved investor confidence in financial reporting, a primary objective of the legislation. The IIA study also indicated improvements in board, audit committee, and senior management engagement in financial reporting and improvements in financial controls. As a testament to the need for stricter financial governance SOX-type laws have been subsequently enacted in Japan, Germany, France, Italy, Australia, India, South African, and Turkey.

Suggestions
Sarbanes Oxley Act provides a number of long term benefits.

Investors' confidence is increased as SOX ensures reliable financial reporting. SOX has had a significant impact on corporate governance. Companies are no longer able to manipulate inventories or stocks of products or sales as there is a real time reporting system in place. SOX nurtures an ethical culture as it forces top management be transparent and employees to be responsible for their acts and also protects whistle blowers.

Conclusion

SOX main aim was to regain the confidence that was lost in the capital market by forcing mandatory standards and rules for companies. It applies on both small and large public companies; however, it excludes private and non-profit organizations. SOX have been praised by a cross-section of financial industry experts, citing improved investor confidence and more accurate, reliable financial statements. The Sarbanes-Oxley act has provided negative and positive impacts to companies regardless of the size of the company. However, small companies are definitely being more deeply affected by the Sarbanes-Oxley Act in their pockets. The positive impact of compiling with Sarbanes-Oxley Act has provided standards and rules for organization that needed them. Even though SarbanesOxley Act is not mandatory for private and non-profit organizations many are adopt Sarbanes-Oxley Act because of its positive benefits to the organization.