Sarbanes-Oxley Problem

Executive Summary

Following essay speaks to Sarbanes-Oxley Act of 2002, more specifically; major provisions of the Act, pro's and con's, and ethical considerations.

The Sarbanes-Oxley Act of 2002 was signed into act on July 30th 2002. This act followed an overriding majority vote by both chambers of the U.S. Congress. The Act calls for alterations to fight accounting fraud, and establishes a new oversight board. Not to mention; enforce new penalties and an assortment of elevated values of corporate control.

The Sarbanes-Oxley Act is a direct reaction to the corrosion in civic confidence with regards to fiscal governance associations and recent scandals involving prominent public companies (i.e. Enron, Tyco and WorldCom). Some analysts believe Sarbanes-Oxley to be the most comprehensive reform of US securities law since the passing of the Securities Exchange Act in 1934.

Currently, provisions of the Act are being implemented by the Securities and Exchange Commission (SEC), which has substantially completed the process of setting its rules. The effects of the Act are far reaching as its provisions pertain to public accounting firms, attorneys, securities analysts as well as management, audit committees, and the boards of directors for public corporations.

Although the Act applies only to public corporations, it is sure to affect the entire business and investing environment. Analysts have stated that they "are already starting to see a cascading effect, which will eventually cause many privately-owned businesses, governmental, and non-profit entities to be affected through similar regulations and requirements." (bnet.com, 2005)

Major Provisions of Sarbanes-Oxley

The major provisions of the Sarbanes-Oxley Act are addressed by J. Carlton Collins, CPA, president of ASA Research, LLC. (Microsoft.com, 2005) The provisions are as follows:

1. Financial records - Companies are required to maintain detailed financial records.

2. Work papers - it is now a felony with penalties of up to 10 years to willfully fail to maintain "all audit or review work papers" for at least five years. The U.S. Securities and Exchange Commission will establish a rule covering the retention of audit records, and the U.S. Public Accounting Oversight Board will issue standards that compel auditors to keep other documentation for seven years.

3. Document destruction - destroying documents in a federal or bankruptcy investigation is considered a felony and can carry penalties of up to 20 years.

4. Fraud discovery - the statute of limitations for the discovery of fraud is extended to two years from the date of discovery and five years after the act. Previously it was one year from discovery and three years from the act.

5. Securities fraud penalty - Criminal penalties for securities fraud have been increased to 25 years.

6. Certification of financial statements and reports by CEOs and CFOs - Section 906 of the Act requires each public company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO) to certify, on threat of severe criminal penalties that periodic reports containing financial statements fully comply with securities laws. CEOs and CFOs found to have knowingly violated Section 906 will be punished with a fine of up to $1 million and imprisonment of up to 10 years. Willful false certification will be punishable by fines of up to $5 million and imprisonment of up to 20 years.

7. Personal loans - Personal loans to executive officers and company directors are banned.

8. Reporting insider trading - Accelerated reporting of insider trading is now required.

9. Prohibited trading - Insider trading is prohibited during pension fund blackouts.

10. Disclosure - CEO and CFO compensation and profits must be made public.

11. Auditor independence - Auditor independence is now specifically required.

12. Internal auditing - U.S. companies are required to have an internal audit function. This function must be certified by external auditors.

13. Unrelated services - Audit firms are banned from providing services to their clients unrelated to their audit work.

14. Accountability - In a nutshell, Sarbanes-Oxley holds CEOs and directors accountable and punishable by up to $5 million and 20 years in prison for the crimes of the company, even if they had no knowledge of those crimes.

15. Protection for whistleblowers - New provisions protects corporate whistleblowers. (Microsoft.com, 2005)

Pro's and Con's

The pros and cons are heavily intermingled, but can be discerned at a high level. For example, this act creates an opportunity for more rigors, by creating committees to administer accountability, which in turn develops checks and balances around the auditing process. The truth is this portion of the act can be viewed as a either a "pro" or a "con".

The website bnet.com provides a comprehensive break out of what Audit firms must now report to Audit Committees:

* Critical accounting policies and practices used

* Other alternative Generally Accepted Accounting Principles (GAAP) methods discussed with management, their ramifications on financial reporting and disclosures and the treatment preferred

* Accounting disagreements and other relevant communications with management

* Results of the audit firm's peer review

* The Act requires each member of an Audit Committee to be a member of the

Board of Directors, and otherwise be independent.

* The audit committee is directly responsible for hiring and firing the external auditor.

* Auditors will report to and be overseen by the Audit Committee, not management.

* Audit committees must pre-approve all services provided by their auditors.

* Each 10-K and 10-Q report shall disclose all material off-balance sheet transactions and their relationships with unconsolidated entities that may have a material current or future effect on the financial condition