Legislative Initiatives and Proposals:

Sarbanes-Oxley Act, 2002 1

Collaborative efforts by:-

NAME ROLL NO.

1. Priya Arora 14
2. Purnima Satija 15
3. Shivani Aggarwal 22
4. Shreya Sharda 23
5. Srishti Ranga 26
2
 Plan of Study

 Introduction

 Corporate Scandals

 History of Sarbanes Oxley Act, 2002

 Events contributing to adoption of SOX

 Objectives of the Act

 Provisions of the Act

 Similar laws in other countries

3
Cont’d…

 SOX impact in India

 Benefits of the Act

 Cost of Compliance

 Future Impact

 Some thoughts on Compliance

 Conclusion

4
 Introduction

 The Sarbanes-Oxley Act of 2002, is a United States federal law also

known as the Public Company Accounting Reform & Investor
Protection Act of 2002 (and commonly called SOX or SarbOx).

 It was enacted on July 30, 2002 by President George W. Bush

 Named after sponsors Senator Paul Sarbanes (D-MD) and

Representative Michael G. Oxley (R-OH).

 The Act came in the wake of a series of corporate financial scandals,

including those affecting Enron, Tyco International, and WorldCom
(now MCI). 5
Cont’d…

Paul Sarbanes and Michael G. Oxley

6
 Cont’d…

 This act has created new corporate standards for accountability to

protect valued stakeholders and the public from fraudulent practices by
organizations.

 The Act covers issues such as establishing a public company

accounting oversight board, auditor independence, corporate
responsibility and enhanced financial disclosure.

 The Sarbanes-Oxley Act requires companies to implement extensive

procedures that prevent illegal activities internally within the company
and to respond to any illegal activity investigations without delay.
7
Corporate Scandals

8
 Enron

About the Company

 Enron was a Houston-based natural gas pipeline company formed by
merger in 1985.

 Enron was heavily involved in energy brokering, electronic energy

trading, global commodity and options trading, etc.

 By early 2001, Enron had morphed into the 7th largest U.S. company,
and the largest U.S. buyer/seller of natural gas and electricity.

 Fortune named Enron as the ‘America's most innovative company’ for

the six consecutive years. 9
Cont’d…

Key Players in the Scandal

KENNETH JEFFREY DAVID ANDREW SHERRON

LAY SKILLING DUNCAN FASTOW WATKINS
Former CEO Enron’s Chief Enron’s chief Former Chief Known as the
of Enron Executive auditor at Financial ‘Enron
Officer Anderson Officer at whistle-
Enron blower’

10
Cont’d…

A Chronology of Events

1985 • Establishment of Enron

1999 • Enron launched its broadband services unit & Enron online

2000 • The company’s annual revenue reached U.S. $100 billion

Aug, 2001 • Skilling announced his departure & Lay resumed the post of CEO

Oct, 2001 • Enron reported a loss of $618 million

Dec, 2001 • Enron filed for bankruptcy

11
Cont’d…

Catalysts to Enron Scam

 Lay & Skilling used “accounting tricks, fiction, misleading statements,
half-truths, omissions & outright lies to commit their crimes.

 Lay approved of the actions of Skilling and Fastow although he did

not always inquire about the details.

 Skilling constantly focused on meeting Wall Street expectations,

advocated the use of mark-to-market accounting

 Skillling pressured Enron executives to find new ways to hide its debt.
12
Cont’d…

Catalysts to Enron Scam

 Lay & Skilling used “accounting tricks, fiction, misleading statements,
half-truths, omissions & outright lies to commit their crimes.

 Lay approved of the actions of Skilling and Fastow although he did

not always inquire about the details.

 Skilling constantly focused on meeting Wall Street expectations,

advocated the use of mark-to-market accounting

 Skillling pressured Enron executives to find new ways to hide its debt.
13
Cont’d…

 Enron used Special Purpose Entities to exclude losses and liabilities

from the parent companies balance sheet thus displaying a very
desirable and flawlessly profitable business

 Enron’s pension scheme: Almost 62% of this pension scheme was

Enron’s stock which crashed drastically from over $80 in early 2001 to
a mere few cents by the end of the same year.

 Relationship with Bankers: Questionable relationship between Enron

and bankers Citigroup and J.P Morgan Chase also contribute to the
downfall of Enron. 14
Cont’d…

Role of different entities in the Enron Scam

Role of
Role of Credit
Role of Investment & Role of Law
Rating
Andersen Commercial Firms
Agencies
Bank

15
 Cont’d…

Consequences of the Enron Scandal

 Enron stands for the greatest company scandal in the history of the
US economy and has become a symbol of corruption for the whole
Western economic system.

 Investors lost some 60 billion dollars within a few days; for many it
meant losing their old-age security.

 Around 5200 employees lost their jobs.

 The pension fund for the company's employees was obliterated.

16
Cont’d…

 Citizen’s trust in the American economic

system was destroyed.

 Losses on the financial market amounted

to the worst stock value loss in peaceful
times.

 Banks were suspected of collusion.

 The auditing firm Arthur Anderson lost

its accreditation.
17
 Worldcom

 Company: Telecommunications company; now MCI, Inc.

 What happened: Inflated assets by as much as billion dollars, leading

to 30,000 lost jobs and $180 billion in losses for investors.

 Main player: CEO Bernie Ebbers & CFO Scott Sullivan

 How they did it:

 In 1999, in an effort to increase revenue, WorldCom reduced the
amount of money it held in reserve by $2.8 billion and moved this
money into the revenue line of its financial statements.

18
Cont’d…

 In 2000, WorldCom began classifying operating expenses as long-

term capital investments. Hiding these expenses in this way gave
them another $3.85 billion.

 They also added a journal entry for $500 million in computer

expenses, but supporting documents for the expenses were never
found.

 These changes turned WorldCom's losses into profits to the tune of

$1.38 billion in 2001.

 It also made WorldCom's assets appear more valuable.

19
Cont’d…

 How they were caught:-

 The SEC requested WorldCom to provide more information.

 The SEC was suspicious because while WorldCom was making so

much profit, AT&T was losing money.

 WorldCom's audit committee was asked for documents supporting

capital expenditures, but it could not produce them.

 The controller admitted to the internal auditors that they weren't

following accounting standards.

 WorldCom filed for bankruptcy.

20
Cont’d…

 Substantial problems with Worldcom:

 No checks and constraints placed on their actions

 Significant pressure to “meet the numbers”

 Lack of courage of employees to communicate the fraudulent

activities.

 A financial system in which controls were extremely deficient

 The BOD and Audit Committee did not appear to have had an
adequate understanding of the company and culture

 Inadequate audits by independent auditors 21

Cont’d…

 Consequences:
 CFO was fired, controller resigned, and the company filed for
bankruptcy.

 Ebbers sentenced to 25 years for fraud, conspiracy and filing false

documents with regulators.

 Sullivan pleaded guilty & took the stand against Ebbers in exchange
for a more lenient sentence of 5 years.

22
 Tyco

 Company: Electronic components, healthcare products, etc.

 Main players: Former CEO Dennis Kozlowski and former CFO

Mark Swartz.

 What happened: CEO and CFO stole million dollars and inflated
company income by $500 million.

 How they did it:

 By giving themselves interest-free or very low interest loans
(sometimes disguised as bonuses) that were never approved by the
Tyco board or repaid 23
Cont’d…

 Selling their company stock without telling investors, which is a

requirement under SEC rules.

 Koslowski, Swartz, and Belnick stole $600 million dollars from

Tyco International through their unapproved bonuses, loans, and
extravagant "company" spending.

 They used the funds for their private purposes like $ 2 million
dollar birthday party for Koslowski’s wife in Italy

24
Cont’d…

 How they got caught: During 2002, the Securities and Exchange
Commission began an investigation of Tyco's top executives that
uncovered questionable accounting practices, including large loans made
to Kozlowski & others, embezzlement of Tyco’s funds, etc.

 Penalties:
 Kozlowski and Swartz were sentenced to 8-25 years in prison.

 A class-action lawsuit forced Tyco to pay $2.92 billion to investors.

25
 History of Sarbanes Oxley Act, 2002

First wave of scandals initiated by Enron/Andersen in late 2001, followed quickly by ImClone,
Global Crossing, and similar stories.

Second wave of scandals, led by WorldCom & Adelphia in the summer of 2002

These scandals resulted in hundreds of billions of dollars in corporate and investor losses in the
United States which led to the erosion of investors confidence.

Corporate defaults and plunging stock prices were followed with stories of excessive executive
compensation, insider dealing, and systematic failures in management and board oversight

Public call to restore investors confidence

26
Cont’d…

Sarbanes Oxley Act introduced in the House as "Corporate and Auditing Accountability,
Responsibility, and Transparency Act of 2002" by Mike Oxley on February 14, 2002

Committee consideration by: Senate Banking

Passed the House on April 24, 2002 (334–90)

Passed the Senate as the "Public Company Accounting Reform and Investor Protection Act of
2002" on July 15, 2002

Reported by the joint conference committee on July 24, 2002; agreed to by the House on July 25,
2002 (423–3) and by the Senate on July 25, 2002 (99–0)

Signed into law by President George W. Bush on July 30, 2002

27
Events Contributing to the adoption of SOX

In an interview, Senator Paul Sarbanes stated:

"The Senate Banking Committee undertook a series of hearings on the problems in the
markets that had led to a loss of hundreds and hundreds of billions, indeed trillions of
dollars in market value. The hearings set out to lay the foundation for legislation. We
scheduled 10 hearings over a six-week period, during which we brought in some of the
best people in the country to testify...The hearings produced remarkable consensus on
the nature of the problems: inadequate oversight of accountants, lack of auditor
independence, weak corporate governance procedures, stock analysts' conflict of
interests, inadequate disclosure provisions, and grossly inadequate funding of the
Securities and Exchange Commission."

28
Cont’d…

Securities analysts’
Boardroom failures
conflicts of interest

Reasons for Banking

Auditors Conflicts
the adoption Practices
of Interest
of SOX

29
 Objectives of Sarbanes Oxley Act, 2002

 Its main objectives were:-

To re-establish investors
To prevent future corporate
confidence in the securities
frauds
market

 Other objectives:
 To enhance the accountability of corporate officers;

 To improve corporate disclosure;

 To introduce new audit committee standards and responsibilities;

 To improve auditor oversight and limit conflicts of interest;

30
Cont’d…

 To strengthen accountability for wrongdoing

 To address analyst conflicts of interest.

 To strengthen internal control mechanisms

 To ensure full disclosures in financial reports

 To transact corporate governance with full

transparency

31
 Provisions

Public Company Accounting Oversight Board

Auditor’s Independence

Corporate Responsibility

Enhanced Financial Disclosures

Analyst conflicts of interest

32
Cont’d…

Commission resources and authority

Studies and reports

Corporate and criminal fraud accountability

White-collar crime penalty enhancements

Corporate tax returns

Corporate fraud and accountability

33
 Title 1:- Public Company
Accounting Oversight Board

34
 Introduction

Title one establish the Public Company Accounting Oversight Board,

“to oversee the audit of public companies that are subject to the securities
laws, and related matters, in order to protect the interest of investors and
further the public interest in the preparation of informative, accurate and
independent audit reports for public companies”.
 It also gives the PCAOB authority to require mandatory registration
of public accounting firms, establish the process and procedure for
compliance audits, conduct continuing inspections and establish fair
procedures for investigations of registered public accounting firms.
35
 Primary responsibilities of PCAOB

Registration of accounting firms that audit U.S. public companies.

 Inspections of registered public accounting firms.

Establishment of auditing and related attestation, quality control,

ethics, and independence standards for registered public accounting
firms.

Investigation and discipline of registered public accounting firms

and their associated persons for violations of specified laws or
professional standards.
36
Cont’d…

The PCAOB aims to identify risks that may have resulted in audit,
quality control, ethics or independence failures by registered firms.

 The PCAOB also uses such analysis to identify weaknesses in, and
appropriate improvements to, its auditing and related professional
practice standards.

The PCAOB further uses this analysis to identify ways in which it

can improve the effectiveness of its oversight programs.

37
 Sections

SEC 101 • Establishment; administrative provisions.

SEC 102 • Registration with the Board.

SEC 103 • Auditing, quality control, & independence standards and rules.

SEC 104 • Inspections of registered public accounting firms.

SEC 105 • Investigations and disciplinary proceedings.

SEC 106 • Foreign public accounting firms.

SEC 107 • Commission oversight of the Board.

SEC 108 • Accounting standards.

SEC 109 • Funding.

38
Cont’d…

Section 101:Establishment; administrative provisions

Establishes an independent, non-governmental board to oversee the

audits of public companies to protect the interests of investors and
further public confidence in independent audit reports.

Section 102:- Registration with the Board

Requires public accounting firms to register with the Board and take
certain other actions to perform audits of issuers.

39
Cont’d…

Section 103-Auditing, quality control & independence standards & rules

Requires the PCAOB to establish, through the adoption of standards

proposed by one or more professional groups of accountants, auditing
standards and related attestation standards to be used by registered
public accounting firms in the preparation and issuance of audit reports.
Section 104-Inspections of registered public accounting firms
Requires the PCAOB to conduct a continuing program of inspections to
assess the degree of compliance of each registered public accounting
firm with the Act. 40
Cont’d…

Section105-Investigations and disciplinary proceedings

Requires the PCAOB to establish rules and procedures for the

investigation and disciplining of registered public accounting firms.
Section 106-Foreign public accounting firms
Requires that any foreign public accounting firm that prepares or
furnishes an audit report with respect to any issuer, shall be subject to
the Sarbanes-Oxley Act, in the same manner and to the same extent as a
U.S. public accounting firm.
41
Cont’d…

Section 107-Commission oversight of the Board

States that the SEC shall have oversight and enforcement authority
over the PCAOB.
Section 108-Accounting standards
Amends Section 19 of the Securities Act of 1933 in that the SEC may
recognize under Section 13(b) of the Securities Act of 1934 as
"generally accepted" any accounting principles established by a
standard setting body that meets certain criteria as further specified in
the Act. 42
Cont’d…

Section 109-Funding
Provides for funding of the PCAOB pursuant to an amendment to
Section 19(b) of the Securities Act of 1933.

43
Title 2:- Auditor’s
Independence

44
 Introduction

 Title2 aims at strengthening the independence of public company

auditors.

 It requires that the client company’s audit committee pre approves

all auditing services and that each public accounting firm shall report
to the audit committee of the board of directors regarding critical
accounting policies and alternative treatments.

This title also addresses audit partner rotation requirements.

45
 Responsibilities of audit committee

 Appointment, compensation and retention of registered public

accounting firms.
 Preapproval of audit services and permissible non -audit services.
 Review of the independent auditor’s plan for an integrated audit of
both ICFR and annual financial statements.
 Review and discussion of financial statements audited or reviewed
by the independent auditor.
 Monitoring the auditor’s independence
 Auditor rotation requirement
46
Auditor’s Independence

47
 Sections

SEC 201 • Services outside the scope of practice of auditors

SEC 202 • Preapproval requirements.

SEC 203 • Audit partner rotation.

SEC 204 • Auditor reports to audit committees..

SEC 205 • Conforming amendments.

SEC 206 • .Conflicts of interest.

SEC 207 • .Study of mandatory rotation of registered public accounting

firms.
SEC 208 • .Commission authority.

SEC 209 • Considerations by appropriate State regulatory authorities.

48
Cont’d…

Section 201-Services outside the scope of practice of auditors

The final rules explicitly identify several categories of non-audit
services that cannot be provided to an audit client. such as
Bookkeeping, Financial information systems design and
implementation, valuation services, fairness opinions, Actuarial
services, Internal audit outsourcing services, Broker/dealer, Legal
services, Expert services unrelated to the audit etc.

49
Cont’d…

Section 202-Pre-approval requirements

The final rules require that audit committees pre-approve all audit,
review, and attest services that are required under the securities laws and
all other permissible non-audit services to be rendered by the audit firm.
Section 203 - Audit partner rotation

The final rules contain new partner rotation requirements that apply
to audit partners. The term audit partner is defined “a partner who is
a member of the audit engagement team” and who:
50
Cont’d…

Has responsibility for decision making on significant auditing,

accounting, and reporting matters that affect the client's financial
statements; or
 Maintains regular contact with client management and the client's audit
committee.

Section 204 Auditor reports to audit committees

The rules amend SEC Regulation S-X to require auditors to report to the
client's audit committee, prior to the filing of the report with the SEC.
51
 Cont’d…

Section 205 - Conforming amendments

This conforms the meaning of certain defined terms throughout the Act
with these same defined terms in the 1934 Exchange Act, such as the terms
Audit Committee and Registered Public Accounting Firm.
Section 206 - Conflicts of interest - Cooling Off Period
Independence would be impaired if the lead or concurring partner, or any
other member of the audit engagement team accepts a position with the
issuer in a financial reporting oversight role , within a one-year period
preceding the commencement of the audit for the year that included
employment of the individual by the issuer. 52
Cont’d…

Accordingly, the prohibition would require that the accounting firm

complete one annual audit subsequent to when an individual was a
member of the audit engagement team.

Section 207 - Study of mandatory rotation of registered public

accounting firms
Requires the Comptroller General of the United States to conduct a study
and review of the potential effects of requiring mandatory rotation of
registered public accounting firms, and report its findings to Congress by
July 30, 2003.
53
Cont’d…

Section 208 - Commission authority

Under this section the SEC was required to issue final regulations
regarding auditor independence by January 26, 2003, making it
unlawful for any registered public accounting firm to prepare or issue
any audit report if the firm has engaged in prohibited activity as
defined by subsections (g) through (l) of Section 10A of the 1934
Exchange Act.

54
Cont’d…

Section 209 - Considerations by appropriate State regulatory

authorities

In supervising non-registered public accounting firms and their

associated persons, appropriate State regulatory authorities shall
make an independent determination of the proper standards
applicable

55
Title 3:-CORPORATE
RESPONSIBILITY

56
 Introduction

Title 3 requires that audit committees must be composed of entirely

independent directors, people who are not officers of the company
and do not accept any consulting or advisory fees from the issuer or
its subsidiaries in any significant way.

Title 3 requires senior executives to certify that based on their

knowledge the reports do not contain any material misstatements and
the financial information is fairly presented.

57
Cont’d…

 They must also certify that they take individual responsibility for
establishing and maintaining their company’s internal control, that
they have designed such controls and that they have recently evaluated
the effectiveness of the internal controls.

Title 3 also state that it is unlawful for any officer or director to

fraudulently influence, manipulate or mislead an auditor for the
purpose of financial statements misleading.

58
 Sections

SEC 301 • Public company audit committees.

SEC 302 • Corporate responsibility for financial reports.

SEC 303 • Improper influence on conduct of audits.

SEC 304 • Forfeiture of certain bonuses and profits.

SEC 305 • Officer and director bars and penalties.

SEC 305 • Insider trades during pension fund blackout periods.

SEC 306 • .Rules of professional responsibility for attorneys.

SEC 307 • Fair funds for investors.

59
Cont’d…

Section 301 - Public company audit committee

Requires the SEC to direct the national securities exchanges and
associations to prohibit the listing of any security of an issuer that is not
in compliance with certain requirements.
Section 302 - Corporate responsibility for financial reports
The final rule implementing Section 302 was issued by the SEC in
August 2002. The rule applies to a company that files periodic reports
under Section 13(a) or 15(d) of the Exchange Act. The rule requires that
a company's CEO and CFO each certify quarterly and annually that: 60
Cont’d…

Section 302 – Improper influence on conduct of audits

 CEO and CFO must review all financial reports.
 Financial report does not contain any misrepresentations.
 Information in the financial report is "fairly presented".
 CEO & CFO are responsible for the internal accounting controls.
 CEO & CFO must report any deficiencies in internal accounting
controls, or any fraud involving the management of the audit
committee.
 CEO and CFO must indicate any material changes in internal
accounting controls 61
Cont’d…

Section 303-Improper influence on conduct of audits

States that it is unlawful for any officer or director of an issuer, or any

person acting under the direction thereof, to take any action to
fraudulently influence, coerce, manipulate, or mislead any
independent public or certified accountant engaged in the performance
of an audit of the financial statements.

62
Cont’d…

Section 304-Forfeiture of certain bonuses and profits

States that if an issuer is required to prepare an accounting
restatement due to the material noncompliance of the issuer, the CEO
and CFO of the issuer shall reimburse the issuer for:
Any bonus received by that person during the 12-month period
following issuance of the financial statements including restatements.
Any profits realized from the sale of securities of the issuer during
that 12 month period.

63
Cont’d…

Section 305-Officer and director bars and penalties

States that in any action or proceeding brought or instituted by the SEC

under any provision of the securities laws, the SEC may seek, and any
Federal court may grant, any equitable relief that may be appropriate
or necessary for the benefit of investors.

64
Cont’d…

Section 306-Insider trades during pension fund blackout periods

It unlawful for any director or executive officer of an issuer to

directly or indirectly purchase, sell or otherwise acquire or transfer
any equity security of the issuer during a pension blackout period
with respect to such security, if the director or executive officer
acquired the security in connection with his or her service or
employment as a director or executive officer.

65
Cont’d…

Section 307-Rules of professional responsibility for attorneys

Requires the SEC to prescribe minimum standards of professional

conduct for attorneys appearing and practicing before the SEC in any
way in the representation of issuers. The standards must include a rule
requiring an attorney to report evidence of a material violation of
securities laws or breach of fiduciary duty.

66
Cont’d…

Section 308-Fair funds for investors

The SEC obtains an order requiring disgorgement against any person
for a violation of such laws or the rules or regulations there under and
the SEC also obtains pursuant to such laws a civil penalty against such
person, the amount of such penalty be added to and become part of the
disgorgement fund for the benefit of the victims of such violation.

67
Title:-4 Enhanced financial
Disclosures

68
 Introduction

Title IV of the Sarbanes-Oxley Act contains a number of provisions

intended to improve financial disclosures. The SEC has recently
released final rules on several of these provisions.

The title includes the sections which defines that companies should
disclose information to the extent that it is necessary for an
understanding of its balance sheet and their material effects on financial
condition, changes in financial condition, revenues or expenses, results
of operations, liquidity, capital expenditures or capital resources.
69
 Sections

SEC 401 • Disclosures in periodic reports.

SEC 402 • Enhanced conflict of interest provisions.

• Disclosures of transactions involving management and principal
SEC 403
stockholders.
SEC 404 • Management assessment of internal controls.

SEC 405 • Exemption.

SEC 406 • Code of ethics for senior financial officers.

SEC 407 • Disclosure of audit committee financial expert.

SEC 408 • Enhanced review of periodic disclosures by issuers.

SEC 409 • Real time issuer disclosures. 70

Cont’d…

Section 401: Disclosures in periodic reports

The general principle is that the registrant should disclose information
to the extent that it is necessary for an understanding of its material
off balance sheet arrangements and their material effects on financial
condition.

71
Cont’d…

Section 402:- Enhanced conflict of interest provisions

States that it shall unlawful for any issuer directly or indirectly,

including through any subsidiary, to extend or maintain credit, to
arrange for the extension of credit, or to renew an extension of credit,
in the form of a personal loan to or for any director or executive
officer of that issuer.

72
Cont’d…

Section 403: Disclosures of transactions involving management and

principal stockholders

It makes certain changes to the Exchange Act shareholding and

transaction reporting requirements for directors, officers and principal
stockholders generally changing the deadline for filing statements
regarding stock transactions of covered persons from 10 days
following the end of the month in which the transaction occurred to 2
business days following the transaction's execution date.

73
Cont’d…

Section 404: Management assessment of internal controls

Requires the SEC to prescribe rules requiring each annual report
required by Section 13(a) or 15(d) of the Securities Exchange Act of
1934 to contain an internal control report, which shall:
 State the responsibility of management for establishing and
maintaining an adequate internal control structure and procedures
for financial reporting.
 The external auditor is required to attest to the assertions made by
management in reference to their assessment of internal controls.
74
Cont’d…

Contain an assessment, as of the end of the most recent fiscal year

of the issuer, of the effectiveness of the internal control structure and
procedures of the issuer for financial reporting.
 Proposed rules were issued by the SEC in October 2002.

Section 405: Exemption

States that nothing in Sections 401, 402 or 404, or the rules of the SEC
under those sections shall apply to any investment company registered
under Section 8 of the Investment Company Act of 1940.

75
Cont’d…

Section 406: code of ethics for senior financial officers

It states that company to disclose whether it has adopted a code of
ethics that applies to the company's principal executive officer,
principal financial officer, principal accounting officer or controller
or persons performing similar functions.

76
Cont’d…

Section 407: Disclosure of audit committee financial expert

The rules require a domestic registrant to annually disclose whether it
has at least one "audit committee financial expert" serving on its
audit committee, and if so, the name of the expert and whether the
expert is independent of management.
Section 408: Enhanced review of periodic disclosures by issuers
It states to review the financial statements and disclosures of issuers
on a regular and systematic basis and indicates that for purposes of
scheduling the reviews. 77
Cont’d…

Section 409: Real time issuers disclosures

It states that each issuer reporting under Section 13(a) or 15(d) 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, as the SEC
determines, by rule, is necessary or useful for the protection of
investors and in the public interest.
78
Title:-5 Analysts conflict
of interest

79
 Sections

• Treatment of securities analysts by registered securities

SEC 501
associations and national securities exchanges.

80
Cont’d…

Section 501: Treatment of security analysts by registered securities

associations and national security exchanges

According to this section SEC requires that brokers, dealers, and

certain persons associated with a broker or dealer include in research
reports certifications by the research analyst that the views expressed
in the report accurately reflect his/her personal views, and disclose
whether or not the analyst received compensation or other payments
in connection with his/her specific recommendations or views.

81
 Title:-6 Commission
resources and authority

82
 Sections

SEC 601 • Authorization of appropriations.

SEC 602 • Appearance and practice before the commission.

SEC 603 • Federal court authority to impose penny stock bars.

SEC 604 • Qualifications of associated persons of brokers and dealers.

83
Cont’d…

Section 601: Authorization of appropriations

This section provides additional funding to the SEC.
Section 602: Appearance and practice before the Commission
This section states the SEC to censure any person, or deny, temporarily
or permanently, to any person the privilege of appearing or practicing
before the SEC in any way, if that person is found by the SEC, after
notice and opportunity for hearing in that matter:
 Not to possess the requisite qualifications.
 To be lacking in character or integrity, or to have engaged in unethical
or improper professional conduct.
84
Cont’d…

Section 603: Federal court authority to impose penny stock bars

This section states that in any proceeding against any person
participating in, or, at the time of the alleged misconduct who was
participating in, an offering of penny stock, the court may prohibit
that person from participating in an offering of penny stock,
conditionally or unconditionally, and permanently or for such period
of time as the court shall determine.

85
Cont’d…

Section 604: Qualifications of associated persons of brokers & dealers

Amends the Securities Exchange Act of 1934 regarding the

qualifications of associated persons of brokers and dealers.

86
Title 7:-Studies and
Reports

87
 Sections

SEC 701 • GAO Study And Report Regarding Consolidation Of Public

Accounting Firms.

SEC 702 • Commission Study And Report Regarding Credit Rating

Agencies.

SEC 703 • Study And Report On Violators And Violations.

SEC 704 • Study Of Enforcement Actions

SEC 705 • Study Of Investment Banks.

88
Cont’d…

Section 701- GAO Study And Report Regarding Consolidation Of

Public Accounting Firms.

The SEC directed the GAO to conduct a study on the consolidation of

public accounting firms and its implications.

Section 702- Commission Study And Report Regarding Credit

Rating Agencies.

The commission was required to conduct a study on the role and

function of credit rating agencies in the securities market.
89
Cont’d…

Section 703- Study And Report On Violators And Violations

This section required the SEC to conduct a study on a number of
securities professionals, defined as public accountants, public accounting
firms, investment bankers, investment advisers, brokers, dealers, attorneys,
and other securities professionals, in violation of securities laws.

Section 704- Study Of Enforcement Actions

The Commission was required to review and analyze all enforcement
actions by it involving violations of reporting requirements imposed
under the securities laws, and restatements of financial statements. 90
Cont’d…

Section 705- Study Of Investment Banks

The Comptroller General of the United States was required to conduct a
study on whether investment banks and financial advisers assisted
public companies in manipulating their earnings and true financial
condition.

91
Title 8:-Corporate Fraud and
Criminal Accountability

92
 Introduction

 This title created new crimes and increased the punishments for
violations of existing provisions.
 It added new statutes relating to the alteration of documents,
increased the limitations period for lawsuits and called for a review of
the Federal Sentencing Guidelines.
 It also inserted a provision designed to encourage and protect
whistleblowers.

93
 Sections

SEC 801 • Corporate and Criminal Fraud Accountability Act of 2002

SEC 802 • Criminal Penalties for Altering Documents

• Debts non dischargeable if incurred in violation of securities

SEC 803
fraud laws

SEC 804 • Statute of limitations for securities fraud

• Review of federal sentencing guidelines for obstruction of justice

SEC 805
and extensive criminal fraud
• Protection for employees of publicly traded companies who
SEC 806
provide evidence of fraud
• Criminal penalties for defrauding shareholders of publicly traded
SEC 807 companies
94
Cont’d…

Section 802 - Criminal Penalties for Altering Documents

This section has two provisions that address the destruction of corporate
documents.
 The first addresses documents within a company:
 Whoever knowingly alters, destroys, mutilates, conceals, or falsifies
records, documents or tangible objects with the intent to obstruct,
impede or influence a legal investigation, shall be subject to fines and or
up to 20 years of imprisonment.
95
Cont’d…

 The second provision addresses a company’s auditors:

Auditors must retain records relevant to the audits and reviews of
financial statements filed with the SEC, for a period of no less than
five years.
 Such documents include those that form the basis of an audit or
review, correspondence, communications, other documents, and
records (including electronic records)which are created, sent, or
received in connection with an audit and contain conclusions,
opinions, analyses, or financial data relating to the audit.
96
Cont’d…

Section 803- Debts non dischargeable if incurred in violation of

securities fraud laws
Under this section, Congress made judgments incurred via securities
fraud non dischargeable in case of bankruptcy.

Section 804 – Statute of Limitations for Securities Fraud

This provision extended the statute of limitations from one year/ three
years to two years/five years. Plaintiffs would now have to sue within
two years of the discovery of fraud and five years of the fraud’s
occurrence.
97
Cont’d…

Section 805-Review of federal sentencing guidelines for obstruction

of justice and extensive criminal fraud

The Congress ordered the United States Sentencing Commission to

review the FSG (Federal Sentencing Guidelines) to ensure that
punishments would be sufficient to deter fraudulent activity.

98
Cont’d…

Section 806- Protection for employees of publicly traded companies

who provide evidence of fraud

 Section 806 provides a civil damages action for public company

whistle blowers who suffer retaliation for providing information in an
investigation or participating as a witness in a proceeding involving
securities law violations.
The statute allows employees to file a complaint with the Secretary
of Labor, so long as the complaints are filed within 90 days of a
discriminatory event leading to whistle blowing.
99
Cont’d…

Section 807- Criminal penalties for defrauding shareholders of

publicly traded companies
 Under Section 807 of the Act, companies and individuals who
defrauded shareholders became subject to criminal penalties.
 Penalties were prescribed in the form of a fine or imprisonment up to
25 years or both.

100
Title 9:-White Collar Crime
Penalty Enhancements

101
 Introduction

 This title placed accountability on the shoulders of the CEO

and CFO to certify financial statements of a company.

 It spelled out possible fines and imprisonment with the

intention to ensure that financial reporting is fair and accurate.

 Even an attempt to commit fraud was made punishable.

102
 Sections

SEC 901 • White-Collar Crime Penalty Enhancement Act of 2002

SEC 902 • Attempts and Conspiracies to commit criminal fraud offenses

SEC 903 • Criminal Penalties for mail and wire fraud

• Criminal Penalties for violations of the employee retirement

SEC 904 income security act of 1974

SEC 905 • Amendment to sentencing guidelines relating to certain white-

collar offenses

SEC 906 • Corporate Responsibility for financial reports

103
Cont’d…

Section 902- Attempts and Conspiracies to commit criminal fraud

offenses
 This section ‘outlawed attempts and conspiracies’ to commit
criminal fraud offenses.
 Penalties would be the same as those prescribed for the offense.

Section 903- Criminal Penalties for Mail and Wire fraud

 This section increased the penalties for mail and wire fraud from a
maximum imprisonment of five years to a 20-year maximum.
104
Cont’d…

Section 904- Criminal Penalties for violations of the employee

retirement income security act of 1974

This section established penalties for violations of ERISA,1974. The

maximum fines were increased five and 20-fold and maximum
imprisonment increased from one year to 10 years.

105
Cont’d…

Section 905- Amendment to sentencing guidelines relating to certain

white-collar offenses
The U.S. Criminal sentencing guidelines were amended to provide for
greater chance that white collar criminals would be imprisoned or
seriously fined instead of being put on probation.

Section 906- Corporate Responsibility for Financial Reports

 It stated that, ‘each periodic report containing financial statements
shall be accompanied by a written statement by the chief executive
officer and chief financial officer (or equivalent thereof) of the issuer.’
106
Cont’d…

 The written statements would certify that the reports ‘fairly present
in all material respects, the financial condition and results of
operations. ’
 Under the act, those who provide a 906 certification knowing that
reports are not in compliance with the above criteria would be fined
up to $1 million or imprisoned for not more than 10 years, or both.

 Executives wilfully submitting such statements would be subject to

possible fines up to $5 million and imprisonment of no more than 20
years or both. 107
Title 10:-Corporate Tax
Returns

108
 Sections

• Sense of the senate regarding the signing of corporate tax

SEC 1001
returns by chief executive officers.

109
Cont’d…

Section 1001- Sense of the senate regarding the signing of corporate

tax returns by chief executive officers.

This section stated that the Federal income tax return of a corporation
should be signed by the chief executive officer of such corporation.

110
Title 11:-Corporate Fraud
Accountability

111
 Sections

SEC 1101 • Corporate Fraud Accountability Act of 2002

• Tampering with a record or otherwise impeding an official

SEC 1102
proceeding
• Temporary freeze authority for the securities and exchange
SEC 1103
commission

SEC 1104 • Amendment to the federal sentencing guidelines.

• Authority of the commission to prohibit persons from serving as

SEC 1105
officers or directors.
• Increased criminal penalties under Securities Exchange act of
SEC 1106
1934.

SEC 1107 • Retaliation against Informants.

112
Cont’d…

Section 1102- Tampering with a record or otherwise impeding an

official proceeding
This section made it illegal to tamper with company records or
otherwise impede a government proceeding involving the company.

Section 1103- Temporary freeze authority for the SEC

During investigations into possible violations of the securities laws the

SEC has the authority to seek an injunction to freeze and hold in escrow
for 45 days extraordinary payments that appear likely to be made by an
issuer to certain insiders. 113
Cont’d…

Section 1104- Amendment to the federal sentencing guidelines.

This section also called for the amendment of the Federal Sentencing
Guidelines to provide for more severe sentences for obstruction of
justice type offences.

Section 1105- Authority of the Commission to prohibit persons from

serving as officers or directors.

Section 1105 provides the SEC with the authority to prohibit a person
from serving as an officer or director of a public company.
114
Cont’d…

Section 1106- Increased criminal penalties under Securities Exchange

Act of 1934

This section increased criminal penalties up to a maximum of 25

million dollars.

Section 1107- Retaliation against informants

The Act provides that individuals who knowingly retaliate against

whistleblowers may be fined and imprisoned for up to 10 years.

115
Similar Laws in Other
Countries

116
 Similar Laws in other countries

Acts equivalent of Sarbanes Oxley Act

India • Clause 49

Canada • Keeping the promise for a Strong Economy Act(Budgetary

Measures),2002
Japan • J-SOX

Germany • Germany Corporate Governance Code

Australia • Corporate Law Economic Reform Program (Audit Reform and

Corporate Disclosure) Act 2004
France • Financial Security Law of France

Turkey • TC-SOX 11
117
 Impact in India

Indian SOX=Clause 49
 With the coming of SOX in U.S., India also took new corporate
governance norms under Clause 49 of Listing Agreement which came
into effect from 31st December 2005 and is mandatory for all listed
companies.

 Some of the important provisions are as follows:-

 It is mandatory for a company with Executive Chairman to have 50%
independent directors on Board. If the company has no executive
Chairman,1/3rd of directors should be independent. 118
Cont’d…

 CEO/CFO are required to assess internal controls and take

corrective measures to check the deficiencies.

 CEO/CFOs are also required to certify the financial statements.

 All the companies are required to submit quarterly Compliance

Reports at Stock Exchanges.

 A Compliance Certificate from auditors is to be obtained and

annexed with Directors’ Report.

 Establishment of an Audit Committee.

119
Cont’d…

 Clause 49 was revised to incorporate wider definitions of

independent directors and increasing the responsibility of audit
committee.
 Whistle blower policy is to be set out to provide security to those
who retaliate against wrong doers.
 Formal Code of Conduct is to be laid down for Board of Directors
and Senior Management of the organization.
 Related Party Transactions are to be disclosed separately making the
financial statements more transparent.
120
Significant Changes

121
 Significant Changes

 SOX represented the initial foray of governmental oversight into the

accounting industry. PCAOB works in tandem with the Securities and
Exchange Commission (SEC) to oversee all public accounting firms
and public companies with the expressed purpose of protecting “the
interests of investors and further the public interest in the preparation
of informative, fair and independent audit report”(PCAOB 2002).

 SOX contains several sections that directly impact (limit) the

interaction and scope of services auditing firms are able to perform
for public companies.
122
 Cont’d…

 Section 302, included several requirements related to the

management of public companies. Both the chief executive officer
(CEO) and the chief financial officer (CFO) are now required to take
personal responsibility by personally certifying both the quarterly and
the annual financial statements and disclosures.

 Section 401 requires that all material off-balance sheet transactions

and relationships with unconsolidated entities, which can or will
have economic effects on the company, must be disclosed in the
quarterly
123
Cont’d…

and annual reports. In addition, Section 403 requires that any

transaction involving management or principal stockholders needs to
now be disclosed by the second business day of the transaction.

 Easily the most contentious part of SOX is Section 404, wherein

management is required to issue a statement in each annual report
issued by the company on its responsibility for and its current
assessment of (a) the company's internal control structure and (b) the
effectiveness of those controls.

124
Cont’d…

 SOX, Section 409 served to greatly reduce the reporting disclosure

timetables on information pertaining to material changes in the
company's operations and financial conditions.

125
Benefits of Sarbanes
Oxley Act, 2002

126
 Benefits of the Act

 Costs are “tangible, quantifiable, and immediate”

 Benefits are “intangible, harder to quantify, and long term”

 Michael Oxley: “How can you measure the value of knowing that
company books are sounder than they were before?”

 Paul Sarbanes: “It’s an investment for the future”

 Critics say that the companies are unearthing inefficiencies

 T/R Systems has begun to write off old inventory sooner to comply with the law

 At an April meeting at the SEC it was said that the Act had a “chilling”
effect on the relationship between managers and auditors. 127
Cont’d…

Strengthening the Control Environment

Improving Documentation

Increasing Audit Committee Involvement

Exploiting Convergence Opportunities

Standardised Processes

Reducing Complexities

Strengthening Weak Links

Minimising Human Error

128
Cont’d…

Strengthening the Control Environment

 A proper control environment is a factor considered when evaluating
internal control over financial reporting pursuant to Section 404.
 If a company can demonstrate a strong control environment, then it can
reduce the overall scope of its internal-control evaluation.
 PepsiCo uses an annual survey of senior executives to demonstrate
conditions of its internal control.

Improving Documentation
 Documentation took up a lot of workers’ time during the 1st year of SOX.
129
Cont’d…

 It received gradually increasing support from the executive suite.

 One CFO of a Fortune 1000 real estate company made a
humbling discovery that people signing off on documents weren’t
carefully reading them, leaving the company susceptible to
unenforceable contract provisions, among other things.
Increasing Audit Committee Involvement

 Directors face increased legal liability for inattention.

 Members of the audit committee must be free of most financial &
personal ties to the company. 130
Cont’d…

 “At the very next meeting of our audit committee, it was a

different world in terms of members’ engagement level,” quoted
an executive.
Exploiting Convergence Opportunities
 2 approaches: Meeting requirements, but at minimum cost &
utilizing the fewest possible resources; leverage the resource
expended on compliance to obtain a return on their investment.
 Benefits of this include being able to free up people and reallocate
them to higher-value activities.
131
 Cont’d…

Standardizing Processes
 Several companies with different divisions realized they had different
processes for different tasks.
 CFO of a large clothing manufacturer realized each division of AR
imposed different due and dunning date, late fees, and interest rates on
customers.
 Another company found that each division had different billing
methods.
Reducing Complexity
 Iron Mountain, a records and information management company had 132
Cont’d…
acquired more than 150 competitors.
 Simplification was the game plan, as each company came with its own
organizational chart & Iron Mountain integrated the reporting
structure.
 They also centralized all accounting activities since each company
brought its own system.
Strengthening Weak Links
 Complexity arises from outsourcing, partnerships, & shared-services
arrangements, also known as extended enterprise.
 Many firms’ clients are reevaluating their outsourcing arrangements & 133
Cont’d…

partnerships.
Minimizing Human Error
 Many tasks have been made automated to reduce error.
 One executive stated, “You need human judgment to determine
whether the override is reasonable or whether it needs to be
investigated.”

134
 Cont’d…

‘Pros’ of SOX for Investors

 Enhanced controls protects assets and helps to maintain market value

 Audit Committees are engaged and asking tough questions
 CFOs and CEOs are engaged and asking tough questions
 Codes of Conduct are setting tone at the top
 Management has greater accountability
 Criminal penalties are being enforced
 Auditors are focused on quality audits
135
Cont’d…

‘Pros’ of SOX for Companies

 Promotes shareholder confidence and attracts capital investment
 Reduces risks of financial reporting restatements and fraud
 More effective coordination with external auditors
 More effective and efficient processes that provide annual cost
savings
 Documentation for training employees
 Employees gain increased understanding of internal controls
 Communication of business risks to stakeholders 136
Cost of Compliance

137
 Cost of Compliance

 In 2005, $5.8 billion spent to comply which is up by 5% from 2004

 AIG has spent about $300 million per year to comply
 Why is 404 so Expensive?
 The more complex the company the more controls are needed
 SOX requires companies to dig deep and examine the effectiveness of their
controls
 Companies must set up independent audit committees
 Very time consuming and a drain on manpower
• An average of 70,000 man hours for large firms
 Then an external auditor must attest that it has been done adequately
 And those auditors cannot do any other non-audit work for the company138
Cont’d…

Cost of
Compliance

Indirect
Direct Costs
Costs

BOD &
Accounting Decision
Audit Going public Productivity
& Audit Fees Making
Committees

139
Cont’d…

Direct Costs
 Accounting and Audit Fees
 To manage this cost many companies are either outsourcing or co-
sourcing a number of audit functions.

Large Companies Small Companies

(> $5 billion) (< $25 million)
Overall Costs $4.6 million $2 million

Internal Work 35,000 hours 1,150 hours

External Work 6,200 850

140
Cont’d…

 Boards of Directors and Audit Committees

 Boards and Audit Committees have increased the time spent on
corporate governance since the passage of the Act.

 Directors are expected to have more input on company issues.

 Personal liability insurance and consulting and legal fees have

risen.

• 31% of audit committees have hired outside advisors

• 44% plan to do so in the next year
Cont’d…

Indirect Costs
 Going Public
 Cost expected to double as a result of compliance
 Smaller, growing companies bear a larger burden of these costs
 More and more companies are going private
 Decision Making
 Companies may become more risk adverse
 Major decisions may take longer (and cost more) to implement
 Productivity
 Opportunity costs of revamping internal controls
 Future Impact of
Sarbanes Oxley Act, 2002

143
 Future Impact-SOX is likely to Grow

 The results of SOX, both positive and negative, have led to several
discussions on expanding the scope of SOX.
 Congress is reviewing options to expand to nonprofits to reduce
scandals like that of the United Way several years ago.
 Congress is also examining the reporting of privately held
companies.
 The Government Accounting Office is reviewing procedures for
government agencies.
 Additional rules in support of SOX and auditing process are under
review or in draft form. 144
Cont’d…

 State and local governments are revising policies and in a few

cases, legislation, to require SOX-like activity reporting.
 Some Thoughts on Compliance

“It’s so time consuming and laden with red tape that it’s like throwing buckets
of sand into the gears of the market economy”
-Scott McNealy, CEO Sun Microsystems

“As a general rule of thumb, any bill that passes the U.S. Senate 99-0 is
probably a horrible idea”
-Patrick Byrne, CEO Overstock.com

It’s like “chemotherapy” after removing the tumors of Enron and Worldcom
-Gary Smith, CEO Ciena

146
Conclusion

 The Sarbanes-Oxley Act of 2002 is probably the

best piece of legislation to protect investors in
modern times.

 It is a shame that it took debacles like Enron

and others to shake up Congress into writing
this legislation as many innocent people,
investors and employees, literally lost their life
savings.

 Perhaps SOX will make sure that such scandals

doesn't happen again.
147
 References

 Miller, R., & Bredeson, D. (2010). Students Guide to the Sarbanes Oxley Act.
Cengage Learning.

 http://www.sec.gov/about/laws/soa2002.pdf

 http://www.sox-online.com/basics.html

 http://www.edsaz.com/whitepapers/SarbanesOxleyAct.pdf

 http://www.edsaz.com/whitepapers/SarbanesOxleyAct.pdf

 http://usatoday30.usatoday.com/money/industries/energy/2006-01-23-enron-
chronology_x.htm

 http://www2.econ.iastate.edu/classes/econ353/tesfatsion/enron.pdf
148
 Cont’d…

 http://gbr.pepperdine.edu/2010/08/reforming-corporate-america/

 http://www.slideshare.net/sohilganeriwala/enron-scam

 http://www.slideshare.net/paragchaubey/enron-scandal

 http://money.howstuffworks.com/cooking-books9.htm

 http://www.forbes.com/2002/07/25/accountingtracker.html

 http://www.accounting-degree.org/scandals/

 http://www.lawteacher.net/company-law/essays//unethical-issues-or-legal-
issues-in-tyco-international-company-law-essay.php

 http://www.scribd.com/doc/22515691/Tyco-Fraud-case
149
 Cont’d…

 http://schuellerworldcom.blogspot.in/2012/10/worldcom-scandal-why-it-
happened-and-how.html

 http://pcaobus.org/About/Ops/Documents/Strategic Plans/2009-2013.pd

 http://www.thecaq.org/docs/for-investors/guide-to-pcaob-
inspections.pdf?sfvrsn=0

 http://www.sdn.sap.com/irj/scn/go/portal/prtroot/docs/library/uuid/b074fcfd-
4845-2a10-da81-
f37c12623055?QuickLink=index&overridelayout=true&17639430713653

 http://www.marietta.edu/~
150
 Cont’d…

 www.sdn.sap.com/irj/scn/go/portal/prtroot/docs/library/uuid/b074fcfd-4845-
2a10-da81-
f37c12623055?QuickLink=index&overridelayout=true&17639430713653

 http://www.pepperlaw.com/publications_update.aspx?ArticleKey=493

 http://scholars.law.unlv.edu/cgi/viewcontent.cgi?article=1244&context=facpub

 http://www.nysscpa.org/cpajournal/2004/904/perspectives/p13.htm

 http://www.ruf.rice.edu/~schuler/sarbanesoxley.pdf

 http://www.global-ethic-now.de/gen-eng/0d_weltethos-und-wirtschaft/0d-01-
globale-wirtschaft/0d-01-203-enron-folgen.php
151
 Cont’d…

 http://www.whitecase.com/files/Publication/320de404-d9a0-4631-a640-
6c0eda4f93c4/Presentation/PublicationAttachment/5ab56984-6114-4511-9df1-
6c9e2ba8b047/memo_sarbanes_oxley_act_of_2002_summary_of_the_provision
s_02_12_2003.pdf

 http://www.investopedia.com/articles/stocks/09/enron-collapse.asp

 https://www.theiia.org/chapters/pubdocs/2/ACost_BenefitAnalysisofSOXOct200
7.pdf

 https://www.hbr.org

152
Thank
You…

153