Sarbanes Oxley Act and Independence Responsibility View - Research Paper Example

?Sarbanes Oxley Act and Independence Responsibility View Table of Contents Introduction 3 2.Brief Overview of Sarbanes Oxley Act of 2002 4 3.Necessity of Sarbanes Oxley Act for Corporate Governance 6 4.Role of Sarbanes Oxley Act in Meeting the Codes of GAAP 8 5.Impact of the Sarbanes Oxley Act of 2002 9 6.Areas of Concern in Sarbanes Oxley Act and in US GAAP 11 7.Conclusion 13 8.Recommendation 13 Reference 15 1. Introduction Every company whether public or private runs on the funds provided by their stakeholders. Therefore they are not only responsible but also accountable for their stakeholders’ interest. If any scandal occurs in any company then the stakeholders get adversely affected as a result they lose trust in securities market which in turn affects not only the securities market of that country to which the company belong but also the global securities market and hence the global economy gets affected. The Sarbanes Oxley Act was implemented on 30th of July 2002. This is a very important act which affects the public companies. Before the enactment of this act USA faced many corporate and accounting frauds and scandals as a result investors lost a huge amount of money. The scandals not only adversely affected the share price but also the general public lost trust on the securities market. Hence the Sarbanes Oxley Act was formed to increase the accountability of the public company so that in future such type of scandals can be avoided. In this project a detail analysis has been made on the Sarbanes Oxley Act and independence responsibility view. The US GAAP has also been analyzed in the view of the Sarbanes Oxley Act. The US companies prepare the financial statement as per the US GAAP but due to the enactment of this act the public companies has to give some more disclosure apart from GAAP. This project involves a detail analysis of the problems of the Sarbanes Act and the US GAAP. The study also includes how and to what extent the act has impacted to the investor, officers of the company, directors, members and other stakeholders. At the end recommendations have been made on how the problems of this act can be solved and investor’s interest can be protected. 2. Brief Overview of Sarbanes Oxley Act of 2002 Sarbanes Oxley Act was enacted on July 30th, 2002. It increased the sanders to be maintained by all the public companies, its management and accounting firms. The name of this law was given after the name of the US senator and US representative Paul S Sarbanes and Michael G Oxley respectively. This act has eleven main elements. They are as follows:- a) Public Company Accounting Oversight Board- This part contains nine sections. These are related to administration, establishment, audit, commission, accounting standards etc. This board also gives guidance on registration of auditors and also specifies the rules and procedures for conducting audit. b) Auditors Independence- This title mainly signifies the standards regarding the independence of the external auditors. It contains nine sections. These sections deals with the criteria for approval and preapproval of auditors, rotation of audit partners, audit reports and everything related to the auditors and their work. c) Corporate responsibility- This part contain eight sections which deals with the company’s responsibility toward financial reports, forfeiture of profits and bonuses, audit committees of public company etc. As per this title the executives of the company should make sure that the financial reports are accurate and complete. It also signifies the penalties for non compliance of the guidelines. d) Enhanced financial disclosure- This part contains nine sections. This part signifies that the financial statements should also disclose those transactions which are not represented in the balance sheet. It also signifies the ethics to be followed by the financial officers. e) Analyst Conflicts of Interest- This part signifies the measures which should be taken so that the investor can trust the security analyst’s reports. It contains only one section. f) Commission Resources and Authority: This title contains four sections which signify the practices to be followed so that the investor can regain and restore its trust on security analysts. This title also defines the authority of the security exchange commission over the financial analyst. g) Studies and Reports- As per this part the security exchange commission and the comptroller general should study the credit rating agencies, investment banks and also on the violation of the norms and that persons who are violating it. This title contains five sections. h) Corporate and Criminal Fraud Accountability- this title signifies the penalties for any fraud regarding the financial statements. It also signifies the protection provided to the whistle blowers. i) White Collar Crime Penalty Enhancement- As per this section the penalties of the offenders who do white collar crimes that are fraud in financial statements have been increased. j) Corporate Tax Return- As per this section the tax returns should be signed by the CEO. k) Corporate Fraud Accountability- This part contains seven sections. As per this title tampering of records and frauds in a company should be treated as a criminal offence and the penalty should be given as per that. This section authorizes the security exchange commission to temporarily freeze the operations if any fraud is detected (University of Cincinnati, 2011). 3. Necessity of Sarbanes Oxley Act for Corporate Governance The previous section has given a brief overview of Sarbanes Oxley Act that is mainly guides the US listed company to follow proper corporate governance. Therefore, it is necessary to discuss the importance of Sarbanes Oxley Act in meeting the corporate governance. In this regard, two major areas must be covered i.e. the concept of corporate governance, and emerging necessity of this act during 2002. Corporate governance is a constantly evolving area and with the passage of its necessity keeps growing. Basically, corporate governance refers to the ethical behaviors of the corporate bodies. The corporate world is one of the indispensible determinants of economic growth and development and hence, any fluctuations in corporate governance directly influence an economy and its common people. The increasing corporate scandals and unethical practices are fatal for entire financial market that hurts investors’ confidence. The corporate governance codes generally includes major areas of concern like conflict of interest, accountability, disclosures, accounting standards, role and rights of auditors, board of directors, shareholders, management etc. According to OECD corporate governance is a set of processes that guides, directs and controls the corporate bodies. “The corporate governance structure specifies the distribution of rights and responsibilities among the different participants in the organization – such as the board, managers, shareholders and other stakeholders – and lays down the rules and procedures for decision-making” (OECD, 2005). Prior to the development of Sarbanes Oxley Act, there were a number of corporate scandals and unethical practices impacted the US economy negatively. In this regard, collapse of Enron the seventh largest corporate of US was a massive hit on US corporate governance and on economy. SEC filed against the Enron for misguiding by misrepresenting and by tampering the financial reports. This scandal was disclosed after Enron filed for bankruptcy which was resulted by loss of nearly $618 million in third quarter financial results. The management of Enron including its auditors was engaged in unethical practices and on the other hand, the regulatory body was also proved weak in controlling such fatal consequences. Enron was charged for several reasons like for tax evading, artificial inflated profit disclosing, misleading market with inflated stock prices, manipulation of subsidiary companies, manipulation of financial statement for personal gains etc (Tesfatsion, 2011). Besides, there were other multiple corporate scandals were detected and the case of Tyco International scandal was also highly criticized. The CEO and CFO of Tyco International were found guilty for stealing $150 millions. Besides they also sold company’s shares by misappropriations (Rensselaer Polytechnic Institute, 2008, p.1). Securities Exchange Commission also detected a number of corporate frauds like WorldCom, Peregrine, Adelphia, Systems etc. These frauds had led to reduce investors trust on market by making an unstable financial market. Mallin has defined that corporate governance is a key factors that strives to “restore investor confidence in markets that have experienced financial crises” (Mallin, 2007, p.86). By analyzing the brief overview of Sarbanes Oxley Act, it can be clarified that it is meant to regulate the corporate bodies for maintaining a higher level of corporate governance within the US. Sarbanes Oxley Act includes all necessary sections aiming to detect and prevent corporate scandals. SEC is in the charge of implementing this act and it is mandatory for complying with Sarbanes Oxley Act as it enhances the corporate responsibility, “financial disclosures, and combat corporate and accounting fraud” (SEC, 2010). 4. Role of Sarbanes Oxley Act in Meeting the Codes of GAAP Disclosure and accountability are indispensible integral part of corporate governance. A standard disclosure guides the corporate for maintaining proper transparencies by disclosing corporate affairs, meetings, financial reports etc. On the other had accountability of financial reports are significant for proper disclosing and for avoiding misguiding indication to shareholders and other users of financial reports. Financial report depicts the real picture of companies’ financial position, and this is the reasons, in most of corporate frauds cases, the financial reports are manipulated by misinterpreting the accounting standards. Accounting standards is a set of rules which includes very specific accounting principles for avoiding accounting conflict for developing financial statement and a high standard of accounting standard must ensure reliability of financial statements (Singal, Mittal and Ahuja, 2011, p.10.1). Every developed and stable economy has framed their specific accounting standard. However, US GAAP (Generally Accepted Accounting Principles) developed by FASB (Financial Accounting Standards Board) and IFRS (International Financial Reporting Standards) developed by IAS are the most prominent accounting standards. In US, GAAP is accounting standard that must be followed by the publicly listed company. Sarbanes Oxley Act also includes relevant laws regarding accounting standards. This law allows the SEC to recognize standards developed by a “private-sector accounting standard-setter provided that the standard-setter is deemed acceptable by the SEC and considers international convergence in developing standards” (Deloitte Global Services Limited, 2002, p.1). The accounting standards are reviewed and modified at regular interval and hence, there are also numbers of modifications and amendments have been incorporate the US GAAP by FASB which is finally recognized and implemented by SEC. The GAAP is very important for Sarbanes Oxley Act as it guides corporate for meeting the proper disclosure and accounting standard. On the other hand, this act enhances the strength and importance of GAAP accounting standard by making compulsion for listed companies. In the process of closure and accountability, financial statement adjustments (FSA) are critical area. An inappropriate decision for FSA often leads to misguiding the investors by presenting non-complying financial reports. In this regard, GAAP guides the management to make proper decisions for FSA in accordance to Sarbanes Oxley and SEC norms (Maroney and McDevitt, 2008, p.94). For following the codes of GAAP, it is necessary to maintain a proper internal control and in this respect, Sarbanes-Oxley Act includes the section 404 directs the managements’ focus for a better internal control system. Besides, this act have been played very crucial role in formalizing the recognition of FASB by SEC. Sarbanes-Oxley Act offers provisions for FASB to assure timely actions for making necessary changes in accounting principle in order to overcome the issues relating to disclosure of financial reporting and accounting standards. “The Sarbanes-Oxley Act also requires the SEC to study the use of principles-based accounting and financial reporting rather than the existing rules-based system and FASB has already asked for public comment on adopting a principles-based approach” (Katten Muchin Zavis Rosenman, 2003, p.7). 5. Impact of the Sarbanes Oxley Act of 2002 Sarbanes Oxley Act has influenced the public companies and the accounting firms in a number of ways. It has also a major impact on the accountants, financial analysts, directors, officers etc. The main sectors which were mainly influenced by the Sarbanes Oxley Act are given below: Impact on accountants’ liability: Sarbanes Oxley Act has a major impact on the liability of accountants. Previously the liability occurred only when any fraud was detected but now the works of the auditors are reviewed from time to time. This review is done by the public company accounting oversight board. As the works of the accountant are scrutinized periodically the violations can easily be detected. The auditors are now more concerned about the conflicts and try to avoid them. As per the Sarbanes Oxley Act there are certain conflicts which have to be avoided. The audits have become more expensive. If the auditors fail to comply with the norms given in the act he could be suspended or his registration can get cancelled. This has increased the liability of the auditors and made them more cautious while auditing the financial statements (Wegman, 2005, p.12). Impact on investors: The main focus of the Sarbanes Oxley Act was to regain and restore the trust and confidence of the investors who had lost faith on the securities market because of the frauds and scandals. Title five and six of the Sarbanes Oxley Act focused on increasing and restoring the confidence of the investors. The efficiency and the role security analyst were judged as par the act. The role of the credit rating agencies was studied from time to time. Without these steps the investors would never invest again in the stock markets. Managing risk also reduced the chances of fraud which made the securities market safer to invest (Lowenqrub, 2005). Impact on Accounting Practices: The enactment of the Sarbanes Oxley Act has a major impact on the accounting and recording practices. As per the Sarbanes Oxley Act if there is a change in stock’s ownership the company have to post this statement in its website within a particular period of time. The company has to record all the information regarding the change including the date and time of posting. As per section 404 and 302 the company all the records should be maintained properly and also should be retained for future reference (Kahn & Blair, 2003, p.5). Impact on credit rating agencies and securities analyst: The credit rating agencies and the securities analysts were largely influenced by the enactment of the Sarbanes Oxley Act. As per the Sarbanes Oxley Act a periodic study should be made on the credit rating agencies. This study is done by the comptroller general and the security exchange commission. Due to this any type of error in the work can be easily detected which in turn can safeguard the interest of the investors. The security analyst will now have to work more cautiously as their work is also monitored. 6. Areas of Concern in Sarbanes Oxley Act and in US GAAP The previous section has mainly focus on the positive impact of the Sarbanes Oxley Act on the US corporate bodies. However, there has been great deal of debate on the viability and effectiveness of the Sarbanes Oxley Act. Many have identified that this acts are very useful in preventing the increasing corporate scandals. This act was introduced during 2002 when a number of corporate scandals impacted the financial market of US and hampers the investors’ confidence on market. According to Tricia Bisoux, the Sarbanes-Oxley Act of 2002 has helped to develop better corporate environment by maintaining a higher standard of corporate governance where transparency and financial reporting disclosure are the most crucial part. Till the years 2002, the corporate scandals were major issues for US economy and, the successful implementation of this act have played major role in preventing the frequencies of corporate governance (Bisoux, 2005, p.25). On the other hand, it is quite notable that five years after its implementation, collapse of Lehman Brothers and other financial institution again pointed figure against the effectiveness of this act. Many academics, critics and scholars have their doubts on the usefulness and effectiveness of this cat as it has been proved failure in preventing the financial crisis of 2007-2008 which was the reason of corporate governance failure. Some of the researchers have concluded that it is has been effective for agency problem to some extent, but not influential in financial reporting disclosure. Therefore, proper standards for financial reporting system must be the prime goal for the Sarbanes-Oxley Act of 2002 (Qian, Strahan and Zhu, 2009, p.27-28). Many CFO has opposed this act as they believe that compliance cost much higher for their organizations. As per AMR Research, the companies had to incur nearly $20 billion in order to comply with the Sarbanes-Oxley Act. This cost they very high and unconventional for company growth. This act’s prime concern is to restore the investors trust in market, but they believe that it is ineffective. Many of them also believe that it has benefited in restoring investors’ trust but the cost incurred for the compliance ahs outweighed the benefits. In case of small listed companies, the burden of cost is much higher and serious. Kate O'Sullivan has realized that this major issue associated with this act hinders many companies to be listed in US stock exchanges (O'Sullivan, 2006). The section 404 of the Sarbanes-Oxley Act is major concern as it creates a number of challenges for the foreign public issuers in US. According to this act, the companies that meet necessary filings of SEC are required to a report on internal control in their annual reports. However, in this process a number of challenges are faced by the foreign public issuers. Some ate the common challenges are like lack of U.S. GAAP competencies, requirement of proper internal audit committees, improper and complicated process for financial reporting and closing, experiences management group for internal controlling system, language barriers, lack of fraud prevention measures and programs (Deloitte Touche Tohmatsu, 2005, p.3-5). 7. Conclusion The Sarbanes Oxley Act was enacted in order to prevent the accounting and corporate frauds. This act was an outcome of the corporate frauds which was witnessed in 2000 and 2001. The main aim of this act was to regain the confidence of the in securities’ market. Many steps were taken in this respect such as scrutinizing the acts of the auditors, credit rating agencies, and security analyst etc. Changes were also mane in accounting practices. Now the companies have to record the non GAAP transactions properly in order to maintain the guidelines of the act. To some extent the objective of this act was achieved as the accountants liability increased, credit rating agencies’ role was analyzed etc but at the same time 5hius also increased the audit expenditure of the company. The fall of Lehman Brothers revealed that the Sarbanes Oxley Act is not very much effective in controlling all types of corporate frauds. There is still room for improvement. Like any other policy Sarbanes Oxley Act has both advantages and disadvantages. 8. Recommendation This paper has presented a critical review of the Sarbanes-Oxley Act which has included its benefits as well as major areas of concerns. The major identified issues associated with this acts are high cost of compliance, lack of proper financial risk assessments, lack of proper financial disclosure measures and major challenges associated with section 404. Therefore, regulating authorities must aim to address these issues by making necessary changes in the Sarbanes-Oxley Act. However, the laws in this act are meant to ensure market stability by establishing investors’ trust. Therefore, the regulating authorities as well as corporate bodies have to compromise on certain grounds. For example, for small size organization, the act must offer certain provision so that they do not need to incur higher cost. On the other hand, large size firm must try to make capital investment for arranging initial requirement for compliance, and it will generate long term profit for then as well for the entire market. On the hand for in case of requirement for external auditing review for internal control system is the major challenge for foreign private issuers as well as for other firms. The degree of compliance in this case must be removed as these tasks will result in increasing unnecessary cost of compliances with extra and unproductive workload (Holt, 2008, p.81). Reference Mallin, C. A. (2007). Corporate Governance. 2nd ed. Oxford University Press. Singal, R. S. 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Retrieved on July 27, 2011 from http://www.sec.gov/about/laws.shtml#sox2002. Tesfatsion, L. (April 03, 2011). The Enron Scandal and Moral Hazard. Retrieved on July 27, 2011 from http://www2.econ.iastate.edu/classes/econ353/tesfatsion/enron.pdf. Bisoux, T. (August 2005). The Sarbanes-Oxley. Retrieved on July 27, 2011 from http://www.aacsb.edu/publications/archives/julyaug05/p24-29.pdf. Read More