In her article Eight Ways SOX Changed Corporate Governance, author Melissa Maleske lists key provisions of the Sarbanes-Oxley Act (SOX Act) that have predetermined the future of SOX, and made inroads for Managerial Accountants who work for publicly-listed companies to take proactive measures to assure the ethical and compliant operation of their companies.
Corporate governance is the interrelationship of corporate directors and management under the rule of law. Directors have a responsibility to shareholders. Since self-regulation failed, the government stepped in after the Enron collapse with the Sarbanes-Oxley Act of 2002 (SOX). This Act replaced the Financial Accounting Standards Board with the Public Company Accounting Oversight Board (PCAOB). It was assigned the responsibility of measuring firms that have the responsibility of auditing publicly-held companies. SOX is the highest measure of federal legislation covering corporate governance since the Securities Act of 1933. Almost 30 versions of the bill were proposed before the final version, named after Representative Michael Oxley and Senator Paul Sarbanes, was finally passed.
Keywords: Sarbanes, Oxley, managerial, accounting
In this paper we’ll look at various key points from the article, synopsize them and then show how we can properly react from the standpoint of a Managerial Accountant.
The SOX Act re-empowered the corporate board of directors. Section 301 of SOX requires corporations to establish audit committees. These entities then publish established procedures for employee concerns to travel up the ladder to the committee. These are called Whistleblower Policies. If an employee is familiar with a questionable practice, then an internal report to the audit committee can be filed with assurance of protection and privacy. No retaliation is allowed. The Board of Directors is the ultimate recipient of this information. The SOX Act, Section 1107 protects whistleblowers, and states that any person who takes an action against a whistleblower or any person who aids law enforcement, is subject to imprisonment of up to 10 years. Managerial Accountants can assist in implementing this policy by assuring with proper Internal Controls that an independent Audit Committee exists, and that it reports to an independent Board of Directors.
The SOX Act encouraged corporate ethics. The Enron trial occurred after four years of investigations, and involved 108 days of evidence. The executives all took plea deals (Warner, “NACD Library”). The Watkins Whistleblower letter exposed the fraudulent activities in August 2001. The standing judge, Judge Lake, invoked the “ostrich instruction” to the jurors. This allows the jury to find evidence of guilt if the executives deliberately and willfully ignored obvious and clear information. It was found that they had sufficient notice of problems through Ms. Watkin’s letter to Ken Lay. They deliberately refused to act on that information. Willful blindness satisfies a legal requirement of scienter, or criminal intent equivalent to fraud. A deliberate effort to avoid guilty knowledge is all the guilty knowledge the law requires. Jurors quoted after the trial ended said that with all of the information available, the top executives had to know what was going on at their company. Ken Lay was also selling high levels of stock right before the end, while at the same time recommending to his employees that they hold on to theirs. This indicated insider knowledge.
The Watkins letter was initially sent on an anonymous basis. Lay decided to rely on “comfort opinions’ he was receiving. But these firms had conflicts that altered their views of reality. An independent forensic analysis was needed but never authorized. It is ironic but if Ken Lay had simply acted on the initial Whistleblower Letter, he could probably have avoided all fraud charges to himself personally from that point. It was a point of no return.
The SOX Act discourages this type of unethical behavior by requiring all companies to have a Code of Ethics. A Managerial Accountant can verify that the Code of Ethics exists, and by audit techniques can determine if it has been properly communicated to all levels of management and employees.
The SOX Act created the Public Company Accounting Oversight Board (PCAOB). SOX is a major set of rules related to financial reporting. It is designed to produce highly transparent reporting, to enhance the independence of auditors, to create the PCAOB and to improve corporate governance while reducing financial fraud (Willits, “Is the Sarbanes-Oxley Act Working”). The PCAOB recommends that firms who are auditing companies use a control environment structure known as the Committee of Sponsoring Organizations (COSO). COSO has elements that operate at the entity level, and at all divisions of the company. Managerial Accountants can utilize the most recent set of COSO principles, developed to guide audits of public companies, and conduct a controls audit to see if all controls are mapped to the related risk matrix.
The SOX Act clarified and complicated the role of in-house counsel. SOX now requires disclosure from corporate attorneys. Federal law now says that counsel must report “evidence of a material violation of securities law” or “breaches of fiduciary duty.” Prior to SOX these laws did not exist. The law now further requires that this data be reported to the audit committee. It is covered as a protected report. Counsel is now viewed from this time forward under Sarbanes-Oxley as a “mandatory whistleblower” under Title 15 of the U.S. Code. Managerial Accountants can review the minutes of audit committees to assure this control is operating effectively.
The SOX Act made public companies more difficult to run. SOX is not an inexpensive proposition. The cost of complying with Section 404, the internal control requirements, is high. Based upon studies conducted right after SOX took effect, the average Section 404 compliance cost was between $4.4 million and $7.8 million. Large companies, with more than $10 billion in revenue, spent more than $10 million each. However, Managerial Accountants can assure that key risk areas are covered by the right internal controls, and reduce operational costs by assuring there is complete coverage of key internal controls to reduce fraud risk.
The SOX Act empowered the SEC. A single SOX count carries extremely heavy weight in a federal prosecution. One signature alone penned on a document creates this liability. Only days after the law took effect, during July of 2002, Weston Smith, the CFO of Health South, refused to sign on a quarterly report that had been doctored. After a time of negotiation, he changed his mind and signed off. Because of his realization of the consequences, he approached and struck a deal with the prosecutors only months later. Weston cooperated with the FBI from that point forward. Taped conversations with Scrushy were done in secret, under government supervision. Federal judges heard the tapes. Fifteen guilty pleas ensued. Scrushy was later imprisoned under other charges. CEOs and CFOs have routinely in the past signed on financials, but never under the heavy penalty that is now in place. The prosecutors believe it was the new SOX law that empowered the SEC that brought down the house of cards, HealthSouth. This case is a prime example of the success of the Sarbanes Oxley legislation in deterring fraud and bringing those to justice who ignore it at their peril. Managerial Accountants have the responsibility of making sure that publicly listed companies comply with all signature requirements of the SOX Act, and that all exceptions are reported to the audit committee.
- Warner, J. “NACD Library.” 10 Years After Sox: The Legacy of Enron. N.p., 26 Sept. 2012. Web. 23 Feb. 2015.
- Willits, S. “Is the Sarbanes-Oxley Act Working? [CPA Journal, The].” Is the Sarbanes-Oxley Act Working? [CPA Journal, The]. NY State Society of CPAs, 10 June 2014. Web. 23 Feb. 2015.