BA 427 – Assurance and Attestation Services Lecture 12 The New Regulatory Environment

The stock market crash The Great Depression Sarbanes- Oxley Foreign Corrupt Practices Act World War II The Cold War The Securities Acts of 1933 and 1934 The Information Revolution Regulatory Time-Line

October 2000 Reg. FD 2000Oct – Dec Sarbanes- Oxley Act Enron stock price collapses Terrorist Attacks on the World Trade Center New Auditor Independence Rules Bush is elected President in contested election Regulatory Time-Line

1981 – 1989: The Reagan Years

1993 – 2001: The Clinton Years

The New Investor Class

Dow Jones prices 1986 – 2004 Aug 2000Sept 2002

S & P 500 prices 1986 – 2004 Aug 2000

NASDAQ prices 1986 – 2004 Feb 2000

Xerox 1998 – 2002

Tyco 1999 – 2002

Kodak 1998 – 2002

The Telecommunications Industry  The industry lost $2 trillion in shareholder value.  400,000 employees lost their jobs  Global Crossing was the fourth largest bankruptcy in U.S. history.

50% of employee 401(k) assets were tied up in Enron Stock. Within weeks, 4000 employees lost their jobs. Many employees also lost most of their retirement savings. Enron

Lecture 12 – The New Regulatory Environment  Sarbanes-Oxley, Title I  The PCAOB

Sarbanes-Oxley, Title I  “There is established the Public Company Accounting Oversight Board” To oversee the audit of public companies and related matters To protect the interests of investors To further the public interest in the preparation of informative, accurate, and independent audit reports

Sarbanes-Oxley, Title I  The Board shall be a nonprofit corporation.  The Board shall not be an agency or establishment of the U.S. Government.  No member or person employed by the Board shall be deemed to be an employee of the Federal Government.  The PCAOB is overseen by the SEC  PCAOB rules and standards are filed with the SEC, and only become effective when approved by the SEC.

Sarbanes-Oxley, Title I  The Duties of the Board: Register public accounting firms that prepare public company audits. Establish or adopt auditing, quality control, ethics, independence, and other standards relating to the preparation of public company audit reports. Conduct inspections of registered public accounting firms. Conduct investigations and disciplinary proceedings of public accounting firms.

Sarbanes-Oxley, Title I  The Membership of the Board Five members Appointed from “among prominent individuals of integrity and reputation who have a demonstrated commitment to the interests of investors and the public, and an understanding of … financial disclosures … and the obligations of accountants with respect to the preparation and issuance of audit reports ….”

Sarbanes-Oxley, Title I  The Membership of the Board Two and only two members shall be or have been CPAs. The PCAOB Chair cannot have practiced as a CPA within the past five years. Each member shall serve on a full-time basis, for no more than two 5-year terms. The SEC appoints the Board, in consultation with the Chair of the Federal Reserve Board of Governors and Secretary of the Treasury.

Sarbanes-Oxley, Title I, Section 102  PCAOB Registration of Accounting Firms Any auditor preparing or issuing an audit report for a public company must be registered with the PCAOB. As part of the registration application, accounting firms must submit to the Board:  The names of all public company clients  The annual audit and nonaudit fees from each client.  Other financial information pertaining to the firm.

Sarbanes-Oxley, Title I, Section 102  PCAOB Registration of Accounting Firms As part of the registration application, accounting firms must submit to the Board:  A statement of the firm’s quality control policies.  A list of all accountants associated with the firm who participate in public company audits.  Information relating to criminal, civil, or administrative actions or disciplinary proceedings pending against the firm or any member of the firm.  Information about accounting disagreements with any public company clients.

Sarbanes-Oxley, Title I, Section 102  PCAOB Registration of Accounting Firms Each registered public accounting firm shall submit an annual report to the Board to update the information contained in its application. The Board may make any and all of the information in these applications available to the public, although proprietary information shall not be made public.

Sarbanes-Oxley, Title I, Section 103  Auditing, Quality Control, and Independence Standards and Rules: The PCAOB has responsibility for three areas of standard setting:  Auditing Standards  Quality Control Standards  Ethics Standards

Sarbanes-Oxley, Title I, Section 103  Auditing, Quality Control, and Independence Standards and Rules: SOX requires the PCAOB rules to include the following auditing standards:  Audit work papers must be maintained for 7 years;  There must be a concurring or second partner review;  Section 404 reporting requirements

Sarbanes-Oxley, Title I, Section 103  Auditing, Quality Control, and Independence Standards and Rules: SOX requires the PCAOB rules to include the following quality control standards:  Monitoring of professional ethics and independence  Consultation on accounting and auditing questions.  Supervision of audit work.

Sarbanes-Oxley, Title I, Section 103  Auditing, Quality Control, and Independence Standards and Rules: SOX requires the PCAOB rules to include the following quality control standards:  Hiring, professional development, and advancement of personnel;  Acceptance and continuation of engagements;  Internal inspections

Sarbanes-Oxley, Title I, Section 104  Inspections of Registered Public Accounting Firms Annual inspections of accounting firms with more than 100 public company clients. Inspections every three years for firms with fewer than 100 public company clients. These inspections involve reviewing selected audit and review engagements of the firm, and an evaluating the firm’s quality control procedures.

Sarbanes-Oxley, Title I, Section 104  Inspections of Registered Public Accounting Firms The inspection reports are submitted to the SEC and to the appropriate State regulatory authorities. The inspection reports are made available, in appropriate detail, to the public, except that criticisms of the firm, and defects in the firm’s quality control procedures, shall not be disclosed if remedied by the firm with one year.

Sarbanes-Oxley, Title I, Section 105  Investigations and Disciplinary Proceedings The Board may investigate any act or practice, or omission to act, by a firm or member of the firm, that may violate any provision of SOX, the rules of the Board, or the rules established by the SEC. The Board can require testimony by employees of the firm and the client, and the submission of documentation.

Sarbanes-Oxley, Title I, Section 105  The Board has the authority to enforce the following sanctions:  Temporary suspension or permanent revocation of the firm’s registration with the Board.  Temporary suspension or permanent bar of an individual from working for any registered firm.

Sarbanes-Oxley, Title I, Section 105  The Board has the authority to enforce the following sanctions:  Fines of up to $100,000 for individuals and $2,000,000 for firms.  If the auditor’s conduct is intentional, reckless, or repeated, the fines can be $750,000 for individuals and $15,000,000 for firms.

Sarbanes-Oxley, Title I, Section 105  The Board has the authority to enforce the following sanctions:  Censure  Required additional professional education or training

Sarbanes-Oxley, Title I, Section 106  Foreign Public Accounting Firms Foreign public accounting firms that audit SEC clients can be subject to the same PCAOB rules as domestic firms.  The PCAOB can exempt foreign firms from these rules.

Sarbanes-Oxley, Title I  107: The SEC has oversight and enforcement authority over the PCAOB.  108: Determines the criteria by which the SEC can delegate accounting standard setting to the FASB or similar private regulatory body.  109: Establishes funding for the PCAOB and for the FASB. (Hence, the source of the FASB’s funding has changed.)

The PCAOB  One of the first pronouncements by the PCAOB was to adopt existing GAAS and independence and ethics standards.  Hence, except for the new auditing and reporting requirements in SOX, there were no initial differences between auditing standards for public companies and private companies.  Over time, we will see whether the Auditing Standards Board and the PCAOB establish different standards in areas where SOX did not establish new requirements.

PCAOB 2005 Annual Report  Registration of Accounting Firms: Approved 244 applications in 2005 Total number of registered firms: 1, of these firms are based outside of the U.S. 378 of the U.S. registered firms had no SEC clients at the time they registered. In 2005, 13 firms were denied registration.

PCAOB 2005 Annual Report  Inspection of Accounting Firms In 2005, the PCAOB inspected 281 registered accounting firms. PCAOB inspection teams are based in Atlanta, Chicago, Dallas, Denver, New York City, Orange County, San Francisco, and Washington D.C. The inspections in 2005 included the examination of 365 audits performed by the nine largest accounting firms.

PCAOB 2005 Annual Report  Inspection of Accounting Firms Profile of the inspection teams for large accounting firms:  Inspection team leaders have on average 23 years of relevant experience.  All other team members averaged 14 years of relevant experience. The Board issued 173 inspection reports in 2005 relating to 2004 and 2005 inspections. There are several hundred inspectors.

PCAOB 2005 Annual Report  PCAOB Funding Public companies are assessed fees to support the PCAOB The amount of the fee depends on the company’s market capitalization Companies with market capitalization less than $25 million are exempt. About 9,500 companies paid a fee.

PCAOB 2005 Annual Report  PCAOB Funding 14 public companies paid an annual fee in excess of $1 million 29 public companies paid an annual fee between $500,000 and $1 million 203 public companies paid an annual fee between $100,000 and $500,000 4,300 public companies paid an annual fee less than $1,000.

PCAOB 2005 Annual Report  PCAOB Expenses

PCAOB 2005 Annual Report  Enforcement and Investigations The Board announced settled disciplinary proceedings against three registered firms and five associated persons in In 2005, the Board’s Division of Enforcement and Investigations launched 17 formal investigations of registered firms and associated persons.