1. Corporate Governance - USA Sarbanes-Oxley Act “SOX” Lecture 15&16 By Abdur Rashid Mirza University of Lahore

2. Enduring Understanding  The Sarbanes-Oxley Act was enacted to establish new or enhanced standards for U.S. public company boards, Management, and public accounting firms.

3. Essential Questions  Why was the Sarbanes-Oxley Act needed?  How does the Sarbanes-Oxley Act protect stockholders and institutions?

4. Objectives  Describe the events that caused the passing of the Sarbanes-Oxley Act.  Relate the Sarbanes-Oxley Act to accounting.  Explain the goals of the Sarbanes-Oxley Act.  Describe each of the 11 titles of the Sarbanes-Oxley Act.

5. What is SOX?  Also known as the Public Company Accounting Reform and Investor Protection Act of 2002  Created by US Senator Paul Sarbanes (D- Maryland) and US Congressman Michael Oxley (R-Ohio)  Signed into law July 30, 2002  Most dynamic securities legislation since the Securities and Exchange Acts of 1933 and 1934

6. Purpose of SOX  Establish new or enhanced standards for U.S. public company boards, management, and public accounting firms

7. Relation to Accounting  Bad accounting procedures, both intentional and non-intentional, led to the collapse and subsequent investigation of several large companies  Public outrage led Congress to pass SOX to regulate audits of public company accounting procedures and hopefully prevent false financial reports

8. Relation to Accounting, continued…  Companies that do not follow standard accounting procedures may use methods that mislead investors about the financial health of the company.  These practices range from just unethical to illegal.

9. Why was SOX passed?  Failure of Boards of Directors and executives to double-check financial records  Intentional misrepresentation of financial status  Loans from major banks to risky companies hurt bank investors and encouraged others to make risky investments in those companies  Misrepresentation of company earnings caused stockholders to make seemingly good investments that cost them large sums of money

10. Why was SOX passed?, continued…  Auditor conflicts of interest  Some auditing firms provided consulting services to the companies they audited.  Proper auditing procedures, such as challenging a company’s accounting procedures, could damage the client relationship under the consulting agreement.  This caused bad accounting practices and misrepresentation of financial information to go unchecked, leading to the collapse of several companies, like Enron, Worldcom, Healthsouth and Tyco.

11. Causes of Sarbanes-Oxley Headlines

12. Audience Quiz The Problem for Corporate America Deficit

13. Audience Quiz The TRUST deficit The extraordinary loss of trust in corporations and their leaders

14. Goals of SOX  Regain public confidence in markets  Improve corporate governance  Increase executive accountability  Increase efforts to  Increase efforts to prevent, detect, investigate and remediate fraud and misconduct

15. Title I – Public Company Accounting Oversight Board  Created as a non-profit organization to oversee audits of public companies  Under the authority of the Securities Exchange Commission (SEC)  Comprised of 5 appointed members w/ a max of 2 CPA’s  Duties:  Register existing public accounting firms which prepare audits for publicly traded companies  Audit the auditors  Establish and amend rules and standards (in cooperation with other standard setters)  Try and penalize registered public accounting firms who fail to comply with the rules

16. Title II – Auditor Independence  Prohibits registered public accounting firms from performing non-audit services for companies they audit  Prevents conflicts of interest

17. Title III – Corporate Responsibility  CEOs and CFOs must certify accuracy  Surrender bonuses and profits if information is misrepresented

18. Title IV – Enhanced Financial Disclosures  Forbids most personal loans to chief executives  Disclosure of code of ethics for senior financial officers  Disclosure of members of company audit committee  Should include at least one financial expert

19. Title V – Analyst Conflicts of Interest  Requires registered securities associations to adopt rules that prevent conflicts of interest  Ex: Recommendations of analysts in research reports

20. Title VI – Commission Resources and Authority  Increased SEC budget to $780 million  $98 million used to hire 200 employees to oversee auditors  SEC has the authority to investigate and punish violators of security law

21. Title VII – Studies and Reports  US Comptroller General (The Comptroller General of the United States is the director of the Government Accountability Office (GAO, formerly known as the General Accounting Office to conduct a study about the consolidation of public accounting firms) Government Accountability OfficeGovernment Accountability Office  Also conduct investigation of security law violations in the cases of Enron, WorldCom, etc.

22. Title VIII – Corporate and Criminal Fraud Accountability  To knowingly create, destroy, or manipulate documents or impede federal investigations is considered a crime  Punishment = Fines, maximum 20 years in prison, or both  Audit reports should be kept for 5 years  Whistleblower protection  Dishonest or illegal activities (misconduct) occurring in a government department misconduct

23. Title IX – White-collar Crime Penalty Enhancements  CEOs and CFOs must certify that financial statements are accurate representations of the company’s condition  Punishment = Max $5 million fine and/or max 20 year punishment  SEC may ban anyone convicted of a security crime from holding an executive position at a public company

24. Title X – Corporate Tax Returns  Federal income tax returns must be signed by the Chief Executive Officer (CEO) of the company

25. Title XI – Corporate Fraud Accountability  Destroying/altering evidence or otherwise obstructing securities fraud proceedings may be punished with a fine and/or up to 20 years in prison  SEC may freeze payments to accused individuals  Any revenge to whistleblowers is subject to fines and/or 10 years imprisonment

26. Summary  The Sarbanes-Oxley Act of 2002 was passed to regain public confidence in the stock market following a string of major accounting fraud cases involving public companies.  A plan to accomplish this objective is outlined in 11 titles, which:  Prohibit conflicts of interest  Increase corporate accountability  Increase accounting transparency  Form an oversight board to enforce the new rules

27. Exam Questions 1.The Sarbanes-Oxley Act was passed in: a. 1935 a. 1935 b. 1974 b. 1974 c. 1999 c. 1999 d. 2002 d. 2002 2.What events led to the passing of SOX? a. Collapse of the auto industry a. Collapse of the auto industry b. A string of accounting scandals at public companies b. A string of accounting scandals at public companies c. Great Depression c. Great Depression d. Discrimination in the accounting profession d. Discrimination in the accounting profession

28. CORRECT! Back to Test

29. Incorrect, Please Try Again Back to Test

30. Exam Questions, continued… 3.What government institution was established by SOX to oversee auditors? Answer 4.The Public Company Accounting and Oversight Board is under the authority of: a. North Atlantic Treaty Organization (NATO) a. North Atlantic Treaty Organization (NATO) b. Food and Drug Administration (FDA) b. Food and Drug Administration (FDA) c. Securities Exchange Commission (SEC) c. Securities Exchange Commission (SEC) d. US Treasury d. US Treasury 5.Name 4 titles of the Sarbanes-Oxley Act. Answer

31. Public Company Accounting Oversight Board (PCAOB) Back to Test

32. CORRECT! Back to Test

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34. Titles: 1.Public Company Accounting Oversight Board 2.Auditor Independence 3.Corporate Responsibility 4.Enhanced Financial Disclosures 5.Analyst Conflicts of Interest 6.Commission Resources and Authority 7.Studies and Reports 8.Corporate and Criminal Fraud Accountability 9.White-collar Crime Penalty Enhancements 10.Corporate Tax Returns 11.Corporate Fraud Accountability Back to Test

35. Exam Questions, continued… 6.According to Title X, who should sign the company tax return? a. Chief Executive Officer (CEO) a. Chief Executive Officer (CEO) b. President of External Accounting Firm b. President of External Accounting Firm c. Chief Financial Officer (CFO) c. Chief Financial Officer (CFO) d. Company’s Head of Accounting d. Company’s Head of Accounting 7.What events involving major public companies led to the passing of SOX? a. Intentional misrepresentation of company financial records a. Intentional misrepresentation of company financial records b. Auditor conflicts of interest b. Auditor conflicts of interest c. Risky loans from banks based on false earnings c. Risky loans from banks based on false earnings d. all of the above d. all of the above

36. CORRECT! Back to Test

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38. Exam Questions, continued… 8.What is the criminal penalty for violation of SOX? a. life in prison a. life in prison b. fines and/or maximum 20 years in prison b. fines and/or maximum 20 years in prison c. maximum 5 years in prison c. maximum 5 years in prison d. tax increase d. tax increase 9.True/False: Under SOX, auditors are not allowed to provide non-audit services (consulting) to the companies they audit. TrueFalseTrueFalse 10.True/False: SOX does not apply to privately held companies. TrueFalseTrueFalse

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41. Effects of Sarbanes-Oxley If you’re a criminal – the risks of doing business absolutely have increased

42. Crimes/Penalties Created new federal crimes Created new federal crimes Enacted whistleblower protection and cause of action Enacted whistleblower protection and cause of action  Increased criminal penalties for mail/wire fraud  Restricted bankruptcy discharge of securities liabilities  Lowered threshold officer/director bars  Lengthened statute of limitations for securities fraud  Gave SEC power to freeze assets

43. Senate Investigation Effects of Sarbanes-Oxley ● Auditors ● Auditors ● Securities analysts ● Government agencies ● Board of Directors ● Credit rating agencies ● Financial institutions

44. Effects of Sarbanes-Oxley Auditors Enacted auditor independence requirementsEnacted auditor independence requirements Gave guidance to state regulatory authoritiesGave guidance to state regulatory authorities  Made it unlawful to mislead public company auditors

45. Effects of Sarbanes-Oxley Securities Analysts/Government Agencies Regulation mandated by SOXRegulation mandated by SOX SEC budget increasedSEC budget increased SEC required to review public company’s filings more oftenSEC required to review public company’s filings more often  “Real time” disclosure

46. Effects of Sarbanes-Oxley Boards of Directors CEO/CFO certifications CEO/CFO certifications Bonus restrictionsBonus restrictions professional conduct rulesprofessional conduct rules Enhanced reporting requirementsEnhanced reporting requirements Loan prohibitionsLoan prohibitions Internal controls attestationsInternal controls attestations Codes of ethicsCodes of ethics Audit committee requirements (including “audit committee financial experts”) and disclosuresAudit committee requirements (including “audit committee financial experts”) and disclosures

47. Effects of Sarbanes-Oxley Credit Rating Agencies  SEC required by SOX to study Credit Rating Agencies  “Congressional Response” from October 7, 2002 response Investment Banks  GAO required by SOX to study investment banks  “Congressional Response” from January 2, 2003 report

48. Corporate Scandal - Education Some commentators have noted the education level of some of those involved in some corporate scandals: “How could a Harvard MBA behave so unethically?”

49. Corporate Scandal - Education There’s no relation between education and human decency “You can be a Ph.D and an S.O.B.” Justice Oliver Wendell Holmes

50. So - What Really Got Us Here? It’s not their M.B.A. It’s their DNA

51. Moral DNA In my mind, the most important thing that a Board of Directors should do is determine the elements that must be embedded in the company's moral DNA…It should be the foundation on which the Board builds a corporate culture based on a philosophy of high ethical standards and accountability. This culture should penetrate every level of the organization and influence all of the board's decisions including the selection of a CEO and the senior management team who will ultimately ensure that the company's operations reflect its philosophy. William Donaldson Former SEC Chairman Remarks made to the Economic Club of New York May 8, 2003

52. What’s SOX Got To Do With It?  Three separate sections of SOX (805, 905 and 1104) address the US Federal Sentencing Guidelines (the “Guidelines”)  Guidelines amended in 2004 to change references from “Compliance” programs to “Ethics and Compliance Programs”  Boards given direct oversight responsibility

53. US Sentencing Guideline Revisions “Good corporate citizens have been incorporating ethical standards into their compliance programs for a number of years, and recent legislation, such as [SOX], has adopted ethics as a guiding principle.” Commission Vice Chair Ruben Castillo stated “A good corporate citizen must first and foremost operate ethically.”

54. Corporate Culture and Performance “Corporate Ethics: Right Makes Might” Avoiding scandal isn’t the only reason to observe a stringent code of conduct. Doing the right thing also generates more tangible dividends Business Week April 11, 2002

55. The Present and Future Solution Not in the laws The limit of the law is not the test of right and wrong People who do their job and do the right thing