Sarbanes Oxley

The past years have been fraught with big industry accounting scandals, misreporting, criminal investigations and prosecutions. Enron and WorldCom are two organizations that will probably come into most of the public’s minds when thinking of accounting downfalls of large companies.

The SEC and government have worked hard to put limitations into place to restrict activities that place responsibility into corporate accounting procedures. This becomes especially important to the CIO and CEO levels, as they are increasingly held responsible for these mistakes, and must ensure they take a hand in everything their company is doing from an accounting perspective.

This document will take a look at the Sarbanes-Oxley Act and how it can affect your accounting and trading procedures. It will go through some of the high points of the act, some of the pros and cons of the legislation, and some of the ethical considerations.

The Sarbanes-Oxley Act

The Sarbanes-Oxley Act went into effect on November 15, 2002. It is designed to deter financial malpractice and accounting scandal. Often, it is referred to as SOX, SarbOx, or SOA. Two congressmen, Democratic Senator Paul Sarbanes from Maryland and Republican Representative Michael Oxley from Ohio, are the men who pushed the Act through and are credited by name. The Act generally covers governance issues, especially those dealing with trade. The following are some of the high points of the Sarbanes-Oxley Act.

The Board of Directors in a company now must have at least five financially-literate members, which are appointed for five-year terms. Two of these members must be, or have been, certified public accounts, and the other three must not be, or cannot have been CPAs. This allows financially savvy board members to cycle through without spending long terms in the position, and also keeps a balance in the accounting knowledge within the board. The audit lead or coordinator partner and reviewing partner in audits must also rotate every five years.

The Act protects “whistleblowers”, those people who come forth with incriminating information about activities within their company. This becomes especially important with the increasing prosecution following Sarbanes-Oxley, as those who do not want to be involved will have the responsibility to come forth with information. This section requires the company establish procedures for the receipt, retention, and treatment of complaints such as fraud and auditing abuse.

Sarbanes-Oxley provides specific blackout periods for stock trading in which officers and directors cannot purchase or sell stock. Profits resulting from sales in violation of this are recoverable by the issuer of the stock.

The SEC retains a large amount of control with Sarbanes-Oxley, including the ability to restrict people from serving on the Board of Directors if they have a securities fraud issue in their background and freezing extraordinary payments to company officers while they investigate the transaction for illegitimate activities.

Probably the most challenging area for most companies, and the one affecting their day to day operations, is the archival of all communications and the creation of transparent and auditable systems for recording transactions. This should mean traders can’t contact each other in secret, and deals should not be lost in the shuffle of day to day business. Applications such as instant messaging and email are areas singled out by Sarbanes-Oxley that need to be secured and made accountable. The Act also requires “real time disclosure”, where financial conditions or operations must be reported on a rapid and current basis.

Pros and Cons

Sarbanes-Oxley is intended to give the investor back some measure of confidence with the internal accounting practices of the organization. It is designed to keep company officers honest in their financial and trade dealings so investors and employees will not suffer financial loss due to criminal activities. However, there are some issues that come with the Act. I will point out both advantages and disadvantages here.

Since the Act has been put into place, nothing related to financial reporting is taken for granted. Most companies have implemented better corporate governance procedures. Audit Committees and Boards of Directors are now more engaged in their responsibilities related to financial reporting. The relationship between the Audit Committee and the auditors are stronger.

Companies are more often identifying and modifying control deficiencies before misstatements happen on their financial statements. Over time, this will mean less major restatements on financials and fewer SEC financial reporting cases. Eventually, this should lead to less incidents involving accounting fraud. These are all positive effects of the Act.

Companies