Question

How financial reporting for public companies has changed since the Enron scandal in 2001.

Answer 1

Enron Scandal 2001

Enron a global Gas and Energy company incorporated in Omaha Nebraska and once distinguished as the Nation’s 7th largest company. Listed on Forbs Fortune 500 as being among the wealthiest companies listed on the stock exchange. Through this accumulation of “wealth” Enron at one point held a robust market valuation, which was higher other large global companies like AT&T. Many would call Enron a company that was “too big to fail”; this was due to the company’s reported revenue milestone accomplishment of 100 billion dollars.

But what made the Enron scandal so compelling was the fact that it brought down accounting giant Arthur Andersen too. It was a truly amazing situation, a conflation of corporate wrongdoing which would change the accounting world forever.

Changes In Financial Reporting and Other Changes due to Enron Scandal 2001

• Sarbanes Oxley and Management Responsibility:- In 2002 the new law enacted Sarbanes-Oxley Act, this measure on July 30, 2002, amid great fanfare about how it was going to improve corporate governance and reduce fraud. Many of these expectations have not been met.

SOX includes several gatekeeper provisions:

Requiring a company’s board of directors to have an Audit Committee composed solely of independent directors.

Making the Audit Committee responsible for the appointment, compensation, and oversight of the outside auditor and for establishing procedures for the confidential, anonymous submission by company employees of concerns about accounting or auditing practices.

Creating a new agency, the Public Company Accounting Oversight Board (PCAOB), to strengthen the outside audit function. The PCAOB sets standards involving auditing, quality control, ethics, and audit reports and has authority to inspect, investigate, and discipline registered public accounting firms.

Requiring attorneys who practice before the Securities and Exchange Commission (SEC) to report material violations of the securities laws to a company’s chief legal officer or chief executive officer. If those officers do not respond in an appropriate manner, the attorney is then required to report the violations to the Audit Committee of the board or to another committee composed solely of independent directors.

Enhance Regulatory Protections

Federal and state securities regulators and self-regulatory organizations play an important and necessary role in corporate governance. They wield a broad and powerful array of sanctions, and their enforcement actions serve as a strong deterrent against wrongdoing. The SEC’s enforcement priorities, reflected in public speeches by its Commissioners and staff, help shape corporate conduct.

Increase in Regulations after Sarbanes Oxley

The Sarbanes-Oxley Act initiated stringent regulations. The Act was composed of sixty-six sections, some long and others short. Each section dealt with a different part of the reporting cycle (Schaeffer, 2006). These sections are contained within eleven titles, primarily dealing with the issue of internal control. The eleven titles of SOX are as follows: Public Company Accounting Oversight Board, auditor independence, corporate responsibility, enhanced financial disclosures, analyst conflicts of interest, commission resources and authority, studies and reports, corporate and criminal fraud accountability, white-collar crime penalty enhancements, corporate tax returns, corporate fraud and accountability (SOX, 2002). Each of these titles has its own specific impact on different areas of financial reporting, but only a few will be discussed in detail within this paper

Corporate Responsibility

Title III of the Sarbanes-Oxley Act contains several important sections dealing with corporate responsibility. While only a few will be gone into depth in this paper, every section is incredibly vital. Each section contains a particular amount of pertinent information for all forms of companies that comply. The eight sections of Title III are as follows: section 301, public company audit committees (expanded below), (302) corporate responsibility for financial reports, (303) improper influence on conduct of audits, (304) forfeiture of certain bonuses and profits, (305) officer and director bars and penalties, (306) insider trades during pension fund blackout periods, (307) rules of professional responsibility for attorneys, and (308) fair funds for investors (SOX, 2002).

Use of Non-U.S. GAAP or Pro Forma Financial Information

When speaking of foreign companies, most do not follow U.S. Generally Accepted Accounting Principles, hereafter referred to as GAAP. Many foreign companies follow the International Financial Reporting Standards, or IFRS, rather than GAAP. However, for a company that does not prepare their statements according to IFRS, the SEC requires their financial statements to be in accordance with GAAP. Section 401(b) of SOX discusses the rules and regulations that concern how a company can present figures from their financial statements and remain in compliance with SOX (SOX, 2002). For those companies that are registered in the US, with the SEC or PCAOB, section 401(b) requires two disclosures: (a) “a presentation of the most comparable financial measure calculated in accordance with GAAP”; (b) “a reconciliation of the differences between that measure and the non-GAAP measure”. These disclosures come as a result of the SEC’s Regulation G, adopted in January 2003. While this regulation was adopted in January, it was put into effect until March 28, 2003. Regulation G is believed by some to imply that the SEC considers more transparency and consistency in filing and providing information to be more beneficial to investors. Prior to the Sarbanes-Oxley Act, the SEC came to the realization that investors desiring to put capital into firms who did not comply with GAAP might be mislead if the firms masked GAAP results. Because of this realization, and as a provision to SOX, the SEC proposed Regulation G and additional changes to the filing and furnishing rules, with the intent “to ensure that investors and others are not misled by the use of non-GAAP financial measures”. The information that is now required to be disclosed to the investors may aid them in their investing decisions. This information will permit the investors the ability to choose if they concur with the adjustments seen in the firm or if they prefer to reverse these adjustments. According to one researcher, “the frequency of reporting non-GAAP earnings and other financial measures in quarterly earnings press releases did not change with the SEC interventions”. This research appears to show that those firms which originally reported with pro-forma financial statements continued to do so, and firms which did report in accordance with GAAP continued their reporting as well. However, it is important to point out that firms registered with the SEC in the United States must comply with GAAP in their published financial statements, even if their own company statements continue to be in pro-forma format.

Public Company Accounting Oversight Board

The Public Company Accounting Oversight Board, or PCAOB, was created as a result of SOX. However, the PCAOB is not an entity of the United States government, but rather is a nonprofit corporation under the jurisdiction of the District of Columbia. This board is run by five members from various backgrounds. Members have a five-year term, with the option to serve an additional five years. The primary purpose of the PCAOB is to “protect investors by improving the accuracy and reliability of financial reports”