Question

Review the provisions of the Sarbanes-Oxley Act of 2002 to address the accounting scandals in the late 1990s and early 2000s (Enron, WorldCom, etc.)BELOW:

Identify the provisions that you believe made the most significant impact. What other provisions could have been included in the Act to strengthen the responsible stewardship and integrity of the accounting profession? Conversely, what existing provisions in the Act do you believe (if any) are unnecessary or over-regulate the profession?

As a result of corporate accounting scandals, such as those at Enron and WorldCom, the U.S. Congress enacted the Sarbanes-Oxley Act of 2002 (SOX). The purpose of SOX is to restore trust in publicly traded corporations, their management, their financial statements, and their auditors. SOX enhances internal control and financial reporting requirements and establishes new regulatory requirements for publicly traded companies and their independent auditors. Publicly traded companies have spent millions of dollars upgrading their internal controls and accounting systems to comply with SOX regulations.

As shown in Exhibit 1-10, SOX requires the company’s CEO and CFO to assume responsibility for their company’s financial statements and disclosures. The CEO and CFO must certify that the financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the company. Additionally, they must accept responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting. The company must have its internal controls and financial reporting procedures assessed annually.

Some Important Features of SOX

SOX also requires audit committee members to be independent; that is, they may not receive any consulting or advisory fees from the company other than for their service on the board of directors. In addition, at least one of the members should be a financial expert. The audit committee oversees not only the internal audit function but also the company’s audit by independent CPAs.

To ensure that CPA firms maintain independence from their client company, SOX does not allow CPA firms to provide certain nonaudit services (such as bookkeeping and financial information systems design) to companies during the same period of time in which they are providing audit services. If a company wants to obtain such services from a CPA firm, it must hire a different firm to do the nonaudit work. Tax services may be provided by the same CPA firm if pre-approved by the audit committee. The audit partner must rotate off the audit engagement every five years, and the audit firm must undergo quality reviews every one to three years.

SOX also increases the penalties for white-collar crimes such as corporate fraud. These penalties include both monetary fines and substantial imprisonment. For example, knowingly destroying or creating documents to “impede, obstruct, or influence” any federal investigation can result in up to 20 years of imprisonment.

SOX also contains a “clawback” provision in which previously paid CEO’s and CFO’s incentive-based compensation can be recovered if the financial statements were misstated due to misconduct. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 further strengthens the clawback rules, such that firms must recover all incentive compensation paid to any current or former executive, in the three years preceding the restatement, if that compensation would not have been paid under the restated financial statements. In other words, executives will not be allowed to profit from misstated financial statements, even if the misstatement was not due to misconduct.

Answer 1

The Sarbanes–Oxley Act of 2002 (Pub.L. 107–204, 116 Stat. 745, enacted July 30, 2002), also known as the "Public Company Accounting Reform and Investor Protection Act" (in the Senate) and "Corporate and Auditing Accountability, Responsibility, and Transparency Act" (in the House) and more commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law that set new or expanded requirements for all U.S. public company boards, management and public accounting firms.

The Enron scandal was certainly enough to show the American public and its representatives in Congress that new compliance standards for public accounting and auditing were needed. Enron was one of the biggest and, it was thought, one of the most financially sound companies in the U.S.

Enron, located in Houston, TX, was considered one of a new breed of American companies that participated in a variety of ventures related to energy. It bought and sold gas and oil futures. It built oil refineries and power plants.

The various misdeeds and crimes committed by Enron were extensive and ongoing. Particularly damaging misrepresentations pumped up earnings reports to shareholders, many of whom eventually suffered devastating losses when the company failed. But there were many other instances of dishonesty and fraud, including actual embezzlement of corporate funds by Enron executives and illegal manipulations of the energy market.

There was a wave of corporate accounting scandals between 2000 and 2005, with the lion's share occurring in 2002. The most well-known were arguably those involving Enron and WorldCom, but several less-publicized scandals implicated companies like Duke Energy, Homestore.com, and Peregrine Systems. Almost all the scandals involved accusations of so-called “creative accounting,” or complex methods of misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets, or underreporting liabilities. Several involved accusations of securities fraud. Congress passed the Sarbanes-Oxley Act of 2002 (P.L. 107-204) in reaction primarily to the Enron scandal. The act called for the creation of the Public Company Accounting Oversight Board, a private-sector, non-profit corporation to oversee auditors of publicly traded companies “in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.” It vests the board with four main responsibilities: (1) registering accounting firms that audit public companies trading in U.S. securities markets; (2) inspecting registered accounting firms; (3) establishing standards for auditing, quality control, ethics, and independence for registered accounting firms; and (4) investigating and disciplining registered accounting firms, and people associated with them, for violations of law or professional standards.