Sarbanes-Oxley Act of 2002
W. Bush signed the Sarbanes-Oxley Act of 2002 (Public Law 107-204)
on Tuesday, July 30, 2002. Congress presented the act to the president
on July 26, 2002, after passage in the Senate by a 99-0 vote and
in the House by a 423-3 margin.
the law will directly impact the following groups:
- CPAs and
CPA firms auditing public companies;
traded companies, their employees, officers, and owners—including
holders of more than 10 percent of the outstanding common shares.
This category would include CPAs employed by publicly traded companies
as chief financial officers (CFOs) or in the finance department;
who work for or have as clients publicly traded companies; and
dealers, investment bankers and financial analysts who work for
Company Accounting Oversight Board (PCAOB)
- The law
establishes a five-member accounting oversight board that is subject
to Securities and Exchange Commission (SEC) oversight.
- Though the
board oversees accounting firms, only two members of the board
may be CPAs.
- The SEC
will appoint the board.
- Duties of
the board include registering public accounting firms that prepare
audit reports; and establishing or adopting auditing, quality
control, ethics and independence standards.
- The board
also inspects, investigates and disciplines public accounting
firms and enforces compliance with the act.
With the Board Is Mandatory. For public accounting firms,
foreign or domestic, that participate in the preparation or issuance
of any audit report with respect to a public company. Registration
and annual fees collected from each registered CPA firm will go
towards the costs of processing and reviewing applications and
Record Retention Requirement. PCAOB must adopt a rule to require
registered CPA firms to prepare and maintain audit work papers
and other information related to an audit for at least seven years
in sufficient detail to support the conclusions reached in the
audit report. (A separate criminal provision requires retention
of all audit and review workpapers for five years from the end
of the fiscal year in which the audit or review was completed.)
with CPA Groups. The board will cooperate with professional
accountant groups and advisory groups to increase the effectiveness
of the standards setting process. (The PCAOB may cooperate, but
authority to set standards rests with the PCAOB, subject to SEC
Inspections. Inspection of registered public accounting firms
shall occur annually for every registered public accounting firm
that regularly provides audit reports for more than 100 issuers
(at least once every three years for registered firms that audit
fewer than 100 issuers).
The board may investigate any act, omission or practice by
a registered firm or an individual associated with a registered
firm for any possible violation of the act, the board’s
rules, professional standards, or provisions of the securities
laws relating to the preparation and issuance of audit reports.
(a) The board may require testimony or documents and information
(including audit work papers) from a registered firm or individual
associated with a registered firm or in the possession of any
for violations that the board finds may include:
(a) Suspension or revocation of a registration;
(b) Suspension or bar of a person from further associating with
any registered public accounting firm;
(c) Limitations on the activities of a firm or person associated
with the firm; and
(d) Penalize the firm up to $2 million per violation, up to a
maximum of $15 million.
(e) Individuals employed or associated with a registered firm
who violate the act can face penalties that range from required
additional continuing professional education (CPE) or training,
disbarment of the individual from further association with any
registered public accounting firm, or even a fine up to $100,00
for each violation, up to a maximum of $750,000.
(1) A portion of the penalties collected will go to accounting
The law also provides independent funding for the Financial Accounting
Standards Board (FASB). While the SEC and American Institute of
CPAs (AICPA) both have recognized FASB as the standard setting
body for accounting principles, federal authority to issue auditing,
quality control, ethics and independence standards may seriously
impact the AICPAs’ role in official pronouncements.
The budget for the board and FASB will be payable from “annual
accounting support fees” set by the board and approved
by the Commission. The fees will be collected from publicly
traded companies and will be determined by dividing the average
monthly equity market capitalization of the company for the
preceding fiscal year by the average monthly equity market
capitalization of all such companies for that year.
for CPA Firms
Consulting Banned for Audit Clients. Title II of the act prohibits
most “consulting” services outside the scope of practice
(a) These services are prohibited even if pre-approved by the
issuer’s audit committee.
(b) Prohibited services include:
- Bookkeeping and related services,
- Design and implementation of financial information systems,
- Appraisal or valuation services (including fairness opinions
and contribution-in-kind reports),
- Actuarial services,
- Internal audit outsourcing,
- Services that provide any management or human resources,
- Investment or broker/dealer services, and
- Legal and “expert services unrelated to the audit.”
- Any other service that the board determines, by regulation,
(c) Services Not Prohibited. Firms, however, may provide
tax services or others that are not listed, provided the firm
receives pre-approval from the board. However, certain tax planning
products, like tax avoidance services, may be considered prohibited
Reports Require Concurring Partner Review. Requires a concurring
or second partner’s review and approval of all audit reports
and their issuance.
Door” Employment of CPAs with Audit Clients Is Banned.
A registered CPA firm is prohibited from auditing any SEC registered
client whose chief executive, CFO, controller or equivalent was
on the audit team of the firm within the past year.
Partner Rotation Required. Audit partners who either have
performed audit services or been responsible for reviewing the
audit of a particular client must be rotated every five consecutive
years. CPAs should read carefully the requirements for rotation
of both the partner-in-charge and the concurring review partner
for certain organizational constraints.
(a) No Firm Rotation Requirement. Firm rotation is not
required. However, the U.S. Comptroller General will study and
review the potential effects of mandatory rotation and will report
its findings to the Senate Committee on Banking, Housing, and
Urban Affairs and the House Committee on Financial Services.
- CPA Firms
Are Required to Report Directly to the Audit Committee.
- CPA Firm
Consolidations to Be Studied. The U.S. Comptroller General
will conduct a study analyzing the impact of the merger of CPA
firms to determine if consolidation leads to higher costs, lower
quality of services, impairment of auditor independence, or lack
and Criminal Fraud Accountability. Changes to the securities
laws can penalize anyone found to have destroyed, altered, hid
or falsified records or documents to impede, obstruct or influence
an investigation conducted by any federal agency, or in bankruptcy,
with fines or up to 20 years imprisonment, or both.
Requirements for Audit Firms. Accountants are required to
maintain all audit or review workpapers for a period of five years
from the end of the fiscal period in which the audit or review
Rules. The law requires the SEC to promulgate rules and regulations
on the retention of any and all materials related to an audit,
including communications, correspondence and other documents created,
sent or received in connection with an audit or review.
(a) Penalties. For violating the requirement or the rules
that will be developed will result in a fine, or up to 10 years
imprisonment, or both.
Of Note to
Industry Members—Requirements for Corporations, Their Officers
and Board Members
- No Lying
to the Auditor. The act makes unlawful for an officer or director
or anyone acting for a principal to take any action to fraudulently
influence, coerce, manipulate or mislead the auditing CPA firm.
of Ethics for Financial Officers. The SEC is mandated to issue
rules adopting a code of ethics for senior financial officers.
Expert Requirement. The SEC is required to issue rules requiring
a publicly traded company’s audit committee to be comprised
of at least one member who is a financial expert.
Committee Responsible for Public Accounting Firm. The act
vests the audit committee of a publicly traded company with responsibility
for the appointment, compensation and oversight of any registered
public accounting firm employed to perform audit services.
Committee Independence. Requires audit committee members to
be members of the board of directors of the company, and to otherwise
& CFOs Required to Affirm Financials. Chief executive
officers (CEOs) and CFOs must certify in every annual report that
they have reviewed the report and that it does not contain untrue
statements or omissions of material facts.
(a) Penalty for Violation. If material noncompliance causes
the company to restate its financials, the CEO and CFO forfeit
any bonuses and other incentives received during the 12-month
period following the first filing of the erroneous financials.
& CFOs Must Enact Internal Controls. CEOs and CFOs will
be responsible for establishing and maintaining internal controls
to ensure they are notified of material information.
for Fraud. The act also has stiffened penalties for corporate
and criminal fraud by company insiders. The law makes it a crime
to destroy, alter or falsify records in a federal investigation
or if a company declares bankruptcy. The penalty for those found
guilty includes fines, or up to 20 years imprisonment, or both.
Affected by the Act. Publicly traded companies affected by
the act are those defined as an “issuer” under Section
3 of the Securities Exchange Act of 1934, whose securities are
registered under Section 12 of the 1934 Act. An issuer also is
considered a company that is required to file reports under Section
15(d) of the act, or that files or has filed a registration statement
that has not yet become effective under the Securities Act of
1933. The SEC has yet to provide further guidance as to entities
covered by the act.
Not Dischargeable in Bankruptcy. Amends federal bankruptcy
law to make non-dischargeable in bankruptcy certain debts that
result from a violation relating to federal or state securities
law, or of common law fraud pertaining to securities sales or
Statute of Limitations for Securities Fraud. For a civil action
brought by a non-government entity or individual, an action involving
a claim of securities fraud, deceit or manipulation may be brought
not later than the earlier of two years after discovery or five
years after the violation.
- No Listing
on National Exchanges for Violators. The SEC will direct national
securities exchanges and associations to prohibit the listing
of securities of a noncompliant company.
- No Insider
Trading. No insider trading is permitted during pension fund
blackout periods. The insider must forfeit any profit during this
period to the company.
- SEC Rules
on Enhanced Financial Disclosures.
(a) Off-Balance Sheet Transactions: All quarterly and annual
financial reports filed with the SEC must disclose all material
off-balance sheet transactions, arrangements, obligations (including
contingent obligations), and other relationships of the issuer
with unconsolidated entities.
(b) Pro Forma Figures: Pro forma financial information
in any report filed with the SEC or in any public release cannot
contain false or misleading statements or omit material fact necessary
to make the financial information not misleading.
- No Personal
Loans. No personal loans or extensions of credit to company
executives either directly or though a subsidiary, except for
certain extensions of credit under an open-ended credit plan or
charge card, home improvement and manufactured home loans, or
extensions of credit by a broker or dealer to its employee to
buy, trade or carry securities.
(a) The terms of permitted loans cannot be more favorable than
those offered to the general public.
Criminal Penalties Enhanced*
destruction, concealment of any records with the intent of obstructing
a federal investigation.
and/or up to 10 years imprisonment.
to maintain audit or review “workpapers” for at
least five years.
Fine and/or up to 5 years imprisonment.
who “knowingly executes, or attempts to execute, a scheme”
to defraud a purchaser of securities.
and/or up to 10 years imprisonment.
CEO or CFO who “recklessly” violates his or her
certification of the company’s financial statements.
of up to $1,000,000 and/or up tp 10 years imprisonment.
up to $5 million and/or up to 20 years imprisonment.
more persons who conspire to commit any offense against or to
defraud the U.S. or its agencies.
and/or up to 10 years imprisonment.
who “corruptly” alters, destroys, conceals, etc.,
any records or documents with the intent of impairing the integrity
of the record or document for use in an official proceeding.
and/or up to 20 years imprisonment.
and wire fraud.
applicable Employee Retirement Income Security Act (ERISA)
Increase from 5 to 20 years imprisonment.
lengths depending on violation.
* Source: Sarbanes-Oxley
Act of 2002 and New York City Office of the Comptroller.
- No Retaliation
Against Analysts. Brokers and dealers of securities are not
allowed to retaliate or threaten to retaliate against an analyst
employed by the broker or dealer as a result of an adverse, negative
or unfavorable research report on a public company.
of Interest Disclosures. Securities analysts and brokers or
dealers are required to disclose conflicts of interest, such as:
(a) Whether the analyst has investments or debt in the company
it is reporting on;
(b) Whether any compensation received by the broker, dealer or
analyst is “appropriate in the public interest and consistent
with the protection of investors;”
(c) Whether an issuer has been a client of the broker or dealer;
(d) Whether the analyst received compensation with respect to
a research report based on investment banking revenues.
on Attorneys to Report Violations. The SEC is required to
issue rules setting forth minimum standards of professional conduct
for attorneys appearing and representing a public company in any
manner in front of the Commission. As part of this requirement,
the SEC will be required to issue rules on the following:
(a) Requiring attorneys employed by a public company to report
to the chief counsel or CEO of the company, evidence of a “material”
violation of securities law, breach of fiduciary duty, or similar
violation by the company or its agent.
(b) Once reported, if the counsel or CEO does not appropriately
respond to the evidence, the attorney must report the evidence
to the board of directors or its audit committee.