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The Sarbanes-Oxley Act of 2002

Status

President George 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.

As enacted, the law will directly impact the following groups:

  • CPAs and CPA firms auditing public companies;
  • Publicly 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;
  • Attorneys who work for or have as clients publicly traded companies; and
  • Brokers, dealers, investment bankers and financial analysts who work for these companies.

Specifics

New Public 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.
  • Registration 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 annual reports.
  • Seven-Year 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.)
  • Cooperation 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 review.)
  • Annual 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).
  • Investigations. 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 other person.
  • Sanctions 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 scholarships.
  • Funding. 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.

    (a) Source. 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.

Other Requirements for CPA Firms

  • Most Consulting Banned for Audit Clients. Title II of the act prohibits most “consulting” services outside the scope of practice of auditors.
    (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, is impermissible.
    (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 nonaudit services.
  • Audit Reports Require Concurring Partner Review. Requires a concurring or second partner’s review and approval of all audit reports and their issuance.
  • “Revolving 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.
  • Audit 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 of choice.
  • Corporate 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.
  • Current 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 was concluded.
  • Additional 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.
  • Code of Ethics for Financial Officers. The SEC is mandated to issue rules adopting a code of ethics for senior financial officers.
  • Financial 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.
  • Audit 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.
  • Audit Committee Independence. Requires audit committee members to be members of the board of directors of the company, and to otherwise be independent.
  • CEOs & 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.
  • CEOs & 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.
  • Penalties 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.
  • Companies 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.
  • Debts 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 purchases.
  • Expanded 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*

BEHAVIOR
SENTENCE
The alteration, destruction, concealment of any records with the intent of obstructing a federal investigation. Fine and/or up to 10 years imprisonment.
Failure to maintain audit or review “workpapers” for at least five years. Fine and/or up to 5 years imprisonment.
Anyone who “knowingly executes, or attempts to execute, a scheme” to defraud a purchaser of securities. Fine and/or up to 10 years imprisonment.

Any CEO or CFO who “recklessly” violates his or her certification of the company’s financial statements.

If “willfully” violates.

Fine of up to $1,000,000  and/or up tp 10 years imprisonment.

Fine of up to $5 million and/or up to 20 years imprisonment.

Two or more persons who conspire to commit any offense against or to defraud the U.S. or its agencies. Fine and/or up to 10 years imprisonment.
Any person 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. Fine and/or up to 20 years imprisonment.

Mail and wire fraud.

Violating applicable Employee Retirement Income Security Act (ERISA) provisions.

Increase from 5 to 20 years imprisonment.

Various lengths depending on violation.

* Source: Sarbanes-Oxley Act of 2002 and New York City Office of the Comptroller.

Analyst Conflicts of Interest

  • 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.
  • Conflict 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; and
    (d) Whether the analyst received compensation with respect to a research report based on investment banking revenues.

Attorney Requirements

  • Requirement 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.


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