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Regulation Best Practice

Sarbanes–Oxley After Nearly 10 Years

by Curtis C. Verschoor

Executive Summary

  • The Enron and WorldCom frauds led to the US Congress to enact the Sarbanes–Oxley Act of 2002 (SOX), which covers public corporations and their independent auditors.

  • Before SOX, regulation of the auditing industry was largely carried out by the industry and by auditors themselves.

  • This chapter discusses the costs and benefits of the provisions set out in the 11 titles, or sections, of the Act.

  • On the whole, the legislation is viewed as having been successful. The most negative comments relate to the costs of compliance with Section 404(b), which requires the independent auditor to express an opinion on the client’s internal controls over financial reporting.

Introduction

Two massive financial statement frauds were uncovered within months of each other in 2001–02: Enron and WorldCom. They capped a string of similar earlier fraud cases and became the trigger for the US Congress to overwhelmingly pass in July 2002 the most far-reaching legislation affecting public corporations and their independent auditors since the 1930s. Reflecting the diversity of subject matter covered, the Sarbanes–Oxley Act of 2002 (SOX) was known as the Public Company Accounting Reform and Investor Protection Act in the US Senate and the Corporate and Auditing Accountability and Responsibility Act in the US House of Representatives. Some of the various titles of the Act also had additional descriptive names.

The many provisions of SOX apply to all companies that are publicly traded in markets in the United States regardless of their legal domicile or country of origin. Implementing various aspects of the legislation that affect companies headquartered in other countries has been slower than the progress in the United States. This has been particularly true in countries that have a less robust regulatory environment than that existing in the United States.

The main thrusts of SOX (as well as of this chapter) involve three areas:

  • a total revision of the regulatory framework for the public accounting and auditing profession;

  • assignment of new responsibilities to senior management of public companies and to their boards of directors, particularly the audit committee;

  • other miscellaneous provisions.

Perhaps independent auditors are the group that has been affected most significantly by SOX. Since auditing became a distinct occupation many hundreds of years ago, auditors have functioned largely as self-regulating professionals. Previous to SOX, important decisions—including setting the bar for entry into practice, promulgating the auditing standards auditors should use, determining the quality of performance in using those standards, and disciplining those who failed to practice properly in accordance with the standards—were tasks largely or exclusively performed by the auditing industry and auditors themselves.

Although sentiment for a total repeal or significant overhaul of at least some of the provisions of SOX has lingered for years, most unbiased observers believe that, on the whole, the legislation has been successful in most areas. The most negative commentary about SOX has arisen because of the costs of compliance with the provisions of Section 404(b), which requires a company’s independent auditor to express an opinion on the adequacy of their client’s internal controls over financial reporting. Another SOX provision that was designed to protect employee whistleblowers from retaliation in cases of financial fraud has not resulted in success.

The Act contains 11 titles, or sections, that set out specific mandates and requirements for financial reporting. The costs and benefits of the various provisions of SOX are discussed title by title more fully below.

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Further reading

Book:

  • Ramos, Michael J., and Linda C. Delahanty. Making Audits Pay: Leveraging the Audit into Consulting Services. American Institute of Certified Public Accountants (AICPA) Practice Aid Series. New York: AICPA, 1999.

Articles:

  • Goelzer, Daniel L. “PCAOB board issues report on inspection observations of auditing during the economic crisis.” Press release. September 29, 2010. Online at: tinyurl.com/8ywlqmm
  • Doty, James R. “Rethinking the relevance, credibility, and transparency of audits.” Speech at SEC and Financial Reporting Institute 30th Annual Conference, Pasadena, CA, June 2, 2011. Online at: tinyurl.com/3dns5eo
  • Nowland, John, and Andreas Simon. “The effect of a change in analyst composition on analyst forecast accuracy: Evidence from U.S. cross-listings.” Journal of International Accounting Research 9:1 (Spring 2010): 23–38. Online at: dx.doi.org/10.2308/jiar.2010.9.1.23

Reports:

  • Public Company Accounting Oversight Board (PCAOB). “Updated information on PCAOB international inspections.” June 30, 2011. Online at: tinyurl.com/7t9hqok
  • Securities and Exchange Commission (SEC). “Report pursuant to Section 308(c) of the Sarbanes Oxley Act of 2002.” January 2003a. Online at: www.sec.gov/news/studies/sox308creport.pdf
  • Securities and Exchange Commission (SEC). “Report on the role and function of credit rating agencies in the operation of the securities markets.” January 2003b. Online at: www.sec.gov/news/studies/credratingreport0103.pdf
  • Securities and Exchange Commission (SEC). “Study and recommendations on Section 404(b) of the Sarbanes-Oxley Act of 2002 for issuers with public float between $75 and $250 million.” April 2011a. Online at: www.sec.gov/news/studies/2011/404bfloat-study.pdf
  • Securities and Exchange Commission (SEC). “Work plan for the consideration of incorporating international financial reporting standards into the financial reporting system for U.S. issuers: Exploring a possible method of incorporation.” May 26, 2011b. Online at: tinyurl.com/3wkej8m [PDF].
  • Securities and Exchange Commission (SEC). “Report on review of reliance on credit ratings.” July 2011c. Online at: www.sec.gov/news/studies/2011/939astudy.pdf
  • Securities and Exchange Commission (SEC). “2011 summary report of Commission staff’s examinations of each nationally recognized statistical rating organization.” September 2011d. Online at: tinyurl.com/7e3f2y2 [PDF].
  • Securities and Exchange Commission (SEC). “Work plan for the consideration of incorporating international financial reporting standards into the financial reporting system for US issuers: An analysis of IFRS in practice.” November 16, 2011c. Online at: tinyurl.com/7s3k477 [PDF].
  • US Government. “H. R. 4173: Dodd-Frank Wall Street reform and consumer protection act.” 2010. Online at: tinyurl.com/7nhkvgq [PDF].

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