Sarbanes Oxley Act (2002)

1. Sarbanes Oxley Act (2002) A brief summary

2. What is Sarbanes-Oxley? • Legislation intended to restore the public’s confidence in investing and the securities markets. • Also known as Public Company Accounting Reform and Investor Protection Act of 2002 • President Bush: “The most far-reaching reforms of American business practices since the time of FDR."

3. What drove the need for Sarbanes-Oxley? • Enron, Tyco, WorldCom scandals • Falling share prices • Internet bubble burst • Board conflicts of interest exposed • Auditor conflicts of interest exposed • Analysts/Investment Banker conflicts of interest exposed • Faulty commercial bank lending practices exposed • Excessive executive compensation schemes led to managing earnings at expense of stockholders and employees • Need to re-build public confidence by strengthening accounting controls and reducing/eliminating perceived and actual conflicts of interest.

4. Whom does SOX affect? • Boards of Directors • Auditors and CPA Firms • Analysts • SEC • Top Management (CEOs, CFOs, etc.) • Investors • Credit Rating Agencies

5. How is SOX organized? • 11 Titles • Several Sections per Title • Key Sections are: 302, 401, 404, 409, 802 and 906 • Enforceable under the Securities Exchange Act of 1934. • Auditors register with “the Board”

6. Title I - Public Company Accounting Oversight Board (PCAOB) • PCAOB provides independent oversight of public accounting firms providing audit services. • Not an “arm” of the SEC, but under SEC supervision • Defines specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with SOX mandates.

7. Title II - Auditor Independence • Establishes standards for external auditor independence to limit conflicts of interest • Addresses new auditor approval requirements • Addresses audit partner rotation policy • * Restricts auditing companies from doing non-audit business (i.e. consulting) with audit clients.

8. Title III - Corporate Responsibility • Senior executives take individual responsibility for the accuracy and completeness of corporate financial reports • Defines the interaction of external auditors and corporate audit committees • Limits behaviors of corporate officers • Describes specific forfeitures of benefits and civil penalties for non-compliance • Section 302: CEO and CFO should certify and approve the integrity of their quarterly company financial reports

9. Title IV - Enhanced Financial Disclosures • enhanced reporting requirements for off-balance sheet transactions, pro-forma figures and stock transactions of corporate officers • requires internal controls for assuring the accuracy of financial reports and disclosures • requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports

10. Title V - Analyst Conflicts of InterestTitle VI - Commission Resources and Authority • defines practices to restore investor confidence in securities analysts • defines the codes of conduct for securities analysts • requires disclosure of knowable conflicts of interest • defines conditions under which a person can be barred from practicing as a broker, adviser or dealer

11. Title VII - Studies and Reports • Outlines processes for conducting research for enforcing actions against violations by the SEC registrants (companies) and auditors • Specific studies outlined: • the effects of consolidation of public accounting firms • the role of credit rating agencies in the operation of securities markets • securities violations and enforcement actions • whether investment banks assisted Enron and others in manipulating earnings and obfuscating true financial conditions

12. Title VIII - Corporate and Criminal Fraud Accountability • Corporate and Criminal Fraud Act of 2002 • describes specific criminal penalties for fraud by manipulation, destruction or alteration of financial records or other interference with investigations • “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.” • provides certain protections for whistle-blowers • Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offence, shall be fined under this title, imprisoned not more than 10 years, or both.

13. Title IX - White Collar Crime Penalty Enhancement • White Collar Crime Penalty Enhancement Act of 2002 • increases criminal penalties associated with white-collar crimes and conspiracies • recommends stronger sentencing guidelines • * failure to certify corporate financial reports is a criminal offense

14. Title X - Corporate Tax Returns • CEO should sign the company tax return • Meant to reduce tax fraud/evasion and provide check on financial reporting

15. Title XI - Corporate Fraud Accountability • Corporate Fraud Accountability Act of 2002 • corporate fraud and records tampering are criminal offenses • revises sentencing guidelines and strengthens penalties for these offenses (i.e. large payment freezes)

16. Is SOX working? PROs • Institute of Internal Auditors (IIA): corporations have improved their internal controls and financial statements are perceived to be more reliable. • Skaife/Collins/Kinney/Lefond research: borrowing costs are lower for companies that improved their internal control, by between 50 and 150 basis points • Iliev research: SOX 404 indeed led to more conservative reported earnings, but also reduced stock valuations of small firms. • The Lord & Benoit research: SOX disproportionately benefitted companies whose accounting was originally more conservative/less suspect. Did not help pre-SOX “suspect” companies. • S&P 500 index increased 6% the day the law passed in Congress

17. Is SOX working? CONs • Stock market still in a slump • FEI Survey: 78% surveyed say costs have exceeded benefits • Who’s paying for SOX? • De-Listing (to UK, etc.) – Wharton: # of American companies deregistering from public stock exchanges nearly tripled in year after SOX became law • SOX 404 is killing smaller companies: disproportionate costs • Ron Paul: “SOX was an unnecessary and costly government intrusion into corporate management that places U.S. corporations at a competitive disadvantage with foreign firms.”

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