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Corporate Reform Current Status and Future Implications

Corporate Reform Current Status and Future Implications. REALTORS ® Treasurer’s Forum November 9, 2002 Brian Ofenloch, Partner Ernst & Young, LLP. Overview. Impetus for Change The Sarbanes-Oxley Act of 2002 Implications to Treasurers.

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Corporate Reform Current Status and Future Implications

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  1. Corporate Reform Current Status and Future Implications REALTORS® Treasurer’s Forum November 9, 2002 Brian Ofenloch, Partner Ernst & Young, LLP

  2. Overview • Impetus for Change • The Sarbanes-Oxley Act of 2002 • Implications to Treasurers

  3. Vivendi Universal, the world's second-biggest media company, posted a first-half loss of 12.3 billion euros after slashing the value of assets bought by ousted chief executive Jean-Marie Messier Former Tyco chief executive L. Dennis Kozlowksi arrives for bail hearing state Supreme Court in NY John Rigas, founder Adelphia Communications, arrested in July  WorldCom’s former chief executive Bernard Ebbers reportedly near financial ruin Martha Stewart and Peter Bacanovic, a Merrill Lynch broker, who was suspended by the brokerage firm Global Crossing Chairman Garry Winnick testifies on Capitol Hill New York Attorney General Eliot Spitzer investigates brokerage houses Bad news for the economy…

  4. Accounting profession criticized…

  5. The collapse of Enron sparked considerable debate about the reforms necessary to restore confidence in the financial reporting system

  6. With the continued revelations of fraud and corporate abuse – punctuated by the accounting irregularities and bankruptcy of Worldcom – the pace of legislative action accelerated dramatically

  7. “No CEO would be stupid enough to falsely certify their books”US Treasury Secretary Paul O'Neill Corporate reform signed into law…

  8. Across Corporate America, a governance revolution is under way…

  9. The Corporate Reform InitiativeSarbanes-Oxley Act of 2002 Technically applies to public companies only – but will raise the bar for accountants, treasurers and management of all entities.

  10. The Basics • The Sarbanes-Oxley Act was signed into law July 30, 2002 • Purpose is to restore investor confidence in public financial reporting • Passed resoundingly in both the House of Representatives and the Senate • Overhauls corporate fraud, securities and accounting laws, and established new standards for prosecuting wrongdoing • Many elements of the Act are dependent upon the establishment of new Public Company Accounting Oversight Board and SEC Rulemaking

  11. May not extend credit to directors or corporate officers, with certain specified exceptions Must make “real time” disclosures concerning material changes in the financial condition or operations of the issuer Must include in 10-K an internal control report stating management’s responsibility for adequate internal controls Must disclose all material off-balance sheet transactions Must reconcile pro forma information with GAAP and not omit information that makes financial disclosures misleading May not engage its auditor for nine specifically prohibited non-audit services Must disclose pre-approvals of non-audit services Accelerates Exchange Act Section 16 reporting of securities transactions by corporate “insiders” Must disclose whether they have adopted codes of ethics for their senior financial officers New “whistleblower” protections for employees Enhanced penalties for securities law violations New Public Company Accounting Oversight Board (“Board”) to an issuer Must wait one year before hiring an audit engagement team member to be CEO, CFO, CAO or equivalent Key Provisions for Issuers

  12. Two separate CEO/CFO certification requirements: A criminal provision requiring certification in each filed periodic report containing financial statements stating that the report (i) “fully complies” with Exchange Act requirements (no materiality qualifier); and (ii) “fairly presents, in all material respects, the financial condition and results of operations of the issuer,” and A civil provision requiring officer certification that (i) the financial statements and other financial information “fairly present in all material respects” the company’s financial condition; and (ii) the officer accepts responsibility for and makes several other representations regarding internal controls. Officers, directors, and others may not “fraudulently influence, coerce, manipulate or mislead” their auditors CEO and CFO must disgorge certain bonuses and profits from securities sales after restatements due to misconduct SEC can bar “unfit” officers and directors Officers and directors are prohibited from trading during pension “blackout” period SEC has authority to temporarily freeze the pay of corporate officers Key Provisions for Issuers (Specifically Related to Corporate Boards of Directors and Officers)

  13. Must be directly responsible for auditor appointment, compensation, and oversight Must be given authority and funds to engage advisers as needed Members must be independent of the issuer Issuer must have a “financial expert” on the committee (or issuer must disclose reasons for lack of expert) Must establish complaint procedures regarding accounting and auditing matters Must receive reports from the auditor on alternative accounting treatments Must pre-approve all audit and non-audit services Can delegate non-audit service pre-approval authority to a single member Key Provisions for Issuers (Specifically Related to Audit Committees)

  14. Register, pay fees, and submit periodic reports to the new Public Company Accounting Oversight Board (“Board”) with SEC oversight Comply and cooperate with the Board’s standards, quality control inspections, investigations, and disciplinary process Be subject to Board sanctions, including fines, censures, suspensions, or bars Rotate lead audit and review partners every five years Comply with a “cooling off” period before audit engagement team members canaccept certain positions with an audit client Attest to management’s assessment of internal controls in annual reports and present an “evaluation” of certain aspects of the internal control structure and procedures Obtain audit committee pre-approval for audit and permitted non-audit services Report to audit committees on alternative accounting treatments Key Provisions For Accounting Firms Note: These provisions are effective upon establishment of the Board and firm registration, or upon SEC rulemaking.

  15. Bookkeeping or other services related to the accounting records or financial statements of the audit client; Financial information systems design and implementation; Appraisal or valuation services, fairness opinions, or contribution-in-kind reports; Actuarial services; Internal audit outsourcing services; Management functions or human resources; Broker or dealer, investment adviser, or investment banking services; Legal services and expert services unrelated to the audit; and Any other service that the Public Company Accounting Oversight Board determines, by regulation, is impermissible. Non-Audit Services Prohibited Under the Act

  16. Thoughts on Implicationsof Corporate Reform

  17. Impact on Accounting Standards • Compliance with rules vs. economic substance • New and Anticipated Changes • Consolidation • Revenue and Expense recognition • Stock Compensation • Derivatives • Principle vs. Rule Based Standards • Fair Value based statements? • Convergence of U.S. GAAP and International Standards

  18. Common Reasons for Financial Statement Restatements • Revenue recognition • Expense recognition (capitalization, restructuring) • Consolidation (SPE’s) • Allowances/Asset impairments • Contingencies

  19. Focus on Internal Control • Process vs. Controls • Documentation of controls • Assignment of Responsibility • Supervision • Internal audit function

  20. Consider Risk of Fraud • Earnings management issues – budget to actual reviews • Aggressive accounting policies • Insufficient internal controls or segregation of duties • Significant, unusual, or highly complex transactions or innovative deals • Significant related party transactions not in the ordinary course of business

  21. Fiduciary Responsibilities • Ethics • TONE AT THE TOP • Conflicts of interest • Objectivity • Transparency of Disclosure & Communications • Renewed interest in accounting function

  22. Next Steps • Not business as usual • Significant change in next 6-18 months • Fiduciary responsibility increased dramatically • Challenge your own organizational practices • Align your policies and procedures with best practices

  23. Corporate Reform Current Status and Future Implications REALTORS® Treasurer’s Forum November 9, 2002 Brian Ofenloch, Partner Ernst & Young, LLP

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