week 1 discussion 2

Ethics Evolution in the Era of Sarbanes- Oxley Winter 2012

By Ibolya Balog, CPA

The approaching 10th anniversary of the Sarbanes-Oxley Act of 2002 is an opportune time to review the changes in corporate governance over the past decade. The enactment of this legislation, following several highly publicized fraud scandals, had been the most significant legislation affecting public companies since the securities acts of the 1930s.1 Corporate governance covers an array of distinct concepts, according to the definition adopted by the Organization of Economic Cooperation and Development (OECD). It says, “Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions in corporate affairs.” Sarbanes-Oxley defined new rules pertaining to various aspects of governance reflected in this definition, as well as created the Public Company Accounting Oversight Board and specified auditor independence requirements. Sarbanes-Oxley Section 406 – and the Securities and Exchange Commission’s (SEC) final rule on the implementation of this section – requires SEC registrants to report whether they have adopted a written code of ethics covering principal executive officers, financial officers, accounting officers, and controllers, or individuals performing such functions. Amendments to the code of ethics covering the responsible individuals and waivers, if any, must be promptly disclosed. The purpose of a written code of ethics is twofold: to deter wrongdoing and to promote ethical conduct. The code of ethics has to provide a means of dealing with actual or apparent conflicts of interest; ensuring compliance with applicable laws, rules, and regulations; prompting internal reporting of violations of the code; filing timely and accurate disclosures with the SEC; and addressing accountability for adherence to the code. The New York Stock Exchange and NASDAQ listing standards have similar, but broader, requirements, with expanded coverage to employees beyond those involved in financial reporting responsibilities. Oversight and management of ethics and compliance programs are responsibilities of executives and boards of directors. Frequently it is the audit committee that is involved in overseeing ethics and compliance on behalf of the board, and it works with management to ensure that the adopted code of ethics meets the requirements. Adopting a code of ethics, however, is not the end of the process. Creating an ethical culture within the corporation requires clear communications and recurrent training. A good policy may also require that all board members comply with the organization’s code of ethics. Oversight will involve ongoing monitoring and assessing of the effectiveness of the ethics program.

Sarbanes-Oxley Section 301 set up a requirement that audit committees of listed companies must implement processes for receiving, retaining, and addressing complaints pertaining to accounting, internal control, or auditing matters. Also included would be violations of the code of ethics or conduct from internal or external sources. Providing a telephone hotline for communicating concerns or tips has become the predominant way to address Section 301 requirements. The existence of a well-defined and effective internal investigation and complaint resolution system is even more important in view of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Dodd-Frank Section 922 gave the SEC enhanced authority to extend whistleblower rewards to any securities law violations. On May 25, 2011, the SEC approved final rules for implementing the whistleblower provisions. The SEC rules provide for rewards of 10 to 30 percent of monetary sanctions for whistleblowers who voluntarily report to the SEC original information leading to securities law enforcement actions that recover more than $1 million. Companies and boards of directors will be well-advised to take a proactive approach to maintaining awareness of the internal reporting process and whistleblower protections and to encouraging the use of established procedures. Exploring the enhancement of internal whistleblowing systems presents an opportunity for improving governance and oversight functions. The lingering effects of the financial crisis of 2008-2009 have affected corporate revenues, and difficult economic conditions exert additional pressures on performance expectations. Maintaining a culture that emphasizes ethics and compliance is challenging, but it is the means to fulfilling sustainable long-term enhancement of shareholder value.

1 John Bostelman et al., Public Company Deskbook (2009) Ibolya Balog, CPA, is an assistant professor in the department of business, management, and economics at Cedar Crest College in Allentown, and a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at [email protected].

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