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Sarbanes-Oxley-2018-19.ppt

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Corporate Governance

Seminar 4 – Sarbanes-Oxley Act 2002

Why Sarbanes-Oxley?

Response to Enron, WorldCom and other corporate scandals

Seminar 4 - Sarbanes-Oxley Act

What does it do?

New rules on:
Corporate governance
Disclosure
Audit
Conflicts of interest

Seminar 4 - Sarbanes-Oxley Act

Who does it affect?

Issuers (companies)
Directors
Officers (e.g. CEO, CFO)
Employees
Attorneys
Auditors
Investment banks and analysts

Seminar 4 - Sarbanes-Oxley Act

What else?

New federal crimes
Increased penalties for some existing crimes
Studies to be conducted by SEC with a view to possible future legislation/regulation on
Credit rating agencies
SEC enforcement
Investment banks
Consolidation of accounting firms

Seminar 4 - Sarbanes-Oxley Act

Implications for issuers (1)

Enhanced requirements on disclosure
Material changes to financial condition or operations to be reported on a rapid and current basis
Internal control report to be included in annual report
Financial information must be reconciled to GAAP
Financial information must reflect any material adjustment

Seminar 4 - Sarbanes-Oxley Act

Implications for issuers (2)

Corporate Governance
Audit committee
All members must be independent
Enhanced powers
Delisting for failure to comply
Ethics
Improper influence on audits prohibited
Code of ethics for CFO to be adopted

Seminar 4 - Sarbanes-Oxley Act

Implications for issuers (3)

Enhanced SEC review and enforcement, for example:
Periodic reports to be reviewed at least every 3 years
Power to freeze extraordinary payments by an issuer under investigation

Seminar 4 - Sarbanes-Oxley Act

Implications for Directors and Officers (1)

Certification of periodic reports by CEO/CFO
Involving criminal penalties
Full compliance with relevant law
Fair presentation of financial condition and operation
Penalties:
$1million or 10 years or both for certification knowing that it does not comply
$5million or 20 years or both for willful certification knowing that it does not comply

Seminar 4 - Sarbanes-Oxley Act

Implications for Directors and Officers (2)

Certification of periodic reports by CEO/CFO
Involving civil penalties
That officer has reviewed report
No untruth or omission re material fact based on officer’s knowledge
Stringent requirements re internal control
Disclosure of problems to auditor and audit committee
Any changes potentially affecting internal control after date of evaluation

Seminar 4 - Sarbanes-Oxley Act

Implications for Directors and Officers (3)

Repayment of bonuses, etc.
In event of accounting restatement being required (whether personally involved in misconduct or not)
Bonuses, other incentives or equity-based compensation from previous 12 months
Whether involved in misconduct or not

Seminar 4 - Sarbanes-Oxley Act

Implications for Directors and Officers (4)

Personal loans to directors and executive officers prohibited
Reporting of share transactions speeded up (within 2 business days—previously within 10 days of end of month)
NB these reports must be filed electronically and appear on issuer website to assist transparency

Seminar 4 - Sarbanes-Oxley Act

Implications for Employees

Protection for whistleblowers
i.e. for those dismissed for disclosing breach of various federal laws, especially relating to fraud
Any person who knowingly dismisses whistleblower as retaliation is subject to criminal penalties (fine or up to 10 years prison or both)

Seminar 4 - Sarbanes-Oxley Act

Implications for Attorneys

Must report evidence of breach of securities law or fiduciary duty or similar violation to issuer’s Chief Legal Counsel or CEO
If they fail to respond appropriately, must report to Audit Committee or other independent committee or to the Board itself

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (1)

Public Company Accounting Oversight Board
Replaces existing self-regulatory approach
Functions
Register public accounting firms
Establish standards for preparing audit reports
Inspect public accounting firms
Investigation and discipline of firms
Enforce compliance
Subject to SEC oversight and control
Rules must be approved by SEC

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (2)

Registration with the PCAOB
Mandatory
Includes consent to cooperate with the Board in any investigation
Significant additional disclosure requirements

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (3)

PCAOB to develop standards on:
Auditing
Quality control
Ethics
Independence
PCAOB has broad discretion, but Act sets some minimum requirements, for example
Retention of documents for at least 7 years
Second partner must review audit
Report on scope of testing, evaluation of internal control, description of weaknesses or non-compliance

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (4)

Inspection of firms by PCAOB
Annually if audit >100 issuers
Less frequently if <100 issuers
Results public (with exceptions)
Investigation at PCAOB’s discretion
May pass results to regulators
May impose sanctions itself that it deems appropriate

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (5)

Foreign firms
SEC previously held that foreign firms auditing US listed issuers subject to its jurisdiction
Sarbanes-Oxley confirms this stance
Such firms must register with Board and submit to its oversight

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (6)

Independence: services prohibited if contemporaneous with audit, including
Book-keeping
Financial information systems design
Actuarial services
Management or human resources services
Investment services
Legal and other expert services (if not related to audit)
Others permitted if pre-approved by audit committee and disclosed

Seminar 4 - Sarbanes-Oxley Act

Implications for Auditors (7)

Rotation of audit partner (lead and review)
After 5 consecutive years
Auditor reports direct to audit committee
Including alternative treatments under GAAP and their consequences and auditor’s preference
No audit during cooling-off period
That is, where CEO, CFO or CAO worked for auditor on issuer’s audit during previous 12 months
Criminal penalties for knowing and willful failure to retain working papers for 5 years

Seminar 4 - Sarbanes-Oxley Act

Implications for Investment Banks and Analysts

Rules to deal with conflicts of interest between investment banks and analysts, for example
To prevent retaliation against analyst for negative report which could damage existing or potential investment banking relationship
To prevent publication of reports while bank is involved in public offering
To ensure disclosure of conflicts of interest

Seminar 4 - Sarbanes-Oxley Act

New Federal Crimes and Penalties

Destruction of Records in Federal Investigations and Criminal Proceedings
Securities Fraud involving a Public Company
Any such penalties, damages, etc. are not discharged by bankruptcy
Increased penalties for mail and wire fraud
Increased penalties for willful violations of the Securities Exchange Act

Seminar 4 - Sarbanes-Oxley Act

But does it work?

What do the critics say about Sarbanes-Oxley?
Does the rules-based approach solve the problems we identified in the previous seminar with the UK’s principles-based approach?

Seminar 4 - Sarbanes-Oxley Act