Accounting Ethics

Ethical Guidance and Constraint Under

the Sarbanes-Oxley Act of 2002

RICHARD M. ORIN*

This article discusses two key features of the Sarbanes-Oxley Act, which was enacted in 2002 to restore integrity and public confidence to the fi- nancial markets. The law was passed in response to the horrendous cor- porate disasters that had occurred, including Enron, Worldcom, Adelphia, and Tyco. The implementation of effective business ethics became essential and the new law required the publication of corporate codes of ethics. It did not mandate their content. This paper suggests specific sections for inclusion in the general guidelines to encompass the ethical dimensions of the Act. It analyzes the compliance by the cor- porations in their public filings since Sarbanes-Oxley became law. The revelation of the size of the audit and accounting fees paid to Arthur Andersen by Enron and similar fees paid in other current financial debacles lead to another key requirement of Sarbanes-Oxley: mandatory auditor rotation. Here, however, Sarbanes-Oxley did not go far enough. The law required rotation only of the lead auditor within a firm. This paper submits that it should have required rotation of audit firms instead. The positions of the public companies, the American Institute of Certified Public Accountants, the Government Accountability Office, and accounting journals are explored as to the rotation of auditor firms regarding audit-partner rotation within a firm. The paper concludes that Sarbanes-Oxley should be expanded to require audit-firm rotation. This expansion is necessary to reinforce the independence of the public accountant, both in fact and appearance, and to restore competition within the accounting profession, which will benefit the investing public. It is up to the Security and Exchange Commission and the Public Com- pany Accounting Oversight Board and, ultimately, Congress to make this expansion a reality.

*University of Missouri–Columbia This article is dedicated to the memory of the Distinguished Professor of Law Emeritus at New

York University, Homer Kripke. He wrote that the newly adopted Generally Accepted Auditing Standards (GAAS) ‘‘impose a responsibility on the auditors with an attitude of professional skepti- cism to detect and report errors and irregularities leading to misleading financial statements, some- times called management fraud; and to report them to the audit committee’’ (Homer Kripke, ‘‘Reflections on the FASB’s Conceptual Framework for Accounting and on Auditing,’’ Journal of Accounting, Auditing & Finance, Winter 1989, p. 63). The author gratefully acknowledges the research assistance of Eric Weissmann, University of Rochester (2010).

141

Keywords: Accounting, Arthur Andersen, ethics education, corporate gover- nance, auditor rotation, audit-firm rotation, codes of ethics, Sarbanes-Oxley, auditing, Enron

Ethical virtue is acquired by habituation . . . for it is by our actions with other

men in transactions that we are in the process of becoming just or unjust. . . . ‘‘Just’’ means that which is lawful or that which is fair, while ‘‘unjust’’ means

that which is unlawful or that which is unfair.

—Aristotle selected works, translated by Apostle and Gerson (1991, p. 448, 473).

1. Introduction

Five years have passed since Congress enacted the Sarbanes-Oxley Act of 2002

(alternately, the ‘‘Act’’ or ‘‘Sarbanes-Oxley’’). The Act constituted a daring effort to

legislate morality, with the goal of restoring integrity to and public confidence in

the financial markets. Sarbanes-Oxley was a direct response to the corporate scan-

dals of Enron and WorldCom––immediately followed by Adelphia and Tyco, the

collapse of the once-venerated accounting firm of Arthur Andersen, and the mis-

treatment of employees and investors by flagrantly unethical business practices.

Sarbanes-Oxley contains a variety of provisions regarding business ethics.

The two that have particular potential to deter unethical business practices

and that accordingly are the principal focus of this article are, first, the require-

ment that corporations develop codes of ethics for senior financial officers that

include, among other things, enforcement mechanisms (Section 406) and, second,

the requirement that outside auditors be rotated on a regular basis (Sections 203

and 207).1 I find these requirements to be of greatest interest because, collec-

tively, they regulate corporations from both within and without.

The Code of Ethics requirement provides a blueprint for internal corporate

governance: one that formally delineates standards of acceptable conduct for all

of a corporation’s officers, directors, and employees, including its internal

accountants. The auditor rotation requirement is designed to have a similar effect

by ensuring that outside auditors are genuinely independent from—and therefore

free to criticize and question the business practices of—the corporations that they

are called upon to audit.2 These two requirements are directly responsive to some

of the principal ills that contributed to the scandals of the late 1990s: unethical

1. There are a number of other requirements in the Act pertaining to ethics, such as Section 303 (‘‘improper influence on conduct of audits’’); Section 306 (‘‘insider trades during pension fund blackout periods’’); and Section 307 (‘‘rules of professional responsibility for attorneys’’); but they are beyond the scope of this article. See Sarbanes-Oxley Act (2002).

2. The demise of Enron, and the rapid and related demise of its outside auditor, Arthur Ander- sen, stand as an unfortunate testament to how the integrity of both an auditor and the corporation that it is auditing can be compromised when the circumstances permit the independence of the auditor to be called into question.

142 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

corporate cultures, regulated by ‘‘gatekeepers’’ whose careers and finances were

so entwined with their accounts as to compromise, utterly, their professionalism,

independence, and objectivity.

Sarbanes-Oxley has no shortage of critics. Most of them focus heavily, if

not exclusively, on the out-of-pocket costs of compliance, which they posit is an

unfair burden for American businesses.3 Substantively, however, the general per-

ception is that the Act has made inroads against unethical practices (Nocera

[2005]).4 I would submit that the latter advantage is far more important, in the

long run, than the former disadvantage. Thus, as shown below, the principal the-

sis set forth in this article is that, while Sarbanes-Oxley has made favorable

inroads in the amorphous area of achieving a healthy corporate culture, at least

in part through its requirements regarding codes of ethics, its efforts to ensure

vigilant external oversight is a different situation entirely. In limiting the rotation

requirement to audit partners within an audit firm, rather than requiring the rota-

tion of the firm in its entirety, my view is that Sarbanes-Oxley does not go far

enough. For the reasons stated below, I believe that a much more effective

method of achieving this goal is to expand these provisions so that they mandate

audit-firm rotation, rather than simply the rotation of the lead, or engagement,

partner within a firm.

My positive impression of the salutary effect of the code of ethics require-

ment is based, in large measure, on a survey that I conducted of the information

that is publicly available about the codes of ethics of thirty-nine randomly

selected corporations. The results of this survey indicated satisfactory compliance

by the vast majority of these corporations with both the spirit and the letter of

Section 406. For example, 92 percent of the corporations in the survey had

adopted codes of ethics that not only satisfied the basic elements set by the

Sarbanes-Oxley Act, but also reflected that careful thought and attention was

consistently paid to the particular ethical conundrums of our times. Also, all of

the codes of ethics within the survey contained enforcement mechanisms and, in

particular, penalty provisions that appear to be strong enough to attract attention

from corporate insiders and thereby to deter unethical conduct or, alternatively,

ensure punishment of those who choose not to comply.

3. The principal criticism of the Act regards the cost of compliance for corporations. Typical of the criticism are the comments expressed by Stephen M. Bainbridge, a law professor at UCLA Law School, ‘‘They rushed this legislation through without any effort to figure out what it was going to cost. And the costs have been higher than anybody thought.’’ See Sarbanes-Oxley Act (2002).

4. Among other things, the article quotes SEC Commissioner Harvey J. Goldschmidt as saying, ‘‘I think that Sarbanes-Oxley has been a great success in terms of the effect it has had on improved corporate governance. There is no question it has been a great piece of legislation, and anybody who says otherwise is talking like a darn fool.’’ See also O’Hara (2006), stating, ‘‘Institutional investor ad- visory firm Glass, Lewis & Co. estimates that by the time the books are closed for 2005, more than 1,200 of the country’s approximately 15,000 public companies will have announced accounting restatements—a record. There were 619 restatements in 2004. In 2001, the year before Sarbanes- Oxley passed, there were 270.’’

143ETHICAL GUIDANCE AND CONSTRAINT

My skepticism regarding the adequacy of the auditor rotation requirement is

based on a reading of historical data, rather than an empirical study of the effi-

cacy of the auditor rotation requirement. There is an eminently practical reason

for the difference in approach—that is, the rotation requirement has not existed

long enough to be subject to empirical review. The requirement provides for

rotation every five years, yet the Sarbanes-Oxley Act is only five years old.

While it is possible that some auditor rotation has taken place already, such rota-

tion could not be reliably related to the Sarbanes-Oxley mandate and certainly

could not be analyzed as being representative of that requirement’s effectiveness.

Nevertheless, accepting history as a guide, I analyzed the series of account-

ing failures that plagued Arthur Andersen up until the ultimate scandal––

Enron––caused the accounting firm’s demise. The list was long, with many

names that were readily recognizable, such as Sunbeam, Waste Management,

WorldCom, and Qwest, and other names that were not nationally known but

were no less important to the particular investors, employees, directors, and offi-

cers who were involved. This survey revealed that there was no commonality

among the names of the individual partners associated with each respective scan-

dal. Nevertheless, the accusations in each case were strikingly the same: mis-

statements on financial statements, failures to comply with generally accepted

accounting principles, deliberate destruction of records, and so on. Were the cur-

rent Sarbanes-Oxley requirement of auditor rotation to have been imposed on

Arthur Andersen in those years, it is reasonable to conclude that its principal

effect, at least in many cases, may have been simply to swap the troubled

accounts among partners who already were engaging in accounting improprieties

elsewhere.

Putting aside the risk of a systemic unethical culture, under any system of

internal partner rotation, newly appointed audit partners would have practical, fi-

nancial, and legal incentives to acquiesce in existing patterns of improprieties

perpetuated by their predecessor partners––especially when the opposite course

may lead to client resistance, financial losses, reputational harm for the newly

appointed partner’s own firm and––potentially––complete individual and institu-

tional ruin. In contrast, historical examples set forth below suggest that newly

appointed auditing firms would have exactly the opposite incentives. Were they

to inherit accounts rife with accounting improprieties, there is reason to believe

that they would be motivated, from the perspective of both self-preservation and

natural competitiveness, if nothing else, to disclose and attempt to correct these

historical problems. The ultimate incentive, which may prove to be the sine qua non, is that a failure to do so could expose them to the disastrous possibility of

being deemed to have embraced these historical problems and to become

accountable for them as their own.

This analysis, along with other findings set forth below, supports my opinion

that, even if partner rotation takes place in the upcoming years strictly in compli-

ance with Sections 203 and 207, such rotation is not likely to be sufficient to sat-

isfy the underlying goal of genuine auditor independence. To the contrary, the

144 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

principal effect of audit-partner rotation may be merely to increase the number

of individual partners named in each of the resulting lawsuits, administrative pro-

ceedings, and civil and criminal sanctions.

2. Section 406: The Code of Ethics

One of the principal challenges corporations have faced in handling ethical

matters is that ethics historically have not been taught in this country in any sort

of systematic, formalized, or reliable way. A survey conducted by BusinessWeek as late as 2003, even as the recent wave of corporate scandals was breaking,

showed that there continues to be a general acceptance of the concept that ethics

cannot be formally taught, especially at higher levels of education.5

Commentators have long bemoaned that ‘‘[e]thics are not taught in the

home, the school or the college system’’ (Banerjee [2005], p. 9). At the under-

graduate level, for example, accounting majors historically have not been

required to take ethics courses.6 In 1988, a study conducted by the Association

for the Advancement of Collegiate Schools of Business (AACSB), the organiza-

tion responsible for accrediting business school programs, found that only one-

third of its members required their students to take an ethics course as a

mandatory part of the curriculum (Stewart [2004]). In 1993, a separate study

reported in the Journal of Business Ethics established that only about three hours

were devoted to the topic within accounting courses.7

In 2002, in response to the onset of corporate scandals, a number of educa-

tors launched a campaign for mandatory education in ethics, at least in the con-

text of formal business and accounting curricula. These actions were spearheaded

by Diane Swanson, a professor of business at Kansas State University, and Bill

Frederick, a retired ethics specialist from the University of Pittsburgh, under the

name of Campaign AACSB. Their goal, which was to persuade that association

to require a stand-alone ethics course as a condition of accreditation, was

endorsed by more than 200 professors and practitioners, as well as two professio-

nal associations (Swanson & Frederick [2005]).

Their efforts were ultimately unsuccessful, in that the AACSB did not

change its accreditation standards (Swanson & Frederick [2005]). It should come

as little surprise, therefore, that an informal survey conducted in 2003 by the

5. According to the Reader Survey Results, ‘‘[T]he vast majority of readers think ethics are bet- ter taught someplace other than B-school, with 75% saying the best values are taught at home by parents, while 8% chose elementary or secondary school, and only 4% chose B-School’’ (2003, p. 2).

6. According to Haas, ‘‘Several surveys conducted in the late 1980s found little integration of ethics into the accounting curriculum’’ (2005, pp. 66–68).

7. According to Haas, ‘‘A 1993 study [Frances McNair and Edward E. Milam, ‘‘Ethics in Accounting Education: What Is Really Being Done,’’ Journal of Business Ethics, October 1993] reported that the average time covering ethics in an accounting course was a little over three hours’’ (2005, p. 67).

145ETHICAL GUIDANCE AND CONSTRAINT

AACSB found that only 35 percent of its member schools required students to

take an ethics course, a percent that was virtually unchanged from the results of

the study it had conducted fifteen years before (Stewart [2004]).

Even without an accreditation mandate, however, either Campaign AACSB

or the collective impact of the corporate scandals, or a combination of such fac-

tors, may be starting to affect business and accounting programs. Notably, in

2004, a survey of ethics requirements within master of business administration

(MBA) programs was conducted by the Task Force on Business Ethics Educa-

tion, an organization born out of Campaign AACSB (Swanson & Frederick

[2005], at 2). The survey reviewed curriculum requirements related to ethics for

each of the thirty top MBA programs in the United States as ranked by Business- Week, using each university’s Web site and online catalogue as a data source,

with telephone confirmation of the offerings (Business Ethics Education Initiative

[2005]). The results showed that 43 percent of the surveyed programs required a

course in business ethics in 2004, which was an improvement on the 35 percent

figure found by the AACSB in the previous fifteen years (Stewart [2004]; Busi-

ness Ethics Education Initiative [2005]).8 Ten of the thirty schools in the Task

Force study required a separate course on ethics, either alone or in combination

with a related topic such as business law or public policy (Stewart [2004]; Busi-

ness Ethics Education Initiative [2005]).9 Three of them required a module or

segment on ethics as part of a larger series of events or seminars, but not a full-

credit course (Stewart [2004]; Business Ethics Education Initiative [2005]).10

Still, seventeen schools among the top thirty business schools had no required

foundational ethics courses in 2004 (Stewart [2004]; Business Ethics Education

Initiative [2005]).11

Although the trend appears to be favorable, it is reasonable at this point to

assume that most people have received or will receive little to no formal educa-

tion in ethics, but for the most elemental lessons of kindergarten:

Most of what I really need to know about how to live, and what to do, and

how to be, I learned in kindergarten. Wisdom was not at the top of the grad-

uate school mountain, but there in the sandbox. These are the things

8. Even outside of the top thirty schools on this list, ethics requirements are starting to emerge. For example, the College of Business at the University of Missouri-Columbia requires its accounting students to elect at least one course in philosophy, ethics, or logic (University of Missouri Undergrad- uate Catalog [2004–06], p. 194).

9. These schools are New York University, Harvard University, University of Virginia, Univer- sity of California-Berkley, University of North Carolina, Notre Dame University, Carnegie Mellon University, University of Pennsylvania, Georgetown University, and University of Michigan.

10. These schools are Stanford University, University of Maryland, and Purdue University. 11. These schools are Columbia University, Duke University, University of Chicago, Yale Uni-

versity, University of Rochester, University of Texas-Austin, Massachusetts Institute of Technology, Northwestern University, Dartmouth College, Cornell University, University of California-Los Angeles, University of South Carolina, Indiana University, Emory University, Washington University, Vanderbilt University, and Babson College.

146 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

I learned: share everything, play fair, don’t hit people, put things back where

you found them, clean up your own mess, don’t take things that aren’t yours,

say you’re sorry when you hurt somebody, wash your hands before you eat

(Fulghum [1986]).

As we move toward written codes of ethics, in hopes that they will function

as tolerable substitutes for the instincts and understanding that might have been

inbred by years of formal training, it is appropriate to examine their underlying

ethical bases. Contemporary ethical beliefs have evolved from ‘‘Utilitarian,’’

‘‘Deontological,’’ and ‘‘Virtue’’ ethics. Utilitarianism is the moral philosophy that

asserts that an act or practice is right if it leads to the greatest possible balance

of good consequences (Donaldson, Werhane, & Cording [2002]; Capaldi [2004];

Dershowitz [2004]).12 This concept of utilitarianism can then be divided between

‘‘rule utilitarianism,’’ which maintains that a rule or code is morally right if the

consequences of adopting the rule or code are more favorable than unfavorable

to everyone, as contrasted with ‘‘act utilitarianism,’’ which maintains that the

morality of the action (not a rule or code) is determined in relation to the favor-

able or unfavorable consequences that emerge from the action.13 The second eth-

ical category is deontological ethics, which assets that a variety of relationships

among persons have a significance independent of consequences that may impose

duties in a moralistic sense.14 The third ethical category is virtue ethics or moral

virtue, as developed by Aristotle, which emphasizes the moral character and

behavior of the person. The social practices of business managers can be equated

with the ethical virtue of self-restraint and control.15

The division between ‘‘act utilitarianism’’ and ‘‘rule utilitarianism’’ recog-

nizes the obvious: that written rules, in isolation, are not enough.16 Codes of

12. According to Donaldson, Werhane, and Cording, ‘‘Bentham and Mill thought that utilitari- anism was a revolutionary theory, both because it accurately reflected human motivation and because it had clear application to the political and social problems of their day. If one could measure the benefit or harm of any action, rule, or law, they believed, one could sort out good and bad social and political legislation as well as good and bad individual actions’’ (2002, p. 4).

13. According to Dershowitz, ‘‘�Rule Utilitarianism� is a formulation of utilitarianism which maintains that a behavioral code or rule is morally right if the consequences of adopting that rule are more favorable than unfavorable to everyone. It is contrasted with �act utilitarianism� which maintains that the morality of each action is to be determined in relation to the favorable or unfavorable conse- quences that emerge from that action’’ (2004, p. 242).

14. According to Heath and Schneewind, ‘‘Deontology is ethical reasoning that creates princi- ples of moral imperatives based on duty and universal rules that one is obliged to follow regardless of the consequences. A voluntary action of an autonomous individual based on the right reason that is a good and free act of the will’’ (1997, pp. 50, 62–65); see also Donaldson, Werhane, and Cording (2002).

15. See Apostle and Gerson, ‘‘Since virtues are of two kinds, intellectual and ethical, an intel- lectual virtue originates and grows mostly by teaching, and in view of this it requires experience and time, whereas an ethical virtue is acquired by habituation (ethos) . . . Hence virtues arise in us neither by nature nor contrary to nature; but by our nature we can receive them and perfect them by habitua- tion’’ (1991, p. 44); see also Donaldson, Werhane, and Cording (2002).

16. This concept is embedded, in a slightly different context, in the U.S. Sentencing Guidelines, set forth at www.ussc.gov.

147ETHICAL GUIDANCE AND CONSTRAINT

conduct may assist in the establishment of levels of competence, standards of

performance, and guidance for decision making, but they do not provide actual

solutions to individual problems (Sack [2002]; Gibson & Goering [2001]). Thus,

there must be systems in place to translate the written rules into action (Sack

[2002]). In the particular concept here, namely, written codes of ethics for corpo-

rate conduct, these systems should include the following: (1) communication of

the rules to all employees of the corporation; (2) formal education of employees

in ethical decision making; and (3) methods of enforcement (Sack [2002]).

The best proof that written codes of values, in isolation, are not enough lies

in the fact that such codes proliferated among Fortune 1000 companies in the

mid to late 1990s––just as the actions were being taken that produced the wave

of scandals (Weaver, Trevino, & Cochran [1999]).17

Mindful of this problem, the Sarbanes-Oxley Act attempts to ensure that

codes of ethics are more than window-dressing.18 The Act does so largely by

empowering the Securities and Exchange Commission (SEC) to enact such rules

and regulations that the SEC deems necessary to put teeth into the requirements

pertaining to the issuance of such codes:

The Commission shall issue rules to require each issuer, together with peri-

odic reports required pursuant to Section 13(a) or 15(d) of the Securities

Exchange Act of 1934, to disclose whether or not, and if not, the reason

therefore, such issuer has adopted a code of ethics for senior financial offi-

cers, applicable to its principal financial officers and comptroller or principal

accounting officer, or persons performing similar functions (Section 406, see

Appendix A).

The Commission shall revise its regulations concerning matters requir-

ing prompt disclosure on Form 8-K (or any successor thereto) to require the

immediate disclosure, by means of the filing of such form, dissemination by

the Internet or by other electronics means, by any issuer of any change in or

waiver of the code of ethics for senior financial officers (Section 406, see

Appendix A).

The SEC rose to this difficult challenge by inviting comments from corpora-

tions, professional associations, accountants, law firms, analysts, consultants, aca-

demics, investors, and others about the amount and types of disclosures that

should be required The response came in the form of more than 200 comment

letters. Investors generally supported the objectives and some proposed additional

17. The Weaver, Trevino, and Cochran (1999) study established that, although there was a high degree of corporate adoption of ethics policies at that time, there was a wide variability in the extent to which these policies were implemented. The authors conclude that the vast majority of firms were committed to the lower cost and symbolic side of ethics activities, and accordingly the codes in the study mostly were symbolic recitals of preexisting corporate structure or processes.

18. The Code of Ethics (Section 406) can be found in Appendix A and the regulations for the section can be found in Appendices B, C, D, and E.

148 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

disclosures. Other commentators thought that more disclosure was required than

was necessary to achieve the change of the Act and suggested changes to the

proposals (SEC [2003b]).

The result is what the SEC describes as a ‘‘disclosure-based regulatory

scheme.’’19 As the SEC explains in its comments on the final rules, it limited its

mandates to what corporations should make public, rather than mandating what

their written codes should say:

[T]he rules do not specify every detail that the company must address in its

code of ethics, or prescribe any specific language that the code of ethics

must include. They further do not specify the procedures that the company

should develop, or the types of sanctions that the company should impose,

to ensure compliance with its code of ethics (SEC [2003b], p. 16).

Consistent with the philosophy of corporate individuality, the SEC did not

set forth a model code of ethics. It did, however, provide corporations with gen-

eral guidelines as to some of the ethical issues that their individually written

codes should address. A blueprint of specific sections to be included in a speci-

men code follows:

Sections on accuracy and retention of business records; company property;

fraud and theft; payments and gifts to third parties; privacy; confidential in-

formation; computer resources and computer security; intellectual property;

inside information; conflict of interest; family members and close personal

relationships; ownership in other businesses; corporate activities; outside

employment, affiliations or activities; gifts, gratuities and entertainment; fair

dealing; relationships with suppliers or service providers; consultants and

agents; antitrust and unfair competition; relationships with government agen-

cies and outside organizations; selling to government institutions; political

contributions and activities; personal involvement and the political action

committees; government procurement; responding to government and other

inquiries; tax violations; and any other area that is unique to the company

(Chief Security Offices [2004]).

Similarly, without delving into details, the rules make clear that every code

should contain an enforcement mechanism that includes both ‘‘severe penalties

for violations’’ and a formal procedure for waivers of compliance:

[E]ach code should provide severe penalties for violations of the code and a

procedure to report violations with complete confidentiality, including ano-

nymity (SEC [2003b], p. 16).

19. According to the SEC, ‘‘We continue to believe that ethics codes do, and should, vary from company to company and that decisions as to the specific provisions of the code, compliance proce- dures and disciplinary measures for ethical breaches are best left to the company. Such an approach is consistent with our disclosure-based regulatory scheme’’ (2003b, p. 16).

149ETHICAL GUIDANCE AND CONSTRAINT

An analysis of the public filings and Internet disclosures of thirty-nine ran-

domly selected corporations shows that, for the most part, corporations have

responded admirably to the code of ethics requirements of Sarbanes-Oxley.20

None of their codes reflected a merely token effort; to the contrary, the codes

reflected a substantial amount of work, effort and thought.

The Code of Corporate Conduct of ITT Industries, for example, is thirty

pages long, followed by an addendum (see Appendix F, Code 29). The Rayonier

Inc. Standard of Ethics and Code of Corporate Conduct is twenty-four pages

long, with an introduction by the chairman, president and chief executive officer

(CEO) (see Appendix F, Code 31). The Hovnanian Enterprises, Inc. Code of

Ethics is a detailed twenty pages, beginning with a table of contents and ending

with an acknowledgment certificate form to be executed by each employee (see

Appendix F, Code 28). Fannie Mae, also known as the Federal National Mort-

gage Association, apparently appreciated the philosophical underpinnings of its

Code of Business Conduct; that code opens with a quote from Henry David

Thoreau.21

In accordance with both the Act and the SEC’s rules, 92 percent of the cor-

porations in this study had disclosed in their annual reports or Form 10-Ks that

their codes of ethics or conduct were publicly available on their Web sites.22 A

review of their Web sites then confirmed that these disclosures were correct; the

codes were there, and were easy to find.

Moreover, the codes themselves tended to address the principal ethical issues

of our times. An analysis of thirty-six such codes shows that they collectively

addressed thirty-one different categories of ethical conduct. Appendix G identifies

these categories and reviews what percent of the codes address each of them.

Notably, all of the codes studied had sections pertaining to the ‘‘Accuracy

and Retention of Business Records,’’ which was the fatal flaw to the financial

reports of Enron, Worldcom, and Tyco and which destroyed Arthur Andersen.

All of them had sections specifically describing the obligations of the CEO, chief

financial officer, and other financial officers, which also appears to be a direct

response to these recent corporate scandals. In addition, 83 percent of the codes

had detailed sections regarding conflicts of interest and 75 percent had provided

corporate protection for whistle-blowers (see Appendix G).

Some codes warn employees to avoid speculation or the appearance of

speculation: topics that are peculiarly modern-day ethical conundrums. The

20. Appendix F identifies the thirty-nine corporations that were the subject of this study. 21. Appendix F, Code 24, stating, ‘‘It is truly enough said that a corporation has no conscience.

But a corporation of conscientious individuals is a corporation with a conscience’’ (Thoreau [1906]). 22. Of the three corporations that did not reference their codes of ethics in the public filings,

they still disclosed them in full on their Web sites. Thus, while they may not have complied exactly with the technical requirement regarding the public filings, they were in compliance with the funda- mentally more important requirement of public disclosure of their codes of ethics.

150 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

Dow Jones & Company Code of Conduct, for example, contains provisions

encouraging employees to be long-term investors in the company’s stock

and prohibiting them from the short selling of any securities (see Appendix F,

Code 21).

Other codes reveal sensitivity to avoiding abuses by directors of the types

that have aggravated the recent wave of scandals. For example, Curtiss-Wright

Corporation requires its directors to certify that they have read and understand

their Corporate Governance Guidelines; to certify that they have not been

involved, during the past twelve months, in any situation that violates the Guide-

lines; and, further, to certify that they are not aware that any Curtiss-Wright

director, officer, or employee is involved, or during the past twelve months has

been involved in any situations that violate the Guidelines (see Appendix F,

Code 20).

It is particularly notable that most of the codes in the survey included a

range of potential penalties for code violations.23 For example, 81 percent pro-

vided for a variety of disciplinary penalties as a consequence of noncompli-

ance, including reprimand, censure, suspension, and termination. Forty-two

percent provided penalties of civil or criminal liability for noncompliance (see

Appendix G).

First Republic Bank has a typical code of ethics (see Appendix F, Code 7),

which subjects violators of the code to the following disciplinary measures:

. Warning and/or reprimand

. Probation

. Suspension

. Salary reduction

. Bonus reduction or elimination

. Demotion

. Termination

23. Notably, these penalty provisions for violations of codes of ethics are not the only penalty provisions set forth within the scope of the Sarbanes-Oxley Act. In addition to these provisions, in Title VIII Corporate and Criminal Fraud Accountability imposes, under Section 802, criminal penal- ties for altering documents; Section 803 provides for nonchargeable debts if incurred in violation of securities fraud laws; and Section 807 imposes criminal penalties for defrauding shareholders of pub- licly traded companies. Title IX White Collar Crime Penalty Enhancements under Section 903 imposes criminal penalties for mail and wire fraud; Section 904 provides for criminal penalties for violations of the Employee Retirement Income Security Act of 1974; Section 905 amends the sen- tencing guidelines relating to certain white-collar offenses; and Section 906 imposes corporate responsibility for financial reports. Also in Title XI Corporate Fraud and Accountability under Sec- tion 1102 imposes fines and/or imprisonment for tampering with records or otherwise impeding an official proceeding; Section 1103 gives the SEC authority for a temporary freeze; Section 1104 amends the Federal Sentencing Guidelines Section 1105 increases the penalties under the Securities Exchange Act of 1934; and Section 1107 imposes fines and/or imprisonment for retaliation against informants. See Sarbanes-Oxley Act (2002), Title VIII—Sections 802, 803, 807; Title IX—Section 903, 904, 905, 906; Title XI—Section 1102, 1103, 1104, 1105, 1107.

151ETHICAL GUIDANCE AND CONSTRAINT

In addition, violations of legal and regulatory requirements might carry their

own civil and criminal penalties, including fines and imprisonment (see Appen-

dix F, Code 7).

While the codes that I surveyed were largely satisfactory, especially consid-

ering that they are relatively new, I nevertheless believe that many of them can,

and should, go further. In my opinion, it would be appropriate if each code con-

tained a letter from the CEO, emphasizing the importance of compliance and

understanding by all of the employees and directors.24 Similarly, I believe that

every director and every employee, from the chairman of the board to the mail

clerk, should be required to sign a certification confirming that they have

received the code and will comply with it.25 In the same vein, it is my opinion

that any waiver of compliance should require the express approval of the Audit

Committee, ideally requested and given before the noncompliant action takes

place, and the waiver should be disclosed in all appropriate public filings. I

believe that such changes, and others that may become apparent over time, are

likely to increase the effectiveness of the codes and further the goals of ensuring

that the codes rise above the merely symbolic role that they once were limited to

serving.

In this regard, when enough time passes to produce reliable and consistent

data, a study should be done of the actual efficacy of the written codes of ethics

mandated by Section 406 of Sarbanes-Oxley, perhaps through a focus on the

measurable fact of the penalties that actually are imposed within corporations for

code violations. But at this point, in the relative infancy of the Act, the prognosis

generally seems good with regard to the code of ethics requirements. Corpora-

tions appear to be making more than token efforts to establish appropriate codes;

to make them readily available to employees, shareholders, and others; and to

stand ready to enforce them against violators if, and unfortunately when, that

time comes.

3. Sections 203 and 207: Audit-Partner Rotation

Just as the discussion of written codes of ethics underscored concerns about

ensuring efficacy rather than symbolism, the same concern will be manifest in

the ensuing discussion of the audit rotation requirements. Here, though, my

assessment is far less optimistic. My opinion is that the Sarbanes-Oxley require-

ment of audit-partner rotation is too narrow to protect the public from audits in

appearance only. Although I cannot support my assessment with empirical evi-

dence at this time, due to the fact that the rotation requirement is only five years

old, the following discussion should demonstrate why I believe that Sarbanes-

24. Only 22 percent of the codes surveyed contained introductions from CEOs. 25. Only 31 percent of the codes surveyed contained requirements for acknowledgment

signatures.

152 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

Oxley must be expanded to require mandatory rotation of audit firms, not just

the named partners within ongoing audit firms.26

The natural starting point for this discussion is a review of why auditor inde-

pendence is essential to ensuring ethical corporate behavior. As stated by the

SEC, independent auditors function as ‘‘�gatekeepers� to the public securities mar-

kets.’’27 Professor John C. Coffee, of Columbia Law School, describes their role

as follows:

Securities markets have long employed ‘‘gatekeepers’’ – independent profes-

sionals who pledge their reputational capital – to protect the interests of dis-

persed investors who cannot easily take collective action. The clearest

examples of such reputational intermediaries are auditor and securities ana-

lysts, who in different ways verify or assess corporate disclosures in order to

advise investors (Coffee [2004]).

The accounting profession has long recognized that auditor independence is

essential to achieving the essential goals of being objective and avoiding con-

flicts of interest.28 Thus, the Code of Professional Conduct of the American Insti-

tute of Certified Public Accountants (AICPA) consists of two sections. The first

section includes six principles, which provide the professional behavior and

framework for the Rules of Professional Conduct (Duska & Duska [2003],

pp. 75–77). Specifically, principle IV on Objectivity and Independence provides

that ‘‘[a] member should maintain objectivity and be free of conflicts of interest

in discharging professional responsibilities. A member in public practice should

be independent in fact and appearance when providing auditing and other attesta-

tion services.’’ This principle has been recognized as perhaps the most important

of all the principles in the AICPA Code (Duska & Duska [2003], p. 85).

Further, the AICPA Code contains a section on the rules and the bylaws

requiring its members to adhere to its Rules of Professional Conduct. The rules

section consists of five sections of which the first is ‘‘Independence, Integrity

and Objectivity’’ (Duska & Duska [2003], p. 93). The independence rule (Rule

101) states, ‘‘[a] member in public practice shall be independent in the

26. In the years that have passed since the enactment of Sarbanes-Oxley, the sufficiency of the audit-partner rotation requirement has provoked continuous dispute and controversy. Compare the fol- lowing Op Ed Article published in the Wall Street Journal by Ernst &Young Chairman Jim Turley (February 4,2002), stating that mandatory audit-firm rotation ‘‘would likely reduce audit quality in both the early and late years of an audit term,’’ with the article in the Accounting Horizon by Eugene A. Imhoff (2003), supporting audit-firm rotation on grounds that ‘‘[r]otating CPA firms every three years could be the single most effective change for enhancing independence.’’ Other commentators on this controversial subject limit their conclusions to the innocuous finding that ‘‘increased auditor tenure does not lead to reduced audit and earnings quality. . . . However, our results also do not imply that forcing firms to remain with the same auditors would improve earnings quality or audit quality’’ (Myers, Myers, & Omer [2003]).

27. See Securities Act Release No. 7870 (June 30, 2000). Chief Justice Warren Burger opted for the more colorful term ‘‘public watchdog’’ to express this same concept (Duska & Duska [2003]).

28. In this respect, the audit rotation requirements stand as complementary counterparts—but not mere derivatives—of the Code of Ethics requirements described in Section 2 of this article.

153ETHICAL GUIDANCE AND CONSTRAINT

performance of professional services as required by standards promulgated by

bodies designated by Council’’ (Duska & Duska [2003], p. 93). These bodies

include the state board of accountancy, Certified Public Accountants (CPA) soci-

ety, the SEC, U.S. Department of Law, and the AICPA SEC Practice Section

(Centers of Public Company Audit Firms). A positive explanation of ‘‘indepen-

dence’’ as freedom from conflicting interests to the responsibilities of the account-

ant is negatively interpreted by examples of impairment to ‘‘independence’’ by

direct or material indirect financial interest in or with the client; loans to or from

the client, or its officers, directors, or principal stockholders; and connection with

the client as a promoter, underwriter, voting trustee, director, officer, employee,

or manager (Duska & Duska [2003], p. 93). Similarly, the conflict of interest

rule (Rule 102) states, ‘‘In the performance of any professional service, a mem-

ber shall maintain objectivity and integrity, shall be free of conflicts of interest,

and shall not knowingly misrepresent facts or subordinate his or her judgment to

others’’ (Duska & Duska [2003], pp. 95–96).

Against that backdrop, the audit-partner rotation requirement currently found

within the Act reads as follows:

It shall be unlawful for a registered public accounting firm to provide audit

services to an issuer if the lead (or coordinating) audit partner (have primary

responsibility for the audit), or the audit partner responsible for reviewing

the audit, has performed audit service for that issuer in each of the 5 previ-

ous fiscal years of that issuer (see Appendix H).

This provision requires the ‘‘lead’’ and ‘‘concurring’’ partners to rotate after

five years and, upon rotation, be subject to a five-year ‘‘time-out’’ period. The

terms ‘‘lead partner’’ and ‘‘concurring partner’’ have specified meanings. The

‘‘lead partner’’ has the primary responsibility for the audit. The ‘‘concurring part-

ner’’ performs a second level of review to provide additional assurance that the

financial statements are in conformity with general accounting principles and

generally accepted auditing standards and rules promulgated by the Commission

or the Public Company Accounting Oversight Board (PCAOB), which is a

review board created by Congress in conjunction with the passage of Sarbanes-

Oxley.29

The problem is that this provision does not require the rotation of audit

firms, only partners within a firm. It technically would be satisfied with a token

change of the name of the lead partner—even though the lead partner in practice

may continue unchanged for years, or even decades. It therefore is ripe for abuse,

especially by large and stratified accounting firms.

Historical evidence makes the weakness of this requirement all too clear.

First, one need look no further than the history of Arthur Andersen to appreciate

29. The Commission exempted firms with fewer than five audit clients and fewer than ten part- ners. This exemption was codified in the Act with the safeguard that the PCAOB would conduct a review of the accounting firm’s engagements at least once every three years. See SEC (2003a, IIC.1).

154 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

that auditor rotation would serve no purpose when it takes place with an

‘‘unethical corporate culture that repeatedly permits unethical practices.’’ In the

years leading up to the catastrophic Enron scandal, Arthur Andersen was plagued

with a series of comparable, but unrelated, accounting scandals. There was no

overlap among the engagement partners involved in each case, although there

was a marked similarity among the allegations of improper behavior. Thus, the

inevitable and unfortunate inference is that the Sarbanes-Oxley auditor rotation

requirement would have offered no protection for the investors in Arthur Ander-

sen’s clients during those years. The argument can be made that its principal

effect would merely have been to increase the number of partners named in the

resulting lawsuits and administrative proceedings.

In the Enron scandal, the engagement partner at Arthur Andersen—and the

individual held accountable as the principal decision maker—was David B.

Duncan.30 The scandals at Arthur Andersen that preceded Enron, and the principal

partners involved in each one, include the following:

. Baptist Foundation of America: In November 1999, this nonprofit charity

based in Arizona declared bankruptcy, with debts of approximately $640

million. In response to investor allegations of accounting improprieties,

including the nondisclosure of possible fraudulent activity, Arthur Ander-

sen ultimately paid a $217 million settlement. The senior partner from

Arthur Andersen was Jay Steven Ozer.31

. Sunbeam: This Florida-based home appliance company was accused by

the SEC of multiple fraudulent accounting statements, including artifi-

cially boosting quarterly net income, accelerating sales from later periods

into the present quarter, and other methods of improperly inflating reve-

nue. In August 2002, a federal judge approved a settlement of an investor

lawsuit that, among other things, required Arthur Andersen to pay $110

million. The engagement partner from Arthur Andersen was Phillip

E. Harlow.32

. Waste Management: This accounting scandal lead to the first antifraud

injunction issued against an accounting firm in twenty years. In 2001 and

2002, in response to accounting practices that were alleged to be

extremely improper, Arthur Andersen paid a $7 million fine as well as an

approximately $75 million settlement to Waste Management shareholders.

The engagement partners from Arthur Andersen were Robert F. Allgyer,

Edward G. Maier, and Walter Cervaschi.33

. WorldCom: Also in 2002, reports surfaced of enormous misstatements in

financial statements filed from 1999 through 2002 by this telecommunications

30. In re Enron Securities Litig., 235 F. Supp. 2d 549. 31. In re Enron Securities Litig., 235 F. Supp. 2d 549, 676, n.111. 32. In re Enron Securities Litig., 235 F. Supp. 2d at 675, n.110. 33. In re Arthur Andersen Exchange Act Release No. 34-4444, 2001 WL 687561 (June 19,

2001). See the SEC Litigation Release, at http://www.sec.gov/litigation/litreleases/Ir17039.htm.

155ETHICAL GUIDANCE AND CONSTRAINT

giant based in Clinton Mississippi. Lawsuits filed by both investors and

the SEC led to the imposition of a civil penalty in the astonishing sum of

$2,250,000,000, among other sanctions. The engagement partners from

Arthur Anderson were Mark Schoppet (2000) and Melvin Dick (2001)

(Worldcom [2003]).

. Qwest: In 2002, the SEC accused Qwest Communications International

Inc. of making false representations on its financial statements from 1999

through 2002, leading to the fraudulent recognition of approximately

$43.8 billion of spurious revenue and the fraudulent exclusion of $231

million in expenses. At the time, the Colorado-based company was one of

the largest telecommunications and Internet services companies in the

United States (SEC [2003c]). A securities fraud class action in U.S. Dis-

trict Court in Colorado has reportedly produced a partial settlement of

$400 million (Hevesi [2006]). As recently as April 18, 2006, New York

State Comptroller Alan Hevesi filed a securities fraud lawsuit against

Qwest and Arthur Andersen for $250 million to recoup losses suffered by

the State Common Retirement Fund (Hevesi [2006]). The lead audit part-

ner from Arthur Andersen was Mark Iwan (SEC [2005a]).34

In contrast to this walk of shame for the accounting profession—a walk that

continues for much longer than a few examples set forth here—this author finds

hope in an unexpected reaction: an SEC lawsuit against three Arthur Andersen

auditors for fraud in connection with the year 2000 audit of American Tissue,

Inc., a manufacturer of tissue and paper products. The lawsuit was brought

against Arthur Andersen partner Fred Gold, along with audit manager John D.

Parson and senior accountant Brendan P. McDonald. The SEC charged all three

executives with failing to exercise due professional care in issuing an unqualified

audit report on the company’s fiscal 2000 financial statements (SEC [2005b]).35

The good news, relatively speaking, lies in the following allegations in the

SEC’s complaint:

[I]n July 2001, when the defendants learned their fiscal 2000 American Tis-

sue audit had been selected for a peer review by another accounting firm,

they intentionally altered audit work papers in an attempt to conceal the fail-

ures of their audit work. In September 2001, when the defendants learned

that another accounting firm had discovered that the company had overval-

ued inventory and would have to restate financial results for fiscal 2000,

they destroyed documents and e-mails in a further attempt to conceal their

audit failures (SEC [2005b]).

34. The SEC release states that Iwan agreed to a settlement that imposed a suspension from appearing or practicing before the Commission as an accountant.

35. The SEC release states that two of these auditors agreed to settlements that impose injunc- tions, civil penalties, and suspensions from appearing or practicing before the Commission as accountants.

156 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

These allegations, if true, support the argument that audit-firm rotation

would be a more effective method of ensuring auditor independence than auditor

rotation within a single firm. They suggest that partners within an audit firm are

far more likely to second-guess their actions when they anticipate review by a

competitor than when they anticipate review by one of their own partners.

Review by a competitor has particular value because, under ordinary circumstances,

it would seem that a competitor would have both a financial and a legal incen-

tive to disclose and correct, rather than conceal, any accounting irregularities

inherited from a predecessor company. The history of Arthur Andersen, however,

suggests that the reverse would be true for audit-partner rotation within a single

accounting firm.

A second reason for doubting the efficacy of the auditor rotation require-

ment—as distinguished from an audit-firm rotation requirement is that the audi-

tor rotation requirement is little more than a minor extension of a previous

rotation requirement that had been established by the accounting profession. That

provision, established by the AICPA’s SEC Practice Section (now known as the

Center of Public Company Audit Firms or the Center for Audit Quality), recom-

mended that the lead partner rotate off the engagement of SEC registrants after

seven years, with a two year ‘‘time-out’’ period.36

That previous requirement was in effect during the accounting scandals that

led to the creation of Sarbanes-Oxley. These accounting scandals therefore stand

as unfortunate, yet convincing, evidence that this requirement was not stringent

enough to be effective. Because the new rotation requirement embodied within

Sarbanes-Oxley is substantially similar, with only a slight alteration of the origi-

nal time periods, it is hard to see how this requirement could be sufficient to

achieve its goals.

A third reason for questioning the auditor rotation requirement is that the

accounting profession professed lukewarm support for the limited rotation

requirement. That fact ironically stands as a testament to the requirement’s weakness.

The AICPA submitted comments on the proposed requirement to the SEC in

a sixty-two-page letter on January 9, 2003. The letter agreed with and supported

the objectives of the Congress and the SEC in requiring partner rotation. It

pointed out that the AICPA had required lead audit-partner rotation for the past

twenty-five years. It recognized the importance of a ‘‘fresh set of eyes,’’ but

maintained that the benefit must be balanced with the cost of continuity and

‘‘institutional knowledge’’ (AICPA [2003]).

Most notable about the letter was that it stressed the AICPA’s objections

to audit-firm rotation—the very concept that I believe is critically needed and

conspicuously absent from the requirements of Sarbanes-Oxley. The letter stated

36. See AICPA (1978, pp. 1–5). While the prior lead partner-rotation requirements specified a seven-year period prior to rotation, the original rotation requirements developed by the SECPS speci- fied a five-year rotation period.

157ETHICAL GUIDANCE AND CONSTRAINT

that ‘‘audit firm rotation has significant costs that far outweigh the potential ben-

efits.’’ The costs cited were increase in audit failures, increased start-up costs,

increased difficulties in timely reporting, loss of institutional knowledge, oppor-

tunity to disguise voluntary rotations, reduced incentives to improve efficiency

and audit quality, and a sharp increase in time and resources dedicated to pro-

posal process (AICPA [2003]).

There are many possible reasons to explain the AICPA’s vehement objec-

tions to audit-firm rotation, and some of them likely are based in political, finan-

cial, and economic realities. It is common knowledge, for example, that the

AICPA is heavily represented by members of the Big Four accounting firms and,

as a result, are necessarily sensitive to protecting the interests of those firms.

This mutually dependent relationship was affirmatively acknowledged in 2003 by

Charles Bowsher, a former partner at Arthur Andersen who served as comptroller

general of the United States for fifteen years and also as chairman of the

PCAOB. In an interview with the editor-in-chief of the CPA Journal about the

AICPA’s reaction to the Sarbanes-Oxley Act, he stated:

I’m not sure if the AICPA is leading the Big Four or the other way around.

The morale of all CPAs about their profession has sunk so low over the last

two years, and to a great extent it is because the leaders of the big firms and

the AICPA have undertaken initiatives that turned out to be disastrous. The

AICPA has become a big public relations and lobbying machine. It does a

good job with some of its education programming, but its involvement with

auditing and professional standards setting has become de-emphasized

(Morris [2003]).37

Although the membership of the AICPA consists mostly of mid-size and

small accounting firms, which vastly outnumber the Big Four, this membership

does not appear to be represented proportionately in the leadership of the organi-

zation or to have a proportionate influence upon AICPA policy or concerns. The

officers, directors, and committee chairs of the AICPA are predominantly part-

ners of the Big Four firms, and their views tend to be reflected within official

positions taken by the association on issues of professional consequence.38

The fourth and final reason for questioning the merits of auditor rotation lies

in a report prepared by the Government Accountability Office (GAO) that, ironi-

cally, is viewed by many as a primary reason why auditor rotation was selected

over audit-firm rotation in the first place. That report was prepared and submitted

by the GAO pursuant to Section 207(b) on November 21, 2003, after obtaining

and reviewing comments from seventy-four public accounting firms having ten

37. According to the interview, ‘‘The AICPA and the Big Four have become a hardball lobby- ing coalition with enormous amounts of money. Some of their efforts have come at enormous costs to their prestige, and now, because the results are perceived as contributing to the recent financial disaster of several large public companies, many in Washington are having second thoughts’’ (Morris [2003]).

38. See AICPA Web site (2005), ‘‘Committee Volunteers,’’ http://www.aicpa.org.

158 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

or more SEC clients, 201 chief financial officers of Fortune 1000 public compa-

nies, and 191 of their audit committee chairs (GAO [2003]). The report strongly

favored the adoption of the limited audit-partner rotation requirement, instead of

the more substantial audit-firm rotation requirement. Yet the GAO was subject to

criticism for placing undue emphasis from the outset—even before conducting

the survey that ultimately led to the report—on the costs and fees relating to

audit-firm rotation (GAO [2003]). As one commentator stated, the elimination of

future losses by shareholders and employees, along with the restoration of public

confidence in the market, deserve greater attention and consideration than the

concern for the initial year audit and support costs and increased marketing

expenses of the public accounting firms (Mason [2004], R7, R10).

It is beyond dispute that the responses of the largest entities surveyed by the

GAO were largely negative with regard to mandatory firm rotation. About 79

percent of the auditing firms and public companies that responded to the survey

expressed concern that mandatory firm rotation would increase risks, while

increasing costs. Specifically, some predicted that changing firms would substan-

tially increase the risk of audit failure in the early years for the new auditor

(GAO [2004]).39 Others predicted that mandatory rotation would not relieve the

lead partner of the pressure of dealing with material financial reporting issues or

retention of the client (GAO [2004]).40 Still others predicted audit-firm rotation

would result in more costly audits (GAO [2004]).41

Nevertheless, even the GAO acknowledged that these results were not sur-

prising. The Big Four accounting firms that audit 90 percent of the companies

listed on the New York Stock Exchange, and the management of the large public

companies, were the predominant source of answers to the questionnaires (Mason

[2004], R11). This resulted in those with vested economic self-interest control-

ling the result.

Importantly, however, mandatory audit-firm rotation is still on the table. As

even the GAO concluded in endorsing audit-partner rotation, the SEC and the

PCAOB should monitor and evaluate the effectiveness of the Act’s partner-

rotation requirements for several years and then decided whether to pursue the

topic of mandatory firm rotation (GAO [2003]). This conclusion probably

reflected, at least in part, the concerns raised by a minority of respondents, which

happen to echo my personal concerns expressed above. For example, some

responses acknowledged that mandatory firm rotation had the potential to increase

39. According to GAO ‘‘The primary reason we oppose mandatory rotation of auditing firms is that it would lower audit quality and thereby injure the public interest’’ (GAO [2004], p. 132).

40. ‘‘I believe that the issue that results in audit failures and the drive for auditor rotation are caused by individuals or firm cultures. No amount of regulation is going to control human behavior or address unethical acts’’ (GAO [2004], p. 116).

41. ‘‘Unfortunately, for small firms (under $75,000,000) in revenue the concept ignores the effi- ciency involved in changing firms from both the client and firm perspective. The difference and big- ger issue relates to the fact that for large firms, the audit client is most likely the only client the engagement partner has’’ (GAO [2004], p. 117).

159ETHICAL GUIDANCE AND CONSTRAINT

competition among auditor firms, with the twin benefits of improving indepen-

dence and lowering costs:

Mandatory rotation will provide opportunities for certain firms other than the

Big 4 to grow their public company practice especially for large public com-

panies. This increased level of service to the public company market segment

will enhance competition for talent and for the opportunity to serve these

larger entities requiring services throughout the year (GAO [2004], p. 123).42

Other responses acknowledged that the perception held by individual inves-

tors of auditor’s independence substantially increased under mandatory auditor

rotation (Mason [2004], R7).

Starting in late 2008, six years after the adoption of Sarbanes-Oxley and one

year after the audit-partner rotation requirement will have taken effect, careful

research should be conducted by the SEC, the PCAOB, and various academic, asso-

ciation, and private research organizations to assess whether Sections 203 and 207

are proving effective in protecting the independence of outside auditors. These stud-

ies will present many practical obstacles, because it likely will be difficult to secure

genuine cooperation and accurate disclosures from within private corporations and

auditing firms who have substantial vested interests in validating the adequacy of

the limited audit-partner rotation requirements. Nevertheless, certain objective bench-

marks may be of use in assessing the efficacy of the requirements, such as whether

there is any recognizable change in audit practices or disclosures following a change

in lead partners, as compared with the types of changes that commonly occur fol-

lowing a change in audit firms under other circumstances. Over time, other measura-

ble benchmarks may include whether the original lead partners are simply reinstated

at the end of the five-year time-out periods, giving rise to an inquiry into whether

such partners had remained, for all practical purposes, in charge during the interim

period despite nomenclature to the contrary.

A less empirical, but perhaps far more reliable, method of assessing the effi-

cacy of the rotation requirement will be simply to read the newspapers over the

next few years. If the rotation requirement proves to be too limited, and if corpo-

rations and outside auditors have not learned from the past, then accounting

scandals are likely to continue to occur. If that happens, then Congress will be

well advised immediately to take the actions recommended herein, with regard to

expanding the rotation requirements of Sarbanes-Oxley to include audit-firm

rotation. There would be no need to wait for years to pass and empirical research

to be conducted; the failure of the audit-partner rotation provisions would be

readily apparent in the faces of those individuals who are harmed by unchecked,

unethical business practices.

42. ‘‘The Sarbanes-Oxley Act of 2002 and the recently issued SEC rules on strengthening audi- tor independence, along with vigilant audit committees, are major steps in restoring the investors’ trust and confidence in the capital markets. These positive actions must be given time to work and rebuild investors’ confidence’’ (GAO [2003b], p. 123).

160 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

4. Conclusion

The Sarbanes-Oxley Act has provided an excellent start to ensure that the

accounting disasters of recent years will not be repeated. Some of the key pro-

visions of the Act, such as the Code of Ethics requirements, appear to have

struck their mark and to have begun making improvements. The efficacy of

other provisions, such as the audit-partner rotation requirements, are destined, in

my opinion, to fall short, but should improve considerably with the substitution

of a requirement for audit-firm rotation. Accordingly, every effort should be

made by government decision makers to resist industry pressures to scale back

these provisions. To the contrary, all efforts should be made to allow these pro-

visions to be as effective as possible and, if they prove ineffective, to expand

them.

APPENDIX A

Title IV—Enhanced Financial Disclosures

Section 406. Code of Ethics for Senior Financial Officers

(a) Code of Ethics Disclosure—The Commission shall issue rules to require each

issuer, together with periodic reports required pursuant to Section 13(a) or

15(d) of the Securities Exchange Act of 1934, to disclose whether or not, and if

not, the reason therefore, such issuer has adopted a code of ethics for senior fi-

nancial officers, applicable to its principal financial officers and comptroller or

principal accounting officer, or persons performing similar functions.

(b) Changes in Codes of Ethics—The Commission shall revise its regulations con-

cerning matters requiring prompt disclosure on Form 8-K (or any successor

thereto) to require the immediate disclosure, by means of the filing of such

form, dissemination by the Internet or by other electronic means, by any

issuer of any change in or waiver of the code of ethics for senior financial

officers.

(c) Definitions—In this section, the term ‘‘code of ethics’’ means such standards as

are reasonably necessary to promote—

(1) honest and ethical conduct, including the ethical handling of actual or appar-

ent conflicts of interest between personal and professional relationships;

(2) full, fair, accurate, timely, and understandable disclosures in the periodic

reports required to be filed by the issuer; and

(3) compliance with applicable governmental rules and regulations.

(d) Deadline for Rulemaking—The Commission shall—

(1) propose rules to implement this section, no later than 90 days after the date

of enactment of this Act, and

(2) issue final rules to implement this section, not later than 180 days after that

date of enactment.

161ETHICAL GUIDANCE AND CONSTRAINT

APPENDIX B

Reg. S229.406 (Item 406) Code of Ethics

(a) Disclose whether the registrant has adopted a code of ethics that applies to the

registrant’s principal executive officer, principal financial officer, principal

accounting officer or controller, or persons performing similar functions. If the

registrant has not adopted such a code of ethics, explain why it has not done so.

(b) For purposes of this Item 406, the term code of ethics means written standards

that are reasonably designed to deter wrongdoing and to promote:

(1) Honest and ethical conduct, including the ethical handling of actual or appar-

ent conflicts of interest between personal and professional relationships;

(2) Full, fair, accurate, timely, and understandable disclosure in reports and

documents that a registrant files with, or submits to, the Commission and

in other public communications made by the registrant;

(3) Compliance with applicable governmental laws, rules and regulations;

(4) The prompt internal reporting of violations of the code to an appropriate

person or persons identified in the code; and

(5) Accountability for adherence to the code.

(c) The registrant must:

(1) File with the Commission a copy of its code of ethics that applies to the

registrant’s principal executive officer, principal financial officer, principal

accounting officer or controller, or persons performing similar functions, as

an exhibit to its annual report.

(2) Post the text of such code of ethics on its Internet website and disclose, in

its annual report, its Internet address and the fact that it has posted such

code of ethics on its Internet website; or

(3) Undertake in its annual report filed with the Commission to provide to any

person without charge, upon request, a copy of such code of ethics and

explain the manner in which such request may be made.

(d) If the registrant intends to satisfy the disclosure requirement under Item 10 of

Form 8-K regarding an amendment to, or a waiver from, a provision of its code

of ethics that applies to the registrant’s principal executive officer, principal fi-

nancial officer, principal accounting officer or controller, or persons performing

similar functions and that relates to any element of the code of ethics definition

enumerated in paragraph (b) of this Item by posting such information on its

Internet website, disclose the registrant’s Internet address and such intention.

Instructions to Item 406

(1) A registrant may have separate codes of ethics for different types of officers.

Furthermore, a code of ethics within the meaning of paragraph (b) of this Item

may be a portion of a broader document that addresses additional topics or that

applies to more persons than those specified in paragraph (a). In satisfying the

requirements of paragraph (c), a registrant need only file, post or provide the

portions of a broader document that constitutes a code of ethics as defined in

paragraph (b) and that apply to the persons specified in paragraph (a).

162 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

(2) If a registrant elects to satisfy paragraph (c) of this Item by posting its code of

ethics on its website pursuant to paragraph (c)(2), the code of ethics must remain

accessible on its website for as long as the registrant remains subject to the

requirements of this Item and chooses to comply with this Item by posting its

code on its website pursuant to paragraph (c)(2).

APPENDIX C

Part 249.220f—Forms, Securities Exchange Act of 1934

Item 16B of Form 20-F Code of Ethics

(a) Disclose whether the registrant has adopted a code of ethics that applies to the

registrant’s principal executive officer, principal financial officer, principal

accounting officer or controller, or persons performing similar functions. If the

registrant has not adopted such a code of ethics, explain why it has not done

so.

(b) For purposes of this Item 16B, the term ‘‘code of ethics’’ means written stan-

dards that are reasonably designed to deter wrongdoing and to promote:

(1) Honest and ethical conduct, including the ethical handling of actual or

apparent conflicts of interest between personal and professional relation-

ships;

(2) Full, fair, accurate, timely, and understandable disclosure in reports and

documents that a registrant files with, or submits to, the Commission and

in other public communications made by the registrant;

(3) Compliance with applicable governmental laws, rules and regulations;

(4) The prompt internal reporting of violations of the code to an appropriate

person or persons identified in the code; and

(5) Accountability for adherence to the code.

(c) The registrant must:

(1) File with the Commission a copy of its code of ethics that applies to the

registrant’s principal executive officer, principal financial officer, principal

accounting officer or controller, or persons performing similar functions, as

an exhibit to its annual report;

(2) Post the text of such code of ethics on its Internet website and disclose, in

its annual report, its Internet address and the fact that it has posted such

code of ethics on its Internet website; or

(3) Undertake in its annual report filed with the Commission to provide to any

person without charge, upon request, a copy of such code of ethics and

explain the manner in which such request may be made.

(d) The registrant must briefly describe the nature of any amendment to a provision

of its code of ethics that applies to the registrant’s principal executive officer,

principal financial officer, principal accounting officer or controller, or persons

performing similar functions and that relates to any element of the code of

ethics definition enumerated in Item 16B(b), which has occurred during the

registrant’s most recently completed fiscal year.

163ETHICAL GUIDANCE AND CONSTRAINT

(e) If the registrant has granted a waiver, including an implicit waiver, from a pro-

vision of the code of ethics to one of the officers or persons described in Item

16B(a) that relates to one or more of the items set forth in Item 16B(b) during

the registrant’s most recently completed fiscal year, the registrant must briefly

describe the nature of the waiver, the name of the person to whom the waiver

was granted, and the date of the waiver.

Instructions to Item 16B

1. Item 16B applies only to annual reports, and does not apply to registration state-

ments, on Form 20-F.

2. A registrant may have separate codes of ethics for different types of officers. Fur-

thermore, a ‘‘code of ethics’’ within the meaning of paragraph (b) of this Item

may be a portion of a broader document that addresses additional topics or that

applies to more persons than those specified in paragraph (a). In satisfying the

requirements of paragraph (c), a registrant need only file, post or provide the por-

tions of a broader document that constitutes a ‘‘code of ethics’’ as defined in

paragraph (b) and that apply to the persons specified in paragraph (a).

3. If a registrant elects to satisfy paragraph (c) of this Item by posting its code of

ethics on its website pursuant to paragraph (c)(2), the code of ethics must remain

accessible on its website for as long as the registrant remains subject to the require-

ments of this Item and chooses to comply with this Item by posting its code on its

website pursuant to paragraph (c)(2).

4. Not Applicable

5. The registrant does not need to provide any information pursuant to paragraph (d)

and (e) of this Item if it discloses the required information on its Internet website

within five business days following the date of the amendment or waiver and the

registrant has disclosed in its most recently filed annual report its Internet address

and intention to provide disclosure in this manner. If the registrant elects to dis-

close the information required by paragraph (d) and (e) through its website, such

information must remain available on the website for at least a 12-month period.

Following the 12-month period, the registrant must retain the information for a

period of not less than five years.

Upon request, the registrant must furnish to the Commission or its staff a copy

of any or all information retained pursuant to this requirement.

6. The registrant does not need to disclose technical, administrative or other non-

substantive amendments to its code of ethics.

7. For purposes of this Item 16B:

a. The term ‘‘waiver’’ means the approval by the registrant of a material departure

from a provision of the code of ethics; and

b. The term ‘‘implicit waiver’’ means the registrant’s failure to take action within

a reasonable period of time regarding a material departure from a provision of

the code of ethics that has been made known to an executive officer, as

defined in Rule 3b-7 (S240.3b-7 of this chapter), of the registrant.

164 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

APPENDIX D

Part 249.240f—Forms, Securities Exchange Act of 1934

Notes to Paragraph (8) of General Instruction B

9. (a) Disclose whether the registrant has adopted a code of ethics that applies to

the registrant’s principal executive officer, principal financial officer,

principal accounting officer or controller, or persons performing similar

functions. If the registrant has not adopted such a code of ethics, explain

why it has not done so.

(b) For purposes of this paragraph (9) of General Instruction B, designed to deter

wrongdoing and to promote:

(1) Honest and ethical conduct, including the ethical handling of actual

or apparent conflicts of interest between personal and professional

relationships;

(2) Full, fair, accurate, timely, and understandable disclosure in reports

and documents that a registrant files with, or submits to, the Com-

mission and in other public communications made by the registrant;

(3) Compliance with applicable governmental laws, rules and regula-

tions;

(4) The prompt internal reporting of violations of the code to an appro-

priate person or persons identified in the code; and

(5) Accountability for adherence to the code.

(c) The registrant must:

(1) File with the Commission a copy of its code of ethics that applies to

the registrant’s principal executive officer, principal financial officer,

principal accounting officer or controller, or persons performing simi-

lar functions, as an exhibit to its annual report;

(2) Post the text of such code of ethics on its Internet website and dis-

close, in its annual report, its Internet address and the fact that it has

posted such a code of ethics on its Internet website; or

(3) Undertake in its annual report filed with the Commission to provide

to any person without charge, upon request, a copy of such code of

ethics and explain the manner in which such request may be made.

(d) The registrant must briefly describe the nature of any amendment to a pro-

vision of its code of ethics that applies to the registrant’s principal

executive officer, principal financial officer, principal accounting officer

or controller, or persons performing similar functions and that relates to

any element of the code of ethics definition enumerated in paragraph

(9)(b) of General Instruction B, which has occurred during the registrant’s

most recently completed fiscal year. File a copy of the amendment as an

exhibit to the annual statement.

(e) If the registrant has granted a waiver, including an implicit waiver, from a

provision of the code of ethics to one of the officers or persons described

in paragraph (9)(a) that relates to one or more of the items set forth in

165ETHICAL GUIDANCE AND CONSTRAINT

paragraph (9)(b) of General Instruction B during the registrant’s most

recently completed fiscal year, the registrant must briefly describe the

nature of the waiver, the name of the person to whom the waiver was

granted, and the date of the waiver.

APPENDIX E

Part 249.240f—Forms, Securities Exchange Act of 1934

Notes to Paragraph (9) of General Instruction B

1. Paragraph (9) of General Instruction B applies only to annual reports, and does

not apply to registration statements, on Form 40-F.

2. A registrant may have separate codes of ethics for different types of officers. Fur-

thermore, a ‘‘code of ethics’’ within the meaning of paragraph (9)(b) of this General

Instruction may be a portion of a broader document that addresses additional topics

or that applies to more persons than those specified in paragraph (9)(a). In satisfying

the requirements of paragraph (9)(c), a registrant need only file, post or provide the

portions of a broader document that constitutes a ‘‘code of ethics’’ as defined in

paragraph (9)(b) and that apply to the persons specified in paragraph (9)(a).

3. If a registrant elects to satisfy paragraph (9)(c) of this General Instruction by post-

ing its code of ethics on its website pursuant to paragraph (9)(c)(2), the code of

ethics must remain accessible on its website for as long as the registrant remains

subject to the requirements of this paragraph (9) of General Instruction B and

chooses to comply with this paragraph (9) of General Instruction B by posting its

code on its website pursuant to paragraph (9)(c)(2).

APPENDIX F

Corporate Codes of Ethics or Conduct

Annual Reports, 2004–05 No.

References a Code of Ethics or Code of Conduct 03

Contains a Code of Ethics or Code of Conduct 36

Total Corporations in the Study 39

Note: The annual reports included the Form 10-Ks.

List of Corporations

1. Arrow Electronics, Inc.—Annual Report references code in 10-K Finance Code

of Ethics available on Web site.

2. British American Tobacco—Code of Corporate Governance and Standards of

Business Conduct available on Web site; company noted that it is exempt from

Sarbanes-Oxley, but does comply.

166 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

3. CommScope, Inc.—Annual Report references Code of Ethics and Business Code

for senior corporate officers; Code of Ethics for senior corporate officers avail-

able on Web site.

4. Conagra Foods, Inc.—Annual Report references Code of Ethics for senior corpo-

rate officers; Code of Ethics for senior corporate officers available on Web site.

5. El Paso Electric Company—Code of Ethics not mentioned in Annual Report;

Code of Ethics is available on Web site.

6. Exxon Mobil Corporation—Code of Ethics and Standards of Business Conduct

referenced in 10-K; Code of Ethics and Standards of Business Conduct available

on Web site.

7. First Republic Bank—Code of Ethics mentioned in 10-K; Code of Ethics and

Corporate governance is available on Web site.

8. Friendly Ice Cream Corporation—Code of Ethics referenced in Annual Report;

Code of Ethics is available on Web site.

9. Gannett Co. Inc.—Code of Ethics is mentioned in Annual Report; Code of

Ethics is available on Web site.

10. IVAX Corporation—Code of Ethics is not mentioned in Annual Report; Code of

Conduct is available on Web site.

11. Kellogg Company—Code of Ethics is referenced in Annual Report; Global Code

of Ethics is available on Web site.

12. Kimco Realty Corporation—no reference to Code of Ethics in Annual Report;

Code of Ethics is available on Web site.

13. Newmont Mining Corporation—reference to Code of Ethics in 10-K; Code of

Ethics is integrated into Principles of Business Conduct and Ethics, which is

available on Web site.

14. Ryder System, Inc.—reference to Business Code of Ethics in 10-K; Code of

Ethics available on Web site.

15. Seagate Technology—reference to Code of Business Conduct and Ethics in 10-

K; Code of Business Conduct and Ethics and International Integrity and Ethics

in Worldwide Business Operations, applicable to the senior officers, is available

on Web site.

16. The Sherwin-Williams Company—reference to Business Ethics Policy in 10-K;

Business Ethics Policy available on Web site.

17. Sony Corporation—reference to Code of Ethics in 10-K; Code of Ethics is

included in Code of Conduct, which is available on Web site.

18. Vodafone Group, Plc—Code of Ethics applicable to all officers referenced to in

Annual Report; Code of Ethics available on Web site.

19. Amerada Hess—reference to Code of Business Conduct and Ethics in 10-K;

Code of Business Conduct and Ethics is available on Web site.

20. Curtiss-Wright Corporation—no reference to any ethical code in Annual Report

or in 10-K; Corporate governance guidelines available on Web site.

21. Dow Jones & Company—Annual Report references Code of Ethics; Code of

Conduct and Code of Conduct for Directors are available on Web site.

22. Entergy Corporation—Code of Business Conduct and Ethics for Directors and

Code of Business Conduct and Ethics for Employees (including provisions for

corporate officers) is referenced to in 10-K; Code of Business Conduct and

Ethics for Directors and Code of Business Conduct and Ethics for Employees is

available on Web site.

167ETHICAL GUIDANCE AND CONSTRAINT

23. Ethan Allen—reference to Code of Business Conduct and Ethics in 10-K; Code

of Business Conduct and Ethics is available on Web site

24. Federal National Mortgage Association—Code of Ethics for corporate officers is

referenced in 10-K; Code of Ethics for Directors and Code of Business Conduct

and Ethics for Employees is available on Web site.

25. Genentech, Inc.—Code of Ethics applying to chief executive officer and finan-

cial officers referenced in 10-K; Code of Ethics applying to chief executive offi-

cer and financial officers available on Web site.

26. Gerber Scientific, Inc.—Financial Code of Ethics referenced in 10-K; Financial

Code of Conduct and Ethics applicable to chief executive officer and senior fi-

nancial officers available on Web site.

27. Hormel Foods Corporation—Code of Ethical Business Conduct referenced in

Annual Report; Code of Ethical Business Conduct (covering directors, officers

and employees) is available on Web site.

28. Hovnanian Enterprises, Inc.—Annual Report references Code of Ethics; Code of

Ethics (applying to directors, officers and associates) is available on Web site.

29. ITT Industries—Annual Report references the Code of Ethics titled ‘‘Code of

Corporate Conduct’’ and states that it applies to the chief executive officer and

all financial officers; Code of Corporate Conduct available on Web site.

30. Perry Ellis International Inc.—Code of Ethics applying to all directors, officers,

and employees referenced in 10-K.

31. Rayonier Inc.—Standards of Ethics and Code of Corporate Conduct are refer-

enced in 10-K; Standards of Ethics and Code of Corporate Conduct are available

on Web site.

32. SEI Investments Company—Annual Report references Code of Ethics for senior fi-

nancial officers; Code of Ethics for senior financial officers available on Web site.

33. Schlumberger Limited—Code of Ethics referenced in 10-K; Code of Ethics for

all officers, directors, and employees available on Web site.

34. Taubman Centers, Inc.—Annual Report references Code of Business Conduct

and Ethics; Code of Business Conduct and Ethics available on Web site.

35. Toyota Motor Corporation—Toyota noted that it is exempt from Sarbanes-

Oxley. It has independently chosen to adopt a Code of Ethics applying to all

officers, in addition to their Code of Conduct and the company’s Guiding Princi-

ples. The Code of Ethics is available by viewing Toyota’s 20-F (foreign com-

pany equivalent of a 10-K).

36. Valmont Industries Inc.—Annual Report references a Code of Ethics applicable

to the chief executive officer, chief financial officer, and controller; Code of

Ethics for senior officers available on Web site.

37. Vishay Intertechnology, Inc.—Code of Business Conduct and Ethics and Code

of Ethics applicable to chief executive officer and chief financial officer refer-

enced in 10-K; Code of Ethics applicable to senior financial officers available

on Web site.

38. Westar Energy, Inc.—no reference to Code of Ethics in Annual Report or in 10-

K; Code of Business Conduct and Ethics available on Web site.

39. Winnebago Industries, Inc.—Code of Ethics for chief executive officer and other

financial officers is referenced in 10-K; Code of Ethics for senior financial offi-

cers available on Web site.

168 JOURNAL OF ACCOUNTING, AUDITING & FINANCE

APPENDIX G

36 Codes of Ethics or Conduct, 2004–05

Code Content %

Accuracy and Retention of Business Records 100

Applicable to CEO, CFO, Financial Officers 100

Code Enforcement 92

Confidential Information 83

Conflict of Interest 83

Penalties for Noncompliance—Disciplinary up to Termination 81

Company Property 78

Family Members and Close Personal Relationships 78

Whistle-Blowers 75

Inside Information 69

Compliance with Laws 67

Privacy 58

Ownership in Other Businesses 58

Gifts, Gratuities, and Entertainment 58

Corporate Activities 50

Fair Dealing 44

Fraud and Theft 43

Penalties for Noncompliance—Civil and Criminal Liability 42

Payments and Gifts to Third Parties 39

Intellectual Property 37

Political Contributions and Activities 36

Outside Employment, Affiliations, or Activities 36

Acknowledgment Signature 31

Relationships with Suppliers or Service Providers 28

Antitrust and Unfair Competition 25

Responding to Government and Other Inquiries 25

Relationships with Government Agencies and Outside Organizations 22

Introductory Letter from CEO 22

Personal Involvement and the Political Action Committees 22

Selling to Government Institutions 19

Consultants and Agents 17

Computer Resources and Computer Security 14

Government Procurement 6

169ETHICAL GUIDANCE AND CONSTRAINT

APPENDIX H

Title II - Auditor Independence

Section 203. Audit Partner Rotation

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1) as amended

by this Act, is amended by adding at the end of the following:

(j) Audit Partner Rotation - It shall be unlawful for a registered public accounting

firm to provide audit services to an issuer if the lead (or coordinating) audit

partner (having primary responsibility for the audit), or the audit partner respon-

sible for reviewing the audit, has performed audit services for that issuer in

each of the 5 previous fiscal years of that issuer.

Section 207. Study of Mandatory Rotation of Registered Public Accounting Firms

(a) Study and Review Required - The Comptroller General of the United States

shall conduct a study and review of the potential effects of requiring the man-

datory rotation of registered public accounting firms.

(b) Report Required - Not later than 1 year after the date of enactment of this Act,

the Comptroller General shall submit a report to the Committee on Banking,

Housing, and Urban Affairs of the Senate and the Committee on Financial

Services of the House of Representatives on the results of the study and review

required by this section.

(c) Definitions - For purposes of this section, the term ‘‘mandatory rotation’’ refers

to the imposition of a limit on the period of years in which a particular registered

public accounting firm may be the auditor of record for a particular issuer.

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