The Sarbanes-Oxley Act of 2002
Introduction
Throughout this research the author will make a great effort to describe the environment in which Sarbanes-Oxley Act was born by providing a depiction of some of events occurred, involving Enron organization. In addition, the author will attempt to accomplish a thorough analyze on several parts of Sarbanes-Oxley Act, and ramifications associated with Sarbanes-Oxley Act post- enactment.
What instigate Sarbanes-Oxley Act? : Enron’s failure.
Enron was an organization that was founded based on 2(two) natural gas companies:
The first company was InterNorth, (a gas pipeline) that was started on 1930 in Nebraska and was known as Northern Natural Gas, (a name that was kept until 1980, then changed to InterNorth) Hampton, Hoovers D & B).
The second company was Houston Natural Gas (HNG), which was known as gas distributor, created in 1925 in south Texas, and start emerging oil and gas in 1953.
The name Enron was first utilized in 1985; InterNorth got its hands on Houston Natural Gas (HNG), and created the largest natural gas pipeline system of USA, which relocated its center of operations to Houston (from Omaha).. Rapidly growing within, Enron expended its business not only within USA but also globally (Portland, Argentina Porto Rico, UK, Brazil, Australia (Hampton, Hoovers D & B). Unfortunately, despite its enormous progress Enron organization and its executives developed diverse and profound issues that were mostly related to:
1- Enron’s and its senior executives’ greed.
Enron’s senior executives got used to gigantic compensation incentives package to the point that they were willing to intentionally manipulate the accounting, in order to maintain their compensations (Giroux, 2008).
2- Enron’s senior executives’ arrogance (they believed they will get away with it).
3-The existence of deregulation (allowed Enron to hide organization’s loses and manipulate balances sheets). Enron’s distinction was internationalization of market mechanism, and this opportunity was result of the deregulation subsistence (Kobrak, 2009).
4- Enron’s sophisticated fraud, (by utilizing complex financial instruments).
5- Enron’s massive assistance on committing the fraud and hiding it, retrieved by third party (Enron’s auditor, Arthur Anderson played an enormous role on Enron’s scandal) (Giroux, 2008).
6- Enron’s and its executives (involved in scandal) lack of ethical standards.
Another factor that has a negative effect (in the long run) was the, political system used by some politicians. Some politicians constantly favored Enron, thanks to massive contributions to their campaigns and immense lobbying (Giroux, 2008).
As the result of all above Enron was deeply involved on accounting fraud, which caused the seventh largest corporation to be implicated on the white collar crime. Enron’s disgraced situation was due to violation of accounting practice, disobedience of Securities and Exchange Commission (SEC) policies. The accounting Fraud at Enron was complex and that’s exactly why resulted on Enron’s collapse. Enron’s annual reports annual reports prepared for shareholders declared very far above the ground earnings, but set aside approximately all its debt off the annual reports by stating in a footnote that a special purpose entity covered all its debts, but that special entity did not have the assets to cover the debt and was headed by individuals connected to the corporation that covered the debt [that was a violation of (SEC) regulations]. Furthermore, investors in the special purpose entity did not have sufficient capital at risk [which is also violation of (SEC) regulations].
It would have been wiser for Enron to utilize its high income for paying its debts, but then shareholders would have been unhappy with their dividends and stock prices would have advanced with a slower past. Consequently Enron’s debts increased to $1.2 billion (while there were no assets available) forcing Enron to file for Bankruptcy (Siegfried, 2005).
Arthur Andersen & Company was also intensively scrutinized as the result of its attachment and association with Enron. The Chicago, Illinois firm use to provide audit, tax and consulting services for Enron. In 2002, Arthur Andersen & Company was convicted of obstruction of justice when David Duncan (a lead partner on the Enron account) and Nancy Temple (of Andersen's legal team) shredded supporting documents produced from their audit of Enron. As consequence Arthur Andersen & Company sow no other option but surrendering its licenses and ending its operations (Petra & Loukatos, 2009).
The consequences for Enron and Arthur Anderson & Co
1- Enron collapsed and filed chapter 11 bankruptcy protection.
2- 15 former executives of Enron were found guilty and punished by law.
3- The conviction of the Enron’s founder Ken Lay was dismissed because of his death.
4-Former CEO Jeff Skilling was sentenced to 24 years in prison.
5-Former Chief financial officer Andrew Fastow was sentenced to 6 year in prison.
6- Former Chief accounting officer Richard Causey was sentenced to 5and ½ years in prison.
7-Michael Cooper former executive was sentenced to 3 and ½ years in prison.
8-Former CEO, Kenneth Rice was sentenced to 27 months in prison and $15 million fine.
9-Former Enron Breadboard COO Kevin Hannon was sentenced to 2 years in prison and fined $125,000.
10- Mark Koenig former investor’s relations chief was sentenced to 18 months in prison.
11- Former Breadboard CEO Joe Hirko was sentenced to 16 months in prison.
12- Vice president of finance Kevin Howard received 1 year probation (9 moths of that under home confinement) and $25,000 fine (Cellmates, 2007)
Consequences for Arthur Anderson & Co
1- Auditor Arthur Andersen LLP was sentenced to 5 years probation and $500,000 fine.
2- Andersen firm lost its right to audit Public companies
3- Andersen (once the largest accounting firm with 85,000 employees) within a year was reduced
to a small company with less than 300 employees (Rouse, 2005).
4- Andersen lost almost all its clients and business
5- Andersen firm was forced (from the situation created) sell all its assets to it competitors.
6- Lost its reputation (Flower, 2002).
The Legislative consequences: The Sarbanes-Oxley Act of 2002.
Enron’s financial collapse had substantial ramification throughout the financial investment field, tax compliance professions and the accounting profession. The deep
Congressional assessment resulted in a new epoch of transparency, stringent standards (as provided in Sarbanes – Oxley) and substantional penalties for failure to act in accordance with (Bottiglieri, 2009).
The United States House of Representatives voted 423:3 and the US Senate voted 99:0, in favor of Sarbanes-Oxley Act of 2002, which then was signed by President George W. Bush and became a law on July 30, 2002. Sarbanes-Oxley Act of 2002 is seen as a quick response to accounting and corporate governance scandals (Petra & Loukatos, 2009) and also is considered the most significant change to federal securities legislation in the country in over 50 years.
Chief sponsors of Sarbanes-Oxley Act of 2002 were Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH) (Encyclopedia of small business, 2007).
Failure to abide by SOX means individuals and companies would be subject to civil responsibilities and criminal charges.
Sarbanes-Oxley Act of 2002 is applicable and valid for:
1- All public organizations in the United States
2- All international organizations that have their equity or debt securities registered with SEC (Securities and Exchange Commission)
3- All accounting firms that execute auditing services for above mentioned organizations (Valoir, 2010).
The Purpose of Sarbanes – Oxley Act
The main objective of Sarbanes – Oxley Act’s purpose are: 1- To protect investors 2-Enforce the prohibition on audit firms from providing supplementary services to their clients
3- Govern the activities of publicly traded companies (Bottiglieri, 2009).
4- To accurate and perfect general flaws in corporate governance constitution
5-To advance accounting oversight, also to make auditor independence more powerful,
6- To demand additional transparency in corporate financial subject,
7- To reduce/remove conflicts of interest, and stipulate greater accountability from corporate executives.
8- To provide considerable large lawful protection for whistleblowers (according to Sarbanes-Oxley: taking any action that is hurtful to any person in vengeance just because that individual provides information regarding a federal crime to law enforcement representatives is considered felony ) (Brickey, 2003).
This bill increases supervision of the accountants that audit public companies, strengthened corporate responsibility, increased transparency of corporate financial statements, also increased protections for employees’ access to their retirement accounts (Bottiglieri, 2009)
Titles of Sarbanes – Oxley Act
The Sarbanes – Oxley Act has 11 titles, which are divided into 2(two) sections. Title I – Public accounting Oversight Board
Title II – Auditor Independence Title III – Corporate Responsibility Title IV – Enhanced Financial disclosures
Title V – Analyst Conflicts of Interest Title VI and VII – Sec Role and Studies
Title VIII – Corporate and Criminal Fraud accountability
Title IX – White Collar Crime Penalty Enhancements
Title X – Corporate Tax returns
Title XI – Corporate fraud and accountability (Encyclopedia of small business, 2007).
13 Major DOS and DON’TS of Sarbanes – Oxley Act
1-Audit firms shall be registered. They must do audits only. If they do other work for a company, they must not do audits for that company (Encyclopedia of small business, 2007).
2-The Company’s audit committee members shall be independent board members.
3-Stock analysts shall be subject to conflict of interest rules.
4-Companies must disclose all pertinent information that may in any way affect company finances, whether on or off the balance sheet.
5-Companies shall not lend money to executive officers or directors.
6-CEO and CFO compensation, bonuses, and profit sharing shall be reported to the public.
7-Insider trades must be made public immediately.
8-Insiders shall not trade company stock during periods of pension fund blackouts.
9-Financial reports must be certified by the CEO and CFO.
10-Financial reports must be accompanied by a special report on internal controls and an assessment on how well they work.
11-Federal income tax filings must be signed by the CEO.
12-Whistleblowers shall be protected.
13-Violators shall pay higher fines and spend longer times in prison (Encyclopedia of small business, 2007).
Post- enactment and outcomes of Sarbanes – Oxley Act
Several researches completed after Sarbanes – Oxley Act passage make available evidence of a significant boost in the issuance of going-concern opinions, related to earlier time periods. The researchers discovered that, in general auditors reflect and demonstrate a more conservative behavior when their occupation (line of work) is in headlines. Unfortunately, auditor’s conventional performance it is not persistent, indeed such behavior fades with time. According to examinations accomplished by various researchers, the percentage of going – concern modifications for the year of 2002 -2003, stridently amplified when compared to 2000 -2001.
But, if compared to the after 2003 years, that percentage declined and eventually came down to its pre-Enron event records (Feldmann, & Read, 2010).
Bradford, et, al., (2010) insist that several researchers came to the conclusion that the Sarbanes – Oxley Act very quickly appeared to become one of the most expensive laws in history associated to accounting regulations. The cost of this act was related to significant, deep internal control evidence that was required to be evaluated by auditors.
At one point, the cost of Sarbanes – Oxley Act compliance for public organizations was portrayed by the press and studies as ‘tremendous”. Furthermore, the legislation was seen as unpopular by many, because:
1- The Act had a high cost
2- The Act lacked clear guidance on it implementation
3-The Act was opposed and resisted by publicly traded organizations
In one of its articles written on March 2010, Information Management Journal goes even further, by insinuating the end of the Sarbanes-Oxley Act (SOX). The article states that U.S Congress and Supreme Court very possible could come to a decision to declaw the act in a very near future. During a recent section, the House of Representatives voted to endorse an amendment completed by Garret-Adler. Garret-Adler amendment (if approved) will no longer hold small companies liable as required by SOX section 404 requirements. The amendment is supported by a study conducted independently by Pennsylvania State University. The study demonstrated that small companies ($75 million mark and under), paid out close to $700,000 more for audit fees, averaging negative earnings of 1.4 million in 2004 alone. In addition, the Supreme Court is taking into consideration the constitutionality of the Public Company
Accounting Oversight Board (PCAOB). A profound analyze of the above proceedings, implies the possibility of a long – term implications and repercussions for Sarbanes – Oxley Act of 2002 (Information Management Journal, 2010).
Regardless all the negative and unenthusiastic reaction to Sarbanes-Oxley Act cost of compliances, there is subjective indication, which implies that companies did slowly accustomed to the new standards and regulations obligatory on them. First year, companies start complying with Sarbanes-Oxley Act was 2004. Their focus was to document, test, and remediate internal controls. Most of the public companies rushed to settle on what controls to test, how much to test, what to document, and what would satisfy their auditors for remediation purposes (Bradford, et. al., 2010).
Conclusion
Corporate fraud and bankruptcies have always been and will continue to be part of the business environment. As we all are aware of, business failures and frauds are witnessed every decade and not surprisingly the major ones accrue during recession and/or problematic situations with the economy. Normally the reason behind frauds, scandals and scams are greed and arrogance. After Enron’s collapse we observe a considerable and effective oversight and regulations been enforced. Furthermore, the less numbers of accounting – related scandals are suggesting that the post Sarbanes –Oxley oversight and regulations are working reasonably well Giroux, 2008). But, despite the reforms provided by Sarbanes-Oxley, scandals continue to occur (not on the scale that they were witnessed in previous decades though). For instance, the multi –billion dollars scandal of Madoff’ or Sanford Financial group fraud (with its billionaire Allen Sanford) conforms the above statement and reinforces the fact that other Enron could possibly be around the corner which means oversight and regulations are not only necessary and need to continuously be enforced ,but also it is obligatory to evaluate the situations constantly and create new rules and regulations to prevent the frauds and scams before they transpire (Bottiglieri,2009).
Clearly, Sarbanes-Oxley Act of 2002 is not going to be the last word on corporate governance transformation or punishing unlawful fraud. As we all are aware, no simple resolution exists to a culture of deceitfulness established on greed, mismanagement, conflicts of interest, and failure of professional and regulatory oversight. Sarbanes-Oxley is proved to be a beneficial improvement in the right direction. Probably it is not the best, but it clearly signals that this should never happen again and if it happens consequences will follow (Brickey, 2003).
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