3:  Sarbanes-Oxley Act of 2002


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The bankruptcy of the one of the best companies
in the United States, Enron, resulted in big shock and decrease in the public
confidence. After Enron, to improve the public confidence of the United States
people and the rest of the world, and also to strengthen weaknesses in the
accounting profession, there had to be something done. The introduction of the
Sarbanes-Oxley Act was then the key to address all these matters. Passing of
Sarbanes-Oxley Act was important in setting the foundation for some accounting
principles and filling the gaps shown by the Enron scandal and other accounting
scandals, including WorldCom, in the accounting profession.  


3.2 Sarbanes-Oxley
Act of 2002 Background

Sarbanes-Oxley is a federal law of United
States, which was passed on 30 July 2002. The act was named after Michael G.
Oxley, who was the representative of the United States, and Paul Sarbanes, who
was the United States senator. The bill was passed as a result of previous
major accounting and corporation scandals, predominantly the Enron scandal. The
main objective of the Act, was to improve the audit process for United States
public companies. Sarbanes-Oxley tried to achieve its objectives by regulating
the accounting profession. To encourage increased public confidence, and to defend
objectivity on independence of securities analysts Sarbanes-Oxley called for
Securities and Exchange Commission (SEC) rule making. The Sarbanes-Oxley Act
enhanced previously enacted standards and also came up with new standards for every
United States public accounting board. Many United States public companies
tried to privatize themselves to avoid compliance with the Act, as the Act
applied to public companies only. The act had 11 titles or sections.


Sarbanes-Oxley Act objectives

Given the systemic weaknesses in the governance
of corporate structure and poor public confidence, after the Enron scandal. The
introduction of Sarbanes-Oxley Act had to correct the systemic weaknesses in
the governance of corporate structure and boost the public confidence. These were
seen as the most important goals that the Act had to achieve. The following
were some of the important objectives of Sarbanes-Oxley:

Improving the accounting oversight

Strengthening the auditor independence

Demanding increased transparency in financial
matters of the company

analysts’ conflicts of interests, and

Demanding more accountability from corporate


Auditor’s incentives and Independence

Many of the weaknesses, that were not
discovered prior the Enron bankruptcy, in auditing the company’s financial
statements were pointed out after Enron scandal. According to Ribstein and
Larry (2002, p. 5) the major issues that caused the auditing of Enron financial
statements not to be efficient were:

the excessive ties of the client, Enron and the
auditing firm, Arthur Anderson.

Insufficient evaluation of accounting firm’s
work by the client company’s audit committees.

Insufficient industry examination of accounting
firm’s work, and

Excessively sloppy accounting standards.

Every companies’ (excluding non-profit
organisations) intention is to make profit, same goes for accounting firms. No
matter how big the size of the accounting firm, the firm may have incentives to
overlook any non-compliance by the client from which its makes material fees
for non-audits work and consulting.

In response to these issues mentioned above and
lack of auditors’ independence, Sarbanes-Oxley Act (s 201,), stated that it is
unlawful for accounting firms to perform both the audits and any non-audit work
for the same client. The Act (Sarbanes-Oxley Acts s 201 (a) 2002) listed the
following as the non-audits services that should not be performed together with
the audit by the accounting firm to the same client.

Actuarial services

Internal audits outsourcing servicing

Designing and implementing the financial
information system

Valuation and appraisal services

Experts and legal services that are not related
to the audit

Investment advisor, dealer or broker, or
investment banking services

Human resources or managerial functions

Bookkeeping or any other services related to
the financial statements or accounting records of the audit client, and

Any other services determined by the Board, by
regulation, is impermissible.

Bratton and William (2002, p.1023) in their
research found that the provision of the Act clearly imposed a complete bar on
consulting. The Act may be confusing as it specifically states that “any
non-audits services including…”, which may mean that the list provided is only
for illustration purposes and that the controlling idea is “any non-audits
services”, which shall be forbidden in whatever nature. But since the lists
ends up with “Any other services determined by the Board, by regulation, is
impermissible”, the controlling idea is ignored. This implied that the
non-audit services that are not on the lists are acceptable until the Public
Oversight Board (POB) outspreads the prohibition. This Act was accepted by many
countries, as even South Africa’s Companies Act No.71 of 2008 (s 90(2(b)(2)(4)(5)(6)) include some prohibitions
relating to auditors who perform the audit and also performs non-audit services
to the same client.

According to L. Ettredge, Scholz and Chan Li
(2007), The Enron, other accounting scandals (i.e. WorldCom) and introduction
of Sarbanes-Oxley resulted in major increase in required accounting and
auditing work. The increase in accounting work and audit resulted to a
corresponding increase in audit fees charged to public companies. This is
supported by SAICA code of professional conduct (s.240), which states that the
auditors and accountants must be remunerated fairly in order to perform their
duties with due and professional competence (Jackson and Stent, p.2/21).


Directors Independence and Audit Committee

Some people may argue that the collapse of
Enron was because of executive directors. According to Eiseberg (1976), this
called upon the creation of “monitoring” board. The underlying concept is that
the company’s main decision-making body should consist mainly the “independent”
directors, who are not full-time employees of the company. These directors are
referred to as “independent non-executive directors”. This concept was
introduced to enable the “independent non-executive directors” to watch over
the executive directors, control the election of directors and nominate
committees that should be involved with the auditing firm (audit committee).

This concept of “monitoring” board had big
influence on accounting profession around the world. Due to huge success its
had, many countries adopted its and one of those countries include South
Africa. All these principles are included in the South Africa’s King IV and
Companies Act 71 of 2008. King IV (2016), states that the Board must have the
majority of non-executive members and most of them must be independence.
Companies Act, states that every Listed Public Company must be Audited.

The Sarbanes-Oxley together with New York
Exchange Board, in 2002 after Enron, submitted to the SEC listing standards which

Demanding the majority board members to have no
substantial relationship with the company

Lengthening the “cooling-off period” to five
years for board duties by former employees of the issuer or its auditor

Prohibiting compensation of audit committee
members apart from directors’ fees

Requiring that an audit committee chairman be a
financial management or accounting expert, and

Isolating the responsibility of electing the
auditing firm

Many of these standards are critical in
accounting profession right now. Since many all of them are adopted by many
countries including South Africa. In South Africa these standards are included
on the King IV. Although non-compliance with King IV but it is a good practise
to comply for many reasons including listing requirement.


Preventing the Next “Enron”

To prevent what happened with Enron,
Sarbanes-Oxley tightened the criminal offences and sentencing guidelines for
high-end frauds. The legal protection provided to the whistle-blowers was also
strengthened. This to many people, especially investors were perceived as one
of good principles passed by Sarbanes-Oxley, since manipulation of financial
statements were to be minimized. Not only did the passing of this principle had
appraisal but there were people, in particular accountants and directors who
were against the passing of this principle. Critics complained that the
Sarbanes-Oxley provisions relating to criminal offences were unnecessarily
redundant. Their motive was that Sarbanes-Oxley relied too much on improved
criminal penalties to meet their objectives. Given the critics, I believe that
passing of this criminal provision by Sarbanes-Oxley, had greater impact on
reducing fraud in the accounting profession and this is the same reason that
caused every country have its tight criminal offences.



Introduction of Sarbanes-Oxley had great impact
not only accounting profession but also on general economy. Although history
does not repeat its self but what happened to Enron might be happening now and
again if Sarbanes-Oxley Act did not recognise the potential downfalls in the
accounting profession and did potentially best to correct them. Although there
were many principles passed by Sarbanes-Oxley, but what happened to Arthur
Anderson firm nearly happened to KPMG (South Africa) last year, due to its
involvement with Gupta family.    

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