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Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (Public Company Accounting Reform and Investor Protection Act, Pub.L. 107-204, July 30, 2002, 116 Stat. 745, July 30, 2002) was enacted by Congress in the wake of corporate and accounting scandals that led to bankruptcies, severe stock losses, and a loss of confidence in the stock market. The act imposes new responsibilities on corporate management and criminal sanctions on those managers who flout the law. It makes securities fraud a serious federal crime and also increases the penalties for white-collar crimes. In addition, it creates a new oversight board for the accounting profession.
During the 1990s, the stock market rose dramatically in value, fueled by the promise of the Internet revolution as well as large corporate mergers and acquisitions. Several of that decade's changes produced severe consequences during the first years of the new century. The five major U.S. accounting firms developed consulting divisions that advised corporations on ways to maximize their profits. Their advice often clashed with the traditional auditing functions and standards of these accounting firms. At worst, the accounting firms forfeited their traditional oversight function and allowed or encouraged financial reporting practices that misled investors. On the corporate side, managers were expected to produce short-term gains on a quarterly basis to satisfy investment analysts who worked for stock brokerages. These analysts were sometimes encouraged and directed by management to tout the value of questionable stocks. Some corporate managers, who skirted or broke laws that mandated honest financial reporting, transformed the drive for profitability into a lust for personal fortune. The bubble burst when the Enron Corporation filed for bankruptcy in December 2001 and the accounting firm of Arthur Andersen was convicted of obstruction of justice for its actions in shredding Enron-related documents. As the stock market plummeted and investor confidence waned, Congress responded. Senator Paul S. Sarbanes (D-Md.) and Representative Michael Oxley (R-Ohio) worked to enact a set of provisions that would prevent future debacles such as those that ruined Enron and Arthur Andersen. President George W. Bush, after initially downplaying the need for reform, signed the bill into law on July 30, 2002.
Under the act, the Securities and Exchange Commission (SEC) has the authority to prohibit, conditionally or unconditionally, permanently or temporarily, any person who has violated laws governing the issuing of stock from acting as an officer or director of an corporation if the SEC has found that such person's conduct "demonstrates unfitness" to serve as an officer or a director. The act also imposes new disclosure requirements when companies file financial reports. Under Section 302 of the act, the SEC is required to issue a rule that mandates that the principal executive officer and the principal financial officer certify in each annual or quarterly report the accuracy of certain information. The signing officer must disclose to the auditors and audit committee any significant deficiencies in the design or operation of the internal controls, any fraud, whether or not material, that involves management or other employees who have a significant role in the issuer's internal controls, and any significant changes in the internal controls. Section 906 requires that the chief executive officer and chief financial officer provide written statements to be filed with each periodic report filed under the Securities Exchange Act of 1934 certifying that the periodic report containing the financial statements fully complies with the requirements of Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. A knowing violation of Section 906 is punishable by up to ten years in jail and a $1 million fine. A willful violation is punishable by up to 20 years in jail and a $5 million fine.
Section 303 prohibits any officer, director, or person acting at their direction "to fraudulently influence, coerce, manipulate, or mislead" an accountant who is conducting an audit. Under Section 304, if an issuer is required to restate its financial statements as a result of misconduct, the chief executive officer and chief financial officer must reimburse the issuer for any bonus or other incentive-based compensation paid during the twelve-month period following the improper reporting. Those officers also must pay to the company any profits realized from the sale of its securities during that twelve-month period.
The Sarbanes-Oxley Act also authorizes the establishment of a Public Company Accounting Oversight Board, which will oversee the accounting profession. Under Section 1 of the act, the board will have five financially experienced members who are appointed to five-year terms. Two of the members must be or have been certified public accountants, and the remaining three must not be, and must never have been, CPAs. The chair may be held by one of the CPA members, provided that he or she has not been engaged as a practicing CPA for five years. The board's members will serve on a full-time basis. Members of the board are appointed by the SEC "after consultation with" the chairman of the Federal Reserve Board and the secretary of the Treasury. No member may, concurrent with service on the Board, "share in any of the profits of, or receive payments from, a public accounting firm," other than "fixed continuing payments," such as retirement payments. The Commission may remove members "for good cause."
The Accounting Oversight Board will register accounting firms, develop auditing standards and rules of ethics for the profession, and investigate accounting firms. The board may discipline and sanction accounting firms that violate rules. It is required to "cooperate on an on-going basis" with designated professional groups of accountants and any advisory groups convened in connection with standard-setting, and although the board may, "to the extent that it determines appropriate," adopt standards proposed by those groups, it will have authority to amend, modify, repeal, and reject any standards suggested by the groups. The board must report to the SEC on its standard-setting activity on an annual basis.
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Monks, Robert A. G., and Nell Minow, eds. 2001. Corporate Governance. 2d ed. New York: Blackwell.
Root, Steven J. 2000. Beyond Coso: Internal Control to Enhance Corporate Governance. New York: John Wiley & Sons.