| Sarbanes-Oxley Act | | | | markets, securities violations and enforcement actions, |
| In the United States, the Sarbanes-Oxley Act (SOX) | | | | and whether investment banks assisted Enron, Global |
| has introduced new standards of accountability on the | | | | Crossing and others to manipulate earnings and |
| board of directors for U.S. companies or companies | | | | obfuscate true financial conditions. |
| listed on U.S. stock exchanges. Under the Act | | | | 8) Corporate and Criminal Fraud Accountability |
| members of the board risk large fines and prison | | | | Title VIII consists of seven sections and it also referred |
| sentences in the case of accounting crimes. Internal | | | | to as the “Corporate and Criminal Fraud Act of |
| control is now the direct responsibility of directors. This | | | | 2002”. It describes specific criminal penalties for |
| means that the vast majority of public companies now | | | | fraud by manipulation, destruction or alteration of |
| have hired internal auditors to ensure that the | | | | financial records or other interference with |
| company adheres to the highest standards of internal | | | | investigations, while providing certain protections for |
| controls. Additionally, these internal auditors are required | | | | whistle-blowers. |
| by law to report directly to the audit board. This group | | | | 9) White Collar Crime Penalty Enhancement |
| consists of board of directors members where more | | | | Title IX consists of two sections. This section is also |
| than half of the members are outside the company | | | | called the “White Collar Crime Penalty |
| and one of those members outside the company is an | | | | Enhancement Act of 2002.” This section increases |
| accounting expert | | | | the criminal penalties associated with white-collar |
| Sarbanes-Oxley contains 11 titles that describe specific | | | | crimes and conspiracies. It recommends stronger |
| mandates and requirements for financial reporting. | | | | sentencing guidelines and specifically adds failure to |
| Each title consists of several sections, summarized | | | | certify corporate financial reports as a criminal offense. |
| below. | | | | 10) Corporate Tax Returns |
| 1) Public Company Accounting Oversight Board | | | | Title X consists of one section. Section 1001 states |
| (PCAOB) | | | | that the Chief Executive Officer should sign the |
| Title I consists of nine sections and establishes the | | | | company tax return. |
| Public Company Accounting Oversight Board , to | | | | 11) Corporate Fraud Accountability |
| provide independent oversight of public accounting | | | | Title XI consists of seven sections. Section 1101 |
| firms providing audit services ("auditors"). It also creates | | | | recommends a name for this title as “Corporate |
| a central oversight board tasked with registering | | | | Fraud Accountability Act of 2002”. It identifies |
| auditors, defining the specific processes and | | | | corporate fraud and records tampering as criminal |
| procedures for compliance audits, inspecting and | | | | offenses and joins those offenses to specific penalties. |
| policing conduct and quality control, and enforcing | | | | It also revises sentencing guidelines and strengthens |
| compliance with the specific mandates of SOX. | | | | their penalties. This enables the SEC to temporarily |
| 2) Auditor Independence | | | | freeze large or unusual payments. |
| Title II consists of nine sections, establishes standards | | | | Agency cost |
| for external auditor independence, to limit conflicts of | | | | An agency cost is an economic concept on the cost |
| interest. It also addresses new auditor approval | | | | incurred by an organization that is associated with |
| requirements, audit partner rotation policy, conflict of | | | | problems such as divergent management-shareholder |
| interest issues and auditor reporting requirements. | | | | objectives and information asymmetry. The costs |
| Section 201 of this title restricts auditing companies | | | | consist of two main sources: 1. The costs inherently |
| from doing other kinds of business apart from auditing | | | | associated with using an agent (e.g. the risk that |
| with the same clients. | | | | agents will use organizational resource for their own |
| 3) Corporate Responsibility | | | | benefit) and 2. The costs of techniques used to |
| Title III consists of eight sections and mandates that | | | | mitigate the problems associated with using an agent |
| senior executives take individual responsibility for the | | | | (e.g the costs of producing financial statements or the |
| accuracy and completeness of corporate financial | | | | use of stock options to align executive interests to |
| reports. It defines the interaction of external auditors | | | | shareholder interests). |
| and corporate audit committees, and specifies the | | | | The information asymmetry that exists between |
| responsibility of corporate officers for the accuracy | | | | shareholders and the Chief Executive Officer is |
| and validity of corporate financial reports. It | | | | generally considered to be a classic example of a |
| enumerates specific limits on the behaviors of | | | | principal-agent problem. The agent (the manager) is |
| corporate officers and describes specific forfeitures of | | | | working on behalf of the principal (the shareholders), |
| benefits and civil penalties for non-compliance. For | | | | who does not observe the actions of the agent. This |
| example, Section 302 implies that the company board | | | | information asymmetry causes the agency problems |
| (Chief Executive Officer, Chief Financial Officer) should | | | | of moral hazard and adverse selection. |
| certify and approve the integrity of their company | | | | Agency costs mainly arise due to divergence of |
| financial reports quarterly in order to establish | | | | control, separation of ownership and control and the |
| accountability. | | | | different objectives (rather than shareholder |
| 4) Enhanced Financial Disclosures | | | | maximization)the managers consider. Managers usually |
| Title IV consists of nine sections. It describes enhanced | | | | want to satisfy their own objectives such as |
| reporting requirements for financial transactions, | | | | job-guarantee, less work by investing in pt |
| including off-balance-sheet transactions, pro-forma | | | | projects(projects that are not valuable positively for |
| figures and stock transactions of corporate officers. It | | | | the company) , by selecting projects with low payback |
| requires internal controls for assuring the accuracy of | | | | period etc. |
| financial reports and disclosures, and mandates both | | | | According to Ross and Westerfield (Corporate |
| audits and reports on those controls. It also requires | | | | Finance, 7th edition): when a firm has debt, conflicts of |
| timely reporting of material changes in financial | | | | interest arise between stockholders and bondholders. |
| condition and specific enhanced reviews by the SEC | | | | Because of this, stockholders are tempted to pursue |
| or its agents of corporate reports. | | | | selfish strategies, imposing agency costs on the firm. |
| 5) Analyst Conflicts of Interest | | | | These strategies are costly, because they lower the |
| Title V consists of only one section, which includes | | | | market value of the whole firm. These strategies may |
| measures designed to help restore investor | | | | be: 1. Incentive to take large risks; 2. Incentive toward |
| confidence in the reporting of securities analysts. It | | | | underinvestment; 3. Milking the property. |
| defines the codes of conduct for securities analysts | | | | Intellectual property |
| and requires disclosure of knowable conflicts of | | | | Intellectual property (IP) is a legal field that refers to |
| interest. | | | | creations of the mind such as musical, literary, and |
| 6) Commission Resources and Authority | | | | artistic works; inventions; and symbols, names, images, |
| Title VI consists of four sections and defines practices | | | | and designs used in commerce, including copyrights, |
| to restore investor confidence in securities analysts. It | | | | trademarks, patents, and related rights. Under |
| also defines the SEC’s authority to censure or bar | | | | intellectual property law, the holder of one of these |
| securities professionals from practice and defines | | | | abstract "properties" has certain exclusive rights to the |
| conditions under which a person can be barred from | | | | creative work, commercial symbol, or invention by |
| practicing as a broker, adviser or dealer. | | | | which it is covered. |
| 7) Studies and Reports | | | | Intellectual property rights give creators exclusive rights |
| Title VII consists of five sections and are concerned | | | | to their creations, thereby providing an incentive for the |
| with conducting research for enforcing actions against | | | | author or inventor to develop and share the |
| violations by the SEC registrants (companies) and | | | | information rather than keep it secret. The legal |
| auditors. Studies and reports include the effects of | | | | protections granted by IP laws are credited with |
| consolidation of public accounting firms, the role of | | | | significant contributions toward economic growth. |
| credit rating agencies in the operation of securities | | | | |