[Type the company name]| Why the Sarbanes-Oxley Act should not be repealed. | [Type the document subtitle]| | Introduction of Sarbanes Oxley On March 5th, 2001, Fortune magazine released an article by Bethany McLean. The theme of this article was that Enron’s stocks were overpriced. She stated that Enron’s stocks were really popular and that its numbers were really impressive. Its revenues had doubled to over $100 billion, earnings were increasing by 25% and stocks were returning over 89%. All this seemed a little too much like a fairy tale.
She raised questions like ‘Where does Enron get its revenues from? ’, ‘Why it was so complicated to get information from Enron? ’ and so on. When asked these questions, various Enron executives had different answers; most popular of them was “We do not want to let people know where we make money from. ” We all know what happened to Enron in October of the same year. Many such scandals broke out during the period of 2000-2002, WorldCom, Tyco International, Adelphia, Peregrine Systems were a few to name.
These scandals resulted in many investors losing their money, some who had invested their life savings, due to stock price crashes also causing instability in the stock markets. After a series of analysis and discussions, the senate passed a bill call ‘Sarbanes Oxley Act of 2002’. What areas did the ‘Sarbanes Oxley Act’ cover? The Sarbanes–Oxley Act contains specific mandates and requirements for financial reporting. Like other regulatory requirements, some sections of the act are more pertinent to compliance than others.
The following are the key Sarbanes-Oxley sections: Section 302, Section 401, Section 404, Section 409 and Section 802. 1. Section 302: This section is listed under Title III of the act, and pertains to ‘Corporate Responsibility for Financial Reports’. Periodic statutory financial reports are to include certifications that: •.. The.. signing.. officers.. have.. reviewed.. the.. report. • The report does not contain any material untrue statements or material omission.. or.. be.. considered.. misleading. • The financial statements and related information fairly present the financial condition.. nd.. the.. results.. in.. all.. material.. respects • The signing officers are responsible for internal controls and have evaluated these internal controls within the previous ninety days and have reported on their.. findings. • A list of all deficiencies in the internal controls and information on any fraud that involves employees who are involved with internal activities • Any significant changes in internal controls or related factors that could have a negative impact on the internal controls. 2. Section 401:
This section is listed under Title IV of the act (Enhanced Financial Disclosures), and pertains to ‘Disclosures in Periodic Reports’. According to this section: Financial statements are published by issuers are required to be accurate and presented in a manner that does not contain incorrect statements or admit to state material information. These financial statements shall also include all material off-balance sheet liabilities, obligations or transactions. The Commission was required to study and report on the extent of off-balance transactions resulting transparent reporting.
The Commission is also required to determine whether generally accepted accounting principles or other regulations result in open and meaningful reporting by issuers. 3. Section 404: This section is listed under Title IV of the act (Enhanced Financial Disclosures), and pertains to ‘Management Assessment of Internal Controls’. According to this section: Issuers are required to publish information in their annual reports concerning the scope and adequacy of the internal control structure and procedures for financial reporting.
This statement shall also assess the effectiveness of such internal controls and procedures. The registered accounting firm shall, in the same report, attest to and report on the assessment on the effectiveness of the internal control structure and procedures for financial reporting. 4. Section 409: This section is listed within Title IV of the act (Enhanced Financial Disclosures), and pertains to ‘Real Time Issuer Disclosures’. According to this section: Issuers are required to disclose to the public, on an urgent basis, information on material changes in their financial condition or operations.
These disclosures are to be presented in terms that are easy to understand supported by trend and qualitative information of graphic presentations as appropriate. 5. Section 502: This section is listed within Title VIII of the act (Corporate and Criminal Fraud Accountability), and pertains to ‘Criminal Penalties for Altering Documents’. According.. to.. this.. section: This section imposes penalties of fines and/or up to 20 years imprisonment for altering, destroying, mutilating, concealing, falsifying records, documents or tangible objects with the intent to obstruct, impede or influence a legal investigation.
This section also imposes penalties of fines and/or imprisonment up to 10 years on any accountant who knowingly and wilfully violates the requirements of maintenance of all audit or review papers for a period of 5 years. Does its benefits overcome the costs? Lord & Benoit, LLC a SOX Research and Compliance firm has conducted preliminary research comparing average relative share price movements between companies with material weaknesses in their internal controls over financial reporting as opposed to companies without material weaknesses in heir internal controls over financial reporting. The data was compiled using www. AuditAnalytics. com, a leading provider of audit and internal control related due diligence information for public companies. This report presents results for all December year-end Accelerated Filers that were registrants one year before Section 404 was required and have submitted at least two Section 404 assertions (population of 2,481 companies). The research covers share price movements representing approximately half of the entire market capitalization of all publicly traded companies in the United States.
The research involved assembling three distinct data sets of share prices for all of the 2,481 December year-end publicly held Accelerated Filers that had filed at least two years of Section 404 assessments. An average share price was calculated for each company on each of three dates: March 31, 2004, 2005 and 2006. These dates represented pre-Section 404 compliance, post first year Section 404 compliance and post second year Section 404 compliance periods. The research showed that over the two year period there was a: * 27. 7% increase in the average share prices for companies that had effective controls in both years (8. 92% increase in year one and 18. 72% increase in year two) * 25. 74% increase in average stock prices for companies that had ineffective 404 controls in year one but effective 404 controls in year two (0. 6% increase in year one and 25. 14% increase in year two). * 5. 75% decrease in average stock prices of companies that reported ineffective 404 controls in both years (9. 85% decreases in year one partially offset by a 4. 11% increase in year two).
These historical statistics imply that companies that either historically operated organizations with no material weaknesses in their internal controls, or were able to identify and correct material weaknesses in a timely manner experienced much greater increases in share prices than companies that did not. One could raise cause-and-effect questions with this analysis, but in retrospect, investors would have wanted to know which companies had material weaknesses in their internal controls over financial reporting as of March 31, 2004 and which did not.
As of March 31, 2004 there was no clarity as to the status of a registrant’s internal controls over financial reporting. As of March 31, 2006 there was ample clarity. An investor holding a portfolio of companies at March 31, 2004 who ended up reporting two straight years of adverse 404 assessments would not have been satisfied with those results. An investor holding a portfolio of companies that at first reported an adverse assessment but then remediated their control problems by the second year would have been much more satisfied with their results, but still would not have earned market returns.
The only satisfied investor in this circumstance would have been the one that held a portfolio of companies that had two years of clean internal controls. Sarbanes Oxley was introduced at a time when investors had no faith in corporate America. It was introduced to change that. It tightened rules for corporate audits and forced executives to certify financial statements. Over the years, a lot of corporate leaders have stated that the law is too complex and costly. But according to Mr Christopher Cox, Chairman, Securities and Exchange Commission, the ACT has been well worth the cost.
Here are a list of reasons why – * To make sure that investors could rely on financial statements, rely on audit committees that check against fraud in those financial statements, that they could be assured of more real-time disclosure, and that there would be oversight of the entire accounting profession, which the law established. * The number of private securities class action suits that are brought to rectify instances of fraud have come down over the years. This is one way of measuring that the law has brought down the number of incidences of corporate fraud. According to Mr Cox, many companies who were initially against the law have come around now and have seen the benefits of the law in terms of costs and performance. ——————————————– [ 1 ]. Bethnay, Mc Lean. “Is Enron Overpriced?. ” January 19, 2006. Web. . [ 2 ]. Addison-Hewitt Associates, . “A Guide To The Sarbanes-Oxley Act. ” SARBANES-OXLEY ACT 2002. Web. . [ 3 ]. Lord & Benoit, LLC, . “The Lord & Benoit Report. ” Do the Benefits of 404 Exceed the Cost?. Lord & Benoit, LLC, 2006. Print. [ 4 ]. “Sarbanes-Oxley Lowers Corporate Fraud Lawsuits . “National Public Radio. Web. .