A Guide to Sarbanes-Oxley, Part One

It was 2002. As a measure to ameliorate the financial industry atrocities that were revealed, the Sarbanes-Oxley Act was adopted. Questions arose regarding its effectiveness, its reach, implementation and adoption. SmartPros dedicated a two-part article to examine the Act and collect opinions and reactions from professionals associated with the industry. Even though 12 years have passed since its implementation and the article has been removed from the SmartPros site, it would serve financial industry newcomers to have a reference point about the "why" of the Act and the early reactions to it.

A Guide to Sarbanes-Oxley, Part One

by
Niquette M. Kelcher
October 2002 -- The groundbreaking Sarbanes-Oxley Act signed into law by President Bush in July 2002 will forever be remembered as the legislation spurred by corporate corruption, crooked CEOs and creative accounting.

In reality, the accounting industry has been heading toward a major reform for many years - it just finally came to a head. Now that it's here, financial executives find themselves at a crossroads, facing the daunting task of implementing major changes in day-to-day operations, while at the same time quickly educating their staff on the sweeping changes brought on by proactive - but also reactive - legislation.

This article provides a concise overview of the many facets of the Sarbanes-Oxley Act (SOA) including:

• How accounting reform caught up with the industry
  
• Major provisions of the Act
  
• Reaction from the trenches
  
• What SOA means to the accounting profession
  
• How managers can implement SOA into the company culture
  
• How to keep staff members educated and informed
  

How Accounting Reform Initiatives Caught Up With the Industry

It's viable to stretch back to the beginning of accounting as an "industry" to address how this recent reform effort came to be, but all we really need to do to understand this phenomenon is step back into the 1990's - a decade that proved to be incredibly tumultuous for the accounting industry overall, a decade that began with an economic slump and ended at the tail-end of a technology boom - to understand why we are here today.

In former Securities and Exchange Commission chairman Arthur Levitt's new book, Take on the Street, published this month, he writes about the politically-charged nature of Wall Street during his tenure as SEC chief in the 90's. Levitt, the 25th chairman and also longest-serving, held the reigns at the watchdog agency for seven years under the Clinton administration. A strong supporter of auditor independence, Levitt, who calls himself "pro-investor," constantly battled with accounting firms and the AICPA over the controversial issue, as firms began to package their auditing services with technology consulting.

But it was an incident involving the Financial Accounting Standards Board that Levitt cites as the biggest mistake he made as SEC chief. In the early part of the 90's, Levitt says he persuaded the FASB to soften its stock-based compensation rules because of political and corporate pressures to do so. (Of course, this same topic is in debate today.)

Levitt states that he learned a valuable lesson from this mistake: "Accounting firms were passive when it came to standing up for investor interests," he writes. "[Auditors] failed to rally to the cause of investors and instead supported the demands of corporate clients. They had become advocates. I would forever look upon the accounting profession differently after this episode."

Hence, Levitt began to tout major accounting reform efforts. At the turn of the millennium he left current SEC chief Harvey Pitt with a lot of reformation left to be done, and until Enron happened, the industry was pretty sure Pitt's "kinder" and "gentler" SEC would stem the talk of accounting reform.

However, Enron helped investors see what Levitt realized many years prior - that the self-regulated industry failed to protect them. Consequently, a weak economy and discontent voters pushed Congress to action. Suddenly Levitt's ideas weren't so radical after all; In fact, many of the reforms proposed by him while he served as SEC chairman have been adopted by the Sarbanes-Oxley Act, legislation that has yet to show its true colors.

Major Provisions of the Sarbanes-Oxley Act

Specifically, the new law, as explained in a SmartPros Financial Management Network segment:

1. Establishes an independent auditing oversight board under the SEC;
   
2. Beefs up penalties for corporate wrongdoers;
   
3. Requires faster and more extensive financial disclosure; and
   
4. Creates avenues of recourse for aggrieved shareholders.
   

One of the most fundamental changes for the accounting profession is the creation of the independent Public Company Accounting Oversight Board, a non-profit corporation funded by public companies and subject to SEC supervision. At this time the Board has yet to be formed, but it is expected to wield significant power. [See $435,000 Oversight Positions Prove Tough to Fill]

Here are links to in-depth texts on the Act:

• Summary at the AICPA Web site
  
• Overview at the Financial Executives International Web site
  
• Full text (PDF) and SOA timeline at CCBN Regulation FD Center
  

Other articles worth reading:

• Four Significant Accounting Changes of the Sarbanes-Oxley Act
  
• Audit Committee and Management Disclosure Requirements of the Sarbanes-Oxley Act
  
• Lawmakers Reach Accord on Corporate Reform Bill
  

Reaction from the Trenches

So far, the reaction from accounting and finance professionals in the field has been mixed. Many say it's about time such legislation passed, while others matter-of-factly state that all the legal ramifications in the world won't stop corporate crooks from lying, cheating and stealing.

In a recent survey conducted by CFO magazine, most financial officers voiced opposition to specific reforms. Some 52 percent, in fact, did not believe audit firms should be banned from providing consulting services to clients; 65 percent did not think auditors should be barred from going to work for clients for a specified period; and 52 percent did not think it wise to rotate auditors on a regular basis.

"For CFOs," says Julia Homer, editor-in-chief of CFO magazine, "all of these proposals are just going to make their jobs more time-consuming and expensive."

Gary Wyatt, CPA, a benefits and compensation specialist with Texas-based Travis Wolff Advisors & Accountants, says those accounting firms with a large number of public clients will be dramatically impacted.

"It will change the way they do business," Wyatt explains. "No longer can the financial statement audit be used as a 'loss leader' in hopes of selling more lucrative tax and consulting services. The largest accounting firms will likely lose many tax-consulting clients to each other. Also, high-quality regional and specialty 'boutique' accounting firms may pick up significant new tax and consulting engagements."

Wyatt also believes private companies will feel the effects of SOA: "Even though the Act is generally applicable only to public companies, the principles may eventually spread into 'best practices' affecting auditors of private companies."

William Maslo, an experienced speaker on financial topics with his own CPA practice in Reading, Pennsylvania, agrees. He speaks for the "non-SEC practitioner" who "is fearful that the concepts of the Sarbanes-Oxley Act could be adopted by state legislatures to affect non-public companies. The larger firms manage to spin off divisions and operate in a way that, at the end of the day, all is well. But for smaller firms this could spell disaster," explains Maslo.

Rebecca Wallace, a Colorado-based attorney and CPA, says the "Act is most significant for accountants because it takes away accountants ability to regulate themselves . . .. While increased oversight of the accounting firms should help to keep the audits in check, too much SEC control over the process is not necessarily a good idea. The creation of layer upon layer of bureaucracy could lead to inevitable inefficiencies in the end sought by the Act."

Bruce W. Marcus, a consultant in marketing and strategic planning for professional firms and the editor of The Marcus Letter on Professional Services Marketing, says the ramifications of the sweeping SOA "may be more damaging than the conditions they mean to correct."

In a recent article, What Sarbanes-Oxley Will Mean to the Accounting Profession, Marcus highlights the inherent challenges accountants - and accounting firms in particular - now face with the implementation of SOA, including the separation of auditing and consulting services. "Many services are relevant to improving the audit," he argues. To meet the needs of its clients, firms will need to find a way to implement consulting services that improve the audit, such as technology services that improve the flow of financial data, without the "consulting services that flagrantly taint the attest function."

Additionally, Marcus recommends the accounting profession re-examine its partnership structure by "reworking the governance structures for better management, and to allow the outside world to see more clearly how each firm is serving the clients and protecting their shareholders."

Likewise, the profession and those who regulate it should remember it does not operate in isolation to the markets it serves. "The time has come for all professionals to recognize that they exist only in their ability to meet the needs of their clients and the public – and not themselves," says Marcus.

Go on to Part Two and learn:

• How managers can implement SOA into the company culture
  
• How to keep staff members educated and informed

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