Sarbanes-Oxley and What It Means To You

Do you remember the media frenzy over Enron and Worldcom a few years ago? I don’t think any of us have forgotten those sensational headlines. Out of nowhere, every newspaper, magazine and radio broadcast discussed accounting errors, auditing procedures, allegations of corporate improprieties and the role of the auditors in corporate America. The day Enron filed for bankruptcy its stock closed at 72 cents, down from more than $75 less than a year earlier. Many employees lost their life savings and tens of thousands of investors lost billions in the stock market. The collapses of Enron and Worldcom have changed the regulatory environment in which auditors and their respective clients interact. As a result, The Sarbanes-Oxley Act of 2002 (SOX) was enacted and applies to registered public accounting firms who audit public companies and increases corporate accountability for the companies under audit.

With the enactment of SOX, the Securities and Exchange Commission (SEC) created the Public Company Accounting Oversight Board (PCAOB) to oversee the audit of public companies. The PCAOB may adopt auditing, accounting, ethical and other standards, subject to SEC approval. It also has the power to impose suspensions and revocations of firms who are not complying with the standards set forth by the PCAOB. In addition, SOX has established harsh penalties for securities law violations, corporate fraud and document shredding.

One of the major changes that public company auditors will need to adhere to are the SOX standards for assessing the effectiveness of a company’s internal controls. Internal controls should address the company’s establishment and maintenance of strategies and policies company management has in place to ensure proper financial reporting. Company management is required to identify, document and evaluate significant internal controls on a regular basis and accept responsibility for the effectiveness of those controls. Company auditors are now responsible to report on management’s assertion about the effectiveness of its internal controls each year. These new requirements are increasing compliance costs for both publicly-traded companies and their auditors.

SOX also raised corporate accountability for certain officers of publicly traded companies. In all quarterly and annual filings, the CEO and CFO must personally certify that the financial statements issued “fairly present, in all material respects, the financial condition and results of the operations of the issuer.” By their signature, corporate officers have indicated that they are responsible for the design, testing and effectiveness of the company’s internal controls. Their signatures also indicate that they have disclosed to the auditors and the company’s audit committee any fraudulent behavior that involves management or other employees who have a significant role in the company’s internal controls. Violations of SOX provisions may yield a penalty of up to 25 years of imprisonment, depending on the severity of the violation. For example, any person who alters, destroys, mutilates, conceals, falsifies or makes a false entry in any record or document with the intent to impede or influence proper financial reporting may be imprisoned for up to 20 years.

SOX also severely restricted the services auditors and accounting firms can perform for publicly-traded audit clients. SOX lists eight types of services that are unlawful if provided to a publicly-held company by its auditor: bookkeeping, information systems design and implementation, appraisals or valuation services, actuarial services, internal audits, management and human resources services, broker/dealer and investment banking services, and legal or expert services unrelated to the audit. As a result, publicly-traded companies are engaging multiple accounting firms in order to meet all compliance and consulting needs.

SOX dramatically changed the relationship between auditors and their publicly traded clients, but what does all this mean to a closely-held company that has not yet been effected by the regulatory provisions of SOX? It is at the discretion of each state’s lawmakers to interpret and implement the provisions set forth by SOX for companies within its jurisdiction. At this time, Washington State has elected not to implement the provisions of SOX for auditors of non-public entities. A closely-held company in Washington is not currently subject to the SOX provisions, but they do indicate what the future may hold. Generally accepted auditing standards governing the audits of closely-held companies are also under scrutiny in response to the audit failures of companies like Enron and Worldcom. Non-public company auditors are responding to these changes and as a result, there is more emphasis on company management to evaluate their internal control structure and to implement strategies to mitigate fraudulent behavior and corporate improprieties.

Please keep in mind that we have provided only a summary of the major provisions in The Sarbanes-Oxley Act of 2002 and as time goes on, these provisions may be amended to better serve the needs of the public. We’ll keep our closely-held business clients abreast of changes at the federal and state level which may impact them in the future.

Theola Eng, CPA
Assurance Services Department