Overview of SarbanesOxley Act

1
Overview of Sarbanes-Oxley Act

• Corporate scandals resulted in numerous
  investigations by Congress and regulatory
  agencies
• Congress responded with the Sarbanes-Oxley Act
  which some view as the most sweeping corporate
  reform legislation since the Securities Exchange
  Act of 1934
• The Act was signed into law by President Bush on
  July 30, 2002
• The SEC is responsible for implementation and
  will establish necessary rules in the coming
  months

2
Provisions of Sarbanes-Oxley Act

• Creates Public Company Accounting Oversight Board
  (Meet the Boards founding members)
• Empowers audit committees to be the client and
  to oversee the audit function independent of
  management
• Establishes new financial reporting requirements
  and criminal penalties for corporate misconduct
• Requires financial statements to be certified by
  the CEO and CFO
• Prohibits certain non-audit services

3
Prohibited Non-audit Services
The Securities Exchange Act of 1934 was amended
to prohibit the following services most of which
were previously prohibited by the SECs rule on
auditor independence

• Bookkeeping or other services related to the
  accounting records or financial statements
• Financial information systems design and
  implementation
• Appraisal or valuation services, fairness
  opinions, or contribution-in-kind reports
• Actuarial services
• Internal audit outsourcing services

• Management or human resources functions
• Broker or dealer, investment adviser, or
  investment banking services
• Legal and expert services unrelated to the audit
• Any other service that the Public Company
  Accounting Oversight Board (Board) determines, by
  regulation, is impermissible

4
Provisions Affecting CPA Firms

• Audit committees must approve audit and non-audit
  services
• Firms must rotate the lead audit and review
  partners every five years
• Audit documentation must be maintained for at
  least seven years
• Firms may not audit a company if its CEO, CFO,
  controller, chief accounting officer, or person
  in a similar capacity worked for the firm during
  the one-year period prior to the initiation of
  the audit

5
Provisions Affecting CPA Firms

• Auditors must describe their testing of internal
  control and report on their findings
• Auditors must report to the audit committee
• All critical accounting policies and practices
• All alternative treatments (and their
  implications) of financial information within
  GAAP discussed with management
• Other material written communications between the
  firm and management (e.g., schedule of unadjusted
  differences and management letters)

6
Corporate Governance Changes

• US stock exchanges have embraced requirements of
  Sarbanes-Oxley
• Approved and proposed changes strengthen the
  integrity and independence of the BOD and its
  committees, especially the audit, nominating, and
  compensation committees
• Read more about these changes at
• www.amex.com
• www.nasdaq.com
• www.nyse.com

7
Corporate Governance Changes
8
Demise of Andersen

• Andersen closed its audit practice and offices
  after the firms June 2002 conviction for
  obstruction of justice related to Enron
• Firm is no longer allowed to audit public
  companies under SEC rules as a result of the
  verdict
• Andersen still exists but very few employees
  remain at the firm
• Andersen was fined 500,000 and placed on five
  years probation as a result of the Enron verdict

9
Disposition of Consulting Units

• The Big 5 firms began disposing of their
  consulting practices well before Sarbanes-Oxley,
  partially to address concerns over independence
  and conflicts of interest
• The last two remaining Big 5 consulting units
  were recently disposed of
• PwC sold its consulting practice to IBM for 3.5
  billion
• Deloitte Consulting went private and was renamed
  Braxton
• Earlier dispositions
• Ernst Young consulting sold to Cap Gemini in
  Feb. 2000
• Andersen Consulting separated from Andersen in
  Aug. 2000, went public, and was renamed Accenture
• KPMG Consulting went public in Feb. 2001, and was
  recently renamed BearingPoint

10
Current Look at the Big 4

• Revenue (2) Prof. (2)
  Revenue
• Rank Firm million
  Staff AA Tax MAS Other
• 1 PwC (1)
  8,057 31,142 35
  20 31 14
• 2 Deloitte Touche (1) 6,130
  20,472 33 21 35
  11
• 3 Ernst Young 4,485
  13,871 58 39 0
  3
• 4 KPMG 3,400
  10,400 44 38
  18 0
• Source Accounting Today March 18- April 7, 2002
  at www.electronicaccountant.com
• (1) Data include consulting practices sold or
  separated in 2002
• (2) Revenue and staff figures do not reflect
  clients and staff gained after Andersen
  discontinued its audit practice

11
Corporate Scandals

• 2002 has seen numerous corporate scandals and
  shareholder value has declined by billions of
  dollars
• Highly publicized scandals include
• ? Tyco ? Adelphia Communications
• ? WorldCom ? Global Crossing
• ? Qwest ? ImClone
• Get updates on corporate scandals from CNN
  Moneys Fraud.inc web site

12
Corporate Scandals Primer

• Tyco CEO and CFO charged with looting the
  company of more than 600 million
• WorldCom Corporate officers charged with
  issuing fraudulently prepared financial
  statements, CEO and CFO are currently under
  investigation regarding capitalization of certain
  expenses
• ImClone CEO admitted to trading on insider
  information prior to the FDAs announcement
  regarding its cancer fighting drug
• Adelphia Communications Members of the
  companys founding family charged with unapproved
  borrowing from the company to cover personal
  investment losses

13
Enron Update

• Arthur Andersen LLP was found guilty of
  obstruction of justice on June 15, 2002. Two days
  later, the firm relinquished its membership in
  the SEC Practice Section.
• Michael Kopper, former assistant to Andy Fastow,
  pleaded guilty to money laundering and conspiracy
  to commit wire fraud. He is cooperating in the
  governments ongoing investigation.
• Andy Fastow, former Enron CFO, was arrested on
  October 2, 2002 and charged with securities, mail
  and wire fraud, as well as money laundering and
  conspiracy. On October 31, a Grand Jury indicted
  him on 78 additional counts.
• David Duncan, former Andersen partner in charge
  of the Enron audit, pleaded guilty on April 6,
  2002 and is awaiting sentencing on obstruction of
  justice charges.
• Enron continues to operate and is pursuing a plan
  to restructure under Chapter 11 bankruptcy.

14
New Fraud Standard - SAS No. 99

• New brainstorming meeting among audit
  engagement team about fraud risks and discussion
  about professional skepticism
• Broader set of information gathered to assess
  fraud risks
• Focus on the fraud triangle
• Expand auditor responses to fraud risks
• Mandate procedures in all audits to address
  ever-present risk of management override

15
The Fraud Triangle
Opportunities Weak Board of Directors Weak
Internal Controls
Attitudes/Rationalizations Lack of a Code of
Conduct Disregard for Financial Reporting
Incentives/Pressures Tight Debt
Covenants Unrealistic Analyst Expectations
16
Information to Assess Fraud Risks
Analytical Procedures
Fraud Risk Factors
Other Information
Brainstorming
Inquiries
Identified Fraud Risks
17
Other New SASs

• The ASB has issued two other new standards
• SAS No. 97, Amendment to SAS No. 50
• SAS No. 98, Omnibus-2002

• SAS No. 97 auditors may not provide a written
  report on a hypothetical transaction
• SAS No. 98 omnibus standard that includes a
  number of amendments and revisions

18
On the Horizon

• Joint Risk Assessments Task Force
• Joint effort between ASB and IAASB
• Considering a revision of the current risk model
• Exposure draft is to be issued in December 2002
• Audit Committee Task Force
• Consider impact of Sarbanes-Oxley Act on SASs
• Modify establishment of understanding with client
  given that audit committees are now to be viewed
  as the client
• Include additional required discussions in the
  communications with audit committees