Regulatory Bodies, Standard Setters, and Best Practices

1
Regulatory Bodies, StandardSetters, and Best
Practices

• Chapter VII

2
Chapter Objectives

• Understand the roles and responsibilities of
  regulators and standard setters.
• Provide an overview of fundamental provisions
  of SOX and their impacts.
• Provide an overview of the evaluation of SOX
  (cost and benefits).
• Understand why the SEC was established.
• Provide an overview of the primary functions of
  the PCAOB.
• Become familiar with the role of the FASB and
  its activities.
• Provide an overview of the GASB.
• Understand the challenges facing the IFAC.
• Identify the primary responsibilities of the
  Committee of European Securities Regulators.
• Understand the role and authority of the state
  attorney general.
• Be aware of how state laws affect corporate
  governance.
• Be aware of the role of courts in corporate
  governance.
• Become familiar with corporate governance
  listing standards and best practices.

3
Key Terms

• Accounting and Auditing Enforcement Releases
  (AAERS)
• Accounting Regulatory Committee (ARC)
• Administrative law judges
• American Bar Association (ABA)
• American Institute of Certified Public
  Accountants (AICPA)
• Anticontractarianists
• Blackout period
• California Public Employees Retirement System
  (CalPERS)
• Committee of European Securities Regulators
  (CESR)
• Contractarianists
• Council of Institutional Investors (CII)
• European Financial Reporting Advisory Group
  (EFRAG)
• Generally accepted accounting principles (GAAP)
• generally accepted accounting standards (GAAS)
• Government Accounting Standards Board (GASB)
• International Accounting Standards Board (IASB)
• investment protection principles (IPPs)
• Investor Task Force
• Office of Risk Assessment

4
Regulations

• Regulations are aimed at protecting the investors
  and creating an environment for organizations to
  conduct their affairs in the utmost ethical,
  legal, and competent manner.
• Regulations are typically enacted in response to
  specific crises and concerns or protection needed
  due to the failure of market based correction
  mechanisms. Adequate regulation creates a balance
  between reducing the likelihood of recurrence of
  the crisis and the imposed enforcement and
  compliance costs. Underregulation is when
  adequate rules are not in place to ensure
  long-term improvements and stability.

5
Sarbanes Oxley Act of 2002

• Was enacted in July 2002 in response to the
  economic downturn of the early 2000s, several
  years of steady decline in the capital markets
  and numerous high-profile financial scandals.
• The fundamental provisions of SOX can be
  categorized into the following five categories
  (1) corporate governance (2) financial
  reporting (3) audit functions (4) federal
  securities law enforcement and (5) others (e.g.,
  legal counsel, financial analysts).

6
SOX provisions

• Influence on corporate governance (1) auditors,
  analysts, and legal counsel who were not
  traditionally considered as components of
  corporate governance are now brought into the
  realm of internal governance as the gatekeepers,
  (2) the legal status and fiduciary duties of
  directors and officers, particularly the audit
  committee and CEO, have been enhanced
  significantly, (3) certain aspects of state
  corporate law were preempted and federalized.
  (e.g. Section 404 of SOX prohibits loans to
  directors and officers, whereas state law permits
  such loan), (4) SOX is considered a process whose
  impact on improving the effectiveness of
  corporate governance will continue for years to
  come.

7
SOX provisions

• Financial reporting provisions of SOX and
  SEC-related rules are
• 1. Certification of financial statements and
  internal controls by CEOs and CFOs
• 2. Disclosure of off balance sheet transactions
• 3. Disclosure pertaining to the use of non-GAAP
  financial measures
• 4. Disclosure of material current events
  affecting companies
• 5. Mandatory internal control reporting by
  management
• 6. A study of principles-based accounting
  standards
• 7. Convergence of accounting standards
• 8. Recognition of an adequate funding for the
  FASB as an accounting standard-setting body
• 9. Oversight function of the FASB by the SEC.

8
SOX provisions

• Provisions of SOX and SEC-related rules
  addressing audit functions are
• 1. Creation of the PCAOB to regulate public
  accounting firms practice before the SEC
• 2. Adoption of new rules related to auditor
  independence
• 3. Establishment of auditing standards in guiding
  auditors to improve audit quality
• 4. Issuance of new rules related to improper
  influence on auditors
• 5. Issuance of new rules pertaining to retention
  of records and audit evidence relevant to reviews
  and audits of financial statements
• 6. Establishment of quality control standards to
  protect investors from receiving misleading
  financial information
• 7. Oversight function of the PCAOB by the SEC
• 8. Attestation of and report on ICFR

9
SOX provisions

• SOX empowered the SEC to better enforce federal
  securities laws to improve public trust and
  investor confidence in the capital markets. SOX
  enabled the SEC to use various means to bring
  enforcement actions against corporate wrongdoers,
  sanction them, obtain penalties and disgorgement,
  and compensate injured investors.
• The following SEC-related rules address the
  conduct of gatekeepers other than directors,
  management, and auditors
• 1. Rules governing research analysts potential
  conflicts of interest
• 2. Rules regarding standards of conduct for
  attorneys practicing before the SEC
• 3. Rules pertaining to rating agencies
• 4. Rules concerning mutual and hedge funds
• 5. Rules pertaining to investment banks

10
SOX Global Reach

• Several provisions of SOX have been adopted in
  countries worldwide, which lends credibility to
  SOX and its intended purpose of protecting
  investors.
• Adopted provisions by other countries, including
  Australia, Canada, China, India, and Mexico, are
  executive certification of financial statements,
  mandatory audit committees consisting of all
  independent directors, creation of standard
  setting bodies similar to the PCAOB in regulating
  the auditing profession, the rotation of audit
  partners and audit firms, and executive
  certification of ICFR without requiring an audit
  opinion.

11
Securities and Exchange Commission

• The SEC has four divisions
• 1) Division of Corporate Finance, which oversees
  corporate disclosure of public information by
  reviewing registration statements for newly
  offered securities, annually audited and
  quarterly reviewed filings (Forms 10-K and 10-Q)
• 2) Division of Market Regulations, which
  establishes and maintains standards for fair,
  orderly, and efficient capital markets by
  regulating the major securities market
  participants, including broker/dealer firms and
  self-regulatory organizations (SROs) such as
  stock exchanges and the NASD
• 3) Division of Investment Management, which
  oversees and regulates the investment management
  industry and administers securities laws relevant
  to investment companies (e.g., mutual funds) and
  investment advisors
• 4) Division of Enforcement, which investigates
  possible violations of securities laws,
  recommends actions either in a federal court or
  before an administrative law judge, negotiates
  settlements on behalf of the commission, and
  publishes accounting and auditing enforcement
  releases (AAERs).

12
Securities and Exchange Commission

• The SEC is regarded as an independent agency
  created by Congress to protect investor
  interests.
• (Securities Act of 1933 and the Securities
  Exchange Act of 1934)
• Sec Enforcement Actions

13
Public Company Oversight Board

• Section 101 of SOX authorizes the establishment
  of the PCAOB to oversee the audit of public
  companies under the SEC jurisdiction.
• Congress authorized the PCAOB to fund its
  expenses by imposing a fee on all public
  companies determined in proportion to their
  market capitalizations and registration fees
  received from public accounting firms.
• PCAOB .
• The PCAOB has appointed a standing advisory group
  (SAG) of thirty members with expertise in
  accounting, auditing, corporate governance,
  investments, and corporate finance to assist in
  carrying out its standard-setting
  responsibilities.

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Public Company Oversight Board (Cont)

• PCAOB responsibilities
• Prepare its budget and manage its operation.
• Register both U.S. and non-U.S. public accounting
  firms auditing U.S. public companies.
• Inspect registered public accounting firms.
• Establish auditing, quality control, and ethics
  standards for registered public accounting firms.
• Enforce compliance with applicable laws and
  regulations.
• Investigate registered public accounting firms.
• Impose sanctions for violations.
• Hold roundtables addressing emerging issues
  affecting the functions and performance of
  registered public accounting firms to obtain the
  views of interested parties, including accounting
  firms, public companies, investor groups,
  standard setters, and academicians.
• Take initiatives in addressing auditing in a
  small business environment.
• Perform other duties or functions as deemed
  necessary.

15
Public Company Oversight Board (Cont)

• PCAOB rule-making process looks like the
  following schema

16
Federal Sentencing Guidelines For Organizations

• In 1984, Congress created the U.S. Sentencing
  Commission (USSC) with the authority to issue
  guidelines for punishing organizations, including
  companies that have committed federal crimes.
• The revised guidelines are expected to have a
  significant impact on the effectiveness of
  corporate governance by requiring
• companies to establish and maintain an effective
  compliance program
• boards of directors to accept accountability to
  ensure compliance throughout the company
• companies to assign high-level individuals (e.g.,
  executives) to oversee the companys compliance
  program.

17
American Institute of Certified Public Accountants

• The AICPA is a national professional association
  of more than 330,000 CPAs in public practice,
  industry, government, and academia.
• In the post-Enron and SOX era, the AICPA has
  introduced 6 leadership roles
• Standard-setting role of obtaining greater
  involvement of users of financial statements in
  setting auditing standards
• Fraud prevention and detection liaison role
• Research role in promoting academic research in
  such areas as fraud prevention
• Educational role of developing training programs
  aimed at combating fraud
• Financial reporting role of working with other
  standard setters to improve quality, reliability,
  and transparency of business and financial
  reporting
• Corporate governance role to improve corporate
  governance and internal control systems.

18
Financial Accounting Standards Board

• The SEC has delegated its accounting
  standard-setting authority to the FASB to issue
  authoritative Statements of Financial Accounting
  Standards (SFAS) for the measurement,
  recognition, and reporting of
• business transactions and economic events and the
  preparation of their financial statements.
• Traditional Financial Statements KPIs
• Sec Rules to allow foreign companies to file
  their statements using IFRS without
  reconciliation to U.S. GAAP.

19
Government Accounting Standards Board (GASB)

• GASB, in April 2005, issued its Concept Statement
  No. 3, Communication Methods in General Purpose
  External Financial Reports that Contain Basic
  Financial Statements. Concept Statement No. 3
  provides
• A conceptual framework for determining
  communication methods for improving the
  presentation of financial reports of governmental
  entities,
• criteria for each communication method,
• a hierarchy for their use.

20
International Federation of Accountants

• Challenges facing IFAC are finding ways to
  improve the credibility of the accounting
  profession worldwide, establishing globally
  accepted accounting and auditing standards, and
  developing global corporate governance guiding
  principles.
• \
• These challenges require IFAC to quickly move
  toward the global convergence of both accounting
  and auditing standards issued by a variety of
  standard-setting bodies such as the FASB, AICPA,
  PCAOB, and IASB.

21
Committee of European Securities Regulators

• The EC established the Committee of European
  Securities Regulators (CESR) to ensure efficient
  functioning of the European capital market.
• In May 2004, the SEC and CESR released a joint
  statement that specifies the terms of reference
  for future cooperation and coordination between
  the two bodies.
• The primary objectives of such cooperation are
  to (1) identify and address emerging risks in
  the EU and U.S. markets at an early stage (2)
  discuss potential regulatory projects to
  facilitate converging ways of addressing common
  issues and (3) set priorities for discussion and
  collaboration between the two bodies, including
  market structure issues, the role and
  responsibility of credit rating agencies and
  analysts, and mutual fund regulation.

22
State Influence on Corporate Governance.
Corporate Governance and Courts.

• State laws generally affect corporate governance
  by setting requirements for companies directors
  and officers. There is no uniform body of
  corporate law in the United States because each
  state is allowed to establish its own model.
• The judicial process and court decisions in
  several landmark cases have affected the
  structure of corporate governance in the United
  States. Many of the court cases have led to
  increased accountability and liability for a
  companys board of directors.

23
Corporate Governance and Self-Regulatory
Organizations

• By establishing listing standards for their
  listed companies, SROs including stock exchanges
  can also influence corporate governance.
• List of self-regulatory organizations

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Best Practices

• The effectiveness of corporate governance depends
  on compliance with state and federal statutes and
  listing standards, as well as best practices
  recommended by investor activists and
  professional organizations.
• Best practices of corporate governance are these
  of The Conference Board, American Law Institute
  (ALI), American Bar Association (ABA),
  institutional investors, Council of Institutional
  Investors, National Association of Corporate
  Directors, Business Roundtable, Public Pension
  Funds and etc.
• Best practices can be used as benchmarks to
  determine the best way to improve business
  processes and corporate governance by following
  the means by which leading organizations achieve
  excellence performance.

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Conclusion

• Compliance with applicable laws, regulations,
  rules, and standards is essential to the
  efficiency and integrity of the capital markets,
  the effectiveness of corporate governance, and
  the reliability of financial reports.
• The fundamental provisions of SOX can be
  categorized into the following five categories
  (1) corporate governance (2) financial
  reporting (3) audit functions (4) federal
  securities law enforcement and (5) others (e.g.,
  legal counsel, financial analysts).
• The SEC was established to protect investor
  interests and was given the responsibility for
  issuing financial reporting standards.
• SOX directs the SEC to issue rules in
  implementing its provisions pertaining to
  corporate governance, financial reporting, audit
  activities, and others.
• Section 101 of SOX authorizes the establishment
  of the PCAOB as an independent, nongovernmental,
  not-for-profit organization to oversee the audits
  of public companies under SEC jurisdiction.

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Conclusion

• The PCAOBs primary functions are to (1)
  register public accounting firms that audit
  public companies (2) inspect the registered
  public accounting firms on a regular basis (3)
  establish auditing, attestation, ethics, quality
  control, and independence standards and (4)
  conduct investigations and disciplinary
  proceedings.
• The PCAOB ended several decades of
  self-regulation and peer reviews for registered
  public accounting firms because both domestic and
  foreign public accounting firms that prepare or
  issue audit reports must now register with the
  PCAOB.
• The AICPA has introduced many initiatives in the
  post-SOX era to improve public trust in the
  accounting profession and public accounting
  firms.
• FASB has been the designated private sector
  not-for-profit organization for promulgating
  standards of financial accounting and reporting
  since 1973.