Impact on Business and Society - Term Paper Example

Public Policy Analysis Public Law 107-204, 107th Congress The Corporate and Criminal Fraud Accountability Act of 2002 Short Sarbanes-Oxley Act of 2002 Name of Student Name of Professor Name of University Table of Contents 2.History of the Act 3 3.Implementation 4 4.Impact on Business and Society 7 5.Policy Analysis 8 5.1 Recommendations 12 References 13 1. Introduction 3 2. History of the Act 4 3. Implementation 5 4. Impact on Business and Society 7 5. Policy Analysis 8 5.1 Recommendations 12 References 13 Public Policy Analysis: Public Law 107-204, 107th Congress The Corporate and Criminal Fraud Accountability Act of 2002 Short Title: Sarbanes-Oxley Act of 2002 1 Introduction Sarbanes Oxley Act (2002) (SOX) is the Government’s response to the ramifications of corporate scandals attributed to deficiencies in corporate reporting. The Act envisages comprehensive reforms for institutions issuing publicly traded securities, auditors, board members, and lawyers. The Act in a nutshell creates a Public Accounting Oversight Board to impose on the accounting profession certain professional standards, ethics and thereby ensure competence. Independence of the auditing companies engaged in auditing of public companies is strengthened even more. It imposes penalties for violation of security laws at higher rates than were applicable earlier. It also increases resources for the Securities and Exchange Commission. The Act is applicable to all the companies whether American or foreign if they are required to file annual and periodical reports with the SEC. This public policy analysis is to have a better appreciation of regulatory relationship between government and corporation (Zameeruddin, 2003). (Lovik, Merkel, & Bowser, 2006) 2. History of the Act The enactment of the legislation is timely in order to protect the interests of the investor from corporate fraud and to require corporate executives to enhance corporate ethical standards. These are with a view to make the US securities market robust enough to be a safe place for investors to invest and do business. It is argued that SOX is an essential policy tool to realize these objectives. The Act comes into force to address the market failure as a result of scandals such as Enron and others. The Enron scandal alone justifies the legislation to address the market failure characterized by the following consequences. Bankruptcy: 20,000 employees were rendered jobless and deprived of health insurance. Average severance pay was $ 4,500 and top management executives were paid bonuses exceeding $ 55 million. Employees’ retirement funds of $ 1.2 billion were lost. Retirees did not get their $ 2 billion retirement funds. Company’s top executives en-cashed their stocks worth $ 116 million. Criminal Charges: There were 15 guilty pleas, 6 convictions, 1 acquittal and 11 cases not decided. Three California based stock traders entered their guilty plea for wire fraud. 4 Meryll Lynch executives confessed to fraud in the Nigerian Barge case. Enron’s stock hit a high of $ 90 in 2000 and fell to $ 1 in 2001. 29,000 employees of auditing firm of Arthur Anderson lost their jobs. And Enron’s shareholders sued the company and their banks for $ 20 billion (Jesso, 2009). 3. Implementation SOX came into force from January 23, 2002. SOX is to be enforced by three authoritative bodies. One, SEC charged with overseeing. Two, U.S. Department of Justice which has the primary function of prosecuting federal crimes arising out of SOX such as attempts or conspiracies to commit fraud, certification of false financial statements, destruction of or tampering with documentary evidence and retaliatory acts against whistleblowers. Three, the Federal Bureau of Investigation has the authority to investigate crimes concerning corporate fraud and to be the primary agency to investigate and arrest individuals for corporate misconduct. The Act has the titles as summarized below. Title I: Public Company Accounting Oversight Board which should report to the SEC. The Board has the function of overseeing the audit of public companies, formulation of audit report rules and standards, inspection, investigation and enforcement of all compliance requirements, imposing of disciplinary sanctions for neglect and funding the boards through collection of fees from issuers. Title II: Dealing with auditor independence, the title bars auditors from performing alternative services, bars an auditor to so remain for more than five years and requires creditors to report to the audit committee. Title III: Corporate responsibility envisages each member of the audit committee to be a member of the Board of Directors. The chapter requires SEC to ensure CEOs and CFOs to certify financial reports. It requires that CEO/CFO should forfeit certain bonuses and compensation. This title prohibits the trading by the company directors and executive officers in public company’s stock during pension fund blackouts. Title IV: Senior management and principal stockholders must declare changes in the ownership of stocks as and when they take place. Title V: Conflict of Interest with analysts who should not pre-approve research reports. Table VIII: Corporate and Criminal Fraud Accountability: This chapter seeks to impose criminal penalties for deliberate destruction, alteration, concealment or falsification of records. Makes certain debts incurred in violation security fraud laws non-dischargeable in bankruptcy. Renders any person liable for fine or imprisonment for maximum 25 years for knowingly defrauding the shareholders of publicly traded companies. Title IX: White Collar Crime Penalty Enhancements. Imposes penalties for mail fraud, violation of Employee Retirement Income Security Act of 1974 and imposes criminal fines up to $ 500,000 and imprisonment up to 20 years of corporate officers who fail to certify financial reports. Title X: Corporate Tax Returns. Requires that the CEO should sign the Federal Income tax return. Title XI: Corporate Fraud Accountability: SEC is authorized to freeze extraordinary payments to designated persons and subject them to investigations for any Federal Securities law violations. Provides for enhanced fines up to $ 25 million and maximum 20 years imprisonment for violations under the Securities Act 1934. (Jesso, 2009), (Newsome & Wilson, 2002) Section 404 which is the part of title IV is very important. This deals with the compliance standards entailing marginal costs to the Corporates. This section has prompted emergence of many consulting firms to help Corporates implement the compliance standards (Jesso, 2009). . SEC reports that implementation of section 404 from 2004 met with difficulties in assessment of incremental costs. It is because companies did not track or disclose these costs distinctly from traditional item such as administrative expenditure. Internal labour is the largest cost component for section 404 (b) companies. However costs tended to reduce year after year. Thus, it was $ 1,532,512 prior to the 2007 reforms and $ 1,346,855 in the year after the reforms. For the next year, it was expected to be still lower at $ 1,216,721. The next largest cost component for section 404 (b) companies was fees paid for the independent audit of ICFR. Total mean audit fees did fall in the consecutive fiscal years. The fees were $ 2,501,855 in the year prior to 2007 reforms. It dropped to $ 2,328,062 the year after 200r reforms and for the next year it was expected to be reduced to $ 2,158, 145. Outside vendor costs which was the next largest cost component was $ 437,787 prior to 2007 reforms and $ 311, 323 the year after and $ 222, 463 for the next year. (SEC, 2009). 4. Impact on Business and Society Interviews with a CFO of Fortune 15 company and an auditor of a Big Four Accounting firm revealed the following responses that can be taken as the impact of the SOX Act. The CFO contends that there is a greater awareness and ownership of business process owners, appreciation for processes and controls which serve as a catalyst for a positive change and that SOX is good for business to understand how business operates. The most challenging issue is that organizations have different starting points of compliance. The most rewarding impacts of SOX are the emergence of talent pool with better business judgments for taking informed decisions. As for ethics, transparency, and expeditious processing of issues are enabled. Corporate code of ethics is in place as the corporations have become regulated industry. About SOX compliance costs outweighing the benefits, the CFO contends that such costs should be manageable if there are efficient management processes in place and that some benefits do outweigh costs. For those who are not innovative, costs can be prohibitive. However, the costs could be evened out in the long run. The auditor of a Big Four accounting firm, replied that accounting firm has become a regulated industry although it was a self-regulated one even earlier. Resources and training have been the most challenging aspect of SOX. As for the costs of implementation, it has become very costly especially in respect of section 404 (Jesso, 2009). (Salem & Franze, 2003), (Lovik, Merkel, & Bowser, 2006). (iSheriff, 2003) 5. Policy Analysis Within perspective of economics and public policy, Enron is an example of market failure as a result of information asymmetry. It is easy to analyze a failure of market or firms due to external economic conditions such as reduced product demand, lack of innovation, global competition, and natural calamities. But in the case of Enron collapse, it is due to internal conditions exacerbated by the insiders’ bad behavior. Because of the Enron episode, businesses are looked at with suspicion which had not been the case in the past one hundred years in America, a “home of free enterprise and individual achievement”. (Jesso, 2009) Policy analysis of government regulations like SOX should be analyzed as a problem from the perspective of investors or from the social point of view. Government’s intervention in the form of SOX is justified as an action as a result of market failure, a situation in which private action does not result in an efficient use of society’s resources and in a fair distribution of society’s goods. Information available in form 10 K report is for public consumption and is non-exclusive in use or both and hence is public good. Market failure is ascribed to wrongful pursuit of private interest resulting in inefficient use of society’s resources such as funds of investors or stakeholders. If Form 10 K filed by a corporate is vitiated by information deficit, it shows the inefficiency of the system or inadequacy of the regulation warranting government’s intervention to safeguard the societal interest sought to be undermined by wrongful pursuit of interest. It has been realized that information deficits as seen above can result in competitive failures. Information deficit in corporate fraud represents lying, cheating, and stealing. As such the information asymmetry is essentially the centerpiece of SOX. Consider the following about the information asymmetry: (Jesso, 2009). “Information is involved in market failure in at least two distinct ways. First, information itself has public good characteristics. Consumption of information is nonrivalrous- one person’s consumption does not interfere with another’s; the relevant analytical question is primarily whether exclusion is or is not possible. Thus, in the public goods context, we are interested in the production and consumption of the information itself. Second- and the subject of our discussion here there may be situations where the amount of information about the characteristics of a good varies in relevant ways across persons. The buyer and seller in a market transaction, for example may have different information about the quality of the good being traded” (Weimer & Vining, 1999, p. 107). It should be noted that within the context of Enron and like scandals, product being traded is not a tangible thing like a shoe or bread “but a multiple stakeholder, market centered product, employment, 401Ks, money management accounts, investment banking and capital accounts.” All these involve money used in good faith. These scandals of 1990s and early 2000s cannot be simplified as market failures but the collapse of organizations, livelihoods, retirement funds, investor confidence in the American Capital market which once was a place for constructive self interest facilitating buyers and sellers to grow capital, wealth and the future (Jesso, 2009).. In spite of the dire necessity to contain the information asymmetry and the resultant market failure, critics of SOX maintain that it has become costly for businesses to comply with the Act as much as 1 % of total revenue in first year’s costs relating to compliance with the internal control requirements. Though Oxley has said that it would be less than 1 %, in reality marginal cost to the firm would have diminishing benefits in due course. For example, Wal-Mart‘s compliance costs would be $ 3 billion, as 1 % of its sales revenue $ 300 billion in 2006. However, this is worth incurring as a tax for the public benefit in the interests of ethics control and corporate social responsibility. This is unavoidable because society expects that government should create laws and allocate resources at a national level in the event of market failure and information asymmetry in order to remedy the situation. There is no question that SOX is a democratic action to better prepare institutions to face crises like market failure. There had been instances of Congressional enactment followed by executive persuasion during 1930s and 1960s to address the Great Crash in 1929 and civil rights failure in 1960s respectively. It is pertinent to recall the period between 1929 and 1933 which witnessed stock price crashes resulting in social upheaval and questioning of viability of capital market system in the U.S. Congress’ intervention that resulted in the enactment Securities Act 1933 to enable enhanced disclosure about corporate affairs that could lead to a better evaluation and financial viability of corporations. The Securities Act 1933 required new securities offered for public sales to be registered and Securities Exchange Act 1934 required continuous reporting by publicly owned companies and also registration of securities, security exchanges and brokers and dealers of certain categories. Both the enactments gave power to SEC to call for disclosure of sufficient information about securities exchanged or sold. Subsequent legislations that broadened the power of the SEC were the Public Utility Holding Act 1935, the Trust Indenture Act 1939, the Investment Company Act 1940, the Investment Advisors Act 1940, Securities Investors Protection Act 1970, the Foreign Corrupt Practices Act 1977 to address different purposes (Belkaoui, 1985, p. 149). None of these enactment have dealt with corporate bad behavior i.e the greed that gave rise to the problems of 1990s and 2000s to address which SOX has been enacted (Jesso, 2009). The Glass-Steagall Act 1933 (The Banking Act 1933) was enacted responding to the market crash of 1929. It envisaged that commercial banks, investment banks and brokers should be separate industries to avoid any conflict of interest. The Act also required Insurance companies to be separate especially by non-interlocking boards of directors. History reveals that the theory behind the market crash of 1929 and the depression was due to the fact these industries were closely tied. The Glass-Steagall Act which was in force ever since was repealed in 1999 and again these corporation came back tied up as conglomerate corporations due to the lobbying of Sanford of Citigroup, Chuck Prince, the lawyer for City group and Weill’s corporate counsel, and Allan Greenspan who was the Chairman of Federal Reserve Bank of the United States for reasons of cost savings and better product offerings to the customer especially because this competitive model had proved to be successful in Japan and Europe. It is argued that ironically in these foreign markets fraud is rampant (Jesso, 2009). 5.1 Recommendations Based on the foregoing policy analysis, SOX has proved to be a good legislation as a response to corporate misconduct. SOX will continue to be debated for some more years to come. But the recovery from the Enron era will require these future years to help erase the memories of the fraud era. However, SOX will evolve and remain to be relevant to the demands of the investors and to the American and international commerce. References Sarbanes-Oxley Act ,Public Law 107-204 , 107th Congress. (2002). Belkaoui, A. (1985). Public Policy and the prcatice and problems of accounting . Westport, CT: Greenwood Press. iSheriff. (2003). SOX: Sarbanes-Oxley Act : isheriff compliance white paper series:. Retrieved March 10, 2014 Jesso, S. D. (2009). Sarbanes-Oxley-Context & Theory : Market failure, information assymetry & the case for regulation. Journal of Academy of Business and Economics , 9 (3), 1-13. Lovik, L. W., Merkel, E. T., & Bowser, C. L. (2006). The sarbanes-oxley act: a cost benefit analysis. Retrieved March 10, 2014 Newsome, W. B., & Wilson, R. W. (2002). Sarbane-Oxley Act of 2002 ("SOX) : An Overview. Dallas, TX: Haynes and Boone . Salem, G. R., & Franze, L. M. (2003). The Whistleblower Provisions of the Sarbanes-Oxley Act of 2002. Retrieved March 10, 2014 SEC. (2009). Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Finacial Reporting Requirements . Ofice of Econmoic Analysis, US SEC . Weimer, D., & Vining, A. (1999). Policy Analysis : Concepts and practice . Upper Saddle River, N.J.: Prentice-Hall. Zameeruddin, R. (2003). The Sarbanes-Oxley Act of 2002: An Overview, Analysis, and Caveats. A Journal of Applied Topics in Business and Economics . Read More