In the name of the dollar: a closer look at the Sarbanes-Oxley Act of 2002.

To protect the investing public, Congress passed and President Bush signed the Sarbanes-Oxley Act of 2002 in July.

Following is a summary of the major provisions of the Sarbanes-Oxley Act, adapted from materials provided by the AICPA. California CPA will continue to provide readers with analysis and updates in future issues.

Sec. 3: SEC Rules and Enforcement.

A violation of Rules of the Public Company Accounting Oversight Board (Board) is treated as a violation of the 1934 Act, giving rise to the same penalties that may be imposed for violations of that Act.

Sec. 101: Establishment; Board membership.

The Board will have five financially-literate members, appointed for five-year terms. Two of the members must be or have been certified public accountants, and the remaining three must not be and cannot have been CPAs. The chair may be held by one of the CPA members, provided that he or she has not been engaged as a practicing CPA for five years.

The Board's members will serve on a full-time basis.

No member may, concurrent with service on the Board, "share in any of the profits of, or receive payments from, a public accounting firm," other than "fixed continuing payments," such as retirement payments.

Members of the Board are appointed by the SEC, "after consultation with" the chairman of the Federal Reserve Board and the secretary of the treasury.

Sec. 103: Auditing, Quality Control and Independence Standards and Rules.

The Board shall:

* Register public accounting firms;

* Establish, or adopt, by rule, "auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers,

* Conduct inspections of accounting firms;

* Conduct investigations and disciplinary proceedings, and impose appropriate sanctions;

* Perform such other duties or functions as necessary or appropriate;

* Enforce compliance with the Act, the rules of the Board, professional standards, and the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect thereto;

* Set the budget and manage the operations of the Board and the staff of the Board.

Auditing Standards. The Board would be required to "cooperate on an ongoing basis" with designated professional groups of accountants and any advisory groups convened in connection with standard-setting, and although the Board can "to the extent that it determines appropriate" adopt standards proposed by those groups, the Board will have authority to amend, modify, repeal and reject any standards suggested by the groups. The Board must report on its standard-setting activity to the SEC on an annual basis.

The Board must require registered public accounting firms to "prepare, and maintain for a period of not less than seven years, audit work papers, and other information related to any audit report, in sufficient detail to support the conclusions reached in such report."

The Board must require a second partner review and approval of audit reports. Registered accounting firms must adopt quality control standards.

The Board must adopt an audit standard to implement the internal control review required by Sec. 404(b). This standard must require the auditor to evaluate whether the internal control structure and procedures include records that accurately and fairly reflect the transactions of the issuer, provide reasonable assurance that the transactions are recorded in a manner that will permit the preparation of financial statements in accordance with GAAP, and a description of any material weaknesses in the internal controls.

Sec. 109(d): Funding; Annual Accounting Support Fee for the Board.

To audit a public company, a public accounting firm must register with the Board. The Board shall collect "a registration fee" and "an annual fee" from each registered public accounting firm, in amounts that are "sufficient" to recover the costs of processing and reviewing applications and annual reports.

The Board also shall establish by rule a reasonable "annual accounting support fee" as may be necessary or appropriate to maintain the Board. This fee will be assessed on issuers only.

Sec. 104: Inspections of Registered Public Accounting Firms.

Annual quality reviews (inspections) must be conducted for firms that audit more than 100 issues, all others must be conducted every three years. The SEC or the Board may order a special inspection of any firm at any time.

Sec. 106: Foreign Public Accounting Firms.

The bill would subject foreign accounting firms who audit a U.S. company to register with the Board. This would include foreign firms that perform some audit work, such as in a foreign subsidiary of a U.S. company, that is relied on by the primary auditor.

Sec. 107(d): Censure of the Board and Other Sanctions. The SEC shall have "oversight and enforcement authority over the Board." The SEC can, by rule or order, give the Board additional responsibilities. The SEC may require the Board to keep certain records, and it has the power to inspect the Board itself, in the same manner as it can self-regulatory organizations such as the NASD.

Sec. 108: Accounting Standards.

The SEC is authorized to "recognize, as 'generally accepted' ... any accounting principles" that are established by a standard-setting body that meets the bill's criteria, which include requirements that the body:

* Be a private entity;

* Be governed by a board of trustees (or equivalent body), the majority of whom are not or have not been associated persons with a public accounting firm for the past two years;

* Be funded in a manner similar to the Board;

* Have adopted procedures to ensure prompt consideration of changes to accounting principles by a majority vote; and

* Consider, when adopting standards, the need to keep them current and the extent to which international convergence of standards is necessary or appropriate.

Sec. 201: Services Outside the Scope of Practice of Auditors; Prohibited Activities.

It shall be "unlawful" for a registered public accounting firm to provide any non-audit service to an issuer contemporaneously with the audit, including:

* Bookkeeping or other services related to the accounting records or financial statements of the audit client;

* Financial information systems design and implementation;

* Appraisal or valuation services, fairness opinions or contribution-in-kind reports;

* Actuarial services;

* Internal audit outsourcing services;

* Management functions or human resources;

* Broker or dealer, investment adviser, or investment banking services;

* Legal services and expert services unrelated to the audit; or

* Any other service that the Board determines, by regulation, is impermissible.

The Board may, on a case-by-case basis, exempt from these prohibitions any person, issuer, public accounting firm or transaction, subject to SEC review.

It will not be unlawful to provide other non-audit services if they are pre-approved by the audit committee. The bill allows an accounting firm to "engage in any non-audit service, including tax services," that is not listed above, only if the activity is pre-approved by the audit committee of the issuer. The audit committee will disclose to investors in periodic reports its decision to pre-approve non-audit services. Statutory insurance company regulatory audits are treated as an audit service, and thus do not require pre-approval.

The pre-approval requirement is waived with respect to the provision of non-audit services for an issuer if:

* The aggregate amount of all such non-audit services provided to the issuer constitutes less than 5 percent of the total amount of revenues paid by the issuer to its auditor. This is calculated on the basis of revenues paid by the issuer during the fiscal year when the non-audit services are performed;

* Such services were not recognized by the issuer at the time of the engagement to be non-audit services; and

* Such services are promptly brought to the attention of the audit committee and approved prior to completion of the audit.

The authority to pre-approve services can be delegated to one or more members of the audit committee, but any decision by the delegate must be presented to the full audit committee.

Sec. 203: Audit Partner Rotation.

The lead audit or coordinating partner and the reviewing partner must rotate off of the audit every five years.

Sec. 204: Auditor Reports to Audit Committees.

The accounting firm must report to the audit committee all "critical accounting policies and practices to be used ... all alternative treatments of financial information within [GAAP] that have been discussed with management ... ramifications of the use of such alternative disclosures and treatments, and the treatment preferred" by the firm.

Sec. 206: Conflicts of Interest.

The CEO, controller, CFO, chief accounting officer or person in an equivalent position cannot have been employed by the company's audit firm during the one-year period preceding the audit.

Sec. 207: Study of Mandatory Rotation of Registered Public Accountants.

The GAO will do a study on the potential effects of requiring the mandatory rotation of audit firms.

Sec. 209: Consideration by Appropriate State Regulatory Authorities. State regulators are directed to make an independent determination as to whether the Board's standards shall be applied fo small and midsize non-registered accounting firms.

Sec. 301: Public Company Audit Committees.

Each member of the audit committee shall be a member of the board of directors of the issuer, and shall otherwise be independent.

"Independent" is defined as not receiving, other than for service on the board, any consulting, advisory or other compensatory fee from the issuer. It is also defined as not being an affiliated person of the issuer, or any subsidiary thereof.

The SEC may make exemptions for certain individuals on a caseby-case basis.

The audit committee of an issuer shall be directly responsible for the appointment, compensation and oversight of the work of any registered public accounting firm employed by that issuer.

The audit committee shall establish procedures for the "receipt, retention and treatment of complaints" received by the issuer regarding accounting, internal controls and auditing.

Each audit committee shall have the authority to engage independent counsel or other advisers, as it determines necessary to carry out its duties.

Each issuer shall provide appropriate funding to the audit committee.

Sec. 302: Corporate Responsibility for Financial Reports.

The CEO and CFO of each issuer shall prepare a statement to accompany the audit report to certify the "appropriateness of the financial statements and disclosures contained in the periodic report, and that those financial statements and disclosures fairly present, in all material respects, the operations and financial condition of the issuer." A violation of this section must be knowing and intentional to give rise to liability.

Sec. 303: Improper Influence on Conduct of Audits.

It shall be unlawful for any officer or director of an issuer to take any action to fraudulently influence, coerce, manipulate or mislead any auditor engaged in the performance of an audit for the purpose of rendering the financial statements materially misleading.

Sec. 305: Officer and Director Bars and Penalties; Equitable Relief. If an issuer is required to prepare a restatement due to "material noncompliance" with financial reporting requirements, the chief executive officer and the chief financial officer shall "reimburse the issuer for any bonus or other incentive-based or equity-based compensation received" during the 12 months following the issuance or filing of the non-compliant document and "any profits realized from the sale of securities of the issuer" during that period.

In any action brought by the SEC for violation of the securities laws, federal courts are authorized to "grant any equitable relief that may be appropriate or necessary for the benefit of investors."

Sec. 305: Officer and Director Bars and Penalties.

The SEC may issue an order to prohibit, conditionally or unconditionally, permanently or temporarily, any person who has violated Sec. 10(b) of the 1934 Act from acting as an officer or director of an issuer if the SEC has found that such person's conduct "demonstrates unfitness" to serve as an officer or director of any such issuer.

Sec. 306: Insider Trades During Pension Fund Black-Out Periods Prohibited.

Prohibits the purchase or sale of stock by officers and directors and other insiders during blackout periods. Any profits resulting from sales in violation of this section "shall inure to and be recoverable by the issuer." If the issuer fails to bring suit or prosecute diligently, a suit to recover such profit may be instituted by "the owner of any security of the issuer."

Sec. 401(a): Disclosures in Periodic Reports; Disclosures Required.

"Each annual and quarterly financial report...shall disclose all material off-balance sheet transactions" and "other relationships" with "unconsolidated entities" that may have a material current or future effect on the financial condition of the issuer.

Each financial report that is required to be prepared in accordance with GAAP shall "reflect all material correcting adjustments...that have been identified by a registered accounting firm..."

Sec. 403: Disclosures of Transactions Involving Management and Principal Stockholders.

Directors, officers and 10-percent owners must report designated transactions by the end of the second business day following the day on which the transaction was executed.

Sec. 404: Management Assessment of Internal Controls.

Requires each annual report of an issuer to contain an "internal control report", which shall:

* State the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and

* Contain an assessment, as of the end of the issuer's fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.

Each issuer's auditor shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this section shall be in accordance with standards for attestation engagements issued or adopted by the Board. An attestation engagement shall not be the subject of a separate engagement.

The language in the report of the Committee which accompanies the bill to explain the legislative intent states, "...the Committee does not intend that the auditor's evaluation be the subject of a separate engagement or the basis for increased charges or fees."

The Sarbanes-Oxley Act directs the SEC to require each issuer to disclose whether it has adopted a code of ethics for its senior financial officers and the contents of that code.

The Sarbanes-Oxley Act directs the SEC to revise its regulations concerning prompt disclosure on Form 8-K to require immediate disclosure "of any change in, or waiver of," an issuer's code of ethics.

Sec. 407: Disclosure of Audit Committee Financial Expert. The SEC shall issue rules to require issuers to disclose whether at least one member of its audit committee is a "financial expert."

Sec. 409: Real Time Disclosure. Issuers must disclose information on material changes in the issuer's financial condition or operations on a rapid and current basis.

Title VIII: Corporate and Criminal Fraud Accountability Act of 2002. It is a felony to "knowingly" destroy or create documents to "impede, obstruct or influence" any existing or contemplated federal investigation.

Auditors are required to maintain "all audit or review work papers" for five years.

The statute of limitations on securities fraud claims is extended to the earlier of five years from the fraud, or two years after the fraud was discovered, from three years and one year, respectively.

Employees of issuers and accounting firms are extended "whistleblower protection" that would prohibit the employer from taking certain actions against employees who lawfully disclose private employer information to, among others, parties in a judicial proceeding involving a fraud claim. Whistle-blowers are also granted a remedy of special damages and attorney's fees.

A new crime for securities fraud that has penalties of fines and up to 10 years imprisonment.

Title IX: White Collar Crime Penalty Enhancements.

Maximum penalty for mail and wire fraud increased from 5 to 10 years.

Creates a crime for tampering with a record or otherwise impeding any official proceeding.

SEC given authority to seek court freeze of extraordinary payments to directors, offices, partners, controlling persons, agents of employees.

US Sentencing Commission to review sentencing guidelines for securities and accounting fraud.

SEC may prohibit anyone convicted of securities fraud from being an officer or director of any publicly traded company.

Financial statements filed with the SEC must be certified by the CEO and CFO. The certification must state that the financial statements and disclosures fully comply with provisions of the Securities Exchange Act and that they fairly present, in all material respects, the operations and financial condition of the issuer. Maximum penalties for willful and knowing violations of this section are a fine of not more than $500,000 and/or imprisonment of up to five years.