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Sarbanes-Oxley: an overview of current issues and concerns.


In July of 2002, the Public Company Accounting Reform and Investor Protection Act of 2002, [46], popularly known as Sarbanes-Oxley (hereinafter "SOX"), became law. The law, enacted largely in response to the Enron and WorldCom scandals, [43], has been described as the most sweeping and significant change in securities law since the 1930's. Politicians, including President Bush, [80], heralded the law's passage and characterized it as critically needed reform [45]. Business Week, in its periodic review of Congressional activity, applauded SOX as an example of quick Congressional response to the corporate scandals [6]. Since the enactment and implementation of SOX, politicians, academics, business persons and the media have reviewed its impact, costs and effectiveness.

We will review key provisions of SOX, offering a summary of current concerns and criticisms, and a discussion of SOX's impact and efficacy.


SOX is a wide-ranging, complex statute that amended United States securities law in significant ways [13]. SOX established new law, made changes to existing law, and effected Securities and Exchange Commission (hereinafter the "SEC") rule-making and stock market listing standards [26]. SOX's provisions affect accountants, lawyers, and many others who "deal with public companies or issuers" [13]. SOX included many "reforms aimed at improving and enhancing financial reporting and at regulating the accounting and audit professions" [1]. Our review and discussion of the most significant accounting reforms and the impact on corporate responsibility requirements, as well as enhanced attorney responsibilities and enforcement provisions, will follow.

Accounting Reforms

The accounting profession was largely self-regulating prior to the adoption of SOX. This era ended when SOX was enacted in July 2002. The creation of The Public Company Accounting Oversight Board ("PCAOB") pursuant to Section 101 was the first of these reforms and set the stage for others we discuss below [47]. The PCAOB is a new federal oversight board that is charged with: (1) registering and disciplining accounting firms that prepare audit reports on public companies; (2) establishing audit and accounting standards; and (3) conducting inspections and investigations of registered accounting firms that audit public companies [47]. The PCAOB is funded through fees from public companies and mutual funds and has five members appointed by the SEC [47]. The requirement of registering with the PCAOB applies to foreign as well as domestic accounting firms [48].

The lack of auditor independence is viewed as a significant contributor to the major corporate scandals mentioned earlier. SOX clearly focuses on this issue with Section 201, which constrains potential auditor conflicts through measures intended to enhance auditor independence. This is accomplished by forbidding auditors of public firms from providing to their audit clients most non-audit consulting services [49]. Accounting firms are permitted to provide tax services to audit clients [74]. However, the audit committee of the company must approve the services in advance [74]. This approval requirement is an important example of the increased importance, influence, and potential for liability that the audit committee has received because of SOX.

SOX continued its major reforms by focusing on another key factor affecting auditor independence with the adoption of Section 203 [50]. This section mandates the rotation of audit partners in charge of audit clients. Lead audit partners and audit partners who are responsible for review of the audit must be rotated off after five years [50]. In addition, these partners are subject to a five-year time-out period [50]. Other audit partners, not including lead or concurring partners, are subject to a seven-year rotation and a two-year time-out period. [50] Section 206 mandates a one-year "cooling off" period for auditors from going to work for an audit client in a key position [52].

Corporate Responsibility, Conflicts of Interest and Criminal Penalties

Section 301 requires that public companies have audit committees that will take charge of the audit and the selection of the auditors [53]. The audit committee must abide by several requirements. Among those is a mandate that it is comprised of only independent directors and have at least one member with financial expertise [53]. In addition, SOX requires that audit committees establish procedures for whistle blowers' complaints [53]. Section 204 requires that auditors report to audit committees [51].

Two of the most controversial provisions in SOX, one in Section 302 [54], and a second in Section 906 [66], require CEO's and CFO's to certify that the company's SEC filings are accurate. CEO's and CFO's must sign two separate certifications in their companies' periodic reports to the SEC. Section 906 is an amendment to the Federal Criminal Code and carries criminal penalties [66].

Section 402 prohibits issuers from making personal loans, directly or indirectly, to their directors or executive officers [56]. Section 403 accelerated prior reporting requirements for officers, directors, and 10% shareholders of companies for most transactions by insiders [57].

The SEC was mandated by SOX Section 307 to adopt rules of professional responsibility for attorneys representing public companies before the SEC [55]. In January 2003, the SEC adopted such rules which required the following: a) attorneys must report evidence of a material violation of securities law or breach of fiduciary duty to the Chief Legal Officer ("CLO"), or the equivalent if the issuer has a CLO, or to both the CLO and the CEO of the company; and b) if corporate executives do not respond appropriately, attorneys must report to the Board of Directors or an appropriate committee thereof [55]. This requirement has been referred to as the "up the ladder reporting standard" [19].

SOX directed the SEC, Section 404, to promulgate rules mandating the inclusion of an internal control report and assessment in annual reports [58]. In June of 2003, the SEC issued a release entitled "Management's Report on Internal Control over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports" [67]. Section 404 has perhaps generated the most controversy of all SOX provisions. Objections to implementation costs have received the most attention to date. In response to these concerns, the SEC has formally extended the deadline again for small cap companies to demonstrate compliance with Section 404. These companies will not have to comply with this provision until 2008 [4].

SOX Section 501 addressed the conflict of interest concerns relating to stock analyst practices. In particular, stock analysts are now prohibited from being compensated based on how much investment banking revenue they generate. In addition, investment bankers cannot be given veto power over stock analyst recommendations [59].

SOX Section 601 authorized large budgetary increases for the SEC, particularly in enforcement [60]. In addition, Congress authorized increased criminal penalties for existing crimes and created new securities crimes [61]. Title VII of SOX is entitled "The Corporate Criminal Fraud Accountability Act of 2002" [62], and creates criminal liability for alteration of documents. Section 901 of SOX, which is entitled "White Collar Crime Penalty Enhancement Act of 2002" [63], increases various penalties for mail and wire fraud [65], and establishes the new offense of "Conspiring to Commit Mail, Wire or Securities Fraud" [64].

Primary Concerns and Criticisms of the Sarbanes-Oxley Act

Although there are many aspects of Sarbanes-Oxley, a review of the literature since the passage of SOX indicates several leading criticisms and concerns. In fact, the passage of SOX was met with a storm of criticism that anticipated significantly negative outcomes resulting from its implementation [68]. This criticism has continued through the present. This paper summarizes these concerns into several categories: Increased Regulation, Professional Conflicts, Increased Compliance Costs, Corporate Federalism, and Lack of Clarity.

Increased Regulation

Congress' reaction to the corporate scandals of Enron, WorldCom (MCI), and Global Crossing was to pass legislation that in effect regulated the accounting profession, heretofore a self-regulated profession, through the American Institute of Certified Public Accountants (AICPA). SOX has had numerous far-reaching effects upon the accounting profession, with new regulations regarding auditing and consulting. These regulations were outlined earlier in this paper.

A series of conversations with internal audit directors in 2003 anticipated many of the challenges that would confront the accounting profession, and particularly all aspects of the audit function. This study expected that internal auditors would find an expanded role in, among other areas, the evaluation of internal controls and interpretation of SOX and other SEC rules. The authors also foresaw an expansion of the services of internal auditors to meet this increased reliance by management and directors [3]. The role of the auditor has changed substantially following the adoption of SOX and, in late 2004, SEC Commissioner Harvey Goldschmid "... reminded auditors that the investing public views them as gatekeepers ..." [78].

Some argue that the new regulations are too strict or misdirected, and others propose amending the law for greater clarification of information and ease of the public obtaining such information [1]. It is understood that the new regulations have resulted in increased expense, time, and liability of auditing companies [13 and 28]. It is further believed that the loss of consulting fees will be offset by the increase in auditing fees. William G. Parrett, chief executive of Deloitte Touche Tohmatsu, stated: "I think that the experience we have had with the PCAOB has mostly been positive. Just like when we audit companies, they tell us things we don't like to hear, but it makes us better" [31].

Professional Conflicts

SOX has not only affected the regulatory environment of the accounting profession, but extends to the legal profession as well. This is accomplished by Section 307, which requires counsel to report material state and federal violations, as well as breaches of fiduciary duty, with attendant liability for failure to comply [55 and 13]. Up to the enactment of Sarbanes-Oxley, the highest court of each individual state traditionally set rules of professional conduct. Sarbanes-Oxley creates federally legislated rules of conduct.

Timothy Chinaris examines the implications of the new ethical obligations mandated by SOX. Chinaris concludes that the application of this section is unclear and may lead to conflict with state codes of professional conduct and additional malpractice liability, and may affect the integrity of the confidentiality of the attorney-client relationship [8 and 73]. It is also noted that SOX creates "an innate conflict between the duty of confidentiality and the lawyer's personal interest in avoiding discipline or indictment [32], or dismissal [24]. In a 2003 interview, SEC Commissioner Goldschmid noted that the new attorney reporting rules would have a positive effect on disclosure, transparency and, more generally, governance [10].

Lack of Clarity

The clarity of the regulatory scheme for the accounting and legal professions is in contrast to that affecting small, private and foreign corporations. This lack of clarity is a major concern for small cap businesses. (1) It is commonly expressed that these companies will not be able to afford the cost of compliance, and may therefore withdraw from the market or "go dark" [18 and 44], or "go private" [70]. These costs include "... accelerated disclosure requirements [which would] produce increased costs in the form of increased staff hours, the addition of software to streamline filing processes, and expanded outside legal and auditor assistance" [70].

The IPO and the resulting exchange listing is an important indicator of success. The impact of this de-listing phenomenon for small, publicly traded companies remains unresolved. For the most part, the decision to de-list is driven by the additional costs that SOX represents [11].

There are calls for amendments or revision to this section of SOX in order to provide small businesses financial relief from the high cost of compliance [25]. One such proposal is a small business exemption or waiver from certain sections of SOX, in particular Section 404 [25 and 7]. Neal L. Wolkoff, the Chairman and CEO of the American Stock Exchange, contends that the impact of SOX on small and midsized companies is dramatic [81]. He argues that SOX compliance consumes nearly 1.5% of revenues for these companies "... severely squeezing operating margins--in many cases to near zero--as companies will also have to comply with Sarbanes-Oxley to varying degrees as the impact and extent of SOX is developed [37]. Private companies may also need to be compliant sooner, rather than later, due to future mergers or sales with public companies, reduction in risk of litigation involving breach of fiduciary duty [23], for initial public offerings, or because lenders and insurers are beginning to require Sarbanes-Oxley compliance for financing and for liability insurance for directors and officers [23].

"It's also true, as the critics maintain, that some small companies are going private at least in part in anticipation of the added expense and regulatory burden of Sarbanes-Oxley. But it is worth remembering that small companies don't yet have to institute Section 404, because the S.E.C. is aware of the added burden, and is trying to figure out a way to reduce it" [31]. Recently announced changes may ease those rules and make it easier and less costly to comply. However, the chairman of the commission has said: "Ultimately, all companies will be required to comply" [33].

Also to be addressed in the future is the issue of foreign companies [75]. As noted by Prentice, "Corporations of France, Germany, Japan and elsewhere have their own traditions of corporate governance that do not necessarily jibe with SOX's requirements" [38]. Others argue that foreign companies receive benefits from participating in U.S. markets, and that it would create disparities if foreign companies did not have to comply with SOX [27]. "The SEC has delayed requiring foreign companies and smaller American companies, those with market capitalizations of less than $75 million, to comply with Section 404 as it tries to find ways to cut costs for those firms" [34].

Future related legislative impacts of Sarbanes-Oxley remain undetermined at this point. Additional regulations adopted by the SEC, and any proposed amendments to SOX, will need to be carefully scrutinized for unanticipated impacts upon the accounting and legal professions, security analysts, state law, and judicial opinions. An example of such an impact is in bankruptcy law, where the priority of unsecured creditors is threatened by the rights of stockholder claimants to disgorgement funds (Section 308--Fair Funds for Investors) [71].

Increased Compliance Costs

The section of Sarbanes-Oxley that is identified as the most troublesome and costly is Title 4, section 404. "Section 404 of SOX aims to assure that the controls that underpin the accuracy and reliability of a company's published financial information are adequate" [36]. The prevailing attitude seems to be that the cost to comply with this section and the rest of SOX will be high, whereas the benefits of SOX are rarely addressed. Even the PCAOB acknowledged the difficulty of the first year of compliance under SOX [36]. This may well be due to the fact that compliance is only entering the second year and it is not yet known if the costs will continue to rise, level off or drop [31 and 41]. For many, the costs of compliance may include several factors, such as auditing expense increases, legal fees, staff increases, and technology upgrade costs [30]. A study by CRA International, paid for by the Big Four accounting firms, found that the average cost for companies with revenue of more than $700 million fell 44 percent, to $4.8 million, in the second year [33].

The CFO of Staples stated that the $7-10 million spent complying with SOX was worth it. "It offered us an opportunity to look at our processes and in many cases to improve them," he said. "We found that our people really benefited from understanding the processes." He concluded: "It has made Staples a better company" [31].

Corporate Federalism

Another overriding concern identified is that of the loss of corporate autonomy and the rise of "federalization" of corporate law [2]. With the enactment of Sarbanes-Oxley, the Federal government has stepped into many areas that were previously controlled in-house or traditionally regulated by state legislatures and state courts. The loss of corporate autonomy is perceived through limitations placed on officer and director appointments [21] (Section 305); requirements for proper corporate governance [16 and 69], including of codes of conduct for senior financial officers (Title III and Section 406); board member qualifications; restrictions on executive compensation and loans (Section 402) [5 and 72], (Title III and Section 403) [29]; and restrictions on audit and consulting services (Section 201) [49]. Several authors have found the argument of corporate federalism to be unfounded and have stated that SOX's reforms may actually reflect the laws of some states and may well lead to additional reform in other states [14, 2 and 23]. Professor Renee M. Jones, however, believes that SOX will have a positive impact on the development of corporation law at the state level only if federal regulation continues to assert itself through sustained Congressional action and SEC rulemaking [22]. These regulations might have the benefit of increased vigilance and understanding on the part of directors and strengthened decision making.

SOX: Implementation and Impact Surveys

Since the enactment of SOX in 2002, this statute has been subject to widespread analysis, commentary and evaluation. Several surveys have been conducted concerning SOX's implementation and impact.

Financial Executives International's January 2004 survey addressed the question of costs associated with SOX's Section 404 requirements. Responders reported estimated costs increased for auditors' fees, external consulting software, and other vendor charges. In addition, companies expected to need additional internal people hours to comply with Section 404 [15]. and conducted a survey of 220 business leaders in December of 2004. The results noted a distinct difference between companies that had reached compliance with SOX and those that had not. The companies that have "crossed the compliance chasm" rated the effectiveness of compliance activities equal to or higher than the costs. In addition, the survey suggested that "while costs are front loaded, there is proportional value once companies get through the compliance process" [42]. Also, Oversight Systems 2004, an invitation only on-line survey, contained a sample of 222 financial executives. Seventy-nine percent of those surveyed reported having "significantly stronger" or "somewhat stronger" internal controls because of SOX. Seventy-four percent reported realizing a benefit from SOX compliance [35].

A 2004 study of the implementation of SOX, conducted jointly by Corporate Board Member Magazine and PricewaterhouseCoopers, LLP, sought the opinions of ten thousand directors of United States corporate boards and probed several areas, including the impacts of SOX [79]. With a response rate of 12.8%, 1279 questionnaires were returned and tallied. Most notably, corporate directors reported that due to the impact of corporate reform and SOX, they believe their role is "more challenging than ever before" and "requires respect and deserves appropriate compensation" [79].

Lastly, a 2006 survey conducted by PricewaterhouseCoopers found:
 "The percentage of internal audit resources being dedicated to
 compliance with the Sarbanes-Oxley Act of 2002, while still high, may
 finally have turned the corner and be leveling off. Once freed of the
 demands of Sarbanes-Oxley, these resources are being redeployed to
 other priority areas, such as risk-based auditing, risk management,
 and continuous auditing.

 Year-to-year comparisons of our survey results (see page 15)
 demonstrate just how dramatically the resource focus of internal audit
 is changing:

 * In our 2005 survey of the internal audit profession, 23% of our
 respondents reported dedicating 100% of their internal audit resources
 to Sarbanes-Oxley during Year One compliance with the act. In 2006,
 only 1% of our survey participants projected that the act would
 require 100% of their internal audit resources during Year Three.

 * In Year One of implementation, 71% of our reporting companies said
 they devoted 50% or more of their internal audit resources to
 compliance with Section 404 of the act, which requires companies to
 document, evaluate, test, and monitor their internal controls over
 financial reporting. In Year Two, only 45% or our respondents were
 reportedly deploying 50% or more of their internal audit resources to
 Section 404 compliance. Projections for year three indicate that only
 33% of our responding companies will be devoting 50% or more of their
 resources to Section 404 compliance" [41].


With the goal of SOX to ensure the accuracy and reliability of financial information of companies trading on public markets, the benefits of the Federal government's intercession are often overlooked. Whereas prior to SOX the accounting profession failed to address the underlying issues regarding fraud, abuse and conflict of interest, now the requirements of full disclosure, accuracy and transparency should lead to a more fair market for investors, and increase the confidence of current and future investors. The accounting profession itself must now address and learn to implement the new regulations while determining how to balance auditing and consulting for clients within the framework of SOX.

SOX will also lead to an examination of the role of lawyers and the extent of the attorney-client privilege in publicly traded companies. The SEC through the PCAOB is reviewing the impacts of the statute and subsequent regulations, to determine how change can be implemented to better serve small, private and foreign companies. State laws and judicial opinions must be analyzed within the context of SOX. Although early opinion suggests that it overreaches in its scope and impact, the full implications of SOX, a wide ranging, complex statute, are yet to be fully understood.


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45. Sarbanes Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745, codified in 15 U.S.C. 78m(k)(2004).

46. SOX [section] 101, 15 U.S.C.A. [section] 7211 (West Supp. 2004).

47. SOX [section] 106, 15 U.S.C.A. [section] 7213 (West Supp. 2004).

48. SOX [section] 201 amending 15 U.S.C.A. [section] 78 j-l (g)-(h) (West Supp. 2004).

49. SOX [section] 203, amending 15 U.S.C.A. [section] 78 j-l (j) (West Supp. 2004).

50. SOX [section] 204, amending 15 U.S.C.A. [section] 78 j-l (k) (West Supp. 2004).

51. SOX [section] 206 amending 15 U.S.C.A. [section] 78 j-l (I) (West Supp. 2004).

52. SOX [section] 301 amending 15 U.S.C.A. [section] 78 j-l (m) (West Supp. 2004).

53. SOX [section] 302, 15 U.S.C.A. [section] 7241 (West Supp. 2004).

54. SOX [section] 307, 15 U.S.C.A. [section] 7245 (West Supp. 2004).

55. SOX [section] 402, amending 15 U.S.C.A. [section] 78m (West Supp. 2004).

56. SOX [section] 403, amending 15 U.S.C.A. [section] 78p (West Supp. 2004).

57. SOX [section] 404, 15 U.S.C.A. [section] 7262 (West Supp. 2004).

58. SOX [section] 501 (a), 15 U.S.C.A. [section] 780-6 (West Supp. 2004).

59. SOX [section] 601, amending 15 U.S.C.A [section] 78 kk (West Supp. 2004).

60. SOX [section] 802 (a), 18 U.S.C.A. [section] 1519 (West Supp. 2004).

61. SOX [section] 802 (b) 18 U.S.C.A [section] 1520 (West Supp. 2004).

62. SOX [section] 901, 116 Stat. 804 (2002).

63. SOX [section] 902 (a), 18 U.S.C.A. [section] 1349 (West Supp. 2004).

64. SOX [section] 903, amending 18 U.S.C.A. [section][section] 1341, 1343 (West Supp. 2004).

65. SOX [section] 906, 18 U.S.C.A. [section] 1350 (West Supp. 2004).

66. SEC Release No. 33-8238.

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(1) The SEC Final Report of the Advisory committee on Smaller Public Companies, April 23, 2006, note 1, page 1 defines "microcap companies" ... [as] public companies with equity capitalizations of approximately $128 million or less .... "smallcap" companies ... are ... public companies with equity capitalizations of approximately $128 million to $787 million ... smaller public companies refer to public companies with equity capitalizations of $787 million and less--includes both microcap and smallcap companies."

Lisa McCauley Parles, Seton Hall University

Susan A. O'Sullivan, Seton Hall University

John H. Shannon, Seton Hall University
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Author:Parles, Lisa McCauley; O'Sullivan, Susan A.; Shannon, John H.
Publication:Review of Business
Date:Mar 22, 2007
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