The establishment and the refinement of governance in the corporate sector have seen massive changes due to the occurrence of several governance upsurges and failures. Upsurges in the 1980s and the late 1990s pointed out harsh conflicts between the brokers and the analysts; this led to the introduction of principle V.F that was involved with analyzing and advising on important principles. The Enron failures looked at these and other important issues with regard to the independence auditor and the entire audit committee and deficiencies in accounting standards; however, these issues are now taken into consideration by principles V.C, V.B, and V.D. the approach to these issues were systematic (Baker, 2005). Other cases such as the Parmalat and the Ahold case in Europe also offered important lessons on corporate governance which prompted national authorities and international regulatory bodies such as IOSCO to take necessary actions. In the cases mentioned above, several corporate governance failures came into play; for instance, they were not strict enough but rather allowed or even facilitated practices that led to poor performance.
As a response to the Enron bankruptcy and several other accounting and corporate governance failures such as the Tyco International and the Adelphia scandals, the congress introduced the Sarbanes-Oxley Act (SOX) bill. They congress then went ahead and rushed to pass the bill after another financial organization, WorldCom filed for bankruptcy in July 2002. Before this incidence, the passage of the bill was uncertain; the senate and the house or representatives were on the process of passing proposals that were at different stages, and even more surprising was the fact that these proposals were different, and not to mention the stiff opposition they faced from trade groups and lobbyists. However, the WorldCom scandal was the last punch; it put everyone on their toes and everyone is Washington wanted to take part in cracking down corporate fraud.
According to the New York Times, the Sarbanes Law is working in eliminating corporate fraud (New York Times, Dec. 3, 2005, p. 1). SOX has very effective in cracking down corporate fraud, it has been told to be the most comprehensive corporate governance by the federal government after the Securities Act of 1933, and the Securities Exchange Act of 1934. However, given its rushed passing and the broadness of the sector, critics have come up to say that it has brought unintended effects in corporate governance; they also argue that its implementation costs surpass its benefits. CPAs have had more than a decade to interact with SOX, it is important to look at it in several dimensions to determine if it has achieved its objectives.
Review of objectives
The major aim of SOX was to make financial reporting more transparent and reinstate investor confidence in the United State’s financial markets. Distinctively, its objectives include the following:
- Improve the independence of the auditor, it aimed at doing this by restricting non-audit services and operations that a CPA company may offer to its audit clients. The law also requested audit-partner rotations.
- SOX also aimed at addressing concerns about the audit professionalism, they did this by establishing the PCAOB that was responsible for regulating the audit profession and establishment of standards.
- SOX aimed at improving corporate governance, consequently eliminating or reducing frauds in financial reporting. It approached this objective by requiring senior managers to certify financial reports and carry out internal controls. The law also provided SEC regulations that allowed independence of the auditors by reducing influence from other executives. Attorneys were also required to report incidences of fraud; disclosures were also required on internal control structures put in place by a financial organization and the existing code of ethics for all financial officers. Significance penalties were also included for those firms that failed to comply with SOX’s requirements.
Recent scandals in the corporate world have increased public calls to do major reforms on business practices and regulations. Cover-ups, dishonesty, and greed are not new concerns in this sector. In fact, most of the regulations that are present today emerged due to vagaries that occurred in the late 1920s and the market crash that followed. The only thing that has changed is the frequency and public outbursts of the corporate scandals. Consider that in 1998, the Economist journal published not even a single editorial regarding corporate governance. In the year 2002 it published twenty such editorials talking about corporate governance, and the following year, they published twenty-three of them (Baker, 2005). The outcry of the public over the increasing corporate scandals has made it crystal clear that they cannot be tolerated further; the public is calling for responsibility, transparency, and accountability in the corporate behavior. These corporate scandals and the overall corporate management cannot be dealt with by the single bullet of leadership alone; government actions must also get incorporated in this battle in the form of regulatory systems and improved law enforcement (Neuman, 2005).
Already policymakers have come up with several regulations. In the year 2002, the congress hurriedly adopted the Sarbanes-Oxley Act that imposed on financial control and reporting among other things in public traded companies. The Securities and Exchange Commission (SEC) in connection with other self-regulatory organizations are tasked with overseeing New York stock exchange (NYSE). There also has been adoption of new standards for public companies and other security dealers by the National Association of Securities Dealers (NASD). The government has also created the Public Company Accounting Oversight Board (PCAOB) which seeks to revamp oversight of editors. Lastly but not least, the federal and the state enforcement officials have responded to several prosecutions against corporate leaders and other people accused of going against financial rules. These and other responses not mentioned above show that the governance of corporate films is under the public scrutiny recently. Recent scandals are enough proof that sloppy regulatory institutions, inefficient standards, and negligent enforcements can have a huge effect on the public economy. The response of the government to these scandals should not be ignored.
Self-regulatory institutions have played a big role in keeping an eye in both the corporate behavior and the behavior of those professionals working there. Right from the 1930s, the national security laws have given authority to self-regulatory organizations such as NASD and NYSE. These organizations have been mandated with the primary task of making rules putting into effect securities violations. They are also tasked with overseeing the behavior of accountants and corporate lawyers. However, due to the recent series of corporate scandals, it is very reasonable to ask ourselves if the current state of self-regulation is really carrying out its mandate. It is not just the question of the government of self-regulatory organization to decide who should regulate corporate behavior, but the real question should be how and when regulation should be done (Hemamalini, 2009).
It is true that self regulation has several advantages, but to some extent self-regulation is an oxymoron; it is like entrusting a fox to guard the chicken. Several disadvantages have been highlighted in this kind of regulation, they include the following:
- Conflicts of interest
- Lack of adequate sanctions
- The problem of under enforcement
- Global competition, and
- Insufficient resources
It is evident that self-regulation has both advantages as well as disadvantages. But a lot needs to be done in addition to what already exists to prevent future corporate scandals from happening. This can be done by using self-regulation in areas where it is most appropriate, and then design them in the best way possible so that they can be effective in regulation. The existing self-regulation organizations receive most blame for the current scandals. However, this does not entirely mean that they should get completely abandoned; in fact the best solution would be to change the internal management of these self-regulatory organizations, and add them more powers as well as resources so that they can carry out their regulation mandate much better than they currently are.
Self-regulatory organizations can also be improved on the side of design. They should be designed in a way that makes them strong enough to be in a position to regulate corporate organizations. Some have limited powers such as just revoking individual licenses. Others have capabilities of adopting rules but are not in a position to enforce them. Additionally, some self-regulatory organizations have become close to the financial institutions to the extent that they operate with the industry’s self interest that what they are mandated to do.
Self-regulatory organizations differ in term of the level of government given to them. Some are totally separate from the government, meaning they get no oversight from the government. Others such as the NYSE and NASD are overseen by the government. Being overseen by the government helps them to rise above some limitations that they may encounter.
Rules versus principles
Both self-regulators and the government must come to the decisions of whether to adopt rules or principles. As a response to the recent scandals in the corporate world, many stakeholders have come to the conclusion the United States government focuses mostly on rules. They argue that rules are simple but they provide loopholes for manipulation. Some observers are suggesting a more principle-oriented approach as the best regulation. Principle-oriented regulations stress more on objectives and goals as opposed to the rule-oriented process which focus on a specific method of achieving the ends. The existing policy responses to the corporate scandals exhibit a tussle between principles and rules. Probably the most notable change in legislation was the passage of the SOX Act which enforced new, comprehensive set of rules on corporations. The FASB has faced many criticisms due to its overreliance on detailed rules (Neuman, 2005).
Both principles and rules have their strengths and weaknesses and therefore regulators should try and combine the two. A good example includes the newly adopted international standards that govern risk computation in financial institutions and the SEC’s standard for calculating the value of mutual funds. These two regulations are based on principles that the financial industry needs to follow in coming up with and deploying comprehensive models for assessing compliance (Williams, 2015).
The SEC and the PCAOB regulatory actions are not enough to deal with the corporate scandals. Yes, it is true they have played a very big role in reducing the burden of complying with section 404 of the SOX Act, but for the actual changes to be felt it will take almost a year. The cost of section 404 can be reduced if auditors put their attention on risk factors affecting financial statements. But still, many auditors still feel the heat in that the regulatory bodies do not comprehensively protect them from litigation. Many people feel that the Sarbanes-Oxley Act requires corporations to have too many certifications regarding financial statements. However, according to Barney Frank, the chairman of the House of Financial Services, the SEC and the PCAOB are well equipped to handle this issue, and further said that no extra legislations are required.
Although most attention is given on the possibility of the SEC and the PCAOB to carry out reforms in the SOX Act, there have been proposals to develop legislations that would prove more effective especially on the side of small public companies. One such legislation is the Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs (COMPETE) Act that got introduced into the House of Representatives on 13th March 2007. A similar legislation was also introduced into the senate the day that followed by senator DeMint and other two co-sponsors. The COMPETE Act allowed small public companies to opt out of the contentious section 404 requirements on reporting. However, it would require them to maintain enhanced internal controls as well as increased transparency. As initially introduced, this bill would advocate for the following:
- Making compliance with section 404 voluntary for small public companies.
- Necessitate small and medium-sized companies that opted out of section 404 to comply with the set internal controls and guidelines according to their size and the estimated risk to investors.
- Necessitate the PCAOB and the SEC to clearly define the standards for audits.
- Carry out modifications on the issue of the independence rule to enable companies that perform internal audits to have access to practical advice on their internal audits.
- Reduce the regularity of conducting external audits for companies that have to comply with section 404 after a successful first year of compliance.
- Finally, it would authorize a study of the set approached to corporate governance.
An even more successful approach would be to change the structure of the contentious section 404 audit from how it is currently constituted to examine the internal financial controls of an organization. This approach as embodied in the SEC and PCAOB regulatory amendments would mean less costly and much easier compliance for the corporate management, and also for auditors. These amendments would further clarify the legal liability of the auditors, and comprehensively limit it to the structural issues surrounding it. The management would be the one responsible for taking control of the structural components.
Although the SOX Act is recognized for calming the US financial markets and raising the confidence of investors, it’s unparalleled burden of reporting and the burden of paperwork are to blame for its high compliance costs, and a decline on the level of competitiveness in the US financial markets. For example, section 404 directs the auditor to sign off on the internal financial controls of the company, which proves to be a very costly process that specifically burdens small public traded companies (Williams, 2015).
The dubious structure of the PCAOB also leaves a lot to be desired in regulating corporate governance. The Public Company Accounting Oversight Board (PCAOB), since its inception has issued many broad interpretations of the SOX rules thereby costing these public companies as well as the US government billions of dollars every year. Surprisingly, according to the SOX, PCAOB is not a part of the government, but it’s viewed as a private company owned by the SEC. this alone goes against the appointment clause of the United States constitution, because it means that PCAOB members are appointed and report to the SEC members rather than to the president. The hybrid nature of the PCAOB is considered a dangerous innovation that makes the line between self-regulatory organizations and government institutions unclear (Hemamalini, 2009). For what it’s worth, the congress should make it clear that PCAOB is a government owned agency, then continue to make the board members appointees of the president who according to the regulations must be approved by the senate. In spite of the legal fiction that the PCAOB is an ancillary of SEC, it practices independently and should therefore get recognized as one.
Even though the congress put its point across that corporate fraud would not be tolerated any further by enacting the SOX Act, such fraud was already considered a crime. For over two decades cases, officials behind WorldCom, Enron, and other similar scandals have been tried, convicted, and sentenced under criminal laws that existed even before the existence of the Sarbanes-Oxley Act. Despite the fact that fraud was already a crime, under SOX, CFOs and CEOs, board members, plus external auditors who knowingly give wrong financial details of a company faced serious criminal charges, which could see them serve time exceeding those given to convicted murderers (Woo, 2011). It therefore correct to say that it has made corporate leaders become more reluctant to risks, therefore deflation corporate earnings. Additionally, SOX criminalized the management’s failure to identify risks that later become problems. Such regulations have also damaged the relationship between auditors and companies.
Although the sweeping legislations such as the Sarbanes-Oxley law and the The Dodd-Frank Consumer Protection Act are a massive piece of financial reform legislations passed as a response to the Enron and WorldCom scandals, and the financial crisis of 2008 respectively, they brought divisions and extra costs within the financial industry. For example SOX introduced terrific new costs and extra duties to accounting firms and public companies. Even today, people are still divided about whether the focus and time lost on SOX are anywhere near the benefits it brought to the industry. It is quite clear that some additional legislation are needed to avert future scandals. However, some controversial sections of the already existing laws need to be amended because they bring more harm than good. Steve Barth, the co-chair of Foley and Lardner’s national transaction and securities practice referred to the SOX as an abject failure. He said that if its aim was to restore confidence in the capital markets, then it has failed miserably (Woo, 2011).
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Hemamalini, T. & Madhumathi, R. (2009). Corporate Governance Regulations across Specific Countries � A Theoretical Examination. Indian Journal Of Corporate Governance, 2(2), 159-171. http://dx.doi.org/10.1177/0974686220090204
Neuman, E. (2005). THE IMPACT OF THE ENRON ACCOUNTING SCANDAL ON IMPRESSIONS OF MANAGERIAL CONTROL. Academy Of Management Proceedings, 2005(1), S1-S6. http://dx.doi.org/10.5465/ambpp.2005.18783289
Williams, J. (2015). Dodging Dodd-Frank: Excessive Speculation, Commodities Markets, and the Burden of Proof. Law & Policy, 37(1-2), 119-152. http://dx.doi.org/10.1111/lapo.12033
Woo, C. (2011). United States Securities Regulation and Foreign Private Issuers: Lessons from the Sarbanes-Oxley Act. American Business Law Journal, 48(1), 119-176. http://dx.doi.org/10.1111/j.1744-1714.2010.01113.x