Sarbanes Oxley Act of 2002 (by Naira Matevosyan)

SARBANES - OXLEY ACT (SOXA):SARBANES - OXLEY ACT (SOXA):

CORPORATE DUTIES & DISCLOSURE

Naira R. Matevosyan, MD, PhD

Candidate for Masters of Science in Jurisprudence (JSM)

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CORE INQUIRIESCORE INQUIRIESWhy was the SOXA enacted ?

The key elements of this legislation

Steps the corporations should take to comply with the SOXA

Has the SOXA solved the problems it was intended to address ?

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(pp 4 - 9)

(p 10)

(pp 11 -13)

(pp 15 -18)

CONTENTSCONTENTSDefinition - 4Coverage – 5Key Differences Between the Corporation, Partnership, & Sole

Proprietorship – 6Exceptions – 7The Route to the SOXA – 8-9Elements of the SOXA – 10Steps to Comply & Corporate Duty – 11-12Enhanced Financial Disclosures - 13 Corporate Whistleblower Protection - 14Penalties - 15Costs & Benefits – 16Notable Cases – 17Parting Thoughts - 18

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DEFINITIONDEFINITIONIn 2002, the U.S. Congress passed a Sarbanes - Oxley Act

(SOXA). Known as "Public Company Accounting Reform & Investor Protection Act,” this federal law was signed to:

protect shareholders and the general public from accounting errors and fraudulent practices in the enterprise;

improve the accuracy of corporate disclosures.[1, 2]

(1) Pub.L. 107–204

(2) Kohn SM, Kohn MD, Colapinto DK (2004). Whistleblower Law:

A Guide to Legal Protections for Corporate Employees. Praeger 44

THE TARGETTHE TARGETIn order to understand a law, one needs to appreciate its coverage or the target. With all extensions, the SOXA provisions apply to the:

U.S. public company boards

corporations

management and public accounting firms

privately held companies that may willfully destruct evidence to impede a Federal investigation.

What about the partnerships, sole proprietorship, non-profits, and international business associations?

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Key Differences Between Corporations, Partners, & Sole Proprietors

- are based on three features: liability distribution, taxation, and transferability.

Corporations are organizational forms utilized by most the U.S. businesses and provide "limited liability" (LLC) for their owners. If a corporation is sued, the owner risks losing the investment. Unlike sole proprietors or partners, in LLC the shareholders are only held liable for their actual investment, and they do not risk personal assets because the corporation is a separate legal entity. Major Corporations, like IBM, Apple, are PUBLICLY HELD (their shares can be sold or exchanged in the stock market). The ones that are not publicly held, like KOCH Brothers, are CLOSELY HELD.

Sole proprietorship has no legal identity separate from its owner.

Partnerships are legally distinct for some purposes but owners retain personal liability for partnership debts. Partners are liable for all debts and legal responsibilities and personal assets may be used to handle this.

Principle liability applies only to the genuine corporations. If a corporation is a sham:

- the shareholders lose the protection of limited liability;- creditors may "pierce the corporate veil" to recover corporate debts from the owners' personal assets. 66

EXCEPTIONSEXCEPTIONS:

In certain situations [3, 4] courts may ignore the limited liability

status of a corporation and hold its officers, directors,

shareholders, and members personally liable for the debts.

This is known as “piercing the corporate veil.”

(3) United States v. Bestfoods, 524 US 51 - Supreme Court 1998

(4) Morris v. Dept. of Taxation, 623 NE 2d 1157 - NY: Court of Appeals 1993

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A Long Road to the SOXA 1900: New York Stock Exchange (NYSE) requires distribution of annual reports to the stockholders1909: NYSE requires annual meeting of the stakeholders1926: NYSE adopts “one share, one vote” standard1929: Stock market crashes1932: Increased financial disclosure & independent audits become mandatory1934: U.S. Securities and Exchange Commission (SEC) is formed1955: Shareholder approvals are required for certain corporate acquisitions1968: American Stock Exchange (AMEX) publishes the first guide establishing listing standards 1977: NYSE requires establishment of an audit committee comprised of independent directors (continued) 88

The Road (continues)1985: National Association of Securities Dealers Automated Quotations (NASDAQ) initiates its first corporate governance listing standards1987: Committee of Sponsoring Organizations (COSO) to Treadway Commission is established to define responsibilities of the auditor in detecting and preventing fraud1999: NYSE/AMEX/NASDAQ adopt new rules based on the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees2002: U.S. Congress passes the Sarbanes-Oxley Act (July 30th) in response to the accounting scandals of early 2000s: Adelphia,

Enron, Peregryne Systems, Tyco International, WorldCom.2002 to present: In trends to the tougher financial governance, SOXA - type laws are subsequently enacted in Canada (C-SOX, 2002), Germany (German Corporate Gov. Code, 2002), South Africa (King Report on Corporate Gov., 2002), France (Loi sur la Sécurité Financière, 2003), The Netherlands (Code Tabaksblat, 2003), Australia (CLERP, 2004), India (Clause 49, 2005), Japan (J-SOX, 2006), Italy (L262, 2006), Israel (AEC Bachar Law, 2010), and Turkey (TC-SOX 11, 2014). 99

ELEMENTS OF THE SOXAELEMENTS OF THE SOXATitle I (Sec. 101-109) - Public Company Accounting Oversight Board (PCAOB)Title II (Sec. 201-209) - Auditor IndependenceTitle III (Sec. 301-308) - Corporate ResponsibilityTitle IV (Sec. 401-409) - Enhanced Financial Disclosures Title V (Sec. 501) - Analyst Conflicts of InterestTitle VI (Sec. 601-604) - Commission Resources and AuthorityTitle VII (Sec. 701-705) - Studies and ReportsTitle VIII (Sec. 801-807) - Corporate and Criminal Fraud AccountabilityTitle IX (Sec. 901-906) - White Collar Crime Penalty EnhancementTitle X (Sec. 1001) - Corporate Tax ReturnsTitle XI (Sec. 1101 - 1107)- Corporate Fraud Accountability

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STEPS TO COMPLYSTEPS TO COMPLYFormerly, auditing firms were self-regulated. Since 2002, Title

I (PCAOB) requires:

- Registering public accounting firms;

- Establishing auditing standards;

- Inspecting registered public accounting firms;

- Conducting investigations and disciplinary proceedings with ability to sanction auditors and audit firms. [5]

(5) Kimmel PD, Weygandt JK, Donald E (2011). Financial Accounting, 6th Edition. Wiley 1111

CORPORATE DUTY & GOVERNANCECORPORATE DUTY & GOVERNANCEAudit Committee = Independent Directors

Duties of the Audit Committee:- to appoint, compensate, and oversee public accounting firm performing the audit;

- to resolve disagreements over financial reporting between management and external auditors;

Duties of the Board:

- to establish “whistle-blower” procedures, as well as new penalties for retaliation against them;

- to reimburse bonuses and profits if public was misled;

- to remove “substantial unfitness” standard;

- to ban trading during a pension “blackout” period.

Minimum attorney standard (both in-house and offshore): - any reimbursed funds from guilty parties must be added to a fund for the benefit of victims.

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ENHANCED FINANCIAL DISCLOSURESENHANCED FINANCIAL DISCLOSURES

- Off-balance sheet arrangements and obligations

- Prohibition of the loans to executives and directors

- Insider trades within two business days

- Adoption of the code of ethics for senior financial officers and requirements

- At least one member of the audit committee must be an “Audit Committee Financial Expert.” [6, 7]

(6) Bernhard K (2008) The Sarbanes Oxley Act: "Big Brother is watching" you, or Adequate Measures of Corporate Governance Regulation? 5 Rutgers Business Law Journal; 64–95(7) SEC-Press Release on 401(c) (2005). Sec.gov. 2005-06-15. 1313

CORPORATE WHISTLEBLOWER PROTECTIONCORPORATE WHISTLEBLOWER PROTECTION

The SOXA protects corporate whistleblowers with its diverse civil, criminal and administrative provisions:

(1) It requires that all publicly traded corporations create internal and independent “audit committees” and procedures for employees to file internal whistleblower complaints.

(2) It sets forth new ethical standards for attorneys who practice before the SEC. This requires from the attorneys, under the circumstances, to blow the whistle on their employer or “client.”

(3) It amended the federal obstruction of justice statute and criminalized retaliation against whistleblowers who provide “truthful information” to a “law enforcement officer” about the “commission or possible commission of any Federal offense.” This provision covers every employer nationwide.

(4) Section 3(b) of the SOXA enforces every clause of the Act. It states that “a violation by any person of the SOXA shall be treated for all purposes in the same manner as a violation of the SEC of 1934.” This section grants jurisdiction to the SEC to enforce every aspect of the SOXA and provides for criminal penalties for any violation, including the whistleblower-related wrongs. 1414

PENALTIESPENALTIESThe SOXA has civil, administrative, and criminal

provisions:

ADMINISTRATIVE - 42 U.S. Code § 7524 (101-103)

CIVIL - 15 U.S.C. § 7241 (302)

CRIMINAL - 18 U.S.C. § 1350 (902-906)

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COSTS & BENEFITSCOSTS & BENEFITS

Benefits:The CEO and CFO are required to unequivocally take ownership

for their financial statements under Section 302.

SOXA helps restore trust in the U.S. markets by increasing accountability, speeding up reporting, and making audits more independent.

SOXA helps improve investor confidence in financial reporting.

Costs:Excessive executive compensation can be tamed by

Compensation Committees.

Directors must be selected and appraised by independent Nominating Committees.

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NOTABLE CASESNOTABLE CASES

In 2006, Free Enterprise Fund v. Public Company Accounting Oversight Board constitutionally challenged the PCAOB, claiming that “because the PCAOB has regulatory powers over the accounting industry, its officers should be appointed by the President, rather than by the SEC.” [8] The District Court dismissed the claim. The DC Court of Appeals reversed in part and remanded. The U.S. Supreme Court affirmed for defendants, holding that “the Board's appointment is consistent with the Appointments clause.”

In 2014's Lawson v. FMR LLC, the U.S. Supreme Court rejected a narrow reading of the SOXA whistleblower protection and held that “anti-retaliation protection of the SOXA also applies to employees of a public company's private contractors and subcontractors.” [9]

In 2010's Free Ent. Fund v. Public Co. ACCTG. Oversight BD, the U.S. Supreme Court held that “the dual for-cause limitations on the removal of Board members contravene the Constitution's separation of powers.” [10]

In 2015's Yates v. United States, the U.S Supreme Court sided with defendant by reversing the previous judgment and reasoning that "in the physical world not all objects can use to record or preserve information,” and that “the fish is not a tangible object in the context of the SOXA.” [11]

(8) 561 U.S. 477, 130 S. Ct. 3138, 177 L. Ed. 2d 706 (2010)

(9) Lawson v. FMR LLC, 134 S. Ct. 1158 – 2014

(10) Free Ent. Fund v. Public Co. ACCTG., 130 S. Ct. 3138 - Supreme Court 2010

(11) Yates v. United States, 574 U.S. (2015) 1717

PARTING THOUGHTSPARTING THOUGHTS

Nearly all of the SOXA provisions apply only to publicly traded corporations. A wake-up call to the entire nonprofit community, some state Attorneys General have proposed elements of the Sarbanes-Oxley Act be applied to nonprofit organizations.

Nonprofit leaders should carefully visit the SOXA provisions and determine whether their organizations ought to deliberately adopt particular governance practices.

Lastly: the SOXA instituted “clawback” provisions requiring CEOs and CFOs to return ill-gotten gains to their employer. Nowaday online social-media freedom creates a need to revisit the SOXA in terms of regulating the gain accountability of the malicious (for profit) websites that blossom by the traffic indices.