impact of enron and sox

8/10/2019 Impact of Enron and SOX

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Accounting, Auditing andCorporate Governance:

Impact of EnronAccounting Scandal and

Sarbanes-Oxley Act


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Pre-Enron Corporate Governance Standards

Listed companies must have a minimum three-person audit committee

composed solely of independent directors.

Existing definition of independence precludes any relationship withthe company that may interfere with the exercise of director'sindependence from management and the company.

Three year cooling-off period for former employees of the companyand business relationships.

Requires all audit committee members to be financially literate and atleast one must have accounting or related financial-managementexpertise.

Audit committee charter must provide that audit committee and boardof directors have ultimate authority to retain and terminateindependent auditors

Requires shareholder approval of equity compensation plans fordirectors, but broad-based plans are exempt

Requires board of directors to adopt and approve a written charter foraudit committee, which must be reviewed annually.


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Enron Cumulative Monthly Excess Returns

January, 1986 to January, 2002

Source: CRSP Excess Return File

-150%

-100%

-50%

0%

50%

100%

150%

Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02

New Name EnronAdopted

CEO Lay challengesmanagers to embrace

deregulation and shiftstrategy

Asset Lightstrategy is adopted.Enron begins

shedding hard assets

CalPERS andEnron enter into

JEDI-I to invest inenergy projects

JEDI-II is formed.

Enron needs a buyerfor CALPERS

interest in JEDI-I

FERC issues order 636 thatrequires all gas

transmission companies toopen up their pipelines to

unowned gas.

Enron entersinto gas

marketing andbegins energy

trading

CHEWCOformed to buy

JEDI interests.Enron employee

under CFOFastow is the

partner. Deal isall debt with

Enron liable forpayments

SkillingbecomesCEO

LJM-1 and 2 formed

to transfer unwantedassets and debt off

Enrons balancesheet

Dynergy merger fails. Enrondebt downgraded to junk status.Enron files for bankruptcy

Enron restatesbooks goingback to 1997

Sherron Watsonwarns that Enroncould implode

Skilling resigns

AnalystsquestionEnronsbooks


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Anatomy of EnronAccounting Scandal

Enron, like many other companies, used specialpurpose enterprises (SPEs) to access capital orhedge risk

By using SPEs such as limited partnerships with

outside parties, a company is permitted to increaseleverage and ROA without having to report debt onits balance sheet

Company contributes hard assets and related debtto an SPE in exchange for an interest in thepartnership


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SPE then borrows large sums of money from afinancial institution to purchase assets or conductother business without debt or assets showing upon the companys financial statements

Company can also sell leveraged assets and book aprofit

To avoid classification of SPE as a subsidiary(thereby forcing entity to include SPEs financial

position and results of operation in its consolidatedfinancial statements), FASB guidelines require thatonly 3% of SPE be owned by outside investor.


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Enron took advantage of these guidelines. Transferred troubled assets that were falling in

value to SPEs

Losses on these assets would then be kept offEnrons financial statements

To compensate partnership investors fordownside risk, Enron promised issuance ofadditional Enron shares

As value of transferred assets fell, Enronincurred larger and larger obligations toissue more of its shares


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August 14, 2001 Sherron Watkins, an Enron vice-president, CPA and

auditor previously with Arthur Andersen for 8 years,sends letter to Enron Chairman Kenneth Layoutlining many of the misleading accountingtreatments used by Enron.

In this memo, Watkins describes her reservationsabout the lack of disclosure of the substance ofrelated party transactions with SPEs run by the CFOof Enron, Andrew Fastow

She states: I realize that we have had a lot of smartpeople looking at this and a lot of accountantsincluding AA & Co. (Andersen) have blessed theaccounting treatment. None of that will protectEnron if these transactions are ever disclosed in the

bright light of day.


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October 16, 2001

Enron Corporation, one of largest corporations

in the world, announced the following:

reduction in its after-tax net income by $544million

reduction in its shareholders equity by $1.2

billion


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October 22, 2001

Enron announced that SEC was looking intorelated party transactions between Enron

and partnerships owned by its CFO, AndrewFastow


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November 8, 2001 Enron announced restatement of its financial

statements for 1997 thru 2000 to reflectconsolidation of SPEs it had omitted as well as tobook adjustments recommended by ArthurAndersen for those years, which Enron hadpreviously deemed immaterial

In addition to recognizing an additional $628 millionin liabilities, these restatements reduced previouslyreported net income as follows:

Year Reported Restated Decline

1997 $105 $28 73%

1998 $703 $133 81%

1999 $893 $248 72%

2000 $979 $99 90%


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January 17, 2002

Enron fires Arthur Andersen as itsindependent auditor

Cites document destruction and lack ofguidance on accounting policy issues


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Enron bankruptcy of particular interest for

following reasons:

Transactions involving SPEs and related

accounting issues Breakdown in corporate governance in

relationship between Board of Directors andAudit Committee

Participation of Enrons independent auditor,Arthur Andersen, in setting up SPEs

Reveals shortcomings of rule-based US GAAP

GAAP override


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Accounting Issues Non-consolidation of SPEs that permitted Enron to

hide losses and debt from investors Sales of investments to unconsolidated (though

actually controlled) SPEs as if they were arms-lengthtransactions Recording as current income, fees for services

rendered in future periods Fair-value restatements of investments that were not

based on trustworthy numbers Accounting for Enron stock issued to and held by

SPEs Disclosure of related party transactions and

conflicts of interest, and their costs to stockholders


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Breakdown of Corporate Governance Many of related party transactions were brought

to attention of Enrons BOD and were discussedin some detail with members of Audit and

Compliance Committee SEC requires that exchanges (NYSE, ASE, and

NASDAQ) require financial literacy for all auditcommittee members and financial expertise forat least one member

At least 4 of 6 members had financial expertise Robert Jaedicke, Professor of Accounting at Stanford University Wendy Graham, PhD in Economics and former Chair of

Commodity Futures Trading Commission Lord John Wakeham, CA and British Secy of State for Energy

Paola Ferraz Pereira, President of State Bank of Rio de Janerio


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Breakdown of Corporate Governance Enrons BOD reviewed and approved

creation of SPEs and assigned Audit

Committee duty to review transactions BOD waived companys code of ethics

for SPE transactions

Audit Committee failed to adequatelyunderstand, review, and monitor SPEsand Enrons accounting and reportingpractices


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Independence of External Auditor Arthur Andersen audited and gave unqualified

opinions on Enrons financial statements since1985

Enron was AAs second largest client In 2000, AA received $25 million in audit fees and $27

million in non-audit consulting fees from Enron In 2000, AA had total worldwide revenues of $9 billion

AA was not only Enrons external auditor, but

also its internal auditor and kept staff onpermanent assignment at Enrons offices

Many of Enrons internal accountants, CFOs andcontrollers were former AA executives andemployees


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Anatomy of an AccountingScandalEnron Corporation

Shortcomings of Rule-Based US GAAP SEC has authority to establish GAAP and GAAS in US,

review and disapprove as inadequate financialstatements of registered companies

SEC has delegated that authority to establish GAAP toFASB, a non-governmental agency

Many believe that US GAAP, as structured andadministered by SEC, the FASB, and the AICPA, aresubstantially responsible for Enron accounting scandal

US model of specifying accounting rules that must be

followed appears to have allowed or required AA toaccept procedures that were within the letter of rule, eventhough they violate basic objectives of US GAAP

US model allows corporate officers to view accountingrequirements of US GAAP as if they were specified in atax code


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Example of Rules-Based US GAAPby Lessee - SPAS 13

Lease Agreement

Is there transfer

of ownership?

Yes

Is there a bargain

purchase option?

YesNo

Is lease term equal

to or greater than

75% of economic

life ?

Yes

No

Capital

Lease

Operating

Lease

Is present valueof payments

equal to or more

than 90% FMV?

Yes

No


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Anatomy of an AccountingScandalEnron Corporation

Shortcomings of Rule-Based US GAAP Fair-value requirement of financial

instruments adopted by FASB permittedEnron to increase its reported assets and net

income and, thereby, hide losses AA appears to have accepted these

valuations because Enron was followingspecific US GAAP rules


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GAAP Override

Are auditors in US allowed to override USGAAP?

Auditors in other countries allowed to

override GAAP Inability of auditors in US to override US

GAAP may have been contributing factor inEnron accounting scandal

Many believe that principles-based IASGAAP that requires true and fair view of anenterprises financial condition is preferableto highly specified rule-based US GAAP


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US Audit Opinion

In our opinion, the financial statementsof XYZ Company present fairly thefinancial position and results of

operations for the years endedDecember 31, 20X1 and 20X2 inaccordance with generally accepted

accounting principlesapplied on abasis consistent with the precedingyear.


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True and Fair View Opinion

In our opinion, the financial statementsof XYZ Company present a true and fairviewof the financial position and

results of operations for the yearsended December 31, 20X1 and 20X2.


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Other Accounting Scandals

WorldCom

Global Crossings

Tyco International Adelphia

Critical Path

Imclone Systems Vivendi


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Other Accounting Scandals


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Aftermath of EnronAccounting Scandal

Sarbanes-Oxley Act of 2002

New NYSE Corporate Governance

Listing Standards New Corporate Governance Rules

adopted by SEC

New Rules and Auditing Standardsadopted or proposed by PublicCompany Accounting Oversight Board


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Last years Sarbanes-Oxley Act broughtthe most sweeping changes in corporategovernance and financial disclosure for

70 years (Financial Times, December 1,2003)

Sarbanes-Oxley will be judged aslandmark legislation. It is one of the most

sweeping reforms since the 1933Securities Reform Legislation. (BethBrooke, Global Vice Chair, Ernst andYoung, September 15, 2003)

Importance ofSarbanes-Oxley Act of 2002


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Audit Committee Hot Seat


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Signed into law on July 30, 2002 Applies to publicly held US companies and

foreign private issuers and their audit firms

Establishes Public Company AccountingOversight Board (PCAOB) to regulateaccounting professionals who audit financialstatements of public companies

Provides for significant corporate governancereforms regarding audit committees and their relationship with their

auditors

financial reporting and auditing process



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Listing of Titles and Sections


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Public Company Accounting Oversight BoardSection 101

Not a government agency

Private sector regulatory agency subject todirect and substantial SEC oversight

previously under Public Oversight Board ofAICPA

Consists of five full-time members who will

Oversee and investigate audits and auditors of

public companies

Sanction both firms and individuals for violationsof laws, regulations, and rules


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Board Composition Two of five board members must be or

have been CPAs

Remaining three must not be andcannot have been CPAs

Chair of Board may be held by one of

the CPAs, but he/she must not havepracticed accounting during five yearspreceding his/her appointment


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Public Company Accounting Oversight BoardSections 102 and 109

Registration with Board

Accounting firms that audit publiccompanies must register with PCAOBand pay registration and annual fees

Funding of Board

PCAOB will be funded by publiccompanies through these mandatoryfees


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Auditing Standard Setting Board will have responsibility for establishing following

standards necessary to protect the public interest: Auditing and related attestation Quality control Ethics Independence

Function previously performed by Auditing StandardsBoard (ASB) of AICPA that establishes GAAS

Board required to cooperate with designated professional

groups of accountants in standard setting (eg, AICPA) Board, however, has authority to amend, modify, repeal

or reject any standard suggested by professional groups Thus, board may, but is not required to, continue to allow

ASB to establish these standards


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Public Company Accounting Oversight BoardSections 104 and 105

Inspection Authority

Empowered PCAOB to regularlyinspect registered accounting firms

operationsInvestigative and Disciplinary Authority

Empowered PCAOB to investigate

potential violations of: Securities laws

Standards

Competency and conduct


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International Authority Foreign accounting firms that prepare

or furnish an audit report involving US

registrants will be subject to authorityof PCAOB If registered US accounting firm relies

on opinion of foreign accounting firm,

foreign firms audit work papers mustbe supplied upon request to PCAOB orSEC


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Accounting Standard Setting establishes criteria that must be met in order for work productof an accounting standard-setting body to be recognized asgenerally accepted

may recognize as "generally accepted" any accountingprinciples established by a standard setting body that:

is organized as a private entity; has, for administrative and operational purposes, a board of trustees

serving in the public interest, the majority of whom are not, concurrentwith their service on such board, and have not been during the two-yearperiod preceding such service, associated persons of any registered publicaccounting firm;

is funded as provided in Section 109 of the Sarbanes-Oxley Act; has adopted procedures to ensure prompt consideration, by majority vote

of its members, of changes to accounting principles necessary to reflectemerging accounting issues and changing business practices; and

considers, in adopting accounting principles, the need to keep standardscurrent in order to reflect changes in the business environment, the extentto which international convergence on high quality accounting standardsis necessary or appropriate in the public interest and for the protection ofinvestors.


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Accounting Standard Setting SEC must conduct a study on the adoption by the

United States financial reporting system of aprinciples-based accounting system

Commission must submit results of this study toCongress by July 30, 2003

Study shall include: the extent to which principles-based accounting and

financial reporting exists in the United States

length of time required for change from a rules-basedto a principles-based financial reporting system

feasibility of and proposed methods by which aprinciples-based system may be implemented


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Sarbanes-Oxley Act of 2002Listing of Titles and Sections

Auditor Independence


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Auditor IndependenceSection 201

New Roles for Audit Committees and Auditors

New law prohibits independent auditors fromoffering certain non-audit services to auditclients

Prohibited services include: Bookkeeping Financial information systems design and implementation Appraisals or valuation services Actuarial services Internal audit outsourcing services Management and human resources services

Broker/dealer and investment banking services Legal services Expert services unrelated to audit services

Other non-audit services not banned are allowedif pre-approved by audit committee

Auditor Independence


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Audit committee must pre-approve allservices (both audit and non-audit notspecifically prohibited) provided by itsindependent auditors

Requires disclosure, in annual report, offees paid to independent accountants for:

- Audit services

- Audit-related services

- Tax services

- Other services


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New Roles for Audit Committees and Auditors Second partner review and approval of audit reports Lead audit partner and audit review partner must be

rotated every five years on public company engagements

An accountant is not independent if, at any point during

audit and professional engagement period, any auditpartner earns or receives compensation based on thatpartner procuring engagements with audit client toprovide any services other than audit, review or attestservices

firms with fewer than five audit clients and fewer than tenpartners may be exempt from partner rotation andcompensation provisions, provided each engagement issubject to special review by PCAOB at least every threeyears

A dit I d d


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Auditor IndependenceSections 204


Independent auditors report to companys auditcommittee, not management

Independent auditor must report newinformation to audit committee including:

Critical accounting policies and practices to beused

Alternative treatments of financial informationwith GAAP that have been discussed with

management Accounting disagreements between auditor and

management

Other relevant communications between auditorand management


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Accounting firm will not be able to provideaudit services to public company if one of

that companys top officials (CEO, Controller,CFO, Chief Accounting Officer, etc) was

employed by firm and

worked on companys audit during previous year


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C t R ibilit


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Corporate ResponsibilitySection 301

Financial Reporting and Auditing Process

Self-Regulatory Organizations (SROs) (NYSEand NASDAQ) must adopt listing standardsfor audit committees

SROs must prohibit listing of any securitywhose issuer does not have audit committeecomprised entirely of independent directors: For a director to be deemed "independent," the board must

affirmatively determine the director has no material relationship

with the listed company (either directly or as a partner,shareholder or officer of an organization that has a relationshipwith the company)

Former employees of company or auditors of companyand theirfamily membersmay not be considered independent until fiveyears after their employment ends.


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Financial Reporting and Auditing Process Audit committee members are prohibited from

receiving any compensation other than directorscompensation fees

Chair of audit committee to have accounting or

related financial-management expertise. Audit committee must have sole authority to hire and

fire independent auditor and approve any non-auditrelationship with independent auditor

Audit committee must establish procedures for

receipt, retention and treatment of complaintsregarding accounting, internal controls or auditingmatters

Issuer must provide appropriate funding for auditcommittee

C


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Financial Reporting and Auditing Process several provisions included to address

special circumstances of particular foreignissuers

allow non-management employees to serve asaudit committee members consistent with co-determination and similar requirements in somecountries

allow foreign government shareholderrepresentation on audit committees


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Financial Reporting and Auditing Process CEO and CFO of each issuer shall prepare

statement to accompany the audit report tocertify "appropriateness of the financial

statements and disclosures contained in theperiodic report, and that those financialstatements and disclosures fairly present, inall material respects, the operations andfinancial condition of the issuer." .

C


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Financial Reporting and Auditing Process Prohibits officers and directors of an issuer

or their representatives from taking actionsto coerce, manipulate, or fraudulently

influence the independent auditor of thefinancial statements if that person knew orshould have known that such action, ifsuccessful, could result in rendering thefinancial statements materially misleading


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Corporate ResponsibilitySections 304 and 306

Financial Reporting and Auditing Process

Management must return bonuses or profitsfrom stock sales received within 12 months

of a restatement of financial results causedby non-compliance with financial reportingrequirements as a result of misconduct

Company officers prohibited from trading

shares during pension blackout periods


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Enhanced Financial DisclosureSections 401, 402 and 403

Requires registrant to:- provide explanation of its off-balance sheet

arrangements in separately captioned sectionof MD&A section

- Provide an overview of certain knowncontractual obligations in tabular format

Prohibits companies from making loansto insiders

Requires electronic filing of disclosuresof insider transactions in company stock

Enhanced Financial Disclosure


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Enhanced Financial DisclosureSection 404

Annual report must contain a report frommanagement on internal controls that States managements responsibility for

establishing and maintaining an adequateinternal control structure and procedures for

financial reporting Contains an assessment of the effectiveness of

internal control related to financial reporting

External auditor must attest to manage-

ments assertion concerning its assessmentof internal control as part of audit- Audit report must contain opinion on

assessment made by management of companysinternal controls structures

E h d Fi i l Di l


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Enhanced Financial DisclosureSection 404

CEO and CFO Certifications of Disclosure Controls Term is broader than internal controls over financial

reporting

Term includes internal controls over financial

reporting but also includes controls and proceduressuch as those to ensure: Timely collection and evaluation of information subject to disclosure

requirements under Regulations S-X, S-K or S-B

Timely collection and evaluation of all information relevant to an

assessment of the need to disclose developments and risks thatpertain to the entitys business

Limited number of companies have strong disclosurecontrols


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Enhanced Financial DisclosureSections 406 and 407

Requires companies to disclose whetherthey have a code of ethics for CEO, CFO, andsenior accounting personnel

Any amendments or waivers of code ofethics for directors or executives must bedisclosed

Requires company to disclose: Whether it has at least one financial expert

serving on its audit committee The name of the expert and whether the expert is

independent of management



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Corporate and Criminal Fraud Accountability


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Corporate and Criminal Fraud AccountabilityWhite Collar Crime Penalty

Criminal Penalties Failure to maintain work papers SEC will establish rule covering retention of audit records Board will issue standards that compel auditors to keep

other documentation for seven years

Document destruction Felony to destroy documents in federal or bankruptcyinvestigation

Up to 20 years in prison

Securities fraud Penalties increased to 25 years in prison

Fraud discovery Statutes of limitations extended to two years from date of

discovery and five years after act Previously one year and three years


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Sarbanes-Oxley ActRamifications of Provisions of Act

Consulting services Other non-audit services, including tax services, require pre-

approval by audit committee

Implications for CPAs with tax practices Expert services not defined in Act

Possible that tax services viewed as expert services and notpermitted by any firm providing audit services for publicly heldaudit client

Cascading effect Concern is that new legislation by US Congress may become

template for parallel federal and state legislation or rules changesthat directly affect both non-public companies that are subject to

other regulations and the CPAs that provide services to them Additional burdens for CPAs in business and industry

CEOs and CFOs now required to certify company financialstatements

Have greater duty to communicate and coordinate with corporateaudit committees who now hire, compensate and oversee

independent auditors

Aftermath of Enron


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Aftermath of EnronAccounting Scandal

New NYSE Corporate Governance Listing Standards On February 13, 2002, Chairman of SEC asked NYSE to review

its corporate governance listing standards

BOD of NYSE appointed Corporate Accountability and Listing

Standards Committee to review current listing standards andmake recommendations

On June 6, 2002, Committee presented NYSE BOD with reportrecommending significant changes in how NYSE-listedcompanies are governed

On August 1, 2002, NYSE approved Committeesrecommendations

On August 16, 2002, NYSE sent recommendations to SEC forapproval

On November 4, 2003, SEC approved new rules


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Selected Final Recommendations of NYSE Corporate


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Selected Final Recommendations of NYSE CorporateAccountability and Listing Standards Committee

Comparison with Current Rules

Final Recommendation Current RuleFor a director to be deemed"independent," the board mustaffirmatively determine thedirector has no material

relationship with the listedcompany (either directly or as apartner, shareholder or officer ofan organization that has arelationship with the company).

Existing definition precludes anyrelationship with the companythat may interfere with theexercise of director's

independence from managementand the company.

Prohibit audit committee

members from receivingcompensation other thandirectors compensation fees

No existing restrictions



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Final Recommendation Current RuleFormer employees of company orauditors of companyand theirfamily membersmay not beconsidered independent until five

years after their employmentends.

Three year cooling-off period forformer employees of the companyand business relationships.

Every listed company must havean internal audit function

No existing requirement.

Require chair of audit committeeto have accounting or relatedfinancial-management expertise.

Requires all audit committeemembers to be financially literateand at least one must haveaccounting or related financial-management expertise.



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Final Recommendation Current RuleGrant audit committee soleauthority to hire and fireindependent auditor and approveany non-audit relationship with

independent auditor

Audit committee charter mustprovide that audit committee andboard of directors have ultimateauthority to retain and terminate

independent auditorsRequire shareholder approval ofall equity compensation plans.

Requires shareholder approval ofequity compensation plans fordirectors, but broad-based plansare exempt



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Final Recommendation Current RuleRequire companies to adopt anddisclose corporate governanceguidelines, codes of businessconduct, and charters for their

audit, compensation andnominations committees.

Requires board of directors toadopt and approve a writtencharter for audit committee, whichmust be reviewed annually. No

existing rules requiringcompensation and nominatingcommittees, corporategovernance guidelines, or codesof business conduct.

Any waivers of codes of business

conduct for directors orexecutives must be disclosed.


Require foreign private issuers todisclose any significant ways inwhich their corporate governance

practices differ from NYSE rules.




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Final Recommendation Current RuleEach listed-company's CEO andCFO must certify annual financialstatements

No existing requirement .

Each listed-company's CEO must

certify annually that he/she is notaware of any violation by thecompany of NYSE corporategovernance standards.

No existing requirement .

NYSE may issue a publicreprimand letter for violation of acorporate governance standard,in addition to the existing penaltyof delisting.

No current provision for a publicreprimand.

The NYSE urges every listedcompany to establish orientation

program for new board members.

No such recommendation hasbeen made previously.


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Summary of SEC Actions and SEC Related ProvisionsPursuant to the Sarbanes-Oxley Act of 2002

Restoring Confidence in the Accounting Profession

The Sarbanes-Oxley Act established the Public CompanyAccounting Oversight Board (PCAOB)

Section 108(b) - On April 25, 2003, recognized the Financial

Accounting Standards Board as the accounting standard setter Section 108(d) - On July 25, 2003, issued a study on principles-

based accounting Section 109 - The Act established an independent funding source

for the FASB

Title II (Sections 201, 202, etc.) - On January 22, 2003, adoptedrules improving the independence of outside auditors Section 303 - On April 24, 2003, adopted rules forbidding the

improper influence on outside auditors Section 802 - On January 22, 2003, adopted rules governing the

retention of audit records by outside auditors

Summary of SEC Actions and SEC Related Provisions


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Improving the "Tone at the Top"

Section 302 - On August 27, 2002, adopted rules requiring CEOs and CFOsto certify financial and other information in their companies' quarterly andannual reports.

Section 304Adopted rule requiring management to return bonuses orprofits from stock sales received within 12 months of a restatement

resulting from material non-compliance with financial reportingrequirements as a result of misconduct.

Section 306 - On January 15, 2003, adopted rules prohibiting companyofficers from trading during pension fund blackout periods.

Section 402Adopted rules prohibiting companies from making loans toinsiders.

Section 403 - On August 27, 2002, adopted rules that accelerateddeadlines and mandated electronic filing of disclosures of insidertransactions in company stock.

Section 406 - On January 15, 2003, adopted rules requiring companies todisclose whether they have a code of ethics for their CEO, CFO and senior

accounting personnel



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Improving Disclosure and Financial Reporting Section 401(a) - On January 22, 2003, adopted rules requiring

disclosure of all material off-balance sheet transactions. Section 401(b) - On January 15, 2003, adopted Regulation G,

governing the use of non-GAAP financial measures, including

disclosure and reconciliation requirements. Section 404 - On May 27, 2003, adopted rules requiring an annual

management report on and auditor attestation of a company'sinternal controls over financial reporting.



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Improving the Performance of "Gatekeepers"

Section 301 - On April 1, 2003, adopted rules directing the SROs toadopt listing standards for audit committees.

On November 4, 2003, approved new rules proposed and adoptedby NYSE and NASDAQ requiring strengthening of corporate

governance statndards for listed companies Section 407 - On January 15, 2003, adopted rules requiring the

disclosure about financial experts on audit committees. Section 307 - On January 23, 2003, adopted rules governing

standards of conduct for attorneys appearing and practicing

before the Commission. Section 501 - On July 29, 2003, approved new SRO rules governing

research analyst conflicts of interest.

SEC Study on Principles-Based Accounting


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In enacting the Sarbanes-Oxley Act, Congress

recognized that accounting standards that contain toomany exceptions, interpretations and bright-linepercentage tests might have contributed to efforts bymanagements and accountants to structuretransactions that provide a desired accounting result

and yet allow the company to avoid clear disclosure ofthe economic consequences of those transactions inits financial statements.

On July 25, 2003, SEC staff released its study.

Study found that standards reflecting only a statedprinciple of accounting ("principle-only standards")would present enforcement difficulties because theywould provide little guidance or structure for exercisingprofessional judgment in applying that principle.



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also found that accounting standards that are too

detailed ("rules-based standards") often provide avehicle for circumventing the intention of the standard. Study indicates that best approach would be to develop

accounting standards that:- Are based on a conceptual framework;

- Clearly state the accounting objective of the standard;- Provide sufficient detail and structure so the standard may be

applied on a consistent basis;- Minimize exceptions from the standard; and- Avoid the use of percentage tests that allow financial engineers

to achieve technical compliance with the standard whileevading the intent of the standard.

study's recommendation is consistent with theapproach currently being developed by the FinancialAccounting Standards Board



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y p g

Study acknowledges that FASB has begun shift toobjectives-oriented standard setting and is doing so ona prospective, project-by-project basis.

study expects that the FASB will continue to movetowards objectives-oriented standard setting on atransitional or evolutionary basis.

According to study, operationalizing objectives-oriented approach to standard setting in U.S. requiresthat the following key steps be taken over time:- Ensure newly-developed standards articulate accounting objectives

and avoid scope exceptions, bright-lines and excessive detail;

- Address deficiencies and inconsistencies in the conceptual framework;- Ensure new standards aligned with improved conceptual framework;- Address current standards that are more rules-based;- Redefine the GAAP hierarchy; and- Continue efforts on convergence of U.S., foreign, and international

accounting standards.

N R l Ad t d b PCAOB


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New Rules Adopted by PCAOB On April 18, 2003, announced process PCAOB will use

to establish auditing and other professional standardsfor registered public accounting firms

Pursuant to Section 103 of Sarbanes-Oxley, newProfessional Auditing Standards will be established by

PCAOB PCAOB decided not to exercise its authority under

Section 103 to designate or recognize any professionalgroup of accountants to propose auditing and otherprofessional standards

PCAOB would have its own standard setting processfor auditing and other professional standards

Rule 3700 would govern formation, composition androle of advisory group in standard setting process



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New Rules Adopted by PCAOB On April 18, 2003, established Interim Professional

Auditing Standards (IPAS) concerning: Auditing (Rule 3200T) Attestation (Rule 3300T) Quality control (Rule 3400T)

Ethics (Rule 3500T) Independence (Rule 3600T)

PCAOB determined that generally accepted auditingstandards (GAAS) proposed by AICPA and AuditingStandards Board (ASB) should be adopted as InterimAuditing Standards

These GAAS will continue to have same authority theycurrently have unless and until they are superceded bystandards promulgated by PCAOB

New Rules Adopted by PCAOB


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Interim standards adopted on an initial, transitional

basis in order to ensure continuity and certainty instandards that govern audits of public companies Interim standards will remain in effect while PCAOB

conducts review of standards applicable to registeredpublic accounting firms

Objective of review will be to determine, on a standardby standard basis, whether the IPAS should becomepermanent Professional Auditing Standards, repealed,or modified

As review of each IPAS is completed, PCAOB will adoptthat standard, with or without modification, repeal thestandard, or take any other appropriate actionregarding that standard



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New Rules Adopted by PCAOB On April 18, 2003, adopted rules, subject to approval by

SEC, establishing accounting support fee required bySarbanes-Oxley Act

On May 6, 2003, adopted, subject to approval by SEC, aregistration system for public accounting firms

On June 30, 2003, adopted, subject to approval by SEC,an Ethics Code for PCAOB

On June 30, 2003, adopted rule, subject to approval bySEC, that requires all registered public accountingfirms to adhere to PCAOBs auditing and relatedprofessional practice standards in connection withpreparation or issuance of any audit report for anissuer and in their auditing and related attestationpractices



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On September 29, 2003, adopted rules, subject toapproval by SEC, on investigations of registered publicaccounting firms

On September 29, 2003, adopted rules, subject toapproval by SEC, on process by which registeredpublic accounting firm can seek to withdraw fromregistration

On October 7, 2003, adopted rules, subject to SECapproval, relating to inspections of registered public

accounting firms

N R l P d b PCAOB


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New Rules Proposed by PCAOB

On October 7, 2003, proposed new rule regardingthe terminology PCAOB will use in its Auditing andRelated Professional Practice Standards to describethe obligations those standards impose onregistered public accounting firms

On December 4, 2003, scheduled an open meetingto consider whether to propose and seek commenton rules related to inspections and investigations ofnon-U.S. public accounting that register with the

PCAOB

New Auditing Standards


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gProposed by PCAOB

On October 7, 2003, proposed new auditing standardentitled An Audit of Internal Control Over FinancialReporting Performed in Conjunction with an Audit ofFinancial Statements

Addresses both: work that is required to audit internal control over

financial reporting and the relationship of audit to the audit of the financial

statements

New Auditing Standards


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gProposed by PCAOB

On November 12, 2003, proposed two new auditingstandards:

First proposed standard would establish generalrequirements for documentation the auditor shouldprepare and retain in connection with any publiccompany audit.

Second proposed standard would require registeredpublic accounting firms to explicitly state in each publiccompany audit report that the audit was conducted in

accordance with the standards of the Public CompanyAccounting Oversight Board

Contact Information


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Contact Information

Professor J. Timothy SaleUniversity of [email protected]://www.cba.uc.edu/faculty/sale/sale.htm
mailto:[email protected]:[email protected]

impact of enron and sox

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