Sarbanes-Oxley and Section 404: Old Dog, New Teeth

Home
>
Business Management
>
Sarbanes-Oxley and Section 404: Old Dog, New Teeth

Sarbanes-Oxley and Section 404: Old Dog, New Teeth

The failures we have seen in the quality and integrity of financial reporting in corporate America are clear evidence that something was awry. It is the responsibility of corporate boards, managements, public accounting firms and regulatory agencies to put confidence back into the financial statements issued by our society's most significant entities. Although some would argue that Sarbanes Oxley went too far, it is also now evident that government action and the use of enforcement muscle was required, if for no other reason than to move toward rebuilding public trust. There is no doubt that Sarbanes Oxley, and in particular, Section 404, has increased the expense of doing business for public corporations; however, this is neither a new mandate, nor a superfluous one. All parties engaged in this process have previously ignored the mandate, and must now accept reality, and get past the complaining.

A little history?back in 1977, the Congress of the United States passed a piece of legislation commonly known as the Foreign Corrupt Practices Act (FCPA). That law is well know for mandating the American corporations regulated by Securities Exchange Commission (SEC) be prohibited from making any type of corrupt payments to agents of governments or corporations in foreign countries. The civil and criminal penalties were quite onerous, and most corporations changed their practices in order to avoid those penalties.

The action taken by the FCPA in 1977 was often characterized as the most extensive application of federal law to the regulation of business since the passage of the 1933 and 1934 securities acts. In light of reports that American corporations were "greasing" government officials in a number of countries, Congress had acted decisively in order to restore the reputation of American business and eliminate improper payments to foreign governments, politicians and political parties. A seldom-remembered aspect of that legislation was that the same corporations were mandated to "devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that?transactions are recorded as necessary to?permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and?to maintain accountability for assets."

This requirement got a great deal of press when the law was first passed, and many articles were written on how the new law would transform the way corporations managed and the way the public accounting firms audited. This was true for a short time, but the business world slipped back into its previous lack of concern for controls, and the public accounting firms conveniently allowed that slippage. Pressure for firms to maintain cost-effective (generally meaning lean) operations and pressure from firms to keep down auditing fees, caused the corporations and the audit firms to be at best, permissive in regards to compliance with the FCPA mandate.

In effect, the act had no teeth. All of the sanctions imposed were focused on punishing illegal payments, not for a failure to comply with the internal controls mandate. For 25 years, Congress, the SEC, public companies and public accounting firms essentially ignored a mandate in large measure because there was little or no enforcement action for a failure to comply. The academic leaders in the accounting profession have know for some time that there was a need to strengthen the systems of internal controls. In 1985, the Treadway Commission was asked to identify what caused fraudulent financial reporting and to make recommendations to reduce its incidence. The Commission's report included specific recommendations for management and boards of directors of public companies, the public accounting profession, the SEC and other regulatory and law enforcement bodies, and academics. The Commission made a number of recommendations that directly addressed internal control.

Importantly, the commission focused on the control environment, codes of conduct, competent and involved audit committees and an active and objective internal audit function. It also called for the sponsoring organizations to work together to create a framework for establishing and evaluating systems of internal controls. The result was the creation of the Committee of Sponsoring Organanizations of the Treadway Commission (COSO), which issued a report that outlined the principles for an effective system of internal controls.

Fast forward to the current rash of business scandals and the latest crises. This time the fear in Congress was so great that the mandate was restated; and this time, sanctions for non-compliance were included in the legislation. Now 25 years of neglect and sloppiness have caught up with the public and private sectors. The threat that corporate officers might actually be held accountable for failure and accordingly charged with civil and criminal penalties, in combination with a comprehensive regulatory system (Public Company Accounting Oversight Board) imposed on the accounting firms and a strengthened accountability by the SEC have now brought internal controls to the forefront.

The plain fact is, there is nothing new with SOX 404. Quality policy, practice and procedure documentation systems have always been the basis of sound internal controls and systems audits. The corollary fact is that corporations have generally given superficial attention to these programs, calling them unduly bureaucratic and unreasonably expensive. Over the last 25 years, we have not only ignored the law, we have also ignored sound management practice. All of this in the guise of being "cost-effective."

Sarbanes Oxley has obviously cost corporations huge amounts of money during this first year, but that is to be expected after 25 years of disregard for a well documented system of controls. In subsequent years the costs will be less, but there will still be a permanent increase in systems costs. Controls cost money and it is our own neglect that has created the need for corporate boards and managements to execute a major catch-up program.

The irony is that the COSO standard may not have been the best standard to impose on the audit process, but it was there and well documented when the Audit community needed to move quickly. With all the "push back" coming from the corporate community, there may well be some modifications that will make the audit process less onerous, but COSO does provide a basis for very much the same kinds of documentation that are imbedded in the standards of documentation found in best practices systems throughout the world. Corporate America simply needs to make the best of this mandate and use it as a launch point for continuous improvement of these controls so that they become both compliant and useful to effective management processes.

Just as with individual behavior, the way to get results in business is to either reward the results you seek, or to punish the results you want to eliminate. In government, more often than not, the sanction is more effective than the reward, or at least it is easier to deploy. We now have sanctions that threaten all participants in the process of establishing and evaluating the 25-year-old mandate for a system of internal controls. Those sanctions have commanded the attention of managements and boards alike; and SOX has been granted serious focus in every public company board room in America. Indeed, these standards are also spreading to non-public corporations, and even becoming a de facto standard for nonprofits as well.

There is little doubt that as time passes, effectiveness and efficiency will improve and thus limit costs, but they will never go away?that is, not as long as the enforcement teeth are still sharp. The sad commentary is that in the face of softer enforcement we disregarded a mandate for 25 years, and for this we are now paying the price.

Gerald Czarnecki, Chairman & CEO of the Deltennium Group, is a consultant, author and public speaker. A leading authority on corporate governance, Mr. Czarnecki conducts seminars and private boardroom sessions on Sarbanes-Oxley and the issues of governance that face boards of directors today. He also serves on the boards of directors of several large American corporations. For more information visit http://www.deltennium.com

In The News:

Yahoo! News: Top Stories

Gaza violence rages on despite UN cease-fire call (AP)

AP - The U.N. Security Council called for an immediate cease-fire in Gaza, but an intense bombardment of missiles from Israeli jets and helicopters early Friday and a barrage of Hamas rockets indicated there may be no quick end to the fighting.

Illinois House on verge of impeaching Blagojevich (AP)

AP - Gov. Rod Blagojevich faces almost certain impeachment by the Illinois House, a historic step that would trigger a trial to determine whether the Democratic governor should be tossed out of office.

Rifts show as Obama urges quick action on stimulus (AP)

AP - Lawmakers are under orders to finish action on President-elect Barack Obama's nearly $800 billion economic recovery plan by mid-February. But already it is plain that a set of serious fissures need to be bridged if the bill is to be completed within five weeks.

Democrats begin new session with labor bills (AP)

AP - Democrats are ushering in what they believe will be a new labor-friendly era in Washington with House votes on two bills aimed at helping women fight pay discrimination in the workplace.

Job losses stack up as recession deepens (AP)

AP - Trying to survive a deepening recession, employers are cutting their work forces to the bone, leaving more Americans unemployed and with dim prospects of finding a new job any time soon.

Toxic coal ash piling up in ponds in 32 states (AP)

AP - Millions of tons of toxic coal ash is piling up in power plant ponds in 32 states, a practice the federal government has long recognized as a risk to human health and the environment but has left unregulated.

Obama to finalize national security team Friday (AP)

AP - President-elect Barack Obama is completing his national security team by announcing his unusual choices for CIA director and a national intelligence director who may face tough Senate confirmation questioning over how he confronted the Indonesian military when civilian massacres were occurring in East Timor.

Emphasis on smooth transition to new Cabinet (AP)

AP - Just minutes after George W. Bush took the oath of office eight years ago, he signed papers formally nominating 13 Cabinet-level officials. Several hours later, the Senate, meeting in a special Saturday session, confirmed seven Cabinet secretaries, including the heads of the key posts at State, Treasury and Defense.

Critics' final answer: `Slumdog' wins 5 awards (AP)

AP - The critics have spoken, and "Slumdog Millionaire" is their final answer.

Mini Dynasty: Tebow leads Gators past Oklahoma (AP)

AP - The game defied expectations. Tim Tebow fulfilled them. He rescued No. 1 Florida, running through and throwing over No. 2 Oklahoma for a 24-14 victory Thursday night that gave the Gators their second BCS championship in three years.

World waits on jobs data as recession weighs (Reuters)

Reuters - U.S. employers probably cut the most jobs in at least 34 years last month as the global economic crisis gathered pace and moves by policy makers took time to filter through to struggling companies.

U.N. calls for immediate Gaza truce (Reuters)

Reuters - Israel pushed ahead with its two-week-old offensive in the Gaza Strip, ignoring a U.N. Security Council resolution calling for an immediate ceasefire.

Panel steps up criticism of Treasury: report (Reuters)

Reuters - A report being released on Friday alleges that the U.S. Treasury has failed to reveal its strategy for stabilizing the financial system, not answered questions asked by a government watchdog, and has done nothing to help struggling homeowners, the Wall Street Journal said.

EU seeks gas supply return after deal (Reuters)

Reuters - Europe sought a swift restoration of gas supplies on Friday after striking a deal with Moscow on monitoring gas shipments via Ukraine that have been halted by a pricing dispute with Kiev.

Citi backs measure to help avoid foreclosures (Reuters)

Reuters - Financial giant Citigroup Inc will support a proposal in Congress to rewrite U.S. bankruptcy law to help troubled mortgage borrowers avoid foreclosure, Chief Executive Vikram Pandit said on Thursday.

Illinois panel recommends governor's impeachment (Reuters)

Reuters - A legislative committee on Thursday recommended the impeachment of Illinois Gov. Rod Blagojevich, citing widespread abuse of power including allegations he tried to sell the U.S. Senate seat vacated by President-elect Barack Obama.

Obama team amending financial rescue package: report (Reuters)

Reuters - President-elect Barack Obama's economic team is urgently overhauling the $700 billion financial rescue package to broaden its scope beyond Wall Street, The Washington Post reported on Friday.

Qaeda Pakistan leader believed dead: U.S. official (Reuters)

Reuters - Al Qaeda's operations chief in Pakistan and a top aide are believed to be dead, a U.S. counterterrorism official said on Thursday, in what appeared to be the latest results of a campaign targeting the militant group's leadership.

Israel and Hamas battle on after UN ceasefire demand (AFP)

AFP - Israel and Hamas launched heavy air strikes and rocket attacks on each other Friday, ignoring a UN Security Council order on the warring rivals to end their conflict.

EU demands immediate resumption of gas supplies (AFP)

AFP - The European Union demanded Friday that Russian gas supplies to Europe resume immediately now that details of a mission to monitor the flow through Ukrainian pipelines have been agreed.

Sarbanes-Oxley and Section 404: Old Dog, New Teeth

Business Management Business Management