- The Washington Times - Monday, July 28, 2003

The scandals thundered across the headlines like a noisy storm, failures so spectacular their names now seem synonymous with corporate ruin: Enron, WorldCom, Tyco, Adelphia.

Washington’s remedy was the Sarbanes-Oxley Act, swiftly signed into law by President Bush on July 30, 2002, and hailed as the most substantial piece of business legislation since the Great Depression.

For many small investors, though, it’s not clear what’s changed, and experts agree it’s too soon to say whether the law will bring about the desired reforms. It’s still being implemented, has yet to be tested in court and has yet to see its first penalty imposed.

The way lawmakers saw it last year, just about every link in the chain of information between corporations and individual investors had been compromised or was vulnerable, said David E. Hardesty, an accountant and author of “Corporate Governance and Accounting Under the Sarbanes-Oxley Act of 2002,” a guide for securities professionals.

“Each place where information could be altered, either inadvertently or on purpose, Sarbanes-Oxley attempts to fix it,” Mr. Hardesty said. “These problems were created by people who were willing to take the risk that they could cook the books and get away with it. In today’s environment, the feeling is that if we cook the books, we might get caught.”

The law, sponsored by Sen. Paul S. Sarbanes, Maryland Democrat, and Rep. Michael G. Oxley, Ohio Republican, accelerated regulatory changes long resisted by Wall Street. It aims to make financial information released by public companies as accurate as possible by tweaking the checks and balances already in place. It boosts the independence of corporate boards and auditors and threatens serious sanctions for chief executives and chief financial officers who violate the rules. Among the highlights:

• Chief executives and chief financial officers must certify reports submitted to the Securities and Exchange Commission. Criminal penalties of up to 20 years can be imposed if records are altered, destroyed or inaccurately stated.

• A corporate board’s audit committee must consist entirely of independent directors and must take control of hiring, overseeing and compensating the company’s auditor. To avoid situations that could lead to conflict, the auditor must report directly to the committee rather than to management.

• A new quasigovernmental board has been established to oversee audits, a provision expected to have a greater impact on the accounting industry than any since the 1930s. The five-member board sets quality-control standards for audits, inspects and investigates registered accounting firms and has the power to issue subpoenas and impose sanctions for rules violations.

• Accounting firms are prohibited from providing most non-audit services for the public companies they audit. To maintain independence, the law requires the rotation of lead audit partners every five years and limits the ability of auditors to take jobs in senior financial positions at the companies they serve.

The law also calls for greater financial disclosures, extends the statute of limitations and expands the penalties for securities fraud and creates new rules to protect whistleblowers who report corporate abuses.

Much of the law’s provisions are already in place, but parts won’t take effect until regulators and stock exchanges write and formally adopt corresponding rules. One provision not in effect is supposed to prevent conflicts of interests for stock research analysts at securities firms. New internal accounting controls won’t take effect for another year. It may take years for the law to be fully understood.

“It’s very hard for the individual investor to say, ‘OK, what have I made off of Sarbanes-Oxley?”’ said John Markese, head of the American Association of Individual Investors. “I think there will be dividends, but they may not pay for a while.”

Congress nearly doubled the SEC’s budget for the fiscal year beginning Oct. 1, to $841.5 million, and the agency, strained by ongoing investigations and prosecutions, plans to expand its staff as it steps up routine reviews of annual reports and other filings from public companies. SEC Chairman William Donaldson has vowed to shift the balance of power away from “imperial CEOs” and back toward boards and investors.

The law has forced people to ask more questions. Chief executives are demanding more information before signing off on financial statements and some companies have started internal certification processes in which line managers attest to the accuracy of their own reports. Boards are questioning auditors more vigorously and directors are re-examining their own performances.

“Some CEOs have said to me that they’ve taken some time to be more financially current,” said Steve Mader, president of the executive search firm Christian & Timbers. “What that really means is they’ve grabbed their chief financial officers and spent much more time with them, saying, ‘Make me comfortable that I know what you know. Tell me more instead of less.’”

Beth A. Brooke, a partner and vice chairwoman at Ernst & Young, said the firm’s auditors are spending much more time with audit committees. The frequency of meetings has increased, she said, and the level of questioning from board members has deepened and broadened. Auditors are asking more questions and are less concerned about taking adversarial positions with CFOs.

“If I’m an investor, I want that audit committee doing its job, and they’re required to do it now in a very engaged way,” she said. “Sarbanes-Oxley has changed everything for everybody.”

The demand for independent financial experts as board members has skyrocketed. Prospective board members face a host of new concerns, with liability insurance often topping the list.

Only 40 percent of companies expect to be in immediate compliance when the law takes full effect, according to a study by the Business Performance Management Forum. Some decide the cost is too high; the number of companies going private, and thus no longer subject to the law, has jumped 22 percent in the past year.

A survey by the Business Roundtable, an industry group made up of chief executives, found that many companies have taken steps to comply, particularly with regard to the independence of their boards.

Whether the law helped strengthen public trust in the markets over the last year isn’t yet clear. Investors will more often cite rising stock prices and the absence of another corporate implosion as the most encouraging factors. But the idea that the government is doing something to deter corporate thieves does hold appeal.

“The typical person is pretty sick and tired of hearing about these financial shenanigans,” said Barbara Nitzberg, a public relations professional who belongs to an investment club in New York. “I think it’s a good move on the part of the government, to do something to help restore investor confidence.”


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