CCH Provides Analysis Of Senate Accounting Reform Act
Bush Urges Fast Track for Bill to Protect Investors
Reign in Accounting Industry, Broker-Dealers, Public Companies
(RIVERWOODS, ILL., July 16, 2002) – With a push from President
Bush, legislation mandating accounting and other reforms in response
to recent corporate scandals – and the dwindling Dow – may make it
to the White House in record time, according to CCH INCORPORATED (CCH),
a leading provider of securities law information.
On the same day that the Senate passed 97-0 its version of reform
legislation – the Public Company Accounting Reform and Investor
Protection Act – President Bush urged Congress to pass a bill he can
sign into law in early August. Within a day, the House reacted, also
passing a bill with provisions providing criminal penalties against
corporate fraud. Whenever the legislative changes come, they’re
likely to be the most significant and far-reaching changes to
securities law since the 1934 Securities Exchange Act.
"Issues surrounding accounting reform continue to heat up, as
the stock market continues to cool down, and lawmakers seem committed
to passing reform legislation as soon as possible," said James
Hamilton, JD, LLM, senior securities law analyst for CCH. Both the
Senate and House have now passed their versions of the legislation.
"Now, the GOP-backed House bill passed in April seems to be of
a different era. Given current developments in corporate America,
there’s far stronger rhetoric and action coming from House
Republicans in recent days and the very good likelihood that they are
willing to work with the Democrats to craft an even more stringent
bill," said Hamilton. The urgency to pass accounting reform
before the August congressional recess could mean bypassing the
traditional congressional conference committee for faster, informal
Below, CCH provides an overview and analysis of major provisions of
the Senate bill and how it differs from the House version. (For a
detailed comparison of the bills, and related resources, visit http://www.cch.com/securitiesreform
Accounting Oversight Board
Both the House and Senate bills agree that an independent
accounting oversight board should be created within the Securities and
Exchange Commission (SEC). However, the bills differ on how much
authority the board should have.
The House bill outlined a board with limited authority, while the
Senate calls for the board to have far broader authority in setting
standards, including power to establish auditing, quality control,
ethics and independence standards for public company auditors.
Under the Senate bill, accounting firms that conduct audits of
public firms would be required to register with the board and the
board has the power to inspect accounting firms that conduct those
audits as well as investigate potential violations of rules and impose
sanctions on the rule-breakers. The Senate bill also applies to
foreign public accounting firms that audit financial statements of
companies under U.S. securities laws.
While the legislation calls for establishing an accounting
oversight board and empowers it to set auditing standards, it also
makes it clear that the Financial Accounting Standards Board (FASB)
will continue to play a role in setting accounting standards (e.g.,
Generally Accepted Accounting Principles – GAAP) and provides public
funding for FASB to fulfill this role.
The once politically unpopular issue of limiting auditors’
non-auditing services is now gaining widespread support. Under the
House bill, accounting firms are restricted explicitly from two areas:
consulting on system implementation and conducing internal audits for
Meanwhile, the Senate bill contains a list non-audit services that
an accounting firm would be barred from doing for an audit client.
These include bookkeeping or other services related to the accounting
records or financial statements; financial information systems design,
appraisal or valuation services; actuarial services; management
functions or human resources; broker or dealer or investment advisor
services; and legal services.
"The central theme running through the restrictions in the
Senate bill is that providing these services to a public company audit
client creates a fundamental conflict of interest for the accounting
firm in carrying out its audit responsibility," said Hamilton.
"Policymakers want it on the books that protecting the
independence of the audit – in order to protect the interest of
shareholders – outweighs the rights of the accounting industry to
increase its service offerings."
However, the Senate bill does give the board authority to grant
case-by-case exceptions and no limitations are placed on accounting
firms in providing non-audit services to public companies that they do
not audit or to any private companies. The bill also requires a
registered public accounting firm to rotate its lead partner (the
partner in charge of the audit engagement) and its review partner (the
partner brought into review the work of the lead partner and audit
team) on audits so that neither role is performed by the same
accountant for the same company for more than five consecutive years.
Senior Management Accountability
The Senate bill contains a number of provisions designed to make
senior management more accountable and to improve financial
disclosures so that investors can be informed as much as possible on
financial issues materially affecting public companies.
Among the provisions: CEOs and CFOs are required to certify their
companies’ financial reports and are prevented from benefiting from
profits they receive if it’s proven that they misstated their
company’s financials. Addressing what was seen as a widening
loophole, the Senate adopted an amendment stating that CEOs and CFOs
of companies that reincorporate outside the U.S. will still be
required to certify financial statements.
Audit committees of publicly held companies also would be
strengthened and held more accountable under the Senate bill.
Specifically, they would have to be independent from company
management and audit committees would be directly responsible for the
appointment, compensation and oversight of the work of the auditors.
The committee also would have to develop procedures for addressing
complaints concerning auditing issues and procedures for employee
whistleblowers to submit their concerns regarding accounting or
"The Senate wants to make it clear that the primary duty of
auditors is to the company’s board of directors and the investing
public and not to senior management," said Hamilton.
Disclosure of Insider Trading and Banning Loan Issuance
The Senate bill calls for prompt disclosure of insider stock trades
and bans loans made to company executives and directors.
Under the bill, insider stock trades must be reported by the second
day following any transaction. Currently insiders do not have to
report trades until the tenth day of the month following the month in
which the trade occurred, meaning that an insider trade could go
unreported for as many as 40 days.
Initially, the Senate bill had allowed loans to company officers
and directors so long as they were disclosed within seven days, and
that the disclosure included the amounts paid and balances owed as
well as any conflicts of interest as defined by the SEC. However, the
bill now makes it unlawful for any public company to make loans to its
executive officers and directors. There is one narrow exemption for
consumer credit loans made to executives on market terms in the
ordinary course of the company’s consumer credit business.
Amendments Abound: What’s In
After arriving on the Senate floor last week, a flurry of
amendments were proposed to the Act. In addition to those mentioned
above, new provisions adopted by the Senate include:
- An amendment creating a new federal felony for securities fraud
with a 10-year maximum penalty and providing for a review of
existing sentencing guidelines for fraud cases and organizational
misconduct to make them tougher as well. The provision also
creates two new anti-shredding penalties, which set clear
requirements for preserving financial audit guides and closes
loopholes in current anti-shredding laws.
"Currently, prosecutors are forced to resort to a patchwork
of technical offenses and regulations that criminalize particular
violations of securities laws, or to treat the cases as generic mail
or wire fraud that results in a five-year maximum penalty,"
said Hamilton. "The new 10-year felony is comparable to
existing bank and health-care fraud statues and simplifies the
process for prosecutors in egregious cases."
- Another provision would allow the SEC, during an investigation,
to seek an order in federal court imposing a 45-day freeze on
extraordinary payments to corporate executives. The target
payments would be placed in escrow, ensuring that corporate assets
are not improperly taken from an executive’s personal benefit.
The provision also would empower the SEC to bar persons from
serving as officers or directors if they committed a securities
law violation and their conduct demonstrated unfitness to serve as
an officer or a director. Under current law, only a federal court
can issue an order prohibiting a person from acting as an officer
or director of a public company.
About CCH INCORPORATED
CCH INCORPORATED, founded in 1913, has served four generations of
business professionals and their clients. The company produces
approximately 700 print and electronic products for securities, tax,
legal, banking, securities, human resources, health care and small
business markets. CCH is a wholly owned subsidiary of Wolters Kluwer
North America. The CCH web site can be accessed at cch.com.
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