While Stock Market Goes Up, Down, Reform Legislation Heads Straight To White House
CCH Looks at Impact on Companies, Investors, Industry
(RIVERWOODS, ILL., July 26, 2002) – President Bush asked for fast
action on a corporate reform bill and Congress obliged. Now, the
time-intensive task of sifting through the Sarbanes-Oxley Act of 2002
to see how it changes existing law and what it means for companies,
investors and the securities and accounting industries begins,
according to CCH INCORPORATED (CCH), a leading provider of securities
law information and software. With the President about to sign the
bill into law, and many of the changes taking effect immediately or
within the near future, there’s no time to waste.
"The legislation will be of significant aid to
investors," said James Hamilton, JD, LLM, senior securities law
analyst for CCH. "It will bring about enhanced market
transparency and give investors more confidence that financial
statements are accurate. This fundamentally changes the way public
companies do business and how the accounting profession performs its
statutorily required audit function. There’s no doubt that it is the
most significant change to securities law since the 1934 Securities
The Act’s major provisions closely follow the Democrat-sponsored
bill passed by the Senate earlier this month. A few concessions were
made to Republican-backed ideas, however, including the complete
adoption of tougher criminal penalties for corporate fraud. And, while
the Act covers significant ground, the Securities and Exchange
Commission (SEC) has issued several proposed rules that seek
additional requirements from publicly traded companies.
Below, CCH provides an overview and analysis of major provisions of
the new law and what additional rules may be next from the SEC. (For
more information and related resources, visit http://www.cch.com/securitiesreform
Accounting Oversight Board
One of the most fundamental changes for the industry is the
creation of an independent Accounting Oversight Board, a nonprofit
corporation subject to SEC oversight. The new board’s power has been
ratcheted back from the initial Democrat bill, directing the SEC to
have more control over the Oversight Board, similar to the powers it
now has over the National Association of Securities Dealers (NASD).
Accounting firms that conduct audits of public firms will be
required to register with the board. The board is directed to review
annually each accounting firm that conducts more than 100 audits a
year; accounting firms conducting fewer than 100 audits yearly are to
be reviewed every three years.
The board can investigate potential violations of rules and impose
sanctions on the rule-breakers. The board’s power extends not just
to domestic accounting firms but also to foreign public accounting
firms that audit financial statements of companies under U.S.
The board will include five members (two who are or have been CPAs)
appointed by the SEC within 90 days after the Act takes effect. The
board must be fully operational and deemed capable by the Commission
of executing its duties within 270 days, approximately nine months,
after the law’s enactment.
The newly established Accounting Oversight Board will set auditing
standards. However, the Act directs the Financial Accounting Standards
Board (FASB) to continue its role in setting accounting standards
(e.g., Generally Accepted Accounting Principles, GAAP) and provides
public funding for FASB to fulfill this role.
For the first time, the government is curtailing ancillary services
provided by accounting firms. Under the Act, accounting firms will be
barred from providing several non-audit services to their audit
clients. These include bookkeeping or other services related to
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 Act does allow the Accounting Oversight Board authority to
grant case-by-case exceptions and does not limit accounting firms from
providing non-audit services to public companies that they do not
audit or to any private companies.
Registered public accounting firms also will have to rotate their
lead partner (the partner in charge of the audit engagement) and their
review partner (the partner brought in to 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
Senior Management Accountability
The Act places a great deal of accountability squarely on the
shoulders of senior executives at publicly held companies, containing
a number of provisions designed to make senior management more
accountable and to improve financial disclosures. Among the
- Certification. CEOs
and CFOs are required to certify their company’s financial
reports and are prevented from benefiting from profits they
receive if it’s proven that they misstated their company’s
financials. The certification provisions apply both to senior
managers at U.S.-based companies as well as CEOs and CFOs of
companies that reincorporate outside the U.S. The Act calls for
companies to comply with this within 30 days of enactment.
- Freezing Assets. During an investigation, the SEC can now
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.
- Restrictions on Services. The SEC now can 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. Previously, only a federal court could issue
an order prohibiting a person from acting as an officer or director
of a public company.
- Audit Committee Independence. Under the Act, the audit
committee has to be independent from company management and audit
committees are directly responsible for the appointment,
compensation and oversight of the work of the auditors. The
committee must develop procedures for addressing complaints
concerning auditing issues and procedures for employee
whistleblowers to submit their concerns regarding accounting or
- Code of Ethics. Public companies also will be required to
disclose whether they have adopted a code of ethics for senior
management and, if not, why. The SEC is ordered to issue final rules
on this within 180 days of enactment.
While much of the Act mirrors the Senate’s earlier bill, most of
the corporate fraud provisions are from legislation the House passed
earlier this month. These provisions include:
- Financial Statement Certification. The Act calls for top
corporate executives to certify that financial statements of the
company fairly and accurately represent the financial condition of
the company. Company executives who knowingly fail to comply with
this provision could face fines of up to $1 million and 10 years in
jail, or both; executives who willfully fail to comply could see
fines as high as $5 million and jail terms of 20 years, or both.
- Securities Fraud. The Act creates a new felony for
securities fraud, punishable by up to 25 years in prison.
- Mail and Wire Fraud. Executives found guilty of committing
these types of fraud could be sentenced up to 20 years of jail time.
- Whistleblower Protections. The Act creates criminal
sanctions against those who retaliate against whistleblowers and
includes both fines and up to 10 years in jail.
- Bankruptcy Loopholes. The Act changes the bankruptcy code to
make judgments and settlements based upon securities law violations
non-dischargeable, thereby helping to protect victims of fraud by
preventing corporate wrongdoers from sheltering their assets under
the umbrella of bankruptcy.
- Document Destruction. The Act strengthens laws that
criminalize obstruction of justice, such as document shredding or
falsifying records, calling for fines and up to 20 years
imprisonment if found guilty.
Disclosure of Insider Transactions and Banning Loan Issuance
Under the Act, insider stock trades will have to be reported by the
second day following any transaction. Under current law, 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. Companies have 30 days to
comply with the new deadline after the Act becomes effective.
Senior management also is prohibited from any insider trading
during pension fund blackout periods, with this provision going into
effect 180 days after the law’s enactment.
The Act further orders companies, within one year, to
electronically file disclosures related to inside stock transactions,
with the SEC then posting these statements on the Internet within a
day after they were filed. The companies also are directed to post
these statements on their own web site by the end of the day after
they were filed.
The Act makes it unlawful for any public company to make loans to
its executive officers and directors. There are a few narrow
exemptions. One exemption applies to consumer credit loans made to
executives on market terms in the ordinary course of the company’s
consumer credit business. Another exemption applies to banks that are
already covered by Federal Reserve regulations on insider loans.
Added Regulation Likely from SEC Proposed Rules
Over the past several months, the SEC also has been busy, taking
initiative and issuing several proposed rules. While the Act covers
some of these areas and, therefore, preempts any SEC rules, there are
many areas not addressed. Among the proposed SEC rules not covered in
the Act are:
- Form 8-K Disclosures. In addition to proposed rules on 8-K
disclosures of insider transactions, which are covered to some
extent in the new legislation, the SEC also issued proposed rules
for disclosure of additional material items, including: making or
terminating agreements not in the ordinary course of business;
changes to customer agreements; new financial obligations;
write-offs, restructurings or other exit activities; credit rating
changes; changes in the trading of company securities; withdrawal by
an auditor, or company decision that it cannot rely on a previous
audit report; and limitations in employee benefit or stock ownership
- Disclosure of Accounting Estimates and Policies. This rule
would require Management’s Discussion and Analysis (MD&A)
sections to discuss and fully disclose critical accounting estimates
made by the company and the company’s adoption of a critical
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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Editor’s Note: Additional information on the securities reform is
For members of the press, complimentary copies of CCH’s Sarbanes-Oxley
Act of 2002: Law and Explanation book will be available soon.
Contact Leslie Bonacum at 847-267-7153 or at email@example.com
or Neil Allen at 847-267-2179 or firstname.lastname@example.org.