The Sarbanes Oxley Act of 2002 addresses the issue of the independence of auditors. The lack of objectivity was a major contributing factor to the events that led to Enron’s collapse and the enactment of the Sarbanes Oxley Act of 2002. Before Enron, investors counted on auditors to protect their interests by setting off the alarm if something was not quite right. Unfortunately, auditors stood to make large sums of money if they did not ring the bell to alert investors. Enron (and many other companies since then), its auditors, and to some extent its executives, analysts, and investment bankers, got away with it only because they participated in a conspiracy of silence that sacrificed objectivity for money, and careers for short-term gain.
The Act designates some specific services as being outside the permissible scope of the practice of auditors. Registered public accounting firms that provide audit services cannot, at the same time, provide non-audit services such as bookkeeping, financial information systems design and implementation, appraisal or valuation services, fairness opinions, actuarial services, internal audit outsourcing services, management and human resources functions, broker or investment banking services, legal services, and expert services unrelated to the audit.
In addition, the public company’s audit committee must pre-approve other non-audit services not on this list, such as tax services. However, the pre-approval requirement is not needed for non-audit services which are not more than 5% of the total amount of annual revenues paid by the client to its auditor if they are promptly brought to the attention of the audit committee, are approved prior to the completion of the audit, and are disclosed to investors.
SOX further stipulates that a registered public accounting firm is not permitted to provide audit services to a public company if the audit lead, or the audit partner responsible for reviewing the audit, has performed audit services for that public company in each of the 5 previous fiscal years. This rotation is intended to reduce the risk of personal relationships interfering with the auditor’s independence and objectivity.
The registered public accounting firm that performs an audit is required to tell the audit committee all critical accounting policies and practices to be used, all alternative treatments of financial information within generally accepted accounting principles that have been discussed with management officials and the consequences of using them, what treatment the firm recommends, and all important written communications between the firm and management of the issuer (such as any management letter or schedule of unadjusted differences).
The Act does not permit a registered public accounting firm to perform any audit service for a public company if the firm employed any of the company’s key executives within a year prior to the start of the audit.
With its far-reaching enforcement powers, the Securities and Exchange Commission monitors and regulates the accounting profession. As well as setting standards for auditing and accounting practices, the Securities and Exchange Commission can start legal, administrative, or disciplinary action against any registered public accounting firm or individual auditor at any time. Penalties can range from censure to disbarment, and include fines of up to $1 million, and prison terms of up to 20 years.
In a continuing effort to restore the trustworthiness it enjoyed prior to the Enron debacle, the accounting profession has instituted an educational requirement that includes mandatory Ethics training, stricter peer reviews, and stiff penalties. However, it is still up to every individual to strive to choose principles and career over short-term material gain.
About the Author
Mike Morley is a Certified Public Accountant who holds the top credit designations in the U.S., Canada, and the U.K. Mike is the author of “Sarbanes-Oxley Simplified,” which is an easy-to-read explanation of the requirements of the U.S. legislation that makes CEO's & CFO's personally responsible for the accuracy and reliability of their company's financial statements.
If you are interested in learning more, Mike teaches seminars which provide continuing education for accountants and non-accountants alike. For more information and a list of upcoming seminars, call 416-275-1278 or go to www.mikemorley.com
