Transcript Document

Corporate Reform
Current Status and Future Implications
REALTORS® Treasurer’s Forum
November 9, 2002
Brian Ofenloch, Partner
Ernst & Young, LLP
Overview
• Impetus for Change
• The Sarbanes-Oxley Act of 2002
• Implications to Treasurers
Bad news for the economy…
Former Tyco chief executive
L. Dennis Kozlowksi arrives
for bail hearing state
Supreme Court in NY
John Rigas,
founder Adelphia
Communications,
arrested in July
Martha Stewart and
Peter Bacanovic, a
Merrill Lynch broker,
who was suspended
by the brokerage firm
Global Crossing
Chairman Garry
Winnick testifies on
Capitol Hill
New York Attorney
General Eliot Spitzer
investigates brokerage
houses
WorldCom’s
former chief
executive
Bernard Ebbers
reportedly near
financial ruin
Vivendi Universal, the
world's secondbiggest media
company, posted a
first-half loss of 12.3
billion euros after
slashing the value of
assets bought by
ousted chief
executive Jean-Marie
Messier
Accounting profession criticized…
The collapse of Enron sparked
considerable debate about the
reforms necessary to restore
confidence in the financial reporting
system
With the continued revelations of fraud
and corporate abuse – punctuated by
the accounting irregularities and
bankruptcy of Worldcom – the pace of
legislative action accelerated
dramatically
Corporate reform signed into law…
“No CEO would
be stupid
enough to
falsely certify
their books”
US Treasury
Secretary Paul
O'Neill
Across Corporate America, a
governance revolution is under way…
The Corporate Reform Initiative
Sarbanes-Oxley Act of 2002
Technically applies to public companies only – but will
raise the bar for accountants, treasurers and
management of all entities.
The Basics
• The Sarbanes-Oxley Act was signed into law July 30,
2002
• Purpose is to restore investor confidence in public
financial reporting
• Passed resoundingly in both the House of
Representatives and the Senate
• Overhauls corporate fraud, securities and accounting
laws, and established new standards for prosecuting
wrongdoing
• Many elements of the Act are dependent upon the
establishment of new Public Company Accounting
Oversight Board and SEC Rulemaking
Key Provisions for Issuers
• May not extend credit to directors or
corporate officers, with certain
specified exceptions
• Must make “real time” disclosures
concerning material changes in the
financial condition or operations of
the issuer
• Must include in 10-K an internal
control report stating management’s
responsibility for adequate internal
controls
• Must disclose pre-approvals of nonaudit services
• Accelerates Exchange Act Section 16
reporting of securities transactions by
corporate “insiders”
• Must disclose whether they have
adopted codes of ethics for their senior
financial officers
• New “whistleblower” protections for
employees
• Must disclose all material off-balance • Enhanced penalties for securities law
violations
sheet transactions
• Must reconcile pro forma information • New Public Company Accounting
Oversight Board (“Board”) to an issuer
with GAAP and not omit information
that makes financial disclosures
• Must wait one year before hiring an
misleading
audit engagement team member to be
CEO, CFO, CAO or equivalent
• May not engage its auditor for nine
specifically prohibited non-audit
services
Key Provisions for Issuers
(Specifically Related to Corporate Boards of Directors and Officers)
• Two separate CEO/CFO certification
requirements:
– A criminal provision requiring
certification in each filed periodic
report containing financial
statements stating that the report (i)
“fully complies” with Exchange Act
requirements (no materiality
qualifier); and (ii) “fairly presents, in
all material respects, the financial
condition and results of operations of
the issuer,” and
– A civil provision requiring officer
certification that (i) the financial
statements and other financial
information “fairly present in all
material respects” the company’s
financial condition; and (ii) the officer
accepts responsibility for and makes
several other representations
regarding internal controls.
• Officers, directors, and others may
not “fraudulently influence, coerce,
manipulate or mislead” their
auditors
• CEO and CFO must disgorge
certain bonuses and profits from
securities sales after restatements
due to misconduct
• SEC can bar “unfit” officers and
directors
• Officers and directors are prohibited
from trading during pension
“blackout” period
• SEC has authority to temporarily
freeze the pay of corporate officers
Key Provisions for Issuers
(Specifically Related to Audit Committees)
• Must be directly responsible for
auditor appointment,
compensation, and oversight
• Must establish complaint
procedures regarding accounting
and auditing matters
• Must be given authority and
funds to engage advisers as
needed
• Must receive reports from the
auditor on alternative accounting
treatments
• Members must be independent
of the issuer
• Must pre-approve all audit and
non-audit services
• Issuer must have a “financial
expert” on the committee (or
issuer must disclose reasons for
lack of expert)
• Can delegate non-audit service
pre-approval authority to a single
member
Key Provisions For Accounting Firms
• Register, pay fees, and submit
periodic reports to the new Public
Company Accounting Oversight
Board (“Board”) with SEC
oversight
• Comply with a “cooling off” period
before audit engagement team
members can accept certain
positions with an audit client
• Comply and cooperate with the
Board’s standards, quality control
inspections, investigations, and
disciplinary process
• Attest to management’s
assessment of internal controls in
annual reports and present an
“evaluation” of certain aspects of
the internal control structure and
procedures
• Be subject to Board sanctions,
including fines, censures,
suspensions, or bars
• Obtain audit committee preapproval for audit and permitted
non-audit services
• Rotate lead audit and review
partners every five years
• Report to audit committees on
alternative accounting treatments
Note: These provisions are effective upon establishment of the Board and firm registration,
or upon SEC rulemaking.
Non-Audit Services Prohibited Under the Act
1. Bookkeeping or other services
related to the accounting
records or financial statements
of the audit client;
2. Financial information systems
design and implementation;
3. Appraisal or valuation services,
fairness opinions, or
contribution-in-kind reports;
4. Actuarial services;
5. Internal audit outsourcing
services;
5. Management functions or
human resources;
6. Broker or dealer, investment
adviser, or investment banking
services;
7. Legal services and expert
services unrelated to the audit;
and
8. Any other service that the
Public Company Accounting
Oversight Board determines, by
regulation, is impermissible.
Thoughts on Implications
of Corporate Reform
Impact on Accounting Standards
• Compliance with rules vs. economic substance
• New and Anticipated Changes
–
–
–
–
Consolidation
Revenue and Expense recognition
Stock Compensation
Derivatives
• Principle vs. Rule Based Standards
– Fair Value based statements?
• Convergence of U.S. GAAP and International
Standards
Common Reasons for Financial Statement
Restatements
• Revenue recognition
• Expense recognition (capitalization, restructuring)
• Consolidation (SPE’s)
• Allowances/Asset impairments
• Contingencies
Focus on Internal Control
• Process vs. Controls
• Documentation of controls
• Assignment of Responsibility
• Supervision
• Internal audit function
Consider Risk of Fraud
• Earnings management issues – budget to actual
reviews
• Aggressive accounting policies
• Insufficient internal controls or segregation of duties
• Significant, unusual, or highly complex transactions or
innovative deals
• Significant related party transactions not in the
ordinary course of business
Fiduciary Responsibilities
• Ethics
– TONE AT THE TOP
– Conflicts of interest
– Objectivity
• Transparency of Disclosure & Communications
• Renewed interest in accounting function
Next Steps
• Not business as usual
• Significant change in next 6-18 months
– Fiduciary responsibility increased dramatically
• Challenge your own organizational practices
– Align your policies and procedures with best practices
Corporate Reform
Current Status and Future Implications
REALTORS® Treasurer’s Forum
November 9, 2002
Brian Ofenloch, Partner
Ernst & Young, LLP