Act: Expanded Enforcement
Philip K. Kleckner and Craig Jackson
Note: Part 3 of a series
1990s, to circumvent federal restrictions on exorbitant executive
salaries, companies created different types of financial packages
to lure executives. Performance-based systems evolved, under
the reasoning that tying executives’ compensation to
the performance of the company would motivate them to maximize
shareholder value. Shareholders, boards of directors, and
companies did not consider the potential for senior management
to devise methods, including falsification of financial information,
to “beat the system” for personal gain.
compensation plans were factors in the demise of Enron,
Global Crossing, and WorldCom. During the late 1990s, several
CEOs saw the opportunity to exercise their stock options
at enormous personal gains, then abandoned the company and
other shareholders when the business began to collapse.
Sarbanes-Oxley Act addressed many of the issues behind recent
accounting failures. The penalties set by Sarbanes-Oxley
sections 302, 304, 802, 906, and 1102 are intended to deter
corporate fraud in the future.
302 and 906. These sections require corporate
CEOs and CFOs to certify quarterly and annual reports filed
with the SEC. The certification states the CEO and CFO claim
They have reviewed the report.
Based on their knowledge, the report is truthful and does
not omit material information.
Based on their knowledge, the financial statements fairly
present, in all material respects, the financial position,
results of operations, and cash flows.
They are responsible for disclosure controls and procedures
and have reviewed those procedures within the 90 days
preceding the report filing date.
All material weaknesses in internal controls have been
disclosed to the audit committee and the independent auditors.
In addition, all known instances of fraud, material or
not, that involve personnel involved with internal control
have also been disclosed.
Significant changes to internal controls subsequent to
the most recent evaluation have been disclosed, including
corrective action with regard to deficiencies.
violation of this certification is subject to criminal penalties
with fines of up to $5 million and up to 20 years in prison.
304. This section states that if a company
must restate its financial statements due to material noncompliance,
misconduct, or with any financial reporting requirement,
the CEO and CFO must reimburse the company for any of the
Bonus or other incentive-based or equity-based compensation
received during the 12-month period following issuance
of the financial statements, including restatements.
Profits realized from the sale of its securities during
that 12-month period.
802 and 1102. The act creates severe penalties
and fines to punish those who disrupt an official investigation.
Section 802 has two provisions that address the destruction
of corporate documents. The first addresses documents within
knowingly alters, destroys, mutilates, conceals, or falsifies
records, documents or tangible objects with the intent
to obstruct, impede or influence a legal investigation,
shall be subject to fines and or up to 20 years of imprisonment.
second provision addresses a company’s auditors:
must retain records relevant to the audits and reviews
of financial statements filed with the SEC, including
workpapers and other documents that form the basis of
the audit or review, as well as correspondence for a period
of no less than seven years.
Cost of Doing Business
July 8, 2004, former Enron President Kenneth Lay pleaded
not guilty to the criminal indictment against him. If convicted
on all 53 counts, Lay could receive up to 175 years in prison
plus fines totaling more than $5.7 million. Separately,
the SEC has filed civil charges against Lay, seeking more
than $90 million. Considering the punishment Lay faces under
prior law, the Sarbanes-Oxley penalties add little. The
most substantial effect that the act will have is the level
of scrutiny given a company’s financial statements.
Hopefully, this scrutiny will reestablish investors’
confidence in the markets.
objective of the act is to ensure that companies take every
step necessary to ensure the accuracy of their financial
statements. How will CEOs improve their internal controls
enough to ensure that they will not end up in jail?
audit of a company’s financial statements does not
provide the assurances necessary to satisfy Sarbanes-Oxley.
Auditors are prohibited from providing the services that
would help executives have full assurance over their accounting
systems and controls. Independent forensic accountants would
not be disqualified under Sarbanes-Oxley because they do
not perform audit functions; they offer the services necessary
to provide additional scrutiny, to provide review of internal
controls, and to investigate fraud so that executives can
ensure their financial statements are free and clear of
to Sarbanes-Oxley, white-collar criminals rarely considered
that they might receive jail sentences for their questionable
actions. Now that the SEC has the authority to make this
happen, unscrupulous executives may reconsider committing
fraud. However much money they make, they are unlikely to
be able to enjoy it behind bars.
K. Kleckner, CFE, CPA/ABV, is the director in charge
of the Business Crimes Group, and Craig Jackson
is an associate, both at RosenfarbWinters, LLC, in Roseland,