Brief Summary of Provisions in the Sarbanes-Oxley Act of 2002

The following provisions apply to auditors of public companies:

Public Company Accounting Oversight Board

Establishes five-member Board to set “auditing, quality control, ethics, independence and other standards relating to the preparation of audit reports.”

The Board will be required to annually inspect audit firms with 100 or more public company clients and to examine audit firms with fewer than 100 public company clients at least once every three years. The Board also will be empowered to investigate and discipline public company auditors, including the imposition of fines. Only two Board members will be allowed to have experience as a CPA. The chairperson must not have practiced accounting during the five years preceding his/her appointment. Board service will be a full-time job. Fees collected from publicly traded companies and accounting firms will fund the Board. The SEC will appoint members of the Board after consultation with the chairman of the Federal Reserve Board and the secretary of the Treasury.

Consulting Services and Pre-approval Process

It will be unlawful for the auditors of public companies to perform the following nonaudit services contemporaneously with the audit:

• Bookkeeping or other services related to the accounting records or financial statements of the audit client;
• Financial information systems design and implementation;
• Appraisal or valuation services, fairness opinions or contribution-in-kind reports;
• Actuarial services;
• Internal audit outsourcing services;
• Management functions or human resources;
• Broker or dealer, investment adviser, or investment banking services;
• Legal services and expert services unrelated to the audit;
• And any other service that the Board determines, by regulation, is impermissible.

Other nonaudit services—including tax services—will require pre-approval by the audit committee on a case-by-case basis. Pre-approved nonaudit services approved by the audit committee will have to be disclosed to investors in periodic reports.

Retention of Work Papers

Auditors of public companies will be required to keep work papers for at least seven years in sufficient detail to support the conclusions in the audit report. Under a separate criminal penalty amendment, auditors will be required to keep all audit or review work papers for five years.

Internal Control Reporting

Management reports on the company’s internal controls, and the auditor opines on the effectiveness of those controls. S. 2673 states, “Any such attestation shall not be the subject of a separate engagement.” The report from the Senate Banking Committee accompanying S. 2673 says, “The Committee does not intend that the auditor’s evaluation be the subject of a separate engagement or the basis for increased charges or fees.”

Auditor Rotation

The lead partner and the reviewing partners for the audit engagement will have to be replaced every five years. Every public company audit will be required to include a review partner who isn’t involved in the audit.

Revolving Door

Audit firms will not be allowed to audit public companies whose CEO, CFO, controller, chief accounting officer or other equivalent has worked for the audit firm during the preceding year.

Hiring of Auditor

The auditor will be hired by the audit committee of the board of directors of the company undergoing the audit, not by the company’s management. The audit committee will set the audit fee.

Cascade Effect

The act says that in supervising nonregistered accounting firms state regulators “should make an independent determination of the proper standards applicable” taking into consideration the size and nature of the business of the firms. Standards applied by the Board “should not be presumed to be applicable” for small- and medium-sized firms.

Foreign Accounting Firms

Foreign accounting firms that issue audit reports or participate in audits of public U.S. companies will be covered by the act and will be required to register with the Board. U.S. accounting firms often form an alliance with a foreign accounting firm in order to audit multi-national companies.

Other Provisions

• The chairman, CEO and CFO will be required to certify the accuracy of the financial reports; criminal penalties could be imposed.
• The SEC will be required to issue a rule requiring a code of ethics for senior financial officers.
• ew criminal penalties will be established for corporate financial fraud (up to 10 years in jail) and obstruction of justice (up to 20 years in jail) involving shredding documents. Penalties also will be increased for mail, wire and pension fraud.
• Some personal loans to executives and directors will be banned.
• Annual and quarterly reports must disclose all material off-balance-sheet transactions and relationships.
• Pro forma statements will have to be reconciled with the financial statements.
• Officers and directors will be prohibited from buying or selling stock during employee blackout periods when employees are barred from trading in their retirement accounts.
• Officers and directors will be prohibited from fraudulently influencing, coercing, manipulating or misleading an auditor in order to make the financial statements materially misleading.