Accounting, Auditing and

Corporate Governance:
Impact of Enron
Accounting Scandal and
Sarbanes-Oxley Act

Corporate Governance in the US

Before Enron Accounting Scandal
Shareholders

Board of
Directors

CEO

Audit
Committee

Pre-Enron Corporate Governance Standards

Listed companies must have a minimum three-person audit committee
composed solely of independent directors.
Existing definition of independence precludes any relationship with
the company that may interfere with the exercise of director's
independence from management and the company.
Three year cooling-off period for former employees of the company
and business relationships.
Requires all audit committee members to be financially literate and at
least one must have accounting or related financial-management
expertise.
Audit committee charter must provide that audit committee and board
of directors have ultimate authority to retain and terminate
independent auditors
Requires shareholder approval of equity compensation plans for
directors, but broad-based plans are exempt
Requires board of directors to adopt and approve a written charter for
audit committee, which must be reviewed annually.

Enron Cumulative Monthly Excess Returns

January, 1986 to January, 2002
Source: CRSP Excess Return File
150%

FERC issues order 636 that

requires all gas
transmission companies to
open up their pipelines to
unowned gas.

100%

Enron enters
into gas
marketing and
begins energy
trading

50%

Skilling
becomes
CEO

CHEWCO
formed to buy
JEDI interests.
Enron employee
under CFO
Fastow is the
partner. Deal is
all debt with
Enron liable for
payments

CEO Lay challenges

managers to embrace
deregulation and shift
strategy

Analysts
question
Enrons
books

Skilling resigns
Sherron Watson
warns that Enron
could implode

0%

Enron restates
books going
back to 1997

CalPERS and
Enron enter into
JEDI-I to invest in
energy projects
-50%

New Name Enron

Adopted

Asset Light
strategy is adopted.
Enron begins
shedding hard assets

JEDI-II is formed.
Enron needs a buyer
for CALPERS
interest in JEDI-I

LJM-1 and 2 formed

to transfer unwanted
assets and debt off
Enrons balance
sheet

-100%

Dynergy merger fails. Enron

debt downgraded to junk status.
Enron files for bankruptcy
-150%
Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02

Anatomy of Enron
Accounting Scandal
Enron, like many other companies, used special
purpose enterprises (SPEs) to access capital or
hedge risk
By using SPEs such as limited partnerships with
outside parties, a company is permitted to increase
leverage and ROA without having to report debt on
its balance sheet
Company contributes hard assets and related debt
to an SPE in exchange for an interest in the
partnership

Anatomy of Enron
Accounting Scandal
SPE then borrows large sums of money from a
financial institution to purchase assets or conduct
other business without debt or assets showing up
on the companys financial statements
Company can also sell leveraged assets and book a
profit
To avoid classification of SPE as a subsidiary
(thereby forcing entity to include SPEs financial
position and results of operation in its consolidated
financial statements), FASB guidelines require that
only 3% of SPE be owned by outside investor.

Anatomy of Enron
Accounting Scandal
Enron took advantage of these guidelines.
Transferred troubled assets that were falling in
value to SPEs
Losses on these assets would then be kept off
Enrons financial statements

To compensate partnership investors for

downside risk, Enron promised issuance of
additional Enron shares
As value of transferred assets fell, Enron
incurred larger and larger obligations to
issue more of its shares

Anatomy of Enron
Accounting Scandal
August 14, 2001
Sherron Watkins, an Enron vice-president, CPA and
auditor previously with Arthur Andersen for 8 years,
sends letter to Enron Chairman Kenneth Lay
outlining many of the misleading accounting
treatments used by Enron.
In this memo, Watkins describes her reservations
about the lack of disclosure of the substance of
related party transactions with SPEs run by the CFO
of Enron, Andrew Fastow
She states: I realize that we have had a lot of smart
people looking at this and a lot of accountants
including AA & Co. (Andersen) have blessed the
accounting treatment. None of that will protect
Enron if these transactions are ever disclosed in the
bright light of day.

Anatomy of Enron
Accounting Scandal
October 16, 2001
Enron Corporation, one of largest corporations
in the world, announced the following:
reduction in its after-tax net income by $544
million
reduction in its shareholders equity by $1.2
billion

Anatomy of Enron
Accounting Scandal
October 22, 2001
Enron announced that SEC was looking into
related party transactions between Enron
and partnerships owned by its CFO, Andrew
Fastow

Anatomy of Enron
Accounting Scandal
November 8, 2001
Enron announced restatement of its financial
statements for 1997 thru 2000 to reflect
consolidation of SPEs it had omitted as well as to
book adjustments recommended by Arthur
Andersen for those years, which Enron had
previously deemed immaterial
In addition to recognizing an additional $628 million
in liabilities, these restatements reduced previously
reported net income as follows:
Year

Reported

Restated

Decline

1997

$105

$28

73%

1998

$703

$133

81%

1999

$893

$248

72%

2000

$979

$99

90%

Anatomy of Enron
Accounting Scandal
December 2, 2001
Enron filed for bankruptcy under
Chapter 11 of US Bankruptcy Code
With assets of $63.4 billion, largest US
corporate bankruptcy in history
Texaco, Inc., which went bankrupt in
April 1977 with assets of $35.9 billion
was next largest

Anatomy of Enron
Accounting Scandal
January 17, 2002
Enron fires Arthur Andersen as its
independent auditor
Cites document destruction and lack of
guidance on accounting policy issues

Anatomy of Enron
Accounting Scandal
Enron bankruptcy of particular interest for
following reasons:
Transactions involving SPEs and related
accounting issues
Breakdown in corporate governance in
relationship between Board of Directors and
Audit Committee
Participation of Enrons independent auditor,
Arthur Andersen, in setting up SPEs
Reveals shortcomings of rule-based US GAAP
GAAP override

Anatomy of Enron
Accounting Scandal
Accounting Issues
Non-consolidation of SPEs that permitted Enron to
hide losses and debt from investors
Sales of investments to unconsolidated (though
actually controlled) SPEs as if they were arms-length
transactions
Recording as current income, fees for services
rendered in future periods
Fair-value restatements of investments that were not
based on trustworthy numbers
Accounting for Enron stock issued to and held by
SPEs
Disclosure of related party transactions and
conflicts of interest, and their costs to stockholders

Anatomy of Enron
Accounting Scandal
Breakdown of Corporate Governance
Many of related party transactions were brought
to attention of Enrons BOD and were discussed
in some detail with members of Audit and
Compliance Committee
SEC requires that exchanges (NYSE, ASE, and
NASDAQ) require financial literacy for all audit
committee members and financial expertise for
at least one member
At least 4 of 6 members had financial expertise
Robert Jaedicke, Professor of Accounting at Stanford University
Wendy Graham, PhD in Economics and former Chair of
Commodity Futures Trading Commission
Lord John Wakeham, CA and British Secy of State for Energy
Paola Ferraz Pereira, President of State Bank of Rio de Janerio

Anatomy of Enron
Accounting Scandal
Breakdown of Corporate Governance
Enrons BOD reviewed and approved
creation of SPEs and assigned Audit
Committee duty to review transactions
BOD waived companys code of ethics
for SPE transactions
Audit Committee failed to adequately
understand, review, and monitor SPEs
and Enrons accounting and reporting
practices

Anatomy of Enron
Accounting Scandal
Independence of External Auditor
Arthur Andersen audited and gave unqualified
opinions on Enrons financial statements since
1985
Enron was AAs second largest client
In 2000, AA received $25 million in audit fees and $27
million in non-audit consulting fees from Enron
In 2000, AA had total worldwide revenues of $9 billion

AA was not only Enrons external auditor, but

also its internal auditor and kept staff on
permanent assignment at Enrons offices
Many of Enrons internal accountants, CFOs and
controllers were former AA executives and
employees

Anatomy of Enron
Accounting Scandal
Independence of External Auditor
AA was consulted on and participated in setting up
SPEs
In conjunction with Enron employees, they set up
the SPEs to conform to the letter of the US GAAP
requirement that outside ownership, presumably
independent, must be at least 3% of the SPE assets
AA admitted it destroyed thousands of documents
and electronic files related to the Enron audits for
1997 thru 2000, in accordance with firm policy,
supposedly before SEC issued subpoena for them
On October 12, 2001, AAs lawyers issued an internal
memo reminding employees of the firms document
retention and destruction policies

Anatomy of an Accounting
Scandal Enron Corporation
Shortcomings of Rule-Based US GAAP
SEC has authority to establish GAAP and GAAS in US,
review and disapprove as inadequate financial
statements of registered companies
SEC has delegated that authority to establish GAAP to
FASB, a non-governmental agency
Many believe that US GAAP, as structured and
administered by SEC, the FASB, and the AICPA, are
substantially responsible for Enron accounting scandal
US model of specifying accounting rules that must be
followed appears to have allowed or required AA to
accept procedures that were within the letter of rule, even
though they violate basic objectives of US GAAP
US model allows corporate officers to view accounting
requirements of US GAAP as if they were specified in a
tax code

Example of Rules-Based US GAAP

by Lessee - SPAS 13
Lease Agreement
Is there transfer
of ownership?

No

Capital
Lease

Yes
Yes

Is there a bargain
purchase option?
No

Yes

Is lease term equal

to or greater than
75% of economic
life ?

Yes

No

Operating
Lease

Is present value
of payments
equal to or more
than 90% FMV?

Anatomy of an Accounting
Scandal Enron Corporation
Shortcomings of Rule-Based US GAAP
Fair-value requirement of financial
instruments adopted by FASB permitted
Enron to increase its reported assets and net
income and, thereby, hide losses
AA appears to have accepted these
valuations because Enron was following
specific US GAAP rules

GAAP Override
Are auditors in US allowed to override US
GAAP?
Auditors in other countries allowed to
override GAAP
Inability of auditors in US to override US
GAAP may have been contributing factor in
Enron accounting scandal
Many believe that principles-based IAS
GAAP that requires true and fair view of an
enterprises financial condition is preferable
to highly specified rule-based US GAAP

US Audit Opinion
In our opinion, the financial statements
of XYZ Company present fairly the
financial position and results of
operations for the years ended
December 31, 20X1 and 20X2 in
accordance with generally accepted
accounting principles applied on a
basis consistent with the preceding
year.

True and Fair View Opinion

In our opinion, the financial statements
of XYZ Company present a true and fair
view of the financial position and
results of operations for the years
ended December 31, 20X1 and 20X2.

Other Accounting Scandals

WorldCom
Global Crossings
Tyco International
Adelphia
Critical Path
Imclone Systems
Vivendi

Other Accounting Scandals

Aftermath of Enron
Accounting Scandal
Sarbanes-Oxley Act of 2002
New NYSE Corporate Governance
Listing Standards
New Corporate Governance Rules
adopted by SEC
New Rules and Auditing Standards
adopted or proposed by Public
Company Accounting Oversight Board

Importance of
Sarbanes-Oxley Act of 2002
Last years Sarbanes-Oxley Act brought
the most sweeping changes in corporate
governance and financial disclosure for
70 years (Financial Times, December 1,
2003)
Sarbanes-Oxley will be judged as
landmark legislation. It is one of the most
sweeping reforms since the 1933
Securities Reform Legislation. (Beth
Brooke, Global Vice Chair, Ernst and
Young, September 15, 2003)

Audit Committee Hot Seat

Sarbanes-Oxley Act of 2002

Signed into law on July 30, 2002
Applies to publicly held US companies and
foreign private issuers and their audit firms
Establishes Public Company Accounting
Oversight Board (PCAOB) to regulate
accounting professionals who audit financial
statements of public companies
Provides for significant corporate governance
reforms regarding
audit committees and their relationship with their
auditors
financial reporting and auditing process

Sarbanes-Oxley Act of 2002

Listing of Titles and Sections

Public Company Accounting Oversight Board

Section 101
Not a government agency
Private sector regulatory agency subject to
direct and substantial SEC oversight
previously under Public Oversight Board of
AICPA

Consists of five full-time members who will

Oversee and investigate audits and auditors of
public companies
Sanction both firms and individuals for violations
of laws, regulations, and rules

Public Company Accounting Oversight Board

Section 101

Board Composition
Two of five board members must be or
have been CPAs
Remaining three must not be and
cannot have been CPAs
Chair of Board may be held by one of
the CPAs, but he/she must not have
practiced accounting during five years
preceding his/her appointment

Public Company Accounting Oversight Board

Sections 102 and 109

Registration with Board

Accounting firms that audit public
companies must register with PCAOB
and pay registration and annual fees
Funding of Board
PCAOB will be funded by public
companies through these mandatory
fees

Public Company Accounting Oversight Board

Section 103

Auditing Standard Setting

Board will have responsibility for establishing following
standards necessary to protect the public interest:

Auditing and related attestation

Quality control
Ethics
Independence

Function previously performed by Auditing Standards

Board (ASB) of AICPA that establishes GAAS
Board required to cooperate with designated professional
groups of accountants in standard setting (eg, AICPA)
Board, however, has authority to amend, modify, repeal
or reject any standard suggested by professional groups
Thus, board may, but is not required to, continue to allow
ASB to establish these standards

Public Company Accounting Oversight Board

Sections 104 and 105

Inspection Authority
Empowered PCAOB to regularly
inspect registered accounting firms
operations
Investigative and Disciplinary Authority
Empowered PCAOB to investigate
potential violations of:
Securities laws
Standards
Competency and conduct

Public Company Accounting Oversight Board

Section 106

International Authority
Foreign accounting firms that prepare
or furnish an audit report involving US
registrants will be subject to authority
of PCAOB
If registered US accounting firm relies
on opinion of foreign accounting firm,
foreign firms audit work papers must
be supplied upon request to PCAOB or
SEC

Public Company Accounting Oversight Board

Section 108
Accounting Standard Setting

establishes criteria that must be met in order for work product

of an accounting standard-setting body to be recognized as
generally accepted
may recognize as "generally accepted" any accounting
principles established by a standard setting body that:

is organized as a private entity;

has, for administrative and operational purposes, a board of trustees
serving in the public interest, the majority of whom are not, concurrent
with their service on such board, and have not been during the two-year
period preceding such service, associated persons of any registered public
accounting firm;
is funded as provided in Section 109 of the Sarbanes-Oxley Act;
has adopted procedures to ensure prompt consideration, by majority vote
of its members, of changes to accounting principles necessary to reflect
emerging accounting issues and changing business practices; and
considers, in adopting accounting principles, the need to keep standards
current in order to reflect changes in the business environment, the extent
to which international convergence on high quality accounting standards
is necessary or appropriate in the public interest and for the protection of
investors.

Public Company Accounting Oversight Board

Section 108

Accounting Standard Setting

SEC must conduct a study on the adoption by the
United States financial reporting system of a
principles-based accounting system
Commission must submit results of this study to
Congress by July 30, 2003
Study shall include:
the extent to which principles-based accounting and
financial reporting exists in the United States
length of time required for change from a rules-based
to a principles-based financial reporting system
feasibility of and proposed methods by which a
principles-based system may be implemented

Sarbanes-Oxley Act of 2002

Listing of Titles and Sections

Auditor Independence
Section 201
New Roles for Audit Committees and Auditors
New law prohibits independent auditors from
offering certain non-audit services to audit
clients
Prohibited services include:

Bookkeeping
Financial information systems design and implementation
Appraisals or valuation services
Actuarial services
Internal audit outsourcing services
Management and human resources services
Broker/dealer and investment banking services
Legal services
Expert services unrelated to audit services

Other non-audit services not banned are allowed

if pre-approved by audit committee

Auditor Independence
Section 202
New Roles for Audit Committees and Auditors

Audit committee must pre-approve all

services (both audit and non-audit not
specifically prohibited) provided by its
independent auditors
Requires disclosure, in annual report, of
fees paid to independent accountants for:
- Audit services
- Audit-related services

- Tax services
- Other services

Auditor Independence
Section 203
New Roles for Audit Committees and Auditors
Second partner review and approval of audit reports
Lead audit partner and audit review partner must be
rotated every five years on public company engagements
An accountant is not independent if, at any point during
audit and professional engagement period, any audit
partner earns or receives compensation based on that
partner procuring engagements with audit client to
provide any services other than audit, review or attest
services
firms with fewer than five audit clients and fewer than ten
partners may be exempt from partner rotation and
compensation provisions, provided each engagement is
subject to special review by PCAOB at least every three
years

Auditor Independence
Sections 204
New Roles for Audit Committees and Auditors
Independent auditors report to companys audit
committee, not management
Independent auditor must report new
information to audit committee including:
Critical accounting policies and practices to be
used
Alternative treatments of financial information
with GAAP that have been discussed with
management
Accounting disagreements between auditor and
management
Other relevant communications between auditor
and management

Auditor Independence
Section 206
New Roles for Audit Committees and Auditors
Accounting firm will not be able to provide
audit services to public company if one of
that companys top officials (CEO, Controller,
CFO, Chief Accounting Officer, etc) was
employed by firm and
worked on companys audit during previous year

Sarbanes-Oxley Act of 2002

Listing of Titles and Sections

Corporate Responsibility
Section 301
Financial Reporting and Auditing Process
Self-Regulatory Organizations (SROs) (NYSE
and NASDAQ) must adopt listing standards
for audit committees
SROs must prohibit listing of any security
whose issuer does not have audit committee
comprised entirely of independent directors:
For a director to be deemed "independent," the board must
affirmatively determine the director has no material relationship
with the listed company (either directly or as a partner,
shareholder or officer of an organization that has a relationship
with the company)
Former employees of company or auditors of company and their
family members may not be considered independent until five
years after their employment ends.

Corporate Responsibility
Section 301
Financial Reporting and Auditing Process

Audit committee members are prohibited from

receiving any compensation other than directors
compensation fees
Chair of audit committee to have accounting or
related financial-management expertise.
Audit committee must have sole authority to hire and
fire independent auditor and approve any non-audit
relationship with independent auditor
Audit committee must establish procedures for
receipt, retention and treatment of complaints
regarding accounting, internal controls or auditing
matters
Issuer must provide appropriate funding for audit
committee

Corporate Responsibility
Section 301

Financial Reporting and Auditing Process

several provisions included to address
special circumstances of particular foreign
issuers
allow non-management employees to serve as
audit committee members consistent with codetermination and similar requirements in some
countries
allow foreign government shareholder
representation on audit committees

Corporate Responsibility
Section 302
Financial Reporting and Auditing Process
CEO and CFO of each issuer shall prepare
statement to accompany the audit report to
certify "appropriateness of the financial
statements and disclosures contained in the
periodic report, and that those financial
statements and disclosures fairly present, in
all material respects, the operations and
financial condition of the issuer." .

Corporate Responsibility
Section 303
Financial Reporting and Auditing Process
Prohibits officers and directors of an issuer
or their representatives from taking actions
to coerce, manipulate, or fraudulently
influence the independent auditor of the
financial statements if that person knew or
should have known that such action, if
successful, could result in rendering the
financial statements materially misleading

Corporate Responsibility
Sections 304 and 306
Financial Reporting and Auditing Process
Management must return bonuses or profits
from stock sales received within 12 months
of a restatement of financial results caused
by non-compliance with financial reporting
requirements as a result of misconduct
Company officers prohibited from trading
shares during pension blackout periods

Sarbanes-Oxley Act of 2002

Listing of Titles and Sections

Enhanced Financial Disclosure

Sections 401, 402 and 403

Requires registrant to:

- provide explanation of its off-balance sheet
arrangements in separately captioned section
of MD&A section
- Provide an overview of certain known
contractual obligations in tabular format

Prohibits companies from making loans

to insiders
Requires electronic filing of disclosures
of insider transactions in company stock

Enhanced Financial Disclosure

Section 404
Annual report must contain a report from
management on internal controls that
States managements responsibility for
establishing and maintaining an adequate
internal control structure and procedures for
financial reporting
Contains an assessment of the effectiveness of
internal control related to financial reporting

External auditor must attest to managements assertion concerning its assessment

of internal control as part of audit
- Audit report must contain opinion on
assessment made by management of companys
internal controls structures

Enhanced Financial Disclosure

Section 404
CEO and CFO Certifications of Disclosure Controls
Term is broader than internal controls over financial
reporting
Term includes internal controls over financial
reporting but also includes controls and procedures
such as those to ensure:
Timely collection and evaluation of information subject to disclosure
requirements under Regulations S-X, S-K or S-B
Timely collection and evaluation of all information relevant to an
assessment of the need to disclose developments and risks that
pertain to the entitys business

Limited number of companies have strong disclosure

controls

Enhanced Financial Disclosure

Sections 406 and 407
Requires companies to disclose whether
they have a code of ethics for CEO, CFO, and
senior accounting personnel
Any amendments or waivers of code of
ethics for directors or executives must be
disclosed
Requires company to disclose:
Whether it has at least one financial expert
serving on its audit committee
The name of the expert and whether the expert is
independent of management

Sarbanes-Oxley Act of 2002

Listing of Titles and Sections

Corporate and Criminal Fraud Accountability

White Collar Crime Penalty

Criminal Penalties
Failure to maintain work papers
SEC will establish rule covering retention of audit records
Board will issue standards that compel auditors to keep
other documentation for seven years

Document destruction
Felony to destroy documents in federal or bankruptcy
investigation
Up to 20 years in prison

Securities fraud
Penalties increased to 25 years in prison

Fraud discovery
Statutes of limitations extended to two years from date of
discovery and five years after act
Previously one year and three years

Sarbanes-Oxley Act
Ramifications of Provisions of Act
Consulting services
Other non-audit services, including tax services, require preapproval by audit committee

Implications for CPAs with tax practices

Expert services not defined in Act
Possible that tax services viewed as expert services and not
permitted by any firm providing audit services for publicly held
audit client

Cascading effect
Concern is that new legislation by US Congress may become
template for parallel federal and state legislation or rules changes
that directly affect both non-public companies that are subject to
other regulations and the CPAs that provide services to them

Additional burdens for CPAs in business and industry

CEOs and CFOs now required to certify company financial
statements
Have greater duty to communicate and coordinate with corporate
audit committees who now hire, compensate and oversee
independent auditors

Aftermath of Enron
Accounting Scandal
New NYSE Corporate Governance Listing Standards
On February 13, 2002, Chairman of SEC asked NYSE to review
its corporate governance listing standards
BOD of NYSE appointed Corporate Accountability and Listing
Standards Committee to review current listing standards and
make recommendations
On June 6, 2002, Committee presented NYSE BOD with report
recommending significant changes in how NYSE-listed
companies are governed
On August 1, 2002, NYSE approved Committees
recommendations
On August 16, 2002, NYSE sent recommendations to SEC for
approval
On November 4, 2003, SEC approved new rules

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

Independent directors must

comprise a majority of board of
directors.

No existing requirement.

Listed companies must have

audit, compensation and
nominating/corporate governance
committees, each composed
entirely of independent directors.

Listed companies must have a

minimum three-person audit
committee composed solely of
independent directors. No
existing rules requiring
compensation and nominating
committees

Non-management directors must

meet without management in
regular executive sessions.

No existing requirement.

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

For a director to be deemed

"independent," the board must
affirmatively determine the
director has no material
relationship with the listed
company (either directly or as a
partner, shareholder or officer of
an organization that has a
relationship with the company).

Existing definition precludes any

relationship with the company
that may interfere with the
exercise of director's
independence from management
and the company.

Prohibit audit committee

members from receiving
compensation other than
directors compensation fees

No existing restrictions

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

Former employees of company or Three year cooling-off period for

auditors of company and their
former employees of the company
family members may not be
and business relationships.
considered independent until five
years after their employment
ends.
Every listed company must have
an internal audit function

No existing requirement.

Require chair of audit committee

to have accounting or related
financial-management expertise.

Requires all audit committee

members to be financially literate
and at least one must have
accounting or related financialmanagement expertise.

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

Grant audit committee sole

authority to hire and fire
independent auditor and approve
any non-audit relationship with
independent auditor

Audit committee charter must

provide that audit committee and
board of directors have ultimate
authority to retain and terminate
independent auditors

Require shareholder approval of

all equity compensation plans.

Requires shareholder approval of

equity compensation plans for
directors, but broad-based plans
are exempt

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

Require companies to adopt and

disclose corporate governance
guidelines, codes of business
conduct, and charters for their
audit, compensation and
nominations committees.

Requires board of directors to

adopt and approve a written
charter for audit committee, which
must be reviewed annually. No
existing rules requiring
compensation and nominating
committees, corporate
governance guidelines, or codes
of business conduct.

Any waivers of codes of business

conduct for directors or
executives must be disclosed.

No existing requirement.

Require foreign private issuers to

disclose any significant ways in
which their corporate governance
practices differ from NYSE rules.

No existing requirement.

Selected Final Recommendations of NYSE Corporate

Accountability and Listing Standards Committee
Comparison with Current Rules
Final Recommendation

Current Rule

Each listed-company's CEO and

CFO must certify annual financial
statements

No existing requirement .

Each listed-company's CEO must

certify annually that he/she is not
aware of any violation by the
company of NYSE corporate
governance standards.

No existing requirement .

NYSE may issue a public

reprimand letter for violation of a
corporate governance standard,
in addition to the existing penalty
of delisting.

No current provision for a public

reprimand.

The NYSE urges every listed

company to establish orientation
program for new board members.

No such recommendation has

been made previously.

Summary of SEC Actions and SEC Related Provisions

Pursuant to the Sarbanes-Oxley Act of 2002

Restoring Confidence in the Accounting Profession

The Sarbanes-Oxley Act established the Public Company
Accounting Oversight Board (PCAOB)
Section 108(b) - On April 25, 2003, recognized the Financial
Accounting Standards Board as the accounting standard setter
Section 108(d) - On July 25, 2003, issued a study on principlesbased accounting
Section 109 - The Act established an independent funding source
for the FASB
Title II (Sections 201, 202, etc.) - On January 22, 2003, adopted
rules improving the independence of outside auditors
Section 303 - On April 24, 2003, adopted rules forbidding the
improper influence on outside auditors
Section 802 - On January 22, 2003, adopted rules governing the
retention of audit records by outside auditors

Summary of SEC Actions and SEC Related Provisions

Pursuant to the Sarbanes-Oxley Act of 2002

Improving the "Tone at the Top"

Section 302 - On August 27, 2002, adopted rules requiring CEOs and CFOs
to certify financial and other information in their companies' quarterly and
annual reports.
Section 304 Adopted rule requiring management to return bonuses or
profits from stock sales received within 12 months of a restatement
resulting from material non-compliance with financial reporting
requirements as a result of misconduct.
Section 306 - On January 15, 2003, adopted rules prohibiting company
officers from trading during pension fund blackout periods.
Section 402 Adopted rules prohibiting companies from making loans to
insiders.
Section 403 - On August 27, 2002, adopted rules that accelerated
deadlines and mandated electronic filing of disclosures of insider
transactions in company stock.
Section 406 - On January 15, 2003, adopted rules requiring companies to
disclose whether they have a code of ethics for their CEO, CFO and senior
accounting personnel

Summary of SEC Actions and SEC Related Provisions

Pursuant to the Sarbanes-Oxley Act of 2002

Improving Disclosure and Financial Reporting

Section 401(a) - On January 22, 2003, adopted rules requiring
disclosure of all material off-balance sheet transactions.
Section 401(b) - On January 15, 2003, adopted Regulation G,
governing the use of non-GAAP financial measures, including
disclosure and reconciliation requirements.
Section 404 - On May 27, 2003, adopted rules requiring an annual
management report on and auditor attestation of a company's
internal controls over financial reporting.

Summary of SEC Actions and SEC Related Provisions

Pursuant to the Sarbanes-Oxley Act of 2002

Improving the Performance of "Gatekeepers"

Section 301 - On April 1, 2003, adopted rules directing the SROs to
adopt listing standards for audit committees.
On November 4, 2003, approved new rules proposed and adopted
by NYSE and NASDAQ requiring strengthening of corporate
governance statndards for listed companies
Section 407 - On January 15, 2003, adopted rules requiring the
disclosure about financial experts on audit committees.
Section 307 - On January 23, 2003, adopted rules governing
standards of conduct for attorneys appearing and practicing
before the Commission.
Section 501 - On July 29, 2003, approved new SRO rules governing
research analyst conflicts of interest.

SEC Study on Principles-Based Accounting

In enacting the Sarbanes-Oxley Act, Congress
recognized that accounting standards that contain too
many exceptions, interpretations and bright-line
percentage tests might have contributed to efforts by
managements and accountants to structure
transactions that provide a desired accounting result
and yet allow the company to avoid clear disclosure of
the economic consequences of those transactions in
its financial statements.
On July 25, 2003, SEC staff released its study.
Study found that standards reflecting only a stated
principle of accounting ("principle-only standards")
would present enforcement difficulties because they
would provide little guidance or structure for exercising
professional judgment in applying that principle.

SEC Study on Principles-Based Accounting

also found that accounting standards that are too
detailed ("rules-based standards") often provide a
vehicle for circumventing the intention of the standard.
Study indicates that best approach would be to develop
accounting standards that:
-

Are based on a conceptual framework;

Clearly state the accounting objective of the standard;
Provide sufficient detail and structure so the standard may be
applied on a consistent basis;
Minimize exceptions from the standard; and
Avoid the use of percentage tests that allow financial engineers
to achieve technical compliance with the standard while
evading the intent of the standard.

study's recommendation is consistent with the

approach currently being developed by the Financial
Accounting Standards Board

SEC Study on Principles-Based Accounting

Study acknowledges that FASB has begun shift to
objectives-oriented standard setting and is doing so on
a prospective, project-by-project basis.
study expects that the FASB will continue to move
towards objectives-oriented standard setting on a
transitional or evolutionary basis.
According to study, operationalizing objectivesoriented approach to standard setting in U.S. requires
that the following key steps be taken over time:
- Ensure newly-developed standards articulate accounting objectives
and avoid scope exceptions, bright-lines and excessive detail;
- Address deficiencies and inconsistencies in the conceptual framework;
- Ensure new standards aligned with improved conceptual framework;
- Address current standards that are more rules-based;
- Redefine the GAAP hierarchy; and
- Continue efforts on convergence of U.S., foreign, and international
accounting standards.

New Rules Adopted by PCAOB

On April 18, 2003, announced process PCAOB will use
to establish auditing and other professional standards
for registered public accounting firms
Pursuant to Section 103 of Sarbanes-Oxley, new
Professional Auditing Standards will be established by
PCAOB
PCAOB decided not to exercise its authority under
Section 103 to designate or recognize any professional
group of accountants to propose auditing and other
professional standards
PCAOB would have its own standard setting process
for auditing and other professional standards
Rule 3700 would govern formation, composition and
role of advisory group in standard setting process

New Rules Adopted by PCAOB

On April 18, 2003, established Interim Professional
Auditing Standards (IPAS) concerning:
Auditing (Rule 3200T)
Attestation (Rule 3300T)
Quality control (Rule 3400T)
Ethics (Rule 3500T)
Independence (Rule 3600T)
PCAOB determined that generally accepted auditing
standards (GAAS) proposed by AICPA and Auditing
Standards Board (ASB) should be adopted as Interim
Auditing Standards
These GAAS will continue to have same authority they
currently have unless and until they are superceded by
standards promulgated by PCAOB

New Rules Adopted by PCAOB

Interim standards adopted on an initial, transitional
basis in order to ensure continuity and certainty in
standards that govern audits of public companies
Interim standards will remain in effect while PCAOB
conducts review of standards applicable to registered
public accounting firms
Objective of review will be to determine, on a standard
by standard basis, whether the IPAS should become
permanent Professional Auditing Standards, repealed,
or modified
As review of each IPAS is completed, PCAOB will adopt
that standard, with or without modification, repeal the
standard, or take any other appropriate action
regarding that standard

New Rules Adopted by PCAOB

On April 18, 2003, adopted rules, subject to approval by
SEC, establishing accounting support fee required by
Sarbanes-Oxley Act
On May 6, 2003, adopted, subject to approval by SEC, a
registration system for public accounting firms
On June 30, 2003, adopted, subject to approval by SEC,
an Ethics Code for PCAOB
On June 30, 2003, adopted rule, subject to approval by
SEC, that requires all registered public accounting
firms to adhere to PCAOBs auditing and related
professional practice standards in connection with
preparation or issuance of any audit report for an
issuer and in their auditing and related attestation
practices

New Rules Adopted by PCAOB

On September 29, 2003, adopted rules, subject to
approval by SEC, on investigations of registered public
accounting firms
On September 29, 2003, adopted rules, subject to
approval by SEC, on process by which registered
public accounting firm can seek to withdraw from
registration
On October 7, 2003, adopted rules, subject to SEC
approval, relating to inspections of registered public
accounting firms

New Rules Proposed by PCAOB

On October 7, 2003, proposed new rule regarding
the terminology PCAOB will use in its Auditing and
Related Professional Practice Standards to describe
the obligations those standards impose on
registered public accounting firms
On December 4, 2003, scheduled an open meeting
to consider whether to propose and seek comment
on rules related to inspections and investigations of
non-U.S. public accounting that register with the
PCAOB

New Auditing Standards

Proposed by PCAOB
On October 7, 2003, proposed new auditing standard
entitled An Audit of Internal Control Over Financial
Reporting Performed in Conjunction with an Audit of
Financial Statements
Addresses both:
work that is required to audit internal control over
financial reporting and
the relationship of audit to the audit of the financial
statements

New Auditing Standards

Proposed by PCAOB
On November 12, 2003, proposed two new auditing
standards:
First proposed standard would establish general
requirements for documentation the auditor should
prepare and retain in connection with any public
company audit.
Second proposed standard would require registered
public accounting firms to explicitly state in each public
company audit report that the audit was conducted in
accordance with the standards of the Public Company
Accounting Oversight Board

Contact Information
Professor J. Timothy Sale
University of Cincinnati
tim.sale@uc.edu
http://www.cba.uc.edu/faculty/sale/sale.htm