SarbanesOxley Act of 2002 The SarbanesOxley Act of

Sarbanes–Oxley Act of 2002 • • The Sarbanes–Oxley Act of 2002, also known as the 'Public Company Accounting Reform and Investor Protection Act' and 'Corporate and Auditing Accountability and Responsibility Act' and commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law enacted on July 30, 2002, which set new or enhanced standards for all U. S. public company boards, management and public accounting firms. It is named after sponsors U. S. Senator Paul Sarbanes (D) and U. S. Representative Michael G. Oxley (R). The bill was enacted as a reaction to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and World. Com. These scandals, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the nation's securities markets. MMS Prepared by Prakash Vaidya 1

– It does not apply to privately held companies. The act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law. Harvey Pitt, the 26 th chairman of the SEC, led the SEC in the adoption of dozens of rules to implement the Sarbanes–Oxley Act. It created a new, quasi -public agency, the Public Company Accounting Oversight Board, or PCAOB, charged with • • overseeing, regulating, inspecting and disciplining accounting firms in their roles as auditors of public companies. – The act also covers issues such as • • MMS auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure. Prepared by Prakash Vaidya 2

• Debate continues over the perceived benefits and costs of SOX. Opponents of the bill claim it has reduced America's international competitive edge against foreign financial service providers, saying SOX has introduced an overly complex regulatory environment into U. S. financial markets. Proponents of the measure say that SOX has been a "godsend" for improving the confidence of fund managers and other investors with regard to the veracity of corporate financial statements. MMS Prepared by Prakash Vaidya 3

• SOX Titles – Public Company Accounting Oversight Board (PCAOB) – Title I consists of nine sections and establishes the Public Company Accounting Oversight Board, to provide independent oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX. – Auditor Independence – Title II consists of nine sections covering following: • establishes standards for external auditor independence, to limit conflicts of interest. • It also addresses new auditor approval requirements • audit partner rotation • auditor reporting requirements • It restricts auditing companies from providing non-audit services (e. g. consulting) for the same clients. MMS Prepared by Prakash Vaidya 4

– Corporate Responsibility – Title III consists of eight sections and covers following points: • It mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. • It defines the interaction of external auditors and corporate audit committees • It specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. • It enumerates specific limits on the behaviors of corporate officers • It describes specific forfeitures of benefits and civil penalties for noncompliance. For example, Section 302 requires that the company's "principal officers" (typically the CEO and CFO) certify and approve the integrity of their company financial reports quarterly. – Enhanced Financial Disclosures – Title IV consists of nine sections. • It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of corporate officers. • It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. • It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports. MMS Prepared by Prakash Vaidya 5

– Analyst Conflicts of Interest – Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest. – Commission Resources and Authority – Title VI consists of four sections. • It defines practices to restore investor confidence in securities analysts. • It also defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, advisor, or dealer. – Studies and Reports – Title VII consists of five sections and requires the Comptroller General and the SEC to perform various studies and report their findings. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations and enforcement actions, and whether investment banks assisted Enron, Global Crossing and others to manipulate earnings and confuse true financial conditions. MMS Prepared by Prakash Vaidya 6

– Corporate and Criminal Fraud Accountability – Title VIII consists of seven sections and is also referred to as the “Corporate and Criminal Fraud Accountability Act of 2002”. It provides certain protections for whistle-blowers. It describes specific criminal penalties for • manipulation, • destruction or • alteration of financial records or other interference with investigations – White Collar Crime Penalty Enhancement – Title IX consists of six sections. This section is also called the “White Collar Crime Penalty Enhancement Act of 2002. ” This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offense. – Corporate Tax Returns – Title X consists of one section. Section 1001 states that the CEO should sign the company tax return. – Corporate Fraud Accountability MMS – Title XI consists of 7 sections. Section 1101 recommends a name for this title as “Corporate Fraud Accountability Act of 2002”. It identifies corporate fraud and records tampering as criminal offenses and joins those offenses to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to resort to temporarily freezing transactions or payments that have been deemed "large" or "unusual". Prepared by Prakash Vaidya 7

• Cost Benefits of Sox – A significant body of academic research and opinion exists regarding the costs and benefits of SOX, with significant differences in conclusions. This is due in part to the difficulty of isolating the impact of SOX from other variables affecting the stock market and corporate earnings. MMS Prepared by Prakash Vaidya 8

• Accounting Scandals – Accounting scandals are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets or underreporting the existence of liabilities, sometimes with the cooperation of officials in other corporations or affiliates. – In public companies, this type of "creative accounting" can amount to fraud and investigations are typically launched by government oversight agencies. Scandals are often only the 'tip of the iceberg'. They represent the visible catastrophic failures. – For example, in the domain of privatization and takeovers: – It is fairly easy for a top executive to reduce the price of his/her company's stock - due to information asymmetry. The executive can accelerate accounting of expected expenses, delay accounting of expected revenue, engage in off balance sheet transactions to make the company's profitability appear temporarily poorer, or simply promote and report severely conservative estimates of future earnings. Such seemingly adverse earnings news will be likely to (at least temporarily) reduce share price. (This is again due to information asymmetries since it is more common for top executives to do everything they can to manipulate their company's earnings forecasts). There are typically very few legal risks to being 'too conservative' in one's accounting and earnings estimates. MMS Prepared by Prakash Vaidya 9

– A reduced share price makes a company an easier takeover target. When the company gets bought out - at a dramatically lower price - the takeover artist gains a windfall from the former top executive's actions to artificially reduce share price. This can represent huge amount of money transferred from previous shareholders to the takeover artist. The former top executive is then rewarded with a golden handshake for presiding over the fire sale that can sometimes be in the hundreds of millions of dollars for one or two years of work. (This is nevertheless an excellent bargain for the takeover artist, who will tend to benefit from developing a reputation of being very generous to parting top executives). – Similar issues occur when a publicly held asset or non-profit organization undergoes privatization. Top executives often reap tremendous monetary benefits when a government owned or non-profit entity is sold to private hands. Just as in the example above, they can facilitate this process by making the entity appear to be in financial crisis - this reduces the sale price (to the profit of the purchaser), and makes non-profits and governments more likely to sell. It can also contribute to a public perception that private entities are more efficiently run reinforcing the political will to sell off public assets. Again, due to asymmetric information, policy makers and the general public see a government owned firm that was a financial 'disaster' miraculously turned around by the private sector (and typically resold) within a few years. MMS Prepared by Prakash Vaidya 10

• Sox Case Study – I: Inspection of Aaron Stein (USA) by PCAOB • • • The Public Company Accounting Oversight Board has conducted an inspection of the registered public accounting firm Aaron Stein. This inspection is carried in accordance with the requirements of the Sarbanes-Oxley Act of 2002. Part I- Inspection Procedures and Certain Observations Board inspections are designed to identify and address weaknesses and deficiencies related to how a firm conducts audits. To achieve that goal, Board inspections include – reviews of certain aspects of selected audits performed by the firm and – reviews of other matters related to the firm's quality control system. • In the course of reviewing aspects of selected audits, an inspection may identify ways in which a particular audit is deficient, including failures by the firm to identify, or to address appropriately, respects in which an issuer's financial statements do not present fairly the financial position, results of operations, or cash flows of the issuer. It is not the purpose of an inspection, however, to review all of a firm's audits or to identify every respect in which a reviewed audit is deficient. MMS Prepared by Prakash Vaidya 11

• • • Review of Audit Engagement The inspection procedures included a review of aspects of the Firm's auditing of financial statements. The scope of this review was determined according to the Board's (PCAOB) criteria, and the Firm was not allowed an opportunity to limit or influence the scope. This review did not identify any audit performance issues that, in the inspection team's view, resulted in the Firm failing to obtain sufficient competent evidential matter to support its opinion on the issuer's financial statements. Review of Quality Control System In addition to evaluating the quality of the audit work performed on a specific audit, the inspection included review of certain of the Firm's practices, policies, and procedures related to audit quality. This review addressed practices, policies, and procedures concerning audit performance, training, compliance with independence standards, client acceptance and retention, and the establishment of policies and procedures. As described above, any defects in, or criticisms of, the Firm's quality control system are discussed in the nonpublic portion of this report and will remain nonpublic unless the Firm fails to address them to the Board's satisfaction within 12 months of the date of this report. MMS Prepared by Prakash Vaidya 12

• • Part II The inspection of the Firm included consideration of aspects of the Firm's system of quality control. Assessment of a firm's quality control system rests both on review of a firm's stated quality control policies and procedures and on inferences that can be drawn from respects in which a firm's system has failed to assure quality in the actual performance of engagements. On the basis of the information that the inspection team reported, the Board has the following concerns about aspects of the Firm's quality control system. Personnel Management The Firm's system of quality control appears not to provide reasonable assurance that the Firm's partner will obtain adequate continuing professional education. The Firm has failed to provide the inspection team any evidence of participation by the Firm partner in general and industry-specific continuing professional education and other professional development activities relating to accounting, auditing, and SEC matters and sufficient to satisfy applicable continuing professional education requirements of relevant regulatory agencies, including the relevant state board of accountancy. MMS Prepared by Prakash Vaidya 13

• Sox Case Study– I: Inspection of Ernst & Young (India) by PCAOB • Part I- Inspection Procedures and Certain Observations • Board inspections are designed to identify and address weaknesses and deficiencies related to how a firm conducts audits. To achieve that goal, Board inspections include – reviews of certain aspects of selected audits performed by the firm and – reviews of other matters related to the firm's quality control system. • • Review of Audit Engagement The inspection team identified what it considered to be audit deficiencies. The deficiencies included failures by the Firm to perform, or to perform sufficiently, certain necessary audit procedures. In some cases, an inspection team's observation that a firm failed to perform a procedure may be based on the absence of documentation and the absence of persuasive other evidence, even if a firm claims to have performed the procedure. The deficiencies identified included deficiencies of such significance that it appeared to the inspection team that, in two of the audits performed by the Firm, at the time it issued its audit report, had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements. Those deficiencies were– MMS Prepared by Prakash Vaidya 14

– the failure to perform sufficient audit procedures related to revenue, including the inadequate performance of substantive analytical procedures; and – the failure to perform sufficient audit procedures with respect to the existence of accounts receivable. • The deficiencies identified also included deficiencies of such significance that it appeared to the inspection team that, in the audit in which the Firm played a role but was not the principal auditor, the Firm had not obtained sufficient competent evidential matter to fulfill the objectives of its role in the audit. Those deficiencies were – – the failure to perform sufficient audit procedures with respect to income tax contingencies; and – the failure to perform sufficient audit procedures with respect to cash and cash equivalents. • • Review of Quality Control System the inspection included review of certain of the Firm's practices, policies, and procedures related to audit quality. This review addressed practices, policies, and procedures concerning audit performance and the following eight functional areas: MMS – tone at the top – practices for partner evaluation, compensation, admission, assignment of responsibilities, and disciplinary actions Prepared by Prakash Vaidya 15

– – – – independence implications of non-audit services; business ventures, alliances, and arrangements; personal financial interests; and commissions and contingent fees; practices for client acceptance and retention; practices for consultations on accounting, auditing, and SEC matters; the Firm's internal inspection program; practices for establishment and communication of audit policies, procedures, and methodologies, including training; and – the supervision by the Firm's audit engagement teams of the work performed by foreign affiliates. MMS Prepared by Prakash Vaidya 16

• India IT Act 2000 • – The Information Technology Act 2000 is an Act of the Indian Parliament (No 21 of 2000) notified on October 17, 2000. The Information technology Act 2000 has been substantially amended through the Information Technology Amendment Act 2008 which was passed by the two houses of the Indian Parliament on December 23, and 24, 2008. It got the Presidential assent on February 5, 2009 and was notified for effectiveness on October 27, 2009. Information technology Act 2000 consisted of 94 sections segregated into 13 chapters. Four schedules form part of the Act. – In the 2008 version of the Act, there are 124 sections (excluding 5 sections that have been omitted from the earlier version) and 14 chapters. Schedule I and II have been replaced. Schedules III and IV are deleted. Characteristics of IT Act 2000 – Legal Recognition of Electronic Documents – Legal Recognition of Digital Signatures – Offenses and Contraventions (breach) – Justice Dispensation Systems for Cybercrimes MMS Prepared by Prakash Vaidya 17

• Criticism – Some of the cyber law observers have criticized the amendments on the ground of lack of legal and procedural safeguards to prevent violation of civil liberties of Indians. – Section 69 empowers the Central Government/State Government/ its authorized agency to intercept, monitor or decrypt any information generated, transmitted, received or stored in any computer resource if it is necessary or expedient so to do in the interest of the sovereignty or integrity of India, defence of India, security of the State, friendly relations with foreign States or public order or for preventing incitement to the commission of any cognizable offence or for investigation of any offence. They can also secure assistance from computer personnel in decrypting data. MMS Prepared by Prakash Vaidya 18