Sarbanes and Ethics -Corporate Governance The Sarbanes-Oxley Act and Codes of Conduct

2. Sarbanes and Ethics -Corporate Governance The Sarbanes-Oxley Act and Codes of Conduct C. Delano Gray May 12, 2005

3. Accountants and Attorneys Under Fire Enron Worldcom Global Crossing Adelphia Followed by the collapse of Arthur Andersen

4. Some Laws • SEC 1933 1934 • RICO 1970 • FCPA 1977 • FDICIA 1991 (COSO Publication) • SARBANES 2002

5. Required • Change: Priorities Attitudes • Put More Emphasis on: Ethics Quality of Audits Investor and Public interest

6. Professional Ethics

7. How to distinguish ethical from unethical behavior in personal and professional contexts.

8. What Are Ethics? Ethics can be defined broadly as a set of moral principles or values. Each of us has such a set of values. We may or may not have considered them explicitly.

9. Need for Ethics Ethical behavior is necessary for a society to function in an orderly manner. The need for ethics in society is sufficiently important that many commonly held ethical values are incorporated into laws.

10. Why People Act Unethically The person’s ethical standards are different from those of society as a whole. The person chooses to act selfishly. In many instances, both reasons exist.

11. Ethical Principles Trustworthiness Respect Responsibility Fairness Caring Citizenship

12. A Person’s Ethical StandardsDiffer from General Society Drug dealers Bank robbers Larcenists Most people who commit such acts feel no remorse when they are apprehended because their ethical standards differ from those of society as a whole.

13. A Selfish Act – 1 Person Afinds a briefcase containing important papers and $1,000. He tosses the briefcase and keeps the money. He brags to his friends about his good fortune. This action probably differs from most of society.

14. A Selfish – 2 Person Bfaces the same situation but responds differently. He keeps the money but leaves the briefcase. He tells nobody and spends the money. He has violated his own ethical standards and chose to act selfishly.

15. Resolving ethical dilemmas using an ethical framework.

16. Ethical Dilemmas An ethical dilemma is a situation a person faces in which a decision must be made about appropriate behavior.

17. RationalizingUnethical Behavior Everybody does it. If it’s legal, it’s ethical. Likelihood of discovery and consequences

18. Resolving Ethical Dilemmas 1. Obtain the relevant facts. 2. Identify the ethical issues from the facts. 3. Determine who is affected.

19. Resolving Ethical Dilemmas 4. Identify the alternatives available to the person who must resolve the dilemma. 5. Identify the likely consequence of each alternative. 6. Decide the appropriate action.

20. Ethical Dilemma A staff person has been informed that he will work hours without recording them as hours worked. Firm policy prohibits this practice. Another staff person has stated that this is common practice in the firm.

21. Ethical Dilemma Is it ethical for the staff person to work hours and not record them as hours worked in this situation? Who is affected? How are they affected? What alternatives does the staff person have?

22. Special Need for Ethical Conduct in Professions Our society has attached a special meaning to the term professional. A professional is expected to conduct himself or herself at a higher level than most other members of society.

23. Code of Professional Conduct

24. Principles Ideal standards of ethical conduct stated in philosophical terms. They are not enforceable. Rules of conduct Minimum standards of ethical conduct stated as specific rules. They are enforceable. Interpretations of the rules of conduct Interpretation of the rules of conduct by the AICPA Division of Professional Ethics. They are not enforceable, but a practitioner must justify departure. Code of Professional Conduct

25. Code of Professional Conduct Ethical rulings Published explanations and answers to questions about the rules of conduct submitted to the AICPA by practitioners and others interested in ethical requirements. They are not enforceable, but a practitioner must justify departure.

26. Ethical Principles 1. Responsibilities: Professionals should exercise sensitive and moral judgments in all their activities. 2. The public interest: Members should accept the obligation to act in a way that will serve and honor the public.

27. Ethical Principles 3. Integrity: Members should perform all responsibilities with integrity to maintain public confidence. 4. Objectivity and independence: Members should be objective, independent, and free of conflicts of interest.

28. Ethical Principles 5. Due care: Members should observe the profession’s standards and strive to improve competence. 6. Scope and nature of services: A member in public practice should observe the Code of Professional Conduct.

29. Independence Independence in auditing means taking an unbiased viewpoint in performing audit tests, evaluating the results, and issuing the audit report. Independence in fact Independence in appearance

30. Sarbanes-Oxley Act The SEC adopted rules strengthening auditor independence in January 2003. • Consulting services • Audit committees • Conflicts arising from employment relationships • Partner rotation

31. Sarbanes-Oxley Act For the year 2000 Enron paid Andersen $25 million in audit fees and $27 million for nonaudit services. Did consulting fees jeopardize independence?

32. Ownership Interests SEC rules adopted in 2000 on financial relationships take an engagement perspective and narrow the restrictions on ownership in clients to those persons that can influence the audit.

33. Rules of Conduct Rule 101 – Independence A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.

34. Financial Interests Interpretations of Rule 101 prohibit covered members from owning any direct investments in audit clients. Direct financial interest Indirect financial interest Material or immaterial

35. Related FinancialInterests Issues • Former practitioners • Normal lending procedures • Financial interests and employment of immediate and close family • Joint investor or investee relationship with client • Director, officer, management, or employee of a company

36. Related FinancialInterests Issues The SEC does not allow audit firms to provide bookkeeping services to public company audited clients. Consulting and other nonaudit services Unpaid fees

38. Sarbanes OxleyAN OVERVIEW

39. Background • The Sarbanes-Oxley Act of 2002 was approved by near unanimous vote in Congress and cleared the joint conference committee within a short period of one week • Enron bankruptcy and related issues provided the impetus for Congress to act. The WorldCom accounting scandal and bankruptcy accelerated the pace with which the legislation was drafted • The Bill was signed by The President on July 30, 2002 and several of the provisions became effective immediately and others will follow in the next several months • Given the fast pace with which the Act was debated and approved the full impact of the Act is not likely to be appreciated immediately and there is going to be a need for numerous interpretations and explanations • The Act has the potential to have far reaching impact on Corporate Governance and Conduct, Financial Reporting and the Public Accounting Profession • The Act has provisions which impact legal community and investment banking analysts

40. Background (cont.) • Several provisions of the Act require detailed regulations to be formulated by the SEC and other regulatory bodies • The Act aims to restore investor confidence in financial reporting and public capital markets • Broadly speaking the Act’s provisions seem to be built around the following principles: • Independence • Integrity • Proper Oversight • Accountability • Strong Internal Controls • Transparency • Deterrence

41. Sarbanes-Oxley Act of 2002 The Act was signed into law on July 30, 2002 and includes eleven titled sections: Title I Public Company Accounting Oversight Board Title II Auditor Independence Title III Corporate Responsibility Title IV Enhanced Financial Disclosures Title V Analyst Conflicts of Interest Title VI Commission Resources and Authority Title VII Studies and Reports Title VIII Corporate and Criminal Fraud Accountability Title IX White Collar Crime Penalty Enhancements Title X Corporate Tax Returns Title XI Corporate Fraud and Accountability Note – Some of the Act’s provisions contemplate the issuance of corresponding SEC regulations or interpretive releases.

42. NYSE Listing Requirements • Board of Directors of NYSE approved new proposals in August • Heightened corporate governance standards through additional listing requirements • SEC, after public comment period, will vote to approve proposals

43. New Requirements • New Governance Requirements • NYSE proposals • Majority of independent directors within 24 months • Independent Audit Committee • All Audit Committee members must be financially literate • At least one member of the Audit Committee must have accounting or related financial management expertise

44. New Requirements • New Audit Committee Responsibilities • NYSE proposal requires that Audit Committees: • Hire and fire independent auditors, and approve any significant non-audit relationship with the independent auditors • Have a written charter • At least annually, obtain and review a report by the independent auditor describing the firm’s internal quality control procedures; any material issues raised by the most recent internal quality control review, peer review or any inquiry or investigation within the preceding five years and assess the auditor’s independence with respect to all relationships between the independent auditor and the company • Discuss annual and quarterly financial statements with management and independent auditor, including MD&A

45. NASDAQAN OVERVIEW

46. Introduction • Board of Directors of NASDAQ approved new proposals in May and July • Designed to enhance investor confidence by increasing accountability and transparency • SEC will vote to approve proposals

47. New Requirements • New Governance Requirements • NASDAQ proposals • Majority of independent directors following first annual meeting that is at least 120 days after SEC approves proposals • Require all Audit Committee members be able to read and understand financial statements at the time of their appointment (rather than within a reasonable time thereafter) • Require that in selecting the financial expert necessary for compliance with the NASDAQ audit committee composition requirements, issuers consider whether a person has sufficient financial expertise in the accounting and auditing areas specified in the Act • Audit Committee must review and approve all related-party transactions

48. New Requirements • New Audit Committee Responsibilities • NASDAQ proposals require that Audit Committees: • Set clear hiring policies for employees of the independent auditors • Have sole authority to hire, compensate and fire outside auditor • Approve, in advance, the provision by the auditor of all permissible non-audit services • Authority to engage and determine funding for independent counsel and other advisors • Limit time non-independent Audit Committee members can serve to 2 years; prohibited from serving as chair

49. The Impact of New Standards on Compliance Programs and Corporate Governance

50. Overview • Requirements Affecting the Board of Directors and Audit Committee • Requirements for Senior Executives • Requirements Affecting In-House Lawyers • New Criminal Penalties • Reporting Requirements • Internal Controls (Disclosure, Controls and Procedures)