Does the Sarbanes-Oxlet Act make Audited Financial Statements more reliable?
By Michael C. Dennis MBA, CBF

More on Advantages and Disadvantages of Selling to Public Companies

In response to a recent article about the Advantages and Disadvantages of Selling to Public Companies, one reader asked if the Sarbanes-Oxley Act makes audited financial statements more reliable. The Sarbanes-Oxley Act was signed into law in 2002 in an effort to combat a wave of accounting fraud scandals involving public companies. This law focuses on the conduct of corporate officers as well as public accounting firms. The Act imposes a number of duties on officers and directors of publicly traded companies. For example, officers must acknowledge in writing that they have evaluated the company's internal financial controls within the 90 days before the SEC filing. The required certification to be signed by the CEO and CFO must indicate that they have reported to the independent auditors and to the audit committee all information regarding significant deficiencies in internal controls that could adversely affect the company's ability to provide accurate financial reports.

The certification statement regarding fair presentation is not limited to financial statements and other financial information. It also includes management's discussion and analysis of financial condition and results of operations. An officer or director that knowingly makes a false certification may be fined up to $5 million and imprisoned for up to 20 years.

This federal law addresses failures to disclose specific facts by requiring public companies to disclose all material off-balance sheet transactions, as well as immediately present material adjustments to financial statements. Other requirements of this law include:

• The CEO, Controller, CFO, Chief Accounting Officer or person in an equivalent position cannot have been employed by the company's audit firm during the 1-year period proceeding the audit.

• A public company must have an audit committee. Each member of the audit committee must be a member of the board of directors. The audit committee must have the authority to hire and fire the company's independent auditing firm. Each audit committee must have the authority to engage independent counsel or other experts at its sole discretion in order to carry out its duties.

• Under this federal law, it is unlawful for any officer or director to take any action to fraudulently influence, coerce, manipulate, or mislead any auditor engaged in the performance of an audit for the purpose of making the financial statements materially misleading.

• The Act provides whistle-blower protection to anyone who assists in any investigation being conducted by a federal regulatory agency, or law enforcement agency.

• Independent auditors must maintain audit work papers for a minimum of seven years, provide for a concurring or second-partner review of each audit report, and describe in each audit report the scope of the auditor's testing of the internal control structure.

• The lead auditor or coordinating partner, and the reviewing partner must rotate off of the audit every five years.

• If a public company is required to re-state its earnings due to "material noncompliance" with financial reporting requirements, the CEO and the CFO must reimburse the company for any bonus or other incentive-based or equity-based compensation received during the twelve months following the filing of the non-compliant financial report, as well as any profits from the sale of securities of the company during that period.

• This law requires annual reports to contain an Internal Control Report that (1) states the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contains an assessment of the effectiveness of these internal control structures and procedures on the financial reporting process

For all of these reasons and others contained in this federal law, relying on audited financial statements is now far safer than it was a year ago.