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