The Impact of the Sarbanes-Oxley Act
What changes can be expected from this new legislation?
In response to the almost daily reports of greed, corruption, fraud and opulence plaguing the top echelons of corporate America, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the "Act"). The intended consequence of the Act is to increase the reliability and accuracy of corporate reporting, accounting and audit practices. Public perception places the blame on rich executive compensation packages and weak governance standards. L&A sees the impact of the Act in three main areas: increased executive compensation, elimination of executive loans, and continued conflicting interests among the Big 4 auditors and consultants.
The full impact of the Act on executive compensation is not yet known; however, following the economic principle of risk-reward, L&A believes there are significant implications of this Act related to executive and board of director compensation. This legislation requires the CEO and CFO to take personal responsibility for the accuracy of the financial reports, with heightened penalties for misstatements. Through legislation, the risks associated with these executive and director positions have grown considerably, as evidenced by the rise in premiums for Director and Officer liability insurance, as well as auditor fees. As a logical result, the rewards will follow; and the compensation packages for the CEO, CFO, and directors will increase further. Additionally, the CEO and CFO positions have now been placed on equal playing ground due to their equal risks; the compensation for these positions may become more closely aligned with each other than in the past.
As for executive loans, the practice has been eliminated. In general, all personal loans made by a publicly traded company to its directors and executives are prohibited unless they are made in the ordinary course of the company's lending business on terms that are not more favorable than those offered to the public. Current outstanding loans are "grandfathered" under the Act; however, they may not be modified or renewed. The prohibition has ramifications for popular compensation programs such as: relocation loans, split dollar life insurance, 401(k) participant loans, cashless exercise of options, and tax loans. For further information on executive loans and the impact of the Act see " Loans to Executives ."
Lastly, although the Act prohibits certain consulting activities to audit clients and allows it for non-audit clients, the Act does not go far enough. Why?-because a conflict of interest does not just exist when you are actually doing work for someone. A "conflict" exists even when you are consulting with prospective audit clients or you are auditing prospective consulting clients. By allowing accounting firms to still consult, Congress leaves the same temptation to compromise values, ethics, and shareholder rights in an effort to create more revenue.