Citizen Works' Analysis of the Accounting Reform Law

President Bush signed the Sarbanes-Oxley Act today (July 30, 2002).

The law includes provisions that ensure stronger auditor independence and stiffen the penalties for securities fraud.

While we believe these are positive steps towards restoring the trust of investors, consumers and the broader public in the self-policing market, they are not enough.

Most obvious is the absence of any requirement to ban or at least expense options. If the current crisis is greed on steroids, it only makes sense to take the steroids away.

Other reforms are needed to address the role of commercial banks such as Citigroup in Enron's collapse, protect whistleblowers from reprisal (in areas apart from securities fraud), strengthen shareholders' ability to exercise their rights of ownership and curb the corporate abuse of offshore tax havens. Stronger penalties, such as the debarment of corporate criminals, are also needed. Twenty years of deregulation have led to a systemic crisis that will not be solved with a single stroke of the pen.

Still, we applaud this positive first step and hope that Congress will continue to move in the right direction by addressing these other areas of reform.

What the bill does |  What was weakened |  What was left out |  What should happen

What the bill does

1. Creates full-time oversight board with broad authorities to regulate auditors of public companies, set auditing standards, and investigate violations of accounting practices. The board can enforce rules and prosecute violators without having to vet its decisions elsewhere. The new board will be funded by mandatory fees paid by all public companies
2. Restricts the non-audit services a public accounting firm may provide to its clients that are public companies
3. Strengthens existing criminal penalties for corporate crime by expanding wire and mail fraud to 20-year crimes, creates a securities fraud felony punishable by up to 20 years in prison, and creates a new crime for schemes to defraud shareholders.
4. Raises the statute of limitations for financial fraud from 3 years to 5 years and 2 years from the date of discovery.
5. Requires audit documents to be preserved for 5 years.
6. Protects victims' right to recoup their losses by preventing fraud artists from hiding in bankruptcy or concealing their crime and using an unfair statute of limitations to hide.
7. Improves corporate whistleblower protections in cases of securities fraud by delineating remedies, including reinstatement, back pay, and compensatory damages, if the claimant prevails.
8. Requires that CEOs and CFOs forfeit bonuses, incentive-based compensation, and profits from stock sales if accounting restatements result from material noncompliance with SEC financial reporting requirements.
9. Requires the SEC to adopt rules designed to protect the independence and integrity of securities analysts.
10. Bans companies from making personal loans to top executives.
11. Requires that the SEC conduct a study of corporations' use of off-balance sheet transactions.
12. Prohibits corporate decision-makers from selling company stock at a time when their employees are prohibited from doing so.
13. Authorizes additional annual funding for the SEC -- $776 million, up from $467 million.
14. Forces Wall Street investment research analysts to disclose any conflicts of interest that they or their financial institution might have in the investment recommendations that they make.
15. Requires the General Accounting Office, GAO, to conduct a study of the factors that have led to consolidation in the accounting industry and the impact that this has had on the securities markets.
16. Calls for an SEC study with respect to aider and abettor violations of the Federal securities law.
17. Requires lawyers to notify company directors of management misconduct that top officers refuse to rectify.
18. When corporate insiders, such as CEOs, trade the stock of the companies they manage, they must take reasonable steps to disclose those transactions to their shareholders, including electronically disclosing those sales within 2 days.
19. Calls on the SEC to issue rules of professional conduct for corporate lawyers.
20. Requires members of a corporation's board of directors audit committee to be "independent" (not tied to company management).
21. Requires CEOs to certify the financial books of their company. For how the SEC is implementing this rule, visit http://www.sec.gov/rules/proposed/34-46300.htm

What was weakened

1. The five-member oversight board can have two accountants and there is no prohibition on the rest of the board having close ties to the accounting industry. (originally, the oversight board had no accountants - this was changed in committee)
2. The disciplinary actions of the oversight board will not be open to the public. (this was added on the Senate floor)
3. The bill does not prohibit auditors from providing all non-audit services, merely some - and even those bans can be removed with special permission from the oversight board. (this was added in conference committee)
4. The bill only requires rotation of audit partners, not firms. (changed in committee)
5. Kennedy amendment (4242): would have allowed employees to sue for breach of fiduciary duty in a 401(k) plan.
6. The standard for holding executives liable for fraud was raised from "reckless" to "knowing" - this will make it harder for prosecutors to prove cases. (changed in conference).

What was left out

The bill does not deal with the biggest accounting loophole of all - the ability for companies to avoid expensing stock options, even as they get a tax write-off. Relevant amendments by Sens. John McCain (R-AZ) and Carl Levin (D-MI) were blocked.

The bill does not extend responsibility for corporate fraud to accountants, lawyers, and banks, all of whom make fraud possible. A relevant amendment by Sen. Richard Shelby (R-AL) was blocked.

The bill is limited in its disgorgement. The bill requires CEOs and CFOs to give back money they made from financial fraud. But two amendments that would have strengthened disgorgement were blocked. One, introduced by Sen. Max Cleland (D-GA) would have expanded the disgorgement to all officers and directors who knew about the misconduct in filing the financial report. The other, introduced by Sen. Byron Dorgan (D-ND) would have extended executives' disgorgement to 12 months prior to the filing of bankruptcy.

What should happen

Deeper reforms need to happen - Here are a few ideas:

1. Deepen Whistleblower Protection. The accounting reform bill gives meaningful protection to corporate whistleblowers who report information related to SEC violations or related to the defrauding of shareholders. Similar protection must be afforded to those whistleblowers who provide information on violations of consumer, environmental, workplace safety laws and regulations.
2. Repeal the 1995 Private Securities Litigation Deform Act. This act facilitated the present scandals, protecting the enablers and internal watchdogs - the accountants and lawyers - from suit. It must be repealed.
3. Debarment. The government shouldn't do business with crooks. Companies that are repeat lawbreakers should be ineligible for government contracts. Certainly a society that tolerates three-strikes-and-you're-out laws for individuals should apply the modest debarment sanction against corporate wrongdoers.
4. Corporate Crime Database. The FBI should maintain a corporate crime database, and produce an annual report on Corporate Crime in America, as an analog to its current Crime in America report (focused on street crime only).
5. Outlaw the use of offshore tax havens.