Reducing Credit Risk: Are Your Publicly Traded Customers' Financial Statements More Reliable in Light of New Federal Legislation? A Review of the Sarbanes-Oxley Act of 2002 and What

Article excerpt

A Review of the Sarbanes-Oxley Act of 2002 and What It Means to the Credit Professional

Headlines of corporate fraud within public companies, from Enron to Adelphia to WorldCom, has prompted the U.S. Congress to overwhelmingly pass federal legislation providing for accounting reform and requiring more accurate financial disclosure and reporting from public companies. This new federal legislation penetrates the area of corporate governance, which traditionally had been left to the states. President Bush has stated that corporate officers must be accountable and the integrity of financial reporting must return.

The Sarbanes-Oxley Act of 2002 (SOA) was signed into law on July 30, 2002, to combat the wave of accounting and financial reporting scandals and corporate bankruptcies. SOA focuses on the conduct of corporate officers and public accounting firms and adequate disclosure in public company financial statements. How will the law affect credit professionals and their publicly traded customers? Will the law change the way corporate officers, accountants and lawyers deal with financial disclosures? Will financial information reported by public companies become more reliable, thereby reducing credit risk for vendors selling on open account?

FEDERAL GOVERNMENT OVERVIEW

SOA provides that the Securities and Exchange Commission (SEC) enforce the legislation and has earmarked $766 million for SEC enforcement. Much of this enforcement comes through SOA's creation of the Public Company Accounting Oversight Board ("Board"). The SOA grants the Board supervisory, investigative, disciplinary and enforcement powers over public accounting firms. The board will enforce mandatory registration of firms that prepare audit reports for public companies and establish auditing, quality control, ethics and independence standards relating to preparation of audit reports. The Board must also enforce other standards that it, or the SEC, determines are "necessary and appropriate." The Board will consist of five members-two CPAs and three non-CPAs.

PUBLIC COMPANY'S DUTIES

SOA imposes a number of duties and restrictions on officers and management of publicly traded companies.

Attempting to Hold Officers Accountable

The CEO and CFO must sign a certification that the company's periodic reports do not contain untrue statements of a material fact. All financial information must accurately present the company's financial conditions and results of operations for the period.

Certifying officers must establish internal controls to ensure that employees provide material information regarding the company and its subsidiaries.

Signing officers must also acknowledge that they have evaluated the company's internal financial controls within the 90 days before the filing of the report. The report must include conclusions of their evaluation. Certification must also state that the CEO and CFO have reported to the auditors and audit committee of the company all information regarding significant deficiencies in internal controls that could adversely affect the company's ability to provide an accurate report.

The CEO must sign the company's tax returns. An officer or director that knowingly makes a false certification may be fined up to $5 million and jailed for up to 20 years.

SOA also prohibits officers and directors from taking any action to fraudulently influence auditors.

SOA prohibits personal loans to officers and directors. A corporate insider must disclose stock sales of the company within two days. SOA requires that transactions involving management and principal stockholders must be disclosed to the public immediately.

Under SOA, if a company is required to make an accounting restatement due to material noncompliance with any of the reporting requirements, the CEO and the CFO must reimburse the company for any bonus or other incentive-based or equity-- based compensation during the 12-month period following first public issuance or filing with the SEC and any profits realized from the sale of securities of the company during that 12-month period. …