Magazine article The CPA Journal

The Sarbanes-Oxley Act and the Evolution of Corporate Governance

Magazine article The CPA Journal

The Sarbanes-Oxley Act and the Evolution of Corporate Governance

Article excerpt

Editor's Note: Third in an ongoing series.

The conflicts of interest in the process of issuing and marketing securities in America have motivated an urgent call for comprehensive corporate and market governance reform. Reform demands the reengineering of all activities in the process of issuing and marketing securities, and the implementation of controls that guarantee that the investor's interest is the ultimate goal of all participants in the process.

The pillars of reform should be integrity, independence, transparency, and accountability. The constituencies involved are:

* Issuers: boards of directors, corporate management, public audit firms, and employees;

* Financial markets: investment banks, mutual and hedge fund managers, self-regulatory organizations (SRO), and trading specialists; and

* Controlling parties: investors, securities regulators, and the government.

Governance reform is a people-driven process, and the top people involved in issuing and marketing securities, as well as those in the controlling constituencies, should lead the change and set the example.


Unspoiled integrity must be the top requirement for those seeking leadership roles within corporations, financial markets, and controlling entities. Unfortunately, most of the corporate and market leaders involved in scandals are notorious for their greed and unethical behavior. The basic tools required to improve integrity among business leaders are culture, fear, and reward.

Cultural change is typically driven by personal attitude toward change and an environment that rewards individuals for embracing the new culture. By emphasizing the "fear factor" through increased penalties and strict enforcement, the latest regulatory actions by government entities fall short in addressing cultural changes among business leaders.

Preventing corporate scandals requires that those selecting business leaders focus on the integrity of candidates first, followed by their skills and competencies. A successful selection process would restrict nomination of top executives to only those board members nominated by investors. Additionally, time limits should be placed on the tenure of executives-perhaps for the length of a strategic plan cycle. Longer tenures tend to favor creation of empires that conceal improprieties and unethical behavior.

Corruption among securities market participants has proven to be more pervasive than initially anticipated. Transaction-driven compensation and lack of control over trading activities are the major causes of unethical behavior. Measures to address this are under consideration, but the issue of compensation for market intermediaries must be seriously addressed as well.


Lack of independence is a serious threat to integrity, as it hampers the ability to overcome conflicts of interest between a leader's personal benefit and a business's best interests. Corporate governance reform requires that change start at the top and cascade down throughout the organization. Therefore, independence must be of paramount importance to each member of the board of directors. Director selection is a key to structuring truly independent boards, and the driving force behind it should be investors, not executive management. Indeed, the process should be completely overhauled to eliminate executive management involvement, and board membership should be restricted to only the chief executive.

The effectiveness of the external audit function depends on the external auditor firm's independence from management. Recent suggestions by the sec to allow investor nomination of director candidates and require disclosure of particulars surrounding the selection (nomination) process are steps in the right direction, although a more aggressive stance on this issue would accelerate governance reform. For example, an outright ban on cross-board memberships, a limit to the number of directorships one can hold, and director reelection restrictions are all measures that will contribute positively to governance reform. …

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