The Sarbanes-Oxley Act of 2002 (SOX) was hurriedly passed by the United States Congress in reaction to the spate of fin de siècle accounting scandals that blighted the US corporate landscape. Although SOX was passed to address domestic concerns, the global importance of the American capital markets gives it a trans-national footprint.
SOX applies to all companies and their subsidiaries that have securities listed on a US stock exchange or file registration statements to offer securities to the public in the US. Also affected are foreign companies required to periodically file reports with the US Securities Exchange Commission (SEC), the regulatory body charged with implementing SOX.
The strict governance requirements imposed by SOX are naturally of greatest concern in jurisdictions with governance regimes fundamentally different from (if not more lax than) the new US dispensation. The fact that there has not been much of an outcry in South Africa is perhaps explained by the existence of our own 2002 King Report on Corporate Governance (popularly known as King II) which sets standards on a par with the best international practice. Nevertheless, SOX does contain certain provisions that should be noted by South African companies that are listed in the US, or which are subsidiaries of such listed companies (referred to as "Foreign Issuers").
A few of the more revolutionary provisions, which would apply to Foreign Issuers, are:
- CEOs and CFOs are required to certify the accuracy of periodic financial disclosures. Criminal penalties of up to USD 5 million and twenty years imprisonment may be imposed on wilful defaulters. Clearly the financial reporting buck now stops with the most senior officers who become personally responsible for the integrity of an audit.
- As part of its annual report, a company must include a statement as to the effectiveness of its internal controls. This requires a qualitative judgement, not a mere report on the system in place.
- Companies are prohibited from making loans to directors and executive officers. This ban may go so far as to preclude not only personal loans but also the provision of company credit cards and the cash-less exercise of share options.
- Companies are required to convene an entirely independent Audit Committee to be solely responsible for appointing, compensating and overseeing the work of the auditing firm and to which the auditing firm must report directly.
- Accounting firms that provide auditing services may no longer provide a number of non-audit services. These prohibited services include bookkeeping; design and implementation of information systems; appraisal or valuation services; actuarial services; management and HR services; investment advisor or investment banking services; legal services and other expert services. One possible implication is that contract, which provide for a certificate produced by a company's auditors as prima facie proof of any amount to be calculated will be problematic as such certification will amount to "appraisal or valuation services".
- Auditing firms must rotate the lead auditing partners in charge of a corporate client every five years. Provision is made for further regulations to be imposed requiring the auditing firm itself to be rotated.
- To avoid potential conflicts of interest, an accounting firm may not audit a company where any senior executive of the company was employed by that accounting firm (and participated in a previous audit of the company) during a period of one year prior to the commencement of the audit.
The SEC is empowered to adopt specific rules that address the Act's extraterritorial reach, and which take into account the home jurisdiction's own corporate governance regime, but as yet has indicated that no general exemption will be forthcoming. Senior management of Foreign Issuers should therefore take care to consider the possible consequences of SOX when appraising their corporate governance structures.
While South African companies without direct links to the US capital markets are not directly subject to SOX, the stringent standards laid down in SOX look set to become the international benchmark, so that doing business on a global scale may require compliance with its tenets. In addition, SOX has without doubt initiated a paradigm shift in the way accounting firms approach their clients, and the ripple effect of the new US framework is being felt locally.
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