market, once again called into question the integrity of the corporate financial disclosure system.[1]
The systemic problem was that the disclosure system had failed to keep pace with changing markets. After the fact, Congress’s General Accounting Office (GAO) concluded that
changes in the business environment, such as the growth in information technology, new types of relationships between companies, and the increasing use of complex business transactions and financial instruments, constantly threaten the relevance of financial statements and pose a formidable challenge to standard setters….Enron’s failure…raised…issues…such as the need for additional transparency, clarity, more timely information, and risk-oriented financial reporting.[2]
By 2002, another round of disclosure reform was under way. Public companies, accounting firms, stock exchanges, analysts, and other participants in securities markets all made voluntary changes. On July 30, 2002, President George W. Bush signed into law the most far-reaching reforms of financial disclosure since the 1930s. The Sarbanes-Oxley Act, sponsored by Senator Paul Sarbanes (D-Md.), senior Democrat on the Senate Banking Committee, and Representative Mike Oxley (R-Ohio), chair of the House Financial Services Panel, created a new agency charged with watching over the accounting watchdogs. The private, nonprofit Public Company Accounting Oversight Board, consisting of five members appointed by the president and a staff of five hundred, was authorized to establish auditing standards, monitor accounting firms' practices, and fine them for improprieties.
The law also limited consulting services that auditors could offer to corporate clients and required rotation of partners assigned to corporations every five years. It established new criminal penalties, including twenty-five-year jail terms for securities fraud and twenty-year terms for destroying records. It required chief executives and financial officers to certify financial reports and required that material changes in financial condition be disclosed immediately in plain English. It also established a restitution fund for wronged shareholders. In what would become the law's most controversial provision – because of its high cost, as its requirements were translated into new demands on companies by outside auditors – section 404 held managers responsible for maintaining adequate internal controls over financial reporting.[3]
In other disclosure reforms, the SEC required public companies to file annual and quarterly reports more quickly (generally annual reports within sixty rather than ninety days after the end of the year and quarterly reports within thirty-five rather than forty-five days after the end of the quarter). New disclosure rules also required expensing of stock options, fuller financial disclosure by mutual funds, and more information about executive pay.[4]
The accounting scandals of 2001 and 2002 also led to new ideas about making financial reporting more useful to investors. A forum convened by the GAO in December 2002 noted that the model of financial reporting had not changed since the 1970s and was "driven by the supply side…accountants, regulators, and corporate management and boards of directors."[5] The GAO suggested layering reporting to give users the information they needed and encouraging “demand-side,” user-centered disclosure reforms.[6]
In an interesting complementary effort to improve the capacity of information users to understand financial information, Congress also approved the Financial Literacy and
- ↑ Smith and Emshwiller, 2003, pp. 374–376.
- ↑ General Accounting Office, 2002, p. 15.
- ↑ Sarbanes-Oxley Act of 2002, Pub. L. 107–204, Title IV, §404, July 30, 2002, 116 Stat. 745 (codified at 15 U.S.C.A. §7201 et seq. (West 2005) and scattered sections of 18 U.S.C.). Section 404 is codified in 15 U.S.C.A. §7262 (West 2005). For a look at how the Sarbanes-Oxley Act has amended various sections of the Securities Exchange Act of 1933, see http://www.sec.gov/divisions/corpfin/33act/index1933.shtml (site accessed June 4, 2006).
- ↑ See, for example, Executive Compensation, 17 C.F.R. §§228.402, 229.402 (2005).
- ↑ General Accounting Office, 2003a, p. 13.
- ↑ General Accounting Office, 2003a, pp. 16–17.
