Bush Urges Fast Track for Bill to Protect Investors and Reign in Accounting Industry, Broker-Dealers, Public Companies
With a push from President Bush, legislation mandating accounting and other reforms in response to recent corporate scandals – and the dwindling Dow – may make it to the White House in record time, according to CCH INCORPORATED (CCH), a leading provider of securities law information.
On the same day that the Senate passed 97-0 its version of reform legislation – the Public Company Accounting Reform and Investor Protection Act – President Bush urged Congress to pass a bill he can sign into law in early August. Within a day, the House reacted, also passing a bill with provisions providing criminal penalties against corporate fraud. Whenever the legislative changes come, they’re likely to be the most significant and far-reaching changes to securities law since the 1934 Securities Exchange Act.
"Issues surrounding accounting reform continue to heat up, as the stock market continues to cool down, and lawmakers seem committed to passing reform legislation as soon as possible," said James Hamilton, JD, LLM, senior securities law analyst for CCH. Both the Senate and House have now passed their versions of the legislation.
"Now, the GOP-backed House bill passed in April seems to be of a different era. Given current developments in corporate America, there’s far stronger rhetoric and action coming from House Republicans in recent days and the very good likelihood that they are willing to work with the Democrats to craft an even more stringent bill," said Hamilton. The urgency to pass accounting reform before the August congressional recess could mean bypassing the traditional congressional conference committee for faster, informal meetings.
Below, CCH provides an overview and analysis of major provisions of the Senate bill and how it differs from the House version. (For a detailed comparison of the bills, and related resources, visit http://www.cch.com/securitiesreform )
Accounting Oversight Board
Both the House and Senate bills agree that an independent accounting oversight board should be created within the Securities and Exchange Commission (SEC). However, the bills differ on how much authority the board should have.
The House bill outlined a board with limited authority, while the Senate calls for the board to have far broader authority in setting standards, including power to establish auditing, quality control, ethics and independence standards for public company auditors.
Under the Senate bill, accounting firms that conduct audits of public firms would be required to register with the board and the board has the power to inspect accounting firms that conduct those audits as well as investigate potential violations of rules and impose sanctions on the rule-breakers. The Senate bill also applies to foreign public accounting firms that audit financial statements of companies under U.S. securities laws.
While the legislation calls for establishing an accounting oversight board and empowers it to set auditing standards, it also makes it clear that the Financial Accounting Standards Board (FASB) will continue to play a role in setting accounting standards (e.g., Generally Accepted Accounting Principles – GAAP) and provides public funding for FASB to fulfill this role.
The once politically unpopular issue of limiting auditors’ non-auditing services is now gaining widespread support. Under the House bill, accounting firms are restricted explicitly from two areas: consulting on system implementation and conducing internal audits for auditing clients.
Meanwhile, the Senate bill contains a list non-audit services that an accounting firm would be barred from doing for an audit client. These include bookkeeping or other services related to the accounting records or financial statements; financial information systems design, appraisal or valuation services; actuarial services; management functions or human resources; broker or dealer or investment advisor services; and legal services.
"The central theme running through the restrictions in the Senate bill is that providing these services to a public company audit client creates a fundamental conflict of interest for the accounting firm in carrying out its audit responsibility," said Hamilton. "Policymakers want it on the books that protecting the independence of the audit – in order to protect the interest of shareholders – outweighs the rights of the accounting industry to increase its service offerings."
However, the Senate bill does give the board authority to grant case-by-case exceptions and no limitations are placed on accounting firms in providing non-audit services to public companies that they do not audit or to any private companies. The bill also requires a registered public accounting firm to rotate its lead partner (the partner in charge of the audit engagement) and its review partner (the partner brought into review the work of the lead partner and audit team) on audits so that neither role is performed by the same accountant for the same company for more than five consecutive years.
Senior Management Accountability
The Senate bill contains a number of provisions designed to make senior management more accountable and to improve financial disclosures so that investors can be informed as much as possible on financial issues materially affecting public companies.
Among the provisions: CEOs and CFOs are required to certify their companies’ financial reports and are prevented from benefiting from profits they receive if it’s proven that they misstated their company’s financials. Addressing what was seen as a widening loophole, the Senate adopted an amendment stating that CEOs and CFOs of companies that reincorporate outside the U.S. will still be required to certify financial statements.
Audit committees of publicly held companies also would be strengthened and held more accountable under the Senate bill. Specifically, they would have to be independent from company management and audit committees would be directly responsible for the appointment, compensation and oversight of the work of the auditors. The committee also would have to develop procedures for addressing complaints concerning auditing issues and procedures for employee whistleblowers to submit their concerns regarding accounting or auditing issues.
"The Senate wants to make it clear that the primary duty of auditors is to the company’s board of directors and the investing public and not to senior management," said Hamilton.
Disclosure of Insider Trading and Banning Loan Issuance
The Senate bill calls for prompt disclosure of insider stock trades and bans loans made to company executives and directors.
Under the bill, insider stock trades must be reported by the second day following any transaction. Currently insiders do not have to report trades until the tenth day of the month following the month in which the trade occurred, meaning that an insider trade could go unreported for as many as 40 days.
Initially, the Senate bill had allowed loans to company officers and directors so long as they were disclosed within seven days, and that the disclosure included the amounts paid and balances owed as well as any conflicts of interest as defined by the SEC. However, the bill now makes it unlawful for any public company to make loans to its executive officers and directors. There is one narrow exemption for consumer credit loans made to executives on market terms in the ordinary course of the company’s consumer credit business.
Amendments Abound: What’s In
After arriving on the Senate floor last week, a flurry of amendments were proposed to the Act. In addition to those mentioned above, new provisions adopted by the Senate include:
- An amendment creating a new federal felony for securities fraud with a 10-year maximum penalty and providing for a review of existing sentencing guidelines for fraud cases and organizational misconduct to make them tougher as well. The provision also creates two new anti-shredding penalties, which set clear requirements for preserving financial audit guides and closes loopholes in current anti-shredding laws.
"Currently, prosecutors are forced to resort to a patchwork of technical offenses and regulations that criminalize particular violations of securities laws, or to treat the cases as generic mail or wire fraud that results in a five-year maximum penalty," said Hamilton. "The new 10-year felony is comparable to existing bank and health-care fraud statues and simplifies the process for prosecutors in egregious cases."
- Another provision would allow the SEC, during an investigation, to seek an order in federal court imposing a 45-day freeze on extraordinary payments to corporate executives. The target payments would be placed in escrow, ensuring that corporate assets are not improperly taken from an executive’s personal benefit. The provision also would empower the SEC to bar persons from serving as officers or directors if they committed a securities law violation and their conduct demonstrated unfitness to serve as an officer or a director. Under current law, only a federal court can issue an order prohibiting a person from acting as an officer or director of a public company.
About CCH INCORPORATED
CCH INCORPORATED, founded in 1913, has served four generations of business professionals and their clients. The company produces approximately 700 print and electronic products for securities, tax, legal, banking, securities, human resources, health care and small business markets. CCH is a wholly owned subsidiary of Wolters Kluwer North America. The CCH web site can be accessed at cch.com.