policy paper research assignment on a public policy/federal law of your choice(SOX). a formal research paper aimed at introducing and/or polishing your skills in the following: Public policy research â€“ policy design, implementation, evaluation Understa

policy_paper_checklist_1 xsample_paper_2 xref_sox_3 refrence_1_4 refrence_2_5 refrence_3_6 sarbanes_oxley_-_context_and_theory_13 sarbanes_oxley_-contextandtheory-market_failure-information_asymmetry_17

policy paper

research assignment on a public policy/federal law of your choice(SOX). a formal research paper aimed at introducing and/or polishing your skills in the following: Public policy research â€“ policy design, implementation, evaluation Understanding a federal law Effectively exploring and utilizing the library system for research Strengthening your academic and competitive writing skills Enhance your critical thinking skills The Basic Structure: 1. Description of the policy/law â€“ history and current situation 2. Rationale for public policy â€“ market or government failure 3. Analysis of policyâ€˜s efficacy 4. Implementation 5. Evaluation 6. Recommendations ***more instructions on the attach materials!

Final Policy Paper Checklist

· Dynamic Cover Page

· Table of Contents Page

· Basics: 12-15 pages, appropriate subheadings, standard MS Word formatting, double-spaced, Times New Roman 12-pt font, page numbers

· Primary Contents (Subheadings)

· Introduction – introduce your project’s main objective

· Include the general plan of the document

· History of the Act – why was the law necessary

· Public policy prescription

· Market failure or Government Failure

· Trace its implementation

· Act, Code, Agency, etc.

· Impact on business and society

· Demonstrate your knowledge from the course content – theories, models, principles, etc.

· Policy Analysis

· Did it work?

· What are its strengths and weaknesses?

· Recommendations for future policy makers

· References Page

· This is the bibliography (ten minimum quality references)

· Academic journal articles, government documents/records, key books, official websites

· Avoid media publications, material with no author, blogs, non peer reviewed material

· Citation format: APA Style

· Helpful website:

http://owl.english.purdue.edu/owl/resource/560/01/

· Excellence Checklist

· Page numbers, professional quality, grammar, insightful, unique contribution, comprehensive, high level critical analysis, strong bibliography & citation formatting, manage the details, teach us something new

[2]

THESARBANES-OXLEY ACT OF 2002

Introduction

On July 30, 2002, President George W. Bush signed the Sarbanes-Oxley Act of 2002 into law. The law is also known as the Public Company Accounting Reform and Investor Protection Act of 2002, or SOX. It is named after sponsors U.S. Senator

Paul Sarbanes

and U.S. Representative

Michael G. Oxley

. “It amends the securities law to provide better protection for investors in public companies by improving the financial reporting of companies. According to the Senate Committee report, ‘the issue of auditor independence is at the center of (SOX).’” (Carroll A. & Buchholtz A. 2008. Pg 135) “The bill was enacted as a reaction to a number of major

corporate and accounting scandals

including those affecting

Enron

Tyco International

Adelphia

Peregrine Systems

and

WorldCom

. These scandals, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the nation’s

securities markets

.” (Sarbanes-Oxley Act. 2011)

This paper addresses questions of Will the Sarbanes-Oxley work? Is the SOX a bad or good law? To answer these questions, the paper will look at different perspectives of SOX such as the history of the Act, the concept of market failure relate to the Act, implementation of the Act, the cost and benefits of the Act, and the Act’s impact on business and society.

After nine years from SOX has been signed into law, companies that have adopted the law have positive feedbacks of the law. The law had implemented at the right time to protect investors from corporate fraud, to strengths corporate ethical standards, to improve corporate internal control and to help the United States to build a strong audit system. Thus, the Sarbanes-Oxley is an effective law, and there’s no doubt that it is a good law.

History of the Act

In 2001, there were many businesses and organizations went to bankrupt. Large companies such as Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom has been found out corporate and accounting scandals. These caused hundreds of thousands of investors lost millions of money. The confidence of investors was badly shaken.

Take the collapse of Enron Corporation as an example. The case is shown the unethical activities of Enron had caused millions of dollars loss. The following list is the detail information of Enron’s failure.

· Bankruptcy facts:

· 20,000 employees lost their jobs and health insurance

· average severance pay $4500

· top executives were paid bonuses totaling $55M

· In 2001:

· Employees lost $1.2B in retirement funds

· Retirees lost $2B in retirement funds

· Enron’s top executives cashed in $116M in stock

· Criminal Charges

· Guilty pleas: 15

· Convictions: 6

· Acquittals: 1

· Pending cases: 11

· Three California traders pled guilty to wire fraud

· Four Merrill Lynch executives pled guilty to fraud in the Nigerian Barge case

· Aug 23, 2000 stock hits high of $90

· Nov 28, 2001 stock drops to $1

· 29,000 Arthur Andersen employees lost their jobs (Enron’s CPA firm)

· Enron shareholders suing Enron and their banks for $20B (Elkind & McLean, 2003).

All of these facts spurred Congress to improve the accuracy and reliability of corporate disclosures. Thus, the Sarbanes-Oxley Act of 2002 has been signed into law. However, there’re two competing views of the impact of SOX. In the article called A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002 has stated that “the view on which Congress based the act is that SOX would improve disclosure and governance, thereby decreasing misconduct by corporate insiders and increasing value for shareholders above and beyond the associated costs of compliance. Under this positive view of the act we would expect the following:

1. Lobbying: Shareholders should support SOX, while corporate insiders should oppose it.

2. Returns during the period leading up to passage of SOX: In the cross-section of firms, returns should be higher for more affected firms. (Hochberg Y. & Sapienza P. & Vissing-Jorgensen A. 2007)

On alternative view of the impacts of SOX would be the large cost of the SOX will have negative net effect of the act on shareholder value. “This view is based on the prior that SOX would be ineffective in diminishing any misconduct, and that compliance costs would be sufficiently large to outweigh any benefits. Under the compliance cost view, one would expect the following:

1. Lobbying: Shareholders should oppose SOX. Corporate insiders should either oppose it (if they are acting on behalf of shareholders or if SOX has some ability to reduce insider misconduct), or be indifferent to it (if SOX is ineffective in reducing insider misconduct).

2. Returns during the period leading up to passage of SOX: In the cross-section of firms, returns should be lower for more affected firms. (Hochberg Y. & Sapienza P. & Vissing-Jorgensen A. 2007)

The debate of SOX was drastic. However, facts speak louder than words. After nine years of the implementation of the Sarbanes-Oxley Act, companies have gain more benefits than costs.

Public policy prescription: Market Failure

According to Dr. Jasso Sean’s article Sarbanes-Oxley-Contest & Theory: Market Failure, Information Asymmetry & The case of Regulation, “Market failure is described as the pursuit of private interest (such as an investor or other stakeholder of a corporation) that does not lead to an efficient use of society’s resources (exemplified by fraudulent use of investor funds for illegal corporate and executive gain).” (Sean J. 2009) Refer to the example of Enron above, “Enron represents a market failure under the theory of information asymmetry. It is much easier, perhaps, to analyze a market or firm that declines or fails because of outlying economic indicators – diminishing product demand, failure to innovate, global competition, natural disaster to name a few. ” (Sean J. 2009)

Weimer and Vining have theoretical context relate to information asymmetry and the centerpiece for Sarbanes-Oxley:

Information is involved in market failure in at least two distinct ways. First, information itself has public good characteristics. Consumption of information is nonrivalrous – one person’s consumption does not interfere with another’s; the relevant analytical question is primarily whether exclusion is or is not possible. Thus, in the public goods context, we are interested in the production and consumption of information itself. Second – and the subject of our discussion here there may be situations where the amount of information about the characteristics of a good varies in relevant ways across persons. The buyer and the seller in a market transaction, for example may have different information about the quality of the good being traded (1999, p. 107).

In the case of Enron and other similar scandals, the product and services being ‘traded’ is not only manufactured products, but also the multiple players in the company. Companies have to be ethical, honest, and moral to create a good and safe market for buyers and sellers. (Sean J. 2009)

Additionally, the Glass-Steagall Act of 1933 will help us to have better understand of SOX and market failure. In 1999, the repeal of the Act allowed insurance companies, commercial banks, and the investment banking firms to work together as alliance.” Three specific people were instrumental in lobbying for the repeal: Sanford Weill of Citigroup, Chuck Prince (the lawyer for Citigroup and Weill’s corporate counsel), and Alan Greenspan, the Chairman of the Federal Reserve Bank of the United States.” (Sean J. 2009) And later, these people had been suited by fraud and the relationship between these three failed. This caused investors and the companies to lose millions of money. Finally, there’s a bill has signed into law to protect investors in 2002- that is the Sarbanes-Oxley Act.

Implementation

(NYSE, SEC, PCAOB, FBI)

The Sarbanes-Oxley Act of 2002 is codified in U.S. Code at 15 USC Sec. 7201, Title 15 “Commerce and Trade”, Chapter 98 – Public Company Accounting Reform and Corporate Responsibility (

http://uscode.house.gov

After it was adopted, “the NYSE, NASDAQ, and AMEX adopted more comprehensive reporting requirements for listed companies, and the Securities and Exchange Commission (SEC) issued a host of new regulations aimed at strengthening transparency and accountability through more timely and accurate disclosure of information about corporate performance.” (Kluyver C. 2009 pg 189)

For example, new NYSE and SEC have rules for compensation committees:

· Listed companies have a compensation committee composed entirely of independent directors;

· The compensation committee has a written charter that addresses, among other things, the committee’s purpose and sets forth the duties and responsibilities of the committee;

· The compensation committee produces-on an annual basis-a compensation committee report on executive compensation, to be included in the company’s annual proxy statement or annual report on Form 10-K filed with the SEC. (Kluyver C. 2009 pg 192)

Sarbanes-Oxley has created the Public Company Accounting Oversight Board (PCAOB) –“a nonprofit corporation established by Congress to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports.” (Public Company Accounting Oversight Board) The responsibilities of PCAOB include:

· Registering public accounting firms;

· Establishing auditing, quality control, ethics, independence, and other standards relating to public company audits;

· Conducting inspections, investigations, and disciplinary proceedings of registered accounting firms;

· Enforcing compliance with Sarbanes-Oxley. (Kluyver C. 2009 pg 196)

When Congress created the PCAOB, it gave SEC the power to regulate PCAOB such as to appoint or remove members, and to approve PCAOB’s budget and rules and so on.

Also, as directed by section 404 of Sarbanes-Oxley, the SEC adopted a rule “requiring registered companies to include their annual reports a report of management on the company’s internal control over financial reporting.” (Kluyver C. 2009 pg 196)

Additionally, the Sarbanes-Oxley Act has implementation power in detective agency. “SOX has implementation power by way of the U.S. Department of Justice whose primary function is to prosecute the federal crimes associated with the Act such as “attempts or conspiracies to commit fraud, certifying false financial statements, document destruction or tampering, and retaliating against corporate whistleblowers” (Department of Justice). In partnership with the Attorney General, the Federal Bureau of Investigation (FBI) is charged with the authority to investigate crimes associated with corporate fraud and remains the primary detective agency to investigate and arrest corporate bad behavior.” (Sean J. 2009)

Thus, the Sarbanes-Oxley Act has fully implemented into different agency and codes. The functions of SOX have been produced the best possible effects.

Impact on business and society:

CSR & to Be a Good Citizen

The spectacular bankruptcy in 2001 and the corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom has shown that unethical businesses behaviors and frauds caused millions of dollars of loss. Thus, one significant impact of the Sarbanes-Oxley Act on business and society is that the companies and businesses start to realize the importance of corporate social responsibility.

Archie Carroll has argued that businesses have four levels of social responsibility: economy, legal, ethic, and philanthropic. According to Carroll’s article called
The Pyramid

of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders
, he has argued that corporate economic responsibilities is important to maximize earnings per share, to being as profitable as possible, and to maintain a strong competitive position. He stated that “before it was anything else, the business organization was the basic economic unit in our society.” (Carroll A. 1991) For the legal responsibilities, Carroll has argued that “As a partial fulfillment of the ‘social contract’ between business and society, firms are expected to pursue their economic missions within the framework of the law… Legal responsibilities reflect a view of ‘codified ethics’ in the sense that they embody basic notions of fair operations as established by our lawmakers.” (Carroll A. 1991) And ethical (behavior) responsibilities are important to create an ethical, moral social and businesses culture. “Ethical responsibilities embody those standards, norms, or expectations that reflect a concern for what consumers, employees, shareholders, and the community regard as fair, just, or in keeping with the respect or protection of stakeholders’ moral rights.” (Carroll A. 1991) Philanthropic responsibility is the top level of Carroll’s pyramid of corporate social responsibility. This includes actively engaging in acts or programs to promote human welfare or goodwill. Examples of philanthropy include business contributions of financial resources or executive time, such as contributions to the arts, education, or the community.” (Carroll A. 1991)

And the next question is what businesses can get out of CSR? The answer will address to Carroll’s another article called
The Business Case for Corporate Social Responsibility: A Review of Concepts, Research and Practice
. According to the article, there are four approaches to answer the question. The first one is called cost and risk reduction. “Cost and risk reduction justifications constitute arguments that contend that engaging in certain CSR activities will reduce costs and risks to the firm.” (Carroll, A. & Shabana, K. 2010) This means that to build positive community relationships may contribute to a firm’s attaining tax advantages and decrease the amount of regulation imposed on the firm.

The second one is called gaining competitive advantage which is “how firms may use CSR practices to set themselves apart from their competitors.” (Carroll, A. & Shabana, K. 2010) By engaging in certain CSR activities, firms may improve their competitiveness. Stakeholders demands are seen as opportunities rather than constraints, also CSR initiatives can help a firm to enhance relationships with its customers. In conclusion, the company may gain competitive advantages by build up a ‘convergence of interests’ relationship between the economic gains and the social benefits.

The third one is called developing reputation and legitimacy which means that “Reputation and legitimacy arguments maintain that firms may strengthen their legitimacy and enhance their reputation by engaging in CSR activities.” (Carroll, A. & Shabana, K. 2010) Also, “N. Smith contends that CSR activities enhance the ability of a firm to attract consumers, investors and employees.” (Carroll, A. & Shabana, K. 2010)

And lastly the last one is called seeking win-win outcomes through synergistic value creation means that the firm exploiting opportunities to connect stakeholder interests and create value for multiple stakeholders simultaneously. “The win–win perspective to CSR practices provides a view in which CSR is perceived as a vehicle that allows both the firm to pursue its interest and stakeholders to satisfy their demands.” (Carroll, A. & Shabana, K.2010)

Additionally, Sarbanes-Oxley Act has rules for businesses and organizations that to make sure the businesses and organizations are ethical, honest, and moral on management, and therefore have reliable financial recording and have contributions to the society.

Another significant impact of SOX to businesses and society is that the Act leads organizations to be a good citizen. Mirivis and Googins has stated in the article called
Stages of Corporate Citizenship
that “Knowing at what stage a company is, and what challenges it faces in advancing citizenship, can clear up an executive’s confusion about where things stand, frame strategic choices about where to go, aid in setting benchmarks and goals, and perhaps speed movement forward.” (Mirivis R. & Googins B. 2006)

One way to become a good citizen for businesses and organizations is to take corporate social responsibilities. Thus, SOX has the combination idea of CSR and to be a good citizen for businesses and organizations to follow. In addition, we’ll have an ethical social culture if every business obeys the Act since it’s a guideline to the way of being ethical.

Policy Analysis:

Benefits & Cost of SOX; Recommendation

Everything has two sides: a good and a bad. The Sarbanes-Oxley Act also has benefits and costs. If the benefits are more than the costs, then we can say the Act works. Since the law doesn’t apply to private companies, we’ll focus on what SOX has brought to the public companies.

The Finance Executive International (FEI) provides an annual survey on SOX Section 404 costs. “For 200 companies with average revenues of $6.8 billion, the average compliance costs were $2.9 million, down 23% from 2005. Cost for decentralized companies (i.e., those with multiple segments or large divisions) were more than twice those of centralized companies. Auditor costs did not decline.” (Analyzing the cost-benefits 2008) When the companies were asked if the benefits of compliance with Section 404 have exceed their costs, 22 % has agreed, and 34% has agreed with that the compliance with Section 404 has helped detect or prevent fraud.

Thus, the Sarbanes-Oxley Act of 2002 is an effective law.

Benefits (strengths)

The Sarbanes-Oxley Act has prevent investors from corporate fraud; has helped to strengths corporate ethical standards, to improve corporate internal control and to help the United States to build a strong audit system.

“Before Sarbanes–Oxley, a correlation existed between abnormal accounting accruals—that is, accruals not predicted by standard empirical models of accruals— and the importance of an audit client to its auditor, but this correlation vanished after the law passed.” (Coates IV J. 2007)

Additionally, investor’s confidence has been increased after the passage of SOX. “By April 2006, even a majority of financial officers—who have generally been critical of Sarbanes–Oxley—believed that the law (and §404 in particular) had increased investor confidence in financial reports.” (Coates IV J. 2007)

Costs (Weakness)

The main cost of the act would be the increasing audit fees and indirect costs such as opportunity cost of manager time spent.

John C. Coates IV has argued that “direct costs consist of PCAOB fees, firms’ compliance costs, and increased audit fees… Indirect costs—like opportunity costs of manager time spent or greater risk- aversion as a result of perceived pressure for tighter financial controls.” (Coates IV J. 2007)

Even though companies have complained about the high costs of SOX many times, SOX can earn more benefits than costs in the long-term. After nine years from 2002, the financial reports of companies have shown people the results. SOX is effective.

Recommendation for future policy makers

The first recommendation would be to create a law that can be worked in long-term. The Sarbanes-Oxley Act is a good example. People complain at the beginning and find out the law is effective in the long-term.

The second recommendation is that we want to create an ethical law that can be functioned for government, businesses, and the society. That is why a law necessary. SOX has taught the businesses to take corporate social responsibility. This is kill two birds with one stone. The business can get more benefits, and contribute to the society at the same time by obeying the law.

The third recommendation is people have to pay attention to the legal loophole. For example, SOX doesn’t apply to private company. Therefore, many companies have turned to private company after the law passed.

A law has to be effective and can cover everyone in the society. People have to have the belief into the law that laws are protecting people, not protecting government and the powerful organizations.

Conclusion

In conclusion, the Sarbanes-Oxley Act of 2002 has brought benefits to the government, businesses and the society. This paper had addressed questions of Will the Sarbanes-Oxley work? Is the SOX a bad or good law? To answer these questions, the paper looked at different perspectives of SOX such as the history of the Act, the concept of market failure relate to the Act, implementation of the Act, the cost and benefits of the Act, and the Act’s impact on business and society.

Lastly, we have to be more careful to making new laws in the future. We should create laws that can be work long-term, pay attention to the legal loophole, and to create laws that prevent everyone in the society. Our goal is to create ethical, equal, and moral social culture.

References

Analyzing the cost-benefit of Sarbanes-Oxley Â« SOX 404 Compliance. (n.d.). . Retrieved July 20, 2011, from

Analyzing the cost-benefit of Sarbanes-Oxley

Carroll A. (1991) The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders Business Horizons

Carroll A. & Buchholtz A. (2008) Business & Society: Ethics and Stakeholders Management (7e). Ohio: South-Western Cengage Learning

Coates IV J. (2001) The Goals and Promise of the Sarbanes–Oxley Act Journal of Economic Perspectives—Volume 21, Number 1

Elkind, P. & McLean, B. (2003). The smartest guys in the room: The rise and fall of Enron. New York: Penguin Group, U.S.A.

Hochberg Y. & Sapienza P. & Vissing-Jorgensen A. (2007) A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002 Nber Working Paper Series

Kluyver C. (2009) A Primer on Corporate Governance New York: Business Expert Press, LLC.

Mirivis R. & Googins B. 2006: Mirvis P. & Googins B. Stages of Corporate Citizenship California Management Review Volume 48 Number 2

Public Company Accounting Oversight Board. (n.d.). . Retrieved July 19, 2011, from http://pcaobus.org/Pages/default.aspx

Sarbanes–Oxley Act – Wikipedia, the free encyclopedia. (n.d.). . Retrieved July 4, 2011, from

http://en.wikipedia.org/wiki/Sarbanes%E2%80%93Oxley_Act

Sean J. (2009) Sarbanes-Oxley-Contest & Theory: Market Failure, Information Asymmetry & The case of Regulation Journal of Academy of Business and Economics, Volume 9 (3) 2009 ISSN: 1542-8710

Weimer, D. L. & Vining, A. R. (1999). Policy analysis: Concepts and practice. Upper Saddle River, N.J.: Prentice-Hall.

H. R. 3763

One Hundred Seventh Congress
of the

United States of America
A T T H E S E C O N D S E S S I O N

Begun and held at the City of Washington on Wednesday,
the twenty-third day of January, two thousand and two

An Act
To protect investors by improving the accuracy and reliability of corporate disclosures

made pursuant to the securities laws, and for other purposes.

Be it enacted by the Senate and House of Representatives of
the United States of America in Congress assembled,
SECTION 1. SHORT TITLE; TABLE OF CONTENTS.

(a) SHORT TITLE.—This Act may be cited as the ‘‘Sarbanes-
Oxley Act of 2002’’.

(b) TABLE OF CONTENTS.—The table of contents for this Act
is as follows:
Sec. 1. Short title; table of contents.
Sec. 2. Definitions.
Sec. 3. Commission rules and enforcement.

TITLE I—PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD
Sec. 101. Establishment; administrative provisions.
Sec. 102. Registration with the Board.
Sec. 103. Auditing, quality control, and independence standards and rules.
Sec. 104. Inspections of registered public accounting firms.
Sec. 105. Investigations and disciplinary proceedings.
Sec. 106. Foreign public accounting firms.
Sec. 107. Commission oversight of the Board.
Sec. 108. Accounting standards.
Sec. 109. Funding.

TITLE II—AUDITOR INDEPENDENCE

Sec. 201. Services outside the scope of practice of auditors.
Sec. 202. Preapproval requirements.
Sec. 203. Audit partner rotation.
Sec. 204. Auditor reports to audit committees.
Sec. 205. Conforming amendments.
Sec. 206. Conflicts of interest.
Sec. 207. Study of mandatory rotation of registered public accounting firms.
Sec. 208. Commission authority.
Sec. 209. Considerations by appropriate State regulatory authorities.

TITLE III—CORPORATE RESPONSIBILITY
Sec. 301. Public company audit committees.
Sec. 302. Corporate responsibility for financial reports.
Sec. 303. Improper influence on conduct of audits.
Sec. 304. Forfeiture of certain bonuses and profits.
Sec. 305. Officer and director bars and penalties.
Sec. 306. Insider trades during pension fund blackout periods.
Sec. 307. Rules of professional responsibility for attorneys.
Sec. 308. Fair funds for investors.

TITLE IV—ENHANCED FINANCIAL DISCLOSURES
Sec. 401. Disclosures in periodic reports.
Sec. 402. Enhanced conflict of interest provisions.
Sec. 403. Disclosures of transactions involving management and principal stock-

holders.

http://www.findlaw.com

H. R. 3763—2

Sec. 404. Management assessment of internal controls.
Sec. 405. Exemption.
Sec. 406. Code of ethics for senior financial officers.
Sec. 407. Disclosure of audit committee financial expert.
Sec. 408. Enhanced review of periodic disclosures by issuers.
Sec. 409. Real time issuer disclosures.

TITLE V—ANALYST CONFLICTS OF INTEREST
Sec. 501. Treatment of securities analysts by registered securities associations and

national securities exchanges.

TITLE VI—COMMISSION RESOURCES AND AUTHORITY
Sec. 601. Authorization of appropriations.
Sec. 602. Appearance and practice before the Commission.
Sec. 603. Federal court authority to impose penny stock bars.
Sec. 604. Qualifications of associated persons of brokers and dealers.

TITLE VII—STUDIES AND REPORTS

Sec. 701. GAO study and report regarding consolidation of public accounting firms.
Sec. 702. Commission study and report regarding credit rating agencies.
Sec. 703. Study and report on violators and violations
Sec. 704. Study of enforcement actions.
Sec. 705. Study of investment banks.

TITLE VIII—CORPORATE AND CRIMINAL FRAUD ACCOUNTABILITY
Sec. 801. Short title.
Sec. 802. Criminal penalties for altering documents.
Sec. 803. Debts nondischargeable if incurred in violation of securities fraud laws.
Sec. 804. Statute of limitations for securities fraud.
Sec. 805. Review of Federal Sentencing Guidelines for obstruction of justice and ex-

tensive criminal fraud.
Sec. 806. Protection for employees of publicly traded companies who provide evi-

dence of fraud.
Sec. 807. Criminal penalties for defrauding shareholders of publicly traded compa-

nies.

TITLE IX—WHITE-COLLAR CRIME PENALTY ENHANCEMENTS
Sec. 901. Short title.
Sec. 902. Attempts and conspiracies to commit criminal fraud offenses.
Sec. 903. Criminal penalties for mail and wire fraud.
Sec. 904. Criminal penalties for violations of the Employee Retirement Income Se-

curity Act of 1974.
Sec. 905. Amendment to sentencing guidelines relating to certain white-collar of-

fenses.
Sec. 906. Corporate responsibility for financial reports.

TITLE X—CORPORATE TAX RETURNS

Sec. 1001. Sense of the Senate regarding the signing of corporate tax returns by

chief executive officers.

TITLE XI—CORPORATE FRAUD AND ACCOUNTABILITY
Sec. 1101. Short title.
Sec. 1102. Tampering with a record or otherwise impeding an official proceeding.
Sec. 1103. Temporary freeze authority for the Securities and Exchange Commis-

sion.
Sec. 1104. Amendment to the Federal Sentencing Guidelines.
Sec. 1105. Authority of the Commission to prohibit persons from serving as officers

or directors.
Sec. 1106. Increased criminal penalties under Securities Exchange Act of 1934.
Sec. 1107. Retaliation against informants.

SEC. 2. DEFINITIONS.

(a) IN GENERAL.—In this Act, the following definitions shall
apply:

(1) APPROPRIATE STATE REGULATORY AUTHORITY.—The term
‘‘appropriate State regulatory authority’’ means the State
agency or other authority responsible for the licensure or other
regulation of the practice of accounting in the State or States

H. R. 3763—3

having jurisdiction over a registered public accounting firm
or associated person thereof, with respect to the matter in
question.

(2) AUDIT.—The term ‘‘audit’’ means an examination of
the financial statements of any issuer by an independent public
accounting firm in accordance with the rules of the Board
or the Commission (or, for the period preceding the adoption
of applicable rules of the Board under section 103, in accordance
with then-applicable generally accepted auditing and related
standards for such purposes), for the purpose of expressing
an opinion on such statements.

(3) AUDIT COMMITTEE.—The term ‘‘audit committee’’
means—

(A) a committee (or equivalent body) established by
and amongst the board of directors of an issuer for the

purpose of overseeing the accounting and financial
reporting processes of the issuer and audits of the financial
statements of the issuer; and

(B) if no such committee exists with respect to an
issuer, the entire board of directors of the issuer.
(4) AUDIT REPORT.—The term ‘‘audit report’’ means a docu-

ment or other record—
(A) prepared following an audit performed for purposes

of compliance by an issuer with the requirements of the
securities laws; and

(B) in which a public accounting firm either—
(i) sets forth the opinion of that firm regarding

a financial statement, report, or other document; or
(ii) asserts that no such opinion can be expressed.

(5) BOARD.—The term ‘‘Board’’ means the Public Company
Accounting Oversight Board established under section 101.

(6) COMMISSION.—The term ‘‘Commission’’ means the Secu-
rities and Exchange Commission.

(7) ISSUER.—The term ‘‘issuer’’ means an issuer (as defined
in section 3 of the Securities Exchange Act of 1934 (15 U.S.C.
78c)), the securities of which are registered under section 12
of that Act (15 U.S.C. 78l), or that is required to file reports
under section 15(d) (15 U.S.C. 78o(d)), or that files or has
filed a registration statement that has not yet become effective
under the Securities Act of 1933 (15 U.S.C. 77a et seq.), and
that it has not withdrawn.

(8) NON-AUDIT SERVICES.—The term ‘‘non-audit services’’
means any professional services provided to an issuer by a
registered public accounting firm, other than those provided
to an issuer in connection with an audit or a review of the
financial statements of an issuer.

(9) PERSON ASSOCIATED WITH A PUBLIC ACCOUNTING FIRM.—
(A) IN GENERAL.—The terms ‘‘person associated with

a public accounting firm’’ (or with a ‘‘registered public
accounting firm’’) and ‘‘associated person of a public
accounting firm’’ (or of a ‘‘registered public accounting
firm’’) mean any individual proprietor, partner, share-
holder, principal, accountant, or other professional
employee of a public accounting firm, or any other inde-
pendent contractor or entity that, in connection with the
preparation or issuance of any audit report—

H. R. 3763—4

(i) shares in the profits of, or receives compensation
in any other form from, that firm; or

(ii) participates as agent or otherwise on behalf
of such accounting firm in any activity of that firm.
(B) EXEMPTION AUTHORITY.—The Board may, by rule,

exempt persons engaged only in ministerial tasks from
the definition in subparagraph (A), to the extent that the
Board determines that any such exemption is consistent
with the purposes of this Act, the public interest, or the
protection of investors.
(10) PROFESSIONAL STANDARDS.—The term ‘‘professional

standards’’ means—
(A) accounting principles that are—

(i) established by the standard setting body
described in section 19(b) of the Securities Act of 1933,
as amended by this Act, or prescribed by the Commis-
sion under section 19(a) of that Act (15 U.S.C. 17a(s))
or section 13(b) of the Securities Exchange Act of 1934
(15 U.S.C. 78a(m)); and

(ii) relevant to audit reports for particular issuers,
or dealt with in the quality control system of a par-
ticular registered public accounting firm; and
(B) auditing standards, standards for attestation

engagements, quality control policies and procedures, eth-
ical and competency standards, and independence stand-
ards (including rules implementing title II) that the Board
or the Commission determines—

(i) relate to the preparation or issuance of audit
reports for issuers; and

(ii) are established or adopted by the Board under
section 103(a), or are promulgated as rules of the
Commission.

(11) PUBLIC ACCOUNTING FIRM.—The term ‘‘public
accounting firm’’ means—

(A) a proprietorship, partnership, incorporated associa-
tion, corporation, limited liability company, limited liability
partnership, or other legal entity that is engaged in the
practice of public accounting or preparing or issuing audit
reports; and

(B) to the extent so designated by the rules of the
Board, any associated person of any entity described in
subparagraph (A).
(12) REGISTERED PUBLIC ACCOUNTING FIRM.—The term ‘‘reg-

istered public accounting firm’’ means a public accounting firm
registered with the Board in accordance with this Act.

(13) RULES OF THE BOARD.—The term ‘‘rules of the Board’’
means the bylaws and rules of the Board (as submitted to,
and approved, modified, or amended by the Commission, in
accordance with section 107), and those stated policies, prac-
tices, and interpretations of the Board that the Commission,
by rule, may deem to be rules of the Board, as necessary
or appropriate in the public interest or for the protection of
investors.

(14) SECURITY.—The term ‘‘security’’ has the same meaning
as in section 3(a) of the Securities Exchange Act of 1934 (15
U.S.C. 78c(a)).

H. R. 3763—5

(15) SECURITIES LAWS.—The term ‘‘securities laws’’ means
the provisions of law referred to in section 3(a)(47) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(47)), as
amended by this Act, and includes the rules, regulations, and
orders issued by the Commission thereunder.

(16) STATE.—The term ‘‘State’’ means any State of the
United States, the District of Columbia, Puerto Rico, the Virgin
Islands, or any other territory or possession of the United
States.
(b) CONFORMING AMENDMENT.—Section 3(a)(47) of the Securi-

ties Exchange Act of 1934 (15 U.S.C. 78c(a)(47)) is amended by
inserting ‘‘the Sarbanes-Oxley Act of 2002,’’ before ‘‘the Public’’.

SEC. 3. COMMISSION RULES AND ENFORCEMENT.

(a) REGULATORY ACTION.—The Commission shall promulgate
such rules and regulations, as may be necessary or appropriate
in the public interest or for the protection of investors, and in
furtherance of this Act.

(b) ENFORCEMENT.—
(1) IN GENERAL.—A violation by any person of this Act,

any rule or regulation of the Commission issued under this
Act, or any rule of the Board shall be treated for all purposes
in the same manner as a violation of the Securities Exchange
Act of 1934 (15 U.S.C. 78a et seq.) or the rules and regulations
issued thereunder, consistent with the provisions of this Act,
and any such person shall be subject to the same penalties,
and to the same extent, as for a violation of that Act or
such rules or regulations.

(2) INVESTIGATIONS, INJUNCTIONS, AND PROSECUTION OF
OFFENSES.—Section 21 of the Securities Exchange Act of 1934
(15 U.S.C. 78u) is amended—

(A) in subsection (a)(1), by inserting ‘‘the rules of the
Public Company Accounting Oversight Board, of which such
person is a registered public accounting firm or a person
associated with such a firm,’’ after ‘‘is a participant,’’;

(B) in subsection (d)(1), by inserting ‘‘the rules of the
Public Company Accounting Oversight Board, of which such
person is a registered public accounting firm or a person
associated with such a firm,’’ after ‘‘is a participant,’’;

(C) in subsection (e), by inserting ‘‘the rules of the
Public Company Accounting Oversight Board, of which such
person is a registered public accounting firm or a person
associated with such a firm,’’ after ‘‘is a participant,’’; and

(D) in subsection (f), by inserting ‘‘or the Public Com-
pany Accounting Oversight Board’’ after ‘‘self-regulatory
organization’’ each place that term appears.
(3) CEASE-AND-DESIST PROCEEDINGS.—Section 21C(c)(2) of

the Securities Exchange Act of 1934 (15 U.S.C. 78u–3(c)(2))
is amended by inserting ‘‘registered public accounting firm (as
defined in section 2 of the Sarbanes-Oxley Act of 2002),’’ after
‘‘government securities dealer,’’.

(4) ENFORCEMENT BY FEDERAL BANKING AGENCIES.—Section
12(i) of the Securities Exchange Act of 1934 (15 U.S.C. 78l(i))
is amended by—

(A) striking ‘‘sections 12,’’ each place it appears and
inserting ‘‘sections 10A(m), 12,’’; and

H. R. 3763—6

(B) striking ‘‘and 16,’’ each place it appears and
inserting ‘‘and 16 of this Act, and sections 302, 303, 304,
306, 401(b), 404, 406, and 407 of the Sarbanes-Oxley Act
of 2002,’’.

(1) the authority of the Commission to regulate the
accounting profession, accounting firms, or persons associated
with such firms for purposes of enforcement of the securities
laws;

(2) the authority of the Commission to set standards for
accounting or auditing practices or auditor independence,
derived from other provisions of the securities laws or the
rules or regulations thereunder, for purposes of the preparation
and issuance of any audit report, or otherwise under applicable
law; or

(3) the ability of the Commission to take, on the initiative
of the Commission, legal, administrative, or disciplinary action
against any registered public accounting firm or any associated
person thereof.

TITLE I—PUBLIC COMPANY
ACCOUNTING OVERSIGHT BOARD

SEC. 101. ESTABLISHMENT; ADMINISTRATIVE PROVISIONS.

(a) ESTABLISHMENT OF BOARD.—There is established the Public
Company Accounting Oversight Board, to oversee the audit of public
companies that are subject to the securities laws, and related mat-
ters, in order to protect the interests of investors and further
the public interest in the preparation of informative, accurate,
and independent audit reports for companies the securities of which
are sold to, and held by and for, public investors. The Board shall
be a body corporate, operate as a nonprofit corporation, and have
succession until dissolved by an Act of Congress.

(b) STATUS.—The Board shall not be an agency or establishment
of the United States Government, and, except as otherwise provided
in this Act, shall be subject to, and have all the powers conferred
upon a nonprofit corporation by, the District of Columbia Nonprofit
Corporation Act. No member or person employed by, or agent for,
the Board shall be deemed to be an officer or employee of or
agent for the Federal Government by reason of such service.

(c) DUTIES OF THE BOARD.—The Board shall, subject to action
by the Commission under section 107, and once a determination
is made by the Commission under subsection (d) of this section—

(1) register public accounting firms that prepare audit
reports for issuers, in accordance with section 102;

(2) establish or adopt, or both, by rule, auditing, quality
control, ethics, independence, and other standards relating to
the preparation of audit reports for issuers, in accordance with
section 103;

(3) conduct inspections of registered public accounting
firms, in accordance with section 104 and the rules of the
Board;

(4) conduct investigations and disciplinary proceedings con-
cerning, and impose appropriate sanctions where justified upon,

H. R. 3763—7

registered public accounting firms and associated persons of
such firms, in accordance with section 105;

(5) perform such other duties or functions as the Board
(or the Commission, by rule or order) determines are necessary
or appropriate to promote high professional standards among,
and improve the quality of audit services offered by, registered
public accounting firms and associated persons thereof, or other-
wise to carry out this Act, in order to protect investors, or
to further the public interest;

(6) enforce compliance with this Act, the rules of the Board,
professional standards, and the securities laws relating to the
preparation and issuance of audit reports and the obligations
and liabilities of accountants with respect thereto, by registered
public accounting firms and associated persons thereof; and

(7) set the budget and manage the operations of the Board
and the staff of the Board.
(d) COMMISSION DETERMINATION.—The members of the Board

shall take such action (including hiring of staff, proposal of rules,
and adoption of initial and transitional auditing and other profes-
sional standards) as may be necessary or appropriate to enable
the Commission to determine, not later than 270 days after the
date of enactment of this Act, that the Board is so organized
and has the capacity to carry out the requirements of this title,
and to enforce compliance with this title by registered public
accounting firms and associated persons thereof. The Commission
shall be responsible, prior to the appointment of the Board, for
the planning for the establishment and administrative transition
to the Board’s operation.

(e) BOARD MEMBERSHIP.—
(1) COMPOSITION.—The Board shall have 5 members,

appointed from among prominent individuals of integrity and
reputation who have a demonstrated commitment to the
interests of investors and the public, and an understanding
of the responsibilities for and nature of the financial disclosures
required of issuers under the securities laws and the obligations
of accountants with respect to the preparation and issuance
of audit reports with respect to such disclosures.

(2) LIMITATION.—Two members, and only 2 members, of
the Board shall be or have been certified public accountants
pursuant to the laws of 1 or more States, provided that, if
1 of those 2 members is the chairperson, he or she may not
have been a practicing certified public accountant for at least
5 years prior to his or her appointment to the Board.

(3) FULL-TIME INDEPENDENT SERVICE.—Each member of the
Board shall serve on a full-time basis, and may not, concurrent
with service on the Board, be employed by any other person
or engage in any other professional or business activity. No
member of the Board may share in any of the profits of,
or receive payments from, a public accounting firm (or any
other person, as determined by rule of the Commission), other
than fixed continuing payments, subject to such conditions as
the Commission may impose, under standard arrangements
for the retirement of members of public accounting firms.

(4) APPOINTMENT OF BOARD MEMBERS.—
(A) INITIAL BOARD.—Not later than 90 days after the

date of enactment of this Act, the Commission, after con-
sultation with the Chairman of the Board of Governors

H. R. 3763—8

of the Federal Reserve System and the Secretary of the
Treasury, shall appoint the chairperson and other initial
members of the Board, and shall designate a term of service
for each.

(B) VACANCIES.—A vacancy on the Board shall not
affect the powers of the Board, but shall be filled in the
same manner as provided for appointments under this
section.
(5) TERM OF SERVICE.—

(A) IN GENERAL.—The term of service of each Board
member shall be 5 years, and until a successor is appointed,
except that—

(i) the terms of office of the initial Board members
(other than the chairperson) shall expire in annual
increments, 1 on each of the first 4 anniversaries of
the initial date of appointment; and

(ii) any Board member appointed to fill a vacancy
occurring before the expiration of the term for which
the predecessor was appointed shall be appointed only
for the remainder of that term.
(B) TERM LIMITATION.—No person may serve as a

member of the Board, or as chairperson of the Board,
for more than 2 terms, whether or not such terms of
service are consecutive.
(6) REMOVAL FROM OFFICE.—A member of the Board may

be removed by the Commission from office, in accordance with
section 107(d)(3), for good cause shown before the expiration
of the term of that member.
(f) POWERS OF THE BOARD.—In addition to any authority

granted to the Board otherwise in this Act, the Board shall have
the power, subject to section 107—

(1) to sue and be sued, complain and defend, in its corporate
name and through its own counsel, with the approval of the
Commission, in any Federal, State, or other court;

(2) to conduct its operations and maintain offices, and
to exercise all other rights and powers authorized by this Act,
in any State, without regard to any qualification, licensing,
or other provision of law in effect in such State (or a political
subdivision thereof);

(3) to lease, purchase, accept gifts or donations of or other-
wise acquire, improve, use, sell, exchange, or convey, all of
or an interest in any property, wherever situated;

(4) to appoint such employees, accountants, attorneys, and
other agents as may be necessary or appropriate, and to deter-
mine their qualifications, define their duties, and fix their
salaries or other compensation (at a level that is comparable
to private sector self-regulatory, accounting, technical, super-
visory, or other staff or management positions);

(5) to allocate, assess, and collect accounting support fees
established pursuant to section 109, for the Board, and other
fees and charges imposed under this title; and

(6) to enter into contracts, execute instruments, incur liabil-
ities, and do any and all other acts and things necessary,
appropriate, or incidental to the conduct of its operations and
the exercise of its obligations, rights, and powers imposed or
granted by this title.

H. R. 3763—9

(g) RULES OF THE BOARD.—The rules of the Board shall, subject
to the approval of the Commission—

(1) provide for the operation and administration of the
Board, the exercise of its authority, and the performance of
its responsibilities under this Act;

(2) permit, as the Board determines necessary or appro-
priate, delegation by the Board of any of its functions to an
individual member or employee of the Board, or to a division
of the Board, including functions with respect to hearing, deter-
mining, ordering, certifying, reporting, or otherwise acting as
to any matter, except that—

(A) the Board shall retain a discretionary right to
review any action pursuant to any such delegated function,
upon its own motion;

(B) a person shall be entitled to a review by the Board
with respect to any matter so delegated, and the decision
of the Board upon such review shall be deemed to be
the action of the Board for all purposes (including appeal
or review thereof); and

(C) if the right to exercise a review described in
subparagraph (A) is declined, or if no such review is sought
within the time stated in the rules of the Board, then
the action taken by the holder of such delegation shall
for all purposes, including appeal or review thereof, be
deemed to be the action of the Board;
(3) establish ethics rules and standards of conduct for Board

members and staff, including a bar on practice before the
Board (and the Commission, with respect to Board-related mat-
ters) of 1 year for former members of the Board, and appropriate
periods (not to exceed 1 year) for former staff of the Board;
and

(4) provide as otherwise required by this Act.
(h) ANNUAL REPORT TO THE COMMISSION.—The Board shall

submit an annual report (including its audited financial statements)
to the Commission, and the Commission shall transmit a copy
of that report to the Committee on Banking, Housing, and Urban
Affairs of the Senate, and the Committee on Financial Services
of the House of Representatives, not later than 30 days after the
date of receipt of that report by the Commission.

SEC. 102. REGISTRATION WITH THE BOARD.

(a) MANDATORY REGISTRATION.—Beginning 180 days after the
date of the determination of the Commission under section 101(d),
it shall be unlawful for any person that is not a registered public
accounting firm to prepare or issue, or to participate in the prepara-
tion or issuance of, any audit report with respect to any issuer.

(b) APPLICATIONS FOR REGISTRATION.—
(1) FORM OF APPLICATION.—A public accounting firm shall

use such form as the Board may prescribe, by rule, to apply
for registration under this section.

(2) CONTENTS OF APPLICATIONS.—Each public accounting
firm shall submit, as part of its application for registration,
in such detail as the Board shall specify—

(A) the names of all issuers for which the firm prepared
or issued audit reports during the immediately preceding
calendar year, and for which the firm expects to prepare
or issue audit reports during the current calendar year;

H. R. 3763—10

(B) the annual fees received by the firm from each
such issuer for audit services, other accounting services,
and non-audit services, respectively;

(C) such other current financial information for the
most recently completed fiscal year of the firm as the
Board may reasonably request;

(D) a statement of the quality control policies of the
firm for its accounting and auditing practices;

(E) a list of all accountants associated with the firm
who participate in or contribute to the preparation of audit
reports, stating the license or certification number of each
such person, as well as the State license numbers of the
firm itself;

(F) information relating to criminal, civil, or adminis-
trative actions or disciplinary proceedings pending against
the firm or any associated person of the firm in connection
with any audit report;

(G) copies of any periodic or annual disclosure filed
by an issuer with the Commission during the immediately
preceding calendar year which discloses accounting dis-
agreements between such issuer and the firm in connection
with an audit report furnished or prepared by the firm
for such issuer; and

(H) such other information as the rules of the Board
or the Commission shall specify as necessary or appropriate
in the public interest or for the protection of investors.
(3) CONSENTS.—Each application for registration under this

subsection shall include—
(A) a consent executed by the public accounting firm

to cooperation in and compliance with any request for
testimony or the production of documents made by the
Board in the furtherance of its authority and responsibil-
ities under this title (and an agreement to secure and
enforce similar consents from each of the associated persons
of the public accounting firm as a condition of their contin-
ued employment by or other association with such firm);
and

(B) a statement that such firm understands and agrees
that cooperation and compliance, as described in the con-
sent required by subparagraph (A), and the securing and
enforcement of such consents from its associated persons,
in accordance with the rules of the Board, shall be a
condition to the continuing effectiveness of the registration
of the firm with the Board.

tion for registration not later than 45 days after the date
of receipt of the application, in accordance with the rules of
the Board, unless the Board, prior to such date, issues a written
notice of disapproval to, or requests more information from,
the prospective registrant.

(2) TREATMENT.—A written notice of disapproval of a com-
pleted application under paragraph (1) for registration shall
be treated as a disciplinary sanction for purposes of sections
105(d) and 107(c).
(d) PERIODIC REPORTS.—Each registered public accounting firm

shall submit an annual report to the Board, and may be required

H. R. 3763—11

to report more frequently, as necessary to update the information
contained in its application for registration under this section, and
to provide to the Board such additional information as the Board
or the Commission may specify, in accordance with subsection (b)(2).

(e) PUBLIC AVAILABILITY.—Registration applications and annual
reports required by this subsection, or such portions of such applica-
tions or reports as may be designated under rules of the Board,
shall be made available for public inspection, subject to rules of
the Board or the Commission, and to applicable laws relating to
the confidentiality of proprietary, personal, or other information
contained in such applications or reports, provided that, in all
events, the Board shall protect from public disclosure information
reasonably identified by the subject accounting firm as proprietary
information.

(f) REGISTRATION AND ANNUAL FEES.—The Board shall assess
and collect a registration fee and an annual fee from each registered
public accounting firm, in amounts that are sufficient to recover
the costs of processing and reviewing applications and annual
reports.

SEC. 103. AUDITING, QUALITY CONTROL, AND INDEPENDENCE STAND-
ARDS AND RULES.

(a) AUDITING, QUALITY CONTROL, AND ETHICS STANDARDS.—
(1) IN GENERAL.—The Board shall, by rule, establish,

including, to the extent it determines appropriate, through
adoption of standards proposed by 1 or more professional groups
of accountants designated pursuant to paragraph (3)(A) or
advisory groups convened pursuant to paragraph (4), and
amend or otherwise modify or alter, such auditing and related
attestation standards, such quality control standards, and such
ethics standards to be used by registered public accounting
firms in the preparation and issuance of audit reports, as
required by this Act or the rules of the Commission, or as
may be necessary or appropriate in the public interest or for
the protection of investors.

(2) RULE REQUIREMENTS.—In carrying out paragraph (1),
the Board—

(A) shall include in the auditing standards that it
adopts, requirements that each registered public accounting
firm shall—

(i) prepare, and maintain for a period of not less
than 7 years, audit work papers, and other information
related to any audit report, in sufficient detail to sup-
port the conclusions reached in such report;

(ii) provide a concurring or second partner review
and approval of such audit report (and other related
information), and concurring approval in its issuance,
by a qualified person (as prescribed by the Board)
associated with the public accounting firm, other than
the person in charge of the audit, or by an independent
reviewer (as prescribed by the Board); and

(iii) describe in each audit report the scope of
the auditor’s testing of the internal control structure
and procedures of the issuer, required by section
404(b), and present (in such report or in a separate
report)—

H. R. 3763—12

(I) the findings of the auditor from such
testing;

(II) an evaluation of whether such internal
control structure and procedures—

(aa) include maintenance of records that
in reasonable detail accurately and fairly
reflect the transactions and dispositions of the
assets of the issuer;

(bb) provide reasonable assurance that
transactions are recorded as necessary to
permit preparation of financial statements in
accordance with generally accepted accounting
principles, and that receipts and expenditures
of the issuer are being made only in accord-
ance with authorizations of management and
directors of the issuer; and
(III) a description, at a minimum, of material

weaknesses in such internal controls, and of any
material noncompliance found on the basis of such
testing.

(B) shall include, in the quality control standards that
it adopts with respect to the issuance of audit reports,
requirements for every registered public accounting firm
relating to—

(i) monitoring of professional ethics and independ-
ence from issuers on behalf of which the firm issues
audit reports;

(ii) consultation within such firm on accounting
and auditing questions;

(iii) supervision of audit work;
(iv) hiring, professional development, and advance-

ment of personnel;
(v) the acceptance and continuation of engage-

ments;
(vi) internal inspection; and
(vii) such other requirements as the Board may

prescribe, subject to subsection (a)(1).
(3) AUTHORITY TO ADOPT OTHER STANDARDS.—

(A) IN GENERAL.—In carrying out this subsection, the
Board—

(i) may adopt as its rules, subject to the terms
of section 107, any portion of any statement of auditing
standards or other professional standards that the
Board determines satisfy the requirements of para-
graph (1), and that were proposed by 1 or more profes-
sional groups of accountants that shall be designated
or recognized by the Board, by rule, for such purpose,
pursuant to this paragraph or 1 or more advisory
groups convened pursuant to paragraph (4); and

(ii) notwithstanding clause (i), shall retain full
authority to modify, supplement, revise, or subse-
quently amend, modify, or repeal, in whole or in part,
any portion of any statement described in clause (i).
(B) INITIAL AND TRANSITIONAL STANDARDS.—The Board

shall adopt standards described in subparagraph (A)(i) as
initial or transitional standards, to the extent the Board
determines necessary, prior to a determination of the

H. R. 3763—13

Commission under section 101(d), and such standards shall
be separately approved by the Commission at the time
of that determination, without regard to the procedures
required by section 107 that otherwise would apply to
the approval of

rules of the Board.

(4) ADVISORY GROUPS.—The Board shall convene, or

authorize its staff to convene, such expert advisory groups
as may be appropriate, which may include practicing account-
ants and other experts, as well as representatives of other
interested groups, subject to such rules as the Board may
prescribe to prevent conflicts of interest, to make recommenda-
tions concerning the content (including proposed drafts) of
auditing, quality control, ethics, independence, or other stand-
ards required to be established under this section.
(b) INDEPENDENCE STANDARDS AND RULES.—The Board shall

establish such rules as may be necessary or appropriate in the
public interest or for the protection of investors, to implement,
or as authorized under, title II of this Act.

(1) IN GENERAL.—The Board shall cooperate on an ongoing
basis with professional groups of accountants designated under
subsection (a)(3)(A) and advisory groups convened under sub-
section (a)(4) in the examination of the need for changes in
any standards subject to its authority under subsection (a),
recommend issues for inclusion on the agendas of such des-
ignated professional groups of accountants or advisory groups,
and take such other steps as it deems appropriate to increase
the effectiveness of the standard setting process.

(2) BOARD RESPONSES.—The Board shall respond in a timely
fashion to requests from designated professional groups of
accountants and advisory groups referred to in paragraph (1)
for any changes in standards over which the Board has
authority.
(d) EVALUATION OF STANDARD SETTING PROCESS.—The Board

shall include in the annual report required by section 101(h) the
results of its standard setting responsibilities during the period
to which the report relates, including a discussion of the work
of the Board with any designated professional groups of accountants
and advisory groups described in paragraphs (3)(A) and (4) of sub-
section (a), and its pending issues agenda for future standard setting
projects.

SEC. 104. INSPECTIONS OF REGISTERED PUBLIC ACCOUNTING FIRMS.

(a) IN GENERAL.—The Board shall conduct a continuing pro-
gram of inspections to assess the degree of compliance of each
registered public accounting firm and associated persons of that
firm with this Act, the rules of the Board, the rules of the Commis-
sion, or professional standards, in connection with its performance
of audits, issuance of audit reports, and related matters involving
issuers.

(b) INSPECTION FREQUENCY.—
(1) IN GENERAL.—Subject to paragraph (2), inspections

required by this section shall be conducted—
(A) annually with respect to each registered public

accounting firm that regularly provides audit reports for
more than 100 issuers; and

H. R. 3763—14

(B) not less frequently than once every 3 years with
respect to each registered public accounting firm that regu-
larly provides audit reports for 100 or fewer issuers.
(2) ADJUSTMENTS TO SCHEDULES.—The Board may, by rule,

adjust the inspection schedules set under paragraph (1) if the
Board finds that different inspection schedules are consistent
with the purposes of this Act, the public interest, and the
protection of investors. The Board may conduct special inspec-
tions at the request of the Commission or upon its own motion.
(c) PROCEDURES.—The Board shall, in each inspection under

this section, and in accordance with its rules for such inspections—
(1) identify any act or practice or omission to act by the

registered public accounting firm, or by any associated person
thereof, revealed by such inspection that may be in violation
of this Act, the rules of the Board, the rules of the Commission,
the firm’s own quality control policies, or professional stand-
ards;

(2) report any such act, practice, or omission, if appropriate,
to the Commission and each appropriate State regulatory
authority; and

(3) begin a formal investigation or take disciplinary action,
if appropriate, with respect to any such violation, in accordance
with this Act and the rules of the Board.
(d) CONDUCT OF INSPECTIONS.—In conducting an inspection

of a registered public accounting firm under this section, the Board
shall—

(1) inspect and review selected audit and review engage-
ments of the firm (which may include audit engagements that
are the subject of ongoing litigation or other controversy
between the firm and 1 or more third parties), performed at
various offices and by various associated persons of the firm,
as selected by the Board;

(2) evaluate the sufficiency of the quality control system
of the firm, and the manner of the documentation and commu-
nication of that system by the firm; and

(3) perform such other testing of the audit, supervisory,
and quality control procedures of the firm as are necessary
or appropriate in light of the purpose of the inspection and
the responsibilities of the Board.
(e) RECORD RETENTION.—The rules of the Board may require

the retention by registered public accounting firms for inspection
purposes of records whose retention is not otherwise required by
section 103 or the rules issued thereunder.

(f) PROCEDURES FOR REVIEW.—The rules of the Board shall
provide a procedure for the review of and response to a draft
inspection report by the registered public accounting firm under
inspection. The Board shall take such action with respect to such
response as it considers appropriate (including revising the draft
report or continuing or supplementing its inspection activities before
issuing a final report), but the text of any such response, appro-
priately redacted to protect information reasonably identified by
the accounting firm as confidential, shall be attached to and made
part of the inspection report.

(g) REPORT.—A written report of the findings of the Board
for each inspection under this section, subject to subsection (h),
shall be—

H. R. 3763—15

(1) transmitted, in appropriate detail, to the Commission
and each appropriate State regulatory authority, accompanied
by any letter or comments by the Board or the inspector,
and any letter of response from the registered public accounting
firm; and

(2) made available in appropriate detail to the public (sub-
ject to section 105(b)(5)(A), and to the protection of such con-
fidential and proprietary information as the Board may deter-
mine to be appropriate, or as may be required by law), except
that no portions of the inspection report that deal with criti-
cisms of or potential defects in the quality control systems
of the firm under inspection shall be made public if those
criticisms or defects are addressed by the firm, to the satisfac-
tion of the Board, not later than 12 months after the date
of the inspection report.
(h) INTERIM COMMISSION REVIEW.—

(1) REVIEWABLE MATTERS.—A registered public accounting
firm may seek review by the Commission, pursuant to such
rules as the Commission shall promulgate, if the firm—

(A) has provided the Board with a response, pursuant
to rules issued by the Board under subsection (f), to the
substance of particular items in a draft inspection report,
and disagrees with the assessments contained in any final
report prepared by the Board following such response; or

(B) disagrees with the determination of the Board that
criticisms or defects identified in an inspection report have
not been addressed to the satisfaction of the Board within
12 months of the date of the inspection report, for purposes
of subsection (g)(2).
(2) TREATMENT OF REVIEW.—Any decision of the Commis-

sion with respect to a review under paragraph (1) shall not
be reviewable under section 25 of the Securities Exchange
Act of 1934 (15 U.S.C. 78y), or deemed to be ‘‘final agency
action’’ for purposes of section 704 of title 5, United States
Code.

(3) TIMING.—Review under paragraph (1) may be sought
during the 30-day period following the date of the event giving
rise to the review under subparagraph (A) or (B) of paragraph
(1).

SEC. 105. INVESTIGATIONS AND DISCIPLINARY PROCEEDINGS.

(a) IN GENERAL.—The Board shall establish, by rule, subject
to the requirements of this section, fair procedures for the investiga-
tion and disciplining of registered public accounting firms and asso-
ciated persons of such firms.

(b) INVESTIGATIONS.—
(1) AUTHORITY.—In accordance with the rules of the Board,

the Board may conduct an investigation of any act or practice,
or omission to act, by a registered public accounting firm,
any associated person of such firm, or both, that may violate
any provision of this Act, the rules of the Board, the provisions
of the securities laws relating to the preparation and issuance
of audit reports and the obligations and liabilities of account-
ants with respect thereto, including the rules of the Commission
issued under this Act, or professional standards, regardless
of how the act, practice, or omission is brought to the attention
of the Board.

H. R. 3763—16

(2) TESTIMONY AND DOCUMENT PRODUCTION.—In addition
to such other actions as the Board determines to be necessary
or appropriate, the rules of the Board may—

(A) require the testimony of the firm or of any person
associated with a registered public accounting firm, with
respect to any matter that the Board considers relevant
or material to an investigation;

(B) require the production of audit work papers and
any other document or information in the possession of
a registered public accounting firm or any associated person
thereof, wherever domiciled, that the Board considers rel-
evant or material to the investigation, and may inspect
the books and records of such firm or associated person
to verify the accuracy of any documents or information
supplied;

(C) request the testimony of, and production of any
document in the possession of, any other person, including
any client of a registered public accounting firm that the
Board considers relevant or material to an investigation
under this section, with appropriate notice, subject to the
needs of the investigation, as permitted under the rules
of the Board; and

(D) provide for procedures to seek issuance by the
Commission, in a manner established by the Commission,
of a subpoena to require the testimony of, and production
of any document in the possession of, any person, including
any client of a registered public accounting firm, that the
Board considers relevant or material to an investigation
under this section.
(3) NONCOOPERATION WITH INVESTIGATIONS.—

(A) IN GENERAL.—If a registered public accounting firm
or any associated person thereof refuses to testify, produce
documents, or otherwise cooperate with the Board in
connection with an investigation under this section, the
Board may—

(i) suspend or bar such person from being associ-
ated with a registered public accounting firm, or
require the registered public accounting firm to end
such association;

(ii) suspend or revoke the registration of the public
accounting firm; and

(iii) invoke such other lesser sanctions as the Board
considers appropriate, and as specified by rule of the
Board.
(B) PROCEDURE.—Any action taken by the Board under

this paragraph shall be subject to the terms of section
107(c).
(4) COORDINATION AND REFERRAL OF INVESTIGATIONS.—

(A) COORDINATION.—The Board shall notify the
Commission of any pending Board investigation involving
a potential violation of the securities laws, and thereafter
coordinate its work with the work of the Commission’s
Division of Enforcement, as necessary to protect an ongoing
Commission investigation.

(B) REFERRAL.—The Board may refer an investigation
under this section—

(i) to the Commission;

H. R. 3763—17

(ii) to any other Federal functional regulator (as
defined in section 509 of the Gramm-Leach-Bliley Act
(15 U.S.C. 6809)), in the case of an investigation that
concerns an audit report for an institution that is
subject to the jurisdiction of such regulator; and

(iii) at the direction of the Commission, to—
(I) the Attorney General of the United States;
(II) the attorney general of 1 or more States;

and
(III) the appropriate State regulatory

authority.
(5) USE OF DOCUMENTS.—

(A) CONFIDENTIALITY.—Except as provided in subpara-
graph (B), all documents and information prepared or
received by or specifically for the Board, and deliberations
of the Board and its employees and agents, in connection
with an inspection under section 104 or with an investiga-
tion under this section, shall be confidential and privileged
as an evidentiary matter (and shall not be subject to civil
discovery or other legal process) in any proceeding in any
Federal or State court or administrative agency, and shall
be exempt from disclosure, in the hands of an agency
or establishment of the Federal Government, under the
Freedom of Information Act (5 U.S.C. 552a), or otherwise,
unless and until presented in connection with a public
proceeding or released in accordance with subsection (c).

(B) AVAILABILITY TO GOVERNMENT AGENCIES.—Without
the loss of its status as confidential and privileged in
the hands of the Board, all information referred to in
subparagraph (A) may—

(i) be made available to the Commission; and
(ii) in the discretion of the Board, when determined

by the Board to be necessary to accomplish the pur-
poses of this Act or to protect investors, be made avail-
able to—

(I) the Attorney General of the United States;
(II) the appropriate Federal functional regu-

lator (as defined in section 509 of the Gramm-
Leach-Bliley Act (15 U.S.C. 6809)), other than the
Commission, with respect to an audit report for
an institution subject to the jurisdiction of such
regulator;

(III) State attorneys general in connection with
any criminal investigation; and

(IV) any appropriate State regulatory
authority,

each of which shall maintain such information as confiden-
tial and privileged.
(6) IMMUNITY.—Any employee of the Board engaged in

carrying out an investigation under this Act shall be immune
from any civil liability arising out of such investigation in
the same manner and to the same extent as an employee
of the Federal Government in similar circumstances.
(c) DISCIPLINARY PROCEDURES.—

(1) NOTIFICATION; RECORDKEEPING.—The rules of the Board
shall provide that in any proceeding by the Board to determine

H. R. 3763—18

whether a registered public accounting firm, or an associated
person thereof, should be disciplined, the Board shall—

(A) bring specific charges with respect to the firm
or associated person;

(B) notify such firm or associated person of, and provide
to the firm or associated person an opportunity to defend
against, such charges; and

not be public, unless otherwise ordered by the Board for good
cause shown, with the consent of the parties to such hearing.

(3) SUPPORTING STATEMENT.—A determination by the Board
to impose a sanction under this subsection shall be supported
by a statement setting forth—

(A) each act or practice in which the registered public
accounting firm, or associated person, has engaged (or
omitted to engage), or that forms a basis for all or a
part of such sanction;

(B) the specific provision of this Act, the securities
laws, the rules of the Board, or professional standards
which the Board determines has been violated; and

(C) the sanction imposed, including a justification for
that sanction.
(4) SANCTIONS.—If the Board finds, based on all of the

facts and circumstances, that a registered public accounting
firm or associated person thereof has engaged in any act or
practice, or omitted to act, in violation of this Act, the rules
of the Board, the provisions of the securities laws relating
to the preparation and issuance of audit reports and the obliga-
tions and liabilities of accountants with respect thereto,
including the rules of the Commission issued under this Act,
or professional standards, the Board may impose such discipli-
nary or remedial sanctions as it determines appropriate, subject
to applicable limitations under paragraph (5), including—

(A) temporary suspension or permanent revocation of
registration under this title;

(B) temporary or permanent suspension or bar of a
person from further association with any registered public
accounting firm;

(C) temporary or permanent limitation on the activi-
ties, functions, or operations of such firm or person (other
than in connection with required additional professional
education or training);

(D) a civil money penalty for each such violation, in
an amount equal to—

(i) not more than $100,000 for a natural person
or $2,000,000 for any other person; and

(ii) in any case to which paragraph (5) applies,
not more than $750,000 for a natural person or
$15,000,000 for any other person;
(E) censure;
(F) required additional professional education or

training; or
(G) any other appropriate sanction provided for in the

rules of the Board.

H. R. 3763—19

(5) INTENTIONAL OR OTHER KNOWING CONDUCT.—The sanc-
tions and penalties described in subparagraphs (A) through
(C) and (D)(ii) of paragraph (4) shall only apply to—

(A) intentional or knowing conduct, including reckless
conduct, that results in violation of the applicable statutory,
regulatory, or professional standard; or

(B) repeated instances of negligent conduct, each
resulting in a violation of the applicable statutory, regu-
latory, or professional standard.
(6) FAILURE TO SUPERVISE.—

(A) IN GENERAL.—The Board may impose sanctions
under this section on a registered accounting firm or upon
the supervisory personnel of such firm, if the Board finds
that—

(i) the firm has failed reasonably to supervise an
associated person, either as required by the rules of
the Board relating to auditing or quality control stand-
ards, or otherwise, with a view to preventing violations
of this Act, the rules of the Board, the provisions
of the securities laws relating to the preparation and
issuance of audit reports and the obligations and liabil-
ities of accountants with respect thereto, including the
rules of the Commission under this Act, or professional
standards; and

(ii) such associated person commits a violation of
this Act, or any of such rules, laws, or standards.
(B) RULE OF CONSTRUCTION.—No associated person of

a registered public accounting firm shall be deemed to
have failed reasonably to supervise any other person for
purposes of subparagraph (A), if—

(i) there have been established in and for that
firm procedures, and a system for applying such proce-
dures, that comply with applicable rules of the Board
and that would reasonably be expected to prevent and
detect any such violation by such associated person;
and

(ii) such person has reasonably discharged the
duties and obligations incumbent upon that person
by reason of such procedures and system, and had
no reasonable cause to believe that such procedures
and system were not being complied with.

(7) EFFECT OF SUSPENSION.—
(A) ASSOCIATION WITH A PUBLIC ACCOUNTING FIRM.—

It shall be unlawful for any person that is suspended
or barred from being associated with a registered public
accounting firm under this subsection willfully to become
or remain associated with any registered public accounting
firm, or for any registered public accounting firm that
knew, or, in the exercise of reasonable care should have
known, of the suspension or bar, to permit such an associa-
tion, without the consent of the Board or the Commission.

(B) ASSOCIATION WITH AN ISSUER.—It shall be unlawful
for any person that is suspended or barred from being
associated with an issuer under this subsection willfully
to become or remain associated with any issuer in an
accountancy or a financial management capacity, and for
any issuer that knew, or in the exercise of reasonable

H. R. 3763—20

care should have known, of such suspension or bar, to
permit such an association, without the consent of the
Board or the Commission.

(d) REPORTING OF SANCTIONS.—
(1) RECIPIENTS.—If the Board imposes a disciplinary sanc-

tion, in accordance with this section, the Board shall report
the sanction to—

(A) the Commission;
(B) any appropriate State regulatory authority or any

foreign accountancy licensing board with which such firm
or person is licensed or certified; and

(C) the public (once any stay on the imposition of
such sanction has been lifted).
(2) CONTENTS.—The information reported under paragraph

(1) shall include—
(A) the name of the sanctioned person;
(B) a description of the sanction and the basis for

its imposition; and
(C) such other information as the Board deems appro-

priate.
(e) STAY OF SANCTIONS.—

(1) IN GENERAL.—Application to the Commission for review,
or the institution by the Commission of review, of any discipli-
nary action of the Board shall operate as a stay of any such
disciplinary action, unless and until the Commission orders
(summarily or after notice and opportunity for hearing on the
question of a stay, which hearing may consist solely of the
submission of affidavits or presentation of oral arguments) that
no such stay shall continue to operate.

(2) EXPEDITED PROCEDURES.—The Commission shall estab-
lish for appropriate cases an expedited procedure for consider-
ation and determination of the question of the duration of
a stay pending review of any disciplinary action of the Board
under this subsection.

SEC. 106. FOREIGN PUBLIC ACCOUNTING FIRMS.

(a) APPLICABILITY TO CERTAIN FOREIGN FIRMS.—
(1) IN GENERAL.—Any foreign public accounting firm that

prepares or furnishes an audit report with respect to any issuer,
shall be subject to this Act and the rules of the Board and
the Commission issued under this Act, in the same manner
and to the same extent as a public accounting firm that is
organized and operates under the laws of the United States
or any State, except that registration pursuant to section 102
shall not by itself provide a basis for subjecting such a foreign
public accounting firm to the jurisdiction of the Federal or
State courts, other than with respect to controversies between
such firms and the Board.

(2) BOARD AUTHORITY.—The Board may, by rule, determine
that a foreign public accounting firm (or a class of such firms)
that does not issue audit reports nonetheless plays such a
substantial role in the preparation and furnishing of such
reports for particular issuers, that it is necessary or appro-
priate, in light of the purposes of this Act and in the public
interest or for the protection of investors, that such firm (or
class of firms) should be treated as a public accounting firm

H. R. 3763—21

(or firms) for purposes of registration under, and oversight
by the Board in accordance with, this title.
(b) PRODUCTION OF AUDIT WORKPAPERS.—

(1) CONSENT BY FOREIGN FIRMS.—If a foreign public
accounting firm issues an opinion or otherwise performs mate-
rial services upon which a registered public accounting firm
relies in issuing all or part of any audit report or any opinion
contained in an audit report, that foreign public accounting
firm shall be deemed to have consented—

(A) to produce its audit workpapers for the Board
or the Commission in connection with any investigation
by either body with respect to that audit report; and

(B) to be subject to the jurisdiction of the courts of
the United States for purposes of enforcement of any
request for production of such workpapers.
(2) CONSENT BY DOMESTIC FIRMS.—A registered public

accounting firm that relies upon the opinion of a foreign public
accounting firm, as described in paragraph (1), shall be
deemed—

(A) to have consented to supplying the audit
workpapers of that foreign public accounting firm in
response to a request for production by the Board or the
Commission; and

(B) to have secured the agreement of that foreign public
accounting firm to such production, as a condition of its
reliance on the opinion of that foreign public accounting
firm.

(c) EXEMPTION AUTHORITY.—The Commission, and the Board,
subject to the approval of the Commission, may, by rule, regulation,
or order, and as the Commission (or Board) determines necessary
or appropriate in the public interest or for the protection of inves-
tors, either unconditionally or upon specified terms and conditions
exempt any foreign public accounting firm, or any class of such
firms, from any provision of this Act or the rules of the Board
or the Commission issued under this Act.

(d) DEFINITION.—In this section, the term ‘‘foreign public
accounting firm’’ means a public accounting firm that is organized
and operates under the laws of a foreign government or political
subdivision thereof.

SEC. 107. COMMISSION OVERSIGHT OF THE BOARD.

(a) GENERAL OVERSIGHT RESPONSIBILITY.—The Commission
shall have oversight and enforcement authority over the Board,
as provided in this Act. The provisions of section 17(a)(1) of the
Securities Exchange Act of 1934 (15 U.S.C. 78q(a)(1)), and of section
17(b)(1) of the Securities Exchange Act of 1934 (15 U.S.C. 78q(b)(1))
shall apply to the Board as fully as if the Board were a ‘‘registered
securities association’’ for purposes of those sections 17(a)(1) and
17(b)(1).

(b) RULES OF THE BOARD.—
(1) DEFINITION.—In this section, the term ‘‘proposed rule’’

means any proposed rule of the Board, and any modification
of any such rule.

(2) PRIOR APPROVAL REQUIRED.—No rule of the Board shall
become effective without prior approval of the Commission in
accordance with this section, other than as provided in section
103(a)(3)(B) with respect to initial or transitional standards.

H. R. 3763—22

(3) APPROVAL CRITERIA.—The Commission shall approve
a proposed rule, if it finds that the rule is consistent with
the requirements of this Act and the securities laws, or is
necessary or appropriate in the public interest or for the protec-
tion of investors.

(4) PROPOSED RULE PROCEDURES.—The provisions of para-
graphs (1) through (3) of section 19(b) of the Securities
Exchange Act of 1934 (15 U.S.C. 78s(b)) shall govern the pro-
posed rules of the Board, as fully as if the Board were a
‘‘registered securities association’’ for purposes of that section
19(b), except that, for purposes of this paragraph—

(A) the phrase ‘‘consistent with the requirements of
this title and the rules and regulations thereunder
applicable to such organization’’ in section 19(b)(2) of that
Act shall be deemed to read ‘‘consistent with the require-
ments of title I of the Sarbanes-Oxley Act of 2002, and
the rules and regulations issued thereunder applicable to
such organization, or as necessary or appropriate in the
public interest or for the protection of investors’’; and

(B) the phrase ‘‘otherwise in furtherance of the pur-
poses of this title’’ in section 19(b)(3)(C) of that Act shall
be deemed to read ‘‘otherwise in furtherance of the purposes
of title I of the Sarbanes-Oxley Act of 2002’’.
(5) COMMISSION AUTHORITY TO AMEND RULES OF THE

BOARD.—The provisions of section 19(c) of the Securities
Exchange Act of 1934 (15 U.S.C. 78s(c)) shall govern the abroga-
tion, deletion, or addition to portions of the rules of the Board
by the Commission as fully as if the Board were a ‘‘registered
securities association’’ for purposes of that section 19(c), except
that the phrase ‘‘to conform its rules to the requirements of
this title and the rules and regulations thereunder applicable
to such organization, or otherwise in furtherance of the pur-
poses of this title’’ in section 19(c) of that Act shall, for purposes
of this paragraph, be deemed to read ‘‘to assure the fair
administration of the Public Company Accounting Oversight
Board, conform the rules promulgated by that Board to the
requirements of title I of the Sarbanes-Oxley Act of 2002,
or otherwise further the purposes of that Act, the securities
laws, and the rules and regulations thereunder applicable to
that Board’’.
(c) COMMISSION REVIEW OF DISCIPLINARY ACTION TAKEN BY

THE BOARD.—
(1) NOTICE OF SANCTION.—The Board shall promptly file

notice with the Commission of any final sanction on any reg-
istered public accounting firm or on any associated person
thereof, in such form and containing such information as the
Commission, by rule, may prescribe.

(2) REVIEW OF SANCTIONS.—The provisions of sections
19(d)(2) and 19(e)(1) of the Securities Exchange Act of 1934
(15 U.S.C. 78s (d)(2) and (e)(1)) shall govern the review by
the Commission of final disciplinary sanctions imposed by the
Board (including sanctions imposed under section 105(b)(3) of
this Act for noncooperation in an investigation of the Board),
as fully as if the Board were a self-regulatory organization
and the Commission were the appropriate regulatory agency
for such organization for purposes of those sections 19(d)(2)
and 19(e)(1), except that, for purposes of this paragraph—

H. R. 3763—23

(A) section 105(e) of this Act (rather than that section
19(d)(2)) shall govern the extent to which application for,
or institution by the Commission on its own motion of,
review of any disciplinary action of the Board operates
as a stay of such action;

(B) references in that section 19(e)(1) to ‘‘members’’
of such an organization shall be deemed to be references
to registered public accounting firms;

(C) the phrase ‘‘consistent with the purposes of this
title’’ in that section 19(e)(1) shall be deemed to read ‘‘con-
sistent with the purposes of this title and title I of the
Sarbanes-Oxley Act of 2002’’;

(D) references to rules of the Municipal Securities Rule-
making Board in that section 19(e)(1) shall not apply; and

(E) the reference to section 19(e)(2) of the Securities
Exchange Act of 1934 shall refer instead to section 107(c)(3)
of this Act.
(3) COMMISSION MODIFICATION AUTHORITY.—The Commis-

sion may enhance, modify, cancel, reduce, or require the remis-
sion of a sanction imposed by the Board upon a registered
public accounting firm or associated person thereof, if the
Commission, having due regard for the public interest and
the protection of investors, finds, after a proceeding in accord-
ance with this subsection, that the sanction—

(A) is not necessary or appropriate in furtherance of
this Act or the securities laws; or

(B) is excessive, oppressive, inadequate, or otherwise
not appropriate to the finding or the basis on which the
sanction was imposed.

(d) CENSURE OF THE BOARD; OTHER SANCTIONS.—
(1) RESCISSION OF BOARD AUTHORITY.—The Commission,

by rule, consistent with the public interest, the protection of
investors, and the other purposes of this Act and the securities
laws, may relieve the Board of any responsibility to enforce
compliance with any provision of this Act, the securities laws,
the rules of the Board, or professional standards.

(2) CENSURE OF THE BOARD; LIMITATIONS.—The Commission
may, by order, as it determines necessary or appropriate in
the public interest, for the protection of investors, or otherwise
in furtherance of the purposes of this Act or the securities
laws, censure or impose limitations upon the activities, func-
tions, and operations of the Board, if the Commission finds,
on the record, after notice and opportunity for a hearing, that
the Board—

(A) has violated or is unable to comply with any provi-
sion of this Act, the rules of the Board, or the securities
laws; or

(B) without reasonable justification or excuse, has
failed to enforce compliance with any such provision or
rule, or any professional standard by a registered public
accounting firm or an associated person thereof.
(3) CENSURE OF BOARD MEMBERS; REMOVAL FROM OFFICE.—

The Commission may, as necessary or appropriate in the public
interest, for the protection of investors, or otherwise in further-
ance of the purposes of this Act or the securities laws, remove

H. R. 3763—24

from office or censure any member of the Board, if the Commis-
sion finds, on the record, after notice and opportunity for a
hearing, that such member—

(A) has willfully violated any provision of this Act,
the rules of the Board, or the securities laws;

(B) has willfully abused the authority of that member;
or

(C) without reasonable justification or excuse, has
failed to enforce compliance with any such provision or
rule, or any professional standard by any registered public
accounting firm or any associated person thereof.

SEC. 108. ACCOUNTING STANDARDS.

(a) AMENDMENT TO SECURITIES ACT OF 1933.—Section 19 of
the Securities Act of 1933 (15 U.S.C. 77s) is amended—

(1) by redesignating subsections (b) and (c) as subsections
(c) and (d), respectively; and

(2) by inserting after subsection (a) the following:
‘‘(b) RECOGNITION OF ACCOUNTING STANDARDS.—

‘‘(1) IN GENERAL.—In carrying out its authority under sub-
section (a) and under section 13(b) of the Securities Exchange
Act of 1934, the Commission may recognize, as ‘generally
accepted’ for purposes of the securities laws, any accounting
principles established by a standard setting body—

‘‘(A) that—
‘‘(i) is organized as a private entity;
‘‘(ii) has, for administrative and operational pur-

poses, a board of trustees (or equivalent body) serving
in the public interest, the majority of whom are not,
concurrent with their service on such board, and have
not been during the 2-year period preceding such
service, associated persons of any registered public
accounting firm;

‘‘(iii) is funded as provided in section 109 of the
Sarbanes-Oxley Act of 2002;

‘‘(iv) has adopted procedures to ensure prompt
consideration, by majority vote of its members, of
changes to accounting principles necessary to reflect
emerging accounting issues and changing business
practices; and

‘‘(v) considers, in adopting accounting principles,
the need to keep standards current in order to reflect
changes in the business environment, the extent to
which international convergence on high quality
accounting standards is necessary or appropriate in
the public interest and for the protection of investors;
and
‘‘(B) that the Commission determines has the capacity

to assist the Commission in fulfilling the requirements
of subsection (a) and section 13(b) of the Securities
Exchange Act of 1934, because, at a minimum, the standard
setting body is capable of improving the accuracy and
effectiveness of financial reporting and the protection of
investors under the securities laws.

H. R. 3763—25

‘‘(2) ANNUAL REPORT.—A standard setting body described
in paragraph (1) shall submit an annual report to the Commis-
sion and the public, containing audited financial statements
of that standard setting body.’’.
(b) COMMISSION AUTHORITY.—The Commission shall promul-

gate such rules and regulations to carry out section 19(b) of the
Securities Act of 1933, as added by this section, as it deems nec-
essary or appropriate in the public interest or for the protection
of investors.

(c) NO EFFECT ON COMMISSION POWERS.—Nothing in this Act,
including this section and the amendment made by this section,
shall be construed to impair or limit the authority of the Commis-
sion to establish accounting principles or standards for purposes
of enforcement of the securities laws.

(d) STUDY AND REPORT ON ADOPTING PRINCIPLES-BASED
ACCOUNTING.—

(1) STUDY.—
(A) IN GENERAL.—The Commission shall conduct a

study on the adoption by the United States financial
reporting system of a principles-based accounting system.

(B) STUDY TOPICS.—The study required by subpara-
graph (A) shall include an examination of—

(i) the extent to which principles-based accounting
and financial reporting exists in the United States;

(ii) the length of time required for change from
a rules-based to a principles-based financial reporting
system;

(iii) the feasibility of and proposed methods by
which a principles-based system may be implemented;
and

(iv) a thorough economic analysis of the
implementation of a principles-based system.

(2) REPORT.—Not later than 1 year after the date of enact-
ment of this Act, the Commission shall submit a report on
the results of the study required by paragraph (1) to the Com-
mittee on Banking, Housing, and Urban Affairs of the Senate
and the Committee on Financial Services of the House of Rep-
resentatives.

SEC. 109. FUNDING.

(a) IN GENERAL.—The Board, and the standard setting body
designated pursuant to section 19(b) of the Securities Act of 1933,
as amended by section 108, shall be funded as provided in this
section.

(b) ANNUAL BUDGETS.—The Board and the standard setting
body referred to in subsection (a) shall each establish a budget
for each fiscal year, which shall be reviewed and approved according
to their respective internal procedures not less than 1 month prior
to the commencement of the fiscal year to which the budget pertains
(or at the beginning of the Board’s first fiscal year, which may
be a short fiscal year). The budget of the Board shall be subject
to approval by the Commission. The budget for the first fiscal
year of the Board shall be prepared and approved promptly fol-
lowing the appointment of the initial five Board members, to permit
action by the Board of the organizational tasks contemplated by
section 101(d).

H. R. 3763—26

(1) RECOVERABLE BUDGET EXPENSES.—The budget of the
Board (reduced by any registration or annual fees received
under section 102(e) for the year preceding the year for which
the budget is being computed), and all of the budget of the
standard setting body referred to in subsection (a), for each
fiscal year of each of those 2 entities, shall be payable from
annual accounting support fees, in accordance with subsections
(d) and (e). Accounting support fees and other receipts of the
Board and of such standard-setting body shall not be considered
public monies of the United States.

(2) FUNDS GENERATED FROM THE COLLECTION OF MONETARY
PENALTIES.—Subject to the availability in advance in an appro-
priations Act, and notwithstanding subsection (i), all funds
collected by the Board as a result of the assessment of monetary
penalties shall be used to fund a merit scholarship program
for undergraduate and graduate students enrolled in accredited
accounting degree programs, which program is to be adminis-
tered by the Board or by an entity or agent identified by
the Board.
(d) ANNUAL ACCOUNTING SUPPORT FEE FOR THE BOARD.—

(1) ESTABLISHMENT OF FEE.—The Board shall establish,
with the approval of the Commission, a reasonable annual
accounting support fee (or a formula for the computation
thereof), as may be necessary or appropriate to establish and
maintain the Board. Such fee may also cover costs incurred
in the Board’s first fiscal year (which may be a short fiscal
year), or may be levied separately with respect to such short
fiscal year.

(2) ASSESSMENTS.—The rules of the Board under paragraph
(1) shall provide for the equitable allocation, assessment, and
collection by the Board (or an agent appointed by the Board)
of the fee established under paragraph (1), among issuers,
in accordance with subsection (g), allowing for differentiation
among classes of issuers, as appropriate.
(e) ANNUAL ACCOUNTING SUPPORT FEE FOR STANDARD SETTING

BODY.—The annual accounting support fee for the standard setting
body referred to in subsection (a)—

(1) shall be allocated in accordance with subsection (g),
and assessed and collected against each issuer, on behalf of
the standard setting body, by 1 or more appropriate designated
collection agents, as may be necessary or appropriate to pay
for the budget and provide for the expenses of that standard
setting body, and to provide for an independent, stable source
of funding for such body, subject to review by the Commission;
and

(2) may differentiate among different classes of issuers.
(f) LIMITATION ON FEE.—The amount of fees collected under

this section for a fiscal year on behalf of the Board or the standards
setting body, as the case may be, shall not exceed the recoverable
budget expenses of the Board or body, respectively (which may
include operating, capital, and accrued items), referred to in sub-
section (c)(1).

(g) ALLOCATION OF ACCOUNTING SUPPORT FEES AMONG
ISSUERS.—Any amount due from issuers (or a particular class of
issuers) under this section to fund the budget of the Board or
the standard setting body referred to in subsection (a) shall be
allocated among and payable by each issuer (or each issuer in

H. R. 3763—27

a particular class, as applicable) in an amount equal to the total
of such amount, multiplied by a fraction—

(1) the numerator of which is the average monthly equity
market capitalization of the issuer for the 12-month period
immediately preceding the beginning of the fiscal year to which
such budget relates; and

(2) the denominator of which is the average monthly equity
market capitalization of all such issuers for such 12-month
period.
(h) CONFORMING AMENDMENTS.—Section 13(b)(2) of the Securi-

ties Exchange Act of 1934 (15 U.S.C. 78m(b)(2)) is amended—
(1) in subparagraph (A), by striking ‘‘and’’ at the end;

and
(2) in subparagraph (B), by striking the period at the

end and inserting the following: ‘‘; and
‘‘(C) notwithstanding any other provision of law, pay the

allocable share of such issuer of a reasonable annual accounting
support fee or fees, determined in accordance with section 109
of the Sarbanes-Oxley Act of 2002.’’.
(i) RULE OF CONSTRUCTION.—Nothing in this section shall be

construed to render either the Board, the standard setting body
referred to in subsection (a), or both, subject to procedures in
Congress to authorize or appropriate public funds, or to prevent
such organization from utilizing additional sources of revenue for
its activities, such as earnings from publication sales, provided
that each additional source of revenue shall not jeopardize, in
the judgment of the Commission, the actual and perceived independ-
ence of such organization.

(j) START-UP EXPENSES OF THE BOARD.—From the unexpended
balances of the appropriations to the Commission for fiscal year
2003, the Secretary of the Treasury is authorized to advance to
the Board not to exceed the amount necessary to cover the expenses
of the Board during its first fiscal year (which may be a short
fiscal year).

TITLE II—AUDITOR INDEPENDENCE

SEC. 201. SERVICES OUTSIDE THE SCOPE OF PRACTICE OF AUDITORS.

(a) PROHIBITED ACTIVITIES.—Section 10A of the Securities
Exchange Act of 1934 (15 U.S.C. 78j–1) is amended by adding
at the end the following:

‘‘(g) PROHIBITED ACTIVITIES.—Except as provided in subsection
(h), it shall be unlawful for a registered public accounting firm
(and any associated person of that firm, to the extent determined
appropriate by the Commission) that performs for any issuer any
audit required by this title or the rules of the Commission under
this title or, beginning 180 days after the date of commencement
of the operations of the Public Company Accounting Oversight
Board established under section 101 of the Sarbanes-Oxley Act
of 2002 (in this section referred to as the ‘Board’), the rules of
the Board, to provide to that issuer, contemporaneously with the
audit, any non-audit service, including—

‘‘(1) bookkeeping or other services related to the accounting
records or financial statements of the audit client;

‘‘(2) financial information systems design and implementa-
tion;

H. R. 3763—28

‘‘(3) appraisal or valuation services, fairness opinions, or
contribution-in-kind reports;

‘‘(4) actuarial services;
‘‘(5) internal audit outsourcing services;
‘‘(6) management functions or human resources;
‘‘(7) broker or dealer, investment adviser, or investment

banking services;
‘‘(8) legal services and expert services unrelated to the

audit; and
‘‘(9) any other service that the Board determines, by regula-

tion, is impermissible.
‘‘(h) PREAPPROVAL REQUIRED FOR NON-AUDIT SERVICES.—A reg-

istered public accounting firm may engage in any non-audit service,
including tax services, that is not described in any of paragraphs
(1) through (9) of subsection (g) for an audit client, only if the
activity is approved in advance by the audit committee of the
issuer, in accordance with subsection (i).’’.

(b) EXEMPTION AUTHORITY.—The Board may, on a case by
case basis, exempt any person, issuer, public accounting firm, or
transaction from the prohibition on the provision of services under
section 10A(g) of the Securities Exchange Act of 1934 (as added
by this section), to the extent that such exemption is necessary
or appropriate in the public interest and is consistent with the
protection of investors, and subject to review by the Commission
in the same manner as for rules of the Board under section 107.

SEC. 202. PREAPPROVAL REQUIREMENTS.

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C.
78j–1), as amended by this Act, is amended by adding at the
end the following:

‘‘(i) PREAPPROVAL REQUIREMENTS.—
‘‘(1) IN GENERAL.—

‘‘(A) AUDIT COMMITTEE ACTION.—All auditing services
(which may entail providing comfort letters in connection
with securities underwritings or statutory audits required
for insurance companies for purposes of State law) and
non-audit services, other than as provided in subparagraph
(B), provided to an issuer by the auditor of the issuer
shall be preapproved by the audit committee of the issuer.

‘‘(B) DE MINIMUS EXCEPTION.—The preapproval require-
ment under subparagraph (A) is waived with respect to
the provision of non-audit services for an issuer, if—

‘‘(i) the aggregate amount of all such non-audit
services provided to the issuer constitutes not more
than 5 percent of the total amount of revenues paid
by the issuer to its auditor during the fiscal year
in which the nonaudit services are provided;

‘‘(ii) such services were not recognized by the issuer
at the time of the engagement to be non-audit services;
and

‘‘(iii) such services are promptly brought to the
attention of the audit committee of the issuer and
approved prior to the completion of the audit by the
audit committee or by 1 or more members of the audit
committee who are members of the board of directors
to whom authority to grant such approvals has been
delegated by the audit committee.

H. R. 3763—29

‘‘(2) DISCLOSURE TO INVESTORS.—Approval by an audit com-
mittee of an issuer under this subsection of a non-audit service
to be performed by the auditor of the issuer shall be disclosed
to investors in periodic reports required by section 13(a).

‘‘(3) DELEGATION AUTHORITY.—The audit committee of an
issuer may delegate to 1 or more designated members of the
audit committee who are independent directors of the board
of directors, the authority to grant preapprovals required by
this subsection. The decisions of any member to whom authority
is delegated under this paragraph to preapprove an activity
under this subsection shall be presented to the full audit com-
mittee at each of its scheduled meetings.

‘‘(4) APPROVAL OF AUDIT SERVICES FOR OTHER PURPOSES.—
In carrying out its duties under subsection (m)(2), if the audit
committee of an issuer approves an audit service within the
scope of the engagement of the auditor, such audit service
shall be deemed to have been preapproved for purposes of
this subsection.’’.

SEC. 203. AUDIT PARTNER ROTATION.

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C.
78j–1), as amended by this Act, is amended by adding at the
end the following:

‘‘(j) AUDIT PARTNER ROTATION.—It shall be unlawful for a reg-
istered public accounting firm to provide audit services to an issuer
if the lead (or coordinating) audit partner (having primary responsi-
bility for the audit), or the audit partner responsible for reviewing
the audit, has performed audit services for that issuer in each
of the 5 previous fiscal years of that issuer.’’.
SEC. 204. AUDITOR REPORTS TO AUDIT COMMITTEES.

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C.
78j–1), as amended by this Act, is amended by adding at the
end the following:

‘‘(k) REPORTS TO AUDIT COMMITTEES.—Each registered public
accounting firm that performs for any issuer any audit required
by this title shall timely report to the audit committee of the
issuer—

‘‘(1) all critical accounting policies and practices to be used;
‘‘(2) all alternative treatments of financial information

within generally accepted accounting principles that have been
discussed with management officials of the issuer, ramifications
of the use of such alternative disclosures and treatments, and
the treatment preferred by the registered public accounting
firm; and

‘‘(3) other material written communications between the
registered public accounting firm and the management of the
issuer, such as any management letter or schedule of
unadjusted differences.’’.

SEC. 205. CONFORMING AMENDMENTS.

(a) DEFINITIONS.—Section 3(a) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)) is amended by adding at the end the
following:

‘‘(58) AUDIT COMMITTEE.—The term ‘audit committee’
means—

‘‘(A) a committee (or equivalent body) established by
and amongst the board of directors of an issuer for the

H. R. 3763—30

purpose of overseeing the accounting and financial
reporting processes of the issuer and audits of the financial
statements of the issuer; and

‘‘(B) if no such committee exists with respect to an
issuer, the entire board of directors of the issuer.
‘‘(59) REGISTERED PUBLIC ACCOUNTING FIRM.—The term

‘registered public accounting firm’ has the same meaning as
in section 2 of the Sarbanes-Oxley Act of 2002.’’.
(b) AUDITOR REQUIREMENTS.—Section 10A of the Securities

Exchange Act of 1934 (15 U.S.C. 78j–1) is amended—
(1) by striking ‘‘an independent public accountant’’ each

place that term appears and inserting ‘‘a registered public
accounting firm’’;

(2) by striking ‘‘the independent public accountant’’ each
place that term appears and inserting ‘‘the registered public
accounting firm’’;

(3) in subsection (c), by striking ‘‘No independent public
accountant’’ and inserting ‘‘No registered public accounting
firm’’; and

(4) in subsection (b)—
(A) by striking ‘‘the accountant’’ each place that term

appears and inserting ‘‘the firm’’;
(B) by striking ‘‘such accountant’’ each place that term

appears and inserting ‘‘such firm’’; and
(C) in paragraph (4), by striking ‘‘the accountant’s

report’’ and inserting ‘‘the report of the firm’’.
(c) OTHER REFERENCES.—The Securities Exchange Act of 1934

(15 U.S.C. 78a et seq.) is amended—
(1) in section 12(b)(1) (15 U.S.C. 78l(b)(1)), by striking

‘‘independent public accountants’’ each place that term appears
and inserting ‘‘a registered public accounting firm’’; and

(2) in subsections (e) and (i) of section 17 (15 U.S.C. 78q),
by striking ‘‘an independent public accountant’’ each place that
term appears and inserting ‘‘a registered public accounting
firm’’.
(d) CONFORMING AMENDMENT.—Section 10A(f) of the Securities

Exchange Act of 1934 (15 U.S.C. 78k(f)) is amended—
(1) by striking ‘‘DEFINITION’’ and inserting ‘‘DEFINITIONS’’;

and
(2) by adding at the end the following: ‘‘As used in this

section, the term ‘issuer’ means an issuer (as defined in section
3), the securities of which are registered under section 12,
or that is required to file reports pursuant to section 15(d),
or that files or has filed a registration statement that has
not yet become effective under the Securities Act of 1933 (15
U.S.C. 77a et seq.), and that it has not withdrawn.’’.

SEC. 206. CONFLICTS OF INTEREST.

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C.
78j–1), as amended by this Act, is amended by adding at the
end the following:

‘‘(l) CONFLICTS OF INTEREST.—It shall be unlawful for a reg-
istered public accounting firm to perform for an issuer any audit
service required by this title, if a chief executive officer, controller,
chief financial officer, chief accounting officer, or any person serving
in an equivalent position for the issuer, was employed by that
registered independent public accounting firm and participated in

H. R. 3763—31

any capacity in the audit of that issuer during the 1-year period
preceding the date of the initiation of the audit.’’.

SEC. 207. STUDY OF MANDATORY ROTATION OF REGISTERED PUBLIC
ACCOUNTING FIRMS.

(a) STUDY AND REVIEW REQUIRED.—The Comptroller General
of the United States shall conduct a study and review of the
potential effects of requiring the mandatory rotation of registered
public accounting firms.

(b) REPORT REQUIRED.—Not later than 1 year after the date
of enactment of this Act, the Comptroller General shall submit
a report to the Committee on Banking, Housing, and Urban Affairs
of the Senate and the Committee on Financial Services of the
House of Representatives on the results of the study and review
required by this section.

(c) DEFINITION.—For purposes of this section, the term ‘‘manda-
tory rotation’’ refers to the imposition of a limit on the period
of years in which a particular registered public accounting firm
may be the auditor of record for a particular issuer.

SEC. 208. COMMISSION AUTHORITY.

(a) COMMISSION REGULATIONS.—Not later than 180 days after
the date of enactment of this Act, the Commission shall issue
final regulations to carry out each of subsections (g) through (l)
of section 10A of the Securities Exchange Act of 1934, as added
by this title.

(b) AUDITOR INDEPENDENCE.—It shall be unlawful for any reg-
istered public accounting firm (or an associated person thereof,
as applicable) to prepare or issue any audit report with respect
to any issuer, if the firm or associated person engages in any
activity with respect to that issuer prohibited by any of subsections
(g) through (l) of section 10A of the Securities Exchange Act of
1934, as added by this title, or any rule or regulation of the
Commission or of the Board issued thereunder.

SEC. 209. CONSIDERATIONS BY APPROPRIATE STATE REGULATORY
AUTHORITIES.

In supervising nonregistered public accounting firms and their
associated persons, appropriate State regulatory authorities should
make an independent determination of the proper standards
applicable, particularly taking into consideration the size and
nature of the business of the accounting firms they supervise and
the size and nature of the business of the clients of those firms.
The standards applied by the Board under this Act should not
be presumed to be applicable for purposes of this section for small
and medium sized nonregistered public accounting firms.

TITLE III—CORPORATE
RESPONSIBILITY

SEC. 301. PUBLIC COMPANY AUDIT COMMITTEES.

Section 10A of the Securities Exchange Act of 1934 (15 U.S.C.
78f) is amended by adding at the end the following:

‘‘(m) STANDARDS RELATING TO AUDIT COMMITTEES.—
‘‘(1) COMMISSION RULES.—

H. R. 3763—32

‘‘(A) IN GENERAL.—Effective not later than 270 days
after the date of enactment of this subsection, the Commis-
sion shall, by rule, direct the national securities exchanges
and national securities associations to prohibit the listing
of any security of an issuer that is not in compliance
with the requirements of any portion of paragraphs (2)
through (6).

‘‘(B) OPPORTUNITY TO CURE DEFECTS.—The rules of the
Commission under subparagraph (A) shall provide for
appropriate procedures for an issuer to have an opportunity
to cure any defects that would be the basis for a prohibition
under subparagraph (A), before the imposition of such
prohibition.
‘‘(2) RESPONSIBILITIES RELATING TO REGISTERED PUBLIC

ACCOUNTING FIRMS.—The audit committee of each issuer, in
its capacity as a committee of the board of directors, shall
be directly responsible for the appointment, compensation, and
oversight of the work of any registered public accounting firm
employed by that issuer (including resolution of disagreements
between management and the auditor regarding financial
reporting) for the purpose of preparing or issuing an audit
report or related work, and each such registered public
accounting firm shall report directly to the audit committee.

‘‘(3) INDEPENDENCE.—
‘‘(A) IN GENERAL.—Each member of the audit com-

mittee of the issuer shall be a member of the board of
directors of the issuer, and shall otherwise be independent.

‘‘(B) CRITERIA.—In order to be considered to be inde-
pendent for purposes of this paragraph, a member of an
audit committee of an issuer may not, other than in his
or her capacity as a member of the audit committee, the
board of directors, or any other board committee—

‘‘(i) accept any consulting, advisory, or other
compensatory fee from the issuer; or

‘‘(ii) be an affiliated person of the issuer or any
subsidiary thereof.
‘‘(C) EXEMPTION AUTHORITY.—The Commission may

exempt from the requirements of subparagraph (B) a par-
ticular relationship with respect to audit committee mem-
bers, as the Commission determines appropriate in light
of the circumstances.
‘‘(4) COMPLAINTS.—Each audit committee shall establish

procedures for—
‘‘(A) the receipt, retention, and treatment of complaints

received by the issuer regarding accounting, internal
accounting controls, or auditing matters; and

‘‘(B) the confidential, anonymous submission by
employees of the issuer of concerns regarding questionable
accounting or auditing matters.
‘‘(5) AUTHORITY TO ENGAGE ADVISERS.—Each audit com-

mittee shall have the authority to engage independent counsel
and other advisers, as it determines necessary to carry out
its duties.

‘‘(6) FUNDING.—Each issuer shall provide for appropriate
funding, as determined by the audit committee, in its capacity
as a committee of the board of directors, for payment of
compensation—

H. R. 3763—33

‘‘(A) to the registered public accounting firm employed
by the issuer for the purpose of rendering or issuing an
audit report; and

‘‘(B) to any advisers employed by the audit committee
under paragraph (5).’’.

SEC. 302. CORPORATE RESPONSIBILITY FOR FINANCIAL REPORTS.

(a) REGULATIONS REQUIRED.—The Commission shall, by rule,
require, for each company filing periodic reports under section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m,
78o(d)), that the principal executive officer or officers and the prin-
cipal financial officer or officers, or persons performing similar
functions, certify in each annual or quarterly report filed or sub-
mitted under either such section of such Act that—

(1) the signing officer has reviewed the report;
(2) based on the officer’s knowledge, the report does not

contain any untrue statement of a material fact or omit to
state a material fact necessary in order to make the statements
made, in light of the circumstances under which such state-
ments were made, not misleading;

(3) based on such officer’s knowledge, the financial state-
ments, and other financial information included in the report,
fairly present in all material respects the financial condition
and results of operations of the issuer as of, and for, the
periods presented in the report;

(4) the signing officers—
(A) are responsible for establishing and maintaining

internal controls;
(B) have designed such internal controls to ensure

that material information relating to the issuer and its
consolidated subsidiaries is made known to such officers
by others within those entities, particularly during the
period in which the periodic reports are being prepared;

(C) have evaluated the effectiveness of the issuer’s
internal controls as of a date within 90 days prior to
the report; and

(D) have presented in the report their conclusions
about the effectiveness of their internal controls based on
their evaluation as of that date;
(5) the signing officers have disclosed to the issuer’s audi-

tors and the audit committee of the board of directors (or
persons fulfilling the equivalent function)—

(A) all significant deficiencies in the design or operation
of internal controls which could adversely affect the issuer’s
ability to record, process, summarize, and report financial
data and have identified for the issuer’s auditors any mate-
rial weaknesses in internal controls; and

(B) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the issuer’s internal controls; and
(6) the signing officers have indicated in the report whether

or not there were significant changes in internal controls or
in other factors that could significantly affect internal controls
subsequent to the date of their evaluation, including any correc-
tive actions with regard to significant deficiencies and material
weaknesses.

H. R. 3763—34

(b) FOREIGN REINCORPORATIONS HAVE NO EFFECT.—Nothing
in this section 302 shall be interpreted or applied in any way
to allow any issuer to lessen the legal force of the statement
required under this section 302, by an issuer having reincorporated
or having engaged in any other transaction that resulted in the
transfer of the corporate domicile or offices of the issuer from
inside the United States to outside of the United States.

(c) DEADLINE.—The rules required by subsection (a) shall be
effective not later than 30 days after the date of enactment of
this Act.

SEC. 303. IMPROPER INFLUENCE ON CONDUCT OF AUDITS.

(a) RULES TO PROHIBIT.—It shall be unlawful, in contravention
of such rules or regulations as the Commission shall prescribe
as necessary and appropriate in the public interest or for the
protection of investors, for any officer or director of an issuer,
or any other person acting under the direction thereof, to take
any action to fraudulently influence, coerce, manipulate, or mislead
any independent public or certified accountant engaged in the
performance of an audit of the financial statements of that issuer
for the purpose of rendering such financial statements materially
misleading.

(b) ENFORCEMENT.—In any civil proceeding, the Commission
shall have exclusive authority to enforce this section and any rule
or regulation issued under this section.

(c) NO PREEMPTION OF OTHER LAW.—The provisions of sub-
section (a) shall be in addition to, and shall not supersede or
preempt, any other provision of law or any rule or regulation
issued thereunder.

(d) DEADLINE FOR RULEMAKING.—The Commission shall—
(1) propose the rules or regulations required by this section,

not later than 90 days after the date of enactment of this
Act; and

(2) issue final rules or regulations required by this section,
not later than 270 days after that date of enactment.

SEC. 304. FORFEITURE OF CERTAIN BONUSES AND PROFITS.

(a) ADDITIONAL COMPENSATION PRIOR TO NONCOMPLIANCE WITH
COMMISSION FINANCIAL REPORTING REQUIREMENTS.—If an issuer
is required to prepare an accounting restatement due to the material
noncompliance of the issuer, as a result of misconduct, with any
financial reporting requirement under the securities laws, the chief
executive officer and chief financial officer of the issuer shall
reimburse the issuer for—

(1) any bonus or other incentive-based or equity-based com-
pensation received by that person from the issuer during the
12-month period following the first public issuance or filing
with the Commission (whichever first occurs) of the financial
document embodying such financial reporting requirement; and

(2) any profits realized from the sale of securities of the
issuer during that 12-month period.
(b) COMMISSION EXEMPTION AUTHORITY.—The Commission may

exempt any person from the application of subsection (a), as it
deems necessary and appropriate.

SEC. 305. OFFICER AND DIRECTOR BARS AND PENALTIES.

(a) UNFITNESS STANDARD.—

H. R. 3763—35

(1) SECURITIES EXCHANGE ACT OF 1934.—Section 21(d)(2)
of the Securities Exchange Act of 1934 (15 U.S.C. 78u(d)(2))
is amended by striking ‘‘substantial unfitness’’ and inserting
‘‘unfitness’’.

(2) SECURITIES ACT OF 1933.—Section 20(e) of the Securities
Act of 1933 (15 U.S.C. 77t(e)) is amended by striking ‘‘substan-
tial unfitness’’ and inserting ‘‘unfitness’’.
(b) EQUITABLE RELIEF.—Section 21(d) of the Securities

Exchange Act of 1934 (15 U.S.C. 78u(d)) is amended by adding
at the end the following:

‘‘(5) EQUITABLE RELIEF.—In any action or proceeding brought
or instituted by the Commission under any provision of the securi-
ties laws, the Commission may seek, and any Federal court may
grant, any equitable relief that may be appropriate or necessary
for the benefit of investors.’’.

SEC. 306. INSIDER TRADES DURING PENSION FUND BLACKOUT
PERIODS.

(a) PROHIBITION OF INSIDER TRADING DURING PENSION FUND
BLACKOUT PERIODS.—

(1) IN GENERAL.—Except to the extent otherwise provided
by rule of the Commission pursuant to paragraph (3), it shall
be unlawful for any director or executive officer of an issuer
of any equity security (other than an exempted security),
directly or indirectly, to purchase, sell, or otherwise acquire
or transfer any equity security of the issuer (other than an
exempted security) during any blackout period with respect
to such equity security if such director or officer acquires such
equity security in connection with his or her service or employ-
ment as a director or executive officer.

(2) REMEDY.—
(A) IN GENERAL.—Any profit realized by a director

or executive officer referred to in paragraph (1) from any
purchase, sale, or other acquisition or transfer in violation
of this subsection shall inure to and be recoverable by
the issuer, irrespective of any intention on the part of
such director or executive officer in entering into the trans-
action.

(B) ACTIONS TO RECOVER PROFITS.—An action to
recover profits in accordance with this subsection may be
instituted at law or in equity in any court of competent
jurisdiction by the issuer, or by the owner of any security
of the issuer in the name and in behalf of the issuer
if the issuer fails or refuses to bring such action within
60 days after the date of request, or fails diligently to
prosecute the action thereafter, except that no such suit
shall be brought more than 2 years after the date on
which such profit was realized.
(3) RULEMAKING AUTHORIZED.—The Commission shall, in

consultation with the Secretary of Labor, issue rules to clarify
the application of this subsection and to prevent evasion thereof.
Such rules shall provide for the application of the requirements
of paragraph (1) with respect to entities treated as a single
employer with respect to an issuer under section 414(b), (c),
(m), or (o) of the Internal Revenue Code of 1986 to the extent
necessary to clarify the application of such requirements and
to prevent evasion thereof. Such rules may also provide for

H. R. 3763—36

appropriate exceptions from the requirements of this sub-
section, including exceptions for purchases pursuant to an auto-
matic dividend reinvestment program or purchases or sales
made pursuant to an advance election.

(4) BLACKOUT PERIOD.—For purposes of this subsection,
the term ‘‘blackout period’’, with respect to the equity securities
of any issuer—

(A) means any period of more than 3 consecutive busi-
ness days during which the ability of not fewer than 50
percent of the participants or beneficiaries under all indi-
vidual account plans maintained by the issuer to purchase,
sell, or otherwise acquire or transfer an interest in any
equity of such issuer held in such an individual account
plan is temporarily suspended by the issuer or by a fidu-
ciary of the plan; and

(B) does not include, under regulations which shall
be prescribed by the Commission—

(i) a regularly scheduled period in which the
participants and beneficiaries may not purchase, sell,
or otherwise acquire or transfer an interest in any
equity of such issuer, if such period is—

(I) incorporated into the individual account
plan; and

(II) timely disclosed to employees before
becoming participants under the individual
account plan or as a subsequent amendment to
the plan; or
(ii) any suspension described in subparagraph (A)

that is imposed solely in connection with persons
becoming participants or beneficiaries, or ceasing to
be participants or beneficiaries, in an individual
account plan by reason of a corporate merger, acquisi-
tion, divestiture, or similar transaction involving the
plan or plan sponsor.

(5) INDIVIDUAL ACCOUNT PLAN.—For purposes of this sub-
section, the term ‘‘individual account plan’’ has the meaning
provided in section 3(34) of the Employee Retirement Income
Security Act of 1974 (29 U.S.C. 1002(34), except that such
term shall not include a one-participant retirement plan (within
the meaning of section 101(i)(8)(B) of such Act (29 U.S.C.
1021(i)(8)(B))).

(6) NOTICE TO DIRECTORS, EXECUTIVE OFFICERS, AND THE
COMMISSION.—In any case in which a director or executive
officer is subject to the requirements of this subsection in
connection with a blackout period (as defined in paragraph
(4)) with respect to any equity securities, the issuer of such
equity securities shall timely notify such director or officer
and the Securities and Exchange Commission of such blackout
period.
(b) NOTICE REQUIREMENTS TO PARTICIPANTS AND BENEFICIARIES

UNDER ERISA.—
(1) IN GENERAL.—Section 101 of the Employee Retirement

Income Security Act of 1974 (29 U.S.C. 1021) is amended by
redesignating the second subsection (h) as subsection (j), and
by inserting after the first subsection (h) the following new
subsection:

H. R. 3763—37

‘‘(i) NOTICE OF BLACKOUT PERIODS TO PARTICIPANT OR BENE-
FICIARY UNDER INDIVIDUAL ACCOUNT PLAN.—

‘‘(1) DUTIES OF PLAN ADMINISTRATOR.—In advance of the
commencement of any blackout period with respect to an indi-
vidual account plan, the plan administrator shall notify the
plan participants and beneficiaries who are affected by such
action in accordance with this subsection.

‘‘(2) NOTICE REQUIREMENTS.—
‘‘(A) IN GENERAL.—The notices described in paragraph

(1) shall be written in a manner calculated to be understood
by the average plan participant and shall include—

‘‘(i) the reasons for the blackout period,
‘‘(ii) an identification of the investments and other

rights affected,
‘‘(iii) the expected beginning date and length of

the blackout period,
‘‘(iv) in the case of investments affected, a state-

ment that the participant or beneficiary should
evaluate the appropriateness of their current invest-
ment decisions in light of their inability to direct or
diversify assets credited to their accounts during the
blackout period, and

‘‘(v) such other matters as the Secretary may
require by regulation.
‘‘(B) NOTICE TO PARTICIPANTS AND BENEFICIARIES.—

Except as otherwise provided in this subsection, notices
described in paragraph (1) shall be furnished to all partici-
pants and beneficiaries under the plan to whom the black-
out period applies at least 30 days in advance of the black-
out period.

‘‘(C) EXCEPTION TO 30-DAY NOTICE REQUIREMENT.—In
any case in which—

‘‘(i) a deferral of the blackout period would violate
the requirements of subparagraph (A) or (B) of section
404(a)(1), and a fiduciary of the plan reasonably so
determines in writing, or

‘‘(ii) the inability to provide the 30-day advance
notice is due to events that were unforeseeable or
circumstances beyond the reasonable control of the
plan administrator, and a fiduciary of the plan reason-
ably so determines in writing,

subparagraph (B) shall not apply, and the notice shall
be furnished to all participants and beneficiaries under
the plan to whom the blackout period applies as soon
as reasonably possible under the circumstances unless such
a notice in advance of the termination of the blackout
period is impracticable.

‘‘(D) WRITTEN NOTICE.—The notice required to be pro-
vided under this subsection shall be in writing, except
that such notice may be in electronic or other form to
the extent that such form is reasonably accessible to the
recipient.

‘‘(E) NOTICE TO ISSUERS OF EMPLOYER SECURITIES SUB-
JECT TO BLACKOUT PERIOD.—In the case of any blackout
period in connection with an individual account plan, the
plan administrator shall provide timely notice of such

H. R. 3763—38

blackout period to the issuer of any employer securities
subject to such blackout period.
‘‘(3) EXCEPTION FOR BLACKOUT PERIODS WITH LIMITED

APPLICABILITY.—In any case in which the blackout period
applies only to 1 or more participants or beneficiaries in connec-
tion with a merger, acquisition, divestiture, or similar trans-
action involving the plan or plan sponsor and occurs solely
in connection with becoming or ceasing to be a participant
or beneficiary under the plan by reason of such merger, acquisi-
tion, divestiture, or transaction, the requirement of this sub-
section that the notice be provided to all participants and
beneficiaries shall be treated as met if the notice required
under paragraph (1) is provided to such participants or bene-
ficiaries to whom the blackout period applies as soon as reason-
ably practicable.

‘‘(4) CHANGES IN LENGTH OF BLACKOUT PERIOD.—If, fol-
lowing the furnishing of the notice pursuant to this subsection,
there is a change in the beginning date or length of the blackout
period (specified in such notice pursuant to paragraph
(2)(A)(iii)), the administrator shall provide affected participants
and beneficiaries notice of the change as soon as reasonably
practicable. In relation to the extended blackout period, such
notice shall meet the requirements of paragraph (2)(D) and
shall specify any material change in the matters referred to
in clauses (i) through (v) of paragraph (2)(A).

‘‘(5) REGULATORY EXCEPTIONS.—The Secretary may provide
by regulation for additional exceptions to the requirements
of this subsection which the Secretary determines are in the
interests of participants and beneficiaries.

‘‘(6) GUIDANCE AND MODEL NOTICES.—The Secretary shall
issue guidance and model notices which meet the requirements
of this subsection.

‘‘(7) BLACKOUT PERIOD.—For purposes of this subsection—
‘‘(A) IN GENERAL.—The term ‘blackout period’ means,

in connection with an individual account plan, any period
for which any ability of participants or beneficiaries under
the plan, which is otherwise available under the terms
of such plan, to direct or diversify assets credited to their
accounts, to obtain loans from the plan, or to obtain dis-
tributions from the plan is temporarily suspended, limited,
or restricted, if such suspension, limitation, or restriction
is for any period of more than 3 consecutive business days.

‘‘(B) EXCLUSIONS.—The term ‘blackout period’ does not
include a suspension, limitation, or restriction—

‘‘(i) which occurs by reason of the application of
the securities laws (as defined in section 3(a)(47) of
the Securities Exchange Act of 1934),

‘‘(ii) which is a change to the plan which provides
for a regularly scheduled suspension, limitation, or
restriction which is disclosed to participants or bene-
ficiaries through any summary of material modifica-
tions, any materials describing specific investment
alternatives under the plan, or any changes thereto,
or

‘‘(iii) which applies only to 1 or more individuals,
each of whom is the participant, an alternate payee

H. R. 3763—39

(as defined in section 206(d)(3)(K)), or any other bene-
ficiary pursuant to a qualified domestic relations order
(as defined in section 206(d)(3)(B)(i)).

‘‘(8) INDIVIDUAL ACCOUNT PLAN.—
‘‘(A) IN GENERAL.—For purposes of this subsection, the

term ‘individual account plan’ shall have the meaning pro-
vided such term in section 3(34), except that such term
shall not include a one-participant retirement plan.

‘‘(B) ONE-PARTICIPANT RETIREMENT PLAN.—For pur-
poses of subparagraph (A), the term ‘one-participant retire-
ment plan’ means a retirement plan that—

‘‘(i) on the first day of the plan year—
‘‘(I) covered only the employer (and the

employer’s spouse) and the employer owned the
entire business (whether or not incorporated), or

‘‘(II) covered only one or more partners (and
their spouses) in a business partnership (including
partners in an S or C corporation (as defined in
section 1361(a) of the Internal Revenue Code of
1986)),
‘‘(ii) meets the minimum coverage requirements

of section 410(b) of the Internal Revenue Code of 1986
(as in effect on the date of the enactment of this
paragraph) without being combined with any other
plan of the business that covers the employees of the
business,

‘‘(iii) does not provide benefits to anyone except
the employer (and the employer’s spouse) or the part-
ners (and their spouses),

‘‘(iv) does not cover a business that is a member
of an affiliated service group, a controlled group of
corporations, or a group of businesses under common
control, and

‘‘(v) does not cover a business that leases
employees.’’.

(2) ISSUANCE OF INITIAL GUIDANCE AND MODEL NOTICE.—
The Secretary of Labor shall issue initial guidance and a model
notice pursuant to section 101(i)(6) of the Employee Retirement
Income Security Act of 1974 (as added by this subsection)
not later than January 1, 2003. Not later than 75 days after
the date of the enactment of this Act, the Secretary shall
promulgate interim final rules necessary to carry out the
amendments made by this subsection.

(3) CIVIL PENALTIES FOR FAILURE TO PROVIDE NOTICE.—
Section 502 of such Act (29 U.S.C. 1132) is amended—

(A) in subsection (a)(6), by striking ‘‘(5), or (6)’’ and
inserting ‘‘(5), (6), or (7)’’;

(B) by redesignating paragraph (7) of subsection (c)
as paragraph (8); and

‘‘(7) The Secretary may assess a civil penalty against a plan
administrator of up to $100 a day from the date of the plan adminis-
trator’s failure or refusal to provide notice to participants and
beneficiaries in accordance with section 101(i). For purposes of
this paragraph, each violation with respect to any single participant
or beneficiary shall be treated as a separate violation.’’.

H. R. 3763—40

(3) PLAN AMENDMENTS.—If any amendment made by this
subsection requires an amendment to any plan, such plan
amendment shall not be required to be made before the first
plan year beginning on or after the effective date of this section,
if—

(A) during the period after such amendment made
by this subsection takes effect and before such first plan
year, the plan is operated in good faith compliance with
the requirements of such amendment made by this sub-
section, and

(B) such plan amendment applies retroactively to the
period after such amendment made by this subsection takes
effect and before such first plan year.

(c) EFFECTIVE DATE.—The provisions of this section (including
the amendments made thereby) shall take effect 180 days after
the date of the enactment of this Act. Good faith compliance with
the requirements of such provisions in advance of the issuance
of applicable regulations thereunder shall be treated as compliance
with such provisions.
SEC. 307. RULES OF PROFESSIONAL RESPONSIBILITY FOR ATTORNEYS.

Not later than 180 days after the date of enactment of this
Act, the Commission shall issue rules, in the public interest and
for the protection of investors, setting forth minimum standards
of professional conduct for attorneys appearing and practicing before
the Commission in any way in the representation of issuers,
including a rule—

(1) requiring an attorney to report evidence of a material
violation of securities law or breach of fiduciary duty or similar
violation by the company or any agent thereof, to the chief
legal counsel or the chief executive officer of the company
(or the equivalent thereof); and

(2) if the counsel or officer does not appropriately respond
to the evidence (adopting, as necessary, appropriate remedial
measures or sanctions with respect to the violation), requiring
the attorney to report the evidence to the audit committee
of the board of directors of the issuer or to another committee
of the board of directors comprised solely of directors not
employed directly or indirectly by the issuer, or to the board
of directors.

SEC. 308. FAIR FUNDS FOR INVESTORS.

(a) CIVIL PENALTIES ADDED TO DISGORGEMENT FUNDS FOR THE
RELIEF OF VICTIMS.—If in any judicial or administrative action
brought by the Commission under the securities laws (as such
term is defined in section 3(a)(47) of the Securities Exchange Act
of 1934 (15 U.S.C. 78c(a)(47)) the Commission obtains an order
requiring disgorgement against any person for a violation of such
laws or the rules or regulations thereunder, or such person agrees
in settlement of any such action to such disgorgement, and the
Commission also obtains pursuant to such laws a civil penalty
against such person, the amount of such civil penalty shall, on
the motion or at the direction of the Commission, be added to
and become part of the disgorgement fund for the benefit of the
victims of such violation.

(b) ACCEPTANCE OF ADDITIONAL DONATIONS.—The Commission
is authorized to accept, hold, administer, and utilize gifts, bequests
and devises of property, both real and personal, to the United

H. R. 3763—41

States for a disgorgement fund described in subsection (a). Such
gifts, bequests, and devises of money and proceeds from sales of
other property received as gifts, bequests, or devises shall be depos-
ited in the disgorgement fund and shall be available for allocation
in accordance with subsection (a).

analyze—
(A) enforcement actions by the Commission over the

five years preceding the date of the enactment of this
Act that have included proceedings to obtain civil penalties
or disgorgements to identify areas where such proceedings
may be utilized to efficiently, effectively, and fairly provide
restitution for injured investors; and

(B) other methods to more efficiently, effectively, and
fairly provide restitution to injured investors, including
methods to improve the collection rates for civil penalties
and disgorgements.
(2) REPORT REQUIRED.—The Commission shall report its

findings to the Committee on Financial Services of the House
of Representatives and the Committee on Banking, Housing,
and Urban Affairs of the Senate within 180 days after of
the date of the enactment of this Act, and shall use such
findings to revise its rules and regulations as necessary. The
report shall include a discussion of regulatory or legislative
actions that are recommended or that may be necessary to
address concerns identified in the study.
(d) CONFORMING AMENDMENTS.—Each of the following provi-

sions is amended by inserting ‘‘, except as otherwise provided in
section 308 of the Sarbanes-Oxley Act of 2002’’ after ‘‘Treasury
of the United States’’:

(1) Section 21(d)(3)(C)(i) of the Securities Exchange Act
of 1934 (15 U.S.C. 78u(d)(3)(C)(i)).

(2) Section 21A(d)(1) of such Act (15 U.S.C. 78u-1(d)(1)).
(3) Section 20(d)(3)(A) of the Securities Act of 1933 (15

U.S.C. 77t(d)(3)(A)).
(4) Section 42(e)(3)(A) of the Investment Company Act of

1940 (15 U.S.C. 80a–41(e)(3)(A)).
(5) Section 209(e)(3)(A) of the Investment Advisers Act

of 1940 (15 U.S.C. 80b–9(e)(3)(A)).
(e) DEFINITION.—As used in this section, the term

‘‘disgorgement fund’’ means a fund established in any administra-
tive or judicial proceeding described in subsection (a).

TITLE IV—ENHANCED FINANCIAL
DISCLOSURES

SEC. 401. DISCLOSURES IN PERIODIC REPORTS.

(a) DISCLOSURES REQUIRED.—Section 13 of the Securities
Exchange Act of 1934 (15 U.S.C. 78m) is amended by adding at
the end the following:

‘‘(i) ACCURACY OF FINANCIAL REPORTS.—Each financial report
that contains financial statements, and that is required to be pre-
pared in accordance with (or reconciled to) generally accepted
accounting principles under this title and filed with the Commission
shall reflect all material correcting adjustments that have been

H. R. 3763—42

identified by a registered public accounting firm in accordance
with generally accepted accounting principles and the rules and
regulations of the Commission.

‘‘(j) OFF-BALANCE SHEET TRANSACTIONS.—Not later than 180
days after the date of enactment of the Sarbanes-Oxley Act of
2002, the Commission shall issue final rules providing that each
annual and quarterly financial report required to be filed with
the Commission shall disclose all material off-balance sheet trans-
actions, arrangements, obligations (including contingent obliga-
tions), and other relationships of the issuer with unconsolidated
entities or other persons, that may have a material current or
future effect on financial condition, changes in financial condition,
results of operations, liquidity, capital expenditures, capital
resources, or significant components of revenues or expenses.’’.

(b) COMMISSION RULES ON PRO FORMA FIGURES.—Not later
than 180 days after the date of enactment of the Sarbanes-Oxley
Act fo 2002, the Commission shall issue final rules providing that
pro forma financial information included in any periodic or other
report filed with the Commission pursuant to the securities laws,
or in any public disclosure or press or other release, shall be
presented in a manner that—

(1) does not contain an untrue statement of a material
fact or omit to state a material fact necessary in order to
make the pro forma financial information, in light of the cir-
cumstances under which it is presented, not misleading; and

(2) reconciles it with the financial condition and results
of operations of the issuer under generally accepted accounting
principles.
(c) STUDY AND REPORT ON SPECIAL PURPOSE ENTITIES.—

(1) STUDY REQUIRED.—The Commission shall, not later
than 1 year after the effective date of adoption of off-balance
sheet disclosure rules required by section 13(j) of the Securities
Exchange Act of 1934, as added by this section, complete a
study of filings by issuers and their disclosures to determine—

(A) the extent of off-balance sheet transactions,
including assets, liabilities, leases, losses, and the use of
special purpose entities; and

(B) whether generally accepted accounting rules result
in financial statements of issuers reflecting the economics
of such off-balance sheet transactions to investors in a
transparent fashion.
(2) REPORT AND RECOMMENDATIONS.—Not later than 6

months after the date of completion of the study required
by paragraph (1), the Commission shall submit a report to
the President, the Committee on Banking, Housing, and Urban
Affairs of the Senate, and the Committee on Financial Services
of the House of Representatives, setting forth—

(A) the amount or an estimate of the amount of off-
balance sheet transactions, including assets, liabilities,
leases, and losses of, and the use of special purpose entities
by, issuers filing periodic reports pursuant to section 13
or 15 of the Securities Exchange Act of 1934;

(B) the extent to which special purpose entities are
used to facilitate off-balance sheet transactions;

H. R. 3763—43

(C) whether generally accepted accounting principles
or the rules of the Commission result in financial state-
ments of issuers reflecting the economics of such trans-
actions to investors in a transparent fashion;

(D) whether generally accepted accounting principles
specifically result in the consolidation of special purpose
entities sponsored by an issuer in cases in which the issuer
has the majority of the risks and rewards of the special
purpose entity; and

(E) any recommendations of the Commission for
improving the transparency and quality of reporting off-
balance sheet transactions in the financial statements and
disclosures required to be filed by an issuer with the
Commission.

SEC. 402. ENHANCED CONFLICT OF INTEREST PROVISIONS.

(a) PROHIBITION ON PERSONAL LOANS TO EXECUTIVES.—Section
13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m), as
amended by this Act, is amended by adding at the end the following:

‘‘(k) PROHIBITION ON PERSONAL LOANS TO EXECUTIVES.—
‘‘(1) IN GENERAL.—It shall be unlawful for any issuer (as

defined in section 2 of the Sarbanes-Oxley Act of 2002), directly
or indirectly, including through any subsidiary, to extend or
maintain credit, to arrange for the extension of credit, or to
renew an extension of credit, in the form of a personal loan
to or for any director or executive officer (or equivalent thereof)
of that issuer. An extension of credit maintained by the issuer
on the date of enactment of this subsection shall not be subject
to the provisions of this subsection, provided that there is
no material modification to any term of any such extension
of credit or any renewal of any such extension of credit on
or after that date of enactment.

‘‘(2) LIMITATION.—Paragraph (1) does not preclude any
home improvement and manufactured home loans (as that term
is defined in section 5 of the Home Owners’ Loan Act (12
U.S.C. 1464)), consumer credit (as defined in section 103 of
the Truth in Lending Act (15 U.S.C. 1602)), or any extension
of credit under an open end credit plan (as defined in section
103 of the Truth in Lending Act (15 U.S.C. 1602)), or a charge
card (as defined in section 127(c)(4)(e) of the Truth in Lending
Act (15 U.S.C. 1637(c)(4)(e)), or any extension of credit by
a broker or dealer registered under section 15 of this title
to an employee of that broker or dealer to buy, trade, or
carry securities, that is permitted under rules or regulations
of the Board of Governors of the Federal Reserve System pursu-
ant to section 7 of this title (other than an extension of credit
that would be used to purchase the stock of that issuer), that
is—

‘‘(A) made or provided in the ordinary course of the
consumer credit business of such issuer;

‘‘(B) of a type that is generally made available by
such issuer to the public; and

‘‘(C) made by such issuer on market terms, or terms
that are no more favorable than those offered by the issuer
to the general public for such extensions of credit.
‘‘(3) RULE OF CONSTRUCTION FOR CERTAIN LOANS.—Para-

graph (1) does not apply to any loan made or maintained

H. R. 3763—44

by an insured depository institution (as defined in section 3
of the Federal Deposit Insurance Act (12 U.S.C. 1813)), if
the loan is subject to the insider lending restrictions of section
22(h) of the Federal Reserve Act (12 U.S.C. 375b).’’.

SEC. 403. DISCLOSURES OF TRANSACTIONS INVOLVING MANAGEMENT
AND PRINCIPAL STOCKHOLDERS.

(a) AMENDMENT.—Section 16 of the Securities Exchange Act
of 1934 (15 U.S.C. 78p) is amended by striking the heading of
such section and subsection (a) and inserting the following:

‘‘SEC. 16. DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS.

‘‘(a) DISCLOSURES REQUIRED.—
‘‘(1) DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS

REQUIRED TO FILE.—Every person who is directly or indirectly
the beneficial owner of more than 10 percent of any class
of any equity security (other than an exempted security) which
is registered pursuant to section 12, or who is a director or
an officer of the issuer of such security, shall file the statements
required by this subsection with the Commission (and, if such
security is registered on a national securities exchange, also
with the exchange).

‘‘(2) TIME OF FILING.—The statements required by this sub-
section shall be filed—

‘‘(A) at the time of the registration of such security
on a national securities exchange or by the effective date
of a registration statement filed pursuant to section 12(g);

‘‘(B) within 10 days after he or she becomes such
beneficial owner, director, or officer;

‘‘(C) if there has been a change in such ownership,
or if such person shall have purchased or sold a security-
based swap agreement (as defined in section 206(b) of
the Gramm-Leach-Bliley Act (15 U.S.C. 78c note)) involving
such equity security, before the end of the second business
day following the day on which the subject transaction
has been executed, or at such other time as the Commission
shall establish, by rule, in any case in which the Commis-
sion determines that such 2-day period is not feasible.
‘‘(3) CONTENTS OF STATEMENTS.—A statement filed—

‘‘(A) under subparagraph (A) or (B) of paragraph (2)
shall contain a statement of the amount of all equity securi-
ties of such issuer of which the filing person is the beneficial
owner; and

‘‘(B) under subparagraph (C) of such paragraph shall
indicate ownership by the filing person at the date of
filing, any such changes in such ownership, and such pur-
chases and sales of the security-based swap agreements
as have occurred since the most recent such filing under
such subparagraph.
‘‘(4) ELECTRONIC FILING AND AVAILABILITY.—Beginning not

later than 1 year after the date of enactment of the Sarbanes-
Oxley Act of 2002—

‘‘(A) a statement filed under subparagraph (C) of para-
graph (2) shall be filed electronically;

‘‘(B) the Commission shall provide each such statement
on a publicly accessible Internet site not later than the
end of the business day following that filing; and

H. R. 3763—45

‘‘(C) the issuer (if the issuer maintains a corporate
website) shall provide that statement on that corporate
website, not later than the end of the business day following
that filing.’’.

(b) EFFECTIVE DATE.—The amendment made by this section
shall be effective 30 days after the date of the enactment of this
Act.

SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS.

(a) RULES REQUIRED.—The Commission shall prescribe rules
requiring each annual report required by section 13(a) or 15(d)
of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d))
to contain an internal control report, which shall—

(1) state the responsibility of management for establishing
and maintaining an adequate internal control structure and
procedures for financial reporting; and

(2) contain an assessment, as of the end of the most recent
fiscal year of the issuer, of the effectiveness of the internal
control structure and procedures of the issuer for financial
reporting.
(b) INTERNAL CONTROL EVALUATION AND REPORTING.—With

respect to the internal control assessment required by subsection
(a), each registered public accounting firm that prepares or issues
the audit report for the issuer shall attest to, and report on, the
assessment made by the management of the issuer. An attestation
made under this subsection shall be made in accordance with stand-
ards for attestation engagements issued or adopted by the Board.
Any such attestation shall not be the subject of a separate engage-
ment.

SEC. 405. EXEMPTION.

Nothing in section 401, 402, or 404, the amendments made
by those sections, or the rules of the Commission under those
sections shall apply to any investment company registered under
section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a–
8).

SEC. 406. CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS.

(a) CODE OF ETHICS DISCLOSURE.—The Commission shall issue
rules to require each issuer, together with periodic reports required
pursuant to section 13(a) or 15(d) of the Securities Exchange Act
of 1934, to disclose whether or not, and if not, the reason therefor,
such issuer has adopted a code of ethics for senior financial officers,
applicable to its principal financial officer and comptroller or prin-
cipal accounting officer, or persons performing similar functions.

(b) CHANGES IN CODES OF ETHICS.—The Commission shall
revise its regulations concerning matters requiring prompt disclo-
sure on Form 8–K (or any successor thereto) to require the imme-
diate disclosure, by means of the filing of such form, dissemination
by the Internet or by other electronic means, by any issuer of
any change in or waiver of the code of ethics for senior financial
officers.

(c) DEFINITION.—In this section, the term ‘‘code of ethics’’ means
such standards as are reasonably necessary to promote—

(1) honest and ethical conduct, including the ethical han-
dling of actual or apparent conflicts of interest between personal
and professional relationships;

H. R. 3763—46

(2) full, fair, accurate, timely, and understandable disclo-
sure in the periodic reports required to be filed by the issuer;
and

(3) compliance with applicable governmental rules and
regulations.
(d) DEADLINE FOR RULEMAKING.—The Commission shall—

(1) propose rules to implement this section, not later than
90 days after the date of enactment of this Act; and

(2) issue final rules to implement this section, not later
than 180 days after that date of enactment.

SEC. 407. DISCLOSURE OF AUDIT COMMITTEE FINANCIAL EXPERT.

(a) RULES DEFINING ‘‘FINANCIAL EXPERT’’.—The Commission
shall issue rules, as necessary or appropriate in the public interest
and consistent with the protection of investors, to require each
issuer, together with periodic reports required pursuant to sections
13(a) and 15(d) of the Securities Exchange Act of 1934, to disclose
whether or not, and if not, the reasons therefor, the audit committee
of that issuer is comprised of at least 1 member who is a financial
expert, as such term is defined by the Commission.

(b) CONSIDERATIONS.—In defining the term ‘‘financial expert’’
for purposes of subsection (a), the Commission shall consider
whether a person has, through education and experience as a public
accountant or auditor or a principal financial officer, comptroller,
or principal accounting officer of an issuer, or from a position
involving the performance of similar functions—

(1) an understanding of generally accepted accounting prin-
ciples and financial statements;

(2) experience in—
(A) the preparation or auditing of financial statements

of generally comparable issuers; and
(B) the application of such principles in connection

with the accounting for estimates, accruals, and reserves;
(3) experience with internal accounting controls; and
(4) an understanding of audit committee functions.

90 days after the date of enactment of this Act; and
(2) issue final rules to implement this section, not later

than 180 days after that date of enactment.
SEC. 408. ENHANCED REVIEW OF PERIODIC DISCLOSURES BY ISSUERS.

(a) REGULAR AND SYSTEMATIC REVIEW.—The Commission shall
review disclosures made by issuers reporting under section 13(a)
of the Securities Exchange Act of 1934 (including reports filed
on Form 10–K), and which have a class of securities listed on
a national securities exchange or traded on an automated quotation
facility of a national securities association, on a regular and system-
atic basis for the protection of investors. Such review shall include
a review of an issuer’s financial statement.

(b) REVIEW CRITERIA.—For purposes of scheduling the reviews
required by subsection (a), the Commission shall consider, among
other factors—

(1) issuers that have issued material restatements of finan-
cial results;

(2) issuers that experience significant volatility in their
stock price as compared to other issuers;

(3) issuers with the largest market capitalization;

H. R. 3763—47

(4) emerging companies with disparities in price to earning
ratios;

(5) issuers whose operations significantly affect any mate-
rial sector of the economy; and

(6) any other factors that the Commission may consider
relevant.
(c) MINIMUM REVIEW PERIOD.—In no event shall an issuer

required to file reports under section 13(a) or 15(d) of the Securities
Exchange Act of 1934 be reviewed under this section less frequently
than once every 3 years.
SEC. 409. REAL TIME ISSUER DISCLOSURES.

Section 13 of the Securities Exchange Act of 1934 (15 U.S.C.
78m), as amended by this Act, is amended by adding at the end
the following:

‘‘(l) REAL TIME ISSUER DISCLOSURES.—Each issuer reporting
under section 13(a) or 15(d) shall disclose to the public on a rapid
and current basis such additional information concerning material
changes in the financial condition or operations of the issuer, in
plain English, which may include trend and qualitative information
and graphic presentations, as the Commission determines, by rule,
is necessary or useful for the protection of investors and in the
public interest.’’.

TITLE V—ANALYST CONFLICTS OF
INTEREST

SEC. 501. TREATMENT OF SECURITIES ANALYSTS BY REGISTERED
SECURITIES ASSOCIATIONS AND NATIONAL SECURITIES
EXCHANGES.

(a) RULES REGARDING SECURITIES ANALYSTS.—The Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended by
inserting after section 15C the following new section:
‘‘SEC. 15D. SECURITIES ANALYSTS AND RESEARCH REPORTS.

‘‘(a) ANALYST PROTECTIONS.—The Commission, or upon the
authorization and direction of the Commission, a registered securi-
ties association or national securities exchange, shall have adopted,
not later than 1 year after the date of enactment of this section,
rules reasonably designed to address conflicts of interest that can
arise when securities analysts recommend equity securities in
research reports and public appearances, in order to improve the
objectivity of research and provide investors with more useful and
reliable information, including rules designed—

‘‘(1) to foster greater public confidence in securities
research, and to protect the objectivity and independence of
securities analysts, by—

‘‘(A) restricting the prepublication clearance or
approval of research reports by persons employed by the
broker or dealer who are engaged in investment banking
activities, or persons not directly responsible for investment
research, other than legal or compliance staff;

‘‘(B) limiting the supervision and compensatory evalua-
tion of securities analysts to officials employed by the
broker or dealer who are not engaged in investment
banking activities; and

H. R. 3763—48

‘‘(C) requiring that a broker or dealer and persons
employed by a broker or dealer who are involved with
investment banking activities may not, directly or
indirectly, retaliate against or threaten to retaliate against
any securities analyst employed by that broker or dealer
or its affiliates as a result of an adverse, negative, or
otherwise unfavorable research report that may adversely
affect the present or prospective investment banking rela-
tionship of the broker or dealer with the issuer that is
the subject of the research report, except that such rules
may not limit the authority of a broker or dealer to dis-
cipline a securities analyst for causes other than such
research report in accordance with the policies and proce-
dures of the firm;
‘‘(2) to define periods during which brokers or dealers who

have participated, or are to participate, in a public offering
of securities as underwriters or dealers should not publish
or otherwise distribute research reports relating to such securi-
ties or to the issuer of such securities;

‘‘(3) to establish structural and institutional safeguards
within registered brokers or dealers to assure that securities
analysts are separated by appropriate informational partitions
within the firm from the review, pressure, or oversight of
those whose involvement in investment banking activities
might potentially bias their judgment or supervision; and

‘‘(4) to address such other issues as the Commission, or
such association or exchange, determines appropriate.
‘‘(b) DISCLOSURE.—The Commission, or upon the authorization

and direction of the Commission, a registered securities association
or national securities exchange, shall have adopted, not later than
1 year after the date of enactment of this section, rules reasonably
designed to require each securities analyst to disclose in public
appearances, and each registered broker or dealer to disclose in
each research report, as applicable, conflicts of interest that are
known or should have been known by the securities analyst or
the broker or dealer, to exist at the time of the appearance or
the date of distribution of the report, including—

‘‘(1) the extent to which the securities analyst has debt
or equity investments in the issuer that is the subject of the
appearance or research report;

‘‘(2) whether any compensation has been received by the
registered broker or dealer, or any affiliate thereof, including
the securities analyst, from the issuer that is the subject of
the appearance or research report, subject to such exemptions
as the Commission may determine appropriate and necessary
to prevent disclosure by virtue of this paragraph of material
non-public information regarding specific potential future
investment banking transactions of such issuer, as is appro-
priate in the public interest and consistent with the protection
of investors;

‘‘(3) whether an issuer, the securities of which are rec-
ommended in the appearance or research report, currently is,
or during the 1-year period preceding the date of the appearance
or date of distribution of the report has been, a client of the
registered broker or dealer, and if so, stating the types of
services provided to the issuer;

H. R. 3763—49

‘‘(4) whether the securities analyst received compensation
with respect to a research report, based upon (among any
other factors) the investment banking revenues (either gen-
erally or specifically earned from the issuer being analyzed)
of the registered broker or dealer; and

‘‘(5) such other disclosures of conflicts of interest that are
material to investors, research analysts, or the broker or dealer
as the Commission, or such association or exchange, determines
appropriate.
‘‘(c) DEFINITIONS.—In this section—

‘‘(1) the term ‘securities analyst’ means any associated per-
son of a registered broker or dealer that is principally respon-
sible for, and any associated person who reports directly or
indirectly to a securities analyst in connection with, the
preparation of the substance of a research report, whether
or not any such person has the job title of ‘securities analyst’;
and

‘‘(2) the term ‘research report’ means a written or electronic
communication that includes an analysis of equity securities
of individual companies or industries, and that provides
information reasonably sufficient upon which to base an invest-
ment decision.’’.
(b) ENFORCEMENT.—Section 21B(a) of the Securities Exchange

Act of 1934 (15 U.S.C. 78u–2(a)) is amended by inserting ‘‘15D,’’
before ‘‘15B’’.

(c) COMMISSION AUTHORITY.—The Commission may promulgate
and amend its regulations, or direct a registered securities associa-
tion or national securities exchange to promulgate and amend its
rules, to carry out section 15D of the Securities Exchange Act
of 1934, as added by this section, as is necessary for the protection
of investors and in the public interest.

TITLE VI—COMMISSION RESOURCES
AND AUTHORITY

SEC. 601. AUTHORIZATION OF APPROPRIATIONS.

Section 35 of the Securities Exchange Act of 1934 (15 U.S.C.
78kk) is amended to read as follows:
‘‘SEC. 35. AUTHORIZATION OF APPROPRIATIONS.

‘‘In addition to any other funds authorized to be appropriated
to the Commission, there are authorized to be appropriated to
carry out the functions, powers, and duties of the Commission,
$776,000,000 for fiscal year 2003, of which—

‘‘(1) $102,700,000 shall be available to fund additional com-
pensation, including salaries and benefits, as authorized in
the Investor and Capital Markets Fee Relief Act (Public Law
107–123; 115 Stat. 2390 et seq.);

‘‘(2) $108,400,000 shall be available for information tech-
nology, security enhancements, and recovery and mitigation
activities in light of the terrorist attacks of September 11,
2001; and

‘‘(3) $98,000,000 shall be available to add not fewer than
an additional 200 qualified professionals to provide enhanced
oversight of auditors and audit services required by the Federal
securities laws, and to improve Commission investigative and

H. R. 3763—50

disciplinary efforts with respect to such auditors and services,
as well as for additional professional support staff necessary
to strengthen the programs of the Commission involving Full
Disclosure and Prevention and Suppression of Fraud, risk
management, industry technology review, compliance, inspec-
tions, examinations, market regulation, and investment
management.’’.

SEC. 602. APPEARANCE AND PRACTICE BEFORE THE COMMISSION.

The Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.)
is amended by inserting after section 4B the following:
‘‘SEC. 4C. APPEARANCE AND PRACTICE BEFORE THE COMMISSION.

‘‘(a) AUTHORITY TO CENSURE.—The Commission may censure
any person, or deny, temporarily or permanently, to any person
the privilege of appearing or practicing before the Commission
in any way, if that person is found by the Commission, after
notice and opportunity for hearing in the matter—

‘‘(1) not to possess the requisite qualifications to represent
others;

‘‘(2) to be lacking in character or integrity, or to have
engaged in unethical or improper professional conduct; or

‘‘(3) to have willfully violated, or willfully aided and abetted
the violation of, any provision of the securities laws or the
rules and regulations issued thereunder.
‘‘(b) DEFINITION.—With respect to any registered public

accounting firm or associated person, for purposes of this section,
the term ‘improper professional conduct’ means—

‘‘(1) intentional or knowing conduct, including reckless con-
duct, that results in a violation of applicable professional stand-
ards; and

‘‘(2) negligent conduct in the form of—
‘‘(A) a single instance of highly unreasonable conduct

that results in a violation of applicable professional stand-
ards in circumstances in which the registered public
accounting firm or associated person knows, or should
know, that heightened scrutiny is warranted; or

‘‘(B) repeated instances of unreasonable conduct, each
resulting in a violation of applicable professional standards,
that indicate a lack of competence to practice before the
Commission.’’.

SEC. 603. FEDERAL COURT AUTHORITY TO IMPOSE PENNY STOCK
BARS.

(a) SECURITIES EXCHANGE ACT OF 1934.—Section 21(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78u(d)), as amended
by this Act, is amended by adding at the end the following:

‘‘(6) AUTHORITY OF A COURT TO PROHIBIT PERSONS FROM PARTICI-
PATING IN AN OFFERING OF PENNY STOCK.—

‘‘(A) IN GENERAL.—In any proceeding under paragraph (1)
against any person participating in, or, at the time of the
alleged misconduct who was participating in, an offering of
penny stock, the court may prohibit that person from partici-
pating in an offering of penny stock, conditionally or uncondi-
tionally, and permanently or for such period of time as the
court shall determine.

‘‘(B) DEFINITION.—For purposes of this paragraph, the term
‘person participating in an offering of penny stock’ includes

H. R. 3763—51

any person engaging in activities with a broker, dealer, or
issuer for purposes of issuing, trading, or inducing or
attempting to induce the purchase or sale of, any penny stock.
The Commission may, by rule or regulation, define such term
to include other activities, and may, by rule, regulation, or
order, exempt any person or class of persons, in whole or
in part, conditionally or unconditionally, from inclusion in such
term.’’.
(b) SECURITIES ACT OF 1933.—Section 20 of the Securities Act

of 1933 (15 U.S.C. 77t) is amended by adding at the end the
following:

‘‘(g) AUTHORITY OF A COURT TO PROHIBIT PERSONS FROM
PARTICIPATING IN AN OFFERING OF PENNY STOCK.—

‘‘(1) IN GENERAL.—In any proceeding under subsection (a)
against any person participating in, or, at the time of the
alleged misconduct, who was participating in, an offering of
penny stock, the court may prohibit that person from partici-
pating in an offering of penny stock, conditionally or uncondi-
tionally, and permanently or for such period of time as the
court shall determine.

‘‘(2) DEFINITION.—For purposes of this subsection, the term
‘person participating in an offering of penny stock’ includes
any person engaging in activities with a broker, dealer, or
issuer for purposes of issuing, trading, or inducing or
attempting to induce the purchase or sale of, any penny stock.
The Commission may, by rule or regulation, define such term
to include other activities, and may, by rule, regulation, or
order, exempt any person or class of persons, in whole or
in part, conditionally or unconditionally, from inclusion in such
term.’’.

SEC. 604. QUALIFICATIONS OF ASSOCIATED PERSONS OF BROKERS
AND DEALERS.

(a) BROKERS AND DEALERS.—Section 15(b)(4) of the Securities
Exchange Act of 1934 (15 U.S.C. 78o) is amended—

(1) by striking subparagraph (F) and inserting the fol-
lowing:

‘‘(F) is subject to any order of the Commission barring
or suspending the right of the person to be associated with
a broker or dealer;’’; and

(2) in subparagraph (G), by striking the period at the
end and inserting the following: ‘‘; or

‘‘(H) is subject to any final order of a State securities

commission (or any agency or officer performing like functions),
State authority that supervises or examines banks, savings
associations, or credit unions, State insurance commission (or
any agency or office performing like functions), an appropriate
Federal banking agency (as defined in section 3 of the Federal
Deposit Insurance Act (12 U.S.C. 1813(q))), or the National
Credit Union Administration, that—

‘‘(i) bars such person from association with an entity
regulated by such commission, authority, agency, or officer,
or from engaging in the business of securities, insurance,
banking, savings association activities, or credit union
activities; or

H. R. 3763—52

‘‘(ii) constitutes a final order based on violations of
any laws or regulations that prohibit fraudulent, manipula-
tive, or deceptive conduct.’’.

(b) INVESTMENT ADVISERS.—Section 203(e) of the Investment
Advisers Act of 1940 (15 U.S.C. 80b–3(e)) is amended—

(1) by striking paragraph (7) and inserting the following:
‘‘(7) is subject to any order of the Commission barring

or suspending the right of the person to be associated with
an investment adviser;’’;

(2) in paragraph (8), by striking the period at the end
and inserting ‘‘; or’’; and

(3) by adding at the end the following:
‘‘(9) is subject to any final order of a State securities

‘‘(A) bars such person from association with an entity
regulated by such commission, authority, agency, or officer,
or from engaging in the business of securities, insurance,
banking, savings association activities, or credit union
activities; or

‘‘(B) constitutes a final order based on violations of
any laws or regulations that prohibit fraudulent, manipula-
tive, or deceptive conduct.’’.

Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended—
(A) in section 3(a)(39)(F) (15 U.S.C. 78c(a)(39)(F))—

(i) by striking ‘‘or (G)’’ and inserting ‘‘(H), or (G)’’;
and

(ii) by inserting ‘‘, or is subject to an order or
finding,’’ before ‘‘enumerated’’;
(B) in each of section 15(b)(6)(A)(i) (15 U.S.C.

78o(b)(6)(A)(i)), paragraphs (2) and (4) of section 15B(c)
(15 U.S.C. 78o–4(c)), and subparagraphs (A) and (C) of
section 15C(c)(1) (15 U.S.C. 78o–5(c)(1))—

(i) by striking ‘‘or (G)’’ each place that term appears
and inserting ‘‘(H), or (G)’’; and

(ii) by striking ‘‘or omission’’ each place that term
appears, and inserting ‘‘, or is subject to an order
or finding,’’; and
(C) in each of paragraphs (3)(A) and (4)(C) of section

17A(c) (15 U.S.C. 78q–1(c))—
(i) by striking ‘‘or (G)’’ each place that term appears

and inserting ‘‘(H), or (G)’’; and
(ii) by inserting ‘‘, or is subject to an order or

finding,’’ before ‘‘enumerated’’ each place that term
appears.

(2) INVESTMENT ADVISERS ACT OF 1940.—Section 203(f) of
the Investment Advisers Act of 1940 (15 U.S.C. 80b–3(f)) is
amended—

(A) by striking ‘‘or (8)’’ and inserting ‘‘(8), or (9)’’; and
(B) by inserting ‘‘or (3)’’ after ‘‘paragraph (2)’’.

H. R. 3763—53

TITLE VII—STUDIES AND REPORTS

SEC. 701. GAO STUDY AND REPORT REGARDING CONSOLIDATION OF
PUBLIC ACCOUNTING FIRMS.

(a) STUDY REQUIRED.—The Comptroller General of the United
States shall conduct a study—

(1) to identify—
(A) the factors that have led to the consolidation of

public accounting firms since 1989 and the consequent
reduction in the number of firms capable of providing audit
services to large national and multi-national business
organizations that are subject to the securities laws;

(B) the present and future impact of the condition
described in subparagraph (A) on capital formation and
securities markets, both domestic and international; and

(C) solutions to any problems identified under subpara-
graph (B), including ways to increase competition and the
number of firms capable of providing audit services to
large national and multinational business organizations
that are subject to the securities laws;
(2) of the problems, if any, faced by business organizations

that have resulted from limited competition among public
accounting firms, including—

(A) higher costs;
(B) lower quality of services;
(C) impairment of auditor independence; or
(D) lack of choice; and

(3) whether and to what extent Federal or State regulations
impede competition among public accounting firms.
(b) CONSULTATION.—In planning and conducting the study

under this section, the Comptroller General shall consult with—
(1) the Commission;
(2) the regulatory agencies that perform functions similar

to the Commission within the other member countries of the
Group of Seven Industrialized Nations;

(3) the Department of Justice; and
(4) any other public or private sector organization that

the Comptroller General considers appropriate.
(c) REPORT REQUIRED.—Not later than 1 year after the date

of enactment of this Act, the Comptroller General shall submit
a report on the results of the study required by this section to
the Committee on Banking, Housing, and Urban Affairs of the
Senate and the Committee on Financial Services of the House
of Representatives.

SEC. 702. COMMISSION STUDY AND REPORT REGARDING CREDIT
RATING AGENCIES.

(a) STUDY REQUIRED.—
(1) IN GENERAL.—The Commission shall conduct a study

of the role and function of credit rating agencies in the operation
of the securities market.

(2) AREAS OF CONSIDERATION.—The study required by this
subsection shall examine—

(A) the role of credit rating agencies in the evaluation
of issuers of securities;

H. R. 3763—54

(B) the importance of that role to investors and the
functioning of the securities markets;

(C) any impediments to the accurate appraisal by credit
rating agencies of the financial resources and risks of
issuers of securities;

(D) any barriers to entry into the business of acting
as a credit rating agency, and any measures needed to
remove such barriers;

(E) any measures which may be required to improve
the dissemination of information concerning such resources
and risks when credit rating agencies announce credit
ratings; and

(F) any conflicts of interest in the operation of credit
rating agencies and measures to prevent such conflicts
or ameliorate the consequences of such conflicts.

(b) REPORT REQUIRED.—The Commission shall submit a report
on the study required by subsection (a) to the President, the Com-
mittee on Financial Services of the House of Representatives, and
the Committee on Banking, Housing, and Urban Affairs of the
Senate not later than 180 days after the date of enactment of
this Act.

SEC. 703. STUDY AND REPORT ON VIOLATORS AND VIOLATIONS.

(a) STUDY.—The Commission shall conduct a study to deter-
mine, based upon information for the period from January 1, 1998,
to December 31, 2001—

(1) the number of securities professionals, defined as public
accountants, public accounting firms, investment bankers,
investment advisers, brokers, dealers, attorneys, and other
securities professionals practicing before the Commission—

(A) who have been found to have aided and abetted
a violation of the Federal securities laws, including rules
or regulations promulgated thereunder (collectively
referred to in this section as ‘‘Federal securities laws’’),
but who have not been sanctioned, disciplined, or otherwise
penalized as a primary violator in any administrative
action or civil proceeding, including in any settlement of
such an action or proceeding (referred to in this section
as ‘‘aiders and abettors’’); and

(B) who have been found to have been primary violators
of the Federal securities laws;
(2) a description of the Federal securities laws violations

committed by aiders and abettors and by primary violators,
including—

(A) the specific provision of the Federal securities laws
violated;

(B) the specific sanctions and penalties imposed upon
such aiders and abettors and primary violators, including
the amount of any monetary penalties assessed upon and
collected from such persons;

(C) the occurrence of multiple violations by the same
person or persons, either as an aider or abettor or as
a primary violator; and

(D) whether, as to each such violator, disciplinary sanc-
tions have been imposed, including any censure, suspen-
sion, temporary bar, or permanent bar to practice before
the Commission; and

H. R. 3763—55

(3) the amount of disgorgement, restitution, or any other
fines or payments that the Commission has assessed upon
and collected from, aiders and abettors and from primary viola-
tors.
(b) REPORT.—A report based upon the study conducted pursuant

to subsection (a) shall be submitted to the Committee on Banking,
Housing, and Urban Affairs of the Senate, and the Committee
on Financial Services of the House of Representatives not later
than 6 months after the date of enactment of this Act.

SEC. 704. STUDY OF ENFORCEMENT ACTIONS.

(a) STUDY REQUIRED.—The Commission shall review and ana-
lyze all enforcement actions by the Commission involving violations
of reporting requirements imposed under the securities laws, and
restatements of financial statements, over the 5-year period pre-
ceding the date of enactment of this Act, to identify areas of
reporting that are most susceptible to fraud, inappropriate manipu-
lation, or inappropriate earnings management, such as revenue
recognition and the accounting treatment of off-balance sheet special
purpose entities.

(b) REPORT REQUIRED.—The Commission shall report its
findings to the Committee on Financial Services of the House of
Representatives and the Committee on Banking, Housing, and
Urban Affairs of the Senate, not later than 180 days after the
date of enactment of this Act, and shall use such findings to revise
its rules and regulations, as necessary. The report shall include
a discussion of regulatory or legislative steps that are recommended
or that may be necessary to address concerns identified in the
study.

SEC. 705. STUDY OF INVESTMENT BANKS.

(a) GAO STUDY.—The Comptroller General of the United States
shall conduct a study on whether investment banks and financial
advisers assisted public companies in manipulating their earnings
and obfuscating their true financial condition. The study should
address the rule of investment banks and financial advisers—

(1) in the collapse of the Enron Corporation, including
with respect to the design and implementation of derivatives
transactions, transactions involving special purpose vehicles,
and other financial arrangements that may have had the effect
of altering the company’s reported financial statements in ways
that obscured the true financial picture of the company;

(2) in the failure of Global Crossing, including with respect
to transactions involving swaps of fiberoptic cable capacity,
in the designing transactions that may have had the effect
of altering the company’s reported financial statements in ways
that obscured the true financial picture of the company; and

(3) generally, in creating and marketing transactions which
may have been designed solely to enable companies to manipu-
late revenue streams, obtain loans, or move liabilities off
balance sheets without altering the economic and business risks
faced by the companies or any other mechanism to obscure
a company’s financial picture.
(b) REPORT.—The Comptroller General shall report to Congress

not later than 180 days after the date of enactment of this Act
on the results of the study required by this section. The report
shall include a discussion of regulatory or legislative steps that

H. R. 3763—56

are recommended or that may be necessary to address concerns
identified in the study.

TITLE VIII—CORPORATE AND
CRIMINAL FRAUD ACCOUNTABILITY

SEC. 801. SHORT TITLE.

This title may be cited as the ‘‘Corporate and Criminal Fraud
Accountability Act of 2002’’.
SEC. 802. CRIMINAL PENALTIES FOR ALTERING DOCUMENTS.

(a) IN GENERAL.—Chapter 73 of title 18, United States Code,
is amended by adding at the end the following:

‘‘§ 1519. Destruction, alteration, or falsification of records
in Federal investigations and bankruptcy

‘‘Whoever knowingly alters, destroys, mutilates, conceals, covers
up, falsifies, or makes a false entry in any record, document, or
tangible object with the intent to impede, obstruct, or influence
the investigation or proper administration of any matter within
the jurisdiction of any department or agency of the United States
or any case filed under title 11, or in relation to or contemplation
of any such matter or case, shall be fined under this title, impris-
oned not more than 20 years, or both.

‘‘§ 1520. Destruction of corporate audit records
‘‘(a)(1) Any accountant who conducts an audit of an issuer

of securities to which section 10A(a) of the Securities Exchange
Act of 1934 (15 U.S.C. 78j–1(a)) applies, shall maintain all audit
or review workpapers for a period of 5 years from the end of
the fiscal period in which the audit or review was concluded.

‘‘(2) The Securities and Exchange Commission shall promulgate,
within 180 days, after adequate notice and an opportunity for
comment, such rules and regulations, as are reasonably necessary,
relating to the retention of relevant records such as workpapers,
documents that form the basis of an audit or review, memoranda,
correspondence, communications, other documents, and records
(including electronic records) which are created, sent, or received
in connection with an audit or review and contain conclusions,
opinions, analyses, or financial data relating to such an audit or
review, which is conducted by any accountant who conducts an
audit of an issuer of securities to which section 10A(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78j–1(a)) applies. The
Commission may, from time to time, amend or supplement the
rules and regulations that it is required to promulgate under this
section, after adequate notice and an opportunity for comment,
in order to ensure that such rules and regulations adequately
comport with the purposes of this section.

‘‘(b) Whoever knowingly and willfully violates subsection (a)(1),
or any rule or regulation promulgated by the Securities and
Exchange Commission under subsection (a)(2), shall be fined under
this title, imprisoned not more than 10 years, or both.

‘‘(c) Nothing in this section shall be deemed to diminish or
relieve any person of any other duty or obligation imposed by
Federal or State law or regulation to maintain, or refrain from
destroying, any document.’’.

H. R. 3763—57

(b) CLERICAL AMENDMENT.—The table of sections at the begin-
ning of chapter 73 of title 18, United States Code, is amended
by adding at the end the following new items:

‘‘1519. Destruction, alteration, or falsification of records in Federal investigations
and bankruptcy.

‘‘1520. Destruction of corporate audit records.’’.

SEC. 803. DEBTS NONDISCHARGEABLE IF INCURRED IN VIOLATION
OF SECURITIES FRAUD LAWS.

Section 523(a) of title 11, United States Code, is amended—
(1) in paragraph (17), by striking ‘‘or’’ after the semicolon;
(2) in paragraph (18), by striking the period at the end

and inserting ‘‘; or’’; and
(3) by adding at the end, the following:
‘‘(19) that—

‘‘(A) is for—
‘‘(i) the violation of any of the Federal securities

laws (as that term is defined in section 3(a)(47) of
the Securities Exchange Act of 1934), any of the State
securities laws, or any regulation or order issued under
such Federal or State securities laws; or

‘‘(ii) common law fraud, deceit, or manipulation
in connection with the purchase or sale of any security;
and
‘‘(B) results from—

‘‘(i) any judgment, order, consent order, or decree
entered in any Federal or State judicial or administra-
tive proceeding;

‘‘(ii) any settlement agreement entered into by the
debtor; or

‘‘(iii) any court or administrative order for any
damages, fine, penalty, citation, restitutionary pay-
ment, disgorgement payment, attorney fee, cost, or
other payment owed by the debtor.’’.

SEC. 804. STATUTE OF LIMITATIONS FOR SECURITIES FRAUD.

(a) IN GENERAL.—Section 1658 of title 28, United States Code,
is amended—

(1) by inserting ‘‘(a)’’ before ‘‘Except’’; and
(2) by adding at the end the following:

‘‘(b) Notwithstanding subsection (a), a private right of action
that involves a claim of fraud, deceit, manipulation, or contrivance
in contravention of a regulatory requirement concerning the securi-
ties laws, as defined in section 3(a)(47) of the Securities Exchange
Act of 1934 (15 U.S.C. 78c(a)(47)), may be brought not later than
the earlier of—

‘‘(1) 2 years after the discovery of the facts constituting
the violation; or

‘‘(2) 5 years after such violation.’’.
(b) EFFECTIVE DATE.—The limitations period provided by sec-

tion 1658(b) of title 28, United States Code, as added by this
section, shall apply to all proceedings addressed by this section
that are commenced on or after the date of enactment of this
Act.

H. R. 3763—58

SEC. 805. REVIEW OF FEDERAL SENTENCING GUIDELINES FOR
OBSTRUCTION OF JUSTICE AND EXTENSIVE CRIMINAL
FRAUD.

(a) ENHANCEMENT OF FRAUD AND OBSTRUCTION OF JUSTICE
SENTENCES.—Pursuant to section 994 of title 28, United States
Code, and in accordance with this section, the United States Sen-
tencing Commission shall review and amend, as appropriate, the
Federal Sentencing Guidelines and related policy statements to
ensure that—

(1) the base offense level and existing enhancements con-
tained in United States Sentencing Guideline 2J1.2 relating
to obstruction of justice are sufficient to deter and punish
that activity;

(2) the enhancements and specific offense characteristics
relating to obstruction of justice are adequate in cases where—

(A) the destruction, alteration, or fabrication of evi-
dence involves—

(i) a large amount of evidence, a large number
of participants, or is otherwise extensive;

(ii) the selection of evidence that is particularly
probative or essential to the investigation; or

(iii) more than minimal planning; or
(B) the offense involved abuse of a special skill or

a position of trust;
(3) the guideline offense levels and enhancements for viola-

tions of section 1519 or 1520 of title 18, United States Code,
as added by this title, are sufficient to deter and punish that
activity;

(4) a specific offense characteristic enhancing sentencing
is provided under United States Sentencing Guideline 2B1.1
(as in effect on the date of enactment of this Act) for a fraud
offense that endangers the solvency or financial security of
a substantial number of victims; and

(5) the guidelines that apply to organizations in United
States Sentencing Guidelines, chapter 8, are sufficient to deter
and punish organizational criminal misconduct.
(b) EMERGENCY AUTHORITY AND DEADLINE FOR COMMISSION

ACTION.—The United States Sentencing Commission is requested
to promulgate the guidelines or amendments provided for under
this section as soon as practicable, and in any event not later
than 180 days after the date of enactment of this Act, in accordance
with the prcedures set forth in section 219(a) of the Sentencing
Reform Act of 1987, as though the authority under that Act had
not expired.
SEC. 806. PROTECTION FOR EMPLOYEES OF PUBLICLY TRADED

COMPANIES WHO PROVIDE EVIDENCE OF FRAUD.

(a) IN GENERAL.—Chapter 73 of title 18, United States Code,
is amended by inserting after section 1514 the following:

‘‘§ 1514A. Civil action to protect against retaliation in fraud
cases

‘‘(a) WHISTLEBLOWER PROTECTION FOR EMPLOYEES OF PUBLICLY
TRADED COMPANIES.—No company with a class of securities reg-
istered under section 12 of the Securities Exchange Act of 1934
(15 U.S.C. 78l), or that is required to file reports under section
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)),

H. R. 3763—59

or any officer, employee, contractor, subcontractor, or agent of such
company, may discharge, demote, suspend, threaten, harass, or
in any other manner discriminate against an employee in the terms
and conditions of employment because of any lawful act done by
the employee—

‘‘(1) to provide information, cause information to be pro-
vided, or otherwise assist in an investigation regarding any
conduct which the employee reasonably believes constitutes
a violation of section 1341, 1343, 1344, or 1348, any rule or
regulation of the Securities and Exchange Commission, or any
provision of Federal law relating to fraud against shareholders,
when the information or assistance is provided to or the inves-
tigation is conducted by—

‘‘(A) a Federal regulatory or law enforcement agency;
‘‘(B) any Member of Congress or any committee of

Congress; or
‘‘(C) a person with supervisory authority over the

employee (or such other person working for the employer
who has the authority to investigate, discover, or terminate
misconduct); or
‘‘(2) to file, cause to be filed, testify, participate in, or

otherwise assist in a proceeding filed or about to be filed
(with any knowledge of the employer) relating to an alleged
violation of section 1341, 1343, 1344, or 1348, any rule or
regulation of the Securities and Exchange Commission, or any
provision of Federal law relating to fraud against shareholders.
‘‘(b) ENFORCEMENT ACTION.—

‘‘(1) IN GENERAL.—A person who alleges discharge or other
discrimination by any person in violation of subsection (a) may
seek relief under subsection (c), by—

‘‘(A) filing a complaint with the Secretary of Labor;
or

‘‘(B) if the Secretary has not issued a final decision
within 180 days of the filing of the complaint and there
is no showing that such delay is due to the bad faith
of the claimant, bringing an action at law or equity for
de novo review in the appropriate district court of the
United States, which shall have jurisdiction over such an
action without regard to the amount in controversy.
‘‘(2) PROCEDURE.—

‘‘(A) IN GENERAL.—An action under paragraph (1)(A)
shall be governed under the rules and procedures set forth
in section 42121(b) of title 49, United States Code.

‘‘(B) EXCEPTION.—Notification made under section
42121(b)(1) of title 49, United States Code, shall be made
to the person named in the complaint and to the employer.

‘‘(C) BURDENS OF PROOF.—An action brought under
paragraph (1)(B) shall be governed by the legal burdens
of proof set forth in section 42121(b) of title 49, United
States Code.

‘‘(D) STATUTE OF LIMITATIONS.—An action under para-
graph (1) shall be commenced not later than 90 days after
the date on which the violation occurs.

‘‘(c) REMEDIES.—
‘‘(1) IN GENERAL.—An employee prevailing in any action

under subsection (b)(1) shall be entitled to all relief necessary
to make the employee whole.

H. R. 3763—60

‘‘(2) COMPENSATORY DAMAGES.—Relief for any action under
paragraph (1) shall include—

‘‘(A) reinstatement with the same seniority status that
the employee would have had, but for the discrimination;

‘‘(B) the amount of back pay, with interest; and
‘‘(C) compensation for any special damages sustained

as a result of the discrimination, including litigation costs,
expert witness fees, and reasonable attorney fees.

‘‘(d) RIGHTS RETAINED BY EMPLOYEE.—Nothing in this section
shall be deemed to diminish the rights, privileges, or remedies
of any employee under any Federal or State law, or under any
collective bargaining agreement.’’.

(b) CLERICAL AMENDMENT.—The table of sections at the begin-
ning of chapter 73 of title 18, United States Code, is amended
by inserting after the item relating to section 1514 the following
new item:

‘‘1514A. Civil action to protect against retaliation in fraud cases.’’.

SEC. 807. CRIMINAL PENALTIES FOR DEFRAUDING SHAREHOLDERS
OF PUBLICLY TRADED COMPANIES.

(a) IN GENERAL.—Chapter 63 of title 18, United States Code,
is amended by adding at the end the following:

‘‘§ 1348. Securities fraud
‘‘Whoever knowingly executes, or attempts to execute, a scheme

or artifice—
‘‘(1) to defraud any person in connection with any security

of an issuer with a class of securities registered under section
12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l)
or that is required to file reports under section 15(d) of the
Securities Exchange Act of 1934 (15 U.S.C. 78o(d)); or

‘‘(2) to obtain, by means of false or fraudulent pretenses,
representations, or promises, any money or property in connec-
tion with the purchase or sale of any security of an issuer
with a class of securities registered under section 12 of the
Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is
required to file reports under section 15(d) of the Securities
Exchange Act of 1934 (15 U.S.C. 78o(d));

shall be fined under this title, or imprisoned not more than 25
years, or both.’’.

(b) CLERICAL AMENDMENT.—The table of sections at the begin-
ning of chapter 63 of title 18, United States Code, is amended
by adding at the end the following new item:

‘‘1348. Securities fraud.’’.

TITLE IX—WHITE-COLLAR CRIME
PENALTY ENHANCEMENTS

SEC. 901. SHORT TITLE.

This title may be cited as the ‘‘White-Collar Crime Penalty
Enhancement Act of 2002’’.

H. R. 3763—61

SEC. 902. ATTEMPTS AND CONSPIRACIES TO COMMIT CRIMINAL
FRAUD OFFENSES.

(a) IN GENERAL.—Chapter 63 of title 18, United States Code,
is amended by inserting after section 1348 as added by this Act
the following:

‘‘§ 1349. Attempt and conspiracy
‘‘Any person who attempts or conspires to commit any offense

under this chapter shall be subject to the same penalties as those
prescribed for the offense, the commission of which was the object
of the attempt or conspiracy.

(b) CLERICAL AMENDMENT.—The table of sections at the begin-
ning of chapter 63 of title 18, United States Code, is amended
by adding at the end the following new item:
‘‘1349. Attempt and conspiracy.’’.

SEC. 903. CRIMINAL PENALTIES FOR MAIL AND WIRE FRAUD.

(a) MAIL FRAUD.—Section 1341 of title 18, United States Code,
is amended by striking ‘‘five’’ and inserting ‘‘20’’.

(b) WIRE FRAUD.—Section 1343 of title 18, United States Code,
is amended by striking ‘‘five’’ and inserting ‘‘20’’.
SEC. 904. CRIMINAL PENALTIES FOR VIOLATIONS OF THE EMPLOYEE

RETIREMENT INCOME SECURITY ACT OF 1974.

Section 501 of the Employee Retirement Income Security Act
of 1974 (29 U.S.C. 1131) is amended—

(1) by striking ‘‘$5,000’’ and inserting ‘‘$100,000’’;
(2) by striking ‘‘one year’’ and inserting ‘‘10 years’’; and
(3) by striking ‘‘$100,000’’ and inserting ‘‘$500,000’’.

SEC. 905. AMENDMENT TO SENTENCING GUIDELINES RELATING TO
CERTAIN WHITE-COLLAR OFFENSES.

(a) DIRECTIVE TO THE UNITED STATES SENTENCING COMMIS-
SION.—Pursuant to its authority under section 994(p) of title 18,
United States Code, and in accordance with this section, the United
States Sentencing Commission shall review and, as appropriate,
amend the Federal Sentencing Guidelines and related policy state-
ments to implement the provisions of this Act.

(b) REQUIREMENTS.—In carrying out this section, the Sen-
tencing Commission shall—

(1) ensure that the sentencing guidelines and policy state-
ments reflect the serious nature of the offenses and the pen-
alties set forth in this Act, the growing incidence of serious
fraud offenses which are identified above, and the need to
modify the sentencing guidelines and policy statements to deter,
prevent, and punish such offenses;

(2) consider the extent to which the guidelines and policy
statements adequately address whether the guideline offense
levels and enhancements for violations of the sections amended
by this Act are sufficient to deter and punish such offenses,
and specifically, are adequate in view of the statutory increases
in penalties contained in this Act;

(3) assure reasonable consistency with other relevant direc-
tives and sentencing guidelines;

(4) account for any additional aggravating or mitigating
circumstances that might justify exceptions to the generally
applicable sentencing ranges;

H. R. 3763—62

(5) make any necessary conforming changes to the sen-
tencing guidelines; and

(6) assure that the guidelines adequately meet the purposes
of sentencing, as set forth in section 3553(a)(2) of title 18,
United States Code.
(c) EMERGENCY AUTHORITY AND DEADLINE FOR COMMISSION

ACTION.—The United States Sentencing Commission is requested
to promulgate the guidelines or amendments provided for under
this section as soon as practicable, and in any event not later
than 180 days after the date of enactment of this Act, in accordance
with the procedures set forth in section 219(a) of the Sentencing
Reform Act of 1987, as though the authority under that Act had
not expired.

SEC. 906. CORPORATE RESPONSIBILITY FOR FINANCIAL REPORTS.

(a) IN GENERAL.—Chapter 63 of title 18, United States Code,
is amended by inserting after section 1349, as created by this
Act, the following:

‘‘§ 1350. Failure of corporate officers to certify financial
reports

(a) CERTIFICATION OF PERIODIC FINANCIAL REPORTS.—Each
periodic report containing financial statements filed by an issuer
with the Securities Exchange Commission pursuant to section 13(a)
or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a)
or 78o(d)) shall be accompanied by a written statement by the
chief executive officer and chief financial officer (or equivalent
thereof) of the issuer.

‘‘(b) CONTENT.—The statement required under subsection (a)
shall certify that the periodic report containing the financial state-
ments fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act pf 1934 (15 U.S.C. 78m or
78o(d)) and that information contained in the periodic report fairly
presents, in all material respects, the financial condition and results
of operations of the issuer.

‘‘(c) CRIMINAL PENALTIES.—Whoever—
‘‘(1) certifies any statement as set forth in subsections

(a) and (b) of this section knowing that the periodic report
accompanying the statement does not comport with all the
requirements set forth in this section shall be fined not more
than $1,000,000 or imprisoned not more than 10 years, or
both; or

‘‘(2) willfully certifies any statement as set forth in sub-
sections (a) and (b) of this section knowing that the periodic
report accompanying the statement does not comport with all
the requirements set forth in this section shall be fined not
more than $5,000,000, or imprisoned not more than 20 years,
or both.’’.
(b) CLERICAL AMENDMENT.—The table of sections at the begin-

ning of chapter 63 of title 18, United States Code, is amended
by adding at the end the following:

‘‘1350. Failure of corporate officers to certify financial reports.’’.

H. R. 3763—63

TITLE X—CORPORATE TAX RETURNS

SEC. 1001. SENSE OF THE SENATE REGARDING THE SIGNING OF COR-
PORATE TAX RETURNS BY CHIEF EXECUTIVE OFFICERS.

It is the sense of the Senate that the Federal income tax
return of a corporation should be signed by the chief executive
officer of such corporation.

TITLE XI—CORPORATE FRAUD
ACCOUNTABILITY

SEC. 1101. SHORT TITLE.

This title may be cited as the ‘‘Corporate Fraud Accountability
Act of 2002’’.

SEC. 1102. TAMPERING WITH A RECORD OR OTHERWISE IMPEDING
AN OFFICIAL PROCEEDING.

Section 1512 of title 18, United States Code, is amended—
(1) by redesignating subsections (c) through (i) as sub-

sections (d) through (j), respectively; and
(2) by inserting after subsection (b) the following new sub-

section:
‘‘(c) Whoever corruptly—

‘‘(1) alters, destroys, mutilates, or conceals a record, docu-
ment, or other object, or attempts to do so, with the intent
to impair the object’s integrity or availability for use in an
official proceeding; or

‘‘(2) otherwise obstructs, influences, or impedes any official
proceeding, or attempts to do so,

shall be fined under this title or imprisoned not more than 20
years, or both.’’.

SEC. 1103. TEMPORARY FREEZE AUTHORITY FOR THE SECURITIES AND
EXCHANGE COMMISSION.

(a) IN GENERAL.—Section 21C(c) of the Securities Exchange
Act of 1934 (15 U.S.C. 78u–3(c)) is amended by adding at the
end the following:

‘‘(3) TEMPORARY FREEZE.—
‘‘(A) IN GENERAL.—

‘‘(i) ISSUANCE OF TEMPORARY ORDER.—Whenever,
during the course of a lawful investigation involving
possible violations of the Federal securities laws by
an issuer of publicly traded securities or any of its
directors, officers, partners, controlling persons, agents,
or employees, it shall appear to the Commission that
it is likely that the issuer will make extraordinary
payments (whether compensation or otherwise) to any
of the foregoing persons, the Commission may petition
a Federal district court for a temporary order requiring
the issuer to escrow, subject to court supervision, those
payments in an interest-bearing account for 45 days.

‘‘(ii) STANDARD.—A temporary order shall be
entered under clause (i), only after notice and oppor-
tunity for a hearing, unless the court determines that

H. R. 3763—64

notice and hearing prior to entry of the order would
be impracticable or contrary to the public interest.

‘‘(iii) EFFECTIVE PERIOD.—A temporary order
issued under clause (i) shall—

‘‘(I) become effective immediately;
‘‘(II) be served upon the parties subject to it;

and
‘‘(III) unless set aside, limited or suspended

by a court of competent jurisdiction, shall remain
effective and enforceable for 45 days.
‘‘(iv) EXTENSIONS AUTHORIZED.—The effective

period of an order under this subparagraph may be
extended by the court upon good cause shown for not
longer than 45 additional days, provided that the com-
bined period of the order shall not exceed 90 days.
‘‘(B) PROCESS ON DETERMINATION OF VIOLATIONS.—

‘‘(i) VIOLATIONS CHARGED.—If the issuer or other
person described in subparagraph (A) is charged with
any violation of the Federal securities laws before the
expiration of the effective period of a temporary order
under subparagraph (A) (including any applicable
extension period), the order shall remain in effect,
subject to court approval, until the conclusion of any
legal proceedings related thereto, and the affected
issuer or other person, shall have the right to petition
the court for review of the order.

‘‘(ii) VIOLATIONS NOT CHARGED.—If the issuer or
other person described in subparagraph (A) is not
charged with any violation of the Federal securities
laws before the expiration of the effective period of
a temporary order under subparagraph (A) (including
any applicable extension period), the escrow shall
terminate at the expiration of the 45-day effective
period (or the expiration of any extension period, as
applicable), and the disputed payments (with accrued
interest) shall be returned to the issuer or other
affected person.’’.

(b) TECHNICAL AMENDMENT.—Section 21C(c)(2) of the Securities
Exchange Act of 1934 (15 U.S.C. 78u–3(c)(2)) is amended by striking
‘‘This’’ and inserting ‘‘paragraph (1)’’.

SEC. 1104. AMENDMENT TO THE FEDERAL SENTENCING GUIDELINES.

(a) REQUEST FOR IMMEDIATE CONSIDERATION BY THE UNITED
STATES SENTENCING COMMISSION.—Pursuant to its authority under
section 994(p) of title 28, United States Code, and in accordance
with this section, the United States Sentencing Commission is
requested to—

(1) promptly review the sentencing guidelines applicable
to securities and accounting fraud and related offenses;

(2) expeditiously consider the promulgation of new sen-
tencing guidelines or amendments to existing sentencing guide-
lines to provide an enhancement for officers or directors of
publicly traded corporations who commit fraud and related
offenses; and

(3) submit to Congress an explanation of actions taken
by the Sentencing Commission pursuant to paragraph (2) and

H. R. 3763—65

any additional policy recommendations the Sentencing Commis-
sion may have for combating offenses described in paragraph
(1).
(b) CONSIDERATIONS IN REVIEW.—In carrying out this section,

the Sentencing Commission is requested to—
(1) ensure that the sentencing guidelines and policy state-

ments reflect the serious nature of securities, pension, and
accounting fraud and the need for aggressive and appropriate
law enforcement action to prevent such offenses;

(2) assure reasonable consistency with other relevant direc-
tives and with other guidelines;

(3) account for any aggravating or mitigating circumstances
that might justify exceptions, including circumstances for which
the sentencing guidelines currently provide sentencing enhance-
ments;

(4) ensure that guideline offense levels and enhancements
for an obstruction of justice offense are adequate in cases where
documents or other physical evidence are actually destroyed
or fabricated;

(5) ensure that the guideline offense levels and enhance-
ments under United States Sentencing Guideline 2B1.1 (as
in effect on the date of enactment of this Act) are sufficient
for a fraud offense when the number of victims adversely
involved is significantly greater than 50;

(6) make any necessary conforming changes to the sen-
tencing guidelines; and

(7) assure that the guidelines adequately meet the purposes
of sentencing as set forth in section 3553 (a)(2) of title 18,
United States Code.
(c) EMERGENCY AUTHORITY AND DEADLINE FOR COMMISSION

ACTION.—The United States Sentencing Commission is requested
to promulgate the guidelines or amendments provided for under
this section as soon as practicable, and in any event not later
than the 180 days after the date of enactment of this Act, in
accordance with the procedures sent forth in section 21(a) of the
Sentencing Reform Act of 1987, as though the authority under
that Act had not expired.

SEC. 1105. AUTHORITY OF THE COMMISSION TO PROHIBIT PERSONS
FROM SERVING AS OFFICERS OR DIRECTORS.

(a) SECURITIES EXCHANGE ACT OF 1934.—Section 21C of the
Securities Exchange Act of 1934 (15 U.S.C. 78u–3) is amended
by adding at the end the following:

‘‘(f) AUTHORITY OF THE COMMISSION TO PROHIBIT PERSONS FROM
SERVING AS OFFICERS OR DIRECTORS.—In any cease-and-desist pro-
ceeding under subsection (a), the Commission may issue an order
to prohibit, conditionally or unconditionally, and permanently or
for such period of time as it shall determine, any person who
has violated section 10(b) or the rules or regulations thereunder,
from acting as an officer or director of any issuer that has a
class of securities registered pursuant to section 12, or that is
required to file reports pursuant to section 15(d), if the conduct
of that person demonstrates unfitness to serve as an officer or
director of any such issuer.’’.

(b) SECURITIES ACT OF 1933.—Section 8A of the Securities
Act of 1933 (15 U.S.C. 77h–1) is amended by adding at the end
of the following:

H. R. 3763—66

‘‘(f) AUTHORITY OF THE COMMISSION TO PROHIBIT PERSONS FROM
SERVING AS OFFICERS OR DIRECTORS.—In any cease-and-desist pro-
ceeding under subsection (a), the Commission may issue an order
to prohibit, conditionally or unconditionally, and permanently or
for such period of time as it shall determine, any person who
has violated section 17(a)(1) or the rules or regulations thereunder,
from acting as an officer or director of any issuer that has a
class of securities registered pursuant to section 12 of the Securities
Exchange Act of 1934, or that is required to file reports pursuant
to section 15(d) of that Act, if the conduct of that person dem-
onstrates unfitness to serve as an officer or director of any such
issuer.’’.
SEC. 1106. INCREASED CRIMINAL PENALTIES UNDER SECURITIES

EXCHANGE ACT OF 1934.

Section 32(a) of the Securities Exchange Act of 1934 (15 U.S.C.
78ff(a)) is amended—

(1) by striking ‘‘$1,000,000, or imprisoned not more than
10 years’’ and inserting ‘‘$5,000,000, or imprisoned not more
than 20 years’’; and

(2) by striking ‘‘$2,500,000’’ and inserting ‘‘$25,000,000’’.
SEC. 1107. RETALIATION AGAINST INFORMANTS.

(a) IN GENERAL.—Section 1513 of title 18, United States Code,
is amended by adding at the end the following:

‘‘(e) Whoever knowingly, with the intent to retaliate, takes
any action harmful to any person, including interference with the
lawful employment or livelihood of any person, for providing to
a law enforcement officer any truthful information relating to the
commission or possible commission of any Federal offense, shall
be fined under this title or imprisoned not more than 10 years,
or both.’’.

Speaker of the House of Representatives.

Vice President of the United States and
President of the Senate.

FindLaw:

The Goals and Promise of the
Sarbanes–Oxley Act

John C. Coates IV

C ongress passed the Sarbanes–Oxley Act on July 25, 2002. By that day, stockmarket indices of large capitalization stocks had fallen 40 percent over thepreceding 30 months. The headlines had been full of prominent compa-
nies involved in financial scandals and bankruptcies: Enron, Worldcom, Xerox,
Sunbeam, Waste Management, Adelphia, Tyco, HealthSouth, Global Crossing, and
others. Accounting restatements—that is, major corrections of past financial state-
ments—were soaring in number, size, and market impact. In a democracy in which
most voters own stock either directly or through their pension and retirement
funds, government was certain to react. The only question was the shape the
reaction would take.

At its core, the Sarbanes–Oxley legislation was designed to fix auditing of U.S.
public companies, which is consistent with the official name of the law: the Public
Company Accounting Reform and Investor Protection Act of 2002. By consensus of
investors and Wall Street professionals alike, auditing had been working poorly.
Sarbanes–Oxley created a unique, quasi-public institution to oversee and regulate
auditing, the Public Company Accounting Oversight Board (PCAOB). The first task
of this new board was to implement a second core goal: to enlist auditors to enforce
existing laws against theft and fraud by corporate officers. Reinforcing this core are
new rules concerning the auditor–firm relationship, auditor rotation, auditor
provision of non-audit services, and corporate whistle-blowers. In a regulatory
division of labor, the Securities and Exchange Commission (SEC) continues to
oversee public companies, while PCAOB oversees auditors.

Sarbanes–Oxley has been attacked as a costly regulatory overreaction. How-
ever, the most trenchant critiques of overreaction are not actually about the
legislation itself. For example, the criminal prosecutions at Enron, Tyco, and

y John C. Coates IV is the John F. Cogan Jr. Professor of Law and Economics, Harvard Law
School, Cambridge, Massachusetts. His e-mail address is �jcoates@law.harvard.edu�.

Journal of Economic Perspectives—Volume 21, Number 1—Winter 2007—Pages 91–116

Worldcom enforced laws that were in place before Sarbanes–Oxley. Existing threa

of personal liability faced by directors of U.S. firms from class action suits by
shareholders remained largely unchanged by Sarbanes–Oxley. When New York
Attorney General Eliot Spitzer opened investigations of research analysts, mutual
funds, insurance companies, and the New York Stock Exchange, he used laws in
place long before Sarbanes–Oxley. Many boards of public companies have changed
their governance rules in recent years, but such changes were primarily due to stock
exchange rules, not Sarbanes–Oxley.

So what effect has Sarbanes–Oxley had? At a direct level, the legislation created
new incentives for firms to spend money on internal controls, above and beyond
the increases in audit costs that would have occurred after the corporate scandals
of the early 2000s. In exchange for these higher costs, Sarbanes–Oxley promises a
variety of long-term benefits. Investors will face a lower risk of losses from fraud and
theft, and benefit from more reliable financial reporting, greater transparency, and
accountability. Public companies will pay a lower cost of capital, and the economy
will benefit because of a better allocation of resources and faster growth. However,
the law’s full costs are hard to quantify, and the benefits even harder, so any honest
assessment of Sarbanes–Oxley must be tentative and qualitative.

This paper will argue that Sarbanes–Oxley should bring net long-term benefits.
If auditing before Sarbanes–Oxley was as poor as widely believed, or if incentives for
public firms to spend money preventing fraud and theft were inadequate, raising
the resources spent on auditing will bring social gains. Wholesale repeal would
simply return the U.S. economy to the world of Enron and Worldcom. However,
even five years after its passage, Sarbanes–Oxley remains a work in progress. Like
many pieces of legislation, Sarbanes–Oxley is actually implemented through rules
and enforcement strategies set by administrative officials. I will argue that Congress
should be prepared to revisit the governance and accountability of the new Public
Company Accounting Oversight Board. I will also argue that the PCAOB (not
Congress) is the better body to customize new rules on control system disclosures
to fit firms of varying types and sizes, and to dampen the incentives that seem to
have initially produced overspending on audit and financial control systems.

Enforcement before Sarbanes–Oxley

Laws against fraud and theft are ancient and uncontroversial. The problem
before the passage of Sarbanes–Oxley was not that such laws did not exist, but that
in the area of corporate governance they were not effective enough. Without
adequate enforcement, laws on the books are not the laws in practice. In the
immediate aftermath of Enron, some held the view that President George W. Bush
initially expressed, that the corporate scandals were only a few “bad apples” amid
an otherwise healthy corporate governance system (Economist, 2002). But an array
of evidence, both anecdotal and large sample, showed that misstatements and fraud
were in danger of becoming systemic.

One piece of evidence was the general rise in accounting restatements (Finan-
cial Executives Research Foundation, Inc. 2001; U.S. General Accounting Office,

92 Journal of Economic Perspectives

2002; Moriarty and Livingston, 2001; Taub, 2005), illustrated in Figure 1. Second,
earnings management—that is, discretionary or special items in a firm’s reported
earnings, or unusually large changes in inventory or accounts receivable relative to
sales, all suggestive of opportunistic accounting by corporate managers—also rose
steadily from 1987 to 2001 (Cohen, Dey, and Lys, 2005b). Third, liquidity and
investor confidence had been experiencing a decline. These concepts are mea-
sured in the finance literature (Jain, Kim, Rezaee, 2006; Holmstrom and Kaplan,
2003) by trading activity, market depth, and bid–ask spreads. Figure 2 illustrates this
change with bid–ask spreads, which will be wider when sellers have more private
information, such that adverse selection is more of a risk, and lower when that
private information is reduced by better auditing and revelation of information.
Figure 2 shows that quoted spreads were widening prior to the passage of Sarbanes–
Oxley, reflecting the effect of scandals on market liquidity and the willingness of
dealers to expose themselves to potential adverse selection in trades. Figure 2 also
shows that quoted spreads fell dramatically during the three-, six-, and nine-month
periods after the passage of Sarbanes–Oxley, reflecting successive implementation
of Sarbanes–Oxley by the enactment of SEC rules.1 Fourth, the number of securi-
ties frauds alleged in significant class action lawsuits rose dramatically (Dyck, Adair,
Zingales, 2006), as Figure 3 shows.

The number of audit failures implicating top audit firms also grew in the
lead-up to Sarbanes–Oxley. In 2000, the accountancy firm Ernst & Young paid a
record $335 million to settle a single shareholder lawsuit. In 2001, an SEC investi-

1 Qualitatively similar results have been found for effective spreads (reflecting actual trades) as well as
the portion of spreads related to likely adverse selection.

Figure 1
Accounting Restatements by U.S. Public Companies, 1992–2002

1992–1996 1997

200

150

100

1998 1999 2000 2001 2002

92
102

174

201

250

Sources: Moriarity and Livington (2001) for 1992–1996; U.S. General Accounting Office (2002) for
1997–2002.

John C. Coates IV 93

gation revealed over 8,000 violations at PricewaterhouseCoopers of a clear, long-
standing rule against auditors owning stock in their audit clients—violations involv-
ing over two-thirds of the firm’s top partners. Also in 2001, the SEC brought a fraud
case against Arthur Andersen for its involvement in the Waste Management scan-
dal. And after those revelations came the wave of even bigger audit failures like
Enron and Worldcom, preceding the passage of Sarbanes–Oxley.

The preexisting system of detecting and enforcing rules against corporate
fraud and theft were apparently not strong enough. Enforcement in this area
occurs in both private and public forums.2

Private enforcement occurs through investor lawsuits. But in the context of
large public companies with dispersed shareholders, private enforcement—which
relies on lawyers to initiate and coordinate lawsuits—is widely recognized to suffer
from the same agency and collective action problems it is meant to address (Macey
and Miller, 1991; U.S. House of Representatives, 1995; Romano, 1991). Private
enforcement also generally depends upon the threat of large damage awards,

2 For a model of some trade-offs between public and private enforcement, see Glaeser, Johnson, and
Shleifer (2001).

Figure 2
Liquidity and Investor Confidence Pre– and Post–Sarbanes–Oxley
(as measured by change in bid–ask spreads over various periods)

–0.31

.50

–.50

–1.00

–1.50

–1.

–1.71

Quoted Spread

C
en

Scandal Period (change from 3/11/02
to 6/26/02)

SOX � SEC Rules after 90 Days
(change from 7/30/02 to 8/30/02)

SOX � SEC Rules after 180 Days

SOX � SEC Rules after 270 Days

Source: Jain et al. (2006)
Note: Qualitatively similar results have been found for effective spreads (reflecting actual trades) as
well as the portion of spreads related to likely adverse selection.

94 Journal of Economic Perspectives

which can often exceed a potential lawbreaker’s net worth, and thus fail to provide
sufficient deterrence (Shavell, 1986). Thus, private enforcement is at best a weak
enforcement tool; and because corporate managers can usually choose to settle the
case and pay litigation costs with company funds, private enforcement can harm
investors. In the 1990s, Congress and the U.S. Supreme Court curtailed private
suits, particularly by requiring specific allegations of fraud and by eliminating
liability for “aiding and abetting” securities fraud. Although some commentators
argued that these legal changes helped pave the way for the financial scandals of
2001 and 2002, the Sarbanes–Oxley legislation loosened those constraints only
modestly, by lengthening the time in which such suits can be filed.

The Securities and Exchange Commission has traditionally been the lead
agency for public enforcement of laws and regulations that (to quote from its
website) “protect investors, maintain fair, orderly, and efficient markets, and facil-
itate capital formation.” In Sarbanes–Oxley, Congress increased the SEC’s budget
from $437 million in 2002 to $776 million in 2003. But as this belated funding
increase implies, SEC funding has lagged enforcement demands, allowing fraud
and deceit to magnify other causes of stock market bubbles (Zingales, 2004).
Before Sarbanes–Oxley, total U.S. spending on securities regulation (SEC spending
together with spending by other public or quasi-public regulatory bodies) per
dollar of market capitalization was less than 80 percent of spending in the United
Kingdom (FSA, 2002). Even after Sarbanes–Oxley, U.S. spending on securities
regulation remains below that of the United Kingdom (FSA, 2004; Jackson, 2005).
The ability of these enforcers to raise the perceived odds of detection is also limited
by information constraints.

Figure 3
Fraud Alleged in Significant Securities Class Actions Against U.S. Public
Companies, 1994–2004

41 42 42

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

5
10
15

Sources: Stanford Class Action Database; Dyck et al. (2006).
Notes: Excludes cases dismissed or settled for �$2.5 million; all firms had $750� million in assets in
the year prior to the class period. Relevant start date is first date of fraud as alleged in lawsuit.

The Goals and Promise of the Sarbanes–Oxley Act

To buttress public enforcement, and to permit the detection of fraud more
efficiently than could be done by after-the-fact enforcement alone, the law has long
relied upon a “gatekeeper” strategy designed to prevent fraud before it happens.
The strategy is to enlist informed private actors to help detect and deter fraud
(Kraakman, 1986; Choi, 1998; Coffee, 2006). Among the private actors are service
providers, such as accountants and underwriters. Auditors have traditionally been
employed as gatekeepers to prevent, detect, and punish lying by corporate agents.
Auditing—mandated by law for public companies since 1934—is fundamentally a
way to verify financial statements as truthful. Prior to Sarbanes–Oxley, however,
auditors had been failing to detect and report improper accounting, allowing
executives to exaggerate growth or profitability. Sarbanes–Oxley was principally
designed to regulate auditors so that they will perform better as gatekeepers.

Prior to Sarbanes–Oxley, auditors were governed by a system of self-regulation
which had apparently not preserved their ability to act as gatekeepers (for example,
PAE, 2000). Public accountants were licensed by the states, but states devote few
resources to supervising auditors; federal regulation of auditing was light; and no
federal agency supervised auditors. A Public Oversight Board for auditors was
created in 1978, but it was dominated by accountants, funded by the audit industry,
and had no full-time directors, no inspection authority, and no rule-making au-
thority. When the SEC proposed reforms after Enron’s collapse, the Public Over-
sight Board (2002) resigned en masse, stating “peer review . . . has come to be
viewed as ineffective [and] has lost credibility.” Sarbanes–Oxley was a response to
the failure of self-regulation of the auditing profession.

A variety of theories have been put forward as to why the auditors failed in their
gatekeeper function. Healy and Palepu (2003) argue that auditing had for a long
period been suffering from a “deprofessionalization”—a loss in the capacity of
auditors to detect fraud—because of increased competition, falling audit fees and
persistent liability risks, which reduced long-term rewards for auditing and
increased incentives for rule-based accounting requiring little discretion or profes-
sional expertise. Levitt (2002) points to increased sales of consulting services by
auditors to audit clients, which increased incentives to ignore fraud. Coffee (2006)
points to legal changes that reduced liability risk for auditors who ignored fraud
and to the fact that auditors were appointed and paid by managers, the very
corporate agents that auditors were supposed to check. Except for legal liability
standards for auditors, which remain largely the same as they were in 2001,
elements of Sarbanes–Oxley respond to all of these theories.

Against Fraud: PCAOB and Institutional Design

The Sarbanes–Oxley legislation was complex: it imposed nine sets of man-
dates, shown in Table 1. Moreover, its application to foreign firms complicates any
overall assessment. At its core, however, Sarbanes–Oxley enhances the role of
auditors in enforcing laws against fraud and theft at public companies. This section
discusses the first core component of the legislation, which fights fraud by creating

96 Journal of Economic Perspectives

a quasi-public institution to supervise auditors. The next section discusses the
second core component, which was to fight theft by enlisting auditors to enforce
new disclosure rules that give firms incentives to increase spending on financial
controls.

The Sarbanes–Oxley legislation recognized that in certain cases, accounting
standards themselves were part of the problem. Thus, the law required that the
Financial Accounting Standards Board and the Securities and Exchange Commis-
sion tighten accounting standards in certain ways. For example, one change was in
the area of the “special purpose entities,” which are firms created by a public
company that usually serve to isolate some particular financial risk. However, Enron
showed that such entities could also be used as a smokescreen for fraudulent
transactions. Another accounting change involved “pro forma” accounting, in
which firms report their results while leaving out unusual and nonrecurring trans-
actions. This kind of accounting also proved susceptible to abuse. More generally,
Sarbanes–Oxley requires the Financial Accounting Standards Board to be funded
directly by public companies rather than by accountants, to ensure that its mem-
bership is independent of the accounting profession, and to consider emphasizing
judgmental principles that seek fair reporting over bright-line rules that, by virtue
of being clear cut, invite evasion.

The rise in accounting restatements and earnings manipulation suggested that
the deeper issue was not with the accounting standards themselves, but rather with
the enforcement of those standards through auditing (Bratton, 2003). Auditors
were failing in their conventional role as gatekeepers against fraud. In response, the
first and longest section of Sarbanes–Oxley creates a unique and significant new
institution, the Public Company Accounting Oversight Board or PCAOB.

An Institutional Innovation: PCAOB
The primary goal of the Sarbanes-Oxley legislation was to improve audit quality

and reduce fraud on a cost-effective basis. However, optimal auditing standards

Table 1
Sarbanes–Oxley Act of 2002: Summary of Provisions

Sections Topics

101–109 PCAOB’s creation, oversight, funding, and tasks
302, 401–406, 408–409, 906 New disclosure rules, including control systems and officer

certifications
201–209, 303 Regulation of public company auditors and auditor–client

relationship
301, 304, 306, 407 Corporate governance for listed firms (audit committee rules,

ban on officer loans)
501 Regulation of securities analysts
305, 601–604, 1103, 1105 SEC funding and powers
802, 807, 902–905, 1102, 1104, 1106 Criminal penalties
806, 1107 Whistleblower protections
308, 803–804 Miscellaneous (time limits for securities fraud, bankruptcy

law, fair funds)

John C. Coates IV 97

should vary with the nature and type of auditing firm and audit client. Congress
recognized that it was in no position to specify in detail either levels of costs or
variations in standards of quality for audits, and decided to delegate.

But delegate to whom? Congress could have delegated to one of three tradi-
tional types of agents: 1) the executive branch of government, like an agency within
the U.S. Department of the Treasury; 2) an independent agency, like the SEC; or
3) a private “self-regulatory” body, like the American Institute of Certified Public
Accountants (AICPA) or the Public Oversight Board that had previously overseen
auditors. However, each of these options risked leaving audit quality too low.
President Bush had initially refused to support any legislative response to the
corporate scandals, making an executive branch department or agency an unlikely
choice. While the SEC would have been the natural existing independent agency to
take on the new task of auditing oversight, the SEC faced the ongoing risk that
future budgets might not be sufficient for additional responsibilities. In addition,
adding another task to the SEC’s extensive existing mandates could have watered
down its effectiveness (Wilson, 1989). Finally, the SEC was at the time led by an
attorney who had long worked for the audit industry, who proposed but failed to
convince Congress that an industry-dominated private body could do better than
the Public Oversight Board and the AICPA had done in the past.

With no appealing conventional choice, Congress innovated.3 The Public
Company Accounting Oversight Board is neither a traditional private body, nor a
public agency. Formally, PCAOB is a nonprofit corporation given a legal mandate
to oversee public company auditors to protect investors and the “public interest in
the preparation of informative, fair, and independent audit reports” (Public Com-
pany Accounting Oversight Board, 2004a). Sarbanes–Oxley tasks the PCAOB with
registering, setting standards for, inspecting, investigating, and disciplining audit
firms for public companies. Two members of its five-member board must be
auditors, a rule intended to assure that PCAOB has the necessary expertise. Three
board members must be independent of the accounting profession, which is
intended to constrain regulatory capture from the audit industry. To prevent the
board coming under political pressure from “above,” board members serve stag-
gered five-year terms, and can be removed only for “cause,” a standard designed to
be difficult to show. Each board member has a full-time position, and now earns
approximately $500,000 per year.

While mixed public/private bodies are not new (Freeman, 2000; Krent, 1990),

3 The innovative design of the PCAOB has cast a legal shadow over the Sarbanes–Oxley legislation. A
lawsuit brought by an audit firm and a group of academics claims that PCAOB is unconstitutional
because it wields the authority of a public agency but its members are not appointed by the president
or the “head” of a “department,” as required by the Appointments Clause of the Constitution (Nagy,
2005; Bader and Berlau, 2005). The suit also claims that because it lacks a “severability” clause—
language commonly included in a statute stating that each of its provisions should be construed
separately for constitutional purposes—the entirety of Sarbanes–Oxley is unconstitutional. The outcome
of the suit is not clear. While the suit faces obstacles, it is a challenge for PCAOB. In the near-term,
Congress might not re-create a body with the same powers, particularly over auditor-attested control
disclosures.

98 Journal of Economic Perspectives

the blend of the Public Company Accounting Oversight Board is unique (Nagy,
2005). The PCAOB is private in that its charter declares that it is not a public agency
and that its employees are not government employees or agents. This provision
exempts PCAOB from many laws that apply to the Securities and Exchange
Commission, such as laws requiring open meetings, public disciplinary hearings
and administrative procedures, public access to records (such as inspection and
disciplinary reports), and some “revolving door” laws regulating post-PCAOB
employment by PCAOB employees. On the other hand, the PCAOB is public in that
the SEC appoints the PCAOB board and the SEC must approve PCAOB’s budget,
litigation, and rules. Moreover, Sarbanes–Oxley specifically granted PCAOB legal
rights generally limited to government agencies, including a privilege protecting its
files and employees from the “discovery” process (for example, court-ordered
depositions) in private lawsuits, and immunity to its employees against civil liability
for investigations.

The mixed public/private nature of the Public Company Accounting Over-
sight Board’s design carries over to its funding. Sarbanes–Oxley empowers PCAOB
to impose “fees” on the audit firms subject to its oversight and, more importantly,
on public companies (based on market capitalization). The SEC has power to
approve and thus constrain PCAOB’s budget, but Sarbanes–Oxley makes clear that
PCAOB fees are “not public monies” of the United States. Neither the SEC nor
Congress can shift PCAOB’s resources to other public purposes as part of Con-
gress’s budget-setting process, as Congress now can do with the SEC’s funds. This
secure and separate source of funding addresses the fact that both the SEC and the
self-regulatory bodies charged with enforcing laws against accounting fraud had
been underfunded in the past. Before the corporate scandals of the early 2000s, the
SEC was notoriously short of funds. Prior to Sarbanes–Oxley, when a dispute arose
over how much authority the Public Oversight Board had over audit firms, the
AICPA cut off funds of the Public Oversight Board. The PCAOB is more financially
secure than either an organization funded out of the federal budget, like the SEC,
or than a self-regulatory organization funding itself from the audit industry would
have been.

The Public Company Accounting Oversight Board now has a budget of
approximately $100 million, which includes eight offices and about 500 employees.
(For comparison, the SEC in 2005 had an approximately $900 million budget,
18 offices, and 3100 employees.) PCAOB’s staff includes about 300 full-time
inspectors annually reviewing all audit firms with more than 100 public company
clients. PCAOB has enacted two lengthy sets of standards, one on auditing, and one
on “control system” disclosures (Public Company Accounting Oversight Board,
2004b; 2004c). “Control systems,” which will be discussed at more length in the next
main section, comprise the set of processes, practices, and technologies designed to
control a company’s assets, ranging from a set of rules governing who and how
many people must approve expenditures, to a procedure for comparing shipping
documents to sales accounts, to computer software with built-in systems for making
changes to computerized data.

The “Big Four” accounting firms—PricewaterhouseCoopers, Deloitte Touche

The Goals and Promise of the Sarbanes–Oxley Act 99

Tohmatsu, Ernst & Young, and KPMG—audit most U.S. public companies; specif-
ically, they audit 80 percent of U.S. public companies by number, and 99 percent
by sales volume (U.S. Government General Accounting Office, 2003). PCAOB staff
spends several months on-site with these firms each year. The PCAOB spot-checks
selected audits, has authority to report deficiencies to the SEC, and provides a
sanitized version of its inspection reports to the public. It reviews audit firm
practices and policies on compensation, promotion, assignment, independence,
client acceptance and retention, internal inspection, and training. If auditors fail to
cooperate with its investigations, or if it finds violations, it may discipline auditors
(subject to review by the SEC and then the courts). It can impose fines and the
auditing equivalent of the death sentence: deregistration, which would force public
companies to fire the auditor. In 2005, PCAOB brought five disciplinary proceed-
ings against audit firms, and published nearly 300 inspection reports.

Improving PCAOB’s Governance and Accountability
If or when Congress revisits the Sarbanes–Oxley legislation, it could im-

prove upon the design of the Public Company Accounting Oversight Board in
several ways.

First, Congress should require that PCAOB be reauthorized after some num-
ber of years of operation (Clark, forthcoming). Such reauthorization would force
an evaluation of PCAOB’s performance and effectiveness, and would provide an
opportunity for Congress to alter the institution if (for example) it has been
captured by the auditing industry or has shown signs of bureaucratic empire-
building. While a near-term reauthorization would face a political risk that the law
might not be approved absent headline-grabbing scandals, a reauthorization after,
say, a decade would give PCAOB sufficient time to build political relationships so
that reauthorization would be likely, absent a strong showing by PCAOB critics that
the agency had been ineffective or unresponsive to legitimate concerns.

Second, rather than giving the SEC alone the task of ensuring ongoing
accountability at PCAOB, it might be better to involve PCAOB’s constituencies in
its governance. For example, the PCAOB could be required to obtain and respond
to evaluations by specified advisory groups—including investors, auditing firms,
finance executives, and representatives of small business—giving those groups a
permanent and substantive role in its deliberations. A process similar to this
operates at the Financial Accounting Standards Board, which consults with a
34-member Financial Accounting Standards Advisory Committee made up of top
corporate executives, audit firm partners, accounting academics, officers of self-
regulatory organizations (such as the New York Stock Exchange), and financial
analysts.

Third, audit clients that are unhappy about audit firm’s judgments—particu-
larly regarding control system weaknesses—should have a prompt and effective way
to appeal the judgment to PCAOB staff. The SEC should monitor such appeals to
verify that PCAOB is restraining the audit firms from imposing costs on public
companies.

Fourth, while PCAOB’s reports disclose problems found with past audits,

100 Journal of Economic Perspectives

Sarbanes–Oxley prohibits PCAOB from releasing portions of inspection reports
that criticize an audit firm’s control systems unless the audit firm fails to address the
criticisms within 12 months of the report. As a result, the market and client firms
will not know about and will not be able to react to those criticisms. Increased
disclosure by PCAOB would be appropriate.

Fifth, PCAOB’s exemptions from public-right-to-know laws, while defensible in
its start-up phase, should be revisited as its power and influence grows.

The PCAOB’s budget and staff will probably grow as it completes its start-up
phase, and as it applies its standards to (or develops new standards for) new audit
tasks. Its board and staff will learn from their inspections and from appeals by
auditing firms to the SEC and the courts, and the PCAOB will learn as it responds
to criticisms of its auditing and disclosure-attestation standards. Eventually the
PCAOB will become a lobbying force, in Congress and at the SEC, in the setting of
accounting standards by the FASB, and in efforts to coordinate audits across
national boundaries by multinational firms subject to multiple regulators.

Against Theft: Control Systems, Disclosure, and Auditor Attestation

While many of the financial scandals in the early 2000s involved fraudulent
disclosure or accounting statements, several prominent scandals also revealed
outright theft by top corporate officials. Enron’s chief financial officer and Tyco’s
chief executive officer have been sent to prison for what amounts to theft. The
second core component of Sarbanes–Oxley is designed to fight theft by enlisting
auditors to enforce new disclosure rules that strengthen the incentives for firms to
increase spending on financial controls.

Earlier Law on Control Systems
U.S. public companies have long maintained “control systems” over their assets

and accounting systems. Since 1977, U.S. public companies have been required to
have such a system to provide “reasonable assurance” that transactions are autho-
rized and recorded to permit preparation of compliant financial statements, and
that fraud—including theft as well as deception—is detected and prevented.

As described earlier, a “control system” is the set of processes, practices, and
technologies to provide such assurance. Courts have interpreted the phrase
“reasonable assurance” to require only cost-justified controls, taking into account
the size and nature of a company’s operations. The SEC enforces the mandate that
companies have a control system, and investors may not sue based solely on the lack
of a control system. By political tradition, federal enforcement of the control
systems mandate has focused on disclosure, leaving it to the states to enforce laws
against theft itself.

Auditor-Attestation Disclosure as a Deterrent
Prior to Sarbanes–Oxley, few nonfinancial firms disclosed engaging in internal

control reviews or even stated that they had effective control systems (McMullen,

John C. Coates IV 101

Raghunandan, and Rama, 1996).4 To be clear: Sarbanes–Oxley in no way mandates
a control system or its contents—that obligation predated the law and remains
unchanged. Nor does Sarbanes–Oxley direct the SEC, PCAOB, or other officials to
focus enforcement resources directly on designing or improving control systems.

What Sarbanes–Oxley adds in §404 are two main obligations: 1) officers must
evaluate and disclose “material weaknesses” in their firm’s control system, which the
chief executive officer and chief financial officer must personally certify; and
2) outside auditors “attest” to those disclosures—that is, either agree with the
officers or express a qualified or adverse opinion. PCAOB has adopted standards
requiring audit firms to disclose three points: 1) how they tested a firm’s financial
control system and the test results; 2) material weaknesses not disclosed by a firm’s
officers; and 3) whether a system is “effective” in the sense that it provides the
required “reasonable assurance.”

A “material weakness” is a deficiency with more than a “slight” chance of
causing a material financial misstatement. This definition— based on pre–
Sarbanes–Oxley auditing standards written by the American Institute of Certified
Public Accountants—was a sensible starting point for the Public Company Account-
ing Oversight Board, drawing on precedent and setting a relatively high standard
to start. However, it has been fairly criticized for two reasons: the criterion of a
“slight” chance has obvious potential to impose unjustified costs; and more gener-
ally, the definition does not incorporate cost–benefit analysis, so weakness can be
identified as “material” even if the cost of eliminating the weakness clearly exceeds
the expected loss or harm that the weakness could impose on the company or
investors. Over the last year, PCAOB announced it would consider amending the
definition, in light of the high level of costs that complying with §404 of Sarbanes–
Oxley has imposed (discussed below).

Incentive Effects of Sarbanes–Oxley on Control System Expenditures
In a formal sense, the two new obligations added by Sarbanes–Oxley seem

modest and nonprescriptive. After all, even before the passage of Sarbanes–Oxley,
if the board or officers knew their control system was materially deficient, such that
their financial statements were materially misleading or employees were able to
steal material assets, directors and officers were required to correct the deficiency.
Likewise, before the passage of Sarbanes–Oxley, uncertainties about the effective-
ness of a firm’s control procedures were required to be disclosed in SEC filings
personally signed by a firm’s officers. Even after the passage of Sarbanes–Oxley,
companies may continue to use a control system with many deficiencies as long as
the system provides “reasonable assurance” that financial material misstatements
will not result. Nothing in the Sarbanes–Oxley legislation requires managers to
agree with auditors, or to fix weaknesses solely because auditors deem them
material. Contrary to claims by certain critics (for example, Butler and Ribstein,

4 Since 1991, banks have been required to evaluate their control systems and disclose this information
to audit committees and regulators, but not to the public.

102 Journal of Economic Perspectives

2006), Sarbanes–Oxley does not mandate a “one-size-fits-all” control system, and
firms continue to spend a wide range of amounts on highly varied control systems.

Nevertheless, Sarbanes–Oxley did create new incentives to disclose control
system weaknesses. Because top officers must certify personally that they have
evaluated their firms’ control systems, their ability to claim plausibly that they were
unaware of control deficiencies—a claim that used to be common—is weakened.
Auditor-attestation has induced further disclosures. Auditors have also spread
knowledge of best practice and common deficiencies. Since the passage of
Sarbanes–Oxley, over 10 percent of firms have disclosed material weaknesses,
although fewer did so in 2005 than in 2004, and among the largest firms with more
than $1 billion market capitalization, only 2 percent disclosed material weaknesses
in 2005 (Dunn, 2006). Beneish, Billings, and Hodder (2006) and De Franco, Guan,
and Lu (2005) each find that prices of firms disclosing weaknesses fall a market-
adjusted 2 percent on average. Some disclosures would have been made under
pressure from market forces and salient scandals, but the sharp increase in such
disclosures is consistent with the goals of Sarbanes–Oxley.

Disclosure, in turn, creates powerful incentives to fix weaknesses. Investors may
be unable to distinguish weaknesses that are cost-justified from those that are not,
and may not trust managers to draw such distinctions. The disclosure mandate
could present managers with a Hobson’s choice of overspending on controls, in the
sense that the higher spending is not warranted by the potential benefits, or facing
higher costs of raising capital. The interaction of disclosure with liability risks also
has a powerful effect: if a material weakness is disclosed but not fixed, a subsequent
material financial misstatement will trigger private lawsuits (and possibly SEC
sanctions) that will be more threatening to individual defendants, because it will be
evident they knew about the weakness. Even a small increase in liability risk caused
by increased disclosure rules creates large new incentives to spend money on
control systems. That is because top executives in a firm may share in any liability
that results from not fixing a deficiency, but will often bear only a tiny fraction of
the firm’s costs in fixing the deficiency—80 percent of chief executive officers of
companies in the Standard and Poor’s 500 own less than 1 percent of their firms’
stock.

Auditor attestation also changes incentives to spend on controls. Requiring
both managers and auditors to disclose weaknesses creates an asymmetric push for
more spending: if managers identify a weakness as material, auditors have no
incentive to disagree; but if managers fail to identify a weakness as material that
auditors believe to be material (whether because of a difference of opinion, or
differing knowledge of best practices, or a greater degree of risk-aversion), man-
agers know the weakness will be disclosed anyway, along with the fact of their
disagreement. At large companies, managers have not yet publicly disagreed with
auditor disclosure that a control system was ineffective (Dunn, 2006). However,
some hints exist that managers and auditors are disagreeing in private. For exam-
ple, auditor dismissals and resignations are strongly correlated with control weak-
ness disclosures and delays in SEC filings (Ettredge, Heintz, Li, and Scholz, 2006;
Ettredge, Li, and Sun, 2006). Auditors are even less likely than managers to bear

The Goals and Promise of the Sarbanes–Oxley Act 103

costs of correcting control weaknesses. In fact, auditors often benefit from addi-
tional spending to fix control weaknesses, regardless of whether the additional costs
are well spent (Langevoort, 2006). Audit fees are roughly 40 percent higher for
firms disclosing material weaknesses (Eldridge and Kealey, 2005).

At larger firms, the incentives to increase control expenditures are increased
by the new, enhanced role of independent audit committee members. A combi-
nation of Sarbanes–Oxley provisions and stock exchange rules now require listed
companies to have fully independent audit committees with the power to hire,
compensate, oversee, and fire auditors, and to communicate with auditors outside
the presence of managers. Most independent directors on these committees own
even less stock than chief executive officers, and so have even less to gain from
keeping control costs low. Also, the independent directors may perceive themselves
to have as much or even more to lose than officers from spending too little. Taking
these incentives together, decisions about control systems seem likely to be made by
agents who have incentives to overspend under Sarbanes–Oxley, as it is currently
implemented.

Evaluation of Control System Disclosure and Auditor Attestation
Setting an optimal level of control costs for public companies depends upon

too many variables that change too continually for principals (dispersed sharehold-
ers) and agents to be able to specify an amount for a particular firm in a verifiable
way. Nor is it plausible for Congress to provide any detailed oversight of control
systems. The level of expenditures on control systems—the purpose of which is to
control agents—must be delegated to an agent of some kind.

Before Sarbanes–Oxley, the agents who set the level of control system expen-
ditures were the same managers the control systems were meant to constrain. They
had (and would still have) incentives to underspend. Even honest managers could
be tempted to underspend if control systems are not accurately priced by the
market (Stein, 1989). The incentive to underspend would be particularly large for
managers planning to engage in fraud, either by deception (to increase incentive
compensation or allow for opportunistic insider trading) or by theft. Whether the
earlier problem of underspending on control systems is worse than the current
situation, with overspending being likely, is not resolvable at the level of theory.
Empirical studies of costs and benefits of Sarbanes–Oxley are discussed below, but
these are not soon likely to resolve the relative merits of underspending and
overspending, either.

However, even if companies are being induced to overspend on control
systems by the way Sarbanes–Oxley is currently being implemented, the next
practical step is for PCAOB to promulgate rules and enforcement patterns that will
reduce such incentives to overspend. In fact, as noted above, PCAOB has already
begun to issue “guidance” to auditors and to begin the process of amending its
standards on attestation in a way that will tend to reduce incentives for control
spending. This change is partly in reaction to pressure from the SEC, and partly
because of the ever-present threat of further legislative intervention by Congress.
But it is also because Sarbanes–Oxley did not mandate any particular level of

104 Journal of Economic Perspectives

control system expenditure, relying instead on the indirect pressure of disclosure
rules, and because the legislation assigned the design and interpretation of those
rules to a well-funded, independent agency, relatively immune (in the short run at
least) from capture by the interests of either managers or auditors. In short,
Sarbanes–Oxley created a flexible, adaptive system for adjusting control system
expenditures that may come closer to an optimum than would be true with any
plausible alternative.

Complements to the Core Elements of Sarbanes–Oxley
To complement the two core elements of Sarbanes–Oxley—the creation of the

PCAOB and requirements for auditor-attested disclosures—the legislation added
rules to protect auditors’ ability to function as gatekeepers. Managers are required
to disclose any control weaknesses (material or not) to audit committees and
auditors, and it became a crime to mislead auditors. Congress earmarked roughly
30 percent of the SEC’s budget increase in 2003 for 200 professionals to oversee
PCAOB and auditors. To constrain managers from suborning auditors, Sarbanes–
Oxley mandated five-year rotation of auditor partners with their client firms (but
not auditing firms, as many advocated). It also required auditors to retain docu-
ments, not to destroy them as the Arthur Andersen auditing firm legally did with
Enron’s work papers. Employees must be able to communicate audit concerns on
a confidential, anonymous basis to audit committees; employees may sue and
recover legal fees from public companies if they are retaliated against for informing
regulators or supervisors of violations of SEC rules or federal antifraud laws; and
such retaliation is criminalized.

The Sarbanes–Oxley Act also increased disclosure requirements for auditor
compensation by requiring a clear breakdown of audit, audit-related, and non-audit
fees, and restricted non-audit services that audit firms can provide to audit clients.
These restrictions have been harshly criticized as “quackery” (Romano, 2005), but
in fact, Sarbanes–Oxley only added two types of non-audit services to a list the SEC
had already banned. The two additional prohibitions—on the design of financial
information systems and the outsourcing of internal audits—are closely interwoven
with firms’ financial controls, which are what auditors are supposed to be evaluat-
ing. The SEC’s rules implementing this part of Sarbanes–Oxley exempted such
services to the extent that the work falls outside an audit’s scope, and audit firms
continue to earn significant non-audit revenues from audit clients, although the
amount has fallen significantly as audit firms have spun off or sold much of their
non-audit consulting businesses. Whatever one’s view of the trade-off between the
efficiencies of providing a bundle of audit and non-audit services and the possibility
that being paid more for non-audit services may lessen incentives for honest and
diligent audits, Sarbanes–Oxley only tweaked prior law in this situation—and did so
to avoid a situation in which auditors would audit their own work. The rules may
need refinement; for example, Abbott, Parker, Peters, and Rama (2005) suggest
that nonroutine internal audit services might be exempt from this provision. But
the PCAOB has the flexibility to make such adjustments, if they prove desirable.

John C. Coates IV 105

Measuring the Benefits and Costs of Sarbanes–Oxley

Serious problems confront any effort to estimate empirically the effects of
Sarbanes–Oxley. The legislation was enacted amidst sharp financial, economic, and
political changes. It makes a large number of simultaneous, disparate legal changes,
which continue to be implemented and phased in over time. The implementation
of the law is also being accompanied by a host of other, overlapping legal changes
(Clark, forthcoming). The benefits of the Sarbanes–Oxley act are by their nature
difficult to isolate, which doesn’t mean they aren’t real and substantial. Given the
corporate scandals of the early 2000s, and the awareness of this behavior by
investors and other market participants, the chances are good that public and
private enforcement and manager behavior would have changed even had Sar-
banes–Oxley not been enacted. The problems of estimating the effects of this
legislation are not unusual or unique to Sarbanes–Oxley (Jackson, 2005), but they
may be more severe than is typical.

Many studies of Sarbanes–Oxley find results consistent with intuitive hypoth-
eses regarding likely effects, but most studies are unable to reject alternative
hypotheses that other events caused those effects, and most studies report effects
consistent with both positive and negative evaluations of the law’s core provisions.5

Benefits of Sarbanes–Oxley: Real But Hard To Quantify
While evidence in this area should be treated as indicative rather than con-

clusive, most evidence is consistent with Sarbanes–Oxley providing benefits. Earn-
ings management, measured in a variety of ways, fell after Sarbanes–Oxley (Cohen,
Dey, and Lys, 2005a, 2005b), as did frauds that form the basis for significant class
action securities lawsuits, as illustrated earlier in Figure 3 (Dyck, Adair, Zingales,
2006). Before Sarbanes–Oxley, a correlation existed between abnormal accounting
accruals—that is, accruals not predicted by standard empirical models of accruals—
and the importance of an audit client to its auditor, but this correlation vanished
after the law passed (Ahmed et al., 2006). Chan, Farrell, and Lee (2006) report that
firms disclosing material control weaknesses engaged in more earnings manage-
ment than other firms. The disclosures mandated by Sarbanes–Oxley appear to be
valued by investors. Markets react in predictable, economically significant ways to

5 In addition to studies reviewed in the text, four studies attempt to measure overall market reactions to
the Sarbanes–Oxley legislation. Three factors caution against drawing any firm conclusions from these
studies. First, the studies produce wildly different overall results. Li, Pincus, and Rego (2006), Chha-
ochharia and Grinstein (2005), and Jain and Razaee (2006) find a positive effect on U.S. firms. Zhang
(2005) reports a negative impact of $1.4 trillion, which as she notes is so large as to undermine its
plausibility. Second, these studies produce different cross-sectional results. Third, the financial scandals
which affected the odds that Sarbanes–Oxley would pass were also affecting what it would likely contain,
how it would be implemented, and its likely costs or benefits. Wintoki (2006) finds positive abnormal
returns for firms in the largest two size quartiles, and negative abnormal returns for firms in the smallest
size quartiles, consistent with evidence discussed in the text. Litvak (2005) finds that stock prices of
cross-listed non-U.S. firms subject to the law fell relative to same-country firms not subject to the law. For
a short review of these studies, see Coates (2006).

106 Journal of Economic Perspectives

new control disclosures (Beneish, Billings, and Hodder, 2006; De Franco, Guan,
and Lu, 2005; Hammersley, Meyers, and Shakespeare, 2005; Chan, Farrell, and Lee,
2006; Leuz, Triantis, and Wang, 2005).

Investor confidence also increased after the passage of Sarbanes–Oxley. Bid–
ask spreads and market depth, which as Figure 2 showed were widening and falling,
respectively, during 2001–2002, reflecting falling investor confidence, began to
tighten and rise again in both the month and in the nine months after passage of
the legislation (Jain, Kim, and Rezaee, 2006). Similar trends can be observed in
survey measures of investor confidence. By April 2006, even a majority of financial
officers—who have generally been critical of Sarbanes–Oxley—believed that the
law (and §404 in particular) had increased investor confidence in financial reports.
In that survey, a third reported that Sarbanes–Oxley had already helped to prevent
or deter fraud (Financial Executives Research Foundation, Inc., 2006). At firms
with more than $25 billion revenues, 83 percent of financial officers agreed that
investors were more confident as a result of Sarbanes–Oxley.

No methodology yet developed permits summing the benefits of Sarbanes–
Oxley into dollar amounts that could be compared meaningfully to rough estimates
of its costs, which, as discussed next, are substantial. Thus, whether the legislation
produced net benefits remains unclear.

Costs: Substantial, Hard To Estimate, Fixed Component, and Falling
Four things are clear about the costs of Sarbanes–Oxley: 1) they are substan-

tial; 2) they are hard to estimate; 3) they have a fixed component, and so fall more
heavily on small firms; and 4) they are falling over time.

Direct costs consist of PCAOB fees, firms’ compliance costs, and increased
audit fees. Only PCAOB fees are known, and they are minor—more than half of
companies paid less than $1,000 in 2004. Few firms disclose compliance costs. Audit
fees are disclosed by firms, and have increased significantly since the passage of
Sarbanes–Oxley, but the portion of the increase attributable specifically to the
legislation is unobservable (Coates, 2006). Audit fees were already rising sharply
prior to Sarbanes–Oxley, in part due to a riskier auditing climate and in part due
to reduced competition as a result of the demise of Arthur Andersen, formerly a top
audit firm (Asthana, Balsam, and Kim, 2004).

Qualitative evidence from news media, surveys, and descriptions of control audits
supports the view that Sarbanes–Oxley directly increased both audit fees and internal
audit costs, on the order of $1 million per $1 billion of revenues, although the ratio of
audit costs to revenues is declining as firm size rises. Those costs have also been falling
over time for a number of reasons: learning; deferred benefits from costs accrued
up-front; push-back from firms unhappy with initial costs; and a gradual relaxation in
caution as memories of Enron and other corporate scandals fade. Firm executives, who
have reason to exaggerate costs, report that total compliance costs fell about 15 percent
in 2005 (Financial Executives Research Foundation, Inc., 2006). Audit firms, who have
reason to understate costs, report that their clients are seeing a decline in total
compliance costs of about 40 percent (Litan, 2005).

Indirect costs—like opportunity costs of manager time spent or greater risk-

The Goals and Promise of the Sarbanes–Oxley Act 107

aversion as a result of perceived pressure for tighter financial controls—are even
harder to measure. But these costs, too, seem to be falling over time, perhaps even
more rapidly than direct costs, as the initial managerial attention needed to comply
with Sarbanes–Oxley can be returned to normal business activities, and the degree
to which the law increases liability risk becomes better known.

Going Private and the Effect of Sarbanes–Oxley on Small Firms
Several papers examine whether Sarbanes–Oxley has caused public companies to

“go private”—that is, cease to be subject to SEC regulations by selling out to managers,
concentrated owners, or privately held firms (Block, 2004; Carney, 2005; Hsu, 2004;
Engel, Hayes, and Wang, 2004). In the best study of this subject to date, Kamar,
Karaca-Mandic, and Talley (2006) report that compared to European Union firms, the
odds that U.S. firms would sell to private buyers increased from 43 to 66 percent.
However, this increase is limited to U.S. firms with market capitalizations of less than
$30 million and to transactions in the first year after passage of Sarbanes–Oxley, with
no effect appearing in the second year. If all exits by such firms since mid-2002 were
caused solely by Sarbanes–Oxley, they would represent less than 0.02 percent of U.S.
market capitalization. Their findings are consistent with Marosi and Massoud (2004)
and Leuz, Triantis, and Wang (2006), who examine a broader set of firms that “go
dark”—that is, that legally cease to file SEC disclosures, either because they have gone
private or because the number of their shareholders has fallen below the trigger level
for SEC registration. They find that Sarbanes–Oxley modestly increased firms going
dark, mostly among very small firms with poor performance and low growth. The U.S.
Government Accountability Office (formerly the U.S. General Accounting Office)
(2006) reports that 25 percent of firms going dark from 2003 through the first quarter
of 2005 were not trading at all.

Thus, claims that Sarbanes–Oxley has triggered a wave of large buyouts (as in
“Going Private,” Wall Street Journal, 2006) have no support in the data. With respect to
small firms, these studies cannot distinguish Sarbanes–Oxley from other contempora-
neous legal changes affecting U.S. companies. These findings are also consistent with
either a positive or negative interpretation: they can support a belief that Sarbanes–
Oxley increased costs more than benefits, or a belief that the law increased information
about accounting manipulation and poor performance. As Kamar, Karaca-Mandic, and
Talley (2006) put it: “[T]he exodus of small firms from the public capital market . . .
would be a blessing if the departing firms were prone to . . . financial fraud . . .” The
studies are also consistent with small firm managers overestimating the cost of com-
pliance with Sarbanes–Oxley. The most costly part of Sarbanes–Oxley—the §404
requirements for disclosure of financial controls described above—does not even
apply to smaller firms (under $75 million in market capitalization) until 2008. It
remains uncertain what form those requirements will then take, or how large their
costs will be.

Cross-Listings and the Effect of Sarbanes–Oxley on Stock Exchanges
Some have claimed that Sarbanes–Oxley has hurt the ability of U.S. stock

exchanges (principally the New York Stock Exchange) to compete successfully with

108 Journal of Economic Perspectives

foreign stock exchanges (principally the London Stock Exchange) for new listings
generally, and particularly for cross-listings of foreign firms. To date, these claims
have not been supported by serious empirical analysis, which faces challenges
possibly even more daunting than those facing the studies discussed above.

One difficulty with such claims is that the decline in U.S. exchanges’ share of
cross-listings fell more in 2001, prior to Sarbanes–Oxley, than it has since Sarbanes–
Oxley, and this pattern holds true for high-tech and non-high-tech firms alike.
Preliminary analysis by Zingales (2006), moreover, suggests that a more plausible
cause of the decline in cross-listings are the continued improvements in the
liquidity of foreign equity markets (Halling, Pango, Randal, and Zechner, 2006),
which have diminished the relative attractiveness of a U.S. listing. To the extent
U.S. legal changes have had an effect on cross-listings, a more likely culprit is the
dramatic decline in the research coverage of U.S.-listed stocks, caused in part by
enforcement actions against investment banks and mutual funds by New York
Attorney General Eliot Spitzer and the SEC, which resulted in costly structural
regulation of research firms and a decline in funds’ “soft-dollar” purchases of
research, and the effects of the SEC’s Regulation FD, which leveled the informa-
tional playing field between professional analysts and the public. Cross-listings may
also be deterred by a fear of private litigation, but as noted above, private enforce-
ment of U.S. laws was not significantly affected by Sarbanes–Oxley.

Thus, Zingales (2006) points out that if the benefits of cross-listing on a U.S.
stock exchange remain, in the form of 90 basis points lower cost of capital (as
estimated by Hail and Leuz, 2006), then the benefit to an average foreign firm from
cross-listing will outweigh even initially high (and now falling) costs of compliance
with Sarbanes–Oxley’s control system disclosure requirements, at least for firms
above $230 million in market capitalization. Further evidence that Sarbanes–Oxley
is not to blame for lost competitiveness by U.S. exchanges is a small survey by
Ernst & Young of the chief executive and financial officers of 20 of the 42 U.S.
companies that chose to list their stock on the AIM market, which is the London
Stock Exchange’s international market for smaller growth companies. Only
20 percent of respondents named Sarbanes–Oxley as a factor in their choice, and
40 percent stated their companies already complied with Sarbanes–Oxley or were
working to do so in the near future. A larger survey by Brau and Fawcett (2006)
covered 249 chief financial officers of U.S. firms that either started to go public in
the United States and then stopped or were large enough to go public but chose
not to do so. In that survey, Sarbanes–Oxley was cited as a reason to not go public
by only 19 percent of the respondents.

Round-up of Other Provisions in Sarbanes–Oxley

Sarbanes–Oxley is a large and complex piece of legislation, and some of its
more controversial aspects are outside the core components just discussed. For the
most part, these noncore parts were either ineffective window dressing or, even
without Sarbanes–Oxley, would have been imposed by existing regulatory bodies

John C. Coates IV 109

(Cunningham, 2003). This section briefly addresses three concerns that have been
raised over noncore parts of the legislation.

No Material Change in the “Criminalization of Agency Costs”
The Sarbanes–Oxley legislation increased maximum criminal sentences for

fraud, consistent with Congress’s penchant over the last 50 years to criminalize
more conduct and increase criminal penalties (Stuntz, 2001; Bowman, 2005). But
in federal law, maximum sentences are unimportant. Most sentences are effectively
chosen by prosecutors under guidelines of the U.S. Sentencing Guidelines Com-
mission. Sentence guidelines for white-collar crime were lengthened in 2001 and
2003, but those changes were underway prior to Sarbanes–Oxley (Pernio, 2002;
Brickey, 2004). Some top executives involved in corporate scandals have received
long sentences: WorldCom’s chief executive officer received a sentence of 25 years;
Enron’s chief executive officer Jeff Skilling, 24 years; Dynergy’s chief executive
officer, 24 years; and Adelphia’s chief executive officer, 15 years. But all of those
sentences reflect pre–Sarbanes–Oxley law and guidelines.

Nor did anything in the Sarbanes–Oxley Act materially add to what Butler
and Ribstein (2006) complain was a “criminalization of agency costs.” While the
act increased resources of the Securities and Exchange Commission, the SEC
does not enforce criminal laws. That task is managed by the Department of
Justice and the states, whose resources were unchanged by Sarbanes–Oxley.
Sarbanes–Oxley did not cause the increase in prosecutions of white-collar crime
in the last five years with its emphasis on corporate managers, nor did it cause
the more aggressive tactics by prosecutors in such cases. At the federal level,
those changes reflect administrative decisions of Bush appointees within the
U.S. Department of Justice (Bucy, 2004; Ashcroft, 2003; Thompson, 2003). At
the state level—and the states put more than twice as many people in prison for
securities fraud than the federal government (Jackson, 2005)—the federal
Sarbanes–Oxley law had no effect. Even if Sarbanes–Oxley had never been
passed, New York State Attorney General Eliot Spitzer could have brought the
same high-profile cases, under the same laws, against Wall Street research
analysts, mutual fund advisors, the New York Stock Exchange, and the insurance
industry.

No Significant New Chief Executive Certification Requirements
As discussed earlier, Sarbanes–Oxley required that chief executive and

financial officers certify they have evaluated a firm’s control systems relating to
both financial statements and disclosures more generally. The law act made two
other minor changes to the officer certification requirements: 1) it required a
formal certificate to be signed, separate and apart from the SEC filings them-
selves, which may have temporarily heightened the salience of the signing
requirement, and 2) it implemented an earlier proposal requiring certification
of quarterly statements by both the chief executive officer and chief financial
officer. Both changes likely contributed to the atmosphere of caution that
followed passage of the legislation, but both are likely to diminish in importance

110 Journal of Economic Perspectives

over time, as the act of signing becomes routine and as any investments in
control systems to back-up these certifications are made.

Despite claims that these requirements represented a significant new require-
ment, the law was only a modest change (Fairfax, 2002). Chief executive and
financial officers have long signed annual reports; chief financial or accounting
officers have long signed quarterly reports; and firms have long been required to
have effective control systems. In addition, prior to Sarbanes–Oxley, the SEC
already required personal certifications from chief executive and financial officers
for quarterly reports of firms with annual revenues greater than $1.2 billion.

The major change in Sarbanes–Oxley was not that chief executive and finan-
cial officers were required to sign forms or certify financial statements, but that they
were required to do so in the shadow of the genuinely new requirement (discussed
earlier) that officers certify and auditors attest to specific disclosures regarding
control systems.

“Corporate Governance” Rules and Bans on Loans to Executives
The Sarbanes–Oxley legislation has been criticized for imposing corporate

governance rules that reshaped boards, without compelling evidence that the
new rules will have a net benefit (Romano, 2005; Linck, Netter, and Yang,
2005). Other than greater disclosure, however, Sarbanes–Oxley prescribes few
corporate governance changes. Both the New York Stock Exchange (NYSE) and
Nasdaq imposed extensive governance changes on firms shortly following the
passage of Sarbanes–Oxley, including requirements that a majority of directors
be independent. NYSE’s rules require that each audit committee member be
“financially literate” and at least one be a “financial expert”; that the audit
committee publish a charter of duties; that the audit committee meet with
auditors separately from managers; and that firms have fully independent
nominating and compensation committees. These changes were underway prior
to Sarbanes–Oxley, and were partly attempts to reduce political pressure to
enact Sarbanes–Oxley, but nothing in Sarbanes–Oxley required them or would
now prevent their modification. The only new governance mandates in Sar-
banes–Oxley require each audit committee member of a listed company be
“independent,” and that the audit committee control the audit–firm relation-
ship—which is also what the stock exchange rules require. Sarbanes–Oxley also
requires firms to disclose if they have a code of ethics and if any audit committee
members are “financial experts,” a step which provides incentives (but no
mandate) for firms to adopt codes and add experts. Were Sarbanes–Oxley
repealed tomorrow, the new post-Enron rules for corporate governance would
endure.

One of the few truly prescriptive parts of Sarbanes–Oxley is its ban on loans
to executive officers, which stemmed in large part from the revelation that
WorldCom’s chief executive officer had borrowed $409 million from WorldCom
prior to its demise. Critics of this provision correctly note that the ban intrudes
into a domain traditionally regulated by the states, which long ago replaced
such bans with liability rules that discourage loans and other self-dealing

The Goals and Promise of the Sarbanes–Oxley Act 111

transactions, and give insiders incentives to have such transactions approved by
independent directors (Coates, 1999). Prior to the 1990s, such loans were
relatively rare. In any event, the ban in Sarbanes–Oxley is ineffective, because it
does not cover economic substitutes for the most common type of loan (to buy
stock), such as the grant of options or restricted stock, nor does it ban an
increase in short-term compensation contemporaneously with a decrease in
long-term compensation. Twenty-five top law firms wrote a memo arguing that
the Sarbanes–Oxley ban did not cover routine credit extensions other than
loans, such as payment of an officer’s legal expenses subject to a contingent
repayment by the officer (Law Firms, 2002). To date, the SEC has not brought
contrary enforcement actions.

Conclusion

The process by which Sarbanes–Oxley was enacted has been criticized for
being rushed and for ignoring relevant research (Butler and Ribstein, 2006;
Romano, 2005; Zingales, 2004). Neither criticism is fair.

The core ideas behind Sarbanes–Oxley had developed for years. Federal bills
to create an auditing oversight body date to 1978, after hearings and reports
prompted by auditing failures in the market downturn of the early 1970s. Similar
legislation was debated again in 1995. In the run-up to Sarbanes–Oxley, Congress
heard scores of witnesses debate in detail how auditing should be regulated. In a
number of other controversial areas—executive compensation and stock options,
audit firm rotation, general design of accounting rules—Congress showed a will-
ingness to choose further study over either regulation or delegation (Bratton,
2003).

Congress acted no differently in passing Sarbanes–Oxley than it does in
passing most significant legislation. In fact, perhaps the most important component
of Sarbanes–Oxley was precisely to delegate power to PCAOB, so that it could
customize rules and respond to feedback much more rapidly than Congress could
do on its own. Professional lobbyists, of course, may seek the outright repeal of
Sarbanes–Oxley as a bargaining tactic while planning to settle on regulatory reform
as a compromise, but academics, policymakers, and the public would do well to see
those tactics for what they are and recognize Sarbanes–Oxley, like many regulatory
institutions, as a work in progress. Rather than pushing for repeal of Sarbanes–
Oxley, a more cost-effective approach is to push for the SEC and PCAOB to use
their authority to exempt or curtail requirements or prohibitions that are unnec-
essarily costly.

112 Journal of Economic Perspectives

References

Abbott, Lawrence J., Susan Parker, Gary F.
Peters, and Dasaratha V. Rama. 2005. “Corpo-
rate Governance, Audit Quality and the Sar-
banes–Oxley Act: Evidence from Internal Audit
Outsourcing.” http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�759864.

Admati, Anat R., and Paul Pfleiderer. 2000.
“Forcing Firms to Talk: Financial Disclosure
Regulation and Externalities.” Review of Financial
Studies, 13(3): 479–519.

Aguilar, Melissa K. 2005. “SOX 404 Deficien-
cies Preceeded by ‘Effective’ 302 Reports.” Com-
pliance Week, July 26, 2005.

Ahmed, Anwer S., Scott Duellman, and
Ahmed M. Abdel-Meguid. 2006. “Auditor Inde-
pendence, Corporate Governance and Abnor-
mal Accruals.” http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�887364.

Ashcroft, John. 2003. Memorandum to All
Federal Prosecutors: Department Policy Con-
cerning Charging Criminal Offenses, Dis-
position of Charges, and Sentencing. September
22, 2003. http://fl1.findlaw.com/news.findlaw.
com/hdocs/docs/doj/ashcroft92203chrgmem .

Asthana, Sharad, Steven Balsam, and Sungsoo
Kim. 2004. “The Effect of Enron, Andersen, and
Sarbanes–Oxley on the Market for Audit Ser-
vices.” http://papers.ssrn.com/sol3/papers.cfm?
abstract_id�560963.

Bader, Hans, and John Berlau. 2005. “The
Public Company Accounting Oversight Board:
An Unconstitutional Assault on Government Ac-
countability.” Competitive Enterprise Institute,
October 4, 2005. http://www.cei.org/gencon/
025,04873.cfm.

Beneish, Messod D., Mary B. Billings, and Leslie
D. Hodder. 2006. “Internal Control Weaknesses
and Information Uncertainty.” http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�896192.

Berger, Philip G., Feng Li, and M. H. Franco
Wong. 2005. “The Impact of Sarbanes–Oxley on
Cross-Listed Companies.” Unpublished Paper.

Block, Stanley B. 2004. “The Latest Movement
to Going Private: An Empirical Study.” Journal of
Applied Finance, 14(1): 36–44.

Bowman, Frank O., II. 2005. “The Failure of the
Federal Sentencing Guidelines: A Structural Anal-
ysis.” Columbia Law Review, 105(4): 1315,1319–20.

Bratton, William W. 2003 “Enron, Sarbanes-
Oxley and Accounting: Rules versus Principles
versus Rents,” Villanova Law Review 48(4): 1023.

Brau, James C., and Stanley E. Fawcett. 2006.
“Initial Public Offerings: An Analysis of Theory
and Practice.” Journal of Finance, 61(1): 399–436.

Brickey, Kathleen F. 2004. “Enron’s Legacy.”
Buffalo Criminal Law Review, 8(1): 221–75.

Bryan, Stephen H., and Steven B. Lilien. 2005.
“Characteristics of Firms with Material Weak-
nesses in Internal Control: An Assessment of
Section 404 of Sarbanes Oxley.” http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�682363.

Bucy, Pamela H. 2004. “Carrots and Sticks.”
Buffalo Criminal Law Review, 8(1): 279–322.

Bushee, Brian J., and Christian Leuz. 2005.
“Economic Consequences of SEC Disclosure
Regulation.” Journal of Accounting and Economics,
39(2): 233–64.

Butler, Henry N., and Larry E. Ribstein. 2006.
The Sarbanes–Oxley Debacle: How to Fix It and What
We’ve Learned. Washington, DC: American Enter-
prise Institute Press.

Carney, William J. 2005. “The Costs of Being
Public after Sarbanes–Oxley: The Irony of
‘Going Private.’” Emory Law Journal, 55(1): 141–
60.

Chan, Kam C., Barbara R. Farrell, and
Picheng Lee. 2006. “Earnings Management, and
Return-Earnings Association of Firms Reporting
Material Internal Control Weaknesses under
Section 404 of the Sarbanes–Oxley Act.” Unpub-
lished Paper.

Chhaochharia, Vidhi and Yaniv Grinstein.
2005. “Corporate Governance and Firm Value—
The Impact of the 2002 Governance Rules.” Cor-
nell University, Johnson School Research Paper
23-2006. http://papers.ssrn.com/sol3/papers.cfm?
abstract_id�556990.

Choi, Stephen. 1998. “Market Lessons for
Gatekeepers.” Northwestern Law Review, 92(4):
916–66.

Clark, Robert C. Forthcoming. “Corporate
Governance Changes in the Wake of the Sar-
banes–Oxley Act: A Morality Tale for Policymak-
ers Too.” Georgia State University Law Review.

Coates, John C., IV. 1999. “‘Fair Value’ as a
Default Rule of Corporate Law: Minority
Discounts in Conflict Transactions.” University of
Pennsylvania Law Review, 147: 1251.

Coates, John C., IV. 2006. “A Short Critique of
Selected Empirical Studies of the Sarbanes–
Oxley Act.” Unpublished Paper.

Coffee, John C., Jr. 2006. Gatekeepers: The Pro-
fessions and Corporate Governance. Oxford: Oxford
University Press.

Cohen, Danial A, Aiyesha Dey, and Thomas
Lys. 2005a. “Trends in Earnings Management
and Informativeness of Earnings Announce-
ments in the Pre- and Post–Sarbanes Oxley
Periods.” http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�658782.

Cohen, Danial A, Aiyesha Dey, and Thomas
Lys. 2005b. “Trends in Earnings Management in

John C. Coates IV 113

the Pre– and Post–Sarbanes Oxley Periods.”
http://papers.ssrn.com/sol3/papers.cfm?
abstract_id�813088.

Cunningham, Lawrence A. 2003. “The Sarbanes–
Oxley Yawn: Heavy Rhetoric, Light Reform (and
It Just Might Work).” Connecticut Law Review,
35(3): 915–989.

De Franco, Gus, Yuyan Guan, and Hai Lu.
2005. “The Wealth Change and Redistribution
Effects of Sarbanes–Oxley Internal Control
Disclosures.”http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�706701.

Dunn, Christine. 2006. “Effective Controls,
Clean Opinions Rule the Roost.” Compliance Week.
April 25, 2006. http://www.complianceweek.
com/.

Dyck, Alexander, Morse Adair, and Luigi Zin-
gales. 2006. “Who Blows the Whistle on Corpo-
rate Fraud?” http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�891482.

Economist. 2002. “The Backlash against Busi-
ness.” July 4. http://www.economist.com/world/
na/displayStory.cfm?story_id�1217728.

Eldridge, Susan W., and Burch T. Kealey.
2005. “SOX Costs: Auditor Attestation under
Section 404.” http://papers.ssrn.com/sol3/papers.
cfm?abstract_id�743285.

Engel, Ellen, Rachel M. Hayes, and Xue Wang.
2004. “The Sarbanes–Oxley Act and Firms’
Going-Private Decisions.” http://papers.ssrn.com/
sol3/papers.cfm?abstract_id�546626.

Ettredge, Michael, Jim Heintz, Chan Li, and
Susan W. Scholz. 2006a. “Auditor Realignments
Accompanying Implementation of Sox 404
Reporting Requirements.” http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�874836.

Ettredge, Michael, Chan Li, and Lili Sun.
2006b. “The Impact of Internal Control Quality
on Audit Delay in the SOX Era.” http://
papers.ssrn.com/sol3/papers.cfm?abstract_
id�794669.

Fairfax, Lisa M. 2002. “Form over Substance?
Officer Certification and the Promise of
Enhanced Personal Accountability under the
Sarbanes–Oxley Act.” Rutgers Law Review, 55(1).

Financial Executives Research Foundation,
Inc. 2001. Quantitative Measures of the Quality of
Financial Reporting, June 7, 2001. http://www.
fei.org/download/QualFinRep-6-7-2k1.ppt.

Financial Executives Research Foundation,
Inc. 2006. Sarbanes–Oxley Compliance Costs Are
Dropping, April 6, 2006. http://www2.fei.org/
news/press.cfm.

Financial Services Authority. 2004. Annual
Report. http://www.fsa.gov.uk/pages/Library/
Corporate/Annual/ar04_05.shtml.

Freeman, Jody. 2000. “The Private Role in Pub-

lic Governance.” New York University Law Review,
75(3): 543–675.

Glaeser, Edward L., Simon Johnson, and An-
drei Shleifer. 2001. “Coase versus the Coasians.”
Quarterly Journal of Economics, 116(3): 853–99.

Griffin, Paul A., and David H. Lont. 2005. “The
Effects of Auditor Dismissals and Resignations on
Audit Fees: Evidence Based on SEC Disclosures
under Sarbanes–Oxley.” http://papers.ssrn.com/
sol3/papers.cfm?abstract_id�669682.

Hail, Luzi, and Christian Leuz. 2006. “Cost of
Capital Effects and Changes in Growth Expecta-
tions around U.S. Cross-Listings.” European Cor-
porate Governance Institute. ECGI Finance Work-
ing Paper 46-2004. http://papers.ssrn.com/sol3/
papers.cfm?abstract_id�549922.

Halling, Michael, Marco Pango, Otto Randal, and
Josef Zechner. 2006. “Where Is the Market? Evidence
from Crosslistings in the U.S.” http://papers.
ssrn.com/sol3/papers.cfm?abstract_id�890308.

Hammersley, Jacqueline S., Linda A. Meyers,
and Catherine Shakespeare. 2005. “Market
Reactions to the Disclosure of Internal Control
Weaknesses and to the Characteristics of Those
Weaknesses under Section 302 of the Sarbanes
Oxley Act of 2002.” http://papers.ssrn.com/
sol3/papers.cfm?abstract_id�830848.

Healy, Paul, and Krishna G. Palepu. 2003.
“How the Quest for Efficiency Undermined the
Market.” Harvard Business Review, July 1, 2003.

Hilary, Gilles, and Clive Lennox. 2005. “The
Credibility of Self-Regulation: Evidence from the
Accounting Profession’s Peer Review Program.”
Journal of Accounting and Economics, 40(1–3):
211–29.

Holmstrom, Bengt, and Steven N. Kaplan.
2003. “The State of U.S. Corporate Governance:
What’s Right and What’s Wrong?” Journal of
Applied Corporate Finance, 15(3): 8–20.

Hsu, Peter C. 2004. “Going Private—A
Response to an Increased Regulatory Burden?”
UCLA, School of Law. Law and Economics
Research Paper: No. 04–16. http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�619501.

Jackson, Howell E. 2005. “Variation in the
Intensity of Financial Regulation: Preliminary
Evidence and Potential Implications.” Harvard
University Law School, John M. Olin Center
Discussion Paper 521. http://www.law.harvard.
edu/programs/olin_center/papers/521_Jackson.
php.

Jain, Pankaj K., Jang-Chul Kim, and Zabihol-
lah Rezaee. 2006. “Trends and Determinants
of Market Liquidity in the Pre– and Post–
Sarbanes–Oxley Act Periods.” Paper presented
at the 14th Annual Conference on Financial
Economics and Accounting, Indiana University,
Bloomington.

114 Journal of Economic Perspectives

Jain, Pankaj K., and Zabihollah Rezaee. 2006.
“The Sarbanes–Oxley of 2002 and Security
Market Behavior: Early Evidence.” Contemporary
Accounting Research 23(3): 629–54.

Kamar, Ehud, Pinar Karaca-Mandic, and Eric
L. Talley. 2006. “Going-Private Decisions and
the Sarbanes–Oxley Act of 2002: A Cross-Coun-
try Analysis.” University of Southern California.
Center in Law, Economics and Organization
Research Paper C06-05. http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�901769.

Kraakman, Reiner H. 1986. “Gatekeepers:
The Anatomy of a Third-Party Enforcement
Strategy.” Journal of Law, Economics, and Organi-
zation, 2(1): 53–104.

Krent, Harold J. 1990. “Fragmenting the Uni-
tary Executive: Congressional Delegations of Ad-
ministrative Authority Outside the Federal Gov-
ernment.” Northwestern Law Review, 62(1): 62–
112.

Langevoort, Donald C. 2006. “Internal Con-
trols after Sarbanes–Oxley: Revisiting Corporate
Law’s Duty of Care as Responsibility for Sys-
tems.” Journal of Corporation Law, 31(3): 893–947.

Law Firms. 2002. Sarbanes–Oxley Act Inter-
pretive Issues under Section 402 —Prohibition
of Certain Insider Loans: http://www.lw.com/
upload/docs/doc29 .

Leuz, Christian, Alexander J. Triantis, and Tracy
Yue Wang. 2006. “Why Do Firms Go Dark? Causes
and Economic Consequences of Voluntary SEC
Deregistrations.” University of Maryland, Robert
H. Smith School of Business Research Paper RHS
06-045. http://papers.ssrn.com/sol3/papers.cfm?
abstract_id�592421.

Levitt, Arthur, Jr. 2002. “Accounting and In-
vestor Protection Issues Raised by Enron and
Other Public Companies.” Presented at U.S.
Senate, Committee on Banking, Housing and
Urban Affairs Hearing, February 12, 2002. http://
www.iasplus.com/resource/levitt .

Li, Haidan, Morton Pincus, and Sonja O. Rego.
2006. “Market Reaction to Events Surrounding the
Sarbanes–Oxley Act of 2002 and Earnings Man-
agement.” Unpublilshed Paper. http://papers.
ssrn.com/sol3/papers.cfm?abstract_id�475163.

Linck, James S., Jeffry M. Netter, and Tina
Yang. 2006. “Effects and Unintended Conse-
quences of the Sarbanes–Oxley Act on Corpo-
rate Boards.” (May 16) AFA 2006 Boston Meet-
ings Paper. http://ssrn.com/abstract�902665.

Litan, Robert. 2005. “Sarbanes–Oxley Section
404 Costs and Implementation Issues: Survey
Update.” http://www.s-oxinternalcontrolinfo.com/
pdfs/CRAII .

Litvak, Kate. 2005. “The Effect of the Sarbanes–
Oxley Act on Non-US Companies Cross-Listed in
the US.” University of Texas Law, Law and Eco-

nomics Research Paper 55. http://ssrn.com/
abstract�876624.

Macey, Jonathan R., and Geoffrey P. Miller.
1991. “Attorney’s Role in Class Action and De-
rivative Litigation: Economic Analysis and Rec-
ommendations for Reform.” University of Chicago
Law Review, 58 (February) pp. 1–7.

Marosi, Andras, and Nadia Z. Massoud. 2004.
“Why Do Firms Go Dark?” http://papers.ssrn.
com/sol3/papers.cfm?abstract_id�570421.

McMullen, Dorothy A., Kannan Raghunandan,
and Dasaratha V. Rama. 1996. “Internal Control
Reports and Financial Reporting Problems.”
Accounting Horizons, 10(4): 67–75.

Moriarty, George B. and Philip B. Livingston.
2001. “Quantitative Measures of the Quality of
Financial Reporting; Statistical Data Included.”
Financial Executive, 17(5): 53.

Nagy, Donna M. 2005. “Playing Peekaboo with
Constitutional Law: The PCAOB and Its Public/
Private Status.” Notre Dame Law Review, 80(3):
975–1071.

Panel on Audit Effectiveness. 2000. Report and
Recommendations (Aug. 31, 2000). http://www.
pobauditpanel.org/download.html.

Perino, Michael A. 2002. “Enron’s Legislative
Aftermath: Some Reflections on the Deterrence
Aspects of the Sarbanes-Oxley Act of 2002.” St.
John’s Law Review 76 (Fall): 671.

Public Company Accounting Oversight Board.
2004a. Annual Report.

Public Company Accounting Oversight Board.
2004b. Auditing Standard No. 2. PCAOB File
No. 2004-08. http://www.sec.gov/rules/pcaob/
34-50688.htm.

Public Company Accounting Oversight Board.
2004c. Auditing Standard No. 3. PACOB File
No-2004-05. http://www.sec.gov/rules/pcaob/
34-50253.htm.

Public Oversight Board. 2002. “The Road To
Reform: A White Paper From The Public Oversight
Board On Legislation To Create A New Private Sector
Regulatory Structure For The Accounting Profession.”

Rezaee, Zabihollah, and Pankaj K. Jain. 2006.
“The Sarbanes–Oxley Act of 2002 and Security
Market Behavior: Early Evidence.” Contemporary
Accounting Research, 23(3): 629–54.

Romano, Roberta. 1991. “The Shareholder
Suit: Litigation without Foundation?” Journal of
Law, Economics, and Organization, 7(1): 55–87.

Romano, Roberta. 2005. “The Sarbanes–
Oxley Act and the Making of Quack Corporate
Governance.” Yale Law Journal, 114(7): 1521–
1161.

Shavell, Steven. 1986. “The Judgment Proof
Problem.” International Review of Law and Econom-
ics, 6(1): 45–58.

Stein, Jeremy C. 1989. “Efficient Capital Mar-

The Goals and Promise of the Sarbanes–Oxley Act 115

kets, Inefficient Firms: A Model of Myopic Cor-
porate Behavior.” Quarterly Journal of Economics,
104(4): 655–69.

Stuntz, William J. 2001. “The Pathological Pol-
itics of Criminal Law.” Michigan Law Review,
100(3): 505–600.

Taub, Steven. 2005. “Record Number of Re-
statements in 2004. Review of Reviewed Item.”
CFO.com, January 21. http://www.cfo.com/article.
cfm/3594659?f�related.

Thompson, Larry D. 2003. “Principles of Fed-
eral Prosecutions of Business Organizations.”
Memorandum to United States Attorneys, Janu-
ary 20, 2003. http://www.usdoj.gov/dag/cftf/
business_organizations .

U. S. House of Representatives. 1995. Confer-
ence Report, Private Securities Litigation Reform Act of
1995. H.R. Report No. 369, 104th Congress.
http://www.lectlaw.com/files/stf04.htm.

U.S. Government Accountability Office. 2006.
Consideration of Key Principles Needed in Addressing Im-
plementation for Smaller Public Companies. GAO-06-361.

U.S. General Accounting Office. 2002. Finan-
cial Statement Restatements: Trends, Market Impacts,
Regulatory Responses, and Remaining Challenges.
GAO-03-138.

U.S. General Accounting Office. 2003. Public

Accounting Firms: Mandated Study on Consolidation
and Competition. GAO-03-864.

Wall Street Journal. 2006. “Going Private.”
June 3. http://www.opinionjournal.com/weekend/
hottopic/?id�110008469.

Wilson, James Q. 1989. Bureaucracy: What
Government Agencies Do and Why They Do It. New
York: Basic Books.

Wintoki, Modupe. 2006. “Corporate Boards,
Regulation and Firm Value: The Impact of the
Sarbanes-Oxley Act and the Exchange Listing
Requirements.” http://www.southernfinance.org/
conference/SFA2006/awards.php?PHPSESSID�
fc396d3399c7ca2a0a6f9b50d9e0eaf7.

Zhang, Ivy X. 2005. “Economic Conse-
quences of the Sarbanes–Oxley Act of 2002.”
http://w4.stern.nyu.edu/accounting/docs/
speaker_papers/spring2005/Zhang_Ivy_
Economic_Consequences_of_S_O .

Zingales, Luigi. 2004. “The Costs and Benefits
of Financial Market Regulation.” European Cor-
porate Governance Institute. ECGI Law Research
Working Paper 21-2004. http://Papers.Ssrn.Com/
Sol3/Papers.Cfm?Abstract_Id�536682.

Zingales, Luigi. 2006. “Is the U.S. Capital Mar-
ket Losing Its Competitive Edge?” Unpublished
Paper.

116 Journal of Economic Perspectives

The Implications of the Sarbanes-Oxley Act for U.S. Foreign Relations

A Senior Honors Thesis

Presented in Partial Fulfillment of the Requirements for graduation
with research distinction in International Studies and Accounting in the undergraduate

colleges of The Ohio State University

Erin M. Lyons

The Ohio State University
June 2008

Project Advisors:

Dr. Richard Dietrich, Department of Accounting and Management Information Systems
Dr. Anthony Mughan, Department of International Studies

Section

Introduction

Part I

PCAOB Registration

Section 102

Section 10

Application of Sections 102 & 106

Sarbanes-Oxley & the Accounting Profession

Compliance & Inspection

Part II

History of U.S. Securities Law

International Challenges of Sarbanes-Oxley

Part III

Economic Impact

Legal Impact

Political Impact

Implications for U.S. Foreign Relations

Part IV

Demand for Alternative Solutions

Alternative One: Development of an International Oversight Body

Alternative Two: Mutual Recognition

The Development of Sarbanes-Oxley and the PCAOB

Conclusion

Bibliography

Page

INTRODUCTION

On July 30, 2002, The Sarbanes-Oxley Act, commonly known throughout the

world as SOX, and was passed into law with President Bush’s signature after an

overwhelming majority of Congress voted in favor of the Act. Sarbanes-Oxley shocked

both the U.S. and international accounting communities upon its passage. The primary

goal of this law is to protect U.S. investors from future accounting scandals. In the wake

of the accounting scandals that rocked U.S. capital markets in the early part of the

century, it is “no surprise the issue of corporate governance in the beginning of 2002

became top of the U.S. political agenda.”1

What is surprising, however, is the significant impact this sweeping piece of

legislation has had on countries throughout the world. With over 1300 foreign companies

currently listed on U.S. markets, SOX is inherently an all-encompassing international

affair that has affected the world tremendously since its creation.2 In addition to

domestic entities, Sarbanes-Oxley impacts foreign companies who are listed on

U.S.

exchanges and those foreign accounting firms who provide services to any U.S.-listed

company.3 The scope of the Act on entities abroad inevitably raises the question of

extraterritoriality. The extraterritorial application of SOX has hindered the United States’

foreign relations with numerous countries throughout the world, resulting in the

emergence of political, legal, and economic repercussions.

1 Becker, Tim and Clarke, Peter. “Is Washington Now the Omnipotent Regulator of the European Financial
System?” Ethical Corporation: Not an Oxymoron. http://www.ethicalcorp.com/content.asp?ContentID=233
(accessed April/20,

2008).

2 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
3 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

Sarbanes-Oxley’s convoluted language and complicated requirements have left

domestic and foreign parties to struggle with the implementation of this legislation.

Auditors, lawyers, politicians and executives have all partaken in the laborious plight to

incorporate SOX into their professional practices.4 Tim Becker and Peter Clarke

summarize the challenge foreign companies face with SOX by stating, “Simply put, a

British or French company with a secondary listing on the New York Stock Exchange

must comply with all provisions of the Sarbanes Oxley Act, unless there is an available

exemption […].”5 With a minimal number of SOX exemptions granted thus far, the idea

that this law will require entities throughout the world that participate in U.S. markets to

comply with the rules and regulations set forth by SOX regardless of nationality has not

produced a favorable reaction. Consequently, this negative perception of SOX has

resulted in increased efforts internationally to restructure the public accounting profession

as an alternative to enduring the U.S. reforms.6

Protecting investors worldwide and improving public company audits is a

righteous objective and SOX will undoubtedly assist regulators in achieving this

objective. However, as many critics of the law argue, that is not to say that Sarbanes-

Oxley is the optimal solution, especially for international entities.7 With varying legal,

institutional, and cultural systems throughout the world, it is imperative to resort to

diplomacy and dialogue when a far-reaching piece of legislation such as SOX is created.

4 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.
5 Becker, Tim and Clarke, Peter. “Is Washington Now the Omnipotent Regulator of the European Financial
System?” Ethical Corporation: Not an Oxymoron. http://www.ethicalcorp.com/content.asp?ContentID=233
(accessed April/20, 2008).
6 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
7 Ibid.

Becker and Clarke state, “In today’s global economy, the need for international

consultation is essential, even if the argument that the U.S. has every right to regulate its

own securities markets is a compelling one.”8

The United States’ decision to pass Sarbanes-Oxley into law without a more

careful and thorough consideration of its international implications has created a strong

negative reaction that, over five years later, has still not been resolved. This is a major

problem that the U.S. must address or else it will continue to receive backlash from the

international community. By requiring foreign entity compliance with SOX regulations,

the U.S. is threatening the sovereignty of foreign nations and tarnishing its image abroad.

If the U.S. does not develop an alternative arrangement for foreigners with respect to

Sarbanes-Oxley, the U.S. will further isolate itself, suffering politically, economically,

and socially.

The intent of this study is to describe in detail the impact of Sarbanes-Oxley from

economic, legal and political perspectives and the subsequent implications for U.S.

foreign relations. The purpose of this study is not to provide the ultimate solution to

safeguard U.S. investors from corporate misconduct. Rather, this paper identifies the

context of the problems that emerged as a result of the impulsive legislation and evaluates

alternative solutions to the original Act. PART I of the study examines the PCAOB

registration process and interprets Sections 102 and 106 of the Act, which address

domestic and foreign registration, respectively. This section also describes the impact of

Sarbanes-Oxley on the public accounting profession and the challenges that arise from

SOX compliance and PCAOB inspection. PART II of the study focuses on the history of

8 Becker, Tim and Clarke, Peter. “Is Washington Now the Omnipotent Regulator of the European Financial
System?” Ethical Corporation: Not an Oxymoron. http://www.ethicalcorp.com/content.asp?ContentID=233
(accessed April/20, 2008).

U.S. securities legislation and its traditional stance with respect to foreign entities. This

section then explores the international challenges of SOX and contrasts it with previously

established U.S. securities laws. PART III surveys the economic, legal, and political

impact of the Act and the subsequent implications for U.S. foreign relations. PART IV of

the study examines the demand for alternative solutions to Sarbanes-Oxley and evaluates

two different alternatives that have been discussed as viable options to the Act in recent

years. Finally, the study concludes with an assessment of the development of SOX and

the PCAOB since 2002.

PART I

PCAOB Registration:

Title I of the Sarbanes-Oxley Act established the Public Company Accounting

Oversight Board, commonly referred to as the PCAOB.9 The principal role of the

PCAOB is to protect U.S. investors, primarily through oversight of public accountants

charged with the role of auditing U.S. public companies. The Board oversees the conduct

of all registered firms. Under SOX, all public accounting firms who participate in the

financial statement audits of publicly listed companies in the United States must register

with the PCAOB. One source notes, “Registration is a key to the PCAOB’s powers in

that registration with the PCAOB opens registering firms to inspections and sanctions by

the PCAOB.”10 Registration essentially provides the PCAOB complete authority under

SOX over those firms registered, U.S. and foreign firms alike. Its authority, in addition

9 One Hundred Seventh Congress of the United States of America. Sarbanes-Oxley Act of 2002. Translated
by U.S. Congress. Vol. H.R. 3763–21Federal, 2002,
news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302 (accessed

November 30, 2007).

10 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

to developing standardized audit practices that firms must follow, includes the ability to

assign penalties to any registered firm found to be in violation of Sarbanes-Oxley or any

section of it.11

It has been said that the idea behind requiring firms to register with the Board is to

attain greater control over the public accounting profession and to better monitor its

activities, thus avoiding future auditing deficiencies.12 Currently there are 1848 public

accounting firms registered with the PCAOB.13 This sizeable number of registrants

clearly demonstrates the power of the Board over the global public accounting

profession. In order to determine whether the Board’s objectives as established by SOX

have been achieved, it is necessary to analyze the sections of the Act that establish the

framework for PCAOB registration. Section 102 of the Act focuses on domestic

registration requirements while section 106 specifically addresses the registration of

foreign accounting entities.

Section 102

The first paragraph under section 102 discusses the mandatory registration

required of U.S. public accounting firms. The legislation states, “It shall be unlawful for

any person that is not a registered public accounting firm to prepare or issue, or to

participate in the preparation or issuance of, any audit report with respect to any issuer.”14

Therefore, any accounting firm that actively participated in preparing a U.S. listed

11 Ibid.
12

PCAOB-Beyond the First Year. Mondaq Business Briefing, July 15, 2004.

13 Public Company Accounting Oversight Board. PCAOB 2008-2013 Strategic Plan 2008,
www.pcaobus.org

(accessed May 2, 2008).

14 One Hundred Seventh Congress of the United States of America. Sarbanes-Oxley Act of 2002.
Translated by U.S. Congress. Vol. H.R. 3763–21Federal, 2002,
news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302 (accessed November 30, 2007).

company’s audit report can no longer continue to do so by law without registering with

the PCAOB.

The subsequent paragraph explains the process of registering with the Board and

provides a detailed description of the information necessary to completing the application

for registration. The content of the application must include a list of the prior year public

companies audited by the firm, a list of the companies the firm believes it will audit in the

current year, a fees disclosure, and any other financial information deemed necessary and

thereby requested by the Board.15 Additionally, the firm must disclose its financial

statement audit control processes, provide a record of its employed accountants including

their licensing information, divulge information about pending disciplinary proceedings

concerning possible audit report deficiencies, if any, and also provide copies of

disclosures pertaining to accounting disagreements between the firm and its clients.16

Finally, the legislation creates a “catch-all” clause for registration, requiring firms to

release “such other information as the rules of the Board or the [Securities and Exchange]

Commission shall specify as necessary or appropriate in the public interest or for the

protection of investors.”17 This final clause ultimately gives the Board total discretion

over the information it can instruct firms to provide in order to register with the PCAOB.

Finally, it is required that firms comprehend and consent to the rules of registration

established by the Board as well as the implications of SOX regarding continued

compliance in the future.18

15 Ibid.
16 Ibid.
17 Ibid.
18 Ibid.

The final three paragraphs of section 102 are vital to fully understand the impact

Sarbanes-Oxley has on registered firms and their business practices. Paragraph (d) of the

section describes the mandatory annual report registered firms must issue each year and

update as necessary per the Board’s request.19 This will increase the workload of public

accounting firms by a significant amount each year as well as the costs of SOX

compliance. Paragraph (e) reveals that information provided to the Board by registered

firms will be made available to the public unless the Board deems part of it to be

sensitive in nature to the firm.20 If, on a case-by-case basis, the Board deems particular

information to be sensitive to a firm, this select information will be shielded from public

release. This introduces the issue of intellectual property and confidentiality laws, raising

speculation from critics that SOX possibly is in violations of these statutes. The final part

of this section, paragraph (f), introduces the fees provision, which requires that firms pay

both an initial registration fee and subsequent fees each year thereafter to the Board.21

This will undoubtedly provide an additional financial burden to accounting firms and it is

interesting to note that the Board has the discretion to determine the appropriate fee

amount firms will need to pay. Per the Board’s 2008 Budget approved by the SEC and

released late in 2007, the 2008 accounting support fee is an estimated $134.5 million (See

attached budget).22 This amount is funded both by public companies listed in the U.S.

and PCAOB registered accounting firms in a manner outlined in detail in Section 109 of

the Act.

19 Ibid.
20 Ibid.
21 Ibid.
22 Public Company Accounting Oversight Board. 2008 Budget by Area, December 2007 www.pcaobus.org
(accessed May 2, 2008).

Section 106

Section 106 is vital to the understanding of Title I of Sarbanes-Oxley because it

describes the influence this piece of U.S. legislation will have on foreign accounting

firms and the international community in general. As one source notes, “With the global

economy and the international structure of audit clients, it is inevitable that accounting

firms will need to rely on foreign accounting firms and other entities in order to complete

certain [parts] of their audit reports.”23 Consequently, it is no surprise that SOX

specifically addresses the treatment of foreign accounting firms and the role that they

play in completing the audits of U.S. public companies. What is surprising, however, is

the lack of distinction between what is required of domestic firms under the Act and what

is now required of foreign firms.

The first paragraph of section 106 defines the applicability of Sarbanes-Oxley to

foreign public accounting firms. The legislation reads:

Any foreign public accounting firm that prepares or furnishes an audit report with

respect to any issuer, shall be subject to this Act and the rules of the Board and the

Commission issued under this Act, in the same manner and to the same extent as a

public accounting firm that is organized and operates under the laws of the United

States, or any state, except that registration pursuant to section 102 shall not by

itself provide a basis for subjecting such a foreign public accounting firm to the

jurisdiction of the Federal or State courts, other than with respect to controversies

between such firms and the Board.24

23 PCAOB-Beyond the First Year. Mondaq Business Briefing, July 15, 2004.
24 One Hundred Seventh Congress of the United States of America. Sarbanes-Oxley Act of 2002.
Translated by U.S. Congress. Vol. H.R. 3763–21Federal, 2002,
news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302 (accessed November 30, 2007).

In other words, those foreign entities involved in the audits of companies listed on U.S.

securities exchanges have to register with the PCAOB and will, in theory, avoid reporting

to the U.S. courts system provided that they are in full compliance with the tenets of

Sarbanes-Oxley. This paragraph also clarifies the authority of the Board over these

foreign firms. The legislation essentially mandates that it is necessary for the foreign

firms to register with the PCAOB in the interest of investor protection even if they do not

directly issue the audit report for a public company but play a significant role in the audit

process.25 This “associated entity” clause not only affects foreign firms who now must

influences domestic accounting firms.26 Accordingly, domestic firms that base some of

their opinion on supplemental work conducted by foreign firms during the course of the

audit are prohibited from relying on it unless the firms are officially registered with the

PCAOB.27

The following paragraph discusses the role of both foreign and domestic firms in

the production of foreign audit workpapers to the Board. This section of the Act

stipulates that, by registering, foreign firms are assumed to have consented to the

production of their workpapers to the Board if requested to do so.28 Additionally, foreign

firm registration assumes having consented “to be subject to the jurisdiction of the courts

of the United States for purposes of enforcement of any request for production of such

25 Ibid.
26 PCAOB-Beyond the First Year. Mondaq Business Briefing, July 15, 2004.
27 Ibid.
28 One Hundred Seventh Congress of the United States of America. Sarbanes-Oxley Act of 2002.
Translated by U.S. Congress. Vol. H.R. 3763–21Federal, 2002,
news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302 (accessed November 30, 2007).

workpapers.”29 On the other hand, those domestic firms registered with the Board have

also provided implied consent to the PCAOB. In this case, domestic firms working with

foreign counterparts during the course of an audit have assumed the responsibility to help

the Board obtain necessary foreign workpapers. Domestic firms are also responsible for

securing a commitment from their foreign counterparts to cooperate with the PCAOB

when necessary.30

The final two paragraphs of section 106 provide clarity pertaining to the Board’s

intended treatment of foreign accounting firms and the firms to which it foresees SOX as

being applicable to. Paragraph (c) describes the power that the PCAOB has to grant

exemptions to foreign firms.31 Basically, this clause grants the PCAOB the power to

exempt foreign firms from complying with certain parts of the Act provided that

investors’ interests remain protected. Additionally, paragraph (d) attempts to clarify the

meaning of foreign accounting firm to distinguish from that of a domestic accounting

firm. SOX reads, “In this section, the term ‘foreign public accounting firm’ means a

public accounting firm that is organized and operates under the laws of a foreign

government or political subdivision thereof.”32 It is interesting to note that the

concluding paragraph of a section devoted to emphasizing the similar treatment of

foreign and domestic firms under SOX stresses a distinction between foreign and

domestic firms that essentially lacks little meaning to the application of this law in

practice.

29 Ibid.
30 Ibid.
31 Ibid.
32 Ibid.

Application of Sections 102 & 106

Upon the acceptance of Sarbanes-Oxley into United States law, both the domestic

and international communities began to recognize the far-reaching effect this law has.

The former European Commissioner for the Internal Market and Services, Fritz

Bolkestein, was quoted as saying, “Section 106 requires all big EU audit firms to register

with the proposed Board, pay registration fees, apply US rules on auditing, ethics, and

quality control, and subject themselves to the investigative and disciplinary sanctions of

the Board and US authorities.”33 He also expressed uneasiness about requiring European

Union accounting firms to simultaneously abide by both EU and U.S. securities laws.

This concern can certainly be extrapolated to other nations and the difficulties they will

face conforming to both the U.S. and their domestic regulatory systems.

An illustrative example clarifies the implication of section 106 and will convey

further meaning to the demand of SOX on foreign firms. Consider if U.S. Firm X audits

a large, multinational company that holds a foreign subsidiary in the European Union and

is registered on a U.S. stock exchange. Firm Y, operating under the laws of the EU,

assists Firm X in its audit of the company by performing the testing of the foreign

subsidiary’s internal controls. Under the Sarbanes-Oxley Act, Firm Y must register with

the PCAOB if any of its audit work is to be relied upon for the purpose of Firm X’s audit

of the U.S. listed corporation.

Consequently, Firm Y, during the course of its registration with the PCAOB and

future compliance with SOX, may find itself in the unfavorable position of complying

with two legal systems simultaneously. Furthermore, Firm Y may find that it cannot

Eu Warns on Sarbanes – Oxley Act. Financial News (Daily), September 6, 2002.

comply with both countries’ laws at the same time due to their inherently conflicting

nature. In the latter case, does Firm Y choose to follow the laws of the country it

operates within or the laws of a foreign country? One source interestingly declares,

“Through its ability to register all firms that audit public companies, including foreign

auditors, […] the PCAOB will be able to regulate both national and foreign audit firms

involved in the U.S. securities market.”34 It is this power, among many others, possessed

by the PCAOB that has led foreign firms to protest Sarbanes-Oxley and question its

effectiveness in relation to international auditors.

Sarbanes-Oxley & the Accounting Profession

Before the PCAOB emerged in the United States under Sarbanes-Oxley, the

accounting profession was responsible for the both its own regulation and funding of this

regulation.35 The American Institute of Certified Public Accountants (AICPA) is the

national association for U.S. public accountants. Prior to Sarbanes-Oxley, the AICPA

issued and enforced a code of conduct by which accountants upheld. After the PCAOB

was founded, oversight of public accountants in the U.S. became separated by law from

the accounting profession. Regulation of the fields of accounting and law in the past has

differed greatly from the regulation of other industries and professions. In the aftermath

of the accounting scandals, however, it became apparent to lawmakers that drastic change

was needed.36 One source summarizes this change by saying, “Consequently, by

implementing provisions such as board audit committees, auditor service restrictions, and

34 Giles, Jill P., Elizabeth K. Venuti, and Richard C. Jones. “The PCAOB and Convergence of the Global
Auditing and Accounting Profession.” The CPA Journal 74, no. 9

(Sep, 2004): 36.

35″NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
36 Ibid.

attorney conduct standards, SOX bridged the long standing divide between federal

securities regulation, state corporate governance law, and professional self-regulation.”37

Effectively, Sarbanes-Oxley in one swift swoop turned the former self-regulating

accounting profession upside down and transformed it into a rule-centered profession that

operates under the constant supervision of the PCAOB. The accounting industry’s

dissatisfaction with this change is rather apparent given the PCAOB’s nickname,

“Peekaboo,” referring to its constant monitoring of the industry’s actions. The CPA

Journal conducted a survey of auditing professionals about Sarbanes-Oxley and the role

of the PCAOB after a few years had passed since the Act’s creation. This source reports

one respondent as saying: “I think that there is an expectations gap here. Even if we get

financial reporting 99.9% accurate, that 0.1% will still generate enough headlines and bad

press to keep accounting problems in the news. So then, how effective is SOX in reality

to the profession?”38 While the future of the newly created Board is not certain, it is

widely recognized that the PCAOB plays a significant role in the accounting industry

worldwide, regardless of its acceptance among professionals.39

Apart from the regulation of public accountants, the overall impact on the

accounting industry and its practices is far-reaching. While the purpose of this study is

not to perform an in-depth analysis of Sarbanes-Oxley in its entirety, it is necessary to

identify the significant areas of the law that impact both U.S. and foreign accounting

practices. The five primary areas in which SOX changes prior practices are: (1) The

relationship between audit committees and their external auditors; (2) Auditor

37 Ibid.
38 PCAOB-Beyond the First Year. Mondaq Business Briefing, July 15, 2004.
39 Hill, Nancy T., John E. McEnroe, and Kevin T. Stevens. “Auditors’ Reactions to Sarbanes-Oxley.” The
CPA Journal 77, no. 7 (Jul, 2007): 6.

independence and services allowed; (3) Mandatory auditor internal control assessment;

(4) Management internal control assessment; and (5) Document retention.40

Additionally, another source notes the added disclosures now required of firms and the

threat of criminal punishment have also drastically affected the industry.41 These new

practices have been difficult and costly for U.S. firms to implement into their operations.

Furthermore, the differences that existed between the U.S. and foreign accounting

industries have made it all the more difficult for those foreign companies and firms under

the reach of SOX to implement these practices. For example, David Sun, a partner-in-

charge of assurance and advisory for Ernst and Young Asia-Pacific commented on the

difficulty of complying with auditor rotation requirements, a tenet designed to ensure

auditor independence. International Securities Outlook Online states, “Sun said that the

SEC’s proposals would not work in many Asian countries without affecting audit quality.

Asian countries are unable to train accountants fast enough to keep pace with their

economic development.”42 Because the stage of development of the accounting

profession varies from region to region, it proves difficult to implement the auditor

rotation requirement mandated by SOX. For instance, the ratios of auditors to people in

the United States and China are 1:1,000 and 1:13,000, respectively.43 This enormous

40 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
41 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
42 “Foreign Securities Regulators Express Concern about Auditor Independence Rules.” International
Securities Outlook Online Volume 4, Issue 1 (January 6, 2003, 2003): December 1, 2007,
http://business.cch.com.
43 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).

difference demonstrates the general rigidity of SOX and the difficulty of putting its

decrees into practice outside of the U.S.

Additionally, the intrinsic disparities that exist between the U.S. rule-centered

accounting system and the European principles-based system lead many abroad to reject

the imposition of SOX. In fact, many Europeans are of the mindset that the rule-based

system is largely responsible for allowing the occurrence of the accounting scandals in

the first place.44 There have been many requests submitted to the SEC, primarily from

Europe, asking for regulators around the world to develop a universal principles

accounting system.45 This would allow for a coherent worldwide system to develop in

place of a system where accountants must reconcile to a number of different regulatory

systems. Former SEC commissioner, Roel Campos, has made it clear, according to one

source, that the SEC does not intend “to hold foreign participants in the U.S. market to a

higher level of regulation or review than the level to which we hold U.S.-based

participants.”46 While this may in fact be the case, adherence to multiple regulatory

environments is a reality for foreign entities. This reality has only been worsened by

Sarbanes-Oxley and foreign market participants are certainly feeling the effects of it.

Compliance & Inspection

Apart from considerable registration and annual membership fees, the costs of

putting Sarbanes-Oxley into practice is substantial for both U.S. listed companies and the

accounting firms auditing them. These heightened costs create an obvious disadvantage

44 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
45 “Foreign Securities Regulators Express Concern about Auditor Independence Rules.” International
Securities Outlook Online Volume 4, Issue 1 (January 6, 2003, 2003): December 1, 2007,
http://business.cch.com.
46 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June 12, 2003.

for smaller firms with limited resources as well as foreign firms, who now face the costs

of multiple regulatory bodies.47 Additionally, not all of the costs of Sarbanes-Oxley with

respect to foreign firms are monetary. The ramifications of subjecting foreign firms to

produce its workpapers or undergo U.S. inspection are by no means purely fiscal. Rather,

these requirements put foreign firms in the unfavorable position of potentially violating

their home country laws in order to comply with SOX.

Where information that is considered confidential under one nation’s law is now

required to be produced under U.S. law, conflict of law is imminent and the cost to

foreign firms is detrimental.48 Ethiopis Tafara, Director of the Office of International

Affairs for the SEC, explained the position of the Commission during a speech in

London. On the production of workpapers and conflict of laws, he states, “Non-

production of the papers and delays can significantly impede an enforcement program.

While [the SEC] certainly respect[s] foreign laws, national boundaries cannot serve to

shield foreign participants in the US market from investigation.”49 Paragraph (c) of

Section 106 grants power to the PCAOB to grant exemptions to foreign governments

when appropriate. Many foreign opponents to the Act have called upon the Board for

workpaper exemption among others, but the Board has not granted this request to date in

the interest of investors.50 Debate over U.S. enforcement of SOX abroad and the

different business and legal structures across the world has been a hot topic. The PCAOB

47 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
48 Ibid.
49 Tafara, Ethiopis. “Speech by SEC Staff: U.S. Perspective on Accountancy Regulation and Reforms by
Ethiopis Tafara.” London, U.S. Securities and Exchange Commission, July 8, 2003, 2003,
http://www.sec.gov/news/speech/spch070803et.htm (accessed December, 1 2007).
50 Miller, Richard I. and Paul H. Pashkoff. “Regulations Under the Sarbanes-Oxley Act.” Journal of
Accountancy 194, no. 4 (Oct, 2002): 33.

will need to find a solution for foreign registrants and address how it intends to conduct

its regulatory activities outside U.S. borders.51

Under Sarbanes-Oxley, the PCAOB holds the power to inspect registrants and

their auditing procedures regardless of nationality. If a firm is found in violation of a

SOX tenet, the Board can issue a number of sanctions. The ultimate sanction the

PCAOB can utilize involves revoking a firm’s registration status, thereby preventing that

firm from auditing public companies listed on U.S. capital markets.52 One source states

that the “PCAOB’s inspections of registered audit firms are intended to assess the degree

of audit firms’ compliance with audit standards in conducting audits. These inspections

may be very thorough, and could entail discussions with audit clients and restatements in

the event accounting errors are discovered.”53 In addition to existing SEC regulations

already followed by foreign companies, SOX now introduces a regular schedule of

inspection for compliance purposes as well as inspections when firm conduct is in

question.54

In lieu of a PCAOB inspection, foreign accounting firms may have the option of

having a domestic regulatory body conduct the inspection. However, the decision of the

PCAOB to rely on the foreign regulatory body’s inspection results will heavily weigh on

the integrity of the system as perceived by the Board.55 The PCAOB has been

51 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
52 Ibid.
53 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.
54 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
55 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.

collaborating with foreign regulators to explore the possibility of conducting joint

inspections to improve cost and efficiency of SOX compliance across borders, but the

outcome of these efforts have yet to be determined.56 Finally, if the Board does in fact

accept the inspection of foreign firms by foreign regulatory bodies, the question still

remains as to the treatment of those firms found in violation of SOX practices. As one

source notes, “Although imprisonment and fines are penalties integrated into the Act, it

remains to be seen how, and for what provisions, the SEC will apply these sanctions to

foreign violators.”57 Even if the PCAOB is able to develop a compatible system of

inspection abroad, it still has not addressed the manner in which it intends to enforce

SOX for accounting firms operating within foreign borders found to be in violation of the

U.S. law.

PART II

History of U.S. Securities Law

Sarbanes-Oxley has been said to be the most significant piece of securities reform

legislation since the 1933 and 1934 Securities Acts, which were created to prevent

another stock market crash like that of 1929. In order to see why Sarbanes-Oxley has

received such negative reaction internationally, one must first understand the basics of

U.S. securities law and how it has previously been applied to international entities. Prior

to SOX, the SEC and U.S. courts in conjunction established a framework that achieved

56 Tafara, Ethiopis. “Speech by SEC Staff: U.S. Perspective on Accountancy Regulation and Reforms by
Ethiopis Tafara.” London, U.S. Securities and Exchange Commission, July 8, 2003, 2003,
http://www.sec.gov/news/speech/spch070803et.htm (accessed December, 1 2007).
57 “COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES – OXLEY
IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO COSTS TO THE UNITED STATES.”
2004 Emory University School of Law Emory International Law Review (Spring, 2004).

foreign compliance with U.S. regulations while still honoring the laws of their domestic

governments.58 SOX does not destroy this loose framework, but it does threaten to tip

the historical balance by not respecting the laws and institutions, mainly those involving

accounting oversight, of countries abroad.

Regulation S was the SEC’s first significant step to address foreign concerns

about SEC foreign registration requirements for securities transactions under the

Securities Act of 1933.59 The SEC’s issuance of Regulations S provided additional

information to foreign companies with respect to registering for U.S. capital market

access while ensuring that the autonomy of their domestic governments was still

honored.60 The purpose of the SEC is to protect U.S. investors from fraudulent business

actions, thereby providing a secure capital market environment in the United States. As a

result, protecting investors from fraud is often said to be the defining characteristic of

U.S. securities law, which consequently affects investors from all over the globe.61

To determine whether fraudulent behavior has occurred and also whether the

United States has jurisdiction of the matter in question, the U.S. courts have developed

two tests for their decision-making process: Effects and Conduct.62 The application of

these tests historically has determined whether the U.S. should pursue extraterritorial

enforcement of its securities laws. The idea behind the tests is to essentially limit U.S.

pursuit of claims regarding securities law violations outside its sovereign borders.63 This

58 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
59 Ibid.
60 Ibid.
61 Ibid.
62 Ibid.
63 Ibid.

format provides a cohesive manner in which courts determine whether subject matter

jurisdiction applies outside of U.S. borders. In addition, the tests limit the amount that

the U.S. can impose its laws and subsequent penalties on foreign citizens and

corporations.64

The SEC threw away its traditional accommodations for foreign issuers with

respect to securities legislation when SOX was issued. Although the SEC has granted

some degree of exemption to foreign firms from Sarbanes-Oxley, the international feeling

toward the law is still unfavorable and many are confused by the United States’

divergence from its historical method of regulation for international entities. One source

believes that “much of this confusion is attributable to a widening gap between the

original premise of the U.S. securities laws in relation to foreign issues and the new

reality of globalization.”65 Although in the past there have been instances in which the

SEC has taken action against foreign issuers, especially with respect to anti-fraud

legislation, non-U.S. companies take these limited occurrences into account when

deciding whether or not to list on U.S. exchanges.66 Historically, the risk of answering to

the U.S. Courts for securities law violation has not deterred the entrance of foreign firms

into the market. However, one must wonder if Sarbanes-Oxley and its heightened risk of

U.S. enforcement abroad will now push foreign companies away from the U.S. capital

market.

64 Ibid.
65 Ibid.
66 “COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES – OXLEY
IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO COSTS TO THE UNITED STATES.”
2004 Emory University School of Law Emory International Law Review (Spring, 2004).

International Challenges of Sarbanes-Oxley

The international outrage toward Sarbanes-Oxley is best summarized by the

following statement: “SOX reaches beyond the registration and disclosure requirements

first established by the 1933 and 1934 Acts and forces foreign corporations to conform to

a model of corporate governance crafted by the U.S. Congress.”67 Those who object to

the Act are wary of the increasing reach of the SEC and newly created PCAOB.

International concern primarily stems from Section 106 and there is a call to allow

foreign exemptions for those firms that are cross-listed on U.S. exchanges.68 Many

critics emphasize that they believe in the overall purpose of Sarbanes-Oxley, but do not

support the tedious requirements now demanded of foreign corporations.

Another common reaction to SOX is that many believe it was created to clean up

the mess of scandals that occurred in the U.S. during 2002 and that foreign firms should

not have to suffer the consequences of cleaning up the U.S. system. One source believes

that “extending this regulation beyond US firms is seen as an arrogant imposition from

American regulators.”69 The negative foreign opinion stems from the fact that U.S. firms

gain the upper hand over international accounting firms who now must answer to

multiple regulatory systems. Disapproval of SOX is especially prevalent in the European

Union, where governments are currently trying to merge several economies, all with

differing laws and regulatory bodies, into a single, unified EU economic system.70

67 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
68 Quinn, Eamon. Accountants Step Up Bid Against Us Law. Sunday Business Post,

September 15, 2002.

69 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
70 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

Sarbanes-Oxley essentially deepens this burden for the EU and the U.S. could possibly

face future repercussions from the EU if it were to unify.

Answering to more than one accounting regulation system is an extreme

disadvantage for foreign firms and representatives of the Big Four Accounting firms

abroad have readily voiced their dissatisfaction with the new law. Aidan Walsh, an

executive of KPMG International, has said that SOX has made it tricky for the firm to

implement abroad and believes that “the Act was put together hastily and with little

regard for the consequences to companies based outside of the US.”71 A European

partner at PriceWaterhouseCoopers echoes a similar attitude toward SOX and explains

international opposition by stating, “No one wants to be a copy of the US. If there is any

country where something has gone wrong in the field of corporate governance, and

accounting and capital markets, it’s the US.”72 Consequently, the international

community is now beginning to wonder if the U.S. capital market is really the place to

invest if companies are now forced to comply with a law that puts them at an inherent

disadvantage in the marketplace.73

In some ways, it is surprising that there is such opposition abroad because foreign

corporations have traditionally followed U.S. securities laws for years in the past. A

careful look into the legal framework of securities regulation provides valuable insight

into this apparent anomaly. Although the creation of Regulation S, as mentioned in the

preceding section, calmed securities registration worries abroad, fraud regulation, despite

71 Kemp, Shirley. Us Laws to Hinder Sa Companies. Moneyweb (South Africa) – AAGM, November 5,
2002.
72 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
73 Kemp, Shirley. Us Laws to Hinder Sa Companies. Moneyweb (South Africa) – AAGM, November 5,
2002.

the tests developed by the U.S. Courts, still creates unstable conditions in the

international marketplace.74 Despite the initial tendency of many to believe that SOX

drastically disrupts this already shaky balance, in reality this is not the case.

In fact, the tenets of SOX that specifically refer to its international application

entirely relate to the activity of those firms already registered on the U.S. capital

market.75 Ironically, SOX technically falls under the guidance of Regulation S and its

specific rules regarding international entities. Regulation S is essentially the weight that

keeps the unstable investment environment in balance by respecting international

sovereignty and calming international compliance concerns.76 This leads one to conclude

that Sarbanes-Oxley would not tip the historic balance and this conclusion could not be

farther from the truth.

It is important to emphasize that the Act does not impose its requirements on just

any international party. SOX simply affects those foreign firms already registered on the

U.S. market, or choose to register in the future, and are voluntarily complying with

existing U.S. securities laws.77 Although compliance is an additional cost associated with

access to U.S. stock exchanges, as long as international firms continue to feel as though

the benefits of the U.S. market exceed the costs listed firms face, they will likely maintain

their listing in the U.S.78 Since the issuance of SOX, however, the sudden decrease in

foreign listings on the market in the United States suggests that foreign firms are now

74 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
75 Ibid.
76 Ibid.
77 Ibid.
78 Ibid.

perceiving the costs of listing to be in excess of the benefits.79 Foreign de-listing creates

a lose-lose situation for U.S. citizens and foreigners alike and ultimately makes it

possible to conclude that the imposition of U.S. laws on foreign corporations is not in

anyone’s best interest.

The major issue international critics have with Sarbanes-Oxley concerns its

corporate governance rules.80 It is believed that Title III of the Act, titled Corporate

Responsibility, is largely responsible for pushing foreign companies to either de-list from

U.S. exchanges or decide not to enter the market in the first place. The critics believe

that it was one thing to voluntary follow past requirements to participate in the U.S.

market, which primarily consisted of providing in-depth earnings information to

regulators, but quite another to require that foreign companies rearrange their

corporations in order to continue to list in the U.S.81 One source summarizes this conflict

and explains, “Since controlling shareholders and banks have traditionally kept a closer

watch on management in many foreign countries, much of the management-centered U.S.

approach, such as strict disclosure of management self-interest and compensation, may be

too oppressive and unnecessary in the case of foreign companies.”82 The intrinsic

differences embedded in corporate architecture across different nations imply that the one

size fits all mentality of Sarbanes-Oxley is not realistic for international companies.

79 Ibid.
80 Ibid.
81 Ibid.
82 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).

The nature of SOX promotes an individualistic business environment that

naturally conflicts with those nations whose cultures promote a collective environment.83

This environmental variance is particularly true of Germany and Japan, two nations who

possess a strong economic presence in the United States.84 Because SOX regulations

were created with the intention to protect U.S. investors and U.S. corporations promote

individual accountability, the regulations were designed to control for individual

behavior. On the other hand, Germany, whose market capitalization and foreign direct

investment in the U.S. are approximately $287 billion and $35 billion, respectively,

designed its corporate structure to reflect shared accountability. Shared accountability

reflects Germany’s collectivist culture.85 An issue now arises because German

companies who list on U.S. exchanges are now subject to the regulations created under

SOX. Conflict will inevitably occur when imposing an individualistic regulation on a

collectivist company. The two-tier board structure of German corporations would make

it nearly impossible to comply with the independence requirements under SOX and lacks

a CEO figure to certify the company’s financial statements.86 The rigid nature of

Sarbanes-Oxley, its indifference toward foreign nations, and the subsequent culture

clashes, generate additional animosity toward the U.S.

Another interesting challenge resulting from the imposition of SOX abroad is the

inability to accurately translate some of the terms mentioned in the Act into certain

83 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
84 Ibid.
85 Ibid.
86 Ibid.

foreign languages.87 This is a direct result of the cultural differences and variable

business norms that exist around the world. Even if some of the phrases used in SOX are

literally translated into a foreign language, the phrases will still lack meaning abroad

because the context is unique to the U.S. business culture. To illustrate, translation of

SOX into the Japanese language has proved difficult because Japan is another culture that

promotes a collective mentality.88 The term “officers” does not transfer to Japanese

business terminology because this culture encourages companies to have boards that

work together to govern corporations. Therefore, the requirements of SOX that demand

“officers” to act in a specific manner and the individual accountability of management in

the U.S. have little or no meaning to the Japanese business culture.89 Additionally, the

process used in Japan to select external auditors differs from U.S. practice and directly

conflicts with the stringent independence standards under SOX. Because Japan allows its

shareholders to directly determine the external auditor for each company and the U.S.

mandates independent audit committees to make the decision, there is another culture

clash.90 Imposition of SOX independence standards on Japanese countries would

override the cultural norms inherent to Japanese business processes.

Ongoing negotiations between the SEC, PCAOB, and foreign representatives

provide hope that the U.S. will soon compromise certain provisions of Sarbanes-Oxley to

better suit international needs, such as corporate governance tenets, which differ in many

instances from the U.S.91 The SEC and PCAOB have listened to these international

87 Ibid.
88 Ibid.
89 Ibid.
90 Ibid.
91 Hope of further Compromise with the SEC. International Accounting Bulletin, January

24, 2003. 8.

concerns and have since responded in the following ways: (1) Granted permission to

follow domestic corporate governance structure provided foreign firms complete a

mandatory disclosure of the differences between the domestic structure and that of the

U.S.; (2) Exceptions have been granted in limited cases when the Act’s provisions have

conflicted with international laws, but never with respect to audit committee

requirements; (3) Extended initial PCAOB registration deadline for foreign firms to July

19, 2004; (4) Foreign firms are permitted to withhold sensitive information when

registering with the Board if it is in conflict with their home country’s laws. The firms

must complete an extensive disclosure statement explaining the need to withhold the

information from the Board in order to be granted the exemption; and (5) The PCAOB is

collaborating with foreign regulators to conduct inspections abroad on its behalf.92 While

these exemptions for foreign firms are a good start, the PCAOB and SEC still have a long

way to go in order to diffuse international concerns.

The permission granted to foreign accounting firms to withhold information from

the Board that would violate its domestic laws was a significant step. However, the

process of earning this allowance is not as simple as it appears for foreign companies.

Foreign entities now must endure a lengthy process of consents and waivers to obtain this

exemption, at a cost inevitably passed onto the foreign accounting firms.93 Additionally,

while the SEC has granted some relief to foreign companies under the controversial Title

III by allowing home country practice to have precedence, it still mandates certain

practices difficult to implement under foreign law, such as the audit committee

92 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.
93 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

provisions.94 Finally, the decision of the PCAOB to extend the registration deadline for

foreign accounting firms and exempt those firms from providing certain information

normally required for registration but in violation of international laws was another

considerable step for the Board. However, the disclosure process to obtain this

exemption is again timely and costly for foreign firms, further deepening the

disadvantages faced by foreign companies in comparison to U.S. firms.95

PART III

Economic Impact

Foreign presence in the U.S. capital market has grown considerably in the past

three decades and non-U.S. companies’ capital is vital to the health of the U.S.

economy.96 The composition of the market, consisting of U.S. and foreign listed

companies, has impacted SEC procedures and resulted in U.S. dependency on foreign

market participation. Former SEC Commissioner Roel Campos addressed the Center for

European Policy Studies in Brussels on June 11, 2003 to discuss the importance of

foreign companies to the U.S. market.97 During this speech, Campos encourages foreign

participation provided the companies were prepared to comply with the SEC and its

intent to protect investor interest.

94 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).
95 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
96 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).
97 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June 12, 2003.

The former Commissioner acknowledges his presence in Europe as a means of

opening dialogue to find a way to maintain, or even expand, the number of foreign

issuers on the U.S. market while still achieving the SEC’s principal goal of protecting

investors.98 Campos’ speech stresses the benefits of having foreign companies listed on

U.S. exchanges and says the Commission is working to strike a balance between foreign

participation and investor protection. He states, “Shielding U.S. firms from foreign

competition, however, would deprive U.S. investors of the benefits derived from the

services and products offered by non-U.S. competitors. [The SEC] also would do [the]

economy a great disservice if we were to shelter our issuers, markets and intermediaries

from competition. We are striving for a balance that will result in fair, reasonable, and

efficient markets.”99 In order to maintain a healthy economy, it is in the best interest of

the United States for the SEC to discover this balance as soon as possible.

The number of foreign companies registering on the U.S. capital market has

significantly declined since the release of SOX late in 2002.100 It appears that foreign

corporations are beginning to believe that the costs of complying with the Act now

exceed the benefits of the U.S. market.101 This will ultimately impact the economic

situation in the U.S. and, as capital moves to markets located outside of the U.S., places

the country at a severe disadvantage. The hindrance SOX is causing to the economy by

impairing the desirability of the U.S. market to foreign companies is hurting the economy

98 Ibid.
99 Ibid.
100 Kemp, Shirley. Us Laws to Hinder Sa Companies. Moneyweb (South Africa) – AAGM, November 5,
2002.
101 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

in a time when it is still suffering the effects of the accounting scandals and also the war

in Iraq.102

Another source notes that, with respect to application of U.S. securities legislation

to international entities, “the SEC has traditionally been lenient in subjecting non-U.S.

issuers to new requirements by liberally granting exemptions from various provisions.”103

Sarbanes-Oxley has been the exception to this norm, generating outrage from the

international business community and creating impediments to a healthy economy.

Critics have even charged the U.S. as attempting to act as a “global regulator” of

securities and insist that SOX creates an “anti-competitive” environment that denies

foreign firms access to the same economic opportunities as U.S. companies.104 Although

the U.S. market has historically generated great wealth for listed companies and their

investors, there is concern that the “biggest pool of capital on earth” may no longer be

characteristic of the U.S. market if foreign firms look elsewhere to list in order to avoid

the implications of the Act.105

The potential for Sarbanes-Oxley to have “a chilling impact on transnational

trade” for the U.S. has led many corporations to examine the attractiveness of foreign

stock exchanges in lieu of U.S. exchanges.106 The simple fact that the Act is causing

corporations to pursue listings outside of the U.S. in order to avoid intensive and costly

102 Kemp, Shirley. Us Laws to Hinder Sa Companies. Moneyweb (South Africa) – AAGM, November 5,
2002.
103 “COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES – OXLEY
IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO COSTS TO THE UNITED STATES.”
2004 Emory University School of Law

Emory International Law Review (Spring, 2004).

104 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).
105 Ibid.
106 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).

regulation proves that Sarbanes-Oxley is not necessarily the key to the problems of the

world’s accounting system.107 Furthermore, it is becoming very apparent that this

legislation is intensifying the economic downturn in the United States and the economy

will continue to worsen as foreign companies decide to de-list as a means of avoiding the

reach of SOX.108 As mentioned before, the decision to list on capital markets involves a

careful cost-benefit analysis. The costs associated with listing on stock exchanges result

from regulation and compliance costs.109 It is these costs that allow listed companies to

access the benefits of the markets and the wealth they seek to obtain. The strict

regulation of markets works to prevent fraud and provide investors with the highest

amount of protection available.110 In the past, the U.S. capital market consistently

produced benefits that outweighed the costs of regulation. This was the case until the

Sarbanes-Oxley, however now the market’s benefits “are suddenly obscured by the

intrusion of the highly developed and complex U.S. regulatory regime.”111

Consequently, U.S. stock exchanges are now left to address the decline in foreign

company participation in the market, a component that has been vital to the strength of

the U.S. economy during the rise in globalization.112 European companies are a vital

component of the U.S. economy but, at the same time, are strongly opposed to the

107 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of

International Law (April, 2003).

108 Ibid.
109 “COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES – OXLEY
IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO COSTS TO THE UNITED STATES.”
2004 Emory University School of Law Emory International Law Review (Spring, 2004).
110 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
111 Ibid.
112 Newman, Bernard H. and Mary Ellen Oliverio. “Perceived Flaws in Sarbanes-Oxley Implementation.”
The CPA Journal 76, no. 9 (Sep, 2006): 6.

implications of the Act. In reality, the problem SOX poses for European companies

could indeed be the motivator the EU needs to knock down national barriers and political

differences it struggles with in order to form a unified EU economy, complete with its

own securities and oversight institutions.113 This unification could mean trouble for the

U.S. because it would face an economy closer to its size and level of power.

Additionally, the U.S. could potentially find itself in the unfavorable position of

answering to multiple regulatory regimes if the EU decides to require non-EU firms listed

on EU exchanges to comply with its regulations.

The U.S. will need to continue to watch foreign reactions to Sarbanes-Oxley and

international acceptance of its securities regulations, especially since the London Stock

Exchange has begun to advertise its market as a favorable alternative to U.S.

exchanges.114 A Wall Street Journal article notes, “A recent London Stock Exchange

survey of 80 international companies that went public on its markets found that of those

that had contemplated a U.S. listing, 90% decided Sarbanes-Oxley made London more

attractive.”115 German car manufacturer Porsche revealed that Section 906 of the Act,

which addresses mandatory CEO/CFO certification of financial statements, is the primary

cause of its decision not to register as planned on the New York Stock Exchange.116

Porsche believes that the collectivist system of management, which reflects the essence

of German culture, does not place the same value on a CEO or CFO in the company and

its management system would not be compatible with the system of management

113 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
114 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business

Law Review (2003).

115

“Peekaboo Powers.” Wall Street Journal, Feb 8, 2006.

116 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).

described in SOX.117 In addition to Porsche, the Japanese company Daiwa, has also

decided to wait to list on the NYSE exchange.118 In support of its decision, Daiwa states,

“We didn’t know what the rules of the game we’d be playing would be.”119 Daiwa

executives chose to not enter the U.S. market to avoid subjecting the company to SOX

before it was evident how it would impact international companies. If the U.S. continues

down this path and does not address the significant impact of SOX on the U.S. economy,

one source predicts that the result will create “ a bite far worse than the bark of Sarbanes-

Oxley.”120

Legal Impact

Sarbanes-Oxley has also had significant impact on the scope of U.S. law and the

legal profession since its creation. One source states, “Such international application of

Sarbanes-Oxley creates issues such as duplication of regulatory burdens, inconsistent

regulatory requirements and laws, cultural differences, and concerns of sovereignty and

comity.”121 Foreign companies listed in the United States will be subject to the U.S.

courts system per the Act, an issue that generates more negative reactions abroad and

produces accusations that the U.S. is interfering with foreign nations’ freedom from

outside intervention and their right to self-govern.122 The potential for legal conflict is

endless for foreign entities under SOX. Answering to multiple regulatory regimes

117 Ibid.
118 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).
119 Ibid.
120 “COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES – OXLEY
IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO COSTS TO THE UNITED STATES.”
2004 Emory University School of Law Emory International Law Review (Spring, 2004).
121 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.
122 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.

ultimately means that firms must adhere to multiple laws and the subsequent enforcement

of the laws. KPMG “warned of legal impediments to transnational oversight and

discipline” and is concerned that double jeopardy could come into play if an auditor is

prosecuted both in its home country as well as in the U.S. for violating each nations’

respective laws.123

It has been traditional practice and characteristic of basic foreign diplomacy to not

apply domestic laws extra-territorially. Former Supreme Court Chief Justice Rehnquist

has spoken against extraterritorial reach of the law because disallowing it permits nations

around the world to respectively co-exist in peace with one another.124 When this respect

is not granted, tension erupts between governments around the world. Former Supreme

Court Justice Holmes, a notable American judge who was on the Supreme Court from

1902 to 1932, once said, “The general and almost universal rule is that the character of an

act as lawful or unlawful must be determined wholly by the law of the country where the

act is done.”125 That said, the intent of Sarbanes-Oxley to expand the reach of this Act to

foreign corporations and accounting firms operating under the laws of another nation

goes against this bedrock principal of one of America’s most respected judges.

In the most extreme cases, there have been a limited number of situations in

which the extraterritorial application of one nation’s law onto another’s has been

warranted. In order to preserve U.S. foreign relations, the Courts have devised a process

to determine whether such an extreme situation exists to apply a U.S. law outside

123

Cheney, Glenn. “Uncle Sam Kicks Ass.” Australian CPA 74, no. 3 (Apr, 2004): 29.

124 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).
125 Ibid.

sovereign borders.126 The Effects Test previously mentioned in PART II determines if

the U.S. has subject matter jurisdiction to pursue a claim internationally.127 Additionally,

the courts test for the reasonableness of the claim, weighing the interests of both nations

involved, and this test is known as the Restatement Test.128 This test evaluates eight

factors, which are:

(1) Substantiality of effect;
(2) The connections of the defendant with the forum;
(3) Character of the activity;
(4) Existence of justified expectations;
(5) Importance of regulation;
(6) Extent to which the regulation is with international norms;
(7) Extent to which another state may have an interest in regulating the activity;
(8) The likelihood of conflict with another nation.129

Applying the Restatement Test to enforcing Sarbanes-Oxley abroad, it is not warranted to

impose this legislation outside U.S. borders, mainly due to the strong weight of the final

two factors of the test.130 Evaluation of the seventh factor does not support

extraterritorial reach because accounting oversight is not unique to the United States.

There are in fact other nations who possess a strong interest in accounting oversight of

their domestic corporations and accounting firms, meaning these nations possess laws of

their own to enforce. In addition, because foreign nations have their own regulatory

institutions for oversight, imposition of the U.S. oversight system would invade their

domestic institutions and threaten to create conflict from U.S. intrusion.

Utilizing numerous theoretical models developed both under the law and within

the academic arena, the same conclusion is reached: The extraterritorial application of

126 Ibid.
127 Ibid.
128 Ibid.
129 Ibid.
130 Ibid.

Sarbanes-Oxley has no legitimacy and violates fundamental tenets of international

relations.131 In order to avoid conflict with other nations, and their respective laws and

institutions, Sarbanes-Oxley should not be imposed on non-U.S. companies to the extent

it originally allows. Aside from its apparent lack of extraterritorial legitimacy, SOX

would also cause problems because the legal environments of foreign nations differ

greatly from that of the U.S.132 The U.S. legal system is comprised of both civil and

common law. However, in other countries throughout the world, legal systems only have

civil laws.133

This distinction is important because of the manner in which common laws are

created. Previous legal disputes and their subsequent verdicts create precedence, thus

forming the basis for the common law system.134 With respect to SOX, an important

common law that has substantially evolved over time refers to professional duty of care.

This common law ultimately exists to protect investors and legally hold professionals to

provide a minimal level of care in their conduct.135 In those countries that operate only

under a civil law system, however, this protection is provided under alternative measures.

For example, in France, it is typical for the state to control a sizeable portion of large

corporations. Therefore, the standard of duty of care is implicit because of the

government’s financial interest and ownership role in the corporation.136 On the

occurrence of corporate scandals, one source notes, “If that misconduct occurs in a

131 Ibid.
132 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
133 Ibid.
134 Ibid.
135 Ibid.
136 Ibid.

French corporation and it relates to the duty of care, what standard of the duty of care is

the attorney to use? The standard honed through U.S. law or that of French law?”137

Thus, holding lawyers and other professionals to a duty of care standard as developed by

the U.S. is not applicable to many legal systems abroad and, in many cases, the existing

foreign legal system may already protect against corporate misconduct.

The bottom line is that Sarbanes-Oxley poses serious legal implications for

governments and companies around the world. Extraterritorial application of the Act will

likely result in serious clashes of law around the world, making it even more challenging

and costly for public corporations and the accounting firms that audit them. The majority

of claims thus far are purely hypothetical; however, the day that real conflict of law

originates may not be too far ahead. In the event that the hypothetical becomes reality,

whose laws are appropriate for foreign entities to follow: their domestic laws or U.S.

laws? This question of legitimacy is one that the Board and U.S. government must

actively work to resolve before it permanently impairs its international relations.

Political Impact

Business actors, especially multi-national corporations, possess the strength to

influence the activities of governments worldwide. The ability to influence political

regimes and dominate the political agendas of various nations shows that business units

and the state are by no means mutually exclusive concepts.138 Recent research has

attempted to explain the “mediating, regulatory, and sometimes even interventionist role

137 Ibid.
138 Bieling, Hans-Jurgen. “The Other Side of the Coin: Conceptualizing the Relationship between Business
and the State in the Age of Globalization.” Business and Politics Vol. 9, Issue no. 3 (January 11, 2008):
April 8, 2008,
http://journals.ohiolink.edu/ejc/article.cgi?issn=14693569&issue=v09i0003&article=1187_tosotcsitaog

of governments and state agencies” with respect to business enterprises.139 With the

onset of globalization, especially in the past thirty years, governments have begun to

exhibit a business-oriented approach to policy decisions.140

Because the convergence of the world economy and transnational trade are now

commonplace, business activity often dominates the government’s agenda. Intense

economic competition, both domestic and international, has led many governments to

center their agendas around business activity. Business activity leads to economic

prosperity and, ultimately, to obtaining the goal nations worldwide seek: power.141 Hans-

Jurgen Bieling, in his article from Business and Politics, explains:

Within this fundamentally changed global environment, social and political

entities such as the state can only adjust to the overwhelming external pressures of

global competition. If they ignore these pressures and try to resist, they must be

ready to cope with substantial welfare loss, which in turn may stimulate a

reorientation of large parts of the electorate.142

This relatively new orientation of governments toward business entities has yet to be

extensively researched. Further research on the relationship between business and

politics is necessary to fully understand the convergence and development of these two

different, but now intertwined, disciplines.143 However, with the foundation of research

Bieling provides, it is possible to extrapolate from his theories the impact Sarbanes-Oxley

has had on U.S. politics.

139 Ibid.
140 Ibid.
141 Ibid.
142 Ibid.
143 Ibid.

Globalization has substantially impacted the interrelationship between business

and politics in recent years. The creation of Sarbanes-Oxley undoubtedly demonstrates

this relationship, revealing the pressure businesses exert on the government and vice

versa. In the wake of the Enron and WorldCom collapses in 2002 that left millions of

everyday investors financially devastated, American citizens cried out for politicians to

take action against those responsible for their financial ruin and also to prevent another

scandal of such magnitude. The government’s subsequent response to the pressure from

constituents reinforces Beiling’s theory that the state must act in a manner that is

competitive internationally while simultaneously responding to the demands of its

domestic citizens.144 If the state fails to make policy decisions that are favored by

constituents and are globally competitive, politicians risk losing their positions and the

powers associated with them. For this reason, U.S. politicians created Sarbanes-Oxley,

which, with its treatment of foreign companies, sends the message to constituents that the

government is concerned about both their interest and staying competitive in the

international economy.

Numerous bills were drafted in response to U.S. citizens’ concern over the

accounting scandals of 2002. Over a time span of less than six months, Sarbanes-Oxley

was signed into law on July 30, 2002.145 In mid-July, WorldCom officially filed for

bankruptcy and it became evident that a corporate reform law was needed to crack down

on corporate misconduct.146 One source reports, “The name of Rep. Michael G. Oxley

144 Ibid.
145 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).

(R-Ohio) wasn’t added to the bill until a last-minute concession by House Republicans

after the WorldCom scandal broke and public opinion began to sway in favor of the

Democrats as the November 2002 elections were approaching.”147

In response to the political pressure on the government, President Bush

announced in late July that Congress would not be allowed to begin summer recess,

which traditionally begins on August 1st each year, until it had created a corporate reform

act.148 As a result, Congressmen Paul Sarbanes and Mike Oxley worked for 72 hours

straight in the last week of July to draft the official Act.149 Congress voted on the bill on

July 25, 2002 and the majority of Congress had already left for summer recess when

President Bush signed the bill into law on July 30th.150 The storm with which SOX hit

Capital Hill was unprecedented and, at the time, few in the accounting profession

understood the full implications of the new legislation. One source comments on this era

and notes, “The political pressure was unrelenting, with criticism of the SEC coming

from every angle as the U.S. public took up the rallying cry for corporate reform.”151

With that, Congress passed the most sweeping form of securities legislation in U.S.

history since the 1933 and 1934 Acts.

146 Norris, Floyd. “WorldCom’s Collapse Gave Boost to Sarbanes-Oxley: The Timing of the Scandal
Helped Build Support for Tougher Rules in the 2002 Bill on Securities Laws.” The New York Times, July
14, 2005, 2005, sec. Business,
http://www.ocregister.com/ocr/sections/business/business_nation/article_596162.

php.

147 Fass, Allison. “One Year Later, the Impact of Sarbanes-Oxley.” Forbes.Com (July 22, 2003, 2003),
http://www.forbes.com/2003/07/22/cz_af_0722sarbanes.html

(accessed May 11, 2008).

148 Dietrich, Richard. Personal Recount of Conversation with Congressmen Mike Oxley

April 30, 2008.

149 Ibid.
150 Ibid.
151 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).

Congressional leaders opposed to this bill were few and far between. The Senate

passed SOX unanimously and the House reported only 3 dissenting votes out of 426.152

Congressmen Jeff Flake of Arizona expressed his dissatisfaction with both the Act and

the speed with which it was passed.153 While Flake agrees with the need to reform

accounting oversight in the U.S., he believes that SOX is not the ideal answer and that

Congress should have taken the time to create a piece of legislation that would not have

generated the amount of repercussions that this act did.154 Flake states, “This hastily

created legislation is more of an attempt to politically inoculate ourselves rather than to

pass a meaningful bill that cracks down on corporate malfeasance.”155 Congressman Ron

Paul of Texas also expresses discontent with the Act and believes that Congress could

have created a law that punishes corporate misconduct without positioning the United

States for the amount of international backlash it received after the passage of SOX.156

Apart from the political repercussions U.S. lawmakers faced upon the creation of

Sarbanes-Oxley, continued pressure is being exerted on U.S. politicians over costly

provisions of the bill and the limited number of exemptions granted to foreign entities by

the PCAOB thus far. One source points out that “in the post-Enron environment, it has

become politically risky to provide accounting exemptions to anyone.”157 As a result, it

appears that the SEC and the Board fear the political reaction in the U.S. to granting

exemptions, especially to foreign companies, over the favorable political reactions abroad

152 Becker, Tim and Clarke, Peter. “Is Washington Now the Omnipotent Regulator of the European
Financial System?” Ethical Corporation: Not an Oxymoron.
http://www.ethicalcorp.com/content.asp?ContentID=233 (accessed April 20, 2008).
153 Ibid.
154 Ibid.
155 Ibid.
156 Ibid.
157 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).

and economic benefits of allowing such exemptions. U.S. political relations with the

United Kingdom, Germany, and Japan have been strained from the imposition of

Sarbanes-Oxley and these developed countries are outraged that the U.S. will not honor

their respective systems of oversight.158 The argument in the UK is that the government

already has a corporate oversight system in place that it has been carefully developing

and refining for several years.159 Public companies in the UK must comply with the

Smith Guidance System. Therefore, one source notes, “The comprehensive protections

against auditing problems contained in the Smith Guidance make the Sarbanes-Oxley Act

requirements unnecessarily duplicative for UK corporations.”160 The UK government

does not believe that, with a respectable oversight system already in operation, the UK

also needs the U.S. oversight system imposed on companies as well. In the opinion of

UK officials, who is to say that the U.S. system is any better than that of the UK?161

On the other hand, American politicians argue that they are dubious about the

unwillingness of foreign counterparts to comply with legislation that, in their opinion,

protects investors by providing the utmost level of professional care and

accountability.162 After the occurrence of such disgraces as Enron, politicians who were

in office at the time of those events are dedicated to preventing future incidents and are

unwilling to compromise the provisions of the very act created to safeguard against this.

An interesting political theory that sheds light onto this extraterritorial regulation debate

is the Issuer Choice Theory.

158 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review

(2004).

159 Ibid.
160 Ibid.
161 Ibid.
162 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).

The Issuer Choice Theory stipulates that companies worldwide should have the

power to decide which regulatory regime they will comply with, similar to the manner

that U.S. companies decide the state in which they will incorporate.163 Under this theory,

the regulatory environment a company chooses to abide by is then respected by all

regulatory systems throughout the world.164 In addition, reconciliation or disclosure of

differing practices would not be required if a company is publicly-listed on exchanges

outside of its regulatory nation in the same way a U.S. company does not have to

reconcile its actions to the rule of the states it operates in, but is not the state of its

incorporation.165 This theory of political cooperation is interesting to ponder, but

unlikely to receive the support of the United States in the near future. It has been

hypothesized that “given Congressional hostility to providing foreign exemptions in

Sarbanes-Oxley, it is unlikely that the United States will start making whole scale

recognitions of other countries’ securities laws anytime soon. Indeed, the current

political climate appears to favor tighter regulation for all issuers, whether domestic or

foreign.”166 Consequently, in place of pursuing an alternative arrangement that could

provide tighter accounting oversight and more favorable international relations, the U.S.

is politically isolating itself in the hopes of avoiding further protest from the American

public regarding its business regulation practices.

Implications for U.S. Foreign Relations

Foreign relations are the foundation upon which nations throughout the world

manage to peacefully coexist with one another. It is inevitable that these relations suffer

163 Ibid.
164 Ibid.
165 Ibid.
166 Ibid.

from events that create conflict among nations and, when this occurs, the conflict must be

addressed to restore balance to the world’s affairs. As one source comments, “From time

to time, relations between the United States and other states are strained by actions that

others look upon as extraterritorial.”167 Sarbanes-Oxley is no exception to this comment

as it has been perceived by foreign nations as a U.S. attempt to super-impose its domestic

laws throughout the world. The young legislation has exerted continuous pressure on

U.S. foreign relations since its 2002 issuance.

Extraterritoriality disputes in reaction to U.S.-dominant behavior and attempts to

control the actions of foreign nations are not new to U.S. foreign relations. Consider past

U.S. economic and political boycotts, especially during the Cold War with respect to

Russia, Cuba, and China, that at the time represented the core of U.S. foreign relations.168

The decision to implement the boycotts derived in the U.S. because it was in line with

American political self-interest. U.S. threat to penalize its allies that continued to trade

with boycotted nations demonstrates the U.S. desire to dictate the actions of other

countries to align with its own. If foreign nations did not align with the U.S., those

countries found themselves in the unfavorable position of an adversary to the U.S.169

Many wonder if Sarbanes-Oxley in coming years will continue to face the

resentment, politically, socially, and economically, as past situations involving business

and trade aspects of foreign relations in the U.S., have produced. It is still unclear

whether the decision to leave or not enter the U.S. capital market at all will be temporary

167 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
168 Ibid.
169 Ibid.

or permanent as a result of SOX.170 This law is not even six years old and the registration

deadline for foreign accounting firms was only two years earlier. As a result, it is still

uncertain how this landmark U.S. securities law will mingle in practice with other foreign

laws.171 It is believed by some academics that once the legislation is completely

amended and finalized, foreign investors will once again flock to the U.S. capital

market.172 On the other hand, opponents of the Act believe that SOX will negatively

impact foreign investment in the U.S. permanently.173 Regardless of which school of

thought ultimately is correct, it is apparent that SOX is causing severe damage to the U.S.

image among foreign investors and currently influencing their decision to invest in the

U.S.

The nature of Sarbanes-Oxley and its implications for foreign entities make this

Act not only a securities reform law, but also a significant component of U.S. foreign

relations. The implications for foreign relations were either not considered during the

drafting of SOX or else ignored by lawmakers in the process. Lawrence Cunningham, a

professor of law at Boston College, states, “Political blindness to the international

relations viewpoint was evident from the US failure to consult regulatory counterparts

abroad and from the heated political rhetoric accompanying SOX.”174 The lack of regard

for international practices and the reaction to imposing the requirements of the Act

outside U.S. borders has brought Sarbanes-Oxley to the forefront of U.S. foreign

170 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).
171 Ibid.
172 Ibid.
173 Ibid.
174 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).

relations. This undoubtedly could have been avoided and saved U.S. relations from the

damage it incurred had the U.S. taken foreign concerns into account prior to super-

imposing legislation extraterritorially.

Many claims have risen that the U.S. is overstepping its bounds with Sarbanes-

Oxley and is blatantly violating the basic norms of respecting international

sovereignty.175 In today’s globalized world, markets are becoming increasingly

international and are inexorably intertwined with one another as a result.176

Communication between all countries is necessary to allow for this type of global

marketplace in order to understand the laws and cultural norms each nation brings to the

table for trade. The United States’ decision to essentially disregard communication with

other nations during the creation of Sarbanes-Oxley and the subsequent passage of the

law has resulted in concern among foreign nations over American imperialist-like

activities.177

Graham Ward, a board member of the International Federation of Accountants, is

opposed to Sarbanes-Oxley and points to the U.S. struggle for independence in the 18th

century to demonstrate why he believes SOX is a hypocritical imposition of regulation on

the part of the U.S.178 He quotes American values embedded in the U.S. Declaration of

Independence, stressing that a nation’s rulers “derive their just powers from the consent

175 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
176 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June

12, 2003.

177 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
178 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.

of the governed.”179 Ward argues that Sarbanes-Oxley represents the very opposite of

this sacred American value. By imposing the regulations of this Act on entities outside of

the control of the U.S. government and also without their consent, the U.S. is withholding

basic rights that centuries ago it fought so hard to obtain.180 SOX leads to feelings of

repression among foreign nations, whose affected companies now must comply with a

stringent law created in another nation and without foreign consultation.

The tenets of SOX in theory provide the SEC with jurisdiction outside the U.S.,

calling into question the comity of the international community and straining foreign

relations as a result.181 The U.S. government now must answer to the international

community and its demand for granting exemptions to foreign entities.182 It is interesting

to note that Congress and President Bush are celebrated by U.S. constituents for the

creation of the Act and protecting their interests in the wake of such scandals as Enron

and WorldCom. However, when U.S. foreign relations exploded from the international

reaction to SOX, the very politicians who endorsed the legislation turned to the SEC to

deal with the conflict, probably out of fear of losing voter support. The SEC is now left

to address the political pressure coming in full force from two different directions:

domestic supporters of SOX and international objectors to it. While the SEC is faced

with the daunting task of cleaning up this political mess, Congress is patting itself on the

back for creating a law it believes will protect everyday U.S. investors from future

accounting scandals. It is evident that “in the future, when Congress regulates US capital

179 Ibid.
180 Ibid.
181 Bather, Andrea and Priscilla Burnaby. “The Public Company Accounting Oversight Board: National
and International Implications.” Managerial Auditing Journal 21,

no. 6 (2006): 657.

182 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.

markets and SEC registrants, it should not punt to the SEC to hedge the resulting

international relations fall-out but address that thicket up front.”183

Congress’s disregard for Sarbanes-Oxley’s impact abroad during the U.S.’s mad

rush to put an end to the disastrous corporate scandals is apparent. However, consultation

with other nations and their government, business and legal professionals might have

prevented the U.S. from the foreign relations debacle it is currently in as a result of this

statute.184 The fact that corporate governance and oversight is by no means a one size fits

all model, the institutional differences that invariably exist throughout the world imply

that the U.S. model simply does not fit the needs of many nations.185 This breeds

animosity toward the U.S. and one source condemns Congress “for neglecting to consider

the diplomatic consequences of such far-reaching and unilateral actions such as Sarbanes-

Oxley.”186

The main takeaway from SOX and its negative reaction abroad is that Congress

should have first only applied the Act to domestic companies.187 This would have

satisfied the U.S. citizenry’s cry for government action after the corporate misconduct

and also provided the opportunity for U.S.-foreign dialogue. The dialogue would have

addressed treatment of non-U.S. firms in the hopes of developing a solution that would

protect investors, ease foreign concerns, and save the U.S. from irreparable damage to its

183 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
184 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
185 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).
186 Ibid.
187 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).

foreign relations.188 Instead, the U.S. plowed ahead with Sarbanes-Oxley and created an

obstacle to open trade in today’s global marketplace.189 Cunningham describes the fast-

moving actions of the U.S. and their subsequent consequences by saying, “It was a case

of domestic political pressures blinding lawmakers to important matters of international

relations. It was a wasted opportunity to exhibit comity in the exercise of US power on a

matter that would have cost the US little.”190 His comments reiterate a fundamental

principal of foreign relations theory: diplomacy as a preventative measure often serves in

the best interest of all and usually results in conflict avoidance. Had the U.S. practiced

proactive diplomacy prior to the imposition of the Act abroad, it is likely that it could

have avoided the backlash that resulted in response to SOX.

Sarbanes-Oxley’s divergence from the traditional practice in foreign relations of

avoiding international economic conflict, or to at least initially engage in dialogue as a

preventive measure, severely impacts foreign perception of the U.S. and the

attractiveness of the U.S. market.191 Foreign companies in the past have not taken

significant issue with complying with U.S. securities laws because the regulation has

traditionally adapted provisions in order to meet international needs.192 After SOX, non-

U.S. companies are confused by Congress’s sudden shift in accommodation and angered

188 Ibid.
189 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
190 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
191 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).
192 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).

at the impact the law has on their business practices.193 Consequently, the U.S. is trying,

after the fact, to repair the damage SOX has generated abroad in lieu of addressing the

Act’s impact and U.S. response to it beforehand.

The U.S., in keeping with its traditional receptiveness to the international

implications of its securities laws, should have engaged in open diplomacy with foreign

regulators and affected companies prior to imposing the Act abroad. Cunningham

purports, “If this were done with SOX, the world would have arrived at the same place,

without undesirable political agitation, anxiety, and backlash risks. This underscores the

international relations aspect of US corporate regulation amid globalization.”194 The SEC

is now engaged in dialogue with its foreign counterparts and attempting to satisfy the

international community’s demands while trying to balance domestic political interests at

the same time.195 SEC representatives stress that the Commission does not want the

international companies to be placed in an unfeasible situation where they are facing

conflicts of law, but also emphasizes that its number one responsibility is protecting the

U.S. investment community.196

As a result, “the SEC has indicated that in certain areas it will take into account

foreign laws and practices in applying the provisions to foreign accounting firms.”197

The international community is paying close attention to the SEC and the fulfillment of

its vows to address foreign interests. In fact, former SEC Chairman Harvey Pitt was

193 Ibid.
194 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
195 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June 12, 2003.
196 Ibid.
197 Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq Business
Briefing, November 23, 2004.

going to skip an EU conference on SOX, citing political tensions in the U.S. as his excuse

for not attending.198 However, EU representatives stressed the importance of his

presence to show the SEC’s commitment to its foreign counterparts and working together

to resolve differences resulting from SOX.199 Ultimately, Pitt wisely attended the

conference and avoided creating further damage to U.S. foreign relations.

Other critics chastise Sarbanes-Oxley as being too “US-centric,” claiming that the

burden of this legislation abroad naturally conflicts with existing foreign institutions. In

addition, the international community perceives the U.S. as having an ethnocentric view

with respect to its accounting system.200 Instead, the U.S. needs to recognize the

American cultural norms embedded in the Act and that foreign cultures do not always

reflect these same norms. In recognizing this seemingly obvious fact, the U.S. should

accommodate to the differences rather than giving the impression that foreign companies

must conform to the American way if they wish to continue to participate in the U.S.

market.201 International entities’ impression of Sarbanes-Oxley is essentially that the

U.S. believes its business culture is superior and all others are innately inferior and

deficient.202 It conveys the message to foreigners that they must adopt the U.S. business

structure necessary to comply with SOX or else look to participate in capital markets

outside of the U.S., irrespective of the cultural roots of their domestic business

198 Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The Accountant, October 21,
2002. 3.
199 Ibid.
200 “SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES SECURITIES
REGULATION.” 2003 Columbia Law School Columbia Business Law Review (2003).
201 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).
202 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).

environment.203 As one source notes, “Ultimately, in order to adopt SOX’s corporate

governance model, foreign corporations are forced to either compromise or abandon their

own cultural values.”204 The intrinsically individualistic nature of SOX is appropriate for

the U.S. culture, however this could not be farther from the truth for cultures that promote

collectivism.205

It is ironic to Europeans that the U.S. suffered from corporate scandals despite its

belief in the superiority of the U.S. accounting system and standards.206 Furthermore,

many perceive the United States’ attempt to correct the business environment in which

the scandals were able to occur and impose the new regulations abroad without

international consideration as insulting.207 Although other nations are not entirely free

from similar corporate scandals, perhaps the most well known international scandal is

Italy’s Parmalat fiasco, it is commonly believed that these scandals are “very much an

American phenomenon.”208 Consequently, internationally there is a tendency for

professionals to reject the integrity of the U.S. regulation system or, at the very least, an

inclination to question the new Act, which dictates that foreign public companies and

their auditors adopt its regulations.

Prior to Sarbanes-Oxley, the international business community was striving to

converge accounting practices worldwide. Unfortunately, the introduction of SOX

203 Ibid.
204 Ibid.
205 Ibid.
206 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
207 Ibid.
208 “NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.” 2004 Boston
College International & Comparative Law Review Boston College International and Comparative Law
Review (Spring, 2004).

severely impairs U.S. foreign relations with other nations to achieve this goal.209 Those

nations who are committed to finding a common solution to the international problem of

accounting oversight that will suit the needs of the globalized economy were offended by

the U.S.’s decision to rashly pass this law without foreign consultation. Dialogue is a key

component of international relations and is what countries worldwide have been utilizing

to develop a system of accounting oversight suitable for many nations of varying cultural

and institutional backgrounds.210 SOX has damaged the perception abroad that the U.S.

is willing and supportive of working together to develop an international system.

Opponents of the Act argue, “Regulators in the United States should abandon efforts to

extraterritorially impose [its] corporate governance legislation and instead work towards

a global regulatory regime.”211 On the other hand, it is possible that Congress’s decision

to pass the Act without discussion with its foreign counterparts could bar the U.S. from

future participation in the development of a worldwide oversight system if its foreign

relations have been too damaged. Had the United States been an active proponent of

foreign dialogue initially, it would not find itself in a position where the rest of the world

is opposed to the U.S. system and could potentially devise a system of its own without

consulting the U.S.

It is believed that the U.S. could face retribution in the form of international

legislation similar in scope to Sarbanes-Oxley. One source states, “Foreign regulatory

bodies have threatened to retaliate against U.S. firms by imposing requirements similar to

209Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
210 Ibid.
211 “Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004 George Washington
University George Washington International Law Review (2004).

those of the Sarbanes-Oxley Act.”212 Imagine the endless number of oversight systems

that would emerge if every other nation in the world chose to develop their own

regulation laws without consulting its international counterparts in the same manner the

U.S. developed SOX. If this were to occur, in theory, a multinational company would

have to comply with its home laws as well as the laws of over 190 other countries if the

company was active in each nation in the world. This clearly demonstrates the

importance of foreign relations worldwide and the need for every nation to be diplomatic

out of consideration of the impact its laws and actions have on the international

community.

The Congressional hearings for the Act did not provide an opportunity for foreign

regulators to voice their concerns about the proposed legislation before it was

extraterritorially imposed on their domestic companies who are listed in the U.S. or

participate in the audits of listed companies.213 Although it is not required under U.S. law

to provide this opportunity, the United States would have saved the blow to its foreign

relations by granting this courtesy to foreign nations.214 One source comments, “On the

road to promoting investor protection and stable markets, […] there is not just one right

path. Countries have different regulatory approaches and different legal, political and

economic systems that must be respected and taken into account.”215 Congress’s decision

to ignore these inherent differences and create SOX generated a negative reaction abroad

212 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
213 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
214 Ibid.
215 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June 12, 2003.

and could impact PCAOB and SEC attempts to enforce the new law in the future.

Without foreign support, it will be challenging for the U.S. to gain the support it needs to

ensure foreign compliance with SOX, thus defeating the purpose of extending the Act’s

reach to include international entities.216 Undoubtedly, the biggest error of Congress was

not addressing existing foreign oversight systems in the process of generating Sarbanes-

Oxley.

Congress’s lack of regard for the international impact of SOX strains foreign

relations with some of the United States’ long-standing allies and trade partners.217 As

Cunningham wisely advises, “The world’s unipower owes its friends respect, particularly

friends whose own history is marked by global preeminence.”218 Although the future of

Sarbanes-Oxley is not certain, it is clear that the United States’ actions, or lack thereof,

toward foreign nations have not been well received. If the U.S. continues down this

ethnocentric path of regulation that is severely damaging its foreign relations, it will risk

isolating itself from the international community. Moreover, the powerful nation could

lose its power to those nations who reject SOX and successfully draw public companies

away from the U.S. capital market toward other markets that operate under a more

flexible regulatory environment. The U.S. should focus on repairing tensions with its

allies as a result of this Act and in the future strive to avoid creating an extraterritorial

nightmare for its foreign relations.

216 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
217 Ibid.
218 Ibid.

PART IV

Demand for Alternative Solutions

As the arguments in the preceding sections of the paper illustrate, Congress’s

creation of the Sarbanes-Oxley Act, while intended to protect investors’ interests, did not

succeed in developing an oversight solution that is accepted throughout the world. The

economic, legal and political problems generated by SOX has impacted the standing of

the U.S. worldwide and jeopardized its foreign relations with many nations, including its

closest allies. As a result, there has been considerable demand for the U.S. to amend

some of its provisions with respect to those involving foreign entities. Because of

domestic political provisions, the U.S. has been hesitant to grant exemptions to foreign

firms from the Act. However, there are two alternative paths the U.S. can proceed down

to rectify the international conflict created by the Act. The first alternative involves

working with foreign nations to develop an international body of accounting oversight.

The second alternative entails U.S. recognition of and reliance on foreign oversight

systems to carry out the mission of the PCAOB.

Alternative One: Development of an International Oversight Body

Adherence to multiple regulatory bodies is a costly and confusing process for

entities worldwide. Presently, foreign companies and accounting firms have been

struggling to comply with their home country system, which may be in the process of

undergoing significant change, as well as the complex U.S. regulatory environment

developed under Sarbanes-Oxley. It is believed that it would benefit business entities

worldwide if regulatory systems from different nations were able to work together to

develop an international regulatory body charged with global accounting oversight.219

Professionals would benefit from the development of a single set of rules, free from

convoluted language, and applicable to many business cultures as opposed to just one.

Graham Ward believes that creating a single, international system of regulation

would provide the opportunity for economic growth throughout the world in place of the

economic decline impacting nations similar to the way SOX affected the U.S.

economy.220 One common international system would likely reduce the risk of fraud and

corporate misconduct because everyone would be held to the same, accepted set of

standards.221 One source states, “Just as the Organisation for Economic Co-operation and

Development has served as a useful forum for anti-trust and tax concern common to all

governments, the International Organization of Securities Commissions would be the

place to discuss common interests in securities regulation and corporate governance.”222

It has been proposed that regulators around the world work to create an international

auditing standard setting organization, utilizing the strengths of oversight systems

currently in place and eliminating the weaknesses that exist in those systems.223

Unfortunately, if the unwillingness of the SEC to compromise the U.S. GAAP system of

accounting to conform with the International Accounting Standards Board’s rules is any

indication, convergence to a global oversight system appears unlikely to succeed anytime

219 Newman, Bernard H. and Mary Ellen Oliverio. “Perceived Flaws in Sarbanes-Oxley Implementation.”
The CPA Journal 76, no. 9 (Sep, 2006): 6.
220 “Notes from AICPA Spring Council: Agenda Includes International Standards, Cost of SOX
Compliance.” Inside Public Accounting 19, no. 6 (Jun, 2005): 5.
221 Ibid.
222 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
223Giles, Jill P., Elizabeth K. Venuti, and Richard C. Jones. “The PCAOB and Convergence of the Global
Auditing and Accounting Profession.” The CPA Journal 74, no. 9 (Sep, 2004): 36.

soon.224 The second proposed solution provides an alternative option to global

convergence and may prove successful at least in the near future.

Alternative Two: Mutual Recognition

A second alternative to Sarbanes-Oxley as originally proposed concerns the U.S.

granting mutual recognition to those countries with a suitable accounting oversight

system in place. Because there are certain inherent differences among nations throughout

the world, mutual recognition would recognize the legitimacy of other oversight systems

while also respecting each nation’s right to sovereignty that is violated under the original

tenets of SOX.225 Foreign entities believe that the U.S. should devise a system that would

evaluate the credibility of foreign oversight systems and determine whether to accept

these systems as quasi-equivalent to the U.S. system.226 This would remove the

extraterritorial component of the Act for the most part while still achieving the primary

objective of SOX: protecting investors.

The extent to which the U.S. would rely on foreign oversight systems is still

highly contested. Foreign nations urge the U.S. to consider full reliance on the system if

it is deemed acceptable by the PCAOB. On the other hand, the PCAOB recognizes that

mutual recognition would allow greater respect of institutional and legal differences

inherent to oversight systems throughout the world, but does not support the idea of full

reliance.227 Partial reliance on foreign systems is under consideration by the Board and

the SEC defends its actions, saying that “the SEC, as well as any national regulator, has

224 “EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.” 2003 the American
Society of International Law American Journal of International Law (April, 2003).
225 Eu Warns on Sarbanes – Oxley Act. Financial News (Daily), September 6, 2002.
226 The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of International Business
Research, January, 2005. 1.
227 Ibid.

the right to determine the terms and conditions under which financial service providers

access investors in its jurisdiction.”228 Cunningham discusses a classification system for

countries appropriate for a mutual recognition system, regardless of the degree of

recognition the U.S. grants. He believes that nations will be classified as one of two

types: Favored Nations or World Class Countries.229 The U.S. will perceive favored

nations as having a satisfactory regulatory framework and World Class Countries will be

those nations who lack an oversight system, but choose to implement and regulate U.S.

standards.230

If the U.S. devises a system to evaluate foreign oversight, it could greatly reduce

negative perception of SOX, diminish inefficient regulation and enforcement, and

simultaneously improve its foreign relations. On the concept of mutual recognition,

Cunningham states, “The key international relations benefit of such a measure is the

result creates a measure of voluntary compliance compared to that generated by a

unilateral fiat such as SOX.”231 In providing foreign nations the opportunity to either

demonstrate the integrity of its domestic system or allow nations who lack a regulatory

system to choose to implement the standards, the U.S. is ultimately acting in a manner

that is more receptive to international needs. The international community accepts this

because foreign nations now play a greater role in their fate as opposed to its actions

being dictated by the U.S. watchdog, as it appeared to be in the past.

228 Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat Foreign and
Domestic Companies Equally, Campos Adds. State Department, June 12, 2003.
229 Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons from the
Inauspicious Case of SOX.”Boston College Law, 2003,
http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113 (accessed April 27, 2008).
230 Ibid.
231 Ibid.

The Development of Sarbanes-Oxley and the PCAOB

The PCAOB has made considerable progress in the years that have passed since

Sarbanes-Oxley was first issued. The Board has recognized the impact of the Act abroad

and the subsequent implications for U.S. foreign relations. It has made significant

advancements in its consultation with foreign counterparts and is proactive in promoting

dialogue both with international regulators and professional auditors. This dialogue has

allowed the PCAOB to obtain a greater understanding of the perceptions that exist around

the world about the provisions of SOX and rules that have been created by the Board.

Additionally, complaints about the costliness of the Act have been declining because

costs of compliance have been decreasing for public companies as they become more

adept at satisfying the requirements of the Act.232 It is estimated that between 2006 and

2007 compliance costs fell by 5.4% for companies, a statistic that has been well-received

by those companies affected by SOX. The remainder of this section discusses the

specific steps recently taken by the PCAOB to address foreign concerns and promote

dialogue as well as plans the Board has regarding its future strategy to achieve investor

protection.

With registered public accounting firms representing over 85 countries throughout

the world, the PCAOB has been working on the development of specific rules designed

to specifically address treatment of foreign firms.233 The idea behind this series of rules

is that the Board would rely under certain circumstances on inspections conducted by

232 Auger, James. “Costs of Complying with Sarbanes-Oxley U.S. Corporate Regulations Coming Down.”
Global Insight, May 1, 2008.
233 Goelzer, Daniel L. “Opening Statement of Daniel L. Goelzer, Board Member at the Open Meeting to
Consider Proposing Release of Full Reliance Policy Statement.” Washington D.C., PCAOB, December 5,
2007, 2007,

www.pcaobus.org (accessed May 2, 2008).

foreign regulators.234 A country’s eligibility for this will depend on the characteristics of

its domestic oversight system, especially with respect to the relationship between its

regulators and auditors.235 Daniel L. Goelzer, a member of the Board, comments on the

proposed rule concerning reliance on foreign regulation, stating, “This sliding scale

approach permits the Board to be faithful to [its] Congressional mandate but at the same

time to utilize the work of non-U.S. regulatory systems when that is consistent with our

mandate.”236 Essentially, the PCAOB has come to realize that joint cooperation with

foreign regulators could potentially provide greater investor protection because the

involvement of more regulators results in access to greater resources and increases the

total number of inspections completed.237 Meanwhile, foreign tensions are greatly

diffused because foreign nations no longer feel completely violated by U.S.

extraterritoriality.

In response to problems arising from the imposition of the Act abroad, the Board

has established a system that evaluates whether the PCAOB is allowed to rely on foreign

regulators to carry out the Board’s duties and to what extent.238 The Board has come to

realize that cooperation with foreign regulators will “minimize administrative burdens

and legal conflicts that firms face and […] conserve Board resources, without

undermining or ignoring the Board’s statutory mandates.”239 As a result, the PCAOB has

worked hard to develop and refine five new rules addressing its interpretation of mutual

234 Ibid.
235 Ibid.
236 Ibid.
237 Ibid.
238 Public Company Accounting Oversight Board. Final Rules Relating to the Oversight of Non-US Public
Accounting Firms PCAOB Rulemaking Docket Matter No. 013, 2004, www.pcaobus.org (accessed May 2,
2008).
239 Ibid.

recognition. Upon the initial completion of these rules, the Board released them to

auditing professionals and regulators for feedback on the implementation of the rules in

practice.240 After receiving this valuable feedback, the PCAOB further revised the five

rules to the form they exist in today.

The first of the five rules is Rule 4011, titled “Statement by Foreign Registered

Public Accounting Firms.” This rule describes a one-time statement created by those

foreign firms who would like the Board to rely on a home country inspection.241 This

statement must be certified by a company official and the PCAOB will work directly with

the regulators of the firm’s home country to gain an understanding of its oversight

system.242 The second rule, Rule 4012, “Inspections of Foreign Registered Public

Accounting Firms,” discusses the criteria relied upon by the Board to evaluate foreign

regulatory systems.243 The extent to which the Board will rely on foreign inspections

depends on the evaluation of the following five factors: (1) System integrity; (2)

Independence of regulators from auditors; (3) Source of funding; (4) Degree of system

transparency; and (5) Past ability of the system to adequately perform.244 Rule 4012 also

provides a clause stating the importance of Board dialogue with its foreign counterparts

in order to establish a cooperative work arrangement.245

The next rule in the series, Rule 5113, titled “Reliance on the Investigations of

Non-U.S. Authorities,” concerns the Board’s reliance upon foreign disciplinary actions

not originally instigated by the United States. This particular rule is still causing

240 Ibid.
241 Ibid.
242 Ibid.
243 Ibid.
244 Ibid.
245 Ibid.

international controversy because of double jeopardy concerns, implying that foreign

entities could potentially face repercussions from multiple regulators in response to the

same action.246 Despite feedback expressing dissatisfaction with Rule 5113, the Board

will not relent, stating that foreign regulators’ objectives and the Board’s are not one and

the same.247 Therefore, if one foreign company’s actions violate its home country law

and U.S. law, it is still subject to discipline under both jurisdictions, a consequence firms

should be aware of from operating across multiple jurisdictions.248

The final two rules, Rules 6001 and 6002, concern PCAOB policy of providing

assistance to foreign regulators’ activities.249 Titled “Assisting non-U.S. Authorities in

Inspections” and “Assisting non-U.S. Authorities in Investigations,” respectively, these

rules address the right of the Board to help other nations enforce their own versions of

SOX-like legislation with respect to U.S. public accounting firms.250 Although these

actions are not defined specifically within the body of Sarbanes-Oxley, Rules 6001 and

6002 are legitimized by the catch-all clause included in the Act.251 This clause authorizes

the SEC the power to legally grant the PCAOB any powers it deems as necessary to

carrying out the Board’s mission.252 Both the SEC and the PCAOB believe that Rules

6001 and 6002 are consistent with the Board’s mission.

Although the introduction of these five rules represents a significant attempt on

the part of the PCAOB to engage in cooperative dialogue with its foreign counterparts,

246 Ibid.
247 Ibid.
248 Ibid.
249 Ibid.
250 Ibid.
251 Ibid.
252 Ibid.

the Board is still not completely free from criticism. The PCAOB is still opposed to a

system of mutual recognition where it would completely rely on its foreign counterparts

to carry out its mission and objectives.253 The Board claims that this “approach would

[not] be in the interests of U.S. investors or the public.”254 The PCAOB believes that

avoiding complete deference to foreign authorities allows it to maintain the right to step

in at any time with the treatment of foreign registered firms if such a situation is

warranted.255

Additionally, in response to the evaluation of the five factors to determine the

Board’s reliance on foreign regulators, the PCAOB has expressed its intention to evaluate

non-U.S. systems as a whole, rather than as a sum of its individual parts.256 One source

criticizes the Board’s strict requirements to permit foreign oversight and deducts, “In

other words, the PCAOB would rely on local oversight systems that were in essence

structured the same as its own.”257 The Board believes it will achieve more objectivity

toward its assessment of systems not identical to the U.S. oversight structure.258

Finally, although the PCAOB now encourages open discussion with

representatives of foreign oversight systems during its evaluation of those systems, it has

decided that once the Board has produced its final evaluation of the system, there will not

be an appeal process for the international representatives to overturn the decision.259 The

253 Ibid.
254 Ibid.
255 Ibid.
256 Ibid.
257 Giles, Jill P., Elizabeth K. Venuti, and Richard C. Jones. “The PCAOB and Convergence of the Global
Auditing and Accounting Profession.” The CPA Journal 74, no. 9 (Sep, 2004): 36
258 Public Company Accounting Oversight Board. Final Rules Relating to the Oversight of Non-US Public
Accounting Firms PCAOB Rulemaking Docket Matter No. 013, 2004, www.pcaobus.org (accessed May 2,
2008).
259 Ibid.

PCAOB will only change its assessment of a particular oversight system if future changes

were made to a country’s system thus strengthening the integrity of it. This has not been

well-received internationally because, in the event a country feels that the Board’s

assessment is not reflective of its system, foreign regulators will not have the opportunity

to argue against the evaluation.

The PCAOB recently released its Strategic Plan for 2008-2013 and a considerable

portion of its plan has been dedicated to continuing its cooperative efforts with

international regulators and companies. Per the Board’s plan, one of its published goals

is as follows: “Work effectively with international audit regulators to facilitate

inspections of non-U.S. registered public accounting firms and to strengthen global

oversight of U.S. public companies.”260 In addition, the PCAOB hopes to develop a more

definitive policy describing its relationship and cooperation framework with its foreign

regulatory counterparts.261 This represents a huge step for the Board to incorporate this

goal into its agenda, although it fails to go describe in detail how it hopes to achieve this

objective. The PCAOB also plans to assume a leadership role within the global

regulatory framework, hoping to both teach foreign regulators and learn from them, as

long as the lessons are in line with the U.S. regulatory vision.262 This represents quite the

contrast to the Board’s original stance toward the international community upon its

creation.

In addition, the plan provides measures to evaluate PCAOB progress toward

achieving its stated goals. Currently, the Board has either performed the dictated number

260 Public Company Accounting Oversight Board. PCAOB 2008-2013 Strategic Plan 2008,
www.pcaobus.org (accessed May 2, 2008).
261 Ibid.
262 Ibid.

of foreign accounting firm inspections directly, after obtaining foreign government

permission, or in conjunction with foreign regulatory institutions.263 The PCAOB

projects that it will inspect approximately 72 and 101 foreign firms in 2008 and 2009,

respectively. Futhermore, the Board has made considerable progress in recognizing the

need for diplomatic relations with foreign nations in order to obtain their cooperation

with PCAOB inspections or enforcement actions outside U.S. borders.264 In seeking to

effectively work in conjunction with foreign regulators, the U.S. is not perceived as being

as intrusive as it was when SOX first emerged. Also, the PCAOB has created an

international forum, known as the International Auditor Regulatory Institute, to not only

address the idea of a global oversight system, but also to enhance international

participants’ understanding of the Board’s methodology and rationale behind its

standards.

By helping international regulators understand the Board’s activities, the PCAOB

hopes to change the international perspective of SOX as an unwarranted imposition into a

warranted measure intended to protect investors. Although these steps have been

significant for the PCAOB, in reality the Board is only acting in a manner consistent with

international requests that emerged at the onset of Sarbanes-Oxley. It is apparent,

however, that the PCAOB has recognized the impact the Act has had on foreign relations

and is doing its best to amend the strains that resulted from SOX.

263 Ibid.
264 Ibid.

CONCLUSION

This study has interpreted the provisions of the Sarbanes-Oxley Act and the

difficulties entities face incorporating the Act’s requirements into their business practices.

Part I focused on domestic and foreign registration with the PCAOB. In Part II, a

thorough examination of the history of U.S. securities legislation provided the foundation

upon which it was possible to compare and contrast SOX with existing securities laws.

PART III of the study explored the economic, legal and political impact of the Act in

order to demonstrate the implications of it for U.S. foreign relations. The final section

explored alternative solutions to Sarbanes-Oxley and the development of SOX and the

PCAOB to date.

Although the PCAOB has taken significant steps to rectify the impact of SOX

abroad and its blow to U.S. foreign relations, the U.S. will need to continue to encourage

foreign dialogue and promptly respond to international concerns over SOX. If the U.S.

does not respond to international concerns over SOX, foreign company membership on

the U.S. market could continue to decline and the U.S. will isolate itself, suffering

politically, economically, and socially. While the future of the Sarbanes-Oxley Act is not

certain, it is certain that global accounting oversight will continue to play a role in future

U.S. foreign relations and the U.S. will need to react to accounting oversight with greater

care than it did its first time around.

Bibliography
“Peekaboo Powers.” Wall Street Journal, Feb 8, 2006.

The Impact of Sarbanes-Oxley Act on Non-U.S. Accounting Firms. Journal of

International Business Research, January, 2005. 1.

“Notes from AICPA Spring Council: Agenda Includes International Standards, Cost of

SOX Compliance.” Inside Public Accounting 19, no. 6 (Jun, 2005): 5.

Better Governance and Reporting Under Sarbanes – Oxley : Are we there Yet? Mondaq

Business Briefing, November 23, 2004.

“COMMENT: WAS ITS BITE WORSE THAN ITS BARK? THE COSTS SARBANES-

OXLEY IMPOSES ON GERMAN ISSUERS MAY TRANSLATE INTO

COSTS TO THE UNITED STATES.” 2004 Emory University School of Law

Emory International Law Review (Spring, 2004).

“NOTE: International Law and the Ramifications of the Sarbanes-Oxley Act of 2002.”

2004 Boston College International & Comparative Law Review Boston College

International and Comparative Law Review (Spring, 2004).

“Note:Sarbanes-Oxley: Ignoring the Presumption Against Extraterritoriality.” 2004

George Washington University George Washington International Law Review

(2004).
PCAOB-Beyond the First Year. Mondaq Business Briefing, July 15, 2004.

“ARTICLE: Accounting, Auditing and Audit Committees After Enron, Et Al.: Governing

Outside the Box without Stepping Off the Edge in the Modern Economy*.” 2003

Washburn Law Journal Washburn Law Journal (Fall, 2003).

“EDITORIAL COMMENT: Extraterritoriality and the Corporate Governance Law.”

2003 the American Society of International Law American Journal of

International Law (April, 2003).

“Foreign Securities Regulators Express Concern about Auditor Independence Rules.”

International Securities Outlook Online Volume 4, no. Issue 1 (January 6, 2003,

2003): December 1, 2007, http://business.cch.com.

Hope of further Compromise with the SEC. International Accounting Bulletin, January

24, 2003. 8.

“SURVEY: SARBANES – OXLEY , FOREIGN ISSUERS AND UNITED STATES

SECURITIES REGULATION.” 2003 Columbia Law School Columbia Business

Law Review (2003).

Text: Rules Changes Will Bolster Confidence, SEC Commissioner Says; Changes Treat

Foreign and Domestic Companies Equally, Campos Adds. State Department, June

12, 2003.
Eu Warns on Sarbanes – Oxley Act. Financial News (Daily), September 6, 2002.

Sarbanes – Oxley Debate: Will Pitt Offer Compromise for Non-US Firms? The

Accountant, October 21, 2002. 3.

Auger, James. “Costs of Complying with Sarbanes-Oxley U.S. Corporate Regulations

Coming Down.” Global Insight, May 1, 2008.

Bather, Andrea and Priscilla Burnaby. “The Public Company Accounting Oversight

Board: National and International Implications.” Managerial Auditing Journal 21,

no. 6 (2006): 657.

Becker, Tim and Clarke, Peter. “Is Washington Now the Omnipotent Regulator of the

European Financial System?” Ethical Corporation: Not an Oxymoron.

http://www.ethicalcorp.com/content.asp?ContentID=233 (accessed April/20,

2008).

Bieling, Hans-Jurgen. “The Other Side of the Coin: Conceptualizing the Relationship

between Business and the State in the Age of Globalization.” Business and

Politics 9, no. 3 (January 11, 2008, 2008): April 8, 2008,

http://journals.ohiolink.edu/ejc/article.cgi?issn=14693569&issue=v09i0003&artic

le=1187_tosotcsitaog.

Cheney, Glenn. “Uncle Sam Kicks Ass.” Australian CPA 74, no. 3 (Apr, 2004): 29.

Cunningham, Lawrence C. “From Convergence to Comity in Corporate Law: Lessons

from the Inauspicious Case of SOX.”Boston College Law, 2003,

http://papers.ssrn.com/sol3/cf_dev/AbsByAuth_LAB.cfm?per_id=185113

(accessed April 27, 2008).

Dietrich, Richard. Personal Recount of Conversation with Congressmen Mike Oxley.

April 30, 2008.

Fass, Allison. “One Year Later, the Impact of Sarbanes-Oxley.” Forbes.Com (July 22,

2003, 2003), http://www.forbes.com/2003/07/22/cz_af_0722sarbanes.html

(accessed May 11, 2008).

Giles, Jill P., Elizabeth K. Venuti, and Richard C. Jones. “The PCAOB and Convergence

of the Global Auditing and Accounting Profession.” The CPA Journal 74, no. 9

(Sep, 2004): 36.

Goelzer, Daniel L. “Opening Statement of Daniel L. Goelzer, Board Member at the Open

Meeting to Consider Proposing Release of Full Reliance Policy Statement.”

Washington D.C., PCAOB, December 5, 2007, 2007, www.pcaobus.org

(accessed May 2, 2008).

Hill, Nancy T., John E. McEnroe, and Kevin T. Stevens. “Auditors’ Reactions to

Sarbanes-Oxley.” The CPA Journal 77, no. 7 (Jul, 2007): 6.

Kemp, Shirley. Us Laws to Hinder Sa Companies. Moneyweb (South Africa) – AAGM,

November 5, 2002.

Miller, Richard I. and Paul H. Pashkoff. “Regulations Under the Sarbanes-Oxley Act.”

Journal of Accountancy 194, no. 4 (Oct, 2002): 33.

Nation., The. “US Act, ‘a New Form of Extra-Territorial Rights Legislation’.” The Nation

(Thailand), January 21, 2003.

Newman, Bernard H. and Mary Ellen Oliverio. “Perceived Flaws in Sarbanes-Oxley

Implementation.” The CPA Journal 76, no. 9 (Sep, 2006): 6.

Norris, Floyd. “WorldCom’s Collapse Gave Boost to Sarbanes-Oxley: The Timing of the

Scandal Helped Build Support for Tougher Rules in the 2002 Bill on Securities

Laws.” The New York Times, July 14, 2005, 2005, sec. Business,

http://www.ocregister.com/ocr/sections/business/business_nation/article_596162.

php.

One Hundred Seventh Congress of the United States of America. Sarbanes-Oxley Act of

2002. Translated by U.S. Congress. Vol. H.R. 3763–21Federal, 2002,

news.findlaw.com/hdocs/docs/gwbush/sarbanesoxley072302 (accessed

November 30, 2007).

Public Company Accounting Oversight Board. PCAOB 2008-2013 Strategic Plan2008,

www.pcaobus.org (accessed May 2, 2008).

———. Final Rules Relating to the Oversight of Non-US Public Accounting Firms

PCAOB Rulemaking Docket Matter No. 013, 2004, www.pcaobus.org (accessed

May 2, 2008).

———. 2008 Budget by Area, December 2007 www.pcaobus.org (accessed May 2,

2008).

Quinn, Eamon. Accountants Step Up Bid Against Us Law. Sunday Business Post,

September 15, 2002.

Tafara, Ethiopis. “Speech by SEC Staff: U.S. Perspective on Accountancy Regulation

and Reforms by Ethiopis Tafara.” London, U.S. Securities and Exchange

Commission, July 8, 2003, http://www.sec.gov/news/speech/spch070803et.htm

(accessed December, 1 2007).

NBERWORKING PAPER SERIES

A LOBBYING APPROACH TO EVALUATING THE SARBANES-OXLEY ACT
OF

Yael V. Hochber

Paola Sapienza

Annette Vissing-Jorgensen

Working Paper

2
http://www.nber.org/papers/w

NATIONAL BUREAU OF ECONOMIC RESEARCH

Massachusetts Avenue

Cambridge, MA 0

March

We thank John de Figueiredo, Wei Jiang, Holger Mueller, Morten Sorensen, Cong Wang, Luigi Zingale

and seminar participants at the European Central Bank, InterDisciplinary Center Hertzlia, Iowa State
University, NBER Law and Economics Summer Meeting, New York University, Northwestern University,
Norwegian School of Economics and Business, Securities and Exchange Commission, UNC – Duke
Corporate Finance Conference, University of Copenhagen, University of Illinois Urbana-Champaign,
University of Oregon, and Yale University for helpful comments and suggestions. We are grateful
to Catherine Leblond and Che Banjoko for outstanding research assistance, to Cindy Alexander for
assistance with SEC requests, to Kin Lo for provision of prior lobbying data, and to Yaniv Grinstein
and Vidhi Chhaochharia for provision of governance data. The views expressed herein are those of
the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research

© 2007 by Yael V. Hochberg, Paola Sapienza, and Annette Vissing-Jorgensen. All rights reserved.
Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provide

that full credit, including © notice, is given to the source.

A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002
Yael V. Hochberg, Paola Sapienza, and Annette Vissing-Jorgensen
NBER Working Paper No. 1

52
March 2007
JEL No. G3,G3

ABSTRACT

We evaluate the net benefits of the Sarbanes-Oxley Act (SOX) for shareholders by studying the lobbying
behavior of investors and corporate insiders to affect the final implemented rules under the Act. Investo

lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business
groups lobbied against strict implementation. We identify the firms most affected by the law as those
whose insiders lobbied against strict implementation, and compare their returns to the returns of less
affected firms. Cumulative returns during the four and a half months leading up to passage of SOX
were approximately 10 percent higher for corporations whose insiders lobbied against one or more
of the SOX disclosure-related provisions than for similar non-lobbying firms. Analysis of returns in
the post-passage implementation period indicates that investors’ positive expectations with regards
to the effects of the law were warranted for the enhanced disclosure provisions of SOX.

Yael V. Hochberg
Finance Department
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL

0208-200

y-hochberg@kellogg.northwestern.edu

Paola Sapienza
Finance Department
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL

208-2001
and NBER
paola-sapienza@northwestern.edu

Annette Vissing-Jorgensen
Finance Department
Kellogg School of Management
Northwestern University
2001 Sheridan Road
Evanston, IL 60208-2001
and NBER
a-vissing@northwestern.edu

Following the Enron/Arthur Andersen scandal in late 2001, the U.S. Congress came under increas

–

ing pressure to pass legislation that would make it more difficult and costly for corporate insiders

to misrepresent company performance and divert resources for personal gain. Bills were introduced

in the House by Representative Michael Oxley on February

, 2002, and in the Senate by Senator

Paul Sarbanes on May 8, 2002. The final bill, the Sarbanes-Oxley Act of 2002, was passed in the

House and Senate on July

, 2002.

There are two main competing views about the likely impact of the Sarbanes-Oxley Act (SOX

)

on shareholders. Proponents of the Act argue that it will lead to improved disclosure and corporate

governance, thereby reducing misconduct of insiders, and that these benefits will outweigh the costs

of compliance. Opponents argue either that SOX will be ineffective in preventing corporate wrong-

doing and/or that any benefits of SOX will not be large enough to outweigh the compliance costs

associated with it.

The central challenge to distinguishing between the two main views regarding the effect of

SOX is the lack of a control group of publicly traded firms unaffected by the legislation. In this

paper, we employ two approaches in an attempt to circumvent the lack of a control group of

comparable firms unaffected by SOX. Our methodology follows from the procedural process used

in the implementation of the SOX legislation.

Following the passage of SOX in 2002, Congress delegated the drafting and implementation of

the principles outlined by SOX to the Securities and Exchange Commission (SEC). The various

sections of SOX were divided into separate rules by the SEC, which then solicited public comments

regarding its proposing rule releases, prior to drafting the final adopting releases. Letters to the

SEC commenting on the proposed rule releases were made publicly available on the SEC web site

or through its public reference office.

Following the main compliance-related titles of SOX, we classify the rules on which the SE

solicited comments into groups, focusing on three major sets of rules: provisions related to enhanced

financial disclosure (including the much discussed Section

4 assessment of internal controls),

provisions related to corporate responsibility, and provisions related to auditor independence. Our

first approach to evaluating the effect of SOX on shareholder value is to classify the nature of

comment letters submitted to the SEC by individual investors and investor groups. We document

that based on their letters to the SEC, individual investors were overwhelmingly in favor of strict

implementation of SOX, across all three categories of proposed rules. Importantly, lobbying by

investor groups such as pension funds and labor unions, who presumably are more sophisticated

than individual shareholders, was equally supportive. These findings allow us to speak to the

perceived value of SOX for shareholders. To the extent that investors were sufficiently informed

and sufficiently sophisticated to evaluate the costs and benefits of SOX, these findings suggest that

SOX was perceived to be beneficial to individual investors and investor groups. This result stands in

stark contradiction to the conclusions of studies such as Zhang (2005), who argue that shareholder

reactions to SOX were unfavorable based on the price movement of the market as a whole.

To provide additional evidence on the value of SOX, our second approach utilizes the comment

letters sent to the SEC by and on behalf of corporate insiders. Our reading of these letters reveals

that an overwhelming majority of insiders in lobbying companies opposed strict implementation

of SOX, and argued strongly for delays, exemptions and loopholes in its implementation. While

lobbying by investors in favor of SOX is useful for distinguishing between the improved disclosure

and corporate governance view and the costly compliance view of SOX, lobbying by insiders against

strict implementation is not informative for this purpose in and of itself. Corporate insiders may

lobby against strict implementation of SOX both if SOX was expected to succeed in improving

disclosure and governance or if the dominant effect of SOX was expected to be its high compliance

costs.1

Lobbying by corporate insiders against strict implementation of SOX, however, can be used as

a proxy to identify companies more likely to be affected by the legislation (positively or negatively),

and thus allows us to circumvent the lack of a control group of firms unaffected by the Act. Under

the improved disclosure and governance view, these more affected firms will be those for whom

the governance gain will be greatest. If SOX provides a net benefit in the form of improved

disclosure and corporate governance for shareholders, companies whose insiders lobbied against

strict implementation of SOX should have higher cumulative returns than otherwise similar non-

lobbying companies in the period leading up to the passage of SOX, as the market adjusts its

expectations of future cash flows for these companies relative to their matched, less-affected peer

Conversely, under the compliance cost view, where SOX is detrimental to shareholders because it

imposes costs that outweigh any associated governance gains, the more affected companies will be

those for whom the net costs are highest, and thus we would expect lobbyers to experience lower
1Under the improved disclosure and governance view, insiders lobby against strict implementation due to SOX’s

effect of reducing insiders’ ability to divert resources to themselves. Under the compliance cost view, insiders may
lobby against SOX either because they choose to lobby in the interest of company shareholders, or because they
anticipate a possible reduction in diversion of resources.

cumulative returns than non-lobbyers.

One aspect of our research design, important for interpreting our findings, is that lobbying

of the SEC with regards to implementation of SOX primarily occurred after the passage of the

Act itself. For our identification strategy to be powerful, it must be the case that the market

could predict which firms would be most affected (and hence, which insiders would lobby against

strict implementation of SOX) based on ex-ante observable characteristics of firms. To validate

our empirical strategy, we provide direct evidence that lobbying was to some extent predictable

based on variables publicly observable at the start of our sample. Furthermore, an event study of

abnormal returns observed around the date of submission of a comment letter by a given company

indicates that there was no discernable market reaction to the submission of the letter, suggesting

that market participants were not surprised to see which

firms lobbied.

Our portfolio analysis of returns reveals that during the period from February to July of 2002

leading up to passage of SOX, cumulative returns were approximately 10 percentage points higher

for corporations whose insiders lobbied against one or more of the SOX ‘Enhanced Disclosure’

provisions than for non-lobbying firms with similar size, book-to-market and industry characteris-

tics. Similarly, we find some evidence of higher cumulative returns for corporations whose insiders

lobbied against one or more of the SOX ‘Corporate Responsibility’ provisions and for corporations

whose insiders lobbied against one or more of the SOX ‘Auditor Independence’ provisions than for

comparable non-lobbying firms. Many firms who lobbied against strict implementation of the ‘Cor-

porate Responsibility’ or ‘Auditor Independence’ provisions, however, also lobbied against strict

implementation of one or more of the ‘Enhanced Disclosure’ provisions. We therefore proceed to

estimate the separate abnormal returns associated with each of the three categories by running

firm-level regressions. The results from our firm-level models imply a total abnormal excess return

of approximately 10 percent during the period leading up to the passage of SOX for firms whose

insiders lobbied against the ‘Enhanced Disclosure’ provisions, but a total abnormal excess return

of only 3 percent and 1 percent for firms lobbying against ‘Corporate Responsibility’ or ’Audi-

tor Independence’ provisions, respectively. These relative returns suggest that while investors did

not disapprove of the ‘Corporate Responsibility’ or ‘Auditor Independence’ provisions, the market

expected SOX to mainly benefit the firms most affected by provisions related to ‘Enhanced Dis-

closure,’ rather than those affected primarily by ‘Corporate Responsibility’ provisions or ‘Auditor

Independence’ provisions.

In the second part of our analysis, we focus on the returns of lobbying and non-lobbying firms

during the period after the passage of SOX. If investors’ positive expectations regarding the overall

effects of SOX were warranted, one would not expect any differences between the returns of lobbying

and non-lobbying firms in the post-passage period. If, on the other hand, shareholders gradually

became aware that the measures introduced by SOX did not in fact result in higher earnings,

due, for example, either to a watering down of the rules during implementation or to higher than

expected compliance costs (for more affected firms in particular), then one should observe abnormal

negative returns for lobbying firms relative to non-lobbyers in the period following SOX passage

and until investor expectations settle at a new, less optimistic level. Our analysis of returns in

the post-passage period indicates that the returns for firms who lobbied against an ‘Enhanced

Disclosure’ rule were similar to the returns for their non-lobbying comparison group of firms, and

thus that the increase in relative stock price experienced by lobbying firms did not tend to reverse

during the post-passage

period.

To further validate our reseach design, in the final part of our analysis, we repeat the study

of returns described above, replacing the lobbying firms with those firms who, based on ex-ante

characteristics, our probit model would predict would lobby. We find roughly similar results when

employing predicted lobbyers rather than actual lobbyers as the proxy for more affected

firms.

In sum, our study documents, first, that investors expected SOX to more closely align interests

of insiders and shareholders; second, that (relative) returns during the period leading up to SOX

passage are consistent with the views of investors; and third, that investors’ positive expectations

may have been warranted, based on returns in the post-SOX period. Consistent with the arguments

presented by Coates (2006), our results indicate that in the eyes of public company shareholders,

the most important and effective provisions in SOX were the ‘Enhanced Disclosure’ provisions,

rather than the provisions related to ‘Corporate Responsibility’ and ‘Auditor Independence’.

An obvious shortcoming of a research design which compares more affected firms to less affected

firms, without having a comparable group of firms unaffected by the legislation studied, is that it

does not speak directly to the overall effect of SOX on the public equity market. We can say that

considering the full period from when serious discussions about the legislation first started in week

7 of 2002 and until the end of 2004 (well into the implementation phase of SOX), the stocks of more

affected firms (as proxied for by lobbying firms) outperformed those of less affected firms (proxied

for by non-lobbying firms). Based on our returns analysis alone, we cannot unambiguously say

that the net benefit of SOX for either group is positive. However, we employ estimates of SOX

compliance costs and argue that the benefit to shareholders in the more affected (lobbying) firms

is likely to be positive. Furthermore, with the addition of two conservative assumptions, we argue

that the new benefit to shareholders in general is likely to be positive.

A second important caveat to our analysis is that we are not able to speak to the welfare effects

of SOX, but rather only to the law’s effects on shareholders of publicly listed companies at the start

of our sample. For example, our analysis cannot measure the overall welfare effect of changes in

the propensity to list or remain listed on U.S. markets due to SOX-related costs (Zingales (2006)).

In addition, we cannot rule out that insiders lost an amount equal to or greater than what outside

investors gained. Finally, we note that while our analysis suggests that shareholders expected

SOX to be value-increasing on average for publicly traded firms, the lobbying firms in our sample

are predominantly large, established organizations, and thus our returns analysis does not provide

specific conclusions as to the effect of SOX on smaller firms.

Our study is related to an emerging literature attempting to evaluate the effects of SOX. An

insightful review of this literature, which has not produced a general consensus on the effects or

value of the Act, is presented in Coates (2006). Zhang (2005) examines the reaction of the overall

U.S. stock market to legislative events leading to the passage of the Act. While Zhang (2005) finds

significantly negative returns around legislative events leading to the passage of SOX, these returns

might be due to other, confounding events unrelated to SOX. Rezaee and Jain (2003) also study

the aggregate market reaction to SOX, reaching the opposite conclusion of Zhang (2005).

As in our paper, other studies seek to circumvent the lack of a control group of unaffected firms

by use of alternative approaches or outcome variables. Cohen, Dey and Lys (2005) evaluate the

impact of SOX by examining changes in earnings management behavior and in the informativeness

of earnings announcements of firms around the passage of the Act. They find a decline in earnings

management activity following the passage of SOX. Engel, Hayes and Wang (2004) study firms’

going-private decisions and find a modest increase in the number of firms going private after the

passage of SOX. The paper closest to ours in approach is Chhaochharia and Grinstein (2005),

who study the announcement effect of SOX on firm value. To overcome the lack of an unaffected

control group, they sort firms into groups most and least compliant with certain proposed SOX

provisions in the pre-SOX period. Based on a comparison of these two groups, their study finds

a positive value effect associated with SOX for large firms, whereby firms that need to make the

most changes in order to comply with the new rules outperform firms that require fewer changes

over the announcement period. Conversely, they find a negative effect for small firms. While

Chhaochharia and Grinstein (2005) study the perceived value of SOX for firms most affected by

certain specific provisions of the Act, our lobbying approach allows us to expand on their work

by examining shareholders’ views regarding the full spectrum of SOX’s provisions, as well as to

differentiate between the various categories of these provisions. Additionally, since our analysis

extends to the period after the passage of the law, we are also able to separate the perceived effects

of the Act as passed in Congress from the net effects resulting from the actual implementation of

those rules.

Our paper is also related to a growing literature that uses the lobbying activities of corporations

to examine the impact of regulation. King and O’Keefe (

86) examine the relationship between

corporate lobbying and trading activities of corporate insiders surrounding proposed accounting

standards that require firms to expense oil and gas exploration expenditures associated with dry

holes. A more closely related study is that of Lo (2003), who examines the economic consequences of

the 1992 revision of executive compensation disclosure rules using a lobbying approach quite similar

to that employed in this study. Lo (2003) finds, in support of the value of increased disclosure,

that corporations whose insiders lobbied the SEC against the proposed regulation had positive

excess stock returns of about 6% over the 8-month period between the SEC’s announcement that it

would be pursuing reform and the adoption of the proposed regulation. In addition to addressing

a different reform, a key difference between Lo (2003) and this study is that we study not only

the opinions of corporations who lobby the SEC, but also the views of non-investor groups and of

individual investors and investor groups.

The remainder of this paper is organized as follows. Section I presents an overview of the

Sarbanes-Oxley Act, the time line of its adoption, and the role of lobbying in the design of the

resulting rules. Section II details our hypotheses and research method. Section III presents and

our empirical findings. Section IV discusses the interpretations and implications of our findings.

Section V concludes.

I. The Sarbanes-Oxley Act Of 2002

A. The Legislative Time-Line

The collapse of Enron in October 2001, followed by the subsequent exposure of a string of accounting

and governance scandals at Qwest Communications, Global Crossing, Worldcom, Adelphia and

Tyco in the spring of 2002, triggered a flurry of legislative proposals to reform corporate business

practices and improve accounting and governance systems for publicly traded companies.

The Sarbanes-Oxley Act resulted from the combination of reform bills introduced by Senator

Paul Sarbanes, Democrat of Maryland, and Representative Michael Oxley, Republican of Ohio,

in the Senate and House, respectively. Representative Oxley’s reform bill was first introduced in

the House on February 13th, 2002. Oxley’s bill was passed in committee on April

th, 2002,

and was subsequently passed in the House on April

th, 2002. In May of 2002, the Sarbanes

reform bill was circulated in the Senate Banking Committee, which passed the bill on June

th,

2002. The full Senate began debate on Sarbanes’ bill on July 8th 2002, and passed the bill with

overwhelming support on July

th, 2002. On July 19th, 2002, the House and Senate formed a

conference committee and began negotiations to merge the two bills. The final legislative bill, to

be known as the Sarbanes-Oxley Act of 2002, was passed in Congress on July 25th, 2002, and was

signed into law by the President on July

th of that year.

SOX directed the SEC to immediately begin rule-making activities, and the SEC commenced

such action in late August 2002. SOX-directed rule making activities continued throughout 2003

and into the beginning of 2004. The major rule-making activities were completed by June 2004.

B. The Content of the Act

The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB)

and laid out new rules for and restrictions on corporations, corporate directors and auditors. The

Act is arranged into eleven titles.

The first four titles of the Act are the most relevant for issues of public company compliance.

Title I of the Act establishes the PCAOB, which is charged with overseeing and registering public

accounting firms and establishing standards related to auditing and internal controls. Title II of

the Act covers issues related to auditor independence, and places restrictions on public accounting

firms with regards to the provision of non-auditing services, as well as mandating periodic rotation

of the coordinating and reviewing auditing partners. Title III of the Act deals with corporate re-

sponsibilities, including the independence of the auditing committee, improper influence on conduct

of audits, executive certification of financial reports, penalties related to financial restatements, and

rules of professional responsibility for attorneys. Title IV of the Act deals with enhanced financial

disclosure, including disclosures in periodic reports, enhanced conflict of interest provisions, disclo-

sure of transactions involving management or principal stockholders, the disclosure of the existence

of an audit committee financial expert, and the much-discussed management assessment of internal

controls.

The remaining titles of the Act primarily deal with issues unrelated to compliance by publicly

traded firms, or set out criminal penalties and as such were (with two exceptions noted below) not

subject to interpretation and implementation by the SEC. Title V of the Act deals with analyst

conflicts of interest, Title VI deals with SEC resources and authority, and Title VII with studies

and reports. Title VIII of the act deals with corporate and criminal fraud accountability, and Title

IX with white collar crime penalty enhancements. Title X deals with the signing of corporate tax

returns by chief executive officers, and Title XI with definitions of corporate fraud and account-

ability. Of these remaining titles only Title VIII, section 802, on criminal penalties for altering

documents and Title IX, Section 906, on corporate responsibility for financial reports generated

SEC rule-making. We group SEC rules related to Sections 802 and 906 with those related to Title

III since they cover similar topics. Due to the SEC’s lack of rule-making activities with regards to

Title V, VI, VII, X and XI, we do not deal directly with these Titles of the Act.

We classify the rule-making activities of the SEC with regards to Titles I through IV of SOX

into three broad categories. Rule-making activities related to auditor independence, Title II of

SOX, are classified as ‘Auditor Independence’ rules. Rule-making activities related to corporate

responsibilities, Title III of SOX, are classified as ‘Corporate Responsibility’ rules. Rule-making

related to issues of enhanced financial disclosure and the PCAOB, Titles IV and I of SOX, are clas-

sified as ‘Enhanced Financial Disclosure’ rules. We include Title I, which establishes the PCAOB,

in the ‘Enhanced Disclosure’ rules category due to the close overlap between the PCAOB’s respon-

sibilities and rule-making and the disclosure items mandated in Title IV. Indeed, a significant part

of the PCAOB’s purpose is to determine and regulate the standards for the enhanced disclosures

mandated by Title IV.2

In conjunction with the federal legislation, the major stock exchanges produced their own
2All our reported results are robust if the rules relating to Title IV are analyzed separately from those relating to

the PCAOB.

governance-related listing requirements. In February of 2002, the SEC called on the major stock

exchanges to review their governance requirements. NYSE’s and NASD’s boards adopted gover-

nance proposals and submitted them to the SEC for approval. The SEC solicited public comment

on these proposals, and upon reviewing the comments, approved the NYSE and NASD propos-

als with some modifications. We include SEC rule-making related to the governance and listing

standards of the NYSE and NASDAQ exchanges in the ‘Corporate Responsibilities’ category.

Additionally, contemporaneously with SOX rule-making, the SEC issued a number of proposed

rules on disclosure-related issues which were either adopted or replaced by a SOX mandated

rule.

Due to the topics of these rules, they are included in the ‘Enhanced Financial Disclosure’ category.3

In the fall of 2003, the SEC proposed one further rule related to corporate responsibility, which

was not part of SOX, and which eventually was not implemented. This rule relates to nominations

of directors by security holders. We tabulate letters for this rule in Appendix A, but subsequently

leave out firms that lobbied for or against this rule from our sets of lobbying and non-lobbying

firms since the rule was not

implemented.

C. The Role of Lobbying in the Design of the Rules

The Sarbanes Oxley Act is a statute, and as such, can only be changed by another Act of Congress

or by a court that rules it unconstitutional. As Congress was well aware of the lengthy time-line

required to perpetuate new or amended legislation, SOX mainly consisted of principles. The rules

and enforcement actions by which these principles are implemented were left to be set by the SEC,

which can respond rapidly to feedback and update the rules as needed (Coates (2006)).

Section 3A of the Sarbanes-Oxley Act grants authority to the Securities and Exchange Com-

mission to “promulgate such rules and regulations, as may be necessary or appropriate in the

public interest or for the protection of investors, and in furtherance of this Act.” The SEC started

rule-making activities in August 2002. The rule-making activities directed by SOX continued into

2003 and 2004. The SEC took public comments into consideration when drafting the final rules,

and indeed, shareholders, corporations and others could and did influence how strictly SOX was

implemented.

After the passage of SOX, the relevant sections of each title were broken down and drafted in

a proposing release, which was then circulated by the SEC for public comment. At the end of the

comment period, the SEC drafted and approved a final adopting release for each rule. In Appendix
3All our reported results are robust to exclusion of these rules.

A we classify and briefly describe all of the SOX-related rules proposed by the SEC. We report

the date of the proposing release, the date of the adopting release, the related SOX section, and

whether the rule was adopted with or without amendments and further restrictions.4

For each of the proposed rules, the SEC solicited public comments that were to be submitted to

the SEC after the proposing release date by a specific deadline prior to the adopting release date.

Comment letters submitted to the SEC by electronic means are made available to the public on

the SEC website. Comment letters submitted in paper form were made available through the SEC

public reference section. In Section III, we describe the content of the letters submitted to the SEC

in detai

The major event window we employ to understand the perceived value of SOX is the time

period leading to the approval of the Sarbanes-Oxley Act. Our event window starts on February

8, 2002, and ends on July

, 2002. The first week of our event window leading up to SOX passage

is thus the week that includes February 13, 2002, when Oxley’s bill was introduced in the House

and the SEC announced that it intended to propose several rules designed to improve disclosure

and governance. The last week of the window includes July 25, 2002, when Congress passed the

law.5 Because most of the rule making activity is concentrated after the passage of the Act (after

July 25th, 2002), the event window allows us to separate the perceived effect of the law from the

information potentially generated by the submission of comments to the SEC.

To understand the effects of SOX as implemented, as opposed the perceived effects of the bill

as passed by Congress, we also examine the period following the passage of the Act, from July

26th, 2002, to the end of 2004. By examining returns for lobbying and non-lobbying firms in the

post-passage period, we can assess the net effect of the final SOX rules, given the strictness and

effectiveness of the implementation, and the costs of compliance associated with such.

II. Hypotheses and Research Method

There are two competing views of the likely impact of SOX. The view on which Congress based

the act is that SOX would improve disclosure and governance, thereby decreasing misconduct by

corporate insiders and increasing value for shareholders above and beyond the associated costs of
4Three of the proposing releases that we list as releases generated by SOX were issued before the actual passage

of the law. These are cases where the content of the SEC’s proposed rule subsequently was mandated by SOX and
adopted as such, or where the SEC’s proposed rule was augmented by a subsequent release under SOX and adopted
as such.

5While the president only signed the law on July 30, 2002, presidential approval was viewed as a foregone conclusion
once the Act was passed in Congress.

compliance. Under this positive view of the act we would expect the

following:

1. Lobbying: Shareholders should support SOX, while corporate insiders should oppose it.

2. Returns during the period leading up to passage of SOX: In the cross-section of firms, returns

should be higher for more affected firms.6

The improved disclosure and governance view of the Act also predicts that, on average, across

firms, returns during the period leading up to passage should be abnormally positive (relative to

a set of firms with no news about disclosure and governance), and average operating performance

should improve in the post-SOX period. Given the lack of a control group of (comparable US)

firms not impacted by SOX, these additional predictions are impossible to test, as they cannot be

distinguished from aggregate shocks unrelated to SOX.

The alternative view of SOX is that the main impact of SOX would be to impose large compli-

ance costs on firms with a negative net effect of the act on shareholder value. This view is based

on the prior that SOX would be ineffective in diminishing any misconduct, and that compliance

costs would be sufficiently large to outweigh any benefits. Proponents of this view would argue

that private markets already lead to the shareholder value maximizing disclosure and governance

structure, and that government interference leads to sub-optimally large amounts of resources being

spent on disclosure and governance issues. Under the compliance cost view, one would expect the

following:

1. Lobbying: Shareholders should oppose SOX. Corporate insiders should either oppose it (if

they are acting on behalf of shareholders or if SOX has some ability to reduce insider mis-

conduct), or be indifferent to it (if SOX is ineffective in reducing insider misconduct).

2. Returns during the period leading up to passage of SOX: In the cross-section of firms, returns

should be lower for more affected firms.

The compliance cost view also has predictions about the average effect of SOX across firms.

Returns during the period leading up to passage should be abnormally negative (relative to a set of

firms with no news about disclosure and governance), and operating performance should be worse
6As the probability of legislation went from zero to one, the price of a given company should gradually move

upward from P to P + ∆Psox where ∆Psox is the present value of the increase in dividends due to SOX. If
∆Psox

differs in the cross-section, firms with large values will be observed to have abnormally good returns over this period.

in the post-SOX period. Once again, given the lack of a control group of firms not impacted by

SOX, these predictions are impossible to test.

From the above, it is clear that studying lobbying behavior is informative about the average

effect (across companies) of SOX on shareholders. The views of shareholders are particularly

informative, while lobbying by corporate insiders against SOX contains less direct evidence about

SOX’s average effect on shareholders, since insiders should oppose SOX under both the improved

disclosure and governance view and the compliance cost view. Lobbying by insiders is however still

useful for distinguishing between the two views of SOX, under the assumption that insiders are more

likely to lobby in firms more affected (positively or negatively) by SOX. Under this assumption,

firms can be split into groups based on whether the insiders lobbied against SOX or not, and this

split can be used to test the cross-sectional predictions regarding returns during the period leading

up to passage of SOX.

One aspect of our research design is important for interpreting our findings. The majority

of lobbying occurs after the passage of SOX in congress on July 25th, 2002. Our approach to

testing the predictions for stock returns during the period leading up to passage will therefore only

be powerful if (i) shareholders were aware which types of firms were likely to lobby, and (ii) the

relationship between lobbying and returns is causal.

In our analysis, we will provide three pieces of evidence to demonstrate (i) above. First, we

examine the extent to which lobbying is predictable based on variables known at the start of our

sample. Second, we conduct a firm level event study of returns for lobbying firms around the date

of submission of a letter to the SEC. To the extent that lobbying is to some extent predictable, and

the event study reveals no abnormal returns, these tests provide support for our research design and

the interpretability of our findings. Third, to the extent that our analysis does reveal differences in

the returns over the leadup period for lobbying and non-lobbying firms, this will provide evidence

in and of itself that our assumption is reasonable.

While the reverse causality concern raised in (ii) is potentially a problem, our research design

allows us to speak to this issue. Reverse causality in our setting would imply that good returns

caused insiders to lobby. However, any such effect would not predict a significant differential in

the excess returns of lobbying firms (over and above similar non-lobbyers) when comparing the

pre- and post-passage periods. To the extent that excess returns of lobbyers differ in the pre- and

post-passage period, this suggests that causality goes in the direction we assume, i.e. that being

more affected by SOX leads to excess returns, rather than it being simply the case that better (or

worse) performing firms tend to lobby, without neccesarily being more affected by the legislation.

A significant differential in the pre- and post-passage excess returns of lobbyers will thus validate

our research design.

It is worth noting that while this approach can be used to help resolve the causality concern in

our return analysis, we cannot use a similar approach to examine changes in operating performance

for lobbying and non-lobbying groups in a causal fashion: while return data is available on a weekly

basis, operating performance is only available to us on an annual basis, and thus does not allows

us to examine whether there is a kink in performance around the date of SOX passage. Following

the presentation of our findings on lobbying and returns, we will return to the question of what we

can learn from an analysis of operating performance in this setting.

A natural question that arises if indeed lobbying is predictable, is why we should choose to use

lobbying as a proxy for more affected firms, rather than simply using the variables that predict

lobbying. There are two central advantages to a research design that employs lobbying rather than

its predictors. First, lobbying is likely a stronger proxy for being more affected than the predictors

of lobbying alone. By employing the predictors instead of lobbying itself, the researcher is limited to

a few observable variables that likely do not fully capture many of the aspects of a firm’s structure

or management that may cause it to be more affected by SOX (and which may be known to the

market). We cannot as econometricians observe the state of a firm’s internal controls, nor many

aspects of its governance or management. Indeed, while we will demonstrate that lobbying is to

some extent predictable, it is clear from our results in the following section that a substantial

amount of the variation in lobbying is not driven by variables observable to us.7 Lobbying, on

the other hand, is in essence revealed preference, and therefore is likely to capture many more of

these aspects of the firm. Second, some characteristics will tend to predict lobbying against all

the different categories of SOX-related rules. Using predictors rather than actual lobbying would

therefore make it difficult to distinguish the relative benefit of the various subsections of SOX.

In contrast, lobbying can be observed at the individual rule level, thus allowing the researcher to

distinguish between shareholders’ reactions to different aspects of SOX. Nonetheless, we will provide

supplementary results analyzing the returns of firms that would be predicted to lobby based on

their ex-ante observable characteristics, regardless of whether or not they actually lobby. Similar
7In contrast, it is reasonable to assume that shareholders were able to observe more information in real-time than

we as econometricians can observe, and therefore that they were better able to predict lobbying than our models can.

patterns in returns for these firms in the pre- and post-passage periods will lend further support to

our research design.

III. Results

A. Opinions of Letter Writers

The opinions of commenters are tabulated in Table I. Overall, our study is based on 2689 letters.

Panel A shows how the letters are distributed across various types of letter writers. Of the 2689

letters, 793 are from corporations (or more precisely, from corporate managers or directors). 2

are

from non-investor groups such as the Business Roundtable and the American Society of Corporate

Secretaries.

5 of the letters are from investor groups, typically pension funds (including union

pension funds), and

3 are from individuals. The remaining 815 letters are from accountants

(individuals and groups), lawyers (individuals and groups), academics, or others (mainly church

groups and governments). Around 92 percent of the letters were submitted after July 25th, 2002,

the date of the passage of the Act, with

percent submitted in the remainder of 2002,

percent

submitted in 2003 and 10 percent submitted in 2004.

We classify the letters into three categories. Letters classified as “Positive” are those who

favored the rule commented on, or who called for stronger measures than those stated in the SEC’s

proposing release. Letters classified as “Negative” are those who opposed the rule commented on,

or argues for delays or exemptions in its implementation. The last category, “Neutral”, is used

for letters which commented on several of the sub-provisions in a particular proposing release and

where the commenter was positive on some sub-provisions and negative on others. A small number

of letters which were difficult to classify are also included in the neutral category.

The top panel of Table I shows for each type of commenter, and across all rules, the total

number and percentage of positive letters, neutral letters, and negative letters. It is clear that

individuals and investor groups were overwhelmingly in favor of the SOX provisions. 78 percent

of letters from individuals and 88 percent of letters from investor groups were in favor of the rule

commented on. An important feature of comment letters from individual and investor groups is

that the opinions expressed are not specific to a particular firm. In other words, the letters most

likely state the letter writer’s view of the average effect of the particular provision across stocks,

as opposed to its effect on an individual firm. Of course, it is possible that some individuals may

be motivated by particularly poor disclosure/governance for a particular firm whose stock they

own. However, since the provisions of SOX apply to all publicly traded firms, it seems fair to

consider opinions expressed as views about the total set of stocks the investor/investor group holds

or intends to hold in the future. Under this assumption, the positive views expressed by the vast

majority of individual investors and investor groups provide support for the improved disclosure

and governance view of SOX.

The remainder of Table I tabulates opinions by the rule and major rule category commented on.

We first present results for the major rule category ‘Enhanced Financial Disclosure and PCAOB’

(SOX Title IV and I)8, then turn to the results for ‘Corporate Responsibility’ (SOX Title III) and

last the results for ‘Auditor Independence’ (SOX Title II). The ‘Auditor Independence’ rule gener-

ated much fewer comments, the majority of which were submitted by accountants and accounting

firms.

Approximately 80 percent of both individual investors and investor groups wrote in favor of the

‘Enhanced Disclosure’ rule they were commenting on, with similar results for individual investors

and investor groups that comment on a ‘Corporate Responsibility’ rule. Investors thus appear to

view both the disclosure and governance provisions of SOX as being value increasing, even after

any compliance costs borne by shareholders. Investor groups who lobbied were overwhelmingly in

favor of the ‘Auditor Independence’ rules, while the few individuals who commented on these rules

were more divided.

The opinions of corporations and of non-investor groups contrast starkly with those of investors.

Across all rules, 82 percent of letters written by corporations (corporate managers or directors) and

72 percent of letters written by non-investor groups argued against the rule they commented on.

Roughly similar percentages of letters from corporations and non-investor groups express negative

views about the rules in all three individual categories of SOX provisions.

Since both the improved disclosure and governance hypothesis and the compliance cost hypoth-

esis predict that insiders should lobby against SOX, alternative theories are required to explain the

7 percent of corporations and

percent of non-investor groups who lobbied in favor of the rule

commented on. At least one CEO of a large publicly traded firm has stated that he is in favor

of SOX because compliance costs were disproportionately large for smaller firms and therefore put

these at a competitive disadvantage. An alternative story for positive lobbying by a minority of

corporations and non-investor groups is that these CEOs acted on behalf of shareholders and thus
8For brevity we will refer to this category as ‘Enhanced Disclosure’ in what follows.

expressed views in line with those of the majority of individuals and investor groups.9

For data availability reasons, our subsequent analysis focuses on publicly traded corporations.

A given letter may be signed by managers or directors of multiple companies. 80 percent of the

793 letters from corporations are signed by at least one manager/director from a publicly traded

company. Letters that represent insiders of publicly traded firms are even more likely to express

negative views about the rule commented on. 87 percent of such letters express negative views,

compared to

percent for letters representing a non-publicly traded firm.

A given company’s managers or directors may be signatories to multiple letters and a total of

publicly traded firms are represented among the corporate letters. To ease the interpretation of our

results, in our groups of lobbying firms below we omit letters from corporations expressing neutral

or positive opinions, as there are too few such letters to allow a separate analysis of these firms.10

Of the 395 publicly traded firms that are represented among the corporate letters,

8 firms are

thus classified as lobbying against ‘Enhanced Disclosure’ and/or ‘Corporate Responsibility’, and/or

‘Auditor Independence’.11

With regards to the other types of letter writers, the majority of accountants and lawyers argued

against the rules they commented on, while opinions of academics and others were more mixed.

The negative views of accountants and lawyers often refer to cases where the letter writer points

out practical complexities of the rule commented on, or where auditors lobby against regulation

that restricts the advisory role of auditing firms.

B. Predictability Of Lobbying By Corporate Insiders

Since most lobbying took place after the passage of SOX, our research design implicitly assumes

that lobbying is, at least to some extent, predictable by investors. If not, we would not expect to

observe different returns between lobbying firms and matched non-lobbying firms during the period

leading up to passage of SOX. The fact that we do find different returns between the two groups

by itself provides evidence that this assumption is reasonable.

Two additional analyses further support this assumption underlying our research design. First,

a simple probit model indicates that lobbying is to some extent predictable based on observable
9In our subsequent returns analysis we will include a measure of insider stock ownership to control for differences

in the incentives of insiders to lobby on shareholders’ behalf.
10If a firm submits comments on several rules within a major rule category (i.e. several rules within ‘Enhanced

Disclosure’) we classify them as lobbying against this major rule category only if all submitted comments are negative.
11The difference between the 395 and the 288 firms is driven by firms with neutral/positive letters and by the firms

who only comment on the SEC’s proposed rule on Security Holder Director Nominations discussed above.

variables known at the start of our sample. Second, a firm-level event study reveals no abnormal

returns for lobbying firms around the date of submission of a letter to the SEC, suggesting that

lobbying does not come as a surprise to the market.

B.1. Probit Models of Lobbying

We begin by demonstrating that it is possible to predict to a certain extent which firms will lobby

based on firm characteristics at the start of our sample. We run probit regressions where the

dependent variable is an indicator variable taking a value of one if the firm lobbied the SEC against

a SOX-related provision, and zero otherwise. We estimate the probit models separately for each of

the three major rule categories. We include a variety of variables that may predict lobbying.

Larger firms may feel they are more likely to be able to influence the SEC rule makers; if there is

a fixed cost element to lobbying, they may also incur lower relative costs of lobbying. In addition,

to lobbying, insiders of larger firms may be extracting more resources and thus have a stronger

incentive to try and weaken the implemented rules. As a measure of size, we include the natural

logarithm of firm book assets. Similarly, firms with more profits for insiders to expropriate may be

more likely to lobby. For each firm, we calculate the ratio of net income to sales as of the end of

the 2000 fiscal year as a measure of profitability.12 Firms with more entrenched management may

be more affected by SOX and may therefore be more likely to lobby. To capture this, we include

the governance index of Gompers, Ishii and Metrick (2002). Higher values of this index indicate

more managerial entrenchment.13 We also include the number of years the firm has been publicly

traded as a measure of firm age. Firms that have a political action committee (PAC) may tend

to be involved in all types of political and lobbying activities. We therefore include an indicator

variable equal to one if the firm has a political action committee which was registered with the

Federal Election Commission at some point during the period 1999-2000. Similarly, evidence of past

lobbying may be indicative of future lobbying. We include an indicator variable equal to one if the

firm lobbied the SEC in regards to the 1992 compensation reform analyzed by Lo (2003), and an

indicator variable equal to one if the firm lobbied the SEC in regard to a contemporaneous 1992 rule

on proxy fights.14 Higher institutional ownership may indicate the firm is better governed ex-ante,
12We use 2000 (as opposed to 2001) data since 2001 net income may only be disclosed in the first half of 2002 and

could thus directly affect returns. The reported measure is winsorized at the 2% level, however our results are not
sensitive to variation in the winsorization cutoff.

13All reported results are robust to substituting the Bebchuk, Cohen and Ferrell (2004) index for the Gompers,
Ishii and Metrick (2002) index.

14Data on both these variables was obtained from Kin Lo. The proxy rule is described in further detail by Bradley,

and therefore less likely to be affected by SOX. To capture this, we include the fraction of shares

outstanding owned by institutions in 2001 as reported by the Thomson Financial CDA/Spectrum

Institutional Holdings database. Since lobbying may be driven by compliance costs, we additionally

include the log of audit fees paid in 2001.15 High pre-SOX audit fees may be associated (positively

or negatively) with SOX compliance costs. To capture the complexity of the firm (which could

affect both compliance costs and the impact of the rules on management behavior), we calculate

the number of business segments and geographical segments from Compustat in year 2001. Finally,

to capture the incentives of insiders to lobby on behalf os shareholders, we include the fraction of

shares outstanding owned by the top executives of the firm in 2001 as reported by ExecuComp.16

Summary statistics for these variables are included in Table II.

Table III presents the results of the probit models for lobbying against the three types of

SOX-related provisions. We present three specifications for each category of provisions. The

first specification includes the independent variables described above. The second specification

examines the extent to which lobbying is predictable based solely on characteristics that have been

systematically shown to relate to returns: market capitalization (calculated at the end of week 6

of 2002), and book-to-market ratio (calculated using book value of equity at the end of fiscal year

2001 and market equity at the end of week 6 of 2002). The third specification includes all of the

variables from the previous two specifications, allowing us to examine the predictive power of our

independent variables above and beyond the systematic return-related characteristics. All three

specifications include industry controls at the 1-digit SIC level. We set a variable to zero if data

is missing and include indicator variables for missing data (the coefficients on these indicators are

omitted from the table).

Given the summary statistics presented in Table II, it is not surprising to see in Table III that

size is a strong predictor of lobbying. A second strong predictor of lobbying is profitability; firms

with higher ratios of net income to sales are significantly more likely to lobby. Note that of the

other regressors included, firm age is a significant predictor of lobbying against an ‘Enhanced Dis-

Brav, Goldstein and Jiang (2006).
15Data on audit fees is obtained from Audit Analytics.
16In unreported results, we also include three additional variables that may indicate poor firm governance. Following

Chchaochcharia and Grinstein (2005), we include an indicator variable taking the value of one if the firm’s CEO has
sold a large amount of stock within the 3-month period leading up to a large reported drop in earnings, and an
indicator variable for restated earnings during 1998-2001. Data for both these variables was provided by Yaniv
Grinstein and Vidhi Chhaochharia. Further, we include a measure of discretionary accruals calculated using the
modified Jones (1991) model, which is intended to measure earnings management. These variables provide little
predictive power in our models, and for brevity, are omitted from our reported results.

closure’ rule, while past lobbying regarding proxy rules and institutional ownership are significant

predictors of lobbying against a ‘Corporate Responsibility’ rule. Such differential predictive ability

of the variables will allow us to bolster our subsequent returns analysis by employing additional

specifications that use predicted rather than actual lobbyers.

Psuedo R-squares for the models range from 27 percent for ‘Enhanced Disclosure’ to

percent

for ‘Corporate Responsibility,’ suggesting that while our models can predict a sizeable amount of

the variation in lobbying activity, there are other variables driving lobbying which we are unable

to observe or model. It is likely that market participants had more detailed information about firm

characteristics, and thus that they were able to predict more accurately than our probit models

which firms would lobby (or more generally, which firms would be more affected by SOX).

B.2. Event Study of Returns Around Date of Comment Letter

To further ascertain whether investors indeed could predict ex-ante who the lobbying firms would

be, we supplement the probit results with an event study of whether abnormal returns were observed

around the date of the submission of a letter by a given company (and posting of the letter on the

SEC web page or accessibility of the letter in the SEC’s public reference room).

We examine an event period of 21 weeks ([-10,+10]) surrounding the submission of a letter

to the SEC. If a firm wrote multiple letters (e.g. lobbying against more than one rule in a given

category), we include an observation for each of the letters, so long as there is no overlap of the

21-week event period [-10,+10]. When letter event periods for the same firm overlap, we use only

the first of the overlapping letters. We examine two sets of abnormal returns, with and without

factor adjustment. For the returns with no factor adjustment, we first average the excess returns for

lobbying firms relative to their matched non-lobbying firms across the set of lobbying firms. This

is done for each week in event time where date zero in event time is the week the letter was filed

with the SEC. Average excess returns are then summed over time (in event time) starting 10 weeks

before the event date, and ending 10 weeks after the event date.17 For the factor-adjusted returns,

we follow the same approach, except that the excess return for a given lobbying firm relative to

its group of matched non-lobbying firms is replaced by the residual from a regression (run on the

post-SOX period from week

of 2002 to the end of 2004) of the excess return on the market

factor, size factor and book-to-market factor. Matching of lobbying and non-lobbying firms is done
17We omit letters filed within the first 10 weeks of SOX passage such that our event study is not affected by the

news of SOX passage itself.

in three ways: 100 size portfolios, 25 size and 5 book-to-market portfolios, and 25 size and 10 1-digit

industry portfolios. We describe our matching approach in more detail below.

Figure 1 illustrates the findings of our event study and includes results for all three major rule

categories. The graphs show results for abnormal returns measured relative to a group of non-

lobbying firms constructed based on 100 size-portfolios. The results based on matching on size

and book-to-market equity or size and industry are similar. If lobbying was not predictable by the

market, we would expect to see a positive or negative reaction to the submission of a letter. Figure

1 reveals no such reaction, suggesting that market participants were not surprised to learn which

firms lobbied.

C. Returns of Lobbying and Non-Lobbying Firms During the Period Leading
up to Passage of the Sarbanes-Oxley Act

We now turn to the comparison of returns for lobbying and non-lobbying firms. Under the improved

disclosure and governance hypothesis, returns should be larger for lobbying firms than for non-

lobbying firms during the period leading up to passage of SOX. The compliance cost view of SOX

has the opposite prediction.

C.1. Portfolio Level Returns

To test these two competing hypotheses, we must first decide precisely how the comparison between

the two sets of firms should be made. The standard approach for this type of analysis is to calculate

excess returns for a portfolio of the affected firms (here lobbyers) over and above the returns for

a portfolio of control firms (here non-lobbyers). To do this calculation, one must decide on which

characteristics lobbying and non-lobbying firms should be matched, and how fine a grid should be

used to match along a given dimension.

A large literature documents that small firms (measured by market value of equity) and firms

with high book-to-market equity ratios on average tend to outperform large firms and firms with

low book-to-market ratios. Furthermore, in a particular time period, realized returns could differ

systematically across firms with different size, book-to-market, industry, or other characteristics,

and such patterns may be entirely unrelated to the effects of SOX. It is therefore important to

compare lobbying and non-lobbying firms with similar characteristics along these dimensions. Of

course, there is a limit to how many characteristics one should match lobbying and non-lobbying

firms on. In the extreme, if one matched along all observable dimensions related to disclosure,

governance and variables measuring likely SOX compliance costs, then it may be more or less

random which firms of a particular set of such characteristics decided to lobby the SEC. Such a

matching scheme would then, by construction, find no different return patterns between lobbyers

and non-lobbyers and would wrongly lead to the conclusion that SOX was irrelevant for firm value.

Based on these considerations, we will consider a variety of approaches to match lobbying and non-

lobbying firms on size, book-to-market, and industry (the leading variables known to be related to

expected returns or likely to be related to realized returns for reasons not related to SOX), but will

not match on variables directly related to disclosure, governance or likely compliance costs. Data

on returns, industry and market capitalization are obtained from CRSP, while data on book equity

values are obtained from COMPUSTAT.

To decide how best to do the matching on size, book-to-market, and industry, we return to Table

II, which tabulates the characteristics of lobbying and non-lobbying firms. For each characteristic,

we provide p-values for t-tests for equal means across the two groups. The statistics for non-

lobbyers refer to firms who did not lobby for or against any SOX provision and are therefore

identical for Panel A, which compares firms who lobbied against any of the ‘Enhanced Disclosure’

rules to non-lobbyers, Panel B, which compares firms who lobbied against any of the ‘Corporate

Responsibility’ rules to non-lobbyers, and Panel C, which compares firms who lobbied against the

‘Auditor Independence’ rule to non-lobbyers.

The strongest difference between the three groups of lobbyers and the non-lobbyers is that

lobbying firms tend to be much larger than non-lobbying firms. Along the book-to-market equity

dimension there is little difference between firms that lobby against ‘Enhanced Disclosure’ or ‘Audi-

tor Independence’ and non-lobbyers, while firms that lobby against ‘Corporate Responsibility’ have

significantly higher mean (but not median) book-to-market ratios than non-lobbyers. The industry

composition of lobbyers and non-lobbyers differs somewhat, with significant differences for several

industry categories. Together these statistics suggest that a fine grid along the size dimension is

the most important for ensuring that the matched non-lobbying firms have characteristics similar

to those of the lobbying firms. We therefore show results for three approaches, defined by how

many comparison portfolios of non-lobbying firms we construct: (a) 100 size-sorted portfolios (with

NYSE break points to set a finer grid at the top end), (b) 125 size and book-to-market sorted

portfolios defined as the interaction of 25 size categories18 and 5 book-to-market categories, and (c)
18In defining the 25 size portfolios, we use increments of seven percentiles for portfolios up to the 70th percentile.

For the remaining portfolios, we use increments of 2 percentiles, to allow for a finer grid at the top of the range.

250 size and industry sorted portfolios, defined as the interaction of 25 size categories (with NYSE

break points) and 10 1-digit SIC industry code categories.19

For each approach, we first calculate the weekly average portfolio returns for each of the

100/125/250 comparison groups of non-lobbying firms. We then calculate the average weekly

excess return for lobbying firms over and above their matched non-lobbying firm portfolio as

1
Nt

ΣNti=1(r
Lobby
i,t − r

N on−Lobby
p,t )

where rLobbyi,t is the return on lobbying firm i’s stock in week t, Nt is the number of lobbying firms

for which returns are available for week t, and rN on−Lobbyp,t is the average weekly return in week t

on the portfolio of non-lobbying firms matched to firm i.

If the matching succeeds in lining up each lobbying firm with a set of non-lobbying firms with

very similar size, book-to-market and industry characteristics, then the above excess return time

series directly measures the abnormal performance (α) of lobbyers. If the match is less accurate,

more precise measures of the abnormal part of any over- or under-performance of lobbyers can

be obtained by estimating a factor model and analyzing the α from such a model. We present

both the results which do not use a factor model and the results which use a 3-factor model and

regress the excess return of lobbyers on the weekly market factor (MKT), size factor (SMB), and

book-to-market factor (HML) calculated from daily factor data from Ken French’s web page:

1
Nt
ΣNti=1(r
Lobby
i,t − r

N on−Lobby
p,t ) = α + βM KT (rM KT,t − rf,t) + βSM BrSM B,t + βHM LrHM L,t + �i,t

where rf is the riskless (30-day T-bill) rate and � is an error term.20 To the extent that results

differ depending on whether a factor model is used, one would expect those from the factor model

to be the most accurate.

Table IV Panel A shows the estimates of abnormal performance of lobbyers relative to non-

lobbyers during the 24-week period leading up to passage of SOX, beginning in week 7 of 2002 and

ending in week 30 of 2002 (February 8, 2002 to July 26, 2002). The top part of the panel shows

strong evidence of positive abnormal returns for firms whose insiders lobbied against one of the

’Enhanced Disclosure’ provisions, relative to their matched sample of non-lobbyers. Without factor
19In all cases we define break points using the full set of lobbying and non-lobbying firms. Size is defined as market

value of equity at the beginning of the week, and is updated weekly. Book-to-market equity ratio is calculated using
book equity for the prior calendar year from COMPUSTAT and market equity for the beginning of the year (with
the exception that we for 2002 use market equity in week 6 of 2002).

20Weekly data are used as opposed to daily data to avoid any potential biases in factor loadings due to differential
liquidity of the stocks of lobbying and non-lobbying firms. An alternative would be to use daily data but include lags
of the factors as regressors.

controls, the weekly alphas in columns (1), (4), and (7) are 0.00

, 0.00

, and 0.00

across the

three methods of matching. This corresponds to total abnormal returns for such lobbyers of 12.1,

10.2, and 7.9 percent over the 24-week period leading up to SOX passage. In each case, the alphas

are statictically significantly different from zero at the one percent level. Results are a bit weaker

when a factor model is used (columns (3), (6) and (9)). A potentially important issue with the

factor model is that if we were to estimate the factor loadings using only 24 weeks of data, this

could lead to overfitting and corresponding downward small sample bias in the estimated abnormal

excess returns (alphas). Instead, we use the full time period from week 7 of 2002 to the end of

2004 and allow for different alphas for the period leading up to SOX passage and the post-passage

period. The alphas from the factor models in columns (3), (6) and (9) imply total abnormal returns

for such lobbyers of 11.8, 9.6, and 8.4 percent over the 24-week period leading up to SOX passage.21

Figure 2 illustrates the cumulative abnormal returns over time for firms that lobbied against

an ’Enhanced Disclosure’ provision of SOX. It is based on portfolio level returns and three sets

of cumulative abnormal returns are shown. The first of the three is based on the size-matched

control groups of non-lobbying firms, the second on the size and book-to-market equity matched

control groups and the third on the size and industry-matched control groups. In each graph,

two lines are shown. The unadjusted cumulative abnormal return is calculated by averaging the

excess returns over the comparison group across lobbying firms in each week, and then summing

these abnormal returns over time, starting in week 7 of year 2002. The factor-adjusted cumulative

abnormal return is calculated by first regressing the excess return over the comparison group on the

excess return on the market, and the Fama-French size and book-to-market factors. The regression

is run using weekly data from week 7 of 2002 until the end of 2004, and the intercept (alpha) plus

the residuals are averaged each week and then summed over time. The two vertical lines indicate

the beginning and end of the 24-week period leading up to SOX passage. It is striking how the

abnormal performance of lobbying firms relative to non-lobbying firms ends right around the time

of the passage of SOX. This pattern further reassures us that we are indeed measuring the impact

of the law on lobbying firms.

The middle and bottom parts of Table IV Panel A repeat the same regressions, but now focusing

on firms who lobbied against a ‘Corporate Responsibility’ or ‘Auditor Independence’ rule. Here,

the evidence for abnormal positive excess returns for lobbying firms relative to their matched non-
21We discuss the alphas for the post-passage period below.

lobbying firms is statistically weaker than for firms who lobbied against an ‘Enhanced Disclosure’

rule.

As mentioned earlier, an alternative to using lobbying as a proxy for being more affected by SOX

is to instead sort firms based on their predicted probability of lobbying based on ex-ante character-

istics. As previously discussed, there are numerous advantages to a research design that employs

lobbying rather than its predictors. A major disadvantage of the predicted lobbyer approach is

that we as econometricians likely employ many fewer firm characteristics than market participants

in predicting which firms will be more affected by SOX. An advantage of this approach, however,

is that it does not rely on the assumption that market participants could predict precisely which

firms would lobby after the passage of SOX.

Panel B of Table IV repeats the analysis in Panel A, substituting firms predicted to lobby by

our probit model for the actual lobbyers, where predicted lobbyers are those firms whom our probit

models place in the top 3% of firms based on likelihood of lobbying. Once again, the top part

of the panel presents strong evidence of positive abnormal returns for firms that our probit model

predicts should lobby against one of the ‘Enhanced Disclosure’ provisions, relative to their matched

sample of non-lobbyers. Without factor controls, the weekly alphas in columns (1), (4), and (7)

are 0.00

, 0.00

, and 0.0027 across the three methods of matching. This corresponds to total

abnormal returns for such lobbyers of 10.6, 11.8, and 6.5 percent over the 24-week period leading

up to SOX passage. The returns implied by the factor models in columns (3), (6) and (9) are

larger: 12.0, 14.4, and 8.9 percent over the 24-week period leading up to SOX passage. In 8 out of

9 specifications in the panel, the alphas are significantly different from zero at the 10 or 5 percent

level.

Figure 3 illustrates the cumulative abnormal returns over time for firms predicted to lobby

against an ‘Enhanced Disclosure’ provision of SOX, and is constructed in a similar manner to

Figure 2. As in Figure 2, which looks at the abnormal returns of lobbying firms relative to non-

lobbying firms, the abnormal performance of predicted lobbyers relative to non-lobbying firms ends

right around the time of the passage of SOX.

The middle and bottom parts of Table IV Panel B repeat the same regressions focusing on

firms who were predicted by our probit model to lobby against a ‘Corporate Responsibility’ or

‘Auditor Independence’ rule. The evidence for abnormal positive excess returns for predicted

lobbyers relative to their matched non-lobbying firms for these two sets of rules is again statistically

weaker than for firms who were predicted to lobby against an ‘Enhanced Disclosure’ rule.

Interpreting the portfolio-level results presented in Table IV is not straightforward, however.

Over 40 percent of the firms that lobbied against an ‘Auditor Independence’ provision also lobbied

against at least one ‘Enhanced Disclosure’ provision, and 36 percent of firms that lobbied against a

‘Corporate Responsibility’ provision also lobbied against at least one ’Enhanced Disclosure’ provi-

sion. To address this issue, we proceed to estimate the separate abnormal returns associated with

each of the three major rule categories by running firm-level return regressions.

C.2. Firm-Level Returns

We run firm level (as opposed to portfolio-level) regressions of the following form:

ΣTt=1(r
Lobby
i,t − rf,t) = δ0 + γ1I(Lobbied Against Enhanced Disclosure Rules)

+γ2I(Lobbied Against Corporate Responsibility Rules)

+γ3I(Lobbied Against Auditor Independence Rule) + X
′
iβ + ui

where I(.) indicates a dummy variable, δ0 is an intercept term, X is a set of control variables and ui

is an error term. The regression is run on the full set of firms, i.e. including both lobbyers and non-

lobbyers, and has one data point per firm. In regressions (1), (2), and (3) of Table V Panel A, the

dependent variable is the sum of the weekly excess returns over the riskless rate during the period

leading up to SOX passage. The regression coefficient γ on the dummy variable for a particular

type of lobbying estimates how much the cumulative weekly excess return during the period differs

between that group of lobbying firms and a typical non-lobbying firm. To control for differences

between lobbying and non-lobbying firms along size, book-to-market, and industry dimensions, and

for similarity to the portfolio-level analysis presented in Table IV, we include indicator variables

for 100 size, 25 size and 5 book-to-market, or 25 size and 10 1-digit industry portfolios, depending

on the specification. Table V Panel A presents our estimates for lobbying firms, while Panel

presents the estimates for predicted lobbyers.

Regressions (1), (2) and (3) of Table V Panel A indicate that the market expected SOX to benefit

the firms most affected by its ‘Enhanced Disclosure’ provisions (as evidenced by their lobbying),

with only small added shareholder value for firms most affected by its ‘Corporate Responsibility’

or ‘Auditor Independence’ provisions. The abnormal excess return for firms lobbying against an

‘Enhanced Disclosure’ rule captured by the γ1 coefficient indicates a total abnormal excess return

for the lead-up period of between 8.6 percent and 13.2 percent across the three regressions. These

effects are comparable (theoretically, and in magnitude) to the effects estimated based on the

alphaLead-Up coefficient in the top part of Panel A. The γ2 coefficient on lobbying against a

‘Corporate Responsibility’ rule indicates little abnormal excess return (economically or statistically)

for the lead-up period across the three regressions. The γ3 coefficient on lobbying against the

‘Auditor Independence’ rule indicates a total abnormal excess return for the lead-up period of

between 3.3 percent and 4.0 percent across the three regressions, but with no statistical significance

at conventional levels.

We obtain similar results in Panel B of the table, where we replace the indicator variables

for lobbying with indicator variables for being predicted to lobby according to the probit model

in Table III. Being predicted to lobby against an ‘Enhanced Disclosure’ provision implies a total

abnormal excess return for the lead-up period ranging from 6.2 percent to 12.6 percent across the

three specifications; no statistically significant excess return is implied by being predicted to lobby

against a ‘Corporate Responsibility’ or ‘Auditor Independence’ provision.

In sum, the results of Tables IV and V support the positive view of SOX, and suggest that

investors expected the legislation to increase shareholder value. In particular, the return results

indicate that firms most affected by the ‘Enhanced Disclosure’ provisions of SOX (as evidenced by

their lobbying) experienced positive abnormal excess returns during the period leading up to SOX

passage of around 10 percent relative to less affected (non-lobbying) firms with similar size, book-

to-market and industry characteristics. There is little effect experienced by firms most affected by

the ‘Corporate Responsibility’ and ‘Auditor Independence’ rules.

D. Returns During the Period Following Passage of the Sarbanes-Oxley Act

From Figure 2, it is apparent that firms lobbying against one or more of the SOX ‘Enhanced Dis-

closure’ rules had returns during the post-SOX period that were fairly similar to those of their

matched comparison group of non-lobbying firms. Tables IV and V confirm this result. Columns

(2)-(3), (5)-(6) and (8)-(9) of Table IV Panel A estimate the portfolio level excess return regressions

on the full period from week 7 of 2002 to the end of 2004, with separate intercepts (α’s) for the

leadup period and the post-passage period, while Panel B presents similar analysis for predicted

lobbyers relative to matched non-lobbyers. In the top part of the panel, which concerns ‘Enhanced

Disclosure,’ the intercept for the post-passage period, alphaPost, is consistently close to zero in

both economic and statistical terms. Similar results obtain in columns (4)-(6) of Table V Panels A

(lobbyers) and B (predicted lobbyers) at the firm-level in the post-passage period: the γ1 regres-

sion coefficient of the dummy variable equal to one for firms that lobbied against an ‘Enhanced

Disclosure’ rule is close to zero. These findings indicate that the returns for firms that lobbied (or

were predicted to lobby) against an ‘Enhanced Disclosure’ rule were similar to the returns for their

non-lobbying comparison group of firms, and thus that the increase in (relative) stock prices expe-

rienced by lobbying firms (or predicted lobbyers) did not tend to reverse during the post-passage

period, suggesting that the positive expectation of shareholders evidenced by thier letters to the

SEC and by returns in the pre-passage period were warranted.

E. Section 404: Assessment of Internal Controls

Among the most controversial and most discussed elements of SOX is Section 404 of the Act,

which deals with management assessment of internal controls. Section 404 is a component of Title

IV of the Act, and thus is part of the ‘Enhanced Disclosure’ rules in our analysis. Since our

research design allows us to examine shareholders’ reactions to individual elements of SOX, it is

a worthwhile exercise to ask whether the results presented above are robust to focusing on this

particular provision alone. To do so, we repeat the analysis above, limiting our group of lobbying

firms to those that lobbied specifically against the rules related to Section 404.

The results, presented in graphic form in Figure 4, are striking. Firms that lobby against rules

related to Section 404 specifically experience an abnormal excess return over the 24 weeks leading

up to the passage of the Act of similar magnitude to that evidenced when we considered all firms

that lobby against any of the ‘Enhanced Disclosure’ rules. Once again, these excess returns appear

to end almost exactly around the passage of SOX, and do not revert away in the post period.

The results in Figure 4 suggest that investors believed that Section 404 specifically would

increase shareholder value, and support the arguments presented in Coates (2006), who suggests

that the enhanced disclosure related to Section 404 was one of the most important elements of the

Act.22

IV. Interpretation and Discussion

A. Mechanism

The results from our analysis in the previous section suggest that that shareholder’s perceptions of

SOX were positive, and that these perceptions were reflected in the relative returns of more and less
22A firm-level analysis with two separate indicator variables for lobbying against Section 404-related rules and

against other ‘Enhanced Disclosure’ rules reveals roughly equal impact for the two sets of rules.

affected firms. What then are the mechanisms through which SOX might be expected to increase

shareholder value?

There are three primary channels through which SOX may affect shareholder value. First, SOX

may directly improve the operating performance of the firm through the elimination of management

ineptness, complacency or the improvement of operations as a result of lessons learned during the

internal control review. Second, SOX may improve operating performance through the elimination

of actual stealing or perquisite consumption on the part of managers who are now subject to greater

disclosure and transparency. Third, SOX may lead to an increase in shareholder confidence that is

reflected in a lower cost of capital.

Evaluating these mechanisms is difficult. There is no clear manner in which to ascertain if SOX

has effectively lowered the discount rate used by shareholders. We can attempt to evaluate the

change in operating performance of lobbying firms relative to matched non-lobbyers comparing the

pre-SOX and post-SOX periods. In unreported results, we measure changes in operating perfor-

mance as (Operating income in 2004-Operating income in 2001)/(Market value of equity at the end

of week 6 of 2002), where operating income is COMPUSTAT Item 13 (operating income before de-

preciation). We then run firm level regressions with one observation per firm and with controls for

size portfolio dummies, size and book-to-market portfolio dummies, or size and industry portfolio

dummies. The estimates from our models suggest that firms that lobbied against an ’Enhanced

Disclosure’ rule experience an improvement in operating income relative to initial market value of

equity of about 5 percentage points, and this effect is statistically significant at the 1 percent level.

When we repeat the same regressions substituting predicted lobbyers for actual lobbyers, we find

similar results, though the magnitudes are sensitive to the type of controls included.

These results, on the one hand, provide some reassurance that our return results are consistent

with changes in profitability, but they are not a valid test of the mechanism through which SOX

may have affected shareholder value. Our results in the previous section indicate that profitability

is a strong predictor of lobbying, thus inducing an endogeneity problem in any test that attempts

to determine whether lobbying firms (or predicted lobbyers) have improved operating performance

over the period in question. In this sense, analyzing operating performance is useful only in that

finding a decrease in the performance of lobbyers relative to non-lobbyers would tend to rule out

operating performance as the mechanism through which SOX affected returns. Finding and increase

in operating performance does not provide a clean test suggesting operating performance is the

mechanism, however, due to the endogeneity problem.

As discussed in Section II, we are able to address this endogeneity concern in our returns analysis

above. Reverse causality in our setting would imply that there should be no significant differential in

the excess returns of lobbying groups over and above similar non-lobbyers when comparing the pre-

and post-passage periods. However, as we demonstrate, a significant differential of approximately

7% exists in the pre- and post-passage excess returns of lobbyers. This return differential suggests

that being more affected by SOX leads to excess returns, rather than it simply being simply the

case that better (or worse) performing firms tend to lobby, without necessarily being more affected

by the legislation. We cannot use a similar approach to examine changes in operating performance

for lobbying and non-lobbying groups in a causal fashion. While return data is available on a weekly

basis, operating performance is only available to us on an annual basis, and thus does not allows

us to examine whether there is a kink in performance around the date of SOX passage.

A second useful exercise is to attempt to ascertain the extent to which investor confidence

has improved since passage of SOX. UBS/Gallup conducts an Index of Investor Optimism Poll,

which provides an indication of investor confidence over the period spanning the passage and

implementation of SOX. In May 2002, 60% of respondents to the poll indicated that questionable

accounting practices in business hurt the investment climate in the U.S. “a lot.” By May 2006, that

percentage had dropped to 39%. Causal interpretation of such survey evidence is, however, not

possible.

B. Costs and Benefits to Shareholders

Following the passage of SOX, a heated debate has emerged about the high costs of complying with

the ’Enhanced Disclosure’ provisions of SOX, notably Section 404’s assessment of internal controls.

It is widely acknowledged that the compliance costs associated with SOX have been higher than

initially expected. In June 2003, the SEC estimated the aggregate cost of implementing Section

404 alone on all registrants at approximately $1.24 billion, or $91,000 per registrant. In January

2004, Financial Executives International (FEI) completed the first of a string of surveys estimating

the cost of SOX, and Section 404 in particular. The survey placed the expected average total cost

of SOX compliance at approximately $1.93 million per company. Expected costs appeared to be

increasing in firm size, with expected total compliance costs for larger firms (over $5 billion in

annual revenues) to reach $4.6 million per company. A first follow-on survey by FEI in June 2004

raised these estimates to $3.15 million and $8 million per company, respectively. A second follow-on

survey by FEI in March of 2005 raised the estimates to $4.36 million and $10 million, respectively.

How do these costs affect our analysis of the post-passage period? We note first that if compli-

ance costs increased equally for all firms (as a fraction of market value), then our analysis of excess

returns of lobbyers over lobbyers will be unaffected by the increase. This is an obvious shortcoming

of a research design which compares more affected firms to less affected firms, without having a

comparable group of firms unaffected by the legislation studied. We can only say that considering

the full period from when serious discussions about the legislation first started in week 7 of 2002

to the end of 2004 (well into the implementation phase of SOX), the stocks more affected firms

(identified as lobbying firms) outperformed those of less affected firms (identified as non-lobbying

firms). Based on our returns analysis alone, we cannot unambiguously say that the net benefit of

SOX for either group is positive.

What then can be said about the net benefit of SOX for shareholders of lobbying and/or non-

lobbying firms? Our analysis of comment letters from investors and investor groups indicates that

shareholders expected SOX to be value increasing on average across publicly traded firms. To our

knowledge, shareholder support for SOX has not diminished since the period covered by the letters

we analyze. For example, at the SEC’s “Roundtable Discussion on Second-Year Experiences with

Internal Control Reporting and Auditing Provisions” held on May 10, 2006, institutional investors

expressed continued support for SOX, specifically for the section 404 on internal controls. In her

statement dated March 1st, Ann Yerger from the Council of Institutional Investors (an association

of more than 130 corporate, union, and public pensions plans with more the $3 trillion in assets)

wrote: “…the Council believes the benefits over time will far outweigh the costs and will be a

positive for all involved in the U.S. capital markets. … In closing, Section 404 is working.”

Furthermore, based on our return results, and drawing on the survey evidence on SOX compli-

ance costs, it can be argued more formally that the net benefit of SOX were positive for shareholders

of lobbying firms. Assume that compliance costs are similar for lobbying and non-lobbying firms.23

Assume in addition that there was no gross benefit of SOX for lobbying firms (again, a conservative

assumption). Under these two assumptions, the cumulative abnormal excess return of about 10

percent for firms lobbying against an ‘Enhanced Disclosure’ rule relative to their matched non-

lobbying firms then implies that the gross benefit of SOX for these lobbying firms was about 10

percent of their initial market value, or approximately $

9 billion in total. It is unlikely that the
23This is likely to be a conservative assumption, as analysis of audit fees pre- and post-SOX indicates that fees rose

more (relative to firm size) for lobbying firms than for non-lobbying firms over the period from 2001 to 2004.

present value of SOX compliance costs for lobbying firms is as high as 10 percent of these firms

initial market value. From Table II Panel A, the mean market value for firms lobbying against

an ‘Enhanced Disclosure’ rule is $16.8 billion, while the median is $2.7 billion. We can compute

the average SOX compliance cost for lobbying firms, using compliance costs estimates from the

FEI 2006 survey, which breaks costs down by sales volume. This average cost is a little under $5

million per firm. Using a discount rate of 10 percent, the present value of the average lobbying

firm’s compliance costs is then $50 million. This corresponds to 0.3 percent of the mean market

value of $16.8 billion and 1.9 percent of the median market value of $2.7 billion.

This admittedly simplified calculation suggests that, at least for the set of firms lobbying against

an ‘Enhanced Disclosure’ rule, SOX was a net benefit of between 8.1 and 9.7 percent of initial market

value. We have data for 196 such firms with a total market value of 196 × $16.8 billion or a little
under $3.3 trillion. At a net benefit of 8.1 percent of market value, the total net benefit of SOX

for these lobbying firms comes to $266 billion. At a net benefit of 9.7 percent of market value, the

total net benefit of SOX for these lobbying firms comes to $319 billion.

We can also go one step further, and attempt to estimate the net benefit of SOX for shareholders

of all those companies publicly traded as of the beginning of our event period. Under the conser-

vative assumption that there was no (gross) benefit of SOX for non-lobbyers, the total benefit to

shareholders from SOX is the gross benefit of SOX for lobbying firms, approximately $329 billion in

total. Based on compliance cost numbers by firm sales reported by the March 2006 FEI survey, the

total estimated annual compliance costs for the full set of US publicly traded firms is approximately

$14 billion.24 At a discount rate of 10 percent, the present value of these costs is $140 billion; at a

discount rate of 5 percent, the present value of these costs would be $280 billion, still considerably

less than the approximate gross benefit of $329B to lobbyers alone.25 This suggests that with even

a small positive gross benefit of SOX for non-lobbyers, the net benefit of SOX for the overall US

stock market could be substantial.
24To calculate the total estimated annual compliance costs for publicly traded firms, we assign each firm the

compliance cost number associated with FEI sales category its sales fall into in 2001. To estimate sales for firms
with no sales data, we regress firm sales on the natural log of market capitalization and its square for firms that do
have sales data. We then use the resulting regression estimates to predict sales for those firms with no sales data,
and assign them the FEI compliance cost for their sales category based on their predicted sales. We then sum the
compliance costs across firms.

25Some lobbying groups, in particular AeA (formerly the American Electronics Association), using their own
internal estimates in addition to FEI data, suggest that total annual compliance costs for SOX will be higher, or
approximately $29-$

B. These groups tend to build these estimates using a per-firm cost estimate taken as the FEI
estimate for large firms, rather than assigning each firm the cost estimate appropriate to its size and sales volume.
Even at an annual cost estimate of $30B, the present value of the costs at a discount rate of 10% would still be
roughly similar to the gross benefits for lobbying firms.

Interpretation of these numbers, however, must be nuanced. Our calculations cannot account

for loss of shareholder welfare due to the decisions of some previously public companies to delist

due to the burdens of SOX regulation; nor can it account for any welfare loss resulting from the

decisions of private companies to remain private or to go public on non-US exchanges (Zingales

(2006)). In addition, we cannot rule out that insiders lost an amount equal to or greater than what

outside investors gained. Additionally, it is important to note that the lobbying firms in our sample

are predominantly large, established organizations, and thus our returns analysis does not provide
specific conclusions as to the effect of SOX on smaller firms.

V. Conclusion

In this paper, we evaluate the impact of SOX on shareholders by analyzing the SOX-related lobbying

behavior of corporations, individuals and organizations. We classify the rules on which the SEC

solicited comments into three major categories: those related to ‘Enhanced Disclosure’, those related

to ‘Corporate Responsibility’, and those related to ‘Auditor Independence’. We then examine the

comment letters sent to the SEC during the drafting of the final SOX rules.

We document that individual investors, as well as large investor groups such as pension funds

and labor unions, were overwhelmingly in favor of the SOX provisions they commented on, speaking

to shareholders’ perceived value of the legislation. In contrast, our reading of letters to the SEC

by corporate insiders reveals that an overwhelming majority of insiders in lobbying companies

opposed the SOX provision they commented on. We then use lobbying by corporate insiders to

distinguish between two views of SOX: the view that SOX improves governance and disclosure, and

the view that SOX will not be beneficial due to high compliance costs outweighing any potential

benefits. Our identifying assumption is that insiders in companies more affected by SOX (positively

or negatively) were more likely to lobby.

Our study of returns reveals that during the 24-week period leading up to passage of SOX, re-

turns were higher for corporations whose insiders lobbied against an ‘Enhanced Disclosure’ provision

of SOX than for non-lobbying firms with similar size, book-to-market and industry characteristics.

This lends support to the improved disclosure and governance hypothesis and suggests that cor-

porate insiders lobbied to water down the implementation of SOX because SOX reduces insiders’

ability to expropriate company resources. Cumulative returns were approximately 10 percent higher

for corporations whose insiders lobbied against one or more of the SOX ‘Enhanced Disclosure’ pro-

visions than for non-lobbying firms with similar size, book-to-market and industry characteristics.

There is no evidence of differential returns between lobbyers and non-lobbyers in the post-passage

period.

In sum, our findings suggest that investors had overwhelmingly positive expectations about

the effects of SOX. These expectations appear to be warranted in the case of the ’Enhanced Dis-

closure’ provisions of SOX, though not in the case of the ’Corporate Responsibility’ or ’Auditor

Independence’ provisions.
33

REFERENCES

Bebchuk, L., A. Cohen and A. Ferrell, 2004, “What Matters in Corporate Governance?”, working

paper, Harvard Law School and NBER.

Bloom, N. and J. Van Reenen, 2006, “Measuring and Explaining Management Practices Across

Firms and Countries,” wokring paper, London School of Economics.

Bradley, M. A. Brav, I. Goldstein and W. Jiang, 2006, “Costly Communication, Shareholder Ac-

tivism and Limits to Arbitrage: evidence from Closed-End Funds”, working paper, Duke University.

Chhaochharia, V., and Y. Grinstein, 2005, “Corporate Governance and Firm Value: The Impact

of the 2002 Governance Rules”, Journal of Finance, forthcoming.

Coates, J. C., 2006, “The Goals and Promise of the Sarbanes-Oxley Act”, Journal of Economic

Perspectives, forthcoming.

Cohen, D. A., A. Dey, and T. Z. Lys, 2005, “Trends in Earnings Management and Informativeness

of Earnings Announcements in the Pre- and Post-Sarbanes Oxley Periods”, working paper, Kellogg

School of Management.

Engel, E., R. M. Hayes, and X. Wang, 2004, “The Sarbanes-Oxley Act and Firms’ Going-Private

Decisions”, working paper, University of Chicago.

Gompers, P., J. Ishii and A. Metrick, 2003, “Corporate Governance and Equity Prices,” Quarterly

Journal of Economics, February.

Greenstone, M.,P. Oyer and A. Vissing-Jørgensen, 2006, “Mandated Disclosure, Stock Returns,

and the 1964 Securities Acts Amendments”, forthcoming, Quarterly Journal of Economics.

Jones, J. J., 1991, “Earnings Managment During Import Relief Investigations,” Journal of Account-

ing Research, 29, 193-228.

King, R. and T. O’Keefe, 1986, “Lobbying Activities and Insider Trading,” The Accounting Review,

61, 1, 76-90.

Lo, K., 2003, “Economic Consequences of Regulated Changes in Disclosure: The Case of Executive

Compensation”, Journal of Accounting and Economics, 35, 285-314.

Rezaee, Z. and P. Jain, 2003, “The Sarbanes-Oxley Act of 2002 and Security Market Behavior:

Early Evidence”, working paper, University of Memphis.

Zhang, I. X., 2005, “Economic Consequences of the Sarbanes-Oxley Act of 2002”, working paper,

University of Rochester.

Zingales, L., 2006, “Is the U.S. Capital Market Losing its Competitive Edge?”, forthcoming, Journal

of Economic Perspectives.

T
ab

le
I:

O
p
in

o
n

o
f

o
m

m
en

e
rs

b
y

u
le

n
d

T
y
p
e

o
f
C

o
m
m
en

e
r

h
e

b
le

p
o
rt

s
th

u
m

b
e

f
le

tt
e
rs

n
t

o
th

S
E

a
n

th
e

o
p
in

io
n

e
x

p
re

e
d

n
th

o
se

le
tt

e
rs

o
r

th
e

p
ro

v
is

n
s

o
f
th

S
a
rb

a
n
e
s-

O
x
le

y
A

c
t

a
n
d

th
e

N
Y

S
E

/
N

S
D

A
Q

o
rp

o
ra

e
g

v
e

n
c
e

ru
le

s
fo

r
w

h
ic

c
o
m

m
e

n
ts

w
e

so
li
c
i

t
e
d

b
y
th
e
S
E

C
.
T

h
e

fi
rs

t
p
a
n
e

l
p
re

e
n

th
e

o
v
e
ra

ll
c
o
u
n
ts

a
c
ro

a
ll

ru
le

s.
R

u
le

a
re

th
e
n

so
rt

e
d

n
to

th
o
se

a
t

c
o
n
c
e
rn

u
d
it

o
r

d
e

e
n
d

e
n
c
e

e
la

te
d

S
O

X
T

it
le

II
),

C
o
rp

o
ra

e
R

e
sp

o
n
si

il
it
y

(r
e
la
te
d
to
S
O

X
ti

tl
e

II
I)

,
a

n
d

E
n
h

a
n
c
e

F
in

a
n

c
ia

l
D

c
lo

u
re

a
n
d

P
C

A
O

B
(m

o
st

y
re

a
te

d
to
S
O
X
T
it
le

IV
).

T
h
e

ti
tl

e
o
f

th
e
ru
le

(u
n
d

e
rl

n
e
d

)

re
fe

s
to

th
e
S
E

C
in

it
ia

l
p
ro

p
o
sa

l
fo

a
ch

sp
e
c
ifi

c
ru

le
.

F
o
r

e
a
ch

ru
le
w
e
r

e
p
o
rt

th
e
n
u
m

b
e
r

o
f
le
tt
e
rs
s

e
n
t

to
th

e
S
E

C
a
n
d

c
la

if
y

e
m

b
y

w
h

e
th

e
r
th
e
le
tt
e
r

p
o
si

ti
v
e

n
e
u
tr

a
l,

o
r

n
e
g

a
ti

v
e
o
n
th
e

p
a
rt

u
la

r
ru

e
c
o
m

m
e

n
te

d
o
n

T
h
e
n
e
u
tr

a
l

c
a
te

g
o
ry

c
lu

e
s

le
tt
e
rs

th
a
t

a
re
p
o
si
ti
v
e
o
n

so
m

e
,

b
u
t

n
e
g
a
ti
v
e

o
n
o
th
e
r

su
b
-p

ro
v
is

n
s,

a
s

w
e
ll

a
s
le
tt
e
rs
th
a
t

c
a
n
n

o
t

b
e
c
la

ss
ifi

e
d

d
u
e

to
in

su
ffi

c
ie

n
t

in
fo

rm
a

ti
o
n

W
e

c
la
ss
if
y
c
o
m
m
e
n
te

s
in

to
th

e
fo

o
w

n
g

c
a
te

o
ri

C
o
rp
o
ra

o
n
s

(i
n
c
lu

d
in

g
le

tt
e
rs

fr
o
m

a
to

p
m

a
n
a
g
e
r

o
r

d
ir

e
c
to

r)
,

n
o
n
-i
n

e
st

o
r

g
ro

u
p
s

(e
.g

.
b
u
si

e
ss

a
ss

o
c
ia

o
n
s)

,
in

v
e
st
o
r
g
ro
u
p
s
(e
.g

.
p
e
n
si

o
n

fu
n
d
s,

a
ss

e
t

a
n
a
g
e
m

e
n
t

fi
rm

s
a

n
d

fo
u
n

d
a

o
n
s)
,
in

d
iv

id
u
a
ls

(e
x
c
lu

d
in

g
la

w
y
e
rs

a
n
d

a
c

c
o
u
n
ta

n
ts

a
c
c
o
u
n
ta

n
ts

(a
ss

o
c
ia

o
n
s,

a
w

fi
rm

s,
a

n
d

in
d
iv

id
u
a
l

w
y
e
rs
),
a
c
c
o
u
n
ta
n
ts
(a
ss
o
c
ia

ti
o
n
s,

c
c
o
u

n
ti

n
g
fi
rm
s,
a
n
d
in
d
iv

id
u
a
l
a
c
c
o
u
n
ta

n
ts

),
a
c

a
d

e
m

ic
s,

a
n
d
o
th
e
r
(e
.g

.
re

li
g
io

u
s

o
rg

a
n
iz

a
ti
o
n
s,

o
v
e
rn

m
e
n
t

re
p
re

se
n
ta

ti
v

e
s,

a
n
d

e
le

c
te

o
ffi

c
ia

ls
).

W
h
e
n

a
v
a
il
a
b
le

,
w

e
re

p
o
rt
,
in

b
ra

ck
e
t

p
a
re

n
th

e
si

,
th

e
S
O

X
S
e

c
ti

o
n

c
o
rr

e
sp

o
n
d

g
to

th
e
p
ro
p
o
sa
l.

C
o
m

m
e
n
t
e
r
:

C
o
r
p
o

r
a

t
io

n
N

o
n
-I

v
e
s

t
o

G
r
o
u
p

n
v
e
s
t
o
r

G
r
o
u
p

I
n
d
iv

id
u
a
l

A
c
c
o
u
n
t

a
n
t

L
a
w

y
e
r

A
c
a
d
e
m

ic
O

h
e
r

T
o

t
a
l

L
e
t
t
e
r
s

C
o
m

m
e
n
t
in

g
o
n

A
ll

R
u
le

o
.

o
f

L
e
tt

e
rs

9
3

5
3

2
7

5
5

4
4

4
0

7
1

9
9

N
o
.

P
o
s/

N
e
u
/
N

e
g

5
9

8
6

6
4

4
2

2
8

1
8

2
4

1
/

1
7

/
1
7

3
3

4
9

/
7
1

4
8

/
2
4
/
1

7
2

3
6
/

3
8

3
2

4
0
/

1
5

1
6

4
4
/
9
/

4
6

P
c
t.

P
o
s/
N
e
u
/
N
e
g

7
/

1
1

8
2

1
7
/
1
1
/
7
2

8
8

/
6
/
6

7
8

/
9
/

1
3

2
0

1
0

7
0

9
/
9
/
8
2

5
6

2
1

2
3

4
4
/
9
/
4
6

T
o
t
a
ls

L
e
t
t
e
r
s
C
o
m
m
e
n
t
in
g
o
n
R
u
le

s
R

e
la
t
e
d
t
o
E

h
a
n

c
e
d

F
in

a
n
c
ia

l
D

is
c
lo

s
u
r
e

a
n
d
P
C
A
O

B
[S

O
X

T
it

le
s

I
V

a
n
d

]

N
o
.

o
f
L
e
tt

e
rs

3
7

1
4

6
5

1
1
3

6
4

0
9

1
5
3
8
N
o
.
P
o
s/
N
e
u
/
N
e
g

1
8
/
5
3
/

3
0

2
0
/
1
4
/

8
0

5
4

/
3
/
8

8
9

/
8
/
1
6

1
7
/
1
4
/
3
3

8
/
9
/

9
2

6
/
5
/
4

2
9

/
4
/
5

P
c
t.
P
o
s/
N
e
u
/
N
e
g

5
/
1
4
/

8
1

1
8
/

1
2

/
7
0

8
3

/
5
/
1
2

7
9
/
7
/
1
4

2
7
/

2
2

5
2

7
/
8
/

8
4

4
0
/
3
3
/
2
7

7
6
/
1
1
/
1
3

B
re

a
k
-d

o
w

n
o
f
L
e
tt

e
rs

S
u
b
m

it
te

d
o
n
E
n
h
a
n
c
e
d
F
in
a
n
c
ia
l
D
is
c
lo

su
re

R
u
le
s:

D
is

c
lo
su
re

n
M

a
n
a
g
e
m

e
n
t’

s
D

is
c
u
ss

io
n

A
n
d

A
n
a
ly

si
s

O
f
C

ri
ti

c
a

l
A

c
c
o
u
n
ti

n
g

P
o
li
c
ie

s
N
o
.
o
f
L
e
tt
e
rs
4
0
1
3

6
6

6
5
2
0
N
o
.
P
o
s/
N
e
u
/
N
e
g

1
/
2
/
3

2
/
0
/
1

4
/
1
/
1

1
/
2
/
3

0
/
0
/
6

0
/
0
/
5

0
/
1
/
1

0
/
0
/
0

c
o
n
ti

n
u
e
d

o
n

n
e
x
t

p
a
g
e

C
o
m
m
e
n
t
e
r
:
C
o
r
p
o
r
a
t
io
n
N
o
n
-I
n
v
e
s
t
o
r
G
r
o
u
p

I
n
v
e
s
t
o
r

G
r
o
u
p
I
n
d
iv
id
u
a
l
A
c
c
o
u
n
t
a
n
t
L
a
w
y
e
r
A
c
a
d
e
m
ic
O
t
h
e
r

[S
O

S
e
c
ti

o
n

0
1

D
is
c
lo
su
re

P
e
ri

o
d

R
e
p
o
rt

D
is
c
lo
su
re

in
M

a
n
a
g
e
m
e
n
t’
s
D
is
c
u
ss
io
n
a
n
d
A
n
a
ly
si
s

o
f
O

ff
-B

a
la

n
c
e

S
h

e
e

A
rr

a
n
g
e

e
n
ts

N
o
.
o
f
L
e
tt
e
rs
1
4
9
2

7
7

9
0

2
N

o
.
P
o
s/
N
e
u
/
N
e
g

0
/
0
/
1

2
/
0
/
7

1
/
1
/
0

7
/
0
/
0

0
/
1
/
6

0
/
1
/
8

0
/
0
/
0
1
/
1
/
0
[S
O

X
S
e
c
ti

o
n

4
0
1
:

D
is
c
lo
su
re

in
P
e
ri

o
d
ic

R
e
p
o
rt

s] C
o
n
d

it
io

n
s

fo
r

U
se

o
f
N

o
n
-G

A
A

P
F
in

a
n
c
ia

l
M

e
a
su

re
s

N
o
.
o
f
L
e
tt
e
rs
5
3
1
4

4
5

7
1
3

0
2

N
o
.
P
o
s/
N
e
u
/
N
e
g

2
/
2
7
/
2
4

1
/
2
/
1
1

1
/
1
/
2

4
/
0
/
1

1
/
4
/
2

0
/
2
/
1
1

–

1
/
0
/
1

[S
O
X
S
e
c
ti
o
n
4
0
1
:
D
is
c
lo
su
re
in
P
e
ri
o
d
ic
R
e
p
o
rt
s]

M
a
n

d
a
te

d
E

c
tr

o
n
ic

F
il
in

g
a
n
d

e
b
si

te
P
o
st

in
g

fo
r

F
o
rm

s
3
,
4

a
n
d
5
N
o
.
o
f
L
e
tt
e
rs

9
4

2
1
1
5

0
0

N
o
.
P
o
s/
N
e
u
/
N
e
g

0
/
8
/
1

1
/
3
/
0

2
/
0
/
0

1
/
0
/
0

0
/
1
/
0

1
/
4
/
0

–
–

[S
O
X
S
e
c
ti
o
n

0
3

D
is
c
lo
su
re

s
O

T
ra

n
sa

c
ti
o
n
s

v
o
lv

in
g

M
a
n
a
g
e
m

e
n
t
a
n
d

P
ri

n
c
ip

a
l
S
to

ck
h

o
ld

e
rs
]
D
is
c
lo
su
re

R
e

q
u
ir

e
d
b
y

S
e
c

ti
o
n
s

0
4

,
4

0
6

a
n
d

0
7

o
f
th
e
S
a
rb
a
n
e
s-
O
x
le
y
A
c
t

o
f
2
0
0
2

N
o
.
o
f
L
e
tt
e
rs

1
3
2

3
9

3
2
0

1
6
3
3
5
5
N
o
.
P
o
s/
N
e
u
/
N
e
g

4
/
4
/
1
2
4

2
/
5
/
3
2

2
/
0
/
1

9
/
4
/
7

3
/
4
/
9

0
/
2
/

3
1

2
/
1
/
2

0
/
1
/
4

[S
O
X
S
e
c
ti
o
n

4
0
4

M
a
n
a
g
e
m
e
n
t

A
ss

e
ss
m
e
n
t

o
f
In

te
rn

a
l
C

o
n
tr

o
ls

]
[S

O
X
S
e
c
ti
o
n

4
0
6

C
o
d
e

O
f
E

th
ic

s
F
o
r

S
e
n
io

r
F
in

a
n
c
ia

l
O

ffi

c
e
rs

]
[S
O
X
S
e
c
ti
o
n

4
0
7

D
is
c
lo
su
re

o
f
A

u
d
it
C
o
m

m
it

te
e

F
in
a
n
c
ia

l
E

x
p

e
rt

]

A
d
d
it
io

n
a
l
F
o
rm

8
-K

D
is
c
lo
su
re

e
q
u
ir

e
m
e
n
ts
a
n
d

A
c
c
e
le

a
ti
o
n

o
f
F
il
in

g
D

a
te
N
o
.
o
f
L
e
tt
e
rs
4
4
1
2
4
4

7
1
4

2
2
N
o
.
P
o
s/
N
e
u
/
N
e
g

4
/
1
/
3
9

5
/
1
/
6

4
/
0
/
0

0
/
0
/
7

1
/
0
/
1
3

0
/
1
/
1
2
/
0
/
0
[S
O
X
S
e
c
ti
o
n

4
0
9
:

R
e
a
l-
T

im
e

Is
su

e
r
D
is
c
lo
su
re
s]
L
e
tt
e
rs
C
o
m

m
e
n
ti

n
g
o
n

O
th

e
r
D
is
c
lo
su
re

R
e
la

te
d
S
E

C
R

u
le

s
(N

o
t

P
a
rt

o
f
S
O

X
It

se
lf
):

D
is
c
lo
su
re

R
e
g
a
rd

in
g

N
o
m

n
a
ti

n
g
C
o
m
m
it
te
e

F
u
n
c
ti

o
n
s
A
n
d
C
o
m

m
u
n
ic

a
ti
o
n
s

B
e
tw

e
e
n

S
e

c
u
ri

ty
H

o
ld
e
rs
a
n
d

o
a
rd

f
D

ir
e
c
to

rs
N
o
.
o
f
L
e
tt
e
rs
1
5

9
3
8

5
6

3
1
4

3
2
7
N
o
.
P
o
s/
N
e
u
/
N
e
g

3
/
2
/
1
0

5
/
1
/
3

3
5
/
0
/
3

5
1

/
2
/
3

3
/
0
/
0

5
/
0
/
9

3
/
0
/
0

2
5

/
2
/
0

F
o
rm
8
-K
D
is
c
lo
su
re
o
f
C
e
rt

a
in

M
a
n
a
g
e
m
e
n
t
T
ra
n
sa
c
ti
o
n
s
N
o
.
o
f
L
e
tt
e
rs
5
6
1
1

6
1

0
1
6

2
0
N
o
.
P
o
s/
N
e
u
/
N
e
g

3
/
5
/
4
8

1
/
1
/
9

5
/
0
/
1

0
/
1
/
3

–
1
/
0
/
1
5

1
/
1
/
0
–

In
d
iv

id
u

a
l
P

C
A

O
B

R
u
le

s
c
o
n
ti

n
u
e
d
o
n
n
e
x
t
p
a
g
e

C
o
m
m
e
n
t
e
r
:
C
o
r
p
o
r
a
t
io
n
N
o
n
-I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
d
iv
id
u
a
l
A
c
c
o
u
n
t
a
n
t
L
a
w
y
e
r
A
c
a
d
e
m
ic
O
t
h
e
r
P
C
A
O

B
A

u
d
it
in

S
ta

n
d
a
rd

N
o
.
1
N
o
.
o
f
L
e
tt
e
rs
0
0
0
0

5
0

0
0
N
o
.
P
o
s/
N
e
u
/
N
e
g
–
–
–
–

4
/
1
/
0

–
–

–
[S

O
X
S
e
c
ti
o
n

1
0
1
:

E
st

a
b
li
sh

e
n
t;

A
d
m

in
is

tr
a
ti

v
e

P
ro

v
is

io
n
s]

[S
O
X
S
e
c
ti
o
n

1
0
3
:

A
u
d
it

n
g
,

u
a
li
ty

C
o
n
tr

o
l,

a
n
d

In
d
e
p
e
n
d
e
n
c
e

S
ta
n
d
a
rd

s
a
n
d

R
u
le

s]
[S

O
X
S
e
c
ti
o
n

1
0
7
:

C
o
m

m
is

si
o
n

O
v
e
rs

h
t

o
f
th

e
B

o
a
rd
]
P
C
A
O
B
A
u
d
it
in

g
S
ta

n
d
a
rd
N
o
.
2
N
o
.
o
f
L
e
tt
e
rs
1
6
3
0

0
1
2

0
1

0
N

o
.
P
o
s/
N
e
u
/
N
e
g

1
/
4
/
1
1

1
/
1
/
1

–
–

6
/
3
/
3

–
0
/
1
/
0

–

T
o
t
a
l
L
e
t
t
e
r
s

C
o
m
m
e
n
t
in
g
o
n
R
u
le

s
o
n

o
r
p
o
r
a
t
e

R
e
s
p
o
n
s
ib

il
it
y
[S
O
X
T
it
le

I
I
]

N
o
.
o
f
L
e
tt
e
rs

3
5
5

1
2
3

1
9

4
2
2

5
1

2
7
8

4
8
5
4
N
o
.
P
o
s/
N
e
u
/
N
e
g

3
2
/
2
9
/
2
9
4

2
1
/
1
3
/
8
9

1
7
6

/
1
4
/
8

3
3
7
/
3
9
/
4
6

2
0
/
6
/
2
5

2
4
/
2
8
/
2

2
6

2
9
/
8
/
1
1

1
4
/
3
/
3
7

P
c
t.
P
o
s/
N
e
u
/
N
e
g

9
/
8
/
8
3

1
7
/
1
1
/
7
2

8
9
/
7
/
4

8
0
/
9
/
1
1

3
9
/
1
2
/
4
9

9
/
1
0
/
8
1

6
0
/
1
7
/
2
3

2
6
/
6
/

6
9

B
re
a
k
-d
o
w
n
o
f
L
e
tt
e
rs
S
u
b
m
it
te
d
o
n
C
o
rp
o
ra

te
R

e
sp
o
n
si

b
il
it
y

R
u
le
s:
S
ta
n
d
a
rd
s
R
e
la

ti
n
g

T
o

L
is

te
d
C
o
m

a
n
y

A
u
d
it
C
o
m

m
it
te

e
s
N
o
.
o
f
L
e
tt
e
rs
8
1
2
3

9
6

1
4
2
7

1
1
5

N
o
.
P
o
s/
N
e
u
/
N
e
g

4
/
5
/
7
2

4
/
1
/
1
8

8
/
1
/
0

4
/
1
/
1

5
/
4
/
5

1
/
3
/
2
3

1
/
0
/
0

2
/
1
/
1

[S
O
X
S
e
c
ti
o
n

3
0
1
:

P
u
b
li
c

C
o
m

p
a
n
y

A
u
d
it
C
o
m
m
it

te
e
s]

C
e
rt

ifi
c
a
ti

o
n

o
f
D
is
c
lo
su
re

in
C

o
m

p
a
n
ie

s’
Q

u
a
rt

e
rl

y
a
n
d

A
n
n
u
a

l
R

e
p
o
rt
s
N
o
.
o
f
L
e
tt
e
rs
1
9
1
4

2
5
2

5
2
3

1
3
N
o
.
P
o
s/
N
e
u
/
N
e
g

4
/
1
/
1
4

3
/
0
/
1

1
/
0
/
1

4
9
/
2
/
1

1
/
1
/
3

3
/
2
/
1
8

1
/
0
/
0

0
/
0
/
3

[S
O
X
S
e
c
ti
o
n

3
0
2

C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
F
o
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]
C
e
rt
ifi
c
a
ti
o
n
o
f
D
is
c
lo
su
re
in
C
e
rt
a
in

E
x
ch

a
n
g
e

A
c
t

R
e
p
o
rt
s
N
o
.
o
f
L
e
tt
e
rs
1
1
0
0
1
4
1
0
N
o
.
P
o
s/
N
e
u
/
N
e
g
0
/
0
/
1
0
/
0
/
1
–
–
1
/
0
/
0
1
/
1
/
2
1
/
0
/
0
–
[S
O
X
S
e
c
ti
o
n

3
0
2
:

C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
fo
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]
[S
O
X
S
e
c
ti
o
n

9
0
6

C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
fo
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]

Im
p
ro

p
e
r

In
fl
u
e
n
c
e

o
n

o
n
d
u
c
t

o
f
A

u
d

it
s

N
o
.
o
f
L
e
tt
e
rs

6
7

2
1
4

1
0
9
0

1
N

o
.
P
o
s/
N
e
u
/
N
e
g

0
/
1
/
5

1
/
0
/
6

2
/
0
/
0

1
4
/
0
/
0

7
/
0
/
3

0
/
1
/
8

–
0
/
0
/
1

[S
O
X
S
e
c
ti
o
n

3
0
3

Im
p
ro
p
e
r
In
fl
u
e
n
c
e
o
n

C
o
n
d
u
c
t

o
f
A
u
d
it

]
c
o
n
ti

n
u
e
d
o
n
n
e
x
t
p
a
g
e

C
o
m
m
e
n
t
e
r
:
C
o
r
p
o
r
a
t
io
n
N
o
n
-I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
d
iv
id
u
a
l
A
c
c
o
u
n
t
a
n
t
L
a
w
y
e
r
A
c
a
d
e
m
ic
O
t
h
e
r

R
e
te

n
ti
o
n

o
f
R

e
c
o
rd

s
R
e
le

v
a
n
t

to
A

u
d
it
s
a
n
d

R
e
v
ie

w
s

N
o
.
o
f
L
e
tt
e
rs
3
1
1
3
1
6
1
0

3
N

o
.
P
o
s/
N
e
u
/
N
e
g

2
/
1
/
0

0
/
0
/
1
1
/
0
/
0
2
/
1
/
0

3
/
1
/
1
2

0
/
0
/
1

–
0
/
1
/
2

[S
O

X
S

e
c
ti
o
n

8
0
2
:

C
ri

m
in

a
l
P
e
n
a
lt
ie

s
fo

r
A

lt
e
ri

n
g

D
o

c
u
m

e
n
ts
]

In
si

d
e
r

T
ra

d
e
s

D
u
ri

n
g

P
e
n
si

o
n

F
u
n
d

B
la

ck
o
u
t

P
e
ri

o
d
s

N
o
.
o
f
L
e
tt
e
rs

3
4

2
1
1
7
0
0
N
o
.
P
o
s/
N
e
u
/
N
e
g
1
/
1
/
1

1
/
0
/
3

1
/
1
/
0
1
/
0
/
0
1
/
0
/
0

0
/
4
/
3

–
–
[S
O

S
e
c
ti
o
n

3
0
6
:

In
si
d
e
r
T
ra
d
e
s
D
u
ri
n
g
P
e
n
si
o
n
F
u
n
d
B
la

ck
o
u
t]

p
le

m
e
n
ta

ti
o
n

o
f
S
ta

n
d
a
rd

s
o

f
P

ro
fe

ss
io

n
a
l
C

o
n
d
u
c
t
fo
r

A
tt

o
rn

e
y

U
p

th
e

L
a
d
d
e
r

P
ro
v
is
io
n
N
o
.
o
f
L
e
tt
e
rs
2
6
1
0
4
2
2

1
1
1
6

1
9

6
N

o
.
P
o
s/
N
e
u
/
N
e
g

2
/
2
/
2
2

2
/
0
/
8

2
/
1
/
1

1
3
/
7
/
2

1
/
0
/
0

1
0
/
8
/

9
8

1
2
/
3
/
4

0
/
0
/
6
[S
O
X
S
e
c
ti
o
n

3
0
7
:

R
u
le
s
O
f
P
ro
fe
ss
io

n
a
l
R

e
sp
o
n
si
b
il
it
y
fo
r
A
tt
o
rn

e
y
s]

Im
p
le
m
e
n
ta
ti
o
n
o
f
S
ta
n
d
a
rd

o
f
P

ro
fe
ss
io
n
a
l
C
o
n
d
u
c
t
fo
r
A
tt
o
rn

e
y
s:

N
o
is

y
-W

it
h

d
ra

w
a
l

N
o
.
o
f
L
e
tt
e
rs
2
3
5
2
2
0
4
6
4
2
N
o
.
P
o
s/
N
e
u
/
N
e
g

2
/
2
/
1
9

0
/
0
/
5
1
/
0
/
1
2
/
0
/
0

–
2
/
1
/

4
3

3
/
0
/
1
1
/
0
/
1
[S
O
X
S
e
c
ti
o
n
3
0
7
:
R
u
le

s
o
f

ro
fe
ss
io
n
a
l
R
e
sp
o
n
si
b
il
it
y
fo
r
A
tt
o
rn
e
y
s]
L
e
tt
e
rs
c
o
m

m
e
n
ti
n
g

o
n
N
Y
S
E
A
n
d

N
A

S
D
A
Q
R
u
le
s
(N
o
t
P
a
rt
o
f
S
O
X
It

se
lf
)

N
Y
S
E
a
n
d
N
A
S
D
R
u
le

m
a
k
in

g
:

e
w

S
ta
n
d
a
rd
s
a
n
d

C
h

a
n
g
e
s

in
C
o
rp
o
ra

te
G

o
v
e
rn
a
n
c
e
a
n
d

P
ra

c
ti
c
e

o
f
L
is

te
d
C
o
m
p
a
n
ie
s
N
o
.
o
f
L
e
tt
e
rs
2
5
1
7
1
5
1
8
2
3
N
o
.
P
o
s/
N
e
u
/
N
e
g

3
/
3
/
1
9

1
/
8
/
8

1
1
/
0
/
0

4
/
0
/
1
0
/
0
/
1

0
/
2
/
6

1
/
0
/
1
2
/
0
/
1
N
Y
S
E
a
n
d
N
A
S
D
R
u
le
m
a
k
in
g
:

S
h
a
re

h
o
ld

e
r

A
p
p
ro

v
a
l
o
f

q
u
it
y

C
o
m

p
e
n
sa

ti
o
n

P
la

n
s
a
n
d
th
e

V
o
ti

n
g
o
f
P

ro
x
ie

s
N
o
.
o
f
L
e
tt
e
rs
4
4
1
5
4
0
3
0
0
N
o
.
P
o
s/
N
e
u
/
N
e
g
0
/
1
/
3

2
/
0
/
2

1
2
/
3
/
0

4
/
0
/
0
–
0
/
1
/
2
–
–
L
e
tt
e
rs
C
o
m
m
e
n
ti
n
g
o
n
O
th
e
r
R
e
la
te
d
S
E
C
R
u
le
s
(N
o
t
P
a
rt
o
f
S
O
X
It
se
lf
)

S
e
c
u
ri

ty
H
o
ld
e
r

D
ir

e
c
to

r
N

o
m

in
a
ti

o
n
s
N
o
.
o
f
L
e
tt
e
rs

1
6
4

3
7

1
5
0

3
1
3

2
3
4

2
0
2
1
N
o
.
P
o
s/
N
e
u
/
N
e
g

1
4
/
1
2
/
1
3
8

7
/
4
/
2
6

1
3
7
/
8
/
5

2
4
4

/
2
8
/

4
1

1
/
0
/
1

7
/
5
/
2
2

1
0
/
5
/
5

9
/
1
/
1
1

[S
O
X
S
e
c
ti
o
n
1
0
3
:
A
u
d
it
in
g
,
Q
u
a
li
ty
C
o
n
tr
o
l,
a
n
d
In
d
e
p
e
n
d
e
n
c
e
S
ta
n
d
a
rd
s
a
n
d
R
u
le
s]
[S
O
X
S
e
c
ti
o
n

4
0
4
:

M
a
n
a
g
e
m
e
n
t
A
ss
e
ss
m
e
n
t
o
f
In
te
rn
a
l
C
o
n
tr
o
ls
]
c
o
n
ti
n
u
e
d
o
n
n
e
x
t
p
a
g
e
39

C
o
m
m
e
n
t
e
r
:
C
o
r
p
o
r
a
t
io
n
N
o
n
-I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
v
e
s
t
o
r
G
r
o
u
p
I
n
d
iv
id
u
a
l
A
c
c
o
u
n
t
a
n
t
L
a
w
y
e
r
A
c
a
d
e
m
ic
O
t
h
e
r
T
o
t
a
l
L
e
t
t
e
r
s
C
o
m
m
e
n
t
in
g
o
n
R
u
le
s
o
n
A
u
d
it
o
r

I
n
d
e
p
e
n
d
e
n
c
e

[S
O
X
T
it
le
I
I
]

S
tr

e
n

g
th

e
n
in

g
T

h
e
C
o
m
m
is

si
o
n
’s

R
e
q
u
ir

e
m
e
n
ts
R
e
g
a
rd
in
g

u
d
it
o
r

In
d
e
p
e
n
d
e
n
c
e
N
o
.
o
f
L
e
tt
e
rs
5
9
1
6
1
2
1
8

1
2
9

1
4

8
7

N
o
.
P
o
s/
N
e
u
/
N
e
g

9
/
4
/
4
6

1
/
1
/
1
4

1
1
/
0
/
1

7
/
2
/
9

1
1
/
4
/
1
1
4

4
/
1
/
9

5
/
2
/
1

1
/
2
/
4

P
c
t.
P
o
s/
N
e
u
/
N
e
g

1
5
/
7
/
7
8

6
/
6
/
8
8

9
2
/
0
/
8

3
9
/
1
1
/
5
0

9
/
3
/
8
8

2
9
/
7
/
6
4

6
3
/
2
5
/
1
3

1
4
/
2
9
/

5
7

[S
O

X
:
S
e
c
ti
o
n

2
0
1
-2

0
7
;
A

u
d
it
o
r

In
d
e
p
e
n
d
e
n
c
e
]

Table II:

Characteristics of Publicly Traded Firms that Did and Did not Lobby the SEC

This table presents firm characteristics for companies who did and did not lobby against the proposed SOX-related SEC

rule releases. Panel A examines the characteristics of both lobbying and non-lobbying companies with regards to the rules on

Enhanced Financial Disclosure and the PCAOB proposed and implemented by the SEC. Panel B examines the characteristics of

both lobbying and non-lobbying companies with regards to the corporate responsibility rules proposed and implemented by the

SEC. Panel C examines the characteristics of both lobbying and non-lobbying companies with regards to

Auditor Independence

rules proposed and implemented by the SEC. We present the mean, standard deviation and the p-value for a t-test for no

differences in means between lobbyers and non-lobbyers. Firm market capitalization is expressed in MM $ and calculated for

the end of week 6 of 2002 (Friday, February 8th). Book-to-market equity is calculated using book equity for the fiscal year

ending in 2001 and market equity for the end of week 6 of 2002; this variable is winsorized at the top 2 and bottom 2 percentiles.

Total assets (COMPUSTAT item 6) is expressed in MM $ and is calculated in year 2001. Number of years the firm has been

public is the number of years the firm has been publicly traded as of 2002; we cap this variable at 30, because firms traded

in NASDAQ are covered in CRSP only since 1972. Net Income (COMPUSTAT item 172) over sales (COMPUSTAT item

12) is calculated as of year 2000; we use 2000 (as opposed to 2001) since 2001 income may only be disclosed in early 2002

and could thus directly affect returns; this variable is winsorized at the top 2 and bottom 2 percentiles. Governance Index

is the firm’s Gompers, Ishii and Metrick (2003) index calculated in year 2000. PAC is an indicator variable equal to one if

the firm has a Political Action Committee that was registered with the Federal Election Commission’s during the 1999-2000

period. Past Lobbying on Compensation Rules is an indicator variable equal to one if the firm has lobbied against the 1992

revision of executive compensation disclosure rules adopted by the SEC (See Lo, 2003). Past Lobbying on Proxy Rules is an

indicator variable equal to one if the firm has lobbied against the new rules on proxy fights adopted by the SEC in 1992 (See

Lo, 2003). Fraction of shares outstanding owned by institutions is calculated for the year 2001 based on Thompson Financial’s

CDA/Spectrum Institutional (13f) Holdings. Number of business segments is calculated using the COMPUSTAT Segments

data for year 2001. Number of geographical segments is calculated using the COMPUSTAT Segments data for year 2001.

Fraction of shares outstanding owned by executives is calculated including all the shared owned by the executives (generally

the top 5) included in Execucomp for year 2001. Audit fees are expressed in MM $ and calculated in year 2001. Finally, the

table reports the summary statistics for Standard Industrial Classification code (indicator variables).

P
a
n
e
l
A

:
E

n
h
a
n
c
e
d
F
in
a
n
c
ia
l
D
is
c
lo
su
re
a
n
d
P
C
A
O
B

o
b
b
y
e
rs

N
o
n
-L

o
b
b
y
e
rs

N
M

e
d
ia

n
M

e
a
n

S
td

.
D

e
v
.

N
M
e
d
ia
n
M
e
a
n
S
td
.
D
e
v
.

p
-v

a
lu

e
s

T
o
ta

l
A

ss
e
ts

($
M

)
1
9
0

6
,9

9
2

5
4
,7

3
2

1
3
8
,5

9
8

6
,1

2
4

2
5
7

3
,3

2
5

4
,1

7
2

0
.0

0
0

N
u
m

b
e
r

o
f

y
e
a
rs

th
e
fi
rm

h
a
s

b
e
e
n

p
u
b
li
c

1
9
6

9
.0

0
0

8
.8

9
3

1
.0

2
7
6
,9

7
5

8
.0

0
0

0
.9

2
7

8
.9

4
2
0
.0
0
0

N
e
t

In
c
o
m

e
/
S
a
le

s
(Y

e
a
r

2
0
0

0
)

1
8
8

0
.0
9
4

0
.1

0
9
0
.1
0
7

5
,8

3
7
0
.0
3
3

–

0
.4

9
3

2
.0

6
1
0
.0
0
0

G
o
v
e
rn

a
n
c
e

In
d
e
x

1
1
5

1
0
.0

0
0

9
.7

3
9

2
.7

8
2

1
,1

9
2
9
.0
0
0
8
.8
5
1

2
.6

9
2
0
.0
0
1

P
o
li
ti

c
a
l
A

c
ti
o
n
C
o
m
m
it
te
e

(P
A

C
)

n
d
ic

a
to

)
1
9
6

0
.0
0
0
0
.4
3
4
0
.4

9
7

6
,9
7
7
0
.0
0
0
0
.0

7
4

0
.2

6
2

0
.0
0
0

a
st

L
o
b
b
y
in

g
o
n
C
o
m
p
e
n
sa
ti
o
n
R
u
le

s
(i

n
d
ic

a
to
r)
1
9
6
0
.0
0
0
0
.1
2
2

0
.3

2
9
6
,9
7
7
0
.0
0
0
0
.0
1
0
0
.1
0
2
0
.0
0
0
P
a
st
L
o
b
b
y
in
g
o
n
P
ro

x
y

R
u
le
s
(i
n
d
ic
a
to
r)
1
9
6
0
.0
0
0
0
.0
7
7
0
.2
6
7
6
,9
7
7
0
.0
0
0
0
.0

0
5

0
.0

7
3

0
.0
0
0

F
ra

c
ti
o
n

o
f
sh

a
re

s
o
w

n
e
d
b
y

in
st

it
u
ti

o
n
s

1
9
3

0
.5

3
7
0
.4
7
3
0
.2
7
0

6
,7

4
2
0
.2
1
9
0
.3
0
2
0
.2
8
0
0
.0
0
0
N
u
m
b
e
r

o
f
b
u
si

n
e
ss

g
m

e
n
ts

in
2

0
0
1

1
2
9

4
.0

0
0

3
.5

2
7

2
.1

2
5

5
,0

5
0
1
.0
0
0
2
.1
5
9

1
.6

1
3
0
.0
0
0
N
u
m
b
e
r

o
f
g
e
o
g
ra

p
h
ic

h
se

g
m
e
n
ts

in
2
0
0
1

1
3
2
2
.0
0
0

2
.8

3
3

1
.7

1
7
4
,1
7
8
2
.0
0
0

2
.5

9
5

1
.9

5
9
0
.1
6
6
F
ra
c
ti
o
n
o
f
sh
a
re
s
o
w
n
e
d
b
y

e
x
e
c
u
ti

v
e
s
1
2
9
0
.0
0
5
0
.0
2
2
0
.0
4
3

1
,4

8
5

0
.0
1
1
0
.0
4
5
0
.0
8
5
0
.0
0
2
A
u
d
it

F
e
e
s

in
2
0
0
1
($
M

)
1
6
2

0
.7

3
4

2
.2

8
8

3
.8

7
5

5
,1

1
5
0
.1

6
8

0
.4
0
1
0
.9
8
3
0
.0
0
0

a
rk

e
t

C
a
p
it

a
li
z
a
ti

o
n

($
M
)
1
9
6

2
,7

0
3

1
6
,7

8
5

4
0
,0

9
8
6
,9
7
7

1
1
9

1
,0

9
9
6
,1
7
2
0
.0
0
0

B
o
o
k
-t

o
-M

a
rk
e
t

R
a
ti

o
1
8
5

0
.5
0
3

1
.5

0
0

4
.4

9
7
5
,8
6
9

0
.6

3
0

1
.3

4
0

3
.2

5
9
0
.5
1
4

A
g
ri

c
u
lt

u
re

,
F

o
re

st
ry

,
A

n
d

F
is

h
in

g
(S

IC
=

0
)
1
9
6
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
2
0
.0
4
6
0
.5
1
6

M
in

in
g

(S
IC

1
)

1
9
6
0
.0
0
0
0
.0
4
6
0
.2
1
0
6
,9
7
7
0
.0
0
0
0
.0

4
7

0
.2
1
1
0
.9
6
5

C
o
n
st

ru
c
ti
o
n

(S
IC

2
)

1
9
6
0
.0
0
0
0
.1

5
8

0
.3
6
6
6
,9
7
7
0
.0
0
0
0
.1
1
3
0
.3
1
6
0
.0
4
8

M
a
n
u
fa

c
tu

ri
n
g

(S
IC

=
3
)

1
9
6
0
.0
0
0
0
.1
8
9
0
.3
9
2
6
,9
7
7
0
.0
0
0
0
.2
2
6
0
.4
1
8
0
.2
2
1
T
ra

n
sp

.,
C

o
m

m
u
n
.,

E
le

c
.,

G
a
s,

a
n
d

S
a
n
it

a
ry

S
e
rv

.
(S

IC
=

4
)

1
9
6
0
.0
0
0
0
.0
9
2
0
.2
9
0
6
,9
7
7
0
.0
0
0
0
.0
8
0
0
.2
7
1
0
.5
3
7

W
h
o
le

sa
le

T
ra
d
e
(S
IC

=
5
)

1
9
6
0
.0
0
0
0
.0
6
1
0
.2
4
0
6
,9
7
7
0
.0
0
0
0
.0
8
3
0
.2
7
5
0
.2
8
0

R
e
ta

il
T
ra

d
e
(S
IC

=
6
)

1
9
6
0
.0
0
0
0
.3
9
3
0
.4
9
0
6
,9
7
7
0
.0
0
0
0
.2
6
4
0
.4
4
1
0
.0
0
0
F
in

a
n
c
e
,
In

su
ra

n
c
e
,
A

n
d

R
e
a
l
E

st
a
te

(S
IC

=
7
)

1
9
6
0
.0
0
0
0
.0
5
6
0
.2
3
1
6
,9
7
7
0
.0
0
0
0
.1
4
0
0
.3
4
7
0
.0
0
1
S
e
rv

ic
e

(S
IC

=
8
)

1
9
6
0
.0
0
0
0
.0
0
5
0
.0
7
1
6
,9
7
7
0
.0
0
0
0
.0
4
7
0
.2
1
1
0
.0
0
6
P
u
b
li
c
A
d
m
in
is

tr
a
ti
o
n

(S
IC

=
9
)

1
9
6
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
0
0
.0
1
2

0
.8

6
7
42

P
a
n
e
l
B

:
C

o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y

L
o
b
b
y
e
rs

N
o
n
-L
o
b
b
y
e
rs
N
M
e
d
ia
n
M
e
a
n
S
td
.
D
e
v
.
N
M
e
d
ia
n
M
e
a
n
S
td
.
D
e
v
.
p
-v
a
lu
e
s
T
o
ta
l
A
ss
e
ts
($
M

)
9
4

2
3
,3

3
3

8
1
,9

5
0

1
6
4
,0

1
7
6
,1
2
4
2
5
7
3
,3
2
5

2
4
,1

7
2
0
.0
0
0
N
u
m
b
e
r
o
f
y
e
a
rs
th
e
fi
rm
h
a
s
b
e
e
n
p
u
b
li
c
9
8

1
5
.5

0
0
1
5
.5
5
1

1
1
.8

9
8
6
,9
7
5
8
.0
0
0

1
0
.9

2
7
8
.9
4
2
0
.0
0
0
N
e
t
In
c
o
m
e
/
S
a
le
s
(Y
e
a
r

0
0
0
)

9
0
0
.0
8
8
0
.1
0
6
0
.1
1
0
5
,8
3
7
0
.0
3
3

-0
.4

9
3
2
.0
6
1
0
.0
0
6
G
o
v
e
rn
a
n
c
e
In
d
e
x
3
4
1
0
.0
0
0

9
.8

8
2

2
.4

3
4
1
,1
9
2
9
.0
0
0
8
.8
5
1
2
.6
9
2
0
.0
2
7
P
o
li
ti
c
a
l
A
c
ti
o
n
C
o
m
m
it
te
e
(P
A
C
)

(i
n
d
ic

a
to

)
9
8

0
.0
0
0
0
.3
4
7
0
.4
7
8
6
,9
7
7
0
.0
0
0
0
.0
7
4
0
.2
6
2
0
.0
0
0
P
a
st
L
o
b
b
y
in
g
o
n
C
o
m
p
e
n
sa
ti
o
n
R
u
le

s
(i
n
d
ic

a
to
r)
9
8
0
.0
0
0
0
.1
2
2
0
.3
2
9
6
,9
7
7
0
.0
0
0
0
.0
1
0
0
.1
0
2
0
.0
0
0
P
a
st
L
o
b
b
y
in
g
o
n
P
ro
x
y
R
u
le
s
(i
n
d
ic
a
to
r)
9
8
0
.0
0
0
0
.1
3
3
0
.3
4
1
6
,9
7
7
0
.0
0
0
0
.0
0
5
0
.0
7
3
0
.0
0
0
F
ra
c
ti
o
n
o
f
sh
a
re
s
o
w
n
e
d
b
y
in
st
it
u
ti
o
n
s
9
4
0
.2
3
0
0
.2
8
8
0
.2
7
7
6
,7
4
2
0
.2
1
9
0
.3
0
2
0
.2
8
0
0
.6
1
7
N
u
m
b
e
r
o
f
b
u
si
n
e
ss

se
g
m

e
n
ts
in
2
0
0
1
7
4
4
.0
0
0
3
.8
9
2
2
.1
4
3
5
,0
5
0
1
.0
0
0
2
.1
5
9
1
.6
1
3
0
.0
0
0
N
u
m
b
e
r
o
f
g
e
o
g
ra
p
h
ic
h
se
g
m
e
n
ts
in
2
0
0
1
7
3
4
.0
0
0

3
.7

2
6
2
.6
1
0
4
,1
7
8
2
.0
0
0
2
.5
9
5
1
.9
5
9
0
.0
0
0
F
ra
c
ti
o
n
o
f
sh
a
re
s
o
w
n
e
d
b
y
e
x
e
c
u
ti
v
e
s
4
0
0
.0
0
2
0
.0
1
5
0
.0
4
2
1
,4
8
5
0
.0
1
1
0
.0
4
5
0
.0
8
5
0
.0
2
6
A
u
d
it
F
e
e
s
in
2
0
0
1
($
M

)
4
6

2
.6
2
9

4
.9

3
7

5
.8

7
5
5
,1
1
5
0
.1
6
8
0
.4
0
1
0
.9
8
3
0
.0
0
0

M
a
rk

e
t
C
a
p
it
a
li
z
a
ti
o
n
($
M
)
9
8

2
,6

6
2

2
1
,9

6
8

5
7
,5

0
9
6
,9
7
7
1
1
9
1
,0
9
9
6
,1
7
2
0
.0
0
0
B
o
o
k
-t
o
-M
a
rk
e
t
R
a
ti

o
8
3

0
.6
0
6
4
.4
2
9

9
.4

3
1
5
,8
6
9
0
.6
3
0
1
.3
4
0
3
.2
5
9
0
.0
0
0
A
g
ri
c
u
lt
u
re
,
F
o
re
st
ry
,
A
n
d
F
is
h
in
g
(S
IC
=
0
)
9
8
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
2
0
.0
4
6
0
.6
4
6
M
in
in
g
(S
IC
=
1
)
9
8
0
.0
0
0
0
.0
7
1
0
.2
5
9
6
,9
7
7
0
.0
0
0
0
.0
4
7
0
.2
1
1
0
.2
4
8
C
o
n
st
ru
c
ti
o
n
(S
IC
=
2
)
9
8
0
.0
0
0
0
.1
4
3
0
.3
5
2
6
,9
7
7
0
.0
0
0
0
.1
1
3
0
.3
1
6
0
.3
4
9
M
a
n
u
fa
c
tu
ri
n
g
(S
IC
=
3
)
9
8
0
.0
0
0
0
.2
6
5
0
.4
4
4
6
,9
7
7
0
.0
0
0
0
.2
2
6
0
.4
1
8
0
.3
5
3
T
ra
n
sp
.,
C
o
m
m
u
n
.,
E
le
c
.,
G
a
s,
a
n
d
S
a
n
it
a
ry
S
e
rv
.
(S
IC
=
4
)
9
8
0
.0
0
0
0
.1
7
3
0
.3
8
1
6
,9
7
7
0
.0
0
0
0
.0
8
0
0
.2
7
1
0
.0
0
1
W
h
o
le
sa
le
T
ra
d
e
(S
IC
=
5
)
9
8
0
.0
0
0
0
.0
4
1
0
.1
9
9
6
,9
7
7
0
.0
0
0
0
.0
8
3
0
.2
7
5
0
.1
3
4
R
e
ta
il
T
ra
d
e
(S
IC
=
6
)
9
8
0
.0
0
0
0
.2
6
5
0
.4
4
4
6
,9
7
7
0
.0
0
0
0
.2
6
4
0
.4
4
1
0
.9
7
7
F
in
a
n
c
e
,
In
su
ra
n
c
e
,
A
n
d
R
e
a
l
E
st
a
te
(S
IC
=
7
)
9
8
0
.0
0
0
0
.0
4
1
0
.1
9
9
6
,9
7
7
0
.0
0
0
0
.1
4
0
0
.3
4
7
0
.0
0
5
S
e
rv
i

c
e
s

(S
IC
=
8
)
9
8
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
4
7
0
.2
1
1
0
.0
2
8
P
u
b
li
c
A
d
m
in
is
tr
a
ti
o
n
(S
IC
=
9
)
9
8
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
0
0
.0
1
2
0
.9
0
6

P
a
n
e
l
C

:
A

u
d
it
o
r
In
d
e
p
e
n
d
e
n
c
e
L
o
b
b
y
e
rs
N
o
n
-L
o
b
b
y
e
rs
N
M
e
d
ia
n
M
e
a
n
S
td
.
D
e
v
.
N
M
e
d
ia
n
M
e
a
n
S
td
.
D
e
v
.
p
-v
a
lu
e
s
T
o
ta
l
A
ss
e
ts
($
M

)
3
1

2
0
,8

0
9

8
7
,5

5
6

1
6
3
,9

9
3
6
,1
2
4
2
5
7
3
,3
2
5
2
4
,1
7
2
0
.7
9
6
N
u
m
b
e
r
o
f
y
e
a
rs
th
e
fi
rm
h
a
s
b
e
e
n
p
u
b
li
c
3
1

3
0
.0

0
0

1
8
.5

1
6

1
2
.8

6
8
6
,9
7
5
8
.0
0
0
1
0
.9
2
7
8
.9
4
2
0
.2
1
9
N
e
t
In
c
o
m
e
/
S
a
le
s
(Y
e
a
r
2
0
0
0
)
3
1
0
.0
9
8
0
.1
0
1
0
.1
1
2
5
,8
3
7
0
.0
3
3
-0
.4
9
3
2
.0
6
1
0
.7
7
4
G
o
v
e
rn
a
n
c
e
In
d
e
x
3
1
1
0
.0
0
0
9
.8
5
7
2
.6
3
2
1
,1
9
2
9
.0
0
0
8
.8
5
1
2
.6
9
2
0
.9
9
9
P
o
li
ti
c
a
l
A
c
ti
o
n
C
o
m
m
it
te
e
(P
A
C
)
(i
n
d
ic
a
to

r)
3
1

1
.0
0
0
0
.6
4
5
0
.4
8
6
6
,9
7
7
0
.0
0
0
0
.0
7
4
0
.2
6
2
0
.7
5
6
P
a
st
L
o
b
b
y
in
g
o
n
C
o
m
p
e
n
sa
ti
o
n
R
u
le
s
(i
n
d
ic
a
to
r)
3
1
0
.0
0
0
0
.2
5
8
0
.4
4
5
6
,9
7
7
0
.0
0
0
0
.0
1
0
0
.1
0
2
0
.3
5
1
P
a
st
L
o
b
b
y
in
g
o
n
P
ro
x
y
R
u
le
s
(i
n
d
ic
a
to
r)
3
1
0
.0
0
0
0
.1
9
4
0
.4
0
2
6
,9
7
7
0
.0
0
0
0
.0
0
5
0
.0
7
3
0
.2
5
3
F
ra
c
ti
o
n
o
f
sh
a
re
s
o
w
n
e
d
b
y
in
st
it
u
ti
o
n
s
3
1
0
.5
9
9
0
.5
2
2
0
.2
6
1
6
,7
4
2
0
.2
1
9
0
.3
0
2
0
.2
8
0
0
.2
2
8
N
u
m
b
e
r
o
f
b
u
si
n
e
ss
se
g
m
e
n
ts
in
2
0
0
1
3
1
4
.0
0
0

4
.6

0
0
2
.7
9
8
5
,0
5
0
1
.0
0
0
2
.1
5
9
1
.6
1
3
0
.7
0
3
N
u
m
b
e
r
o
f
g
e
o
g
ra
p
h
ic
h
se
g
m
e
n
ts
in
2
0
0
1
3
1
4
.0
0
0

3
.9

5
0
2
.0
8
9
4
,1
7
8
2
.0
0
0
2
.5
9
5
1
.9
5
9
0
.9
4
7
F
ra
c
ti
o
n
o
f
sh
a
re
s
o
w
n
e
d
b
y
e
x
e
c
u
ti
v
e
s
3
0
0
.0
0
1
0
.0
0
4
0
.0
0
4
1
,4
8
5
0
.0
1
1
0
.0
4
5
0
.0
8
5
0
.0
0
0
A
u
d
it
F
e
e
s
in
2
0
0
1
($
M
)
3
1
2
.7
0
3

4
.7

9
3

6
.3

0
4
5
,1
1
5
0
.1
6
8
0
.4
0
1
0
.9
8
3
0
.0
0
0
M
a
rk
e
t
C
a
p
it
a
li
z
a
ti
o
n
($
M
)
3
1
6
,9
0
2

3
8
,9

4
7

8
2
,7

1
5
6
,9
7
7
1
1
9
1
,0
9
9
6
,1
7
2
0
.0
0
0
B
o
o
k
-t
o
-M
a
rk
e
t
R
a
ti

o
2
9

0
.5
4
6
1
.7
6
6

5
.1

0
1
5
,8
6
9
0
.6
3
0
1
.3
4
0
3
.2
5
9
0
.4
8
4
A
g
ri
c
u
lt
u
re
,
F
o
re
st
ry
,
A
n
d
F
is
h
in
g
(S
IC
=
0
)
2
9
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
2
0
.0
4
6
0
.1
2
0
M
in
in
g
(S
IC
=
1
)
2
1
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
4
7
0
.2
1
1
0
.0
9
0
C
o
n
st
ru
c
ti
o
n
(S
IC
=
2
)
3
1
0
.0
0
0
0
.1
2
9
0
.3
4
1
6
,9
7
7
0
.0
0
0
0
.1
1
3
0
.3
1
6
0
.0
0
0
M
a
n
u
fa
c
tu
ri
n
g
(S
IC
=
3
)
3
1
0
.0
0
0
0
.2
2
6
0
.4
2
5
6
,9
7
7
0
.0
0
0
0
.2
2
6
0
.4
1
8
0
.0
0
0
T
ra
n
sp
.,
C
o
m
m
u
n
.,
E
le
c
.,
G
a
s,
a
n
d
S
a
n
it
a
ry
S
e
rv
.
(S
IC
=
4
)
3
1
0
.0
0
0
0
.0
6
5
0
.2
5
0
6
,9
7
7
0
.0
0
0
0
.0
8
0
0
.2
7
1
0
.0
0
0
W
h
o
le
sa
le
T
ra
d
e
(S
IC
=
5
)
3
0
0
.0
0
0
0
.1
2
9
0
.3
4
1
6
,9
7
7
0
.0
0
0
0
.0
8
3
0
.2
7
5
0
.0
0
0
R
e
ta
il
T
ra
d
e
(S
IC
=
6
)
2
0
0
.0
0
0
0
.3
5
5
0
.4
8
6
6
,9
7
7
0
.0
0
0
0
.2
6
4
0
.4
4
1
0
.0
0
0
F
in
a
n
c
e
,
In
su
ra
n
c
e
,
A
n
d
R
e
a
l
E
st
a
te
(S
IC
=
7
)
2
0
0
.0
0
0
0
.0
6
5
0
.2
5
0
6
,9
7
7
0
.0
0
0
0
.1
4
0
0
.3
4
7
0
.0
0
2
S
e
rv
ic
e
s
(S
IC
=
8
)
2
2
0
.0
0
0
0
.0
3
2
0
.1
8
0
6
,9
7
7
0
.0
0
0
0
.0
4
7
0
.2
1
1
0
.0
2
3
P
u
b
li
c
A
d
m
in
is
tr
a
ti
o
n
(S
IC
=
9
)
2
4
0
.0
0
0
0
.0
0
0
0
.0
0
0
6
,9
7
7
0
.0
0
0
0
.0
0
0
0
.0
1
2
0
.0
0
0
44

Table III:

Predictability of Lobbying by Corporate Insiders

The table presents the results of probit analysis of the likelihood of a company lobbying against SOX-related SEC rule

releases. In columns (1),(2), and (3) the dependent variable is an indicator taking the value of one if the firm lobbied against

one or more of the rules on Enhanced Financial Disclosure and PCAOB proposed and implemented by the SEC, and zero

otherwise. In columns (4),(5), and (6) the dependent variable is an indicator taking the value of one if the firm lobbied against

one or more of the rules on Corporate Responsibility proposed and implemented by the SEC, and zero otherwise. In columns

(7), (8), and (9) the dependent variable is an indicator taking the value of one if the firm lobbied against one or more of the

rules Auditors Independence proposed and implemented by the SEC, and zero otherwise. In Log of Market Capitalization is

calculated at the end of week 6 of 2002 (Friday, February 8th). Book-to-Market Ratio is calculated using book equity for the

fiscal year ending in 2001 and market equity for the end of week 6 of 2002 (Friday, February 8th). Total assets (COMPUSTAT

item 6) is expressed in MM $ and it is calculated at the end of 2001. Number of years the firm has been public is the number of

years the firm has been publicly traded as of 2002; we cap this variable at 30, because firms traded in NASDAQ are covered in

CRSP only since 1972. Net Income (COMPUSTAT item 172) over sales (COMPUSTAT item 12) is calculated as of year 2000;

we use 2000 (as opposed to 2001) since 2001 income may only be disclosed in early 2002 and could thus directly affect returns;

this variable is winsorized at the top 2 and bottom 2 percentiles. Governance Index is the firm’s Gompers, Ishii and Metrick

(2003) index calculated in year 2000 (Higher values of the governance index indicate more entrenched management and lower

shareholder power). PAC is an indicator variable equal to one if the firm has a Political Action Committee that was registered

with the Federal Election Commission’s during the 1999-2000 period; Past Lobbying on Compensation Rules is an indicator

variable equal to one if the firm has lobbied against the 1992 revision of executive compensation disclosure rules adopted by

the SEC (see Lo, 2003). Past Lobbying on Proxy Rules is an indicator variable equal to one if the firm has lobbied against the

new rules on proxy fights adopted by the SEC in 1992 (see Lo, 2003). Fraction of shares outstanding owned by institutions is

calculated in year 2001 using Thompson Financial’s CDA/Spectrum Institutional (13f) Holdings. Number of business segments

is calculated using the COMPUSTAT Segments data for year 2001. Number of geographical segments is calculated using the

COMPUSTAT Segments data for year 2001. Fraction of shares outstanding owned by executives is calculated including all

the shared owned by the executives (generally the top 5) included in Execucomp for year 2001. The logarithm of the firm’s

audit fees (expressed in MM $) is calculated in year 2001. Finally, all the regressions include indicator variables for Standard

Industrial Classification code. All tests use White (1980) heteroscedasticity-consistent robust standard errors.

L
o
b
b
ie

d
a
g
a
in

st
F
in

a
n
c
ia

l
L
o
b
b
ie

d
a
g
a
in

st
L
o
b
b
ie

d
a
g
a
in

st
D

is
c
lo
su
re
a
n
d
P
C
A
O

B
C

o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
A
u
d
it
o
r
In
d
e
p
e
n
d
e
n
c
e

(1
)

(2
)

(3
)

(4
)

(5
)

(6
)

(7
)

(8
)

(9
)

L
o
g

o
f
T
o
ta

l
A
ss
e
ts
($
M

)
0
.2

6
8
0
*
*
*

0
.2

4
9
6
*
*
*

0
.3

2
7
1
*
*
*

0
.2

7
7
9
*
*
*

0
.1

9
4
2
*
*
*

0
.1

5
0
6

(0
.0

3
0
6
)

(0
.0

4
7
8
)

(0
.0

3
7
6
)

(0
.0

5
5
6
)

(0
.0

6
3
4
)

(0
.0

9
7
5
)

#
o
f
y
e
a
rs

p
u
b
li
c
fi
rm
0
.0

0
8
4
*

0
.0

0
8
1
*

-0
.0

0
0
1
-0
.0

0
1
0

-0
.0

1
6
5

-0
.0

1
7
6
*

(0
.0

0
4
5
)

(0
.0
0
4
5
)
(0
.0

0
6
4
)

(0
.0

0
6
5
)

(0
.0

1
0
5
)

(0
.0

1
0
6

)

N
e
t
In
c
o
m
e
/
S
a
le

s
(2

0
0
0
)

1
.2

2
7
3
*
*
*

1
.0

4
6
2
*
*
*

1
.2

2
9
1
*
*
*

0
.9

5
1
9
*
*

1
.4

2
8
1

1
.1

0
6
1

(0
.3

4
5
0
)

(0
.3

5
7
1
)

(0
.4

4
6
6
)

(0
.4

4
7
9
)

(0
.8

2
4
6
)

(0
.8

6
1
6
)

G
o
v
e
rn
a
n
c
e
In
d
e
x
0
.0

2
4
9

0
.0
2
7
8
0
.0

5
4
5

0
.0

6
1
5
*

0
.0

4
2
7

0
.0

4
7
3

(0
.0

2
0
5

)

(0
.0

2
0
6
)

(0
.0

3
5
9
)

(0
.0

3
6
3
)

(0
.0

4
2
4
)

(0
.0

4
2
7
)

P
o
li
ti
c
a
l
A
c
ti
o
n
C
o
m
m
it
te
e
0
.1

8
0
8
*

0
.1

5
9
7

0
.0

0
3
2

-0
.0

2
4
2

0
.4

3
0
2
*
*

0
.4

1
1
9
*

(0
.1

0
3
0
)

(0
.1

0
3
9
)

(0
.1

6
1
0
)

(0
.1

6
2
4
)

(0
.2

0
9
3
)

(0
.2

1
0
4
)

P
a
st
L
o
b
b
y
in
g
o
n
0
.2

0
9
2

0
.1

9
7
6

-0
.2

5
8
0

-0
.2
9
0
6
0
.3

5
4
8

0
.3

5
7
8

C
o
m
p
e
n
sa
ti
o
n
R
u
le

s
(0

.1
9
4
0
)

(0
.1

9
4
9
)

(0
.3

1
5
7
)

(0
.3

1
8
8
)

(0
.3

2
2
2
)

(0
.3

2
2
9
)

P
a
st
L
o
b
b
y
in
g
o
n
P
ro
x
y
R
u
le

s
-0

.1
4
6
6

-0
.1

6
1
4

0
.8

3
2
2
*
*
*

0
.8

4
5
8
*
*
*

0
.1

1
8
4

0
.0

9
9
5

(0
.2

3
6
7
)

(0
.2

3
7
4
)

(0
.3

1
5
6
)

(0
.3

1
7
4
)

(0
.3

5
6
1
)

(0
.3

5
7
2
)

F
ra
c
ti
o
n
o
w
n
e
d
b
y
in
st
it
u
ti
o
n
s
-0
.0

7
5
8

-0
.1

6
0
7

-1
.1

0
5
1
*
*
*

-1
.2

8
2
3
*
*
*

0
.2

0
0
5

0
.1

2
7
0

(0
.1

9
2
2
)

(0
.1

9
7
1
)

(0
.3

2
4
9
)

(0
.3

3
8
7
)

(0
.4

2
1
8
)

(0
.4

2
8
8
)

#
o
f
b
u
si

n
e
ss
se
g
m
e
n
ts

(2
0
0
1
)

0
.0

1
9
1

0
.0

2
3
5

-0
.0
3
0
3
-0
.0
2
3
4
0
.0

9
3
0
*
*

0
.0

9
7
3
*
*

(0
.0

2
4
3
)

(0
.0

2
4
4
)

(0
.0

3
1
1
)

(0
.0

3
1
5
)

(0
.0

4
7
3
)

(0
.0

4
7
5
)

#
o
f
g
e
o
g
ra

p
h
ic
se
g
m
e
n
ts
(2
0
0
1
)
-0
.0

5
6
4
*
*

-0
.0

5
7
2
*
*

-0
.0

2
8
7

-0
.0
2
8
1
0
.0
2
4
4
0
.0

2
4
5

(0
.0

2
7
1
)

(0
.0

2
7
2
)

(0
.0

2
9
2
)

(0
.0

2
9
5
)

(0
.0

4
2
6
)

(0
.0

4
3
2
)

F
ra
c
ti
o
n
o
w
n
e
d
b
y
e
x
e
c
u
ti
v
e
s

-0
.7

9
3
6

-0
.8

0
8
0

-0
.6

2
0
5
-0
.7

7
4
9

-3
4
.2

5
0
1
*

-3
2
.7

8
3
1
*

(0
.8

6
6
2
)

(0
.8

7
2
8
)

(1
.5

6
3
3
)

(1
.6

2
8
2
)

(1
9
.8

0
2
8
)

(1
9
.3

5
5
3
)

L
o
g
o
f
A
u
d
it
F
e
e
s
in
2
0
0
1
($
M

)
-0

.0
5
3
6

-0
.0

7
5
6

0
.1

6
5
4
*
*

0
.1

3
8
7
*

0
.0

3
9
9

0
.0

1
4
3

(0
.0

4
8
7
)

(0
.0

5
0
1
)

(0
.0

7
5
5
)

(0
.0

7
6
4
)

(0
.1

0
3
7

)

(0
.1

0
5
9
)

L
o
g

o
f
M

a
rk
e
t
C
a
p
it
a
li
z
a
ti
o
n
0
.2

8
3
4
*
*
*

0
.0

4
8
3

0
.2

6
8
7
*
*
*

0
.0

9
0
3
*

0
.2

9
5
9
*
*
*

0
.0

8
2
6

(0
.0

1
8
1
)

(0
.0

4
2
1
)

(0
.0

2
3
7
)

(0
.0

5
1
1
)

(0
.0

3
7
7
)

(0
.0

8
9
4
)

B
o
o
k
-t
o
-M
a
rk
e
t
R
a
ti

o
0
.0

3
0
3
*
*
*

-0
.0
0
3
7
0
.0

5
8
8
*
*
*

0
.0

0
2
2

0
.0

3
6
7
*
*

0
.0

0
0
9

(0
.0

0
8
6
)

(0
.0

1
2
3
)

(0
.0

0
7
5
)

(0
.0

1
1
2
)

(0
.0

1
4
7
)

(0
.0

2
4
0
)

C
o
n
st
a
n
t

-3
.9

2
3
4
*
*
*

-3
.4

4
5
7
*
*
*

-4
.1

1
4
9
*
*
*

-4
.7

6
6
1
*
*
*

-4
.1

9
7
2
*
*
*

-5
.0

1
0
6
*
*
*

-4
.7

9
5
5
*
*
*

-4
.5

9
9
1
*
*
*

-5
.0

4
7
0
*
*
*

(0
.4

0
5
7
)

(0
.1

4
1
2
)

(0
.4

2
1
0
)

(0
.5

7
2
2
)

(0
.2

0
9
8
)

(0
.5

9
0
4
)

(0
.8

9
0
6
)

(0
.3

3
2
6
)

(0
.9

3
2
4
)

In
d
u
st

ry
d
u
m

m
ie

s
Y

E
S

Y
E

S
Y

E
S
Y
E
S
Y
E
S
Y
E
S
Y
E
S
Y
E
S
Y
E
S

O
b
se

rv
a
ti
o
n
s

7
3
5
6

7
3
5
6
7
3
5
6
7
3
5
6
7
3
5
6
7
3
5
6
7
3
5
6
7
3
5
6
7
3
5
6

P
se

u
d
o

R
-s

q
u
a
re

d
0
.2

6
6
9

0
.2

0
7
6

0
.2

6
9
6

0
.3

5
6
5

0
.2

0
0
8

0
.3

6
2
0

0
.3

3
3
3

0
.2

2
2
4

0
.3

3
6
9

Table IV:

Portfolio Analysis: Abnormal Excess Returns During Period Leading Up to Passage
of the

Sarbanes-Oxley Act of 2002 and the Period from Passage to the End of 2004

The table presents the abnormal excess returns for firms that lobbied against SOX related rules relative to non-lobbying

firms. Panel A reports results for weekly excess returns averaged across lobbying firms. Panel B reports results for weekly

excess returns averaged across firms that are predicted to lobby based on the results of Table III. The first section of the tables

presents the results for firms that lobbied against enhanced financial disclosure and PCAOB rules; the second section of the

tables presents the results for firms that lobbied against corporate responsibility rules; the third section of the tables presents

the results for firms that lobbied against auditor independence rules. Excess returns are calculated for each lobbying firm by

subtracting the return on a portfolio of non-lobbying firms of similar size (columns (1)-(3)) or of similar size and book-to-market

equity (columns (4)-(6)) or of similar size and in the same 1-digit industry category (columns (7)-(9)). Excess returns are then

averaged for each week across the set of lobbying firms. These average excess returns are then regressed either just on a constant

or on a constant and the three market, size and book-to-market factors. This is done first for the 24-week period from week

7 to 30 of 2002 leading up to passage of SOX only (columns (1), (4) and (7)) and then for the period starting with week 7 of

2002 and ending in the last week of 2004 (columns (2)-(3), (5)-(6), and (8)-(9)) with different constant terms allowed for the

lead-up period and for the post-SOX period.

Panel A: Lobbyers versus Non-Lobbyers

Dependent variable: r
Lobbying Firm Group
t − r

Matched Non-Lobbying Firm Group
t

Comparison Group Comparison Group Comparison Group
Based On 100 Size Based On 25 Size And Based On 25 Size And

Portfolios 5 Book-To-Market 10 1-Digit Industry
Portfolios Portfolios

(1) (2) (3) (4) (5) (6) (7) (8) (9)

Enhanced Financial Disclosure and PCAOB

αLead-Up 0.0051*** 0.0051*** 0.0049*** 0.0042*** 0.0042*** 0.0040*** 0.0033*** 0.0033*** 0.0035***

(0.0013) (0.0013) (0.0015) (0.0012) (0.0012) (0.0013) (0.0010) (0.0009) (0.0011)
αPost 0.0002 0.0005 0.0000 0.0006 0.0003 0.0004

(0.0004) (0.0004) (0.0004) (0.0004) (0.0003) (0.0003)
βMarket -0.0425* -0.0823*** 0.0045

(0.0233) (0.0206) (0.0188)
βSMB -0.1143*** -0.1161*** -0.0710**

(0.03

) (0.0339) (0.0290)
βHML 0.0401 -0.0780 0.0204

(0.0486) (0.0477) (0.0367)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.406 0.144 0.259 0.3

0.103 0.295 0.343 0.108 0.1

Corporate Responsibility

αLead-Up 0.0021 0.0021 0.0033 0.0020 0.0020 0.0032* 0.0022 0.0022 0.0036*

(0.0020) (0.0020) (0.0021) (0.0018) (0.0018) (0.0018) (0.0018) (0.0018) (0.0018)
αPost -0.0005 -0.0004 -0.0010 -0.0005 -0.0008 -0.0006

(0.0006) (0.0006) (0.0006) (0.0006) (0.0006) (0.0006)
βMarket 0.0683** -0.0014 0.0694**

(0.0321) (0.0295) (0.0289)
βSMB -0.2117*** -0.1935*** -0.2054***

(0.0504) (0.0471) (0.0498)
βHML -0.0017 -0.2056*** -0.0674

(0.0841) (0.0771) (0.0759)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.046 0.017 0.166 0.050 0.026 0.218 0.059 0.023 0.198

Auditor Independence

αLead-Up 0.0035* 0.0035* 0.0045** 0.0032 0.0032 0.0048** 0.0027 0.0027 0.0031

(0.0019) (0.0019) (0.0022) (0.0020) (0.0019) (0.0020) (0.0018) (0.0018) (0.0021)
αPost 0.0259 0.0303 -0.0024

(0.0324) (0.0330) (0.0319)
βMarket -0.1995*** -0.1980*** -0.1906***

(0.0552) (0.0503) (0.0568)
βSMB -0.0676 -0.2253*** 0.0087

(0.0784) (0.0833) (0.0674)
βHML -0.0002 0.0001 -0.0007 -0.0003 -0.0001 0.0002

(0.0007) (0.0007) (0.0008) (0.0007) (0.0007) (0.0007)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.126 0.028 0.130 0.101 0.026 0.193 0.089 0.017 0.099

Panel B: Firms Predicted to Lobby versus Non-Lobbyers

Dependent variable: r
Predicted to Lobby Firm Group
t − r

Matched Non-Lobbying Firm Group
t
Comparison Group Comparison Group Comparison Group
Based On 100 Size Based On 25 Size And Based On 25 Size And
Portfolios 5 Book-To-Market 10 1-Digit Industry
Portfolios Portfolios
(1) (2) (3) (4) (5) (6) (7) (8) (9)
Enhanced Financial Disclosure and PCAOB

αLead-Up 0.0044* 0.0044* 0.0050* 0.0049** 0.0049** 0.0060** 0.0027 0.0027* 0.0037**

(0.0024) (0.0023) (0.0026) (0.0023) (0.0023) (0.0024) (0.0016) (0.0016) (0.0016)
αPost -0.0001 0.0002 -0.0003 0.0002 -0.0002 -0.0001

(0.0006) (0.0005) (0.0007) (0.0006) (0.0005) (0.0005)
βMarket 0.0296 0.0006 0.0732***

(0.0296) (0.03

) (0.0240)
βSMB -0.3162*** -0.3038*** -0.2236***

(0.0538) (0.0515) (0.0386)
βHML 0.1441 -0.0993 0.0850

(0.0903) (0.0969) (0.0645)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.128 0.045 0.285 0.164 0.053 0.268 0.109 0.031 0.265

Corporate Responsibility

αLead-Up -0.0005 -0.0005 0.0014 0.0020 0.0020 0.0032* 0.0022 0.0022 0.0036*

(0.0027) (0.0027) (0.0027) (0.0018) (0.0018) (0.0018) (0.0018) (0.0018) (0.0018)
αPost 0.0007 0.0005 -0.0010 -0.0005 -0.0008 -0.0006

(0.0007) (0.0007) (0.0006) (0.0006) (0.0006) (0.0006)
βMarket 0.1534*** -0.0014 0.0694**

(0.0437) (0.0295) (0.0289)
βSMB -0.3118*** -0.1935*** -0.2054***

(0.0529) (0.0471) (0.0498)
βHML 0.1019 -0.2056*** -0.0674

(0.1125) (0.0771) (0.0759)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.001 0.005 0.259 0.050 0.026 0.218 0.059 0.023 0.198

Auditor Independence

αLead-Up 0.0033* 0.0033* 0.0048** 0.0029 0.0029* 0.0047** 0.0025 0.0025 0.0035**

(0.0018) (0.0017) (0.0019) (0.0018) (0.0017) (0.0021) (0.0017) (0.0017) (0.0018)
αPost -0.0001 -0.0005 -0.0002 -0.0004 -0.0001 -0.0004

(0.0006) (0.0006) (0.0006) (0.0006) (0.0006) (0.0005)
βMarket 0.1639*** 0.1383*** 0.1339***

(0.0321) (0.0338) (0.0291)
βSMB -0.1991*** -0.1715*** -0.2311***

(0.0425) (0.0450) (0.0398)
βHML 0.1674*** -0.0071 0.2445***

(0.0612) (0.0684) (0.0612)
N (Weeks) 24 151 151 24 151 151 24 151 151
R2 0.135 0.032 0.304 0.105 0.025 0.247 0.082 0.019 0.316

Table V:

Firm Level Analysis:
Abnormal Excess Returns During Period Leading Up to Passage of the

Sarbanes-Oxley Act of 2002 and the Period from Passage to the End of 2004

This table reports results for the excess returns at the firm level. In the first three columns the dependent variable is the

sum of each firm’s excess return minus the riskless rate during the lead-up period, while in the last three columns it is the

sum of each firm’s excess return minus the riskless rate during the post-SOX period. In Panel A Lobbied Against Enhanced

Financial Disclosure and PCAOB Rules is an indicator variable equal to one if the firm lobbied against the SEC rules related

to SOX Section IV; Lobbied Against Corporate Responsibility Rules is an indicator variable equal to one if the firm lobbied

against the SEC rules related to SOX Section III; Lobbied Against Auditors Independence Rules is an indicator variable equal

to one if the firm lobbied against the SEC rules related to SOX Section IV. In Panel B Predicted to Lobby Against Enhanced

Financial Disclosure and PCAOB Rules is an indicator variable equal to one if the firm was predicted to lobby against the SEC

rules related to SOX Section IV, based on our probit model of Table III; Predicted to Lobby Against Corporate Responsibility

Rules is an indicator variable equal to one if the firm was predicted to lobby against the SEC rules related to SOX Section

III, based on our probit model; Predicted to Lobby Against Auditors Independence Rules is an indicator variable equal to one

if the firm was predicted to lobby against the SEC rules related to SOX Section IV by our probit analysis. Dummies for size

(100 Size dummies) are indicator variables for each size portfolio. Dummies for size and book to market are indicator variables

for 25 size portfolios and 5 book-to-market categories. Since the firms in our sample are very large, we defined the cutoff for

size to include enough observations in each group (the size ranges are 7 percentiles wide up to the 70th percentile, and then 2

percentiles wide). Dummies for size and industry are indicator variables for 25 size portfolios and 10 industry classifications.

To create these indicators we defined the cutoff for size to include enough observations in each group (the size ranges are 7

percentiles wide up to the 70th percentile, and then 2 percentiles wide).

Panel A:

Cumulative weekly excess Cumulative weekly excess
return minus the riskless rate return minus the riskless rate

during the leadup period during the post period
(1) (2) (3) (4) (5) (6)

Lobbied Against Enhanced Finan- 0.1315*** 0.1070*** 0.0864** 0.0401 0.0248 0.0567
cial Disclosure and PCAOB Rules (0.0353) (0.0369) (0.0347) (0.0649) (0.0690) (0.0649)

Lobbied Against Corporate 0.0048 0.0002 0.0104 -0.0594 -0.0478 -0.0798
Responsibility Rules (0.0481) (0.0511) (0.0471) (0.0880) (0.1003) (0.0882)

Lobbied Against Auditor 0.0401 0.0364 0.0330 -0.0356 -0.0391 -0.0096
Independence Rules (0.0834) (0.0877) (0.0817) (0.1533) (0.1652) (0.1532)

Constant -0.1560*** -0.1634*** -0.1549*** 0.7557*** 0.7991*** 0.7554***
(0.0054) (0.0058) (0.0052) (0.0101) (0.0112) (0.0100)

Dummies for size (100 Size dummies) YES NO NO YES NO NO
Dummies for size and book to market NO YES NO NO YES NO
Dummies for size and industry NO NO YES NO NO YES
Observations 7250 6381 7250 6913 5914 6913
R-squared 0.032 0.076 0.112 0.057 0.067 0.096

Panel B:

Cumulative weekly excess Cumulative weekly excess
return minus the riskless rate return minus the riskless rate
during the leadup period during the post period
(1) (2) (3) (4) (5) (6)

Predicted to Lobby Against Enhanced Finan- 0.1258*** 0.1215** 0.0623 -0.0513 -0.0629 -0.0195
cial Disclosure and PCAOB Rules (0.0468) (0.0483) (0.0486) (0.0874) (0.0932) (0.0921)

Predicted to Lobby Against Corporate -0.0190 -0.0114 -0.0007 0.0717 0.0983 0.0169
Responsibility Rules (0.0362) (0.0410) (0.0359) (0.0663) (0.0821) (0.0670)

Predicted to Lobby Against Auditor 0.0626 0.0542 0.0419 -0.0373 -0.0672 -0.0266
Independence Rules (0.0430) (0.0448) (0.0434) (0.0805) (0.0851) (0.0830)

Constant -0.1567*** -0.1650*** -0.1550*** 0.7562*** 0.8002*** 0.7566***
(0.0055) (0.0060) (0.0053) (0.0103) (0.0116) (0.0102)

Dummies for size (100 Size dummies) YES NO NO YES NO NO
Dummies for size and book to market NO YES NO NO YES NO
Dummies for Size and Industry NO NO YES NO NO YES
Observations 7250 6381 7250 6913 5914 6913
R-squared 0.031 0.076 0.112 0.057 0.067 0.096

A
p
p
e
n
d
ix

A
.
D

e
sc

r
ip

ti
o
n
o
f
th
e
R
u
le
s
T
h
e

fo
l

l
o
w

in
g
ta
b
le

d
e
sc

ri
b
e
s

th
e

m
a
in

fe
a
tu

re
s
o
f
e
a
ch
ru
le

d
o
p
te

d
o
r

p
ro

p
o
se

d
b
y

th
e
S
E

C
,

th
e
d
a
te
o
f
p
ro
p
o
si
n
g

re
le

a
se

,
th

e
d
a
te

o
f

a
d
o
p
ti

n
g
re
le
a
se

if
a
v
a
il
a
b
le

,
a
n
d
w

h
e
th

e
r
th
e
ru
le

w
a
s

a
d
o
p
te

d
w

it
h
o
r

w
it

h
o
u
t

a
m

e
n
d
m

e
n
ts
.

P
r
o
p
o
s
in

g
R

e
le

a
s
e

D
a
t
e

A
d
o
p
t
in

g
R

e
–

le
a
s
e

D
a
t
e

D
e
s
c
r
ip

t
io

n
A

d
o
p
t
e
d
/

P
e
n
d
in

g
/
N

o
t

A
d
o
p
t
e
d

S
O
X
T
it
le

I
I
:
A

u
d
it
o
r
I
n
d
e
p
e
n
d
e
n
c
e

1
2
/
2
/
2
0
0
2

1
/
2
8
/
2
0
0
3

S
tr
e
n
g
th
e
n
in
g
th

e
C

o
m
m
is
si
o
n
’s
R
e
q
u
ir
e
m
e
n
ts
R
e
g
a
rd
in
g

A
u
d
it
o
r

In
d
e
p
e
n
d
e
n
c
e

A
d
o
p
te

(N
o
.

3
3
-8

1
5
4
)

(N
o
.
3
3
-8

1
8
3
)

A
m

e
n

d
e
d

3
/
2
6
/
2
0
0
3

(N
o
.
3
3
-8

1
8
3
a
)

C
h
a
n
g
e
s

th
e

re
q
u
ir

e
m
e
n
ts

re
g
a
rd

in
g

a
u
d
it

o
r

in
d
e
p
e
n
d
e
n
c
e

to
e
n
h
a
n
c
e

th
e
in
d
e
p
e
n
d
e
n
c
e
o
f

a
c
–

c
o
u
n
ta
n
ts
th
a
t
a
u
d
it
a
n
d

re
v
ie

fi
n
a
n
c
ia

l
st

a
te

m
e
n
ts

a
n
d
p
re
p
a
re

a
tt

e
st
a
ti
o
n

re
p
o
rt

s
fi
le

d
w
it
h
th
e
C
o
m
m
is

si
o
n
.

In
c
lu

d
e
s

re
g
u
la

ti
o
n

re
la

te
d

to
n
o
n
-a

u
d
it

se
rv

e
s.

P
ro

h
ib

it
s
p
a
rt

n
e
rs

o
n
th
e
a
u
d
it

e
n
g
a
g
e
m

e
n
t
te

a
m
fr
o
m
p
ro

v
id

in
g
a
u
d
it
se
rv

ic
e
s
to

th
e

is
su

e
r
fo

r
m

o
re

th
a
n

fi
v
e

c
o
n
se

c
u
ti
v
e

y
e
a
rs
.

(w
it

h
a
m

e
n
d
m

e
n
t)

[S
O
X
:
S
e
c
ti
o
n
2
0
1
-2
0
7
;
A
u
d
it
o
r
In
d
e
p
e
n
d
e
n
c
e
]
S
O
X
T
it
le

I
I
I
:
C

o
r
p
o
r
a
t
e
R
e
s
p
o
n
s
ib
il
it
y

1
/
8
/
2
0
0
3

4
/
9
/
2
0
0
3

S
ta
n
d
a
rd
s
R
e
la
ti
n
g
T
o
L
is
te
d
C
o
m
p
a
n
y
A
u
d
it
C
o
m
m
it

te
e
s

A
d
o
p
te

d
(l

e
ss

re
st

ri
c
ti

v
e
)

(N
o
.

3
4
-4

7
1
3
7
)

(N
o
.
3
3
-8

2
2
0
)

R
e
q
u
ir
e
s
n
a
ti

o
n

a
l
se

c
u
ri

ti
e
s

e
x
ch

a
n
g
e
s
a
n
d
n
a
ti
o
n
a
l
se
c
u
ri
ti
e
s
a
ss
o
c
ia
ti
o
n
s

to
p
ro

h
ib

it
th

li
st

in
g
o
f
a
n
y

se
c
u
ri

ty
o
f

a
n
is
su
e
r
th
a
t

n
o
t

in
c
o
m

p
li
a
n
c
e

in
th

e
a
u
d
it

c
o
m
m
it
te
e
re
q
u
ir
e
m
e
n
ts

m
a
n
d
a
te

d
b
y
th
e
S
a
rb
a
n
e
s-
O
x
le
y
A
c
t
o
f
2
0
0
2

(t
h
e

in
d
e
p
e
n
d
e
n
c
e

o
f
a

u
d
it

c
o
m
m
it
te
e

m
e
m

b
e
rs

,
th
e
a
u
d
it
c
o
m
m
it

te
e
’s

re
sp

o
n
si
b
il
it
y

to
se

le
c
t

a
n
d

o
v
e
rs

e
e
th
e
is
su

e
r’

s
in

d
e
p
e
n
d
e
n
t

a
c
c
o
u
n
ta

n
t,

p
ro

c
e
d
u
re

s
fo

r
h
a
n
d
li
n
g

c
o
m

p
la

in
ts

re
g
a
rd
in
g
th
e
is
su
e
r’

a
c
c
o
u
n
ti

n
g

p
ra

c
ti
c
e
s,

th
e

a
u
th

o
ri
ty
o
f
th
e
a
u
d
it
c
o
m
m
it
te
e

to
e
n
g
a
g
e

a
d
v
is

o
rs

;
a

n
d

fu
n
d
in

g
fo

r
th

e
in

d
e
p
e
n
d
e
n
t
a
u
d
it
o
r
a
n
d
a
n
y

o
u
ts

id
e

a
d
v
is
o
rs

e
n
g
a
g
e
d

b
y
th
e
a
u
d
it
c
o
m
m
it
te

e
).

[S
O
X
S
e
c
ti
o
n
3
0
1
:
P
u
b
li
c
C
o
m
p
a
n
y
A
u
d
it
C
o
m
m
it
te
e
s]

6
/
1
7
/
2
0
0
2

8
/
2
9
/
2
0
0
2

C
e
rt
ifi
c
a
ti
o
n
o
f
D
is
c
lo
su
re
in
C
o
m
p
a
n
ie
s’
Q
u
a
rt
e
rl
y
a
n
d

A
n
n
u
a
l
R

e
p
o
rt

s
A

d
o
p
te
d
(N
o
.
3
4
-4

6
0
7
9
)

U
p
–

d
a
te

d
8
/
2
/
2
0
0
2

(N
o
.
3
4
-4

6
3
0
0
)

(N
o
.
3
3
-8

1
2
4
)

R
e
q
u
ir
e
s
a
n
is
su
e
r’

p
ri

n
c
ip
a
l
e
x
e
c
u
ti
v
e
a
n
d
fi
n
a
n
c
ia

l
o
ffi

c
e
rs
e
a
ch

c
e
rt

if
y
th
e
fi
n
a
n
c
ia

l
a
n
d

o
th
e
r
in
fo

rm
a
ti

o
n

c
o
n
ta

in
e
d

in
th

e
is

su
e
r’

q
u
a
rt

e
rl
y
a
n
d

a
n
n
u
a
l

re
p
o
rt

s.
A

ls
o

re
q
u
ir
e
s

th
e
se

o
ffi
c
e
rs
to
c
e
rt
if
y

th
a
t
th

e
y
a
re
re
sp
o
n
si
b
le

fo
r
e
st

a
b
li
sh

in
g
,
m

a
in

ta
in

in
g
is
su
e
r’
s
in
te
rn

a
l

c
o
n
tr

o
ls

.
[S

O
X
S
e
c
ti
o
n
3
0
2
:
C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
F
o
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]

3
/
2
1
/
2
0
0
3

6
/
5
/
2
0
0
3

C
e
rt
ifi
c
a
ti
o
n
o
f
D
is
c
lo
su
re
in
C
e
rt
a
in
E
x
ch
a
n
g
e
A
c
t
R
e
p
o
rt
s
A
d
o
p
te
d
(N
o
.
3
3
-8

2
1
2
)

(i
n
c
lu
d
e
d

in
N

o
.
3
3
-8

2
3
8
)

E
x
te

n
d
s

re
q
u
ir
e
m
e
n
ts
to
p
ro
v
id
e
th

e
c
e
rt

ifi
c
a
ti
o
n
s

re
q
u
ir
e
d
b
y

S
e

c
ti
o
n
s

3
0
2
a
n
d
9
0
6
o
f
th
e
S
a
rb
a
n
e
s-
O
x
le
y
A
c
t
o
f
2
0
0
2

to
re

p
o
rt

s
o
th

e
r
th
a
n

a
n
n
u
a
l
a
n
d

q
u
a
rt
e
rl
y
re
p
o
rt

s.
[S

O
X
S
e
c
ti
o
n
3
0
2
:
C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
F
o
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]
[S
O
X
S
e
c
ti
o
n

9
0
6
:

C
o
rp
o
ra
te
R
e
sp
o
n
si
b
il
it
y
F
o
r
F
in
a
n
c
ia
l
R
e
p
o
rt
s]

1
0
/
1
8
/
2
0
0
2

5
/
2
0
/
2
0
0
3

Im
p
ro
p
e
r
In
fl
u
e
n
c
e

O
n

C
o
n
d
u
c
t

O
f
A

u
d
it
s
A
d
o
p
te
d
(N
o
.
3
4
-4

6
6
8
5
)

(N
o
.
3
4
-4

7
8
9
0
)

Im
p
le
m
e
n
ts
th
e
S
O

X
p
ro

h
ib
it
io
n
to
o
ffi
c
e
rs
a
n
d
d
ir
e
c
to

o
f
a
n

is
su

e
r,

a
n
d

p
e
rs

o
n
s

a
c
ti

n
g

u
n
d
e
r

th
e
d
ir
e
c
ti
o
n
o
f
a
n
o
ffi

c
e
r

o
r
d
ir
e
c
to

r,
fr

o
m

ta
k
in

g
a
n
y

a
c
ti
o
n

to
fr

a
u
d
u
le

n
tl
y

in
fl
u
e
n
c
e
,
c
o
e
rc

e
,

m
a
n
ip

u
la

te
o
r
m

is
le

a
d
th
e
a
u
d
it

o
r
o
f
th

e
is
su
e
r’

s
fi
n
a
n
c
ia

l
st
a
te
m
e
n
ts

fo
r
th

e
p
u
rp

o
se

o
f
re

n
d
e
ri

n
g
th
e
fi
n
a
n
c
ia
l
st
a
te
m
e
n
ts

m
a
te

ri
a

ll
y

m
is

le
a
d
in

g
.

c
o
n
ti
n
u
e
d
o
n
n
e
x
t
p
a
g
e
52

P
r
o
p
o
s
in
g
R
e
le
a
s
e
D
a
t
e
A
d
o
p
t
in
g
R
e
–
le
a
s
e
D
a
t
e
D
e
s
c
r
ip
t
io
n
A

d
o
p
t
e
d
/
P
e
n
d
in

g
/
N
o
t
A
d
o
p
t
e
d
[S
O
X
S
e
c
ti
o
n

3
0
3
:

Im
p
ro
p
e
r
In
fl
u
e
n
c
e
O
n
C
o
n
d
u
c
t
O
f
A
u
d
it
s]

1
1
/
2
1
/
2
0
0
2

1
/
2
4
/
2
0
0
3

R
e
te
n
ti
o
n
o
f
R
e
c
o
rd
s
R
e
le
v
a
n
t
to
A

u
d
it
s

a
n
d
R
e
v
ie
w
s
A
d
o
p
te

d
(N

o
.
3
3
-8

1
5
1
)

(N
o
.
3
3
-8

1
8
0
)

R
e
q
u
ir
e
s
a
c
c
o
u
n
ta
n
ts

w
h
o

a
u
d
it
o
r
re
v
ie

w
a
n

is
su
e
r’
s
fi
n
a
n
c
ia
l
st
a
te
m
e
n
ts
to
re
ta
in
c
e
rt
a
in

re
c
o
rd

s
re

le
v
a
n
t

to
th
a
t
a
u
d
it
o
r
re
v
ie

w
fo

r
a

p
e
ri

o
d
o
f

se
v
e
n

y
e
a
rs
fr
o
m
th
e
e
n
d
o
f
th
e

fi
sc

a
l

y
e
a
r

in
w

h
ic
h
a
n
a
u
d
it
o
r
re
v
ie

w
w

a
s

c
o
n
c
lu

d
e
d
.

(

m
o
re

re
st
ri
c
ti
v
e
)
[S
O

X
S
e
c
ti
o
n

8
0
2
:
C
ri
m
in
a
l
P
e
n
a
lt
ie
s
F
o
r

A
lt
e
ri

n
g
D
o
c
u
m
e
n
ts
]

1
1
/
6
/
2
0
0
2

1
/
2
2
/
2
0
0
3

In
si
d
e
r
T
ra
d
e
s
D
u
ri
n
g
P
e
n
si
o
n
F
u
n
d
B
la
ck
o
u
t
P
e
ri
o
d
s
A
d
o
p
te
d
(N
o
.
3
4
-4

6
7
7
8
)

(N
o
.
3
4
-4

7
2
2
5
)

P
ro
h
ib
it
s
a
n
y
d
ir
e
c
to

r
o
r

e
x
e
c
u
ti
v
e
o
ffi
c
e
r
o
f
a
n
is
su
e
r
o
f
a
n
y

e
q
u
it
y

se
c
u
ri

ty
fr

o
m

,
d
ir

e
c
tl

y
o
r

in
d
ir

e
c
tl
y
,

p
u
rc

a
si

n
g
,

se
ll
in

g
o
r

o
th

e
rw

is
e

a
c
q
u
ir

in
g
o
r

a
n
sf

e
rr

in
g
a
n
y
e
q
u
it
y
se
c
u
ri
ty
o
f
th
e
is
su
e
r

d
u
ri

n
g

a
p
e
n
si

o
n
p
la

n
b
la

ck
o
u
t
p
e
ri
o
d
th
a
t

te
m

p
o
ra

ri
ly

p
re

v
e
n
ts

p
la

n
p
a
rt

ic
ip

a
n
ts

o
r

b
e
n
e

fi
c
ia

ri
e
s

fr
o
m

e
n
g
a

g
in

g
in
e
q
u
it
y
se
c
u
ri
ti
e
s

a
n
sa

c
ti
o
n
s

th
ro

u
g
h

e
ir

p
la

n
a
c
c
o
u
n
ts

,
if

th
e
d
ir
e
c
to
r
o
r
e
x
e
c
u
ti
v
e
o
ffi
c
e
r
a
c
q
u
ir
e
d
th
e
e
q
u
it
y
se
c
u
ri

ty
in

c
o
n
n
e
c
ti

o
n
w
it

h
h
is

o
r
h
e
r
se
rv
ic
e
o
r
e
m

p
lo

y
m

e
n
t
a
s

a
d
ir

e
c
to
r
o
r
e
x
e
c
u
ti
v
e
o
ffi

c
e
r.

[S
O
X
S
e
c
ti
o
n
3
0
6
:
In
si
d
e
r
T
ra
d
e
s
D
u
ri
n
g
P
e
n
si
o
n
F
u
n
d
B
la
ck
o
u
t]
1
1
/
2
1
/
2
0
0
2

1
/
2
9
/
2
0
0
3

Im
p
le
m
e
n
ta
ti
o
n
o
f
S
ta
n
d
a
rd
s
o
f
P
ro
fe
ss
io
n
a
l
C
o
n
d
u
c
t
fo
r
A
tt
o
rn
e
y
s:
U
p
th
e
L
a
d
d
e
r
P
ro
v
is
io
n
A
d
o
p
te
d
(N
o
.
3
3
-8

1
5
0
)

(N
o
.
3
3
-8

1
8
5
)

E
st
a
b
li
sh
e
s
a
n

u
p
-t

h
e
-l
a
d
d
e
r

re
p
o
rt
in
g

sy
st

e
m
fo
r
a
tt
o
rn

e
y
s

w
h
o

a
p
p
e
a
r

a
n
d
p
ra
c
ti
c
e

b
e
fo

re
th

e
C
o
m
m
is
si
o
n
o
n

b
e
h
a
lf

o
f
p
u
b
li
c

c
o
m
p
a
n
ie
s.
R
e
q
u
ir
e
s
a
tt
o
rn
e
y
s
to
re
p
o
rt

e
v
id

e
n
c
e
o
f
a
m
a
te

ri
a
l

v
io

la
ti

o
n
o
f
th
e
se
c
u
ri
ti
e
s
la
w
s,
a
m
a
te
ri
a
l

b
re

a
ch
o
f

a
fi
d
u
c
ia

ry
d
u
ty

,
o
r

a
si

il
a
r

m
a
te
ri
a
l
v
io

la
ti
o
n

b
y

a
c
o
m

p
a
n
y
o
r
a
n
y

o
f
it
s

a
g
e
n
ts

to
it
s

ch
ie

f
le

g
a
l
c
o
u
n
se

l
(C

L
O

)
o
r

to
b
o
th

it
s

C
L
O

a
n
d
ch
ie

e
x
e
c
u
ti
v
e

o
ffi
c
e
r

(

C
E

O
);

a
n
d

if
th

e
C
L
O
o
r
C
E

O
d
o
e
s

n
o
t
re
sp
o
n
d

a
p
p
ro

p
ri
a
te

ly
to

th
e
e
v
id

e
n
c
e
,
re

p
o
rt

th
is

e
v
id
e
n
c
e
to
th
e
a
u
d
it
c
o
m
m
it
te

e
,
o
th

e
r

in
d
e
p
e
n
d
e
n
t

c
o
m
m
it
te

e
,
o
r

th
e

b
o
a
rd

o
f
d
ir

e
c
to

rs
.

[S
O
X
S
e
c
ti
o
n
3
0
7
:
R
u
le
s
O
f
P
ro
fe
ss
io
n
a
l
R
e
sp
o
n
si
b
il
it
y
F
o
r
A
tt
o
rn
e
y
s]
1
/
2
9
/
2
0
0
3
P
e
n
d
in

g
Im

p
le
m
e
n
ta
ti
o
n
o
f
S
ta
n
d
a
rd
s
o
f
P
ro
fe
ss
io
n
a
l
C
o
n
d
u
c
t
fo
r
A
tt
o
rn
e
y
s:
N
o
is
y
-W

h
d
ra

w
a
l
P
e
n
d
in
g
(N
o
.
3
3
-8

1
8
6
)

R
e
q
u
ir
e
s

th
a
t,

in
c
e
rt

a
in

c
ir

c
u
m

st
a
n
c
e
s,

a
n
a
tt
o
rn
e
y
w
it
h
d
ra

w
fr

o
m
re
p
re

se
n
ti

n
g
a
n
is
su
e
r
a
n
d
re
p
o
rt
th
a
t
w
it
h
d
ra

w
a
l
to

th
e
C
o
m
m
is
si
o
n
.
[S
O
X
S
e
c
ti
o
n
3
0
7
:
R
u
le
s
O
f
P
ro
fe
ss
io
n
a
l
R
e
sp
o
n
si
b
il
it
y
F
o
r
A
tt
o
rn
e
y
s]
R
e
la
te
d
N
Y
S
E
A
n
d
N
A
S
D
A
Q
R
u
le
s
(N
o
t
P
a
rt

O
f
S
O

X
It
se
lf
)

8
/
1
6
/
2
0
0
2

1
1
/
4
/
2
0
0
3

N
Y
S
E
a
n
d
N
A
S
D
R
u
le
m
a
k
in
g
:
N
e
w
S
ta
n
d
a
rd
s
A
n
d
C
h
a
n
g
e
s

In
C

o
rp
o
ra
te
G
o
v
e
rn
a
n
c
e
A
n
d
A
d
o
p
te
d

(O
ri

g
in
a
l
P

ro
p
o
sa

l)
(N

o
.
3
4
-4

8
7
4
5
)

P
ra
c
ti
c
e
s

O
f
L
is

te
d
C
o
m
p
a
n
ie

s
(w

it
h

v
a
ri

o
u
s

m
o
d
ifi

c
a
–

4
/
1
1
/
2
0
0
3

(A
m

e
n
d
–

m
e
n
t
N
o
.
1
)

1
0
/
8
/
2
0
0
3

(A
m
e
n
d
–
m
e
n
t
N
o
.
2
)
N
Y
S
E
re
q
u
ir
e
s
fo
r
e
a
ch
li
st
e
d
c
o
m

p
a
n
y
:

(1
)
th
a
t
th
e
b
o
a
rd
o
f
d
ir
e
c
to

rs
c
o
n
si

st
s

o
f
a

m
a
jo

ri
ty

o
f
in
d
e
p
e
n
d
e
n
t
d
ir
e
c
to

rs
;

(2
)
th
a
t
th
e

n
o
n
-m

a
n
a
g
e
m
e
n
t
d
ir
e
c
to

rs
sh

o
u
ld

m
e
e
t

a
t
re
g
u
la

rl
y

sc
h
e
d
–

u
le

d
e
x
e
c
u
ti

v
e

se
ss

io
n
s

w
it
h
o
u
t

m
a
n
a
g
e
m

e
n
t;
(3
)

to
h
a
v
e

n
o
m

in
a
ti

n
g
/
c
o
rp

o
ra

te
g
o
v
e
rn

a
n
c
e
c
o
m
m
it
te
e
c
o
m
p
o
se

d
e
n
ti

re
ly

o
f
in
d
e
p
e
n
d
e
n
t
d
ir
e
c
to
rs
;
(4
)
to
h
a
v
e
a
c
o
m
p
e
n
sa
ti
o
n
c
o
m
m
it
te
e
c
o
m
p
o
se

d
e
n
ti
re

ly
o
f

in
d
e
p
e
n
d
e
n
t
d
ir
e
c
to
rs
;
(5
)
to
h
a
v
e
a
m

in
im

u
m

th
re

e
-p

e
rs
o
n
a
u
d
it
c
o
m

–
m

it
te
e
c
o
m
p
o
se
d
e
n
ti
re

ly
o
f
d
ir

e
c
to

rs
th

a
t
m
e
e
t
th
e
in
d
e
p
e
n
d
e
n
c
e

a
n
d
a
rd

s;
(6

)
th

a
t
th
e
a
u
d
it
c
o
m
m
it
te
e
h
a
s
a
w

ri
tt

e
n
a
u
d
it
c
o
m
m
it
te
e

ch
a
rt

e
r;

(7
)
to
h
a
v
e
a
n

in
te

rn
a
l

a
u
d
it

fu
n
c
ti

o
n
;
(8

)
to

a
d
o
p
t

a
n
d

d
is

c
lo

se
c
o
rp

o
ra
te
g
o
v
e
rn
a
n
c
e

g
u
id

e
li
n
e
s;

(9
)

to
a

d
o
p
t

a
n
d
d
is
c
lo

se
a

c
o
d
e

o
f
b
u
si
n
e
ss

c
o
n
d
u
c
t

a
n
d
e
th

ic
s

fo
r
d
ir
e
c
to

rs
,

o
ffi
c
e
rs
a
n
d
e
m
p
lo

y
e
e
s;

(1
0
)

to
h
a
v
e
th
e
C
E

O
c
e
rt

if
y
to
th

e
N

Y
S
E

e
a
ch
y
e
a
r
th
a
t
h
e
o
r

sh
e

is
n
o
t

a
w
a
re
o
f
a
n
y
v
io
la
ti
o
n
b
y
th
e
c
o
m
p
a
n
y
o
f
th
e
N
Y
S
E

’s
c
o
rp

o
ra
te
g
o
v
e
rn
a
n
c
e
li
st
in
g

st
a
n
d
a
rd

s.
S
im

il
a
r
ru
le
s
fo
r
N

A
S
D

ti
o
n
s)

c
o
n
ti
n
u
e
d
o
n
n
e
x
t
p
a
g
e
53

P
r
o
p
o
s
in
g
R
e
le
a
s
e
D
a
t
e
A
d
o
p
t
in
g
R
e
–
le
a
s
e
D
a
t
e
D
e
s
c
r
ip
t
io
n
A
d
o
p
t
e
d
/
P
e
n
d
in
g
/
N
o
t
A
d
o
p
t
e
d

1
0
/
8
/
2
0
0
2

6
/
3
0
/
2
0
0
3

N
Y
S
E
a
n
d
N
A
S
D
R
u
le
m
a
k
in
g
:
S
h
a
re
h
o
ld
e
r
A
p
p
ro
v
a
l

o
f
E

q
u
it
y
C
o
m
p
e
n
sa
ti
o
n
P
la
n
s
a
n
d
th
e
A
d
o
p
te
d
(N
o
.
3
4
-4

6
6
2
0
)

(N
o
.
3
4
-4

8
1
0
8
)

V
o
ti
n
g
o
f
P
ro
x
ie
s

C
o
rr

e
c
te

d
1
0
/
2
1
/
2
0
0
2

(N
o
.
3
4
-4

6
6
2
0
A

)
R
e
q
u
ir
e
s

sh
a
re

h
o
ld
e
r
a
p
p
ro
v
a
l
o
f
a
ll

e
q
u
it
y
-c

o
m
p
e
n
sa
ti
o
n
p
la
n
s
a
n
d
m
a
te

ri
a

l
re

v
is
io
n
s

to
su

ch
p
la

n
s,

su
b
je

c
t

to
li
m

it
e
d

e
x
e
m

p
ti
o
n
s

fo
r
is
su
e
rs
li
st
e
d
in
N
A
S
D
a
n
d
N
Y
S
E
R
e
la
te
d
S
E
C
R
u
le
s
(N
o
t
P
a
rt
O
f
S
O
X
It
se
lf
)

1
0
/
1
4
/
2
0
0
3

P
e
n
d
in

g
S
e
c
u
ri

ty
H
o
ld
e
r
D
ir
e
c
to
r
N
o
m
in
a
ti
o
n
s
P
e
n
d
in
g
(N
o
.
3
4
-4

8
6
2
6
)

R
e
q
u
ir
e
s,
u
n
d
e
r
c
e
rt
a
in
c
ir
c
u
m
st
a
n
c
e
s,
th
a
t
n
o
m

in
e
e
s

o
f
lo

n
g
-t

e
rm

se
c
u
ri

ty
h
o
ld

e
rs
,
o
r
g
ro
u
p
s
o
f

lo
n
g
-t

e
rm
se
c
u
ri
ty
h
o
ld
e
rs
,
w
it
h

si
g
n
ifi

c
a
n
t

h
o
ld

in
g
s

a
re

in
c
lu

d
e
d
in
c
o
m
p
a
n
y
p
ro
x
y
m
a
te

ri
a
ls

.
S
O
X
T
it
le
I
V
A
n
d
T
it

le
I
:
E
n
h
a
n
c
e
d

F
in
a
n
c
ia
l
D
is
c
lo
s
u
r
e
A
n
d
P
C
A
O
B

5
/
1
0
/
2
0
0
2

o
n
e

D
is
c
lo
su
re

In
M

a
n
a
g
e
m
e
n
t’
s
D
is
c
u
ss
io
n
A
n
d
A
n
a
ly
si
s
O
f
C
ri
ti
c
a
l
A
c
c
o
u
n
ti
n
g
P
o
li
c
ie

s
N

o
t
A
d
o
p
te
d
(N
o
.
3
3
-8
0
9
8
)
D
is
c
lo
su
re
re
q
u
ir
e
m
e
n
ts
th
a
t
re
g
a
rd

a
p
p
li
c
a
ti

o
n

o
f
c
o
m

p
a
n
ie

s’
c
ri

ti
c
a
l
a
c
c
o
u
n
ti

n
g

p
o
li
c
ie

s
in

tw
o

a
re

a
s:

a
c
c
o
u
n
ti
n
g
e
st

im
a
te

s
a
c
o
m
p
a
n
y

m
a
k
e
s

in
a
p
p
ly

in
g
it
s
a
c
c
o
u
n
ti
n
g
p
o
li
c
ie
s
a
n
d
th
e

in
it

ia
l

a
d
o
p
ti
o
n

b
y
a
c
o
m
p
a
n
y
o
f
a
n

a
c
c
o
u
n
ti
n
g

p
o
li
c
y

th
a
t
h
a
s
a
m
a
te
ri
a
l

im
p
a
c
t

o
n
it
s
fi
n
a
n
c
ia
l
p
re
se
n
ta

ti
o
n
.

(p
ro

p
o
se

d
ru

le
re

p
la
c
e
d
b
y
th
e
ru
le

b
e
lo

w
)

[S
O
X
S
e
c
ti
o
n
4
0
1
:
D
is
c
lo
su
re

In
P
e
ri

o
d
ic
R
e
p
o
rt
s]

1
1
/
4
/
2
0
0
2

1
/
2
7
/
2
0
0
3

D
is
c
lo
su
re
In
M
a
n
a
g
e
m
e
n
t’
s
D
is
c
u
ss
io
n
A
n
d
A
n
a
ly
si
s

O
f
O

ff
-B
a
la
n
c
e

S
h
e
e
t

A
rr

a
n
g
e
m

e
n
ts
A
d
o
p
te
d
(N
o
.
3
3
-8

1
4
4
)

(N
o
.
3
3
-8

1
8
2
)

C
o
n
tr

a
c
tu

a
l
O

b
li
g
a
ti
o
n
s

a
n
d

C
o
n
ti
n
g
e
n
t

L
ia

b
il
it
ie

s
A
n
d
C
o
m

m
it
m

e
n
ts
2
6
R
e
q
u
ir
e
s
d
is
c
lo
su
re
o
f

o
ff
-b

a
la
n
c
e

sh
e
e
t

tr
a
n
sa
c
ti
o
n
s,

a
rr

a
n
g
e
m
e
n
ts

,
o
b
li
g
a
ti

o
n
s,
th
a
t

h
a
v
e
,

o
r

m
a
y

h
a
v
e
,
a
m
a
te
ri
a
l

e
ff
e
c
t

o
n
fi
n
a
n
c
ia

l
c
o
n
d
it
io

n
,

ch
a
n
g
e
s

in
fi
n
a
n
c
ia

l
c
o
n
d
it
io
n
,

re
v
e
n
u
e
s

o
r

e
x
p
e
n
se

s,
re

su
lt
s

o
f

o
p
e
ra

ti
o
n
s,

li
q
u
id

it
y
,
c
a
p
it
a
l
e
x
p
e
n
d
it
u
re

s
o
r

c
a
p
it
a
l
re

so
u
rc

e
s.
[S
O
X
S
e
c
ti
o
n
4
0
1
:
D
is
c
lo
su
re
In
P
e
ri
o
d
ic
R
e
p
o
rt
s]

1
1
/
5
/
2
0
0
2

1
/
2
2
/
2
0
0
3

C
o
n
d
it
io

n
s
F
o
r
U
se

O
f
N

o
n
-G
A
A
P
F
in
a
n
c
ia
l
M
e
a
su
re
s
A
d
o
p
te
d
(N
o
.
3
3
-8

1
4
5
)

(N
o
.
3
3
-8
1
7
6
a
n
d
N
o
.

3
3
–

8
2
1
6
)

R
e
q
u
ir

e
s
p
u
b
li
c

c
o
m
p
a
n
ie
s
th

a
t
d
is

c
lo

o
r
re

le
a
se

th
e
se

n
o
n
-G

A
A

P
fi
n
a
n
c
ia

l
m

e
a
su

re
s
to

in
c
lu

d
e
,

in
th
a
t
d
is
c
lo
su
re
o
r
re
le
a
se
,
a
p
re
se
n
ta
ti
o
n
o
f
th
e
m
o
st
c
o
m

p
a
ra

b
le

G
A

A
P

fi
n
a
n
c
ia
l
m
e
a
su

re
a
n
d

a
re

c
o
n
c
il
ia

ti
o
n
o
f
th
e
d
is
c
lo

se
d

n
o
n
-G
A
A
P
fi
n
a
n
c
ia
l
m
e
a
su

re
to

th
e

m
o
st

c
o
m
p
a
ra
b
le
G
A
A
P
fi
n
a
n
c
ia
l
m
e
a
su

re
.

[S
O
X
S
e
c
ti
o
n
4
0
1
:
D
is
c
lo
su
re
In
P
e
ri
o
d
ic
R
e
p
o
rt
s]

1
2
/
2
0
/
2
0
0
2

5
/
7
/
2
0
0
3

M
a
n
d
a
te

d
E
le
c
tr
o
n
ic
F
il
in
g
a
n
d
W
e
b
si
te
P
o
st
in
g
fo
r
F
o
rm
s
3
,
4
a
n
d

5
A

d
o
p
te
d
(N
o
.
3
3
-8

1
7
0
)

(N
o
.
3
3
-8

2
3
0
)

M
a
n
d
a
te
s
th

e
e
le

c
tr
o
n
ic

fi
li
n
g
,
a
n
d

w
e
b
si

te
p
o
st

in
g
b
y
is
su
e
rs
w
it

h
c
o
rp

o
ra

te
w

e
b
si

te
s,

o
f
b
e
n
e
–

fi
c
ia
l
o
w
n
e
rs

h
ip

re
p
o
rt
s
fi
le
d
b
y
o
ffi
c
e
rs
,
d
ir
e
c
to

rs
a
n
d

p
ri
n
c
ip
a
l
se
c
u
ri
ty
h
o
ld
e
rs
[S
O
X
S
e
c
ti
o
n

4
0
3
:

D
is
c
lo
su
re
s
O

f
T
ra

n
sa

c
ti
o
n
s
In

v
o
lv
in
g
M
a
n
a
g
e
m

e
n
t
A

n
d
P
ri
n
c
ip
a
l
S
to

ck
h
o
ld

–
e
rs

]

1
0
/
2
2
/
2
0
0
2

6
/
5
/
2
0
0
3
D
is
c
lo
su
re
R
e
q
u
ir
e
d

B
y

S
e
c
ti
o
n
4
0
4

O
f
S
a
rb

a
n
e
s-
O
x
le

y
O

n
In

te
rn
a
l
C
o
n
tr
o
ls
A
d
o
p
te
d
(N
o
.
3
3
-8

1
3
8
)

(N
o
.
3
3
-8
2
3
8
)
R
e
q
u
ir
e
s
is
su
e
rs
to
in
c
lu
d
e
in
th
e
ir
a
n
n
u
a
l
re
p
o
rt
s
a
re
p
o
rt
o
f
m
a
n
a
g
e
m
e
n
t
o
n
th
e
c
o
m

p
a
n
y
’s

in
te
rn
a
l
c
o
n
tr

o
l

o
v
e
r

fi
n
a
n
c
ia
l
re
p
o
rt
in
g
in
c
lu
d
in

g
:a

st
a
te
m
e
n
t
o
f
m
a
n
a
g
e
m
e
n
t’
s
re

sp
o
n
si

b
il
it
y
fo
r
e
st
a
b
li
sh
in
g
a
n
d
m
a
in
ta
in
in
g

a
d
e
q
u
a
te

in
te
rn
a
l
c
o
n
tr

o
l;

m
a
n
a
g
e
m
e
n
t’

s
a
ss

e
ss
m
e
n
t
o
f
th
e

e
ff
e
c
ti

v
e
n
e
ss

o
f
th
e
c
o
m
p
a
n
y
’s
in
te
rn
a
l
c
o
n
tr
o
l;
a
st
a
te
m
e
n
t

id
e
n
ti
fy

in
g
th
e

fr
a
m

e
w

o
rk

u
se

d
to

e
v
a
lu

a
te
th
e
e
ff
e
c
ti
v
e
n
e
ss
o
f
th
e
in
te
rn
a
l
c
o
n
tr
o
ls
;
a
st
a
te
m
e
n
t
th
a
t
th
e

re
g
is

te
re

d
p
u
b
li
c

a
c
c
o
u
n
ti
n
g
fi
rm

th
a
t
a
u
d
it

e
d
th
e
c
o
m
p
a
n
y
’s
fi
n
a
n
c
ia
l
st
a
te
m
e
n
ts

h
a
s
is

su
e
d

a
n
a
tt
e
st
a
ti
o
n
re
p
o
rt
o
n
m
a
n
a
g
e
m
e
n
t’
s
a
ss
e
ss
m
e
n
t
o
f
th
e
c
o
m
p
a
n
y
’s
in
te

a
l
c
o
n
tr

o
l
o
v
e
r

fi
n
a
n
c
ia
l
re
p
o
rt

in
g
.

c
o
n
ti
n
u
e
d
o
n
n
e
x
t
p
a
g
e
54

P
r
o
p
o
s
in
g
R
e
le
a
s
e
D
a
t
e
A
d
o
p
t
in
g
R
e
–
le
a
s
e
D
a
t
e
D
e
s
c
r
ip
t
io
n
A
d
o
p
t
e
d
/
P
e
n
d
in
g
/
N
o
t
A
d
o
p
t
e
d
[S
O
X
S
e
c
ti
o
n
4
0
4
:
M
a
n
a
g
e
m
e
n
t
a
ss
e
ss
m
e
n
t

o
f
in

te
rn
a
l
c
o
n
tr
o
ls
]
1
0
/
2
2
/
2
0
0
2
1
/
2
2
/
2
0
0
3
D
is
c
lo
su
re
R
e
q
u
ir
e
d
B
y
S
e
c
ti
o
n
s
4
0
6
A
n
d
4
0
7
O
f
S
a
rb
a
n
e
s-
O
x
le
y
O
n
A
u
d
it
C
o
m
m
it
te

e
F
in

a
n
c
ia
l
A
d
o
p
te
d
(N
o
.
3
3
-8
1
3
8
)
(N
o
.
3
3
-8

1
7
7
)

x
p
e
rt

a
n
d
C
o
d
e
o
f
E
th
ic
s
(w
it
h
a
m
e
n
d
m
e
n
t)
A
m

e
n
d
e
d

3
/
2
6
/
2
0
0
3
(N
o
.
3
3
-8

1
7
7
a
)

R
e
q
u
ir
e
s
a
c
o
m
p
a
n
y

to
d
is

c
lo

se
w

h
e
th
e
r
it
s
a
u
d
it
c
o
m
m
it
te
e
in
c
lu
d
e
s
a
t

le
a
st

o
n
e
m
e
m
b
e
r
w
h
o

is
a

fi
n
a
n
c
ia

l
e
x
p
e
rt

;
a
ls

o
re
q
u
ir

e
d
is

c
lo
su
re

o
f
w

h
e
th
e
r
th
e
c
o
m
p
a
n
y
h
a
s
a
d
o
p
te
d
a
c
o
d
e

o
f
e
th

ic
s
fo
r
it
s

se
n
io

r
fi
n
a
n
c
ia

l
o
ffi
c
e
rs
a
n
d

if
n
o
t

w
h
y

it
h
a
s

n
o
t

d
o
n
e

so
.

[S
O
X
S
e
c
ti
o
n

4
0
6
:

C
o
d
e
O
f
E
th
ic
s
F
o
r
S
e
n
io
r
F
in
a
n
c
ia
l
O

ffi
c
e
rs

]
[S
O
X
S
e
c
ti
o
n

4
0
7
:

D
is
c
lo
su
re
O
f
A
u
d
it
C
o
m
m
it
te
e
F
in
a
n
c
ia
l
E
x
p
e
rt
]
6
/
1
7
/
2
0
0
2

3
/
1
6
/
2
0
0
4

A
d
d
it
io
n
a
l
F
o
rm
8
-K
D
is
c
lo
su
re
R
e
q
u
ir
e
m
e
n
ts
A
n
d
A
c
c
e
le

ra
ti
o
n

O
f
F
il
in

g
D
a
te
A
d
o
p
te
d
(N
o
.
3
3
-8
1
0
6
)
(N
o
.
3
4
-4

9
4
2
4
)

A
d
d
s

e
ig

h
t
m
o
re

e
v
e
n
ts

th
a
t

n
e
e
d

to
b
e

re
p
o
rt
e
d
o
n
F
o
rm
8
-K
u
n
d
e
r
th
e
S
e
c
u
ri
ti
e
s
E
x
ch
a
n
g
e
A
c
t
o
f

1
9
3
4
.

A
ls

o
,
tr

a
n
sf
e
rs
tw
o

it
e
m

s
fr

o
m
th
e
p
e
ri
o
d
ic
re
p
o
rt
s
a
n
d

e
x
p
a
n
d

d
is
c
lo
su
re

s
u
n
d
e
r

tw
o

e
x
is

ti
n
g
F
o
rm
8
-K
it
e
m
s.

(l
e
ss

re
st

ri
c
ti
v
e
)

[S
O
X
S
e
c
ti
o
n
4
0
9
:

R
e
a
l
ti

m
e
is
su
e
r
d
is
c
lo
su
re
s]
R
e
la
te
d
S
E
C
R
u
le
s
(N
o
t
P
a
rt
O
f
S
O
X
It
se
lf
)

8
/
8
/
2
0
0
3

1
1
/
2
4
/
2
0
0
3

D
is
c
lo
su
re
R
e
g
a
rd
in
g
N
o
m
in
a
ti
n
g
C
o
m
m
it
te
e
F
u
n
c
ti
o
n
s
A
n
d
C
o
m
m
u
n
ic
a
ti
o
n
s
B
e
tw
e
e
n
S
e
c
u
ri

ty
A

d
o
p
te
d
(N
o
.
3
4
-4

8
3
0
1
)

(N
o
.
3
3
-8

3
4
0
)

H
o
ld

e
rs
A
n
d

B
o
a
rd

s
O
f
D
ir
e
c
to

rs
E

n
h
a
n
c
e
s

d
is
c
lo
su
re
re
q
u
ir
e
m
e
n
ts
re
g
a
rd
in
g
th
e
o
p
e
ra
ti
o
n

o
f
b
o
a
rd

n
o
m

in
a
ti
n
g

c
o
m
m
it
te
e
s
a
n
d

in
tr

o
d
u
c
e
s

a
n
e
w

d
is
c
lo
su
re
re
q
u
ir
e
m
e
n
t
c
o
n
c
e
rn
in
g
th
e

m
e
a
n
s,

if
a
n
y
,
b
y

w
h
ic

h
se
c
u
ri
ty
h
o
ld
e
rs
m
a
y
c
o
m
m
u
n
ic
a
te
w
it

h
m

e
m
b
e
rs
o
f
th

e
b
o
a
rd

o
f
d
ir
e
c
to
rs
.

4
/
1
2
/
2
0
0
2

N
o
n
e

F
o
rm
8
-K
D
is
c
lo
su
re
O
f
C
e
rt
a
in
M
a
n
a
g
e
m
e
n
t
T
ra
n
sa
c
ti
o
n
s

N
o
t

A
d
o
p
te
d
(N
o
.
3
3
-8

0
9
0
)

P
ro
p
o
se
s
th
a
t
so
m

e
p
u
b
li
c

c
o
m
p
a
n
ie

s
h
a
v
e

to
fi
le

c
u
rr

e
n
t
re
p
o
rt

s
d
e
sc

ri
b
in

g
:
d
ir
e
c
to

rs
’

a
n
d
e
x
e
c
u
ti
v
e
o
ffi
c
e
rs

’
tr

a
n
sa
c
ti
o
n
s
in
c
o
m
p
a
n
y
e
q
u
it
y
se
c
u
ri

ti
e
s,

d
ir
e
c
to
rs
’
a
n
d
e
x
e
c
u
ti
v
e
o
ffi
c
e
rs

’
a
rr

a
n
g
e
m
e
n
ts
fo
r
th
e
p
u
rc

h
a
se

a
n
d
sa
le
o
f
c
o
m
p
a
n
y
e
q
u
it
y
se
c
u
ri
ti
e
s,
a
n
d

lo
a
n
s

o
f

m
o
n
e
y

to
a
d
ir
e
c
to
r
o
r
e
x
e
c
u
ti
v
e
o
ffi
c
e
r

m
a
d
e

o
r

g
u
a
ra

n
te
e
d
b
y
th
e
c
o
m
p
a
n
y
o
r
a
n

a
ffi

li
a
te

o
f
th
e
c
o
m

p
a
n
y
.

(p
ro
p
o
se
d
ru

le
li
k
e
ly

re
–

p
la
c
e
d
b
y
S
O

X
ru

le
N

o
.
3
3
-8
1
0
6
li
st
e
d

a
b
o
v
e
)

In
d
iv

id
u
a
l
P

C
A
O
B
R
u
le
s

4
/
6
/
2
0
0
4

5
/
1
4
/
2
0
0
4

P
C
A
O
B
A
u
d
it
in
g
S
ta
n
d
a
rd
N
o
.

1
A

d
o
p
te
d
(N
o
.
3
4
-4

9
5
2
8
)

(N
o
.
3
4
-4

9
7
0
7
)

R
e
q
u
ir
e
s
re
g
is
te
re
d
p
u
b
li
c
a
c
c
o
u
n
ti
n
g
fi
rm
s
to
re
fe

r
to

th
e
st
a
n
d
a
rd
s
o
f
th
e
P
C
A
O

B
in

th
e
ir

a
u
d
it
re
p
o
rt

s,
ra

th
e
r

th
a
n

to
U

.S
.
g
e
n
e
ra

ll
y

a
c
c
e
p
te

d
a
u
d
it

in
g
st
a
n
d
a
rd

s,
o
r

”
G

A
A

S
.”

[S
O
X
S
e
c
ti
o
n
1
0
1
:
E
st
a
b
li
sh

m
e
n
t;

a
d
m

in
is
tr
a
ti
v
e
p
ro
v
is
io
n
s]
[S
O
X
S
e
c
ti
o
n
1
0
3
:

A
u
d
it
in

g
,
q
u
a
li
ty

c
o
n
tr
o
l,
a
n
d
in
d
e
p
e
n
d
e
n
c
e
st
a
n
d
a
rd
s
a
n
d
ru
le
s]
[S
O
X
S
e
c
ti
o
n
1
0
7
:
C
o
m
m
is
si
o
n
o
v
e
rs

ig
h
t

o
f
th
e
B
o
a
rd
]

4
/
8
/
2
0
0
4

6
/
1
7
/
2
0
0
4

P
C
A
O
B
A
u
d
it
in
g
S
ta
n
d
a
rd
N
o
.

2
A

d
o
p
te
d
(N
o
.
3
4
-4

9
5
4
4
)

C
o
r-

re
c
te

d
4
/
1
3
/
2
0
0
4

(N
o
.
3
4
-4

9
5
4
4
A

)
(N
o
.
3
4
-4

9
8
8
4
)

C
o
n
si

st
s
o
f
a
n

a
u
d
it
in

g
st

a
n
d
a
rd

a
p
p
li
c
a
b
le

to
a
u
d
it
s

o
f
in
te
rn
a
l
c
o
n
tr
o
l
o
v
e
r
fi
n
a
n
c
ia
l
re
p
o
rt
in
g

o
f
is

su
e
rs

b
y
re
g
is
te
re
d
p
u
b
li
c
a
c
c
o
u
n
ti
n
g
fi
rm
s
a
n
d
fi
v
e

a
p
p
e
n
d
ic

e
s
c
o
n
ta

in
in

g
e
x
a
m

p
le
re
p
o
rt
s
a
n
d

a
d
d
it
io

n
a
l
g
u
id

a
n
c
e
.

c
o
n
ti
n
u
e
d
o
n
n
e
x
t
p
a
g
e
55

P
r
o
p
o
s
in
g
R
e
le
a
s
e
D
a
t
e
A
d
o
p
t
in
g
R
e
–
le
a
s
e
D
a
t
e
D
e
s
c
r
ip
t
io
n
A
d
o
p
t
e
d
/
P
e
n
d
in
g
/
N
o
t
A
d
o
p
t
e
d
[S
O
X
S
e
c
ti
o
n
1
0
3
:
A
u
d
it
in
g
,
q
u
a
li
ty
c
o
n
tr
o
l,
a
n
d
in
d
e
p
e
n
d
e
n
c
e
st
a
n
d
a
rd
s
a
n
d
ru
le
s]
[S
O
X
S
e
c
ti
o
n
4
0
4
:
M
a
n
a
g
e
m
e
n
t
a
ss
e
ss
m
e
n
t
o
f
in
te
rn
a
l
c
o
n
tr
o
ls
]
56

Figure 1. Cumulative Excess Returns around Date of Filing Lobbying Letter with
Negative Opinion

The figures show the cumulative excess returns for companies who lobby the SEC around the date of SEC receipt of the

lobbying letter. Results are shown separately for firms lobbying against one of the SOX enhanced disclosure rules, corporate

responsibility rules, and auditor independence rules, and are based exclusively on letters expressing negative opinions about

the particular rule. In each graph, results are shown for two different definitions of excess returns. The lines labelled “No

factor adjustment” are based on excess returns defined as (return on lobbying firm stock)-(return on a size-matched comparison

group). The lines labelled “With factor adjustment” are based on excess returns defined as the residual from a regression (run

on weekly data from week 31 of 2002 to the end of 2004) of (return on lobbying firm stock)-(return on size-matched comparison

group) on a constant, the excess return on the market, and Fama and French’s the size and book-to-market factors SMB and

HML. For each approach excess returns are averaged across lobbying firms for each week in event time, and then summed over

time, starting 10 weeks before the week of the letter and ending 20 weeks after the week of the letter. Results are based only

on letters filed at least 10 weeks after the passage of SOX on 7/30/2002 so that no point in the figures overlap with the period

leading up to passage of SOX.

Panel A: Enhanced Disclosure Letters

–

0.04

–

0.02

0
0.02
0.04

0.06

-12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12

Event Time

R
et

ur
n

No Factor Adjustment With Factor Adjustment

Panel B: Auditor Independence Letters

-0.04

-0.02

0
0.02
0.04
0.06
-12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12
Event Time
R
et
ur
n
No Factor Adjustment With Factor Adjustment

Panel C: Corporate Responsibility Letters

-0.04
-0.02
0
0.02
0.04
0.06
-12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12
Event Time
R
et
ur
n
No Factor Adjustment With Factor Adjustment

Figure 2. Cumulative Excess Returns during Years 2002-2004 for Publicly Traded
Firms that Lobbied the SEC

The figure shows the cumulative excess returns of firms lobbying firms against one or more of the ‘Enhanced Disclosure’

provisions of SOX over and above their matched comparison groups starting in week 7 of 2002. Three sets of cumulative excess

returns are shown. Panel A is based on a size-matched (100 size portfolios) control group of non-lobbying firms. Panel B is

based on a size and book-to-market equity (25 size portfolios and 5 book-to-market portfolios) matched control group. Panel

C is based on a size and industry-matched (25 size portfolios and 10 industry portfolios) control group. In each graph, two

lines are shown. The unadjusted cumulative excess return is calculated by averaging the excess returns over the comparison

group across lobbying firms in each week, and then summing these excess returns over time, starting in week 7 of year 2002.

The factor-adjusted cumulative excess return is calculated by first regressing the excess return over the comparison group on

the excess return on the market and the Fama-French size and book-to-market factors. The regression is run using weekly data

from week 7 of 2002 until the end of 2004, and the alpha plus the residuals are averaged each week and then summed over time.

The leftmost vertical lines indicates the beginning of serious negotiations about SOX in Congress while the rightmost vertical

line indicates

the week SOX was passed in Congress.

Panel A: Comparison Group Based on 100 Size Portfolios

-0.02

0.03

0.08

0.13

0.18

2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25

Cale ndar Time

R
et

u
rn

No Factor Adjustment With Factor Adjustment

Panel B: Comparison Group Based on 25 Size and 5 Book-to-Market Portfolios

-0.02
0.03
0.08
0.13
0.18
2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25
Cale ndar Time
R
et
u
rn
No Factor Adjustment With Factor Adjustment

Panel C: Comparison Group Based on 25 Size and 10 1-Digit Industry Portfolios

-0.02
0.03
0.08
0.13
0.18
2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25
Cale ndar Time
R
et
u
rn
No Factor Adjustment With Factor Adjustment

Figure 3. Cumulative Excess Returns during Years 2002-2004 for Publicly Traded
Firms that were Predicted to Lobby the SEC

The figure shows the cumulative excess returns of firms that were predicted to lobby the SEC against one or more of the

‘Enhanced Disclosure’ provisions of SOX according to our models, over and above their matched comparison groups starting in

week 7 of 2002. Predicted lobbyers are those firms whom our probit models place in the top 3% of firms based on likelihood of

lobbying. Three sets of cumulative excess returns are shown. Panel A is based on a size-matched (100 size portfolios) control

group of non-lobbying firms. Panel B is based on a size and book-to-market equity (25 size portfolios and 5 book-to-market

portfolios) matched control group. Panel C is based on a size and industry-matched (25 size portfolios and 10 industry portfolios)

control group. In each graph, two lines are shown. The unadjusted cumulative excess return is calculated by averaging the

excess returns over the comparison group across predicted lobbying firms in each week, and then summing these excess returns

over time, starting in week 7 of year 2002. The factor-adjusted cumulative excess return is calculated by first regressing the

excess return over the comparison group on the excess return on the market and the Fama-French size and book-to-market

factors. The regression is run using weekly data from week 7 of 2002 until the end of 2004, and the alpha plus the residuals

are averaged each week and then summed over time. The leftmost vertical lines indicates the beginning of serious negotiations

about SOX in Congress while the rightmost vertical line indicates the week SOX was passed in Congress.

Panel A: Comparison Group Based on 100 Size Portfolios
-0.02
0.03
0.08
0.13
0.18
2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25
Cale ndar Time
R
et
u
rn
No Factor Adjustment With Factor Adjustment
Panel B: Comparison Group Based on 25 Size and 5 Book-to-Market Portfolios
-0.02
0.03
0.08
0.13
0.18
2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25
Cale ndar Time
R
et
u
rn
No Factor Adjustment With Factor Adjustment
Panel C: Comparison Group Based on 25 Size and 10 1-Digit Industry Portfolios
-0.02
0.03
0.08
0.13
0.18
2002 2002.25 2002.5 2002.75 2003 2003.25 2003.5 2003.75 2004 2004.25 2004.5 2004.75 2005 2005.25
Cale ndar Time
R
et
u
rn
No Factor Adjustment With Factor Adjustment

Figure 4. Cumulative Excess Returns during Years 2002-2004 for Publicly Traded
Firms that Lobbied the SEC (Section 404 Only)

The figure shows the cumulative excess returns of firms lobbying firms against Section 404-related provisions of SOX over

and above their matched comparison groups starting in week 7 of 2002. Three sets of cumulative excess returns are shown.

Panel A is based on a size-matched (100 size portfolios) control group of non-lobbying firms. Panel B is based on a size and

book-to-market equity (25 size portfolios and 5 book-to-market portfolios) matched control group. Panel C is based on a size

and industry-matched (25 size portfolios and 10 industry portfolios) control group. In each graph, two lines are shown. The

unadjusted cumulative excess return is calculated by averaging the excess returns over the comparison group across lobbying

firms in each week, and then summing these excess returns over time, starting in week 7 of year 2002. The factor-adjusted

cumulative excess return is calculated by first regressing the excess return over the comparison group on the excess return on

the market and the Fama-French size and book-to-market factors. The regression is run using weekly data from week 7 of

2002 until the end of 2004, and the alpha plus the residuals are averaged each week and then summed over time. The leftmost

vertical lines indicates the beginning of serious negotiations about SOX in Congress while the rightmost vertical line indicates

the week SOX was passed in Congress.
60

SARBANES-OXLEY – CONTEXT & THEORY:
MARKET FAILURE, INFORMATION ASYMMETRY &

THE CASE FOR REGULATION

ABSTRACT

On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002, also
known as the Public Company Accounting Reform and Investor Protection Act of 2002. At the heart of
the Act is the mandate for corporate reform from the massive financial and leadership fraud of the late
1990s and early 2000s. This paper is part of a series of essays that attempts to look deep into the soul of
the Act not only evaluating the efficacy of the policy, but also to verify the heralding for a new dedication
to the ethical and moral boardroom in the public corporation. The larger project consults legislative,
legal, historical, and philosophical primary and secondary research to confirm the big question, ‘Does
Good Behavior Pay Off?’ In this installment, I look to the Act itself recognizing that the literature on
Sarbanes-Oxley (SOX) to date has lacked the theoretical framework necessary for fully understanding its
public policy domain. The only consistent criticism on SOX from its inception has been from
management, economic, and political scholarship predominantly targeting its financial impact upon the
corporation through its rigid compliance mandates. The primary objective here is to understand
Sarbanes-Oxley as public policy in response to market failure – that is, when the market stops providing
efficient and ethical solutions to society.

Key words: Sarbanes-Oxley; Market Failure; Information Asymmetry; Public Policy Analysis;
Regulatory Environment; Benefits and Costs; Theory of Commerce; Ethics; Corporate
Governance.

1. INTRODUCTION

This paper addresses the questions how does the concept of market failure apply to ethical corporate
governance? Are corporate ethics authentic in the modern corporation or just lip service? Will Sarbanes-
Oxley achieve results? To attend to these questions the essay is organized in three sections. First, I
address the historical and philosophical context of the firm as depicted both by Aristotle and Adam Smith,
both leading thinkers on the concept of commerce and its impact on society. Second, I examine the issue
of market failure and information asymmetry, the theories guiding the reactive regulatory measures of
SOX attributed to corporate bad behavior. Third, I analyze the Sarbanes-Oxley Act from the perspective
of the policy analyst following the politics that designed the bill to the implementation agencies that
oversee its mandates.

The ultimate objective is to provide a better understanding of the regulatory connection between
government and the corporation. The guiding hypothesis is that Sarbanes-Oxley is effective legislation
implemented at the right time to not only protect the investor from corporate fraud and to force executives
to strengthen corporate ethical standards, but moreover, to solidify that the US market remains strong
and that it is not only open for business, but it is a safe place to work and invest. I argue that SOX is the
necessary policy tool to achieve these goals.

2. ON THE THEORY OF COMMERCE

2.1 A Philosophical Analysis

As stated in the abstract, we look to the market for solutions such as products, services, jobs, and
investment opportunities. Why the market? The market in a capitalistic economy offers ownership of the
factors of production: traditionally land, labor, capital, resources, knowledge, and entrepreneurship. This
ownership is immensely personal, and through ownership, the capitalist is driven to sustain certain
freedoms associated with his independence and wealth maximization. In contrast to the capitalistic
system, a socialist system or the extreme of communism diminishes and eventually removes personal
ownership of market factors and transfers them to the government, whereby the government allocates the
production of the solutions described above. Ownership can be attributed to self-interest, a guiding
theme in the discourse of commerce, trade, and the accumulation of wealth.

It is in fact, the self-interest theory that is at the root of the modern corporation – an institution that
personifies the American culture where the combination of entrepreneurship, capital investment,
commitment to quality and customer responsiveness has produced many of society’s great achievements
as well as its profound wealth. Unfortunately, self-interest has also contributed to some of society’s
greatest misfortunes such as the unchecked market of the 1920s to the fraudulent and greed infested
corporation of the 1990s. Notwithstanding some of business’ unfavorable history, our teachers from
Aristotle to Adam Smith recognize that the enterprise is intended to be good for society. For example,
according to Calhoun, “…the function of business [or commerce] as ‘service’… [is] its aim as the
betterment of human life” (1926, p. 5). Here Calhoun is describing the ancient Greek concept of business
as a direct service provider of improving the human condition from the products and services of trade,
commerce, and exchange. Often referred to as the father of the ‘self-interest’ ideal is Adam Smith, and
Morrow adds to the betterment theme and its connection to business describing,

The two main causes of the productivity of modern industry are the division of labor and the accumulation of capital. Self-
interest is the explanation of both these key facts. The individual finds it more to his interest to exercise his strength and
develop his skill in one occupation and exchange the surplus of what he produces for the products of other men’s skill
than to attempt to supply all his various needs by the labor of his own hands; hence the division of labor. Likewise, the
accumulation of capital: ‘The principle which prompts to save is the desire of bettering our condition, a desire which,
though generally calm and dispassionate, comes with us from the womb and never leaves us until we go into the grave.’
Thus, by following his own interest, as the individual sees it, he is furthering the progress of his neighbors and his nation
toward wealth and prosperity…with Adam Smith, the material resources of the modern world, and the human traits which
have created it, and attempts to determine under these conditions ‘wherein consists the happiness and perfection of a
man, not only as an individual, but as a member of the family, and of the great society of mankind (1927, p. 327).

I highlight some of the older discussion pieces from the early part of the 20th Century primarily to illustrate
that the problems and opportunities associated with commerce are the themes of fairness and the
distribution of wealth, which, consequently, are themes business, government, and society contend with
today. For example, at the turn of the century Howerth asserts “the social question [of the present day] is
always a question of the many against the few, and manifests itself invariably in a struggle over some
form of institution; that is to say, a class struggle” (1906, p. 257).

Howerth is correct in his observation of such a struggle, given that class tiers are a fact of life one
hundred years after his publication. Nevertheless, another fact of life is that Adam Smith is often
misunderstood and the invisible hand theory among the self-interest theme is too often perceived as a
discouragement for the poor as well as an association with amoral domination of the elite few
monopolizing the acquisition of wealth. The fact is that Smith believed in the promise of business
exemplified by Harpham that “the call for a ‘system of natural liberty’ is not a rejection of the modern
commercial order and the economic growth that was an essential part of it; it is an affirmation of the
commercial order and a call to place future economic growth on more secure foundations” (1984, p. 768).
Smith would be content with the institutions that grow wealth among nations such as the Western banking
systems and their associated capital markets. Smith would also find pleasure in the liberty associated
with the ongoing political trend of free trade, with its primary objective of satisfying a consumer driven

society. Smith would also find satisfaction from his initial inferences on capitalism that the institutions of
commerce have rigorous fiscal and monetary policy oversight on the stabilization of this sensitive, robust,
and resilient market of the modern day.

Indeed, a prosperous economy relies on another often criticized attribute of commerce: the maximization
of profit. Profit maximization, as the central focus for the firm is not immoral simply due to the fact that
profitability is a measurement of sustainability and growth potential. After all, growth expands demand,
requires more factors of productions such as labor, and often brings wealth opportunities to developing
communities. Nevertheless, profit maximization is also one of the central culprits in this discussion on
Sarbanes-Oxley, as greed of the owning and managing elite brings the corporation tumbling down along
with the many stakeholders who rely on the solutions the firm is meant to offer.

The interrelated characteristics of business and society are also the leading criticisms of business power
namely the theories described above – self-interest, the invisible hand, and profit maximization.
Additional theories include dominance models, where business as a dominant player is portrayed as the
most influential and powerful institution in society, in contrast to the pluralistic model, where business is in
balance with government and other social institutions (Steiner & Steiner, 2006, p. 13). These models are
helpful because they set the stage for the reality of the pre- and post-Sarbanes-Oxley era. We see the
1990s, especially the final years of the decade as well as the first years of the 2000s, as a boom era,
evidenced by significant technological innovation, exceptional economic growth, as well as a turnover in
American political leadership. Sadly, among all of this energy influencing the dynamics of business,
government, and society appears to be the germinating nucleus of immoral behavior – most directly in the
corporate boardrooms of large, publicly held corporations. Perhaps the most infamous scandal
associated with this stream of unethical activities is the collapse of Enron Corporation. Enron has
become the epitome case study for teaching ethics – or more appropriately, the teaching of what ethics is
not. In the following section I describe the theoretical framework that characterizes the scandals
associated with Enron and the many others that shared the headlines. But first, some Enron statistics to
underscore the consequences of market failure and information asymmetry:

Bankruptcy facts:
o 20,000 employees lost their jobs and health insurance
o average severance pay $4500
o top executives were paid bonuses totaling $55M

In 2001:
o Employees lost $1.2B in retirement funds
o Retirees lost $2B in retirement funds
o Enron’s top executives cashed in $116M in stock

Criminal Charges
o Guilty pleas: 15
o Convictions: 6
o Acquittals: 1
o Pending cases: 11

Three California traders pled guilty to wire fraud
Four Merrill Lynch executives pled guilty to fraud in the Nigerian Barge case
Aug 23, 2000 stock hits high of $90
Nov 28, 2001 stock drops to $1
29,000 Arthur Andersen employees lost their jobs (Enron’s CPA firm)
Enron shareholders suing Enron and their banks for $20B (Elkind & McLean, 2003).

3. PUBLIC POLICY THEORY OF SOX

3.1 A Framework for Corporate Bad Behavior

One of the guiding themes of this paper is the concept of the market as provider of solutions. It is a
competitive market, traditionally described as the economic environment of many buyers and sellers,
easy entry and exit for new and old firms, price taking as the standard pricing strategy, as well as the
measurement of economic success when marginal revenues are equal to marginal costs. Additional
assumptions and expectations of the competitive market include a level playing field for industries

competing for customers – customers who assume that they are privy to all relevant information possible
for buying decision making as well as investment decisions for the capital consumer. As described above
in the Enron collapse, something that seemed so entirely right about this Fortune 15 Corporation was in
fact so profoundly wrong. In the domain of economics and public policy, Enron represents a market
failure under the theory of information asymmetry. It is much easier, perhaps, to analyze a market or firm
that declines or fails because of outlying economic indicators – diminishing product demand, failure to
innovate, global competition, natural disaster to name a few. However, what is so morally frustrating, and
what drives the basis of this study, is that the root of the Enron collapse is simply, yet profoundly, bad
behavior.

Recently, Hendry described the concept of market failure within the paradigm of the American
enterprise:

…even in America, for long the spiritual home of free enterprise and individual achievement, the values that drive that
enterprise and achievement have been called into question, as businesses have been treated with a degree of suspicion
not seen for nearly a hundred years…Traditional moral principles still matter, and for some people and in some areas they
still matter deeply. But for most people, in most areas of life, they are no longer the only or dominant consideration.
Increasingly, it seems, we weigh our perceptions of moral duty and obligation against perceptions of our own legitimate
self-interest (2004, p. 1).

The problem at its most basic level is that somewhere along the road of success, a handful of corporate
executives let greed, risk, the thrill of deception, and the lure of excessive and secretive profitability
obscure their ethical guidance system. This paper does not look closely into the soul of the person to
unveil this problem – I reserve this study for my other collection of essays on the future manager.
However, in order to understand more fully the nature of the problem of bad behavior and the regulatory
windfall by way of Sarbanes-Oxley, we must first examine the theoretical context of the public policy field.

3.2 Market Failure and Information Asymmetry

I refer to the traditional approaches to SOX from what is now the standard in the field – the text of Weimer
and Vining’s Policy Analysis: Concepts and Practice, 3rd Ed. The authors approach the understanding of
government regulations such as SOX by analyzing the problem from the policy analyst’s standpoint – that
is, client-based. Weimer and Vining affirm, “the product of policy analysis is advice… relevant to pubic
decisions and informed by social values” (1999, p. 1). With regards to our problem of market failure and
SOX, Weimer and Vining say that policy analysts

…need a perspective for putting perceived social problems in context. When is it legitimate for government to intervene in
private affairs? In the United States, the normative answer to this question has usually been based on the concept of
market failure – a circumstance in which the pursuit of private interest does not lead to an efficient use of society’s
resources or a fair distribution of society’s goods [Additionally], analysts must have an understanding of political and
organizational behavior to predict, and perhaps influence, the feasibility of adoption and successful implementation of
policies. Also, understanding the world views of clients and potential opponents enables the analyst to marshal evidence
and arguments more effectively. [The analyst would ask] the basic question…when considering any market failure why
doesn’t the market allocate this particular good efficiently? The simplest approach to providing answers involves
contrasting public goods with private goods (1999, pg. 74).

Public goods are identified as nonrivalrous in consumption and nonexcludable in use, or both – the
authors refer to the ocean or national defense as a public good. Private goods on the other hand, are
rivalrous in consumption and excludable in ownership use. The authors refer to shoes as private – you
purchased them and no one else except you will use/consume your pair of shoes unless of course you
transfer the ownership to another. With regards to the corporate scandals and the government response
through regulation, the situation pertaining to public goods might refer to the free information available to
the potential investor, such as a 10K report easily obtainable using online databases that specifically
publish the financial reports of public companies. With regards to the private goods associated with the
corporate product, consider the private ownership of stock.

Market failure is described as the pursuit of private interest (such as an investor or other stakeholder of a
corporation) that does not lead to an efficient use of society’s resources (exemplified by fraudulent use of
investor funds for illegal corporate and executive gain) (Dierkens, 1991). Other leaders in the public
policy field connect the issues of market failure to the concept of externalities permeating the consumer
and provider relationship. Externalities such as information deficits enable competitive failures
(Bozeman, 2002). This information deficit, in the case of corporate fraud, is simply lying, cheating, and
stealing. Weimer and Vining put the information problem into the theoretical context of information
asymmetry, in essence, the centerpiece for Sarbanes-Oxley:

Information is involved in market failure in at least two distinct ways. First, information itself has public good
characteristics. Consumption of information is nonrivalrous – one person’s consumption does not interfere with another’s;
the relevant analytical question is primarily whether exclusion is or is not possible. Thus, in the public goods context, we
are interested in the production and consumption of information itself. Second – and the subject of our discussion here
there may be situations where the amount of information about the characteristics of a good varies in relevant ways
across persons. The buyer and the seller in a market transaction, for example may have different information about the
quality of the good being traded (1999, p. 107).

Within the scope of Enron and other similar scandals, the product and service being ‘traded’ here is not
simply shoes or bread or a used car for that matter, but a multiple stakeholder, market centered product:
employment, 401Ks, money management accounts, investment banking and capital accounts – it is
assumed that all of these purchases involve fair information and that the exchange transpired between
corporation and stakeholder/investor in a way such that the money used is in good faith for the growth
and innovation of the firm. In the case of the corporate fraud of the late 1990s and the early 2000s, all of
these professional assumptions are in fact null and void, and the consequences are not simply market
failure, but the collapse of organizations, livelihoods, retirement funds, and, most importantly, the collapse
of investor confidence in the American capital market – a place that was traditionally a good place for
positive self-interest where buyers and sellers would grow capital, wealth, and the future.

4. THE SARBANES-OXLEY ACT – Costs, Politics, and Policy Implementation

4.1 Costs and Critics

The domain of market failure and information asymmetry is the groundwork for understanding Sarbanes-
Oxley’s impact on so many areas of the investment world. Here I focus on the criticisms of the bill’s
costs, followed by a case study describing the politics that influence the birth of the bill, and I conclude
with a theoretical and practical analysis of SOX’s implementation plan. If you were to look into the
historical aspects of SOX, you will generally find biased media related stories of the corporate fraud cases
of Enron, WorldCom, Tyco – these are the big ones. In your search you would find feature articles
highlighting the crimes of the CEOs and CFOs – the millions of dollars embezzled or the millions of
dollars in phony deals, the customized balance sheets, and perhaps you would also read about the large-
scale cover-ups from accounting firms such as Arthur Andersen, a one-time valiant leading CPA firm
grounded in corporate ethics and social responsibility (in its founding years).

Amidst all of this bad news, which one might better understand the reason for government intervention to
cure this problem, remain the critics of government that see corporate reform measures, such as the
Sarbanes-Oxley Act, as unfair, too costly, or an attack on profitability. In fact, the research on SOX is
predominantly critical of its costs and very soft on its benefits. For example, one recent dissertation
analyzing SOX asserts that the “loss in total market value around the most significant rulemaking events
amounts to $1.4T” (Zhang, 2005, p. 2). Costs and their relationship to profitability are indeed important to
the financial health of the firm and the evidence is clear from the growth in consulting firms, for example,
that have evolved to assist with the heavy compliance mandates of Section 404 (which I discuss in detail
below) and the added staff and services required of public companies and the CPA firms who have also
added cost factors to respond to more demand via SOX. According to the co-author of the bill, Rep.
Michael Oxley, the “first-year costs of compliance with the internal-controls requirements [are] less than
1% of total revenue” (Burns, 2004, p.2). Oxley appears to highlight the ‘less than’ but the reality is any
marginal cost to the firm has diminishing benefits over time. Observing the potential impact on Wal-Mart,

for example, if we look at recent published revenue reports for Wal-Mart Corporation, February 2006 total
sales were $25 billion. According to Oxley’s estimates, the cost of compliance at 1% of revenues is
approximately $250,000 additional dollars to Wal-Mart’s February expenses. Wal-Mart, America’s largest
retailer, produces over $300 billion in annual revenues, which means SOX is costing the firm no less than
$3 billion each year to comply with Sarbanes-Oxley (Wal-Mart). Certainly, Wal-Mart and other public
companies would enjoy the opportunity to spend this money on profit sharing (redistribution of wealth) or
on a number of capital investments targeted for growth.

However, like other regulatory mandates, such as laws implemented to minimize or remove pollution as in
the Clean Air and Water Acts, these laws are costs to the firms in the form of taxes or permits. SOX, with
its clear mandate to reform corporate ethical behavior, is a tax-like cost that, like pollution control, is
intended to help the greater good by increasing investor confidence through stronger transparency
requirements as well as strict punishments for executive fraudulent behavior. As with any regulation,
corporations are compelled to innovate their systems and processes to reduce costs and stay
competitive. This will be the test of time for the new and mature corporations under Sarbanes-Oxley to
learn how to deal with this new cost initiative. The intrinsic value and hope, of course, is that both the firm
and its stakeholders bring ethics and corporate social responsibility to the forefront of the overarching
strategy and, most importantly, to the culture of the firm. Like pollution control, ethics control, for the next
generation anyway, is a regulated and a new reality.

4.2 Politics of Power – Business, Government, and Society

Sarbanes-Oxley is new to the world of business, and, like many forceful regulatory mandates, many
criticize the implications of why and how the law came into existence. History indicates that corporate
fraud and its public policy components of market failure and information asymmetry requires some social
institution to cure the problem. When the market fails, society looks to government primarily for its ability
to create laws and allocate resources on a broad national and global scale. There is little argument that
an Act of Congress is democracy in action to the best of the institution’s ability to respond to crises like
market failure. We see the Acts of Congress fueled by executive persuasion in the 1930s and 1960s, for
example, to move society out of economic depression with the responses to the market failure and the
Great Crash of 1929 as well as the social mandates in the 1960s for society to grow out of poverty and
civil rights ‘failure’. No matter how important the need for change may be, getting Congress and the
President to pass and sign legislation is intended by design to be no easy task and to be political. The
difficulties and opportunities lie in the politics – the struggle for power, priorities, and positioning.

The theories that define the political milieu of the so-called ‘Enron era’ are few or nonexistent. Essentially
we have market failure attributed to fraud and investor deception. I would like to add a theory for debate
as to why Sarbanes-Oxley was born, but first I refer to Belkaoui’s helpful overview of reactive public
policies attributed to the history of accounting, banking, and the financial markets of the United States and
their association with the oversight agency for these matters, the Securities and Exchange Commission
(SEC). Belkaoui writes,

The period between 1929 and 1933 saw a dramatic decline in stock prices, creating social upheaval and concern about
the viability of the capital market system in the United States. More and better disclosure about corporate affairs was
needed to allow for a better evaluation of the soundness of corporate endeavors. Congress intervened and passed the
Securities Act of 1933 to require registration of new securities offered for public sales and the Securities Exchange Act of
1934 to require continuous reporting by publicly owned companies and registration of securities, security exchanges, and
certain brokers and dealers. Both acts gave the Securities and Exchange Commission (SEC) the authority to protect the
public interest by calling for the disclosure of adequate information when securities are exchanged or sold. Other acts
were passed later to broaden and strengthen the responsibility of the SEC, namely (a) the Public Utility Holding Act of
1935, which requires registration of interstate holding companies covered by this law; (b) the Trust Indenture Act of 1939,
which requires registration of trust indenture documents and supporting data; (c) the Investment Company Act of 1940,
which requires registration of investment companies; (d) the Investment Advisors Act of 1940, which requires registration
of investment advisers; (e) the Securities Investors Protection Act of 1970, which provides a fund through the Securities
Investor Protection Corporation for the protection of investors; and (f) the Foreign Corrupt Practices of 1977, which
governs questionable and illegal payments by U.S. corporations to foreign political officials and requires accurate and fair
record-keeping and internal-control systems by all public companies (1985, p. 149).

According to my research, there is one element in the list of regulations above that receives very little
attention yet has a profound link to the bad behavior, most notably greed, attributed to the 1990s and
2000s problem we have been discussing. A brief case study of The Glass-Steagall Act of 1933 is a
probable window into the root of the problem and, ironically, it may be a combination of government
failure and market failure

4.3 Glass-Steagall: A Brief Case Study and a New Theory for Understanding SOX

The following analysis is based on a personal interview with an anonymous money manager of a client-
based stock portfolio of several hundred million dollars in corporate stock. This source is credible
because this person is a long-time professional who worked directly with the players in the historical
overview that follows. Any element of bias attributed to the case study has been removed to the best of
my ability with historical fact checking against the equally biased, though not unavailable, media reporting
on the following events. In response to the market crash of 1929, Congress enacted The Banking Act of
1933 (also known as the Glass-Steagall Act), which essentially responded to the notion that commercial
banks, investment banks, and brokers should be separate industries to remove any conflict of interest.
Moreover, Glass-Steagall required the insurance companies to be separate industries – separated
primarily by non-interlocking boards of directors. History confirms that one of the theories behind the
Crash of 1929 and the depression that ensued was that these three industries were closely tied. The
Glass-Steagall Act, like many of its counterparts named by Belkaoui above, had remained the law of the
land since its inception. However, in 1999, Glass-Steagall is repealed, and it is the politics surrounding
this repeal that deserves careful examination.

In 1999, the repeal of the Act allowed insurance companies, commercial banks, and the investment
banking firms to come back together as conglomerate corporations. Three specific people were
instrumental in lobbying for the repeal: Sanford Weill of Citigroup, Chuck Prince (the lawyer for Citigroup
and Weill’s corporate counsel), and Alan Greenspan, the Chairman of the Federal Reserve Bank of the
United States. Greenspan, for example, thought that bringing these entities together would be a benefit
to the country because there would be cost savings and a better product for the consumer; the
competitive model had proven successful in Japan and Europe, where this togetherness is allowed.
Ironically, however, it is also in these foreign markets that rampant fraud is a problem in banking and
finance.

Why these men? Weill and Prince wanted to grow their conglomerate consisting of Citibank, Smith
Barney (their brokerage firm), and Travelers Insurance Co. (their insurance agency). The repeal of
Glass-Steagall allowed these three entities to come under one umbrella again thus providing similar
opportunities for potential corruption and fraud up to 1933. My personal interview with my source also
attributes bad behavior with another player, Jack Grubman, a renowned research analyst in the
telecommunications field and an employee of Smith Barney. Grubman wrote voluminous reports on the
positive characteristics attributed to the reconnection of the three industries and, as a market analyst –
one whose recommendations money managers and Wall Street brokers rely upon in making decisions for
clients – advised the investment world to buy telecommunications stock because they could under the
repeal.

Meanwhile, Grubman is attending the board meetings of WorldCom (no longer a conflict of interest under
the repeal) and in his attendance he is privy to inside information of the board at WorldCom.
Simultaneously, he is also making investment banking recommendations for WorldCom where Smith
Barney and Citibank will be the lending institutions to WorldCom. In fact, Citibank personally loans
money to WorldCom’s CEO Bernard Ebbers and also provides new issues of stock for clients at Smith
Barney to buy even though the WorldCom stock is plummeting all the way to becoming the largest
bankruptcy in American history. All along, Smith Barney is receiving commission income on stock sales
and Citibank and Smith Barney receive fees for investment banking all the while as WorldCom stock falls.

The result of this reunion of companies due to the repeal of Glass-Steagall is a large income stream that
accrues to Citigroup and to its subsidiary Smith Barney. Jack Grubman is fired and barred from the
securities industry for life and a $2 – 5 billion punitive settlement from Citigroup to the SEC ensues.
Additionally, Weill ends his 20-year reign as CEO and Chairman of Citigroup and retires as chairman
emeritus. Chuck Prince, then the current CEO is named CEO and Chairman in April of 2006. This case
study is meant to provide an alternative, inside perspective of the events that are connected to corporate
bad behavior. Are Weill and Prince and Greenspan bad people? Perhaps not. Are they law-abiding?
Indeed, they followed the law of the land – that is, the repeal of Glass-Steagall. We must look carefully at
the multiple players in the game during this time in history – Ebbers of WorldCom is going to jail for 85
years, Grubman must find an alternative industry to make a living, and millions of shareholders are still
recovering from their own financial losses. From the news, it looks like Weill and Prince are doing all right
in retirement. But the ride from 1999 to the present has many consequences – some of which inspired
the Sarbanes-Oxley Act to protect the investor from aggressive, misguided perhaps, and downright
unethical corporate executives.

4.4 Sarbanes-Oxley – A Public Policy Implementation Analysis

Having laid the theoretical public policy framework of market failure and information asymmetry as well as
providing an overview of the political sequences leading to the bill, I now look at SOX as a policy tool. To
best understand SOX for current and future management implications, we must examine the
implementation characteristics of Sarbanes-Oxley. The following analysis examines the legal domain
where Sarbanes-Oxley is codified and where it receives its administrative authority. I conclude my
analysis with a personal interview with two stakeholders on the receiving end of the bill and discuss their
first-hand assessment three years since passage of the Act.

4.5 The Legal Domain of Sarbanes-Oxley

A preface to the legislation is a brief commentary on where the law evolved. The law was formed by a
bipartisan effort of the U.S. Senate and House of Representatives. Specifically, the Senate Committee
on Banking, Housing, and Urban Affairs, at the time chaired by Senator Paul S. Sarbanes (D-MD), and
the House Committee on Financial Services, chaired by Congressman Michael G. Oxley (R-OH), are the
two congressional committees by design to manage market failures. The combined congressional
committees oversee the entire financial services industry, up to and including banking, insurance, and
securities. Consequently, it is Sarbanes and Oxley, by their current leadership of their committees, to
whom Congress, and the public for that matter, looks to address the financial crises attributed to
corporate bad behavior in the early 2000s.

The Sarbanes-Oxley Act became law during the second session of the 107th Congress on January 23,
2002 and was signed into law on July 30, 2002 by President George W. Bush. The law is officially named
The Public Company Accounting Reform and Investor Protection Act of 2002 (H.R. 3763, 2002), although
it is most recognized in the industry and by the government as The Sarbanes-Oxley Act or SOX. The law
is codified in U.S. Code at 15 USC Sec. 7201, Title 15 “Commerce and Trade”, Chapter 98 – Public
Company Accounting Reform and Corporate Responsibility (http://uscode.house.gov).

SOX has three primary authoritative bodies, beginning first with the Securities and Exchange Commission
(SEC), whose primary function is to protect the buying and selling of securities. The laws governing the
SEC are described earlier, and after the Investment Advisers Act of 1940, the Sarbanes-Oxley Act of
2002 is the SEC’s most recent law it is charged to oversee. In addition to the SEC, SOX has
implementation power by way of the U.S. Department of Justice whose primary function is to prosecute
the federal crimes associated with the Act such as “attempts or conspiracies to commit fraud, certifying
false financial statements, document destruction or tampering, and retaliating against corporate
whistleblowers” (Department of Justice). In partnership with the Attorney General, the Federal Bureau of
Investigation (FBI) is charged with the authority to investigate crimes associated with corporate fraud and
remains the primary detective agency to investigate and arrest corporate bad behavior.

I attribute the theoretical framework that best describes the policy process and implementation of laws
such as SOX to the work of Sabatier, who affirms that “the policy process requires looking at an
intergovernmental policy community or subsystem composed of bureaucrats, legislative personnel,
interest group leaders, researchers, and specialist reporters within a substantive policy area” (1991, p.
148). What the author recognizes is that the prescribed agencies noted above authorized to oversee
SOX have enormous governmental scope, and their unique agency cultures combined with their span of
control are important variables in the overarching successful and efficient implementation of the law. In
addition to Sabatier’s framework, Elmore’s theory of backward mapping asserts that “the closer one is to
the source of the problem, the greater is one’s ability to influence it; and the problem-solving ability of
complex systems depends not on hierarchical control but on maximizing discretion at the point where the
problem is most immediate (1980, p. 605).” Both Sabatier and Elmore help provide the necessary theory
behind the successful implementation of public policy from the government’s perspective, primarily
pointing to the multiple layers of complexity of costs and benefits and politics associated with the entire
public policy process. To conclude, the multilayered policy process is best described by Simmons, Davis,
Chapman, and Sager as:

A sequential flow of interaction between governmental and non-governmental participants who discuss, argue about and
find common grounds for agreeing on the scope and types of governmental actions appropriate in dealing with a particular
problem…The purpose here is to look beyond the decision nexus to the interaction involved in the policy process. Thus,
attention centers on the psychology of the actors and the sociology of the groups (1974, p. 458).

Noting Simmons’, et al. focus on ‘psychology of the actors’, the public policy process at all levels – design
through implementation – involves real people operating in a politically democratic and bureaucratic
domain. Consequently, policies are imperfect, are managed by imperfect people, and manage imperfect
situations.

4.5 Sarbanes-Oxley: The Law & Comments from the Field

Like many laws, Sarbanes-Oxley must be read as a rule book thanks to the many mandates listed in the
bill. The following summary highlights the bill’s most strenuous Titles as they apply to the response to the
problem of corporate bad behavior. I abridge the content for illustration purposes, but it is taken directly
from the language of H.R. 3763. The following are the key components of SOX:

Title I: Public Company Accounting Oversight Board – reports to SEC
o Oversees the audit of public companies
o Establishes audit report rules and standards
o Inspects, investigates, and enforces all compliance mandates
o Empowers the Board to impose disciplinary sanctions of neglect
o Funds the Board through fees collected from issuers

Title II: Auditor Independence
o Prohibits auditors from performing alternative services (consulting)
o Prohibits the auditor from being the lead for more than five years
o Requires that creditors report to the audit committee

Title III: Corporate Responsibility
o Requires each member of the audit committee to me a member of the BOD
o Instructs the SEC to require CEOs and CFOs to certify financial reports
o CEO/CFO must forfeit certain bonuses and compensation received if the company is required to

make an accounting restatement due to the material non compliance of an issuer
o Bans the trading by company directors and executive officers in a public company’s stock during

pension fund blackouts
Title IV: Enhanced Financial Disclosures *

o Requires senior management and principal stockholders to disclose changes in the securities
ownership

Title V: Analysts Conflict of Interest
o Restricts the ability of investment bankers to pre-approve research reports

Title VIII: Corporate and Criminal Fraud Accountability
o Imposes criminal penalties for knowingly destroying, altering, concealing, or falsifying records
o Makes non-dischargeable in bankruptcy certain debts incurred in violation of securities fraud laws

o Subjects to fine or imprisonment (up to 25 years) any person who knowingly defrauds shareholders of
publicly traded companies

Title IX: White Collar Crime Penalty Enhancements
o Establishes penalties for mail fraud, violations of the Employee Retirement Income Security Act of

1974, and establishes criminal liability for failure of corporate officers to certify financial reports (these
crimes have penalties up to $500,000 and 20 years in prison)

Title X: Corporate Tax Returns
o Expresses the sense of the Senate that the Federal income tax return of a corporation should be

signed by the CEO
Title XI: Corporate Fraud Accountability

o Authorizes SEC to seek injunction to freeze extraordinary payments earmarked for designated
persons or corporate staff under investigation for possible violations of Federal securities law

o Increases penalties for violations of the Securities Act of 1934 to $25 million and up to 20 years in
prison (H.R. 3763, 2002)

* It is in Title IV that the notorious Section 404 is located. Titled ‘Management Assessment of Internal
Controls, Section 404 is what the end user of SOX, that is, the corporation itself and its CPA firm, has the
most difficulty due to the compliance standards that essentially add the marginal costs to the firm. It is
also 404 that has given rise to compliance consulting firms to assist corporations prepare and manage
the regulations mandated in 404 and all of SOX as well.

4.6 Comments from the Field – An Interview with the Big Four and a CFO

In conjunction with the research program for this paper, I arranged a confidential personal interview with a
partner at one of the Big Four accounting firms (these include Deloitte, Touche, & Tohmatsu, Ernst &
Young, KPMG, and PricewaterhouseCoopers). Additionally, I arranged a confidential interview with a
CFO of a Fortune 15 company. My goal was to ask the first-hand implementers in the field and to learn
what type of impact SOX has had on the management of their organization. The following are the
questions and summary of the responses of my interviews.

4.7 Interview with a CFO of Fortune 15 Company (Transcribed Word-For-Word)

1. How has Sarbanes-Oxley impacted your company?

Biggest impact is a greater awareness and ownership of business process owners [managers of functional
departments]

Appreciation for processes and controls – indeed a catalyst for positive change
SOX is good for business for understanding how the business operates and for the consumer

2. What has been the most challenging issue to overcome pertaining to SOX?

Organizations all have different starting points in compliance
Also, some firms may be on different starting points with regards to all processes across the board.
The more innovative and cutting edge a company is, the easier the company is able to adapt to large-scale

regulations, mandates, etc.
3. What have been the most rewarding impacts regarding SOX compliance policies?

A talent pool with better business judgment, more informed decisions to handle broader aspects of complexity

4. How would you rate (excellent, good, fair, none) the current corporate culture with regards to ethics across
the many stakeholders of the company?

Good. Transparency is key…frequent and candid communication…good process of [expediting] issues and

problems through both the business and financial stream

5. Do you have a corporate code of ethics?

Indeed…we are a very regulated industry and codes are essential
They are part of the culture – they are known and owned and held accountable
Execs ‘walk the walk’

6. What is your opinion about recent reports that say the costs of SOX outweigh the benefits? Do you agree with

this?

If efficient management processes are in place, then a firm should be able to handle such costs
Indeed, the benefits outweigh the costs
However, there are some firms in our industry that are not as innovative and ‘ready’ – hence, the costs are

significantly higher
Costs will eventually tale off and if processes are in place, control aspects will remain and the firm will be better

for it

7. What does your company do to restore and build customer, employee, and investor confidence in your firm?

We rely on transparency and predictability elements in performance – we meet commitments with Wall St. – we
share strategy – we communicate

As for buyers and sellers – commitments on both sides of the supply chain and we are held accountable by way
of getting or losing contracts based on ‘compliance’ commitments

8. How do you avoid an Enron?

Our culture eliminates bad apples – no one can stray from the pack
Notes on Enron – moral compass broken – short-term focus – confidence and courage element – team

environment had a flawed level of integrity throughout the executive suite – all were bad apples

9. What is the future of SOX?

There could be a SOX II in the light of globalization – we’re dealing with high risk countries such as India, China,
Russia, etc., all having entirely different cultures of ethics. Hence, SOX II for global U.S. countries should be on
the researcher’s list to investigate

Following this interview was an additional personal communication with a Big Four CPA Firm.

4.8 Interview with a CPA of a Big Four Accounting Firm (transcribed word-for-word)

1. How has Sarbanes-Oxley impacted your company?

Dramatically…the reality is that the accountants have become a regulated industry. Meaning the public
accounting profession. Before, we were self- regulated, like banks.

From a resourcing standpoint, it has been a public demand on the accounting profession – example, now
‘date certain’ is a tremendous impact on the Big Four to hire additional resources, foreign countries if
necessary, train them and meet our responsibilities…resulted in walking away from high risk customers for
Section 404

In the audit side, there is a tremendous increase in demand in the ‘attest’ business and in the tax side has
created a situation where management – a market shift from your audit firm in specialty practice from audit
business and some of the work has gone to non Big Four

It has raised the bar for quality on audits – documentation has improved noticeably – what gets measured
gets done when you become regulated

2. What has been the most challenging issue to overcome pertaining to SOX?

Resourcing and training has been the most challenging to meet the demand in a changing market place –

highly technical people – experienced auditors not just staff auditors
How this is accomplished – longer and harder hours – transfer of experienced people from international to

domestic demand – firing of clients

3. What have been the most rewarding impacts regarding SOX compliance policies?

Most rewarding impact – auditing committees are more interested in your ‘voice’ – taking the audit more
seriously today – audit committees are much more engaged and a more diligent to their fiduciary
requirements – partners and staff are more engaged and the clients are more interested … hence, good
for confidence to be restored

4. How would you rate (excellent, good, fair, none) the current corporate culture with regards to ‘ethics’ across

the many stakeholders of the company?

Regarding the Big Four…the cost of failure has never been higher and clients are taking the tone at the
top – did you ‘message’ ethics and communicate it enough

Companies had ethics policies…now, the emphasis has become more front and center and is it positive
Internally, with regards to ‘independence’ as an auditor the Big Four has become much more focused as

issues have been identified as standards met around the world – the controls in place that SOX asserts
are more intensely monitored and more focused

5. Do you have a corporate ‘code of ethics’?

Code of ethics – common sense – every quarter and attached to the independence confirmation is the

code of ethics…example of independence…if a family friend of mine is on a board – I couldn’t receive a
gift to mitigate a perception of confidence or appearance of impropriety

6. What is your opinion about recent reports that say the costs of SOX outweigh the benefits? Do you agree with

this?

From the perspective of the Big Four…yes. It has been very costly – regarding 404 – but most of the
dialogue is dealing with 404. I think for smaller companies it’s harder – such as new IPOs with 0 to
millions [in revenues] – SOX is a good thing, but when government makes it a law, the intentions are
good, but the ramifications are not always cost effective – there are talks of exceptions on the horizon

5. CONCLUSION

5.1 Final Assessment of SOX and the New Corporation

This paper set out to address the following questions: how does the concept of market failure apply to
ethical corporate governance? Are corporate ethics authentic in the modern corporation or just lip
service? Will Sarbanes-Oxley achieve results? The methodological approaches to these questions have
varied from a traditional public policy analysis where I examined the theoretical framework associated
with the need for SOX, to modeling the implementation stream, to personal interviews with the end-user.
Nagel provided helpful groundwork for my own questions as he offers a list of standard methodological
perspectives public policy analysts must ask. He specifically pushes the analyst to “draw a conclusion as
to which policy to adopt from information on goals, policies, and relations; to establish the relations
between policies and goals; and to determine what policies are available for adoption and what goals are
appropriate to consider” (1988, p. 8). I refer to Nagel here primarily because he helps shape the
overarching objective in any policy analysis by centering the study on goals – the goals of the government
(remove market failure); the goals of business (maximize profitability); the goals of society (look to the
market for solutions).

The paper is centered on early and contemporary theories of commerce followed by a comprehensive
discussion of market failure and information asymmetry – the theoretical roots leading to the
government’s response to the failure of the corporation. I then provided an analysis from the broker’s
perspective asserting that the repeal of the Glass-Steagall Act was a catalyst for the ensuing bad
behavior among the returning industries under one corporate domain. My objective was to also
categorize the authoritative and agency-power from which SOX obtains its legal and implementation
direction. The multi-level implementation stream requires several years of future data to more fully
analyze the results – results that will measure the efficient output by government as well as its presumed
ability to impact corporate behavior. In these early years of the law, I found the final impact at the
implementation level is most notable by the personal interviews of the practitioners in the field, the CFO
and CPA. The goal was to determine if SOX will work and if it is good legislation. The final verdict from
the field suggests that the law has indeed brought accountability, service, and compliance to the front of
the line in the corporation. Moreover, it appears to have forced companies to innovate their systems to
become more ethically inclined, but also to reduce the costs of compliance.

Based on my findings, I affirm that SOX is good legislation as a reactive policy responding to bad
corporate behavior. I predict that the future of SOX will be debated for several years to come, but that the
recovery from the Enron-era will need these years to distance the memories of the era of fraud.
Additionally, I predict that SOX will evolve to stay relevant to the demands of investors and to the realities

of American and global commerce. Finally, SOX will provide the balance necessary, even initially by
force, to find the mean – to find the intermediate of good corporate behavior. In forthcoming essays, I
look beyond Sarbanes-Oxley by first leaping back to one of the centerpieces of ethics in the philosophical
context of Aristotle and then leaping forward to examine the results of the future manager’s outlook on the
ethical frontier of what I call the New Corporation – that is, the corporation where Sarbanes-Oxley is no
longer new, but part of the long-term corporate culture.

REFERENCES

Belkaoui, A. (1985). Public policy and the practice and problems of accounting. Westport, CT: Greenwood

Press.
Bozeman, B. (2002). Public-value failure: When efficient markets may not do. Public administration

review, 62(2), 145-161.
Burns, J. (2004). Is Sarbanes-Oxley working? [Electronic version]. The Wall Street Journal, 8.
Calhoun, G. M. (1926). The ancient Greeks and the evolution of standards and business. Cambridge,

MA: The Riverside Press.
Department of Justice. Implementation Memo of the Office of the Attorney General, August 1, 2002.
Dierkens, N. (1991). Information asymmetry and equity issues. The journal of financial and quantitative

analysis, 26(2), 181-199.
Elkind, P. & McLean, B. (2003). The smartest guys in the room: The rise and fall of Enron. New York:

Penguin Group, U.S.A.
Elmore, R. F. (1979). Backward mapping: Implementation research and policy decisions. Political

science quarterly 94 (Winter): 601-616.
Harpham, E. J. (1984). Liberalism, civic humanism, and the case of Adam Smith. The American political

science review, 78(3), 764-774.
Hendry, J. (2004). Between enterprise and ethics: Business and management in a bimoral society.

Oxford, UK: Oxford University Press.
Howerth, I. W. (1906). The social question of today. The American journal of sociology, 12(2), 254-268.
H.R. 3743, 107th Cong., 2nd Sess. (2002) [The Sarbanes-Oxley Act of 2002].
Morrow, G. R. (1927). Adam Smith, moralist and philosopher. The journal of political economy, 35(3),

321-342.
Nagel, S.S. (1988). Policy studies: Integration and evaluation. New York: Praeger.
Sabatier, P. A. (1991). Toward better theories of the policy process. Political science and politics, 24(2),

147-156.
Simmons, R. H., Davis, B.W., Chapman, R. J. K., & Sager, D. D. (1974). Policy flow analysis: A

conceptual model for comparative public policy research. The western political quarterly, 27(3), 457-
468.

Steiner, G., & Steiner, J. (2006). Business, government, and society: A managerial perspective (11th ed.).
New York: McGraw Hill.

Wal-Mart. Company statistics available from Wal-Mart’s online corporate information:
http://walmartstores.com/GlobalWMStoresWeb/navigate.do?catg=513&contId=6072

Weimer, D. L. & Vining, A. R. (1999). Policy analysis: Concepts and practice. Upper Saddle River, N.J.:
Prentice-Hall.

Zhang, I. X. (2005). Economic Consequences of the Sarbanes-Oxley Act of 2002. Ph.D. Dissertation.
University of Rochester.

Dr. Sean D. Jasso is a professor of economics at the Graziadio School of Business and Management at
Pepperdine University. He writes, consults, and teaches in the areas of political economy, world politics,
and business strategy. You may contact him at sean.jasso@pepperdine.edu.