Sarbanes-Oxley Act: Tax and Accountability Impacts

Introduction to Sarbanes-Oxley

The Sarbanes-Oxley Act (SOX) requires at least a brief introduction, as it is a complex set of regulations designed and enacted by the federal government in 2002 in response to large-scale corporate business scandals that occurred in the years immediately preceding its enactment. Those scandals resulted in large-scale personal financial loss and a public awareness of widespread corporate accountability failures. The statute amends the already complex U.S. securities laws in some very substantial ways, many of which concern accountability and some of which will directly and indirectly affect the taxation of corporations — particularly those that are publicly traded — and the individuals who work for them.

SOX established new law, made changes to existing law, and affected Securities and Exchange Commission (SEC) rule-making and stock market listing standards (Parles, O'Sullivan & Shannon, 2007, p. 38). SOX's provisions affect accountants, lawyers, and many others who "deal with public companies or issuers." SOX included many "reforms aimed at improving and enhancing financial reporting and at regulating the accounting and audit professions" (Parles, O'Sullivan & Shannon, 2007, p. 38).

To better understand the potential changes that affect taxation, one must first understand some of the changes to accountancy in general. One of the most significant changes is that the accounting profession can no longer be solely responsible for its own self-regulation — a historically significant shift.

In short, it is very likely that Sarbanes-Oxley will affect nearly everything about the way public corporate culture is accountable to investors and the government. Stock prices may change as a result, as will the manner in which accountancy and taxation are determined, governed, and applied (Duffy, 2004, p. 43). It still remains to be seen whether the system will accomplish its intended purpose — reducing fraud and eliminating opportunities for dishonest financial practices, evidence destruction, and a corporate culture that lacks honest business conduct.

As Sanchirico (2004) notes, "it is perhaps possible to infer that the crosscurrent of countervailing effects on these still honest actors makes it likely that, whatever direction the effect points in, the net effect is unlikely to defeat the summary proposition of the foregoing analysis: the main force driving the primary activity benefits of anti-tampering enforcement is the effective taxation of those on the opposite side of the evidence tampering margin, the inframarginal tamperers" (p. 1215).

Auditor Independence and the PCAOB

The creation of the Public Company Accounting Oversight Board (PCAOB) was the first of SOX's major reforms and set the stage for others. The PCAOB is a new federal oversight board charged with: (1) registering and disciplining accounting firms that prepare audit reports on public companies; (2) establishing audit and accounting standards; and (3) conducting inspections and investigations of registered accounting firms that audit public companies. The PCAOB is funded through fees from public companies and mutual funds and has five members appointed by the SEC. The registration requirement applies to foreign as well as domestic accounting firms. The lack of auditor independence is viewed as a significant contributor to the major corporate scandals mentioned earlier (Parles, O'Sullivan & Shannon, 2007, p. 38).

Additionally, Section 201 addresses the potential for conflicts between auditing agencies and corporate or tax accounting firms. The measure is intended to separate the auditing function from other accounting responsibilities, essentially insulating auditing from any strategic taxation incentives that could potentially mislead the public or the corporation about their value and tax liability.

This is accomplished by forbidding auditors of public firms from providing most non-audit consulting services to their audit clients. Accounting firms are permitted to provide tax services to audit clients; however, the audit committee of the company must approve such services in advance. This approval requirement is an important example of the increased importance, influence, and potential liability that audit committees have received as a result of SOX (Parles, O'Sullivan & Shannon, 2007, p. 38).

Auditor independence is also addressed in Sections 203 and 206, which limit the amount of time a single auditing partner may spend auditing a corporation — establishing, through a set of time-based rules, that auditors cannot become permanent contract members of the corporate team and thereby develop potentially compromising familiarity with the corporation's other accounting functions.

Section 203 mandates the rotation of audit partners in charge of audit clients. Lead audit partners and audit partners responsible for review of the audit must be rotated off after five years and are subject to a five-year time-out period. Other audit partners — not including lead or concurring partners — are subject to a seven-year rotation and a two-year time-out period. Section 206 mandates a one-year "cooling off" period before auditors may go to work for an audit client in a key position (Parles, O'Sullivan & Shannon, 2007, p. 38).

The repercussions of SOX's broader themes will likely affect the flow of accountancy and taxation work in the future. As Carpenter, Fennema, Fretwell, and Hillison (2004) explain, seeking out corporate clients based upon standards and ethics may become the responsibility of CPA and accounting firms if they wish to work in environments of accountability, rather than being put at risk by unscrupulous corporate cultures:

"Sarbanes-Oxley recognizes the importance of corporate culture by mandating additional governance responsibilities and reporting requirements for top-level management. Section 406, for example, requires companies that report to the SEC as securities issuers to disclose whether they have adopted a code of ethics for senior financial officers — and if not, why. In light of recent scandals, all CPA firms, whether responsible for audits of large corporations or smaller entities, should be concerned about management's attitude and the tone at the top." (Carpenter, Fennema, Fretwell & Hillison, 2004, p. 57)

Conclusion

In conclusion, Sarbanes-Oxley has made significant strides toward a system that leaves fewer honest people in a position to be unwitting conspirators in scandalous financial practices, while also driving dishonest actors in accountancy and elsewhere either out of business or away from unscrupulous financial conduct. Though many will continue to argue that the act goes too far toward government control of free enterprise, there are also many who argue that it represents a good-faith effort on the part of the federal government to make businesses more accountable for the way they keep and hold funds.