The Sarbanes-Oxley Act of 2002 has strengthened corporate governance and improved audit quality in the past decade, according to a new report by Ernst & Young.
The report, “The Sarbanes-Oxley Act at 10,” marks the 10-year anniversary of the landmark legislation that passed a decade ago in response to a string of accounting scandals at companies like Enron, WorldCom and Tyco, along with the demise of Big Five auditing firm Arthur Andersen.
SOX ended more than 100 years of self-regulation and established the independent oversight of public company audits by the Public Company Accounting Oversight Board. Designed to enhance the reliability of financial reporting and to improve audit quality, SOX shifted responsibility for the external auditor relationship away from corporate management to independent audit committees, which are responsible to shareholders.
“At this anniversary, it is important to acknowledge one of the greatest successes of Sarbanes-Oxley: the alignment of the interests of shareholders, with independent audit committees, audit oversight authorities and auditors,” said Steve Howe, Americas area managing partner for the global Ernst & Young organization. “Increased transparency is critical to improving audit quality, maintaining investor confidence and ensuring the strength and competitiveness of US capital markets.”
While portions of the legislation—such as Section 404—have been criticized, many of these concerns have been addressed through a series of regulatory and legislative actions. As a whole, the Ernst & Young report indicates that SOX has substantially benefited investors and U.S. capital markets. The report cites studies by a number of groups that indicate improvements in both audit quality and corporate governance over the past decade.
Audit quality has been improved through stronger alignment of independent auditors, independent audit committees, independent audit oversight authorities and public company shareholders. According to a 2008 audit committee survey reported by the Center for Audit quality, 90 percent of audit committee members surveyed said that “they work more closely with the independent auditor” post-SOX.
Audit quality has improved because of PCAOB inspections and standard setting. As of Dec. 31, 2011, more than 2,000 audit firms from more than 80 countries were registered with the PCAOB. In 2011, the organization conducted inspections of 213 registered audit firms, and initiated an interim inspection program for broker-dealers.
More audit committees now include financial experts. In 2003, only a small number of audit committee members were financial experts. Today, nearly half of all audit committee members are identified through proxy statement disclosure as meeting the definition of a financial expert.
Companies that comply with all of the internal control provisions in SOX are less likely to issue financial restatements. A November 2009 study published by Audit Analytics found that the rate of financial restatements was 46 percent higher for companies that did not comply with all of the SOX internal control provisions.
Corporate governance is stronger. Prior to SOX, the process for the selection and assessment of the independent auditor typically was controlled by management. Audit committees now play an essential role in corporate governance framework by overseeing the quality and integrity of company financial statements.
Ernst & Young said it believes that achieving and maintaining audit quality requires a process of continuous improvement. Moving forward, the firm said it is reaffirming its commitment to build upon the foundation established by SOX by working with the PCAOB, independent audit committees and shareholders.
For a copy of the report, visit http://www.ey.com/US/en/Issues/Governance-and-reporting.