Corporate governance issues: United States and the European Union.

The unforeseen and shocking demise of companies--such as Enron, Adelphia Communications, WorldCom, Quest, and a few others--propelled Congress to approve the U.S. Securities and Exchange Commission's (SEC) recommendation to pass the Sarbanes-Oxley Act of 2002 as a means to boost investors' confidence. (34) "This failure of corporate governance, [compounded by] an enduring bear market, approaching mid-term elections and uncertainty about terrorism and war, placed the federal government under extraordinary pressure to act." (35) Hence, the passage of the Act was only natural. The Act has been said to be unprecedented because, in addition to regulating disclosure and securities trading, the traditional jurisdiction of U.S federal securities laws, (36) the law also addresses matters of substantive corporate governance and executive fiduciary responsibility. (37) These duties have historically been viewed as a prerogative of the states and self-regulatory organizations (SROs). (38) Whether these corporate scandals should call for more regulation is a scholarly debate between those favoring regulation and those favoring deregulation. (39) SOX has been said to have been significantly costly and the benefits elusive. (40) While the merits of the debate are significant, understanding the changes brought by the Sarbanes-Oxley Act is imperative to comprehending its broader impact beyond U.S. borders. This Article will now examine some of these changes.

A. Corporate Auditing

One of the major innovations of the Act was the creation of a Public Company Accounting Oversight Board (Oversight Board), a quasi-public accounting board that oversees audits of public companies that are subject to the securities laws. (41) The principal purpose of the Oversight Board is to protect the interests of investors and to engage public interest in the "preparation of informative, accurate, and independent audit reports." (42) This is a sort of a new federal "watchdog" for regulation of the public accounting profession. "Although the [Oversight Board] is not technically a government agency, it is closer to a full government agency than to a [SRO] or industry-based group such as the American Institute of Certified Public Accountants, which ha[s] been performing the standard-setting function since 1939." (43) The Oversight Board's specific responsibilities include: "the registration and inspection of all 'public accounting firms that prepare audit reports' for public companies; the adoption and modification of 'auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports' for public company audits; the investigation of registered firms for violations of rules relating to audits; and the imposition of sanctions for such violations." (44) Likewise, SOX contains some auditor-independence provisions that affect auditors, audit committee members, executives, and directors of public corporations; hence, an auditor for an issuer is prohibited from providing a list of nonaudit services. (45) In the same vein, rotation of an audit partner is required every five years, and anyone who was employed by an auditor for an issuer within a one-year period is prohibited from becoming the CEO, controller, CFO, or chief accounting officer of the issuer. (46)

While the Oversight Board's proposal has been generally hailed as appealing to resolving accounting problems in public corporations, it is not without its own shortcomings. The Oversight Board standards require external auditors to consider audit committee effectiveness as part of their overall review of a corporation's internal control over financial reporting. (47) According to Professor Cunningham, the Oversight Board reveals a flaw in the corporate governance system as a result of a mixture of state and federal law regulations. (48) He contends that, although audit committees are essential, no one other than boards and, after the fact, shareholders and courts should have the power to oversee them. (49) However, according to him, what SOX did was simply mandate characteristics and functions, while SEC and SROs mandated characteristic reports. (50) The disclosure to the Oversight Board requires auditors to include an audit committee review as part of the auditors' more general assessment of the company's internal control over financial reporting. (51) Cunningham asserts this results in major problems: First, it highlights the tension between state and federal law, as state corporation law empowers the board to choose the appropriate management tools for a corporation, while federal law mandates specific parameters of the audit function. (52) In this case, neither of these is complete, and even when combined, are still incomplete. (53) Second, the issue of how to monitor the monitors becomes imminent. The federally-prescribed audit committee is directed to supervise the external auditor, and the Oversight Board proposes to have the external auditor evaluate the audit committee. (54) While these evaluations may be feasible, it remains to be seen how they fit in squarely with state law. (55)

In sum, SOX provided the SEC the authority to restructure corporate audit committees: (56) the SEC may authorize the SROs to change their listing rules to meet certain standards, and mandate them to require a public company to disclose whether its audit committee includes a financial expert or explain why it does not. (57) This specific grant of authority to the SEC to regulate the structure and duties of the audit committee and the substantive standards contained in SOX affected entrenched governance norms by taking authority away from management and placing it in the hands of the audit committee. (58)

The next issue to consider is how these requirements and regulations affect foreign companies. As expected, foreign companies and countries doing business in the United States did not necessarily welcome the application of SOX, (59) and some took steps to put their own corporate governance reforms in place, possibly to preempt Enron-like occurrences. (60) The government of the United Kingdom, for example, "initiated a series of reviews, primarily under the auspices of the Department of Trade and Industry (DTI) to examine whether changes were necessary to regimes for the regulation of the UK audit and corporate governance." (61) In the same vein, The House of Commons Treasury Committee initiated its own inquiry: the Higgs Report, (62) the Smith Report on corporate governance, (63) and the Coordinating Group on Audit and Accounting Issues (CGAA) were all welcomed and considered. (64) In particular, the 2003 CGAA report not only considered the issues of auditor independence, corporate governance, audit firm transparency, financial reporting standards and enforcement, and monitoring of audit firms; it also identified twentyseven conclusions and recommendations supporting initiatives including, inter alia, audit partner rotation by the Institute of Chartered Accountants in England and Wales (ICAEW), a principlesbased approach to financial reporting and auditing standards by the Accounting Standard Board (ASB) and, at an international level, by the International Accounting Standard Board (IASB) and the International Auditing and Assurance Standard Board (IAASB). (65) Other related reports on corporate governance include: the Greenbury Report, which focuses on disclosure of director pay; (66) and the Hampel (67) and Turnbell Reports, which review companies' approaches to internal controls. (68)

Likewise, the Canadian securities regulators in keeping abreast with the spirit of SOX (boasting investor's confidence) and aligning their corporate governance rules with those of the United States, unveiled initiatives in 2003 with regard to auditor oversight, officer certifications in companies' reports, and audit committees. (69) The Chairman of the Ontario Securities Commission requested the Canadian Institute of Chartered Accountants to address issues of audit independence and rotation of engagement partners and firms. (70)