Sarbanes Oxley – Making the Corporate Jungle Safer?

Depending on whom you talk to, the Sarbanes-Oxley Act of 2002 was either a panacea to cure the ailing stock market and restore trust in Corporate America or a shot to the bow of America’s capitalist vision.  Just what is Sarbanes-Oxley and whom does it affect?

Sarbanes-Oxley is a complex patchwork of legislative reform of the American system of corporate governance, legal counsel and financial oversight of publicly traded companies. 

Among the key implications of the Act:

—      CEOs and CFOs must certify the financial reports of their companies and face stiffer penalties for knowing or willful violations, including personal liability for noncompliance.

—      Added disclosures are required on the company financials.

—      The SEC must adopt new rules requiring that independent audit committees be created that are authorized to engage advisors.

—      New criminal and civil penalties for directors and officers for, among other things, destroying or changing records and knowingly executing a scheme to defraud investors.

—      Takes away some of the self-policing capability of the accounting industry by creating a five member Public Company Accounting Oversight Board, which is overseen by the Securities Exchange Commission.

—      Similar to the effect on the accounting profession, the legal profession is hit with new regulations, some of which run counter to the self-policing activities of the state bars and presents lawyers with the conundrum of trying to comply with the law while retaining a main cornerstone of the legal profession – attorney client privilege.


Some say Sarbanes-Oxley has had a chilling effect on the American Dream.  Where the rallying cry of the ’90’s was “Go public!,” Sarbanes-Oxley might have turned that into “Go private!” for the future, particularly for the small public companies for whom the new regulations create a cash drain.   But, despite the lure of going private, some insurance industry and legal experts theorize that Sarbanes-Oxley’s effect on public company accounting will put a new onus on private companies as well.  They recommend that private companies follow some of the same rules on a voluntary basis to avoid potential common law negligence. 

Sarbanes-Oxley’s exacting standards have had a dramatic impact on the Directors and Officers Insurance market, which was already reeling from the effects of corporate scandals, and the shrinking of capital in the reinsurance marketplace that was sharpened by the effects of 9/11.  Rates have gone up dramatically and capacity has shrunk, leaving some companies underinsured when they need it most. 

Accountants, particularly CPAs that do public audit work, have felt similar effects.  Fewer companies today are willing to write Accountants Professional Liability for such firms.  The same goes for law firms that specialize in securities law.

Perhaps the most disconcerting aspects of Sarbanes-Oxley, at least for corporate officers, are the punitive provisions for knowingly or willfully committing “white-collar” crimes.   The problem with discerning the effects of these provisions is the difficulty in assessing culpability.   It is possible that fingers might point at parties, who should have known what was going on during their watch, but did not “knowingly” or “willfully” perpetrate a fraud.  The line between benign incompetence and intentional acts might be blurry at times, but directors and officers still face the risk of being caught in the maelstrom of public outrage.   

The best advice that anyone can be given, who is entertaining the notion of becoming a board member of a public corporation, is think twice.  Make sure you know that the company has adequate D & O Insurance with a reputable carrier, and the coverage provides defense against fraud allegations until guilt is proven (in many cases the insurer will settle out of court before guilt becomes a factor in coverage determination).  Moreover, make sure that the limits are adequate for the size of the company.  Although there is no one rule of thumb for adequate limits, most public companies should have at least $25 million in coverage to afford adequate protection. The Microsoft’s and IBM’s of the world should obviously carry much more. 

Private companies can purchase D & O Insurance too, often at more reasonable prices, and with a host of other pertinent coverages such as Employment Practices Liability, Kidnap & Ransom, Fiduciary Liability and sometimes-even Professional Liability comprised under one insurance program.   Whether you purchase on a package basis or a la carte, if you have not looked into D & O Insurance before, now may be the right time.