2.11 The Sarbanes-Oxley Act (2002) & Dodd-Frank Wall Street Reform and the Consumer Protection Act (2010)

Following the financial scandals of 2001, on the 30th of July 2002, the Sarbanes- Oxley Act became Law, under the George W. Bush presidency.1 This Act had the objective of promoting honest and accurate financial reporting and corporate responsibility. The Public Company Accounting Oversight Board was created to supervise the auditors of SEC-registered companies, to protect investors and the public interest, therefore, to avoid fraud.2 This act also mandated the SEC to analyze how a principles-based set of standards, such as the IFRS, could be introduced in the US.3

Later on the 21st of July of 2010, in response to the financial crisis of 2008, the Dodd-Frank Wall Street Reform and Consumer Protection Act became law, under the presidency of Barack Obama.4 Similarly to the Sarbanes-Oxley Act of 2002, the Dodd-Frank Act was meant to restructure the US financial system, including corporate governance, transparent disclosure and credit ratings. However, the Sarbanes-Oxley Act was meant to empower regulators, auditors, corporate boards and investors to make better informed decisions, improve governance and reduce fraud.5 Despite the high criticism of the Sarbanes-Oxley Act and its limitations (e.g. besides being costly, there has been an increasing number of audit deficiencies), it seems to have improved financial disclosure and the quality of financial reporting. The Sarbanes-Oxley Act created the Public Company Accounting Oversight Board, a new independent regulatory agency to control the auditors of listed companies, which was previously based on a peer-review quality control system. Its mandate includes investor protection as its prime responsibility, improvement of audit quality and auditors’ control through setting new audit supervision rules which are independent from management (speech by Steven B. Harris, Public Company Accounting Oversight Board’ board member).6

Another novelty of the Sarbanes-Oxley Act is the requirement of attesting the auditors’ report by both the chief executive and chief financial officer personally to confirm that they have reviewed it and that it “does not contain any material untrue statements or material omission” or any misleading information. This new requirement is likely to contribute to a more rigorous financial disclosure to ensure the highest quality of financial reporting by a given company. The Dodd-Frank Act has a more protective role and has also a larger target audience aiming at restructuring the way financial markets work within and outside the US (e.g. extraterritorial reach, both for foreign and domestic organizations). Under the Dodd-Frank Act, the SEC has its responsibilities extended which has raised concern for potential higher margin of error.

Another concern, from the Center for Audit Quality affiliated with the American Institute of Certified Public Accountants, is the exemption of small listed companies with under 75 USD market capitalization from the requirement to obtain an external audit (attestation report) on management’s assessment of the effectiveness of internal control over financial reporting (section 404 b) Dodd-Frank Act) as it was originally required (introduced) by the Sarbanes-Oxley Act. This was a comply or explain regime, allowing companies to have internal control systems to contain weaknesses, as long as it was publicly disclosed and attested externally by the auditor.7

Literature has documented a direct link between financial crisis and development of more legislation in the financial regulatory framework, increasing transparency and trust in the financial market; this is a positive change.8 We have seen shifts on financial regulation in the UK and in the US after the 1990s collapse of Barings Bank (Financial Services Authority) and after the Enron and WorldCom scandals (Sarbanes Oxley Act), respectively.9 The financial crisis in 2008-2009 has proven the need for reevaluating the current financial accounting framework and therefore, rethinking thoroughly the reshaping of financial regulation.10 In 2009, the G20 called for the development of global accounting standards and gave its support to the International Accounting Standards Board’s work until then. Although intended to improve financial reporting, the Sarbanes-Oxley Act did not avoid a financial crisis just as Dodd-Frank will likely not be able to.11 More regulation, even when designed to improve the efficient functioning of financial markets, if excessively complex and as a result of an impulse, it might turn into a regulatory failure. The objective is to develop high quality financial reporting and audit standards able to foster transparency, market efficiency and integrity within financial markets. Policy-makers are challenged to design quality and effective future regulation which is independent from excessive political interference which might lead to unnecessary costs and reduce benefits.12 There has been mostly a reactive regulatory engagement instead of a proactive regulatory engagement.