Corporate Governance

Corporate Governance

The collapse of energy giant Enron is the largest bankruptcy in U.S. corporate history. In just 15 years, Enron grew into one of America's largest companies, but its success was based on artificially inflated profits, dubious accounting practices, and fraud. (http://www.seen.org/). In response to public outcry over Enron and other corporate and accounting scandals, Congress passed the Sarbanes-Oxley Act in 2002 to protect investors from fraudulent accounting activities within corporations. The Sarbanes-Oxley Act was created in response to high-profile cases involving companies whose fraudulent actions have called into question the ethics and accountability of big business. The Act is intended to prompt corporations to operate with greater integrity and promote ethical behavior. Sarbanes-Oxley fosters this integrity by strongly encouraging covered companies to adopt three standards under the Act's whistleblower provisions for their firms; a code of business ethics, procedures for confidential employee reporting, and conduct rules for in-house attorneys.

A code of business ethics is intended to promote a higher standard of conduct among senior financial officers. Adoption of such a code is strongly encouraged under Section 406 of the Sarbanes-Oxley Act. Under Section 406 of the Sarbanes-Oxley Act, public companies are strongly encouraged to create a code of business ethics for senior financial officers, or must promptly disclose to the SEC the reason for any failure to adopt such a code. Section 406 also requires public companies to report any amendments to, or waivers from, its code. According to Section 406, a code of ethics provides standards reasonably necessary to deter wrongdoing and to promote honest and ethical conduct. (http://niri.org). The SEC's regulations under Section 406 suggest that a business ethics code for senior financial officers address five conduct goals as shown below:

Ð'* Ethical handling of conflicts of interestÐ'--an example of an ethical handling of conflicts of interest would be resolving a conflict of interest using an impartial committee.

Ð'* Internal disclosure proceduresÐ'--an example of internal disclosure procedures intended to avoid conflicts of interest would be ensuring that no senior financial officer is responsible for investigating the complaint cases of his employees.

Ð'* Legal complianceÐ'--an example of legal compliance would be ensuring the proper retention of all auditing and accounting records to comply with state and federal laws.

Ð'* Prompt internal reportingÐ'--an example of a prompt internal reporting of code violations would be reporting within one business day an alleged case of illicit accounting document destruction.

Ð'* Ethical handling of conflicts of interestÐ'--An example of accountability for adherence to the code would be creating an independent committee to periodically ensure the ethics code is properly followed.

An organization's code of business ethics should be like a navigator's guiding star. The code of business ethics provides a reference point that helps members find their way when they are unsure of the right course of action. To provide that point of reference, a code of business ethics should embody an organization's highest ideals or a company's best practices. The code should set the standard that all members strive to meet. The next critical standard to ensure a company's integrity is the procedures for confidential employee reporting.

Confidential reporting procedures are intended to encourage employee whistleblowing. The procedures are mandated under Section 301 of the Sarbanes-Oxley Act. Section 301 mandates that a public company's audit committee create procedures for the confidential reporting of questionable accounting or financial auditing matters. The reporting procedures are intended for individuals both inside and outside the company. An example of an individual inside the company would be any employee, from the CEO down. An example of an individual outside the company would be a contractor or subcontractor who is doing business with the firm. Failure to comply with the confidential reporting procedure requirement under Section 301 could result in the company being de-listed from a national exchange. There are several ways a confidential employee reporting procedure can be provided such as:

Ð'* A confidential reporting procedure could be an anonymous telephone hotline or web site.

Ð'* A confidential reporting procedure could also be an anonymous drop box or voice mail system.

Among other things, this section requires that a public company's audit committee establish procedures that employees can use to confidentially and anonymously submit complaints of alleged corporate wrongdoing. A business has economic responsibilities to its direct stakeholdersÐ'--its investors, employees, and customers. The third critical standard for companies to adopt is the conduct rules for in-house attorneys.

Attorney conduct rules are mandated under Section 307 of the Sarbanes-Oxley Act. This calls for the establishment of new rules of conduct for attorneysÐ'--including in-house attorneysÐ'--who appear or practice before the SEC. Section 307 requires that such attorneys report evidence of a violation of securities law, breaches of fiduciary duties, or similar violations, to a corporation's chief legal counsel or CEO. Section 307 states that if these reports do not properly resolve the attorney's concerns, the attorney must report his or her concerns to the firm's audit committee, or some similar committee. (http://niri.org). Although covered attorneys are obligated to report evidence of securities-related legal breaches and the failure of the firm's chief legal counsel or CEO to resolve the attorney's concerns, the attorneys are, in a sense, acting as whistleblowers. Sarbanes-Oxley would likely protect all such reports.

The Sarbanes-Oxley Act will result in major changes in the way U.S. companies are governed and managed. However, just complying with the Act will not restore investor confidence. Companies must work hard at putting into practice the spirit and intent of the law. They need to ensure transparency, accountability, courage, and leadership in corporate governance. Suitability of candidate directors consists of nominating committees tot ensure that candidate directors are well-qualified and independent. At least one financial expert should be included on the audit committee. Board members must have a clear understanding of the business they are overseeing. Board members

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