The Sarbanes-Oxley Act and Its Impact on European Companies

Diploma Thesis, 2005

160 Pages, Grade: Sehr Gut (Grade: A)


Table of Contents






2.2.1 Enron
2.2.2 WorldCom
2.2.3 Parmalat

3.1.1 Title I - Public Company Accounting Oversight Board
3.1.2 Title II - Auditor Independence
3.1.3 Title III - Corporate Responsibility
3.1.4 Title IV - Enhanced Financial Disclosures
3.1.5 Title V - Analyst Conflicts of Interest
3.1.6 Title VI - Commission Resources and Authority
3.1.7 Title VII - Studies and Reports
3.1.8 Title VIII - Corporate and Criminal Fraud Accountability
3.1.9 Title IX - White-Collar Crime Penalty Enhancements
3.1.10 Title X - Corporate Tax Returns
3.1.11 Title XI - Corporate Fraud Accountability
3.2.1 Definition
3.2.2 Objectives
3.2.3 Committee of Sponsoring Organizations of the Treadway Commission

4.1.1 Sarbanes-Oxley - Beyond Planning
4.1.2 Sarbanes-Oxley Implementation Survey
4.1.3 Insights on Today’s Sarbanes-Oxley and Corporate Governance Challenges
4.1.4 Internal Audit - Sarbanes-Oxley Survey
4.1.5 Business Ethics and Compliance in the Sarbanes-Oxley Era
4.1.6 Sarbanes-Oxley Compliance Costs Exceed Estimates
4.1.7 Sarbanes-Oxley Section 404 Work - Looking at the Benefits
4.1.8 Delisting and Deregistering of German Issuers in the USA
4.1.9 Summary
4.2.1 Research Intention
4.2.2 Definition of Information Needed
4.2.3 Implementation of Variables
4.2.4 Information Collection
4.2.5 Data Preparation
4.2.6 Interim Cognition Part I - Company Based Questions Part II - Implementation Based Questions Part III - Cost Based Questions Part IV - Benefits Based Questions
4.2.7 Cognition Utilization







To Sigrid and my whole family for your unlimited assistance and support.

Furthermore I want to thank Gerhard Nagl and Gerald Wellan for their support, Steve Morang for his time and his very helpful suggestions, Mag. Gerhard Prachner, Mag. Yann-Georg Hansa and Mike van Oene for reviewing my questionnaire. Moreover I thank everyone who participated in the survey.

Table of Figures





































Peter Krimmer Table of Figures


















illustration not visible in this excerpt


The present thesis examines the impact of the Sarbanes-Oxley Act of 2002 (SOA) on European companies and identifies their attitude towards its provisions. To raise the information needed, from May until the end of June 2005 all affected European companies (290) received access to the online questionnaire. Overall nearly twenty percent responded to the questionnaire. The following key findings have been identified:

- The smaller a company is, the more problems it has to comply with the Sarbanes-Oxley Act.
- The degree of the top management’s involvement in the compliance process plays a crucial role.
- Almost every company has a formal code of ethics in place, but their senior management does not communicate it enough to their employees.
- Almost every company has a whistleblower hotline in place to let all em- ployees raise ethics and compliance issues and many of them also indi- cate that it allows an anonymous, confidential reporting and follow-up on raised issues. Only 30 percent of the hotlines were managed by an out- side third party.
- Most of the companies believe that the compliance costs have exceeded the benefits in 2004, but a positive trend - after the first compliance - to- wards the benefits can be identified.

All in all, the thesis provides a representative overview on the SOA compliance situation of European companies.

1 Introduction

Everyone who regularly reads the newspaper has heard about, and probably followed, the financial frauds of Enron and WorldCom and the resulting legislation reform, the Sarbanes-Oxley Act of 2002 (SOA). This reform didn’t just affect U.S. issuers, but also foreign private issuers1. But very few people know about the actual impacts of this law. Even managers of the affected companies have trouble characterizing the most important provisions of the Act. According to a study conducted by Ernst & Young of 300 German companies affected by the SOA, only about 26 percent of the managers were able to link the Act with the terms “personal liability” and “SOA attestation”.2

The author of this thesis first came into contact with the Sarbanes-Oxley Act during an internship as a SOA compliance project collaborator for the Austrian subsidiary3 of the French building materials producer Lafarge, S.A. During this internship, the idea was raised to broaden his knowledge on this subject by writing the master’s thesis about the Act. An ulterior motive was to receive a benchmark on the compliance status and problems of other affected companies. Therefore to provide a representative overview of the SOA compliance situation of European companies and the thereby emerging benefits and costs, it was decided to measure the overall impact of the Act on all European companies which have a second listing at an American stock exchange by using an empirical survey.

This fundamental idea also formed the main research question: “How does the Sarbanes-Oxley Act impact European companies?” This question can be divided into three sub questions:

- What are the reasons for the enactment of SOA?
- What is the Sarbanes-Oxley Act?
- How are European companies affected by the Act?

The thesis proceeds as follows:

Chapter 2 illustrates the historic background of the Act and tries to answer why the Act was signed into law. Hereby a special attention is laid on the description of the most substantial and best known American financial frauds (Enron and WorldCom) and the largest European fraud case (Parmalat).

Section 3 has a more in-depth look at the theory of SOA and tries to explain its scope and its importance to affected companies. The first chapter of this section explains the enactment procedure and describes the content of the Act in detail. As The second chapter exemplifies what an effective internal control system, required by section 404, should look like.

Chapter 4 deals with the empirical survey, with which the author attempts to answer the last question. First a literature review of selected surveys is being described by the author, concentrating on their key findings. The second section explains the methodology, the research process and the key findings of the survey, while the last section summarizes the key findings of the survey.

The last chapter recapitulates the most important points and provides the answers to the posted research questions.

All non specified law provisions in this thesis always refer to the SarbanesOxley Act of 2002.

2 Problem Statement

In order to understand SOA, one has to know the historic background of its enactment. The first subchapter explains the historic background and the second subchapter the most significant financial frauds in the U.S. and in Europe. Section 3 recapitulates the findings of this chapter.

2.1 History

Following the Enron scandal in the fall of 2001, U.S. Congress began considering reform proposals concerning corporate governance, but there had been countless competing proposals and a significant reform was uncertain. The situation tightened when WorldCom announced an overstated cash flow of more than U.S. $3.8 billion. The harm to the American economy caused through the financial frauds between 2000 and 2002 can hardly be measured. The Dow Jones4 lost over a third of its original value from the beginning of 2000 until July 2002 because of the uncertainty of the investors. In the middle of July, the index reached a three year low of 7590.75 points, compared to a value of 11908.5 points at the beginning of 2000.5 Facing the economic loss and the growing accusations of bounced investors and betrayed employees, as well as the forthcoming elections in November, the U.S. President, at that time George W. Bush, announced a radical increase of penalties and an acrimonious prosecution of balance sheet frauds on July 9th 2002.6

Congress therefore had to respond quickly. It took them only 29 days to pass the Sarbanes-Oxley Act (the Act). The Act was enacted in late July 2002 in the run-up to the 2002 congressional elections caused by the startling bankruptcies of the once highly respected companies Enron and WorldCom. Those bankruptcies were caused by fraudulent accounting practices and insider deals by their executives. The economic damage was enormous and thousands of families lost their means of existence. To prevent such debacles from happening again, the scope of the Act affects all public companies listed at any American stock exchange.7

The President emphasized the importance of the law by calling the bill “ the most significant business legislation since the Depression-era Securities Acts of 1933 and 1934, which created the modern stock exchanges and the SEC ” 8. Although Michael Perino, associate professor of St. John’s University School of Law, wrote that the President would have significantly understated the legislation as a substantial number of its provisions also affect foreign private issuers who trade securities in the U.S., in the “American Corporate Reform Abroad: Sarbanes-Oxley and the Foreign Private Issuer” article.9

Michael Perino’s paper discusses why Congress had chosen to extend Sarbanes-Oxley to foreign private issuers, especially as the SEC had traditionally given such issuers special accommodations. His assumption was that Congress had forgotten to give this topic much attention, as they had to react to the previous financial frauds immediately.10

At around the same time the Act was signed into law it was assumed everywhere else in the world - especially in Europe - that these financial frauds were just an American phenomenon. Only about eight months after the WorldCom bankruptcy this assumption was proven wrong: the first financial fraud case outside the United States occurred. In February 2003, the major Dutch food distributor Royal Ahold admitted an accounting irregularity of some U.S. $500 million. This was followed by a corruption trial in France involving 37 people from the oil company Elf. They were accused of stealing over U.S. $400 million through the 1990s.11 At the end of 2004, Europe encountered its biggest financial fraud case: the bankruptcy of Parmalat with liabilities of over U.S. $17 billion12, which will be described in more detail in chapter Up to this day, many European frauds have been detected - one just has to read today’s newspapers: such as BMW14, Daimler-Chrysler15, Infineon16, Volkswagen17 and many more. Furthermore, a 2003 KPMG Austria study proved that 46 percent of the 500 largest Austrian companies had become victims of white-collar crime within the last five years.18

The Sarbanes-Oxley Act changed the corporate governance, including the responsibilities of executive officers and the regulations of accounting firms which audit public companies, corporate reporting and enforcement. It therefore acts as a driver for a stronger regulation of public companies and markets. It was issued to rebuild the lost trust of investors into the capital market. Figure 1 shows how the Sarbanes-Oxley Act is connected with the Securities Act of 1933 and the Securities Act of 1934:

illustration not visible in this excerpt

Figure 1: SOA in Context with Significant U.S.-Capital Market Laws19

The regulations of the Act - among others - are based on the Securities Act of 1933 and the Securities Act of 1934. Their key objective was to protect investors through the registration of security papers and determination of minimum requirements for the issue of securities and through the registration of issuers of securities and the requiring of periodic reporting. These changes had become necessary because of the great depression triggered by the black Thursday20 in 1929.21 All in all, figure 1 shows that the regulations of SOA are almost as extensive - if not more extensive if it is considered that also foreign companies are affected by this law - as the Securities Acts of 1933 and 1934.

2.2 Financial Frauds

As mentioned before, the accelerated enactment of the Sarbanes-Oxley Act was caused by the appearance of numerous financial frauds and the subsequent pressure of the American population. It has to be mentioned that employees of the affected companies didn’t just lose their jobs - according to newspaper reports over one million people lost their jobs -, but also their pension plans, as most of them were linked to securities.22 As a matter of fact, about 50 percent of the American population owns shares, many Americans lost most of their estate, although they did not work for one of the companies or for one their many suppliers.

The following subchapters, 2.2.1, 2.2.2 and 2.2.3, describe the most substantial and best known financial frauds (Enron and WorldCom) and picture the largest European fraud case Parmalat, the so-called European Enron disaster.

2.2.1 Enron

Enron was originally founded in 1930 as the Northern Natural Gas Company, which was a joint venture by Northern American Power and Light Company, Lone Star Gas Company and United Lights and Railways Corporation. The joint venture ownership was dissolved step by step from 1941 until 1947 through a public stock offering. In 1979, the Northern Natural Gas Company was reorganized under a new holding company - the InterNorth Inc. InterNorth Inc. also replaced the Northern Natural Gas Company at the New York Stock Exchange. Six years later, in 1985, the Houston Natural Gas Company (HNG) was acquired by InterNorth - a transaction driven by Kenneth Lay, CEO of HNG, who was appointed to CEO of InterNorth and promptly renamed InterNorth as Enron Corporation with headquarters in Houston, Texas. Initially, he wanted to name the company Enteron, a connection of “enter” and “on”, but when it became apparent the term meant “intestinal” it was shortened immediately.23

Enron’s key business consisted of trading with raw materials, mainly a distribution of futures contracts on gas or electricity over an internet platform owned by Enron. Over the years the range of businesses was enlarged, among others, from broadband capacities to data transfer and hedging on next summer’s weather. Enron represented an Asset Light - strategy. That means all assets, which were not necessarily needed for its business operations, were sourced out. This strategy should prevent a reduction of profits through missing returns on investments. Whereas online trading with electricity was running satisfactorily, other areas like the distribution of broadband capacities did not work out that profitable. The public did not care much about these areas as long as Enron still published rising profits year after year. Enron’s market value increased by U.S. $50 billion from 1996 within five years. In 20 consecutive quarters, Enron was able to raise its profits and was one of the USA’s seven largest companies, before its collapse in December 2001.24

Andrew Tobias described the accounting and reporting methods of Enron in a parody, as follows:

You have two cows. You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows. The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by your CFO who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows, with an option on six more. Now do you see why a company with $62 billion in assets is declaring bankruptcy? ” 25

On October 16th, 2001, Enron published a press report and disclosed a surprising loss of U.S. $618 million for the third quarter of 2001. On the same day, management announced a reduction of equity capital by U.S. $1.2 billion.26 The financial markets responded to these messages immediately with a collapse of the stock price. During the following month, Enron corrected its operating result of the last four years down by U.S. $586 million and filed for chapter 11 on December 2nd, 2001. At this time, this case was the largest bankruptcy in U.S. history.27

Looking back it becomes obvious that most of the public were not able to understand and oversee Enron’s complex operations. The main reason why Enron was able to announce one record profit after another was the transparency caused by the interlaced financial structure.28 For example, Enron’s CFO, Andrew Fastow, established many offshore partnerships with thousands of companies. These partnerships created liabilities of over U.S. $1 billion, which have not been shown in the group balance. It was therefore possible to disclose raised profits in previous periods and to profit from the euphoric attitude of the analysts. With the exposure of the complex financial structure and the collapse of the stock price, the banks refused additional credit, which finally led to the inability to pay.

Critics also targeted Arthur Andersen regarding insufficient information policy and questionable balancing practices, in his function as independent auditor. At that time, Arthur Andersen LLP belonged to the “Big Five” of public accounting firms in the USA and audited Enron for sixteen years. The energy group was one of Arthur Andersen LLP’s largest customers worldwide. They attested Enron’s financial reporting until the exposure of the financial scandal and did not inform the public about Enron’s financial situation. It was speculated that Arthur Andersen justified its own behavior with the high revenues earned through Enron as a customer. The fact that Enron and Arthur Andersen destroyed ex post evidence enhanced the scandal of the bankruptcy. In June 2002, Arthur Andersen was convicted of obstruction of justice.29 Since no convicted felons are allowed to audit public companies, the firm had to surrender its licenses and its right to practice before the SEC. Nowadays the company employs around 200 employees, mostly handling the lawsuits which arose from the scandal. In better times, Arthur Andersen employed 2800030 workers in the U.S. and 8500031 worldwide.32

2.2.2 WorldCom

WorldCom was established in Jackson, Mississippi in 1983, under the name Long Distance Discount Services, Inc. (LDDS). Two years later, Bernard Ebbers was appointed as Chief Executive Officer. LDDS went public in August 1989 when it merged with Advantage Companies Inc. Six years later, in 1995, the company was renamed to WorldCom and grew, through several takeovers of companies like Advanced Communications Corp., IDB Communications Group, Inc., MFS Communications Company, UUNet Technologies, Inc., CompuServe and the data networks of AOL, into one of the largest operators of internet infrastructures.33 On November 10th, 1997, WorldCom announced its merger with MCI Communications for U.S. $37 billion in cash and stock. The company was subsequently renamed to MCI WorldCom. Until the merger of AOL with Time Warner for U.S. $350 billion34, the acquisition of MCI Communications had been the largest merger in the U.S. history. In 2001, the company’s revenues amounted U.S. $39.2 billion.35

Like other companies in the telecommunication industry, WorldCom encountered financial problems because of too optimistic prognoses of the expected capacity demand. Therefore profits resulting from the extensive investments could not meet expectations. WorldCom therefore had to file for chapter 11 bankruptcy protection on June 21st 2002. In its statement of June 25th 2002, WorldCom admitted that, during 2001 and 2002, it had accounted U.S. $3.8 billion for the usage of external telecommunication infrastructure as fixed assets instead of liabilities. This balancing practice initiated by CFO Scott Sullivan was revealed by an audit of the internal audit department.36

The company’s value fell from U.S. $150 billion in January 2000 down to U.S. $150 million in June 2002. In other words, the stock price had fallen from a high of U.S. $64.50 a share in mid 1999, to less than U.S. nine cents a share.37

The scandal escalated after it turned out that U.S. $3.3 billion had been accounted as additional profits when creating accruals for the years 1999 to 2002. In an additional announcement, WorldCom reported that the fixed assets had been depreciated by U.S. $50.6 billion38 as a result of a retroactive correction. By the end of 2003, it was estimated that the company’s assets had been manipulated by around U.S. $11 billion.39

On March 15th, 2005, Bernard Ebbers was found guilty of all charges and convicted of fraud, conspiracy and filing false documents with regulators.40 On July 13th, 2005, he was sentenced to 25 years in prison.41 Former WorldCom CFO Scott Sullivan got a 5-year term. U.S. District Judge Barbara Jones credited him with “extraordinary” cooperation, including the time he spent on testifying against former WorldCom CEO Bernard Ebbers.42 Former accounting manager Betty Vinson was sentenced on Friday August 5th 2005 to five months in prison and five months of house arrest, while Troy Normand - second former WorldCom accountant - was sentenced to three years’ probation. Neither Normand nor Vinson had to pay a fine.43 Other former WorldCom staff members are also facing criminal penalties with reference to the accounting fraud, including former controller David Myers and former accounting director Buford Yates.44

Again Arthur Andersen LLP was criticized for not being able to reveal WorldCom’s balancing frauds. Arthur Andersen was responsible for reviewing WorldCom’s books from 1989 until May 16th 2005. As for the Enron case, the question arose as to how it was possible that a financial fraud amounting to billions of U.S. dollars could stay undetected.45 Arthur Andersen reported that they were not asked for consultation regarding the balancing of ongoing expenses as investments.46

2.2.3 Parmalat

Parmalat SpA was founded in 1961 by Calisto Tanzi, a 22-year old college dropout, in Parma, Italy. During the 1980s, the company had emerged into a global giant diversifying into milk, dairy, beverages, bakery and other product lines. It became listed on the Milan stock exchange in 1990 and expanded further in the 1990s, developing into the biggest dairy company in Europe. With revenues of more than €7.6 billion, Parmalat had been the eighth largest industry group in Italy, specialized in the distribution of food like long-life milk or tomato puree and its operations in 30 countries included 140 production centers, over 36000 employees and 5000 Italian dairy farms, which were dependent on the company for the bulk of their business.47

Before the financial fraud had been disclosed in autumn 2003, Parmalat’s market capitalization amounted to €1.8 billion. After that the share price fell dramatically, resulting in the shares being almost worthless. During the second quarter of 2004, Parmalat’s bonds were traded for only 20 percent of the nominal value. More than 100.000 investors lost huge amounts of money and are still fighting for compensation payments. Parmalat’s problems became public in late autumn 2003, when the group’s headquarters had to admit that Parmalat was not able to retrieve €500 million of its risk fund on the Cayman Islands. Alarm bells rang on December 8th as a bond of over €150 million could not be returned on the day of maturity.48

On November 20th, the milk group slithered into an increased state of financial crisis after bulk sales of shares and bonds. The share prices of the food giant at the stock exchange of Milan were in a downswing. Since the beginning of the month, Parmalat’s papers lost about 20 percent. CFO Alberto Ferraris had to retreat and was substituted by Luciano del Soldato to calm the investors down. This action had been easily seen through by the investors which resulted in an immediate share price loss of 2.5 percent.49

Parmalat was not only hard-pushed because of the €310 million debts of its tourism subsidiary Parmatour, but also because the exchange supervisory authority was investigating Calisto Tanzi’s group. The inspectors accused Parmalat of a lack of information regarding its €500 million investment into the Epicurum bond of the year 2002. The offshore bond, located on the Cayman Islands, was represented by lawyer Gian Paolo Zini, who was considered a close confidant of Parmalat CEO Stefano Tanzi. After the exchange supervisory authority Consob and Deloitte & Touche pressurized Parmalat because of the lack of information on the Epicurum bond in its balance sheet books, Parmalat disclosed that they would withdraw from the bond. The group had to admit that Epicurum would need time to raise the money, as other investors also wanted their investments back. In the meantime, analysts seriously questioned if there was any capital provider except Parmalat.50

One week later Parmalat failed to pay an installment for an agreed acquisition of minority shares of its Brazilian investors. Facing the fact that in the beginning of 2003 Parmalat informed the investors to possess a liquidity of billions of Euros, these shortages were very mysterious. The rating agency Standard & Poor’s demoted Parmalat by four grades to “CC/C”, which had been the second dramatic devaluation within only two days. Right after this degrading, the value of other Parmalat bonds fell dramatically. The Parmalat share was suspended from trade at the Milan stock exchange. What really made the traders and the analysts very nervous was the fact that the debt due was not very high. At the same time, the group controlled by the founder’s family Tanzi displayed liquid assets of four billion Euro and cash reserves of nearly one billion Euro in its balance sheets. Therefore the belief of the investors in the availability of these funds was shaken. In an unusual announcement, Standard & Poor’s commented that the inability to pay a relatively moderate debt indicated an extremely tensed liquidity. Parmalat recently described its financial situation completely differently. Analysts of ABN Amro emphasized that it was hard to evaluate the liquidity of the group, since the occurrences contradicted Parmalat’s past statements.51

On December 9th the shares of the dairy company were suspended from trade: Parmalat had to admit that they would not be able to withdraw from the risky bond business within the promised period. The unclear pecuniary circumstances of the group had burdened its share price for weeks. Since the beginning of November, the paper lost around thirteen percent. Investors asked themselves how company founder Calisto Tanzi would be able to pay back the due repayments of liabilities of €4 billion within the next five years, as Parmalat officially had a net debt of only €1.82 billion at the end of September 2003.52

On December 11th, Parmalat first impended to slither into insolvency. The future CRO (chief restructuring officer) Enrico Bondi, who replaced CFO Luciano del Soldato, who had resigned in the meantime, asked four creditor banks for financial support of €40 million to pay the investors the €150 million for the bond already due. If Parmalat would not pay within a few days, the rating agency Standard & Poor’s would rate the bond as payment default (“D”). Parmalat’s junior executive Stefano Tanzi tried, in vain, to calm the investors. He reassured them that Parmalat would be a solid company and that Parmalat would not go bankrupt.53

At the end of the second week in December, Italian investors panicked: ten thousand tried to sell their Parmalat shares, after Standard & Poor’s had downgraded the credit worthiness of the group to the status of junk bonds. The share of the company lost almost 50 percent of its value and was again suspended from trade.54

On December 15th, Parmalat’s share again reached the daily permitted volatility and was suspended from trade. Therefore in an emergency session declared as a plenary meeting, it was agreed that the company founder Calisto Tanzi, who built up the small dairy to a multinational company, had to resign with immediate effect from all his commitments as president and CEO of Parmalat. The creditor banks pushed for a new start and demanded that Tanzi would be substituted by Enrico Bondi.55 In the meantime, the public prosecutor’s office had already started investigations against Tanzi, who increasingly emerged as the wirepuller in this scandal, which the media called the “European Enron affair”.56

The big bang was caused by an announcement of the Bank of America, in which they declared that the documents, with which Parmalat tried to prove that their subsidiary Bonlat had assets of four billion Euro, were counterfeited.57 The bank also announced that they never had a business relationship with the finance company Bonlat and that this company had never opened an account with them. Before the public accounting firm Grant Thornton, who had been the primary auditor of the whole group until 1999, audited the subsidiary Bonlat, which was the enforcer of most of the financial frauds58, part of the frauds had been pretty obvious: for example the Parmalat subsidiary sold U.S. $359 million of powdered milk from Singapore to Cuba - in such high amounts that 210 liters a year would account for one Cuban. Another example is a U.S. $90 million expensive license for filling UHT milk and the sale of the fruit juice brand Santal for U.S. $210 million. Furthermore Parmalat’s CFO Fausto Tonna had downloaded bond prices from the internet and listed them meticulously in Bonlat’s balance sheets. Given these facts, the question arises as to how all these frauds could have stayed undetected for such a long time.59

A few days before, Parmalat missed another deadline to pay U.S. $400 million to the minority shareholders of its Brazilian subsidiary. A grace period for the takeover of the stock package was granted until the end of December. On Christmas Day, Parmalat filed for bankruptcy protection. About two weeks after the resignation of Calisto Tanzi and just shortly before his arrest, the courthouse in Parma officially declared the company as insolvent. The decision was made after insolvency administrator Enrico Bondi provided the public prosecutor’s office with a widespread report about Parmalat’s financial situation. This report mentioned debts in the region of up to twelve billion Euro. An amount of 9.5 billion Euro was missing altogether.60

On December 28th, the Parmalat stock was finally delisted from the Milan stock exchange, after it broke down to ten Euro cents. In September 2003, the share price quoted at 3.10 Euro. The bonds issued by the group were traded for only 18 percent of their nominal value.

In the beginning of January, the Parmalat group possessed €632 million all in all, but only 26.636 Euro in cash according to an interim cash check. In the end, it turned out that the insolvent group made annual losses of around €350 million to €450 million from 1990 until 2001. Parmalat announced profits in the region of €926 million between 1996 and 2001.61 On January 26th, auditors determined that as of September 2003 Parmalat had liabilities of €14.3 billion Euro, which is almost eight times of what the management had claimed at that time.62

2.3 Summary

The bankruptcies of Enron in December 2001 and WorldCom in June 2002 caused by financial fraud led to a drastic decrease of the American Dow Jones index. The affair was tightened through systematic destruction of evidence by the public accounting firm Arthur Andersen and Enron. The main reasons for these bankruptcies appeared to be a non effective internal control system as well as a too close relationship between public accounting firms and public companies. The same tendencies can be observed in Europe, as frauds at Royal Ahold, Elf, Parmalat, etc. and studies from KPMG Austria document.63

3 The Sarbanes-Oxley Act of 2002

This chapter addresses America’s solution to prevent future financial frauds. Chapter 3.1 explains the enactment of SOA, what it is, who will be affected by it and describes its provisions in detail. As section 404 of the Act requires companies to maintain an effective internal control system, chapter 3.2 exemplifies what such a system should look like and gives some sources where more detailed information about this topic can be found.

3.1 Content

In the days after the announcement by George W. Bush that penalties and the prosecution for balance sheet frauds would be increased radically, Paul S. Sarbanes, democrat and ranking member of the Senate Committee on Banking, Housing and Urban Affairs, developed a bill, which envisioned, among other areas, the creation of the public company accounting oversight board (“PCAOB”, “board”). This board should prevent fraudulent manipulations like the ones made by Enron and Arthur Andersen LLP.64 The bill was passed by the U.S. Senate on July 15th 2002 under the name “Public Company Accounting Reform and Investor Protection Act of 2002”.65

At about the same time, the House of Representatives discussed a bill introduced by Michael Oxley, republican and chairman of the House Committee on Financial Services.66 His demands regarding a newly established control mechanism were by far not as strict as the bill by Senator Sarbanes, but he set considerably higher penalties for the violation of existing laws. During brief discussions, both chambers agreed on one version based on the proposal by Senator Sarbanes. The tightened penalties from the proposal by Congressman Oxley were simply added to the bill. The law was named the “Sarbanes-Oxley Act of 2002” and was passed on July 25th by both chambers of Congress with a superior majority.67 On July 30th, 2002 U.S. President Bush signed the Sarbanes-Oxley Act of 2002 into law with the words “ [ … ] I sign the most far- reaching reforms of American business practices since the time of Franklin Delano Roosevelt ”68.

The enactment of the Sarbanes-Oxley Act has been the most significant change of the U.S. securities laws since the Securities Act of 1933 and the Securities Exchange Act of 1934 (SEA). The regulations of SOA are not limited to the American area. They are obligatory to all companies who have to be registered with the SEC. In other words, the regulations apply to all companies listed at an American Stock Exchange (NYSE, NASDAQ, AMEX) or who trade their shares in public elsewhere in the United States (e.g. Over-the-Counter Market). This means that the principles of the SOA have not been restricted to foreign private issuers. A foreign private issuer is a company which has to be registered at the SEC and its headquarters are based outside the USA. All subsidiaries from SEC registered companies also have to comply with the Act.69 The Parmalat and Royal Ahold cases show that the European capital markets are not immune to financial frauds. There are therefore also European attempts to increase the transparency and to improve the corporate governance. Numerous new laws address similar aspects like the Sarbanes-Oxley Act, but whether they will ever become as important as their American counterpart is arguable.70

The Act consists of 11 titles and 66 subordinated sections. Figure 2 gives an overview over all titles and summarizes their topics with one sentence each. The individual titles and sections will be consecutively illustrated and explained in the following chapters 3.1.1 to 3.1.11.

illustration not visible in this excerpt

Figure 2: Outline of the Sarbanes-Oxley Act71

3.1.1 Title I - Public Company Accounting Oversight Board

The first title of the Sarbanes-Oxley Act deals with the establishment of the PCAOB. It is intended to protect the interests of the investors and to strengthen public trust in audit reports. The board has to consist of five full-time members, who are all nominated by the SEC. The chairman has to be voted out of two members who must be, or have been, certified public accountants (CPA). However, the chairman may not have been a practicing CPA within the last five years. All members have to be absolutely independent from any public accounting firm and may not be engaged in any other professional or business activity. They are nominated for five years and can be reappointed once for another five years.72

Section 102 demands that every public accounting firm which audits a company in the course of the year-end closing, which is listed at an American stock exchange, has to register at the PCAOB. The registration has to be completed no later than 180 days after the date of the determination of the commission - in other words, the deadline was October 23rd 200373. This sector also describes the disclosure requirements of the registered public auditing firms in detail. They are obligated to provide an annual report about the last year’s audited public companies and the amount and the type of received fees. Additionally, the auditing firms have to sign a statement regarding disciplinary procedures in case of a violation against one of the rules issued by the board. The companies are also required to disclose all other information the PCAOB considers to be important.74

According to section 103, the board is required to adopt provisions for standardized audits and attestations. These provisions focus on auditing, quality control and independence standards. The auditing rules regulate, among other matters, the record retention (documents have to be retained for seven years), the reporting commitment and the obligatory partner review of the tested documents.75

Section 104 regulates at which intervals the public accounting firms have to be inspected. Every company who conducts more than 100 audits of U.S. listed companies has to be inspected annually; all other firms have to be checked at least every three years. It shall thereby be determined if the company violated provisions of the SEC and/or federal law. The PCAOB has to report any such cases to the SEC and the appropriate State regulatory authority and begin formal investigations or take disciplinary action. For each inspection the board has to submit a written report to the SEC and the appropriate State regulatory authority.76 This paragraph replaces the peer review system, which is based on self regulation and where audits of the public accounting firms had been performed by other accounting companies.77

The investigation proceedings of the board, as well as the disciplinary proceedings against registered accounting companies and their employees, are regulated in section 105. According to this paragraph, the PCAOB is allowed to investigate every registered public accounting firm and its employees and is entitled to ask them for testimonies, documents, etc. using the authorities of the SEC. The board is obligated to inform the SEC about any forthcoming investigation and to consider obtained information as strictly confidential. Hearings and investigations should also not be published. When a party does not cooperate, the PCAOB may impose sanctions against individuals and/or the whole company. These sanctions range from suspending/barring the individual/s from working at a registered public accounting firm or suspending/revoking the registration of the whole company, to penalties of up to U.S. $750.000 for a natural person and up to U.S. $15 million for a legal person.78

For section 106, which addresses the appliance of the PCAOB to foreign public accounting firms, there are two different interpretations. The AICPA says that:

“ The bill would subject foreign accounting firms who audit a U.S. company to registrations with the Board. This would include foreign firms which perform some audit work, such as in a foreign subsidiary of a U.S. company, which is relied upon by the primary auditor. ”79

Professor Dr. Hans von der Crone and Katja Roth interpret this paragraph differently. As a result of the word choice used in section 106(a), they also see an applicability to any foreign public accounting firm which audits, for example, a European company with a second listing in the United States or one of its subsidiaries.80 This view is also shared by Katrin Werner and Markku Schmitt from the University of Applied Science in Frankfurt am Main.81

Section 106 also obligates a foreign public accounting firm to register with the PCAOB when they play an important role in an audit of a U.S. listed company conducted by another accounting company. In addition to this, a foreign public accounting firm is required to issue information to the board, in case a registered accounting company uses an audit certificate of the foreign accounting firm. Both the SEC and the PCAOB are allowed to issue exceptions to foreign companies.82

According to section 107, the SEC supervises the PCAOB and has to approve new or changed regulations. For sanctions against public accounting firms, the SEC has the right to veto and may demand a change of the penalty.83

Paragraph 108 transfers the right to authorize new accounting standards from the SEC to the PCAOB. These standards are still being created by an independent organization - the Financial Accounting Standards Board.84 The PCAOB has the ability to cancel this delegated competence at any time.

The PCAOB is a non profit organization and is being financed by fees collected from SEC registered companies and from PCAOB registered public accounting firms.85

3.1.2 Title II - Auditor Independence

The second title of the Sarbanes-Oxley Act deals with the independence of auditors. This chapter is a significant provision of the Act, as it regulates auditor independence. Section 201 lists all non-audit services, which the annual auditor may not perform. The decisive factor for this prohibition is that the auditor would otherwise have to audit his own work in line with the year-end closing. His independence could therefore no longer be guaranteed. The PCAOB also has the potentiality to restrict the range of services allowed so far through new provisions.86 The board may grant exceptions on a case by case basis. Further services are allowed - even tax consultancy - if they have been approved by an independent audit committee which the company has to set up.87

According to section 202, a preceding investigation can be delegated to one or more members of the audit committee. This task is not compulsory if fees emerging from non-audit services did not exceed five percent of the company’s annual revenues, the company has not recognized the non-audit service as such and made the audit committee aware of this before the service was ended.88

Section 203 regularizes that the lead audit partner as well as the partner who is responsible for reviewing the audit have to be exchanged at least every five years, in order to prevent too close a relationship between the auditors and the audited company.89 This regulation did exist before SOA, but the rotation period accounted for seven years. Though, European and Japanese reviewing partners will still have to rotate every seven years.90

When a public accounting firm provides services to a client and a member of the audit team switches to a key position in the audited company, section 206 contains regulations to prevent a conflict of interests. One year has to elapse between the date of the change over and the date on which audit services are provided (cooling-off period).91 In other words, an established audit mandate has to be interrupted for at least one year, if an employee switches to the audited company. Key positions are e.g. the roles of a CEO/CFO, member of the supervisory board, controller, treasurer, etc.92

3.1.3 Title III - Corporate Responsibility

The provisions quoted in this chapter should facilitate to hold managers, who have violated the SOA regulations, personally responsible. Section 301 explains the constitution, the duties and the therewith linked responsibilities of the audit committee in detail. Each issuer’s93 audit committee, which is acting as a committee of the board of directors, takes over the responsibility for the adequate and orderly accounting and the selection, monitoring and compensation of any registered public accounting firm. It is also obligated to act as a contact point for complaints regarding accounting and auditing matters. Incidents registered by employees have to be accepted completely confidentially and anonymously. The committee consists of independent members of the board of directors. The committee members may not receive any fees from the public company or a linked company, except for the fee he/she receives for his function as a member of the board of directors. The SEC has the right to issue exceptions.94

The third title also addresses how much or what can be considered as “material”. Prior to SOA, public accountants considered errors or internal control failures as material when the earnings per share altered by some fraction of a cent. Therefore large companies could discover an error in a transaction of probably millions of dollars but would not investigate the reasons as they believe this error would not be material.95

The SEC indicated that the definition for materiality released in its 1999 Staff Accounting Bulletin: No. 99 - Materiality, will now apply. This bulletin states that “ a matter is "material" if there is a substantial likelihood that a reasonable person would consider it important ” 96. This formulation matches the formulation of the U.S. Supreme Court, which consider a fact as “ material if there is a substantial likelihood that the … fact would have been viewed by the reasonable investor as having significantly altered the “ total mix ” of information made available ”.97

There are also four perspectives of working materiality, which all have their own distinct quantitative calculations and limits. Therefore the type of financial statement effect or “exception” has to first be determined by the CPA, so he knows which materiality level applies. There are four exceptions:98

- Misstatements or errors
- Internal control deficiencies
- Accounting estimates
- Fraud99

Section 302 also commits the CEO and CFO of an issuer to make an affirmation for periodic reports submitted to the SEC and to confirm the correctness of statements made therein. Foreign private issuers, who file intermediate messages with the form 6-K with the SEC - which happens on a voluntary basis and therefore is no SEC requirement - do not have to certify these intermediate messages.100 Furthermore, the CEO and CFO are responsible for the constitution, design and support of disclosure controls and procedures. They have to ensure that significant incidences, which concern the company, are disclosed in a timely fashion.101 In addition to this, all identified weaknesses have to be reported to the audit committee and the public accounting firm.

The CEO, or any active manager in a similar position, is not allowed to force, influence or mislead a certified accountant.102 If that is the case and the annual report consequently has to be corrected, the CEO and CFO will have to pay received bonus claims, compensations and profits received through the sale of company shares back to the company.103 Additionally, the SEC is authorized to initiate legal proceedings, including a suspension or even a complete ban of the CEO or CFO, which will benefit investors.104

Directors and managers of a public company are not allowed to buy or sell any equity security during a blackout period, as defined in section 306. Relevant information for the definition of the blackout period must be provided to the SEC by the company. If someone breaches this rule, he/she will be obligated to pay the raised profits to the company.105

The Sarbanes-Oxley Act also contains corporate governance provisions to regularize the adequate behavior of company lawyers. According to this, public company attorneys are required to report violations of laws and regulations to the CEO or to the chief legal counsel. If the informed person does not act appropriately to the evidence, the lawyer has to inform the audit committee.106 It has to be mentioned that Michael Perino writes in his article “Failure To Report Up The Ladder Will Rarely Be Enforced” that the SEC will not vigorously enforce section 307 as tight budget and staff limitations, more pressing enforcement mandates, and a touch of self-protective bias indicate a reluctance to prosecute.107 Additionally the author of this thesis believes that this reluctance is also linked to the fact that this provision offends against local law, e.g. the German law108 or the British law109.

Section 308 requires the SEC to install a compensation fund for the benefit of defrauded investors. All incidental penalties should be collected in there.110

3.1.4 Title IV - Enhanced Financial Disclosures

Title IV regularizes the extension of the disclosure requirements of financial information. Section 401 prescribes that each annual and quarterly financial report required to be filed with the SEC has to disclose all material off-balance sheet commitments.111 In the Enron case, such off-balance sheet commitments were not published. Therefore there was hardly any information about the interlaced financial structure with offshore partnerships, so that Enron could easily commit non-balanced liabilities of more than U.S. $1 billion.112

According to section 402, an issuer is not allowed to grant or extend credits in the form of a personal loan to members of the board of directors. Credits are acceptable as long as they are granted in accordance with the same conditions every other employee of the company would receive.113 Hereby the legislator wants to prevent the almost unrestrained granting of credits to executives.

Section 403 also regulates a shortening of the notification period for transactions, made by the company’s management or people who own more than ten percent of the company’s shares.114

Compliance with section 404 “Management Assessment of Internal Controls” requires the greatest implementation effort of all Sarbanes-Oxley Act regulations. Through the implementation of these provisions it should be prevented that, because of insufficient monitoring, wrongfully or insufficient information becomes part of the financial reporting and can therefore mislead investors. According to section 404, each annual report required by sections 13(a) or 15(d) SEA has to contain an internal control report about financial reporting. This statement has to be certified separately in line with the annual audit by the auditor. The Sarbanes-Oxley Act demands from the SEC that it issues execute statements for these regulations. On August 14th 2003, the SEC fulfilled this request and published the final rule 33-8238 which explains how an internal control system should look like. In this paper the Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework115 is being recommended but the usage of different internal control systems is permitted.116


1 A foreign private issuer is defined as any issuer with less than 50 percent of its outstanding voting securities held by U.S. residents, the majority of executives are U.S. citizens or residents, it has more than 50 percent of its assets located in the U.S. or its business is administered principally in the U.S. [Cp. Perino, M.A. (American Corporate Reform Abroad), p.1]

2 Cp. Frankfurter Allgemeine Zeitung (Inhalt des Sarbanes-Oxley-Gesetzes)

3 Lafarge Perlmooser AG

4 American stock market index

5 Cp. Nassen, M. (Bilanzbetrug), p. 28 et seq.

6 Cp. Berger, S. (Bushfeuer)

7 Cp. Perino, M.A. (American Corporate Reform Abroad), p. 1

8 AFP (SOA Resource)

9 Cp. Perino, M.A. (American Corporate Reform Abroad), p. 1

10 Cp. Perino, M.A. (American Corporate Reform Abroad), p. 2

11 Cp. Moeller, R. (Internal Auditing), p. 257

12 Data gathered from: Edward, M. (Parmalat Fraud)

13 Cp. p. 13

14 Cp. Kröger, F. (Konkurrenz)

15 Cp. Schmahl, H.-J. (Gier); cp. Also Spiegel Online (DaimlerChrysler)

16 Cp. Slodczyk, K. (Korruptionsermittler)

17 Cp. Spiegel Online (VW)

18 Cp. KPMG Austria (Wirtschaftskriminalität), p. 5; cp. also Möchel, K. (Opfer von Kriminellen)

19 Cp. Herzig (Projekterfahrung), Slide 5

20 Known in Europe as black Friday because of the time lag

21 Cp. Thies, C.F. (Crash), p. 1; more detailed information about this topic can be found in Barrie Wigmore’s “The Crash and Its Aftermath: A History of Securities Markets in the United States, 1929-1933” [cp. Wigmore, B.A. (Securites Markets)]

22 Weitmayr, H. (200 Mrd. $ Schaden)

23 Cp. Share, J. (Notes)

24 Cp. Hillenbrand, T. (führendes Unternehmen)

25 Cp. Andrew, T. (Accounting)

26 Cp. FindLaw (USA against Andersen)

27 Cp. Menzies, C. (SOA), p. 8

28 Cp. Ribstein, L.E. (Critique of the Sarbanes-Oxley Act), p. 7

29 Cp. Wirtschaftsblatt (Höchststrafe)

30 Data gathered from: Yost, P. (Prosecution)

31 Data gathered from: Mihalick, C. (Arthur Andersen)

32 More detailed information on the Enron bankruptcy case can be found in the paper “Enron and the Dark Side of Shareholder Value” by William Bratton [cp. Bratton (Shareholder Value)] and “Governance and Intermediation Problems in Capital Markets: Evidence from the Fall of Enron” by Paul M. Healy and Krishna Palepu [cp. Healy, P.M. - Palepu, K. (Fall of Enron)]

33 Cp. Lyke, B. - Jickling, M. (Accounting Scandal), p. 2

34 Cp. Adams, M. (Merger)

35 Cp. Thornburgh, D. (Interim Report), p. 12-19; cp. also Menzies, C. (SOA), p. 9

36 Cp. Sandberg, J. et (WorldCom Scandal) - cp. also Weitmayr, H. (WorldCom-Debakel)

37 Cp. Clarion Ledger, The (Ebbers Timeline)

38 Data gathered from Lyke, B. - Jickling, M. (Accounting Scandal), p. 5

39 Cp. Rovella, D. (WorldCom Trial) - cp. also Weitmayr, H. (WorldCom)

40 Cp. Crawford, K. (Ebbers guilty)

41 Cp. CBC News (Ebbers)

42 Cp. Washington Post (CFO gets 5-year term)

43 Cp. McClam, E. (WorldCom Jail)

44 Cp. Johnson, C. (Ebbers Sentencing)

45 Cp. Menzies, C. (SOA), p. 10

46 Further more detailed information about the WorldCom fraud and its collapse can be found in the research paper “The Failure of Good Intentions: The WorldCom Fraud and the Collapse of American Telecommunications After Deregulation” by J. Gregory Sidak [cp. Sidak, J.G. (World- Com Fraud)]

47 Cp. Arie, S. (Parmalat Dream) - cp. also Lexa, M. (Parmalat)

48 Cp. Fritz, G. (Parmalat Skandal), p. 19 ; cp. also Taroni, M. (Börse Mailand)

49 Cp. Fritz, G. (Parmalat Skandal), p. 20

50 Cp. Arie, S. (Parmalat Dream); cp. also Fritz, G. (Parmalat Skandal), p. 20

51 Cp. Fritz, G. (Parmalat Skandal), p. 21

52 Cp. Fritz, G. (Parmalat Skandal), p. 22

53 Cp. Fritz, G. (Parmalat Skandal), p. 22

54 Cp. BBC News (Parmalat Admits)

55 Cp. BBC News (Parmalat Bankruptcy Protection)

56 Cp. Fritz, G. (Parmalat Skandal), p. 23

57 Cp. D’Orio, G. (Parmalat Scandal), p. 3; cp. also Arie, S. (Parmalat Dream)

58 Cp. Coffee, J.C. (Corporate Scandals), p. 51

59 Cp. Fritz, G. (Parmalat Skandal), p. 62 et seq.

60 Cp. Fritz, G. (Parmalat Skandal), p. 24 et seq.

61 Cp. Fritz, G. (Parmalat Skandal), p. 26

62 Cp. BBC News (Parmalat Timeline)

63 Cp. p. 5

64 Cp. Sarbanes, P. (Biography)

65 Cp. Romano, R. (Corporate Governance), p. 1552

66 Cp. Oxley, M. (Biography)

67 Cp. Nassen, M. (Bilanzbetrug), p. 29 et seq.

68 White House, The (President Bush signs Bill)

69 Cp. (Executive Summary)

70 Cp. PricewaterhouseCoopers (SOA Historie)

71 Cp. Menzies, C. (SOA), p. 14

72 Cp. Congress of the United States (The Act), Section 101

73 Date gathered from: Nassen, M. (Bilanzbetrug), p. 32

74 Cp. Congress of the United States (The Act), Section 102

75 Cp. Congress of the United States (the Act), Section 103

76 Cp. Congress of the United States (the Act), Section 104

77 Cp. Baker, R. PhD (Auditor Independence); cp. also Nassen, M. (Bilanzbetrug), p. 33

78 Cp. Congress of the United States (the Act), Section 105

79 American Institute of Certified Public Accountants (Summary SOA)

80 Cp. Von der Crone, H. Dr. - Roth, K. (extraterritoriale Bedeutung), p. 132

81 Cp. Werner, K. - Schmitt., M. (Anforderungen für deutsche Unternehmen), Slide 23

82 Cp. Congress of the United States (the Act), Section 106

83 Cp. Congress of the United States (the Act), Section 107

84 Cp. (FASB)

85 Cp. Congress of the United States (the Act), Section 108

86 Cp. Streibl, P. (Internes Kontrollsystem), p. 47

87 Cp. Congress of the United States (the Act), Section 201

88 Cp. Congress of the Unites States (the Act), Section 202

89 Cp. Congress of the United States (the Act), Section 203

90 Cp. Kramer, A. (EU feiert Erfolg)

91 Cp. Lander, G.P. (What is Sarbanes Oxley), p. 75 et seq.

92 Cp. Congress of the United States (the Act), Section 206

93 An issuer is a company which is registered with the SEC.

94 Cp. Congress of the United States (the Act), Section 301

95 Moeller, R. (Internal Audit), p. 39

96 Securities and Exchange Commission (Materiality)

97 Securities and Exchange Commission (Materiality)

98 Cp. Vorhies, J.B. (Importance of materiality)

99 More details regarding the exceptions can be found in the article “The New Importance of Materiality” by James Brady Vorhies [cp. Vorhies, J.B. (Importance of materiality)]

100 Cp. Menzies, C. (SOA), p. 18 et seq.

101 Cp. Congress of the United States (the Act), Section 302

102 Cp. Congress of the United States (the Act), Section 303

103 Cp. Congress of the United States (the Act), Section 304

104 Cp. Congress of the United States (the Act), Section 305

105 Cp. Congress of the United States (the Act), Section 306

106 Cp. Congress of the United States (the Act), Section 307

107 Cp. Perino, M.A. (Failure to Report)

108 Cp. Schäfer, A. (Corporate Governance), p. 16

109 Cp. Weitmayr, H. (EU gegen SEC-Finanzaufsicht)

110 Cp. Congress of the United States (the Act), Section 308

111 Cp. Congress of the United States (the Act), Section 401

112 Cp. p. 9

113 Cp. Congress of the United States (the Act), Section 402

114 Cp. Congress of the United States (the Act), Section 403

115 Cp. p. 41 et seq.

116 Cp. Securities and Exchange Commission (Internal Control)

Excerpt out of 160 pages


The Sarbanes-Oxley Act and Its Impact on European Companies
Vienna University of Economics and Business  (Management Accounting and Auditing)
Sehr Gut (Grade: A)
Catalog Number
ISBN (eBook)
File size
1290 KB
Sarbanes-Oxley, Impact, European, Companies
Quote paper
Mag. Peter Krimmer (Author), 2005, The Sarbanes-Oxley Act and Its Impact on European Companies, Munich, GRIN Verlag,


  • No comments yet.
Look inside the ebook
Title: The Sarbanes-Oxley Act and Its Impact on European Companies

Upload papers

Your term paper / thesis:

- Publication as eBook and book
- High royalties for the sales
- Completely free - with ISBN
- It only takes five minutes
- Every paper finds readers

Publish now - it's free