Financial Times

Sarbanes-Oxley Act- How relevant is it to Sri Lanka?
By Ravi Mahendra
The publicity surrounding the collapse of Enron, and more recently, the events involving WorldCom led, quite predictably, to a flurry of action on Capitol Hill. The culmination of this activity was the Sarbanes-Oxley Act of 2002. The House passed the Bill 423-3, and a few hours later, the Senate approved the Bill 99-0. According to the Wall Street Journal, President Bush had referred to the Bill as 'a good piece of legislation', and promised to sign it even before the Senate had voted it into existence.

The Sarbanes-Oxley Act of 2002 was brought about 'to protect investors by improving the accuracy and the reliability of corporate disclosures made pursuant to the security laws, and for other purposes'. It focused on the Formation of the Public Company Accounting Oversight Board, Auditor Independence, Corporate Responsibility, Enhanced Financial Disclosures, Corporate and Criminal Fraud Accountability, Analyst Conflicts of Interest and many other topics relating to the efficient implementation of corporate governance, financial disclosure and the practice of public accounting.

This five-member board will be established under the Act in order to oversee the audits of public companies. It will register auditors, control the ethical standards and quality of auditors, inspect audit firms, conduct disciplinary inquiries when relevant and monitor their compliance with the Act, as well as the rules of the board. It is to be appointed by the Securities and Exchange Commission (SEC), in consultation with the Secretary to the Treasury and will not consist of more than two Certified Public Accountants.

On the other hand, all regulations in Sri Lanka are carried out by the Institute of Chartered Accountants whose governing body, which constitutes the President and the Council members, are practicing auditors.

Regulation of auditors
Apart from the action mentioned above, the Act also introduces many bold reforms on auditors. It prohibits audit firms from providing non-audit services to their clients, requires auditors to provide reports to the audit committees of their clients rather than to the management, insists on the rotation of lead auditor and the audit partner handling a particular account, at least once in every five years and prohibits auditors from auditing clients whose senior executives were former employees of the audit firms concerned.

In Sri Lanka however, even though there are discussions on reforms in areas relating to auditors, at present, no such provisions have been brought about yet.

Enhancing the role of the SEC
Since an audit committee is an independent body comprising of non-executive directors, which liaises with auditors, and monitors the existence of internal controls within the company, the Act has commissioned the SEC to instruct all national stock exchanges in the US to avoid listing companies, which do not have audit committees, as specified.

The Act also requires the SEC to analyse the role and function of credit rating agencies. This is because, the concept of credit rating has become popular in recent times and these agencies provide an evaluation of the financial position of a firm by rating it. Firms, which issue debt instruments to the public, use such ratings, and the SEC should be able to detect potential conflicts of interest, which may arise, and take precautionary measures.

Sri Lankan listed companies however, need not adhere to requirements such as audit committees. Furthermore, a new line of financial services which is being developed in Sri Lanka is credit-rating, and this needs to be regulated, from the initial stages itself.

At present, there is an established international credit rating agency in Sri Lanka (Fitch), and the diversified conglomerate Ceylinco, is currently setting up another one. At such a point, the industry needs to be regulated.

Controls on senior management
The Sarbanes-Oxley Act introduces strict controls on senior management of public companies, whereby they will be held accountable for any wrong information published by their companies. The CEO and the CFO (Chief Financial Officer) have to certify the accuracy and the authenticity of their financial statements, and any bonuses or stock options granted will be reimbursed personally, if the accounts are restated, subsequently. Since the wrong doings of a company are brought to light by whistle-blowers, legal protection shall be provided to those of Public Trading Companies.

In Sri Lanka it is customary for the chairman and a director to sign audit reports but it does not amount to proper certification as mentioned above. This is because no personal responsibility rests on the chairman, the director or the CFO for the correctness of financial statements and furthermore, there are no legal compulsions on senior officers to reimburse any bonuses or stock options granted due to misstated profits. As for whistle blowing, this is rather new to Sri Lanka and no legal provisions exist to provide protection to whistle-blowers.

Criminal liabilities
Any auditor who knowingly and willingly fails to maintain all documents sent, received, or created in connection with an audit or review, five years from the end of the fiscal period for which the audit or review was conducted, shall be charged on the count of criminal liability. In the Enron scandal, the management and auditors destroyed all documents, in order to hinder and cover up the investigations. Thankfully, the Act has brought about action to prevent the repetition of similar malpractices in future.

Unfortunately for us, such harsh measures do not exist in Sri Lanka at the moment.
Although imperfect in some aspects, the Sarbanes Oxley Act of 2002 is a significant step forward in improving corporate governance in the US.

It has developed out of lessons learnt from corporate failures, so it provides somewhat practical solutions, which can produce adequate results. Our government is currently trying to attract international funds to invest in our stock market.
This means that governance will have to improve to match the standards of other countries. Since the US consists of a progressive society it can be considered a good benchmark to follow by us.

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