Enterprise Risk Management (Preview)

18 Part 1 – Concepts and Methods considered overly aggressive and inconsistent with industry practices. It had the effect of inflating the balance sheet and net income of WorldCom. Once the irregularities were discovered and the financial statements restated, the total assets of WorldCom were reduced by $70 billion (from $104 billion to $34 billion), and the previously reported net income of $1.4 billion, became a loss of $15.6 billion. 12 Investors quickly lost confidence and WorldCom filed for bankruptcy in July 2002. In addition to Enron and WorldCom, other major accounting and fraud scandals occurred in the early 2000’s, namely at Global Crossing, Tyco International and Adelphia Communications. The bankruptcy of Nortel in Canada was another major event which included restated financial statements and forecasts due to accounting and forecasting errors. Sarbanes-Oxley Act of 2002 Investor confidence was severely shattered following the unprecedented scale of the accounting and fraud scandals that occurred in the early 2000’s. In response, the United States Congress adopted the Sarbanes-Oxley Act to implement reforms aimed at improving corporate governance, financial reporting and auditor independence. Sarbanes- Oxley applies to companies that have securities registered with the Securities and Exchange Commission (SEC). These securities are typically shares, bonds and derivatives that trade with stock exchanges in the United States. The Sarbanes-Oxley Act directs the SEC to establish and maintain regulations supporting the legislation. Stock exchanges such as the NYSE also have rules that support legal and regulatory requirements associated with Sarbanes-Oxley. The main points of the Sarbanes-Oxley Act and related regulations and rules are as follows: • Financial reports and information – The chief executive officer and chief financial officer (or equivalent executives) must certify (sign-off) that they have reviewed their company reports filed with the SEC, and that the reports are not misleading and present fairly the financial condition and results of operations of the organization. • Financial reporting controls – The executives must certify that they are responsible for controls relating to financial reporting and disclosures, and that these controls have been evaluated. 13 They also need to attest that any fraud or significant deficiency has been disclosed to their financial statement auditors and audit committee. The auditors have to provide an opinion on financial reporting controls. • Off-balance sheet items – Companies must disclose significant off-balance sheet agreements and obligations that they have with other entities. Off-balance sheet items are not recorded in financial statements, but are presented in notes to financial statements in accordance with the accounting principles applicable to those items. • Code of ethics – Companies must establish a code of ethics for their senior finance officials and state that they have done so, or they need to provide explanations for why such a code has not been developed. The code of ethics (when developed) must include clauses relating to conflicts of interest, the accurate disclosure of financial information, and the compliance with laws and regulations. • Independence of board members and auditors – Companies must have a majority of board members that are independent from management, 14 and have an audit committee that includes only independent board members. At least one member of the