Thomas G. Calderon, Ph.D. Professor of Accountancy College of Business Administration

1. Benchmarking Corporate Governance in the Eastern Caribbean against Sarbanes-Oxley Auditing & Disclosure Requirements Thomas G. Calderon, Ph.D. Professor of Accountancy College of Business Administration The University of Akron Akron, OH 44325-4802 330.972.6099 (Phone) 330.972.8597 (Fax) tcalderon@uakron.edu Dr. T. G. Calderon

2. Background - Corporate Governance “…. Corporate governance is a topic recently conceived, as yet ill-defined, and consequently blurred at the edges…” Attributed to Maw et al. [1994, page 1] at http://www.encycogov.com/WhatIsGorpGov.asp Dr. T. G. Calderon

3. Background - Corporate Governance Currently, there are many definitions* of corporate governance, including - "Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation…. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance", OECD April 1999. "Corporate governance is about promoting corporate fairness, transparency and accountability" J. Wolfensohn, president of the Word bank, as quoted by an article in Financial Times, June 21, 1999. “Corporate Governance is concerned with holding the balance between economic and social goals, and between individual and communal goals…the aim is to align as nearly as possible the interests of individuals, corporations and society.” “Sir Adrian Cadbury Corporate Governance Overview, 1999, World Bank Report” as quoted at http://economicdevelopment.gov.mu/int/introbk.pdf. *The first two items above came from http://www.encycogov.com/WhatIsGorpGov.asp Dr. T. G. Calderon

4. Background - Corporate Governance “If a country does not have a reputation for strong corporate governance practices, capital will flow elsewhere. If investors are not confident with the level of disclosure, capital will flow elsewhere. If a country opts for lax accounting and reporting standards, capital will flow elsewhere. All enterprises in that country--regardless of how steadfast a particular company’s practices may be--suffer the consequences. Markets must now honor what they perhaps, too often, have failed to recognize. Markets exist by the grace of investors. And it is today’s more empowered investors that will determine which companies and which markets will stand the test of time and endure the weight of greater competition. It serves us well to remember that no market has a divine right to investors’ capital.” Arthur Levit as quoted at http://economicdevelopment.gov.mu/int/introbk.pdf. Dr. T. G. Calderon

5. Background - Corporate Governance “Good corporate governance helps . . . to ensure that corporations take into account the interests of a wide range of constituencies, as well as of the communities within which they operate, and that their boards are accountable to the company and the shareholders. This, in turn, helps to assure that corporations operate for the benefit of society as a whole. It helps to maintain the confidence of investors – both foreign and domestic – and to attract more “patient”, long-term capital.” OECD Principles of Corporate Governance, April 1999. Dr. T. G. Calderon

6. Transparency • Information Asymmetry • Trust • Agency • Stewardship • Sociological • Reporting • Disclosure • Auditing Theory Method Outcome Background - Corporate Governance Dr. T. G. Calderon

7. Background - Corporate Governance Fundamentally, the role of corporate governance is to mitigate threats that can prevent an organization from achieving its objectives, particularly from the perspective of the broad range of external stakeholders who do not participate in the organization’s management. Sarbanes-Oxley (S-O) reduces the fuzziness that existed in corporate governance for many years and makes “good” corporate governance legally mandatory for public companies in the U.S. Dr. T. G. Calderon

8. Perfect Storm • Corporate governance failures • Erosion in market confidence • Extreme market volatility Sarbanes-Oxley – Public Law 107-204, July 30, 2002 Title i—public company accounting oversight board Title ii—auditor independence Title iii—corporate responsibility Title iv—enhanced financial disclosures Title v—analyst conflicts of interest Title vi—commission resources and authority Title vii—studies and reports Title viii—corporate and criminal fraud accountability Title ix—white-collar crime penalty enhancements Title x—corporate tax returns Title xi—corporate fraud and accountability U.S. Securities & Exchange January 2003 Rules on Auditor Independence “A vast patchwork quilt of reforms” {SEC Mail, 02-7-30(2)} Background – Sarbanes-Oxley Dr. T. G. Calderon

9. Scope of S-O • SEC registered U.S. companies • Non-U.S. companies that file SEC Forms 20-F and 40-F • All U.S. and non-U.S. auditing firms that audit financial statements filed with the SEC • Uncertainty as to application to foreign governments Dr. T. G. Calderon

10. Section 101: Public Companies Accounting Oversight Board (PCAOB) • Five financially-literate members, appointed for five-year terms. • Two CPAs or past CPAs • Three non-CPAs. • The Chair may be a CPA who has not practiced for five years. • PCAOB is “independent” but the SEC has oversight responsibilities for it. Dr. T. G. Calderon

11. PCAOB FUNCTIONS • register public accounting firms by 10/31/03, including foreign firms that audit subsidiaries of U.S. public companies • establish, or adopt, by rule, "auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers" • conduct (with subpoena power) inspections, investigations and disciplinary proceedings, and impose appropriate sanctions on public accounting entities • enforce compliance with the Act, the rules of the Board, professional standards, and the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants Dr. T. G. Calderon

12. Specific PCAOB Charges • authority to amend, modify, repeal, and reject any standards suggested by accounting/auditing rule-making entities • require registered CPA firms to retain for at least 7 years work papers and documents they relied upon in arriving at their opinion (sec. 103a(2)) • require 2nd partner review and approval of audit reports • require quality standards for registered CPA firms and one to three year quality reviews for CPA firms • adopt an audit standard to implement the independent auditor internal control review and evaluation required by section 404(b). • review requests for exemptions from work scope limitations for independent auditors on a case-by-case basis Dr. T. G. Calderon

13. Section 201: Work Scope Limitations • Illegal for independent auditors to perform certain non-audit services contemporaneously with the audit, including: • bookkeeping or other services related to the accounting records or financial statements of the audit client; • financial information systems design and implementation; • appraisal or valuation services, fairness opinions, or contribution-in-kind reports; • actuarial services; • internal audit outsourcing services; • management functions or human resources; • broker or dealer, investment adviser, or investment banking services; • legal services and expert services unrelated to the audit; • any other service that the Board determines, by regulation, is impermissible. • Other non-audit services must be pre-approved (5% waiver rule) by the audit committee of the company’s board, but must be disclosed to investors in periodic reports Dr. T. G. Calderon

14. Section 203: Audit Partner Rotation. • The lead audit or coordinating partner and the reviewing partner must rotate off of the audit every 5 years • SEC Rules require a 5 year time out • SEC Rules require a seven-year rotation for lead partners on audits of significant subsidiaries and other partners at parent company, with a 2 year time out Dr. T. G. Calderon

15. Section 204: Auditor Reports to Audit Committees. The accounting firm must report to the audit committee (which is given the responsibility under S-O for hiring, retaining, and dismissing independent auditors): • all critical accounting policies and practices • all alternative treatments of financial information within [GAAP] that have been discussed with management • ramifications of the use of alternative treatments, and the treatment preferred by the independent auditors • all other information communicated to management Dr. T. G. Calderon

16. Section 206: Conflicts of Interest • A firm cannot serve as independent auditor of a company if within one year of the engagement date its employees were hired by the company to fill any of the following positions: • CEO • CFO or Controller • Chief Accounting Officer • Other persons with financial reporting oversight, including board members, finance director, financial reporting manager, internal auditor, and others (based on SEC rules) Dr. T. G. Calderon

17. Section 301: Public Company Audit Committees. • Made up of independent board members • Be directly responsible for the appointment, compensation, and oversight of the work of any registered public accounting firm • Shall establish procedures for the "receipt, retention, and treatment of complaints" received by the company regarding accounting, internal controls, and auditing • Shall have the authority to engage independent counsel or other advisors, as it determines necessary to carry out its duties. • Shall receive appropriate funding from the company to execute its responsibilities. Dr. T. G. Calderon

18. Section 302: Responsibility For Financial Reports. • The CEO and CFO must certify the appropriateness and fairness of financial statements and disclosures • A violation of this section must be knowing and intentional to give rise to liability. Dr. T. G. Calderon

19. Section 304/305: Forfeiture of Compensation and Benefits • In cases of non-compliance with financial reporting requirements, officers and directors will forfeit any of the following types of compensation and benefits they received within twelve months following the issuance of a non-compliant filing: • bonuses • incentive-based compensation • equity-based compensation • profits realized from the sale of the company securities Dr. T. G. Calderon

20. Section 401(a): Periodic Reports and Disclosures. • Periodic reports and disclosures must • reflect material correcting adjustments that were identified by a registered accounting firm • disclose all material off-balance sheet transactions and other material relationships with unconsolidated entities • pro forma financial information must not contain false or misleading statements and disclosures Dr. T. G. Calderon

21. Section 404: Management Assessment of Internal Controls • Each annual report must to contain an internal control report, which will • state management’s responsibility for an adequate internal control structure and procedures for financial reporting; • contain an assessment, as of the end of the issuer's fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. • A company’s independent auditor must attest to, and report on, the internal control assessment made by the company’s management. • Curiously, language in the report of the Committee which accompanies the S-O bill to explain its legislative intent states, "--- the Committee does not intend that the auditor's evaluation be the subject of a separate engagement or the basis for increased charges or fees." Dr. T. G. Calderon

22. Section 409: Real Time Disclosure • Companies must disclose information on material changes in their financial condition or operations on a rapid and current basis • Comment: It is presumed thatthese entities will have the necessary infrastructure for real-time reporting and continuous auditing Dr. T. G. Calderon

23. Title VIII: Corporate and Criminal Fraud Accountability • Destruction or creation of documents to "impede, obstruct or influence" a federal investigation is a felony punishable by fines and up to 20 years of imprisonment (Sec 802) • Auditors are required to maintain all audit or review work papers for five years (to be periodically reviewed by the SEC), with fines and imprisonment for up to 10 years for violations [sec 802 (a)(1,2)]. • The statute of limitations on securities fraud claims is extended to two years after discovery or a maximum of five years after perpetration (sec 805) • Employers are prohibited from taking certain actions against employees (whistle blowers) who lawfully disclose private employer information to a certain entities (sec 806) Dr. T. G. Calderon

24. Benchmarking Method • Prepared a 37 item survey instrument • Contents reflected corporate governance issues addressed in S-O and relating to auditing, financial reporting, and disclosure • Most items in the instrument had agree/disagree responses • Sent instrument to 24 OECS public companies through • Received 6 responses Dr. T. G. Calderon

25. The Instrument Dr. T. G. Calderon

26. Descriptive Statistics Dr. T. G. Calderon

27. Agree/Disagree Responses Dr. T. G. Calderon

28. Highlights • Self assessments indicate adherence to many important principles of “good” corporate governance • Certain areas need attention • Appetite for possible reforms Dr. T. G. Calderon

29. Areas of Strength • Board members’ compensation • Independent board chairman • Board approval for non-audit services provided by auditors • Functioning audit committee of the board • Audit committee’s access to information • Audit committee effectiveness • Functioning internal audit unit. • Audit unit head reports to the board or board committee • Respect for auditor independence • Non-employment of independent auditors’ employees • Disclosure of adjustments and corrections identified by independent auditors • Off-balance sheet and related party disclosures • Financial statement and related disclosures • Real-time disclosures • Infrastructure for real-time disclosures • Effective internal controls • Equitable treatment of all shareholders Dr. T. G. Calderon

30. Areas Needing Attention Dr. T. G. Calderon

31. Appetite for Possible Reforms Dr. T. G. Calderon

32. Conclusion • S-O is broad and complex • It reduces fuzziness in the area of corporate governance and clarifies many issues relating to the responsibility for financial reporting and disclosure • S-O could, however, increase the likelihood of auditor litigation, particularly in the U.S. • S-O has a very broad reach/scope that could easily extend to entities operating in the OECS and other Caribbean states • The preliminary benchmarking study reported here should be refined and extended • Future corporate governance reform in the region could benefit from similar benchmarking studies Dr. T. G. Calderon