WELCOME TO ACCT 7050: Corporate Governance Ethics and Business Sustainability

1. WELCOME TO ACCT 7050: Corporate Governance Ethics and Business Sustainability Professor Zabi Rezaee PhD, CPA, CMA, CIA, CFE, CGFM Thompson-Hill Chair of Excellence & Professor of Accountancy Fogelman College of Business and Economics The University of Memphis

2. Financial Statement Fraud: Prevention and Detection • Review in Journal of Accountancy,December 2002, pp. 89−90: • “Financial Statement Fraud is a good reference for understanding some of the current corporate financial statement problems and making sure that financial statements are correct.” • Review in Internal Auditing May/June 2002, • p. 46−47: • “This professional reference is highly recommended reading for all internal auditors and should be included in all internal auditing libraries and used in internal auditing training programs. This book should hit the bestseller lists rather quickly.” by Zabihollah Rezaee, published by John Wiley & Sons, March 2002

3. Cooks Recipes EndResults FSF = Crime Incentives Monitoring Cooking the Books = FSF = CRIME Financial Statement Fraud Formula Cooks + Recipes + Incentives + Monitoring (lack of) + End Results = CRIME

4. Corporate Governance Post-Sarbanes-Oxley: Regulations, Requirements, and Integrated Processes Lynn Turner writes, “Corporate Governance Post-Sarbanes-Oxley appropriately provides the reader with a useful discussion of emerging and contemporary issues confronting those involved with corporate governance including those in the monitoring function, as well as those in the growing field of not-for-profit organizations. And it adds an international flavor to its pages, which is unquestionably important and useful as today’s largest investors as well as accomplished management teams and directors come from a multitude of countries.” Michael McCauley, Director of Corporate Governance for the Florida State Board of Administration, wrote, “Corporate Governance Post-Sarbanes-Oxley offers one of the most comprehensive examinations available. Dr. Rezaee achieves an in-depth, thorough review of today’s corporate governance landscape and provides a sound perspective for the reader. His systematic description offers a practical guide for any investor interested in the role of governance within the capital markets. An excellent book.” by Zabihollah Rezaee, published by John Wiley & Sons, 2007

5. Chinese Translation of the Book: Corporate Governance Post-Sarbanes Oxley

6. Corporate Governance and Ethics by Zabihollah RezaeePublished by Wiley, July 2008

7. http://www.youtube.com/watch?v=7LYmAY5dUS4,,VIDEO

8. Business Schools • How Business Schools Have Failed Business: “Why not more education on the responsibility of boards?" by Michael Jacobs, The Wall Street Journal, April 24, 2009 --- http://online.wsj.com/article/SB124052874488350333.html • “By failing to teach the principles of corporate governance, our business schools have failed our students.” • “B-school graduates have matured into executives and investment bankers who have failed American workers.” • Do you think B-schools prepare the most competent and ethical future business leaders?

9. Business Curriculum • Business schools should provide higher education with relevant curriculum. • Three areas recently receiving long-awaited attention are: • Business ethics • Corporate governance • Internal auditing • Forensic Accounting • Business Sustainability • Business schools play an important role in preparing the next generation of ethical and competent business leaders. • Internal auditing should be emphasized in the accounting and business curricula.

10. Why Teach Corporate Governance Ethics and Forensic Accounting? • Reported financial scandals (e.g., Enron, WorldCom, Global Crossing, Adelphia, Qwest, Parmalat, Madoff, Satyam) underscore importance of vigilant corporate governance and ethical conduct by corporations. • The Sarbanes-Oxley Act (video) of 2002 (SOX) is intended to improve corporate governance by enforcing more accountability for public companies and requiring adoption of a code of ethics for their executives. • Anecdotal evidence and academic studies suggest that corporate governance ethics and internal auditing are not properly integrated into business education, and coverage of these issues should be increased.

11. The Association to Advance Collegiate Schools of Business International (AACSB) has promoted the integration of business ethics and corporate governance into the business curriculum. • AACSB in its task force report promotes the coverage of business ethics and corporate governance in the business curriculum. • Professional organizations (AICPA , ACFE and AAA) promote forensic accounting practice and education. • The AACSB report identifies four important areas as the “cornerstones of a comprehensive and viable ethics education curriculum in business schools”: • responsibility of business in society • ethical decision making • ethical leadership • corporate governance

12. SOX was signed into law on July 30, 2002, to reinforce corporate accountability and rebuild investor confidence in public financial reports. It was designed to: (1) establish an independent regulatory structure for the accounting profession; (2) set high standards and new guiding principles for corporate governance; (3) improve the quality and transparency of financial reporting; (4) improve the objectivity and credibility of audit functions and empower the audit committee; (5) create more severe civil and criminal remedies for violations of federal securities laws; and (6) increase the independence of securities analysts. Sarbanes-Oxley Act of 2002

13. Summary of the Provisions of SOX 1. Enhanced audit committee responsibility for hiring, firing, compensating, and overseeing auditors and preapproval of non audit services 2. Disclosure, in the periodic reports, whether the audit committee has at least one member who is a “financial expert” and if not, why not 3. CEOs and CFOs certification of the accuracy and completeness of quarterly and annual reports 4. Management assessment and reporting of the effectiveness of disclosure controls and procedures 5. Ban on personal loans by companies to their directors or executives other than certain regular consumer loans 6. Establishment of procedures by each audit committee for receiving, retaining, and handling complaints received by the company concerning accounting, internal controls, or auditing matters 7. Review of each quarterly and annual report (forms 10-Q and 10-K) by officers 8. Forfeiture by CEO or CFO of certain bonuses and profits when the company restates its financial statements due to its material noncompliance with any financial reporting requirements 9. Improper influence on conduct of audits 10. Insider trades during pension fund blackout periods 11. Officers and directors’ bars and penalties for violations of securities’ laws or misconduct

14. Summary of the Provisions of SOX Financial Reporting 1. CEO/CFO certification of financial reports 2. Internal control report by management 3. Attestation and report by auditors on management’s assessment of internal controls 4. Disclosures of off–balance sheet arrangements 5. Disclosures of contractual obligations 6. Disclosures of reconciliation of non-GAAP financial measures pertaining to pro forma financial information 7. Disclosures of material correcting adjustments by auditors 8. Disclosures of transaction involving management and principal stockholders 9. Accelerated filing of changes in beneficial ownership by insiders 10. Real time disclosures of information concerning material changes in financial condition or operations (form 8-K disclosures) 11. Periodic review of published financial statements by the SEC at least once every three years 12. SEC-enhanced authority to determine what constitutes U.S. GAAP

15. Summary of the Provisions of SOX Audit Functions 1. Establishment and operation of the Public Company Accounting Oversight Board (PCAOB), an independent nongovernmental agency 2. Registration with the PCAOB of public accounting firms that audit public companies 3. Requirement that auditors be appointed, compensated, and overseen by the audit committee 4. Many non audit services are prohibited from being performed contemporaneously with an audit 5. Rotation of the lead (or coordinating) audit partner and the lead review partner every five years 6. Auditors report to the audit committee 7. Prohibiting where CEO or CFO previously employed by auditor 8. Auditors’ attestation to and reporting on management assessment of internal controls 9. Limitations on partner compensation 10. Disclosure of fees paid to the auditor 11. Requirements for preapproval of audit and permitted non audit services by the audit committee 12. Retention of audit work papers and documents for five years 13. Increased penalties for destruction of corporate audit records

16. Summary of the Provisions of SOX Other 1. Professional responsibilities for attorneys appearing and practicing before the SEC 2. Disclosures of corporate code of ethics 3. Collection and administration of funds for victim investors 4. Analyst conflicts of interest (Regulation AC) 5. Whistleblower protection 6. Debts nondischargeable in bankruptcy 7. Temporary freeze authority for SEC 8. SEC censure or bar of any person who is not qualified, lacks the requisite character or integrity, or with unethical conduct, from appearing before the SEC 9. Lengthened statute of limitations for securities fraud 10. Criminalization of corporate misconducts 11. Criminal penalties for defrauding shareholders of public companies 12. Retaliation against informants 13. Increased criminal penalties under securities laws and mail and wire fraud 14. Future studies on consolidation of public accounts by firm, audit firm rotation, accounting standards, credit rating agencies, and investment banks

17. Cost Benefit Of Sarbanes- Oxley A 2007 survey of 2000 corporate executives reveals that: (1) The compliance costs of SOX for the second consecutive year declined substantially; (2) The cost dropped 23 percent in 2006; (3) Total compliance costs decreased to an average $2.9 million per company in 2006, which is down 35 percent from the $4.51 million average costs in 2006; (4) There was no significant change in audit fees; (5) The majority of surveyed executives (78 percent) reported that the costs to comply with section 404 still outweigh any benefits. More manageable and cost-effective Section 404 compliance is currently being addressed by the SEC and the PCAOB.

18. Training Competent and Ethical Accountants There are several ways to ensure training competent and ethical graduating accountants and future business leaders of the accounting profession, such as: • Integrating corporate governance and ethics into the accounting programs • Making internships an integral part of the accounting education process

19. Encouraging accounting students to obtain their professional certifications (CPA, CMA, CIA, CFE, CGFM) • Ensuring that the professional exams adequately and effectively test standards, knowledge, skills, competency, and integrity • Requiring the minimum number of CPE exams hours to obtain professional certifications and licenses • Providing 150/hour accounting program to make accounting education comparable to the examination requirements in their professional schools (medical and law)

20. Establishing separate schools of accountancy comparable to other professional schools (medical, law, dental) to enhance the prestige of accounting programs • Establishing a strong, diversified advisory board to oversee and support accounting programs • Promoting accounting professional organizations (Beta Gamma Sigma, Beta Alpha PSI, IMA, IIA, CFE students chapters) • Promoting effective mastery of accountancy principles

21. Adopting dynamic, market-driven accounting curriculum that continuously evolves in meeting the needs for training the most competent and ethical future accountancy and business leaders • Strengthening the accountancy PhD program to ensure sufficient supply of quality accounting faculty • Promoting diversity (gender, ethnic) in the accounting profession, including students, faculty, and practitioners

22. Good News and Bad News • Big 4 public accounting firms (Ernst and Young, Deloitte, PwC, and KPMG) have been ranked in the top five during the past three years by Business Week as “the best places to launch a career”. • Accounting enrollment is up at least 19% to over 203,000 students across all degree programs during the past 3 years (ASCPA, 2008).

23. Minorities comprise 26% of Bachelor’s enrollment: • 11% African American • 8% Asian • 6% Hispanic/Latino • 1% American Indian • At the Master’s level, enrollment is 20% minority: • 10% Asian • 5% African American • 5% Hispanic/Latino • The female-to-male enrollment ratio is 52% female, 48% male.

24. Public accounting firms remain the primary employer for new graduates. They hire 34% of BBA and 70% of MBA graduates. Job Market Video (Video)

25. The Free Market Systemand Business Chapter I

26. Chapter Objectives: • Learn the free market system and business. • Understand the role and responsibility of business in society. • Understand the primary goal of corporate governance. • Recognize that effective corporate governance is established through power sharing among all participants, particularly shareholders, boards of directors, and management. • Exemplify the importance of reliable and transparent financial information. • Be aware of the effect of corporate governance on investor confidence. • Present various definitions of corporate governance. • Provide an overview of corporate governance reforms. • Introduce business ethics. • Provide an overview of costs and benefits of corporate governance reforms. • Address the impacts of corporate governance reforms on accountability.

27. Key Terms Corporate accountability reporting Corporate culture Corporate gatekeeper Corporate governance Ethical accountability Federal sentencing guidelines Generally Accepted Accounting Principles (GAAP) Listing standards Multiple bottom lines (MBL) Public Company Accounting Oversight Board (PCAOB) Sarbanes-Oxley Act of 2002 (SOX) Securities Act of 1933 Securities Exchange Act of 1934 Securities and Exchange Commission (SEC) Social accountability

28. The Free Enterprise System and Capital Markets The free enterprise system in the US is a bedrock principle of the US economy, and capital markets are the backbone of such systems. The free enterprise system has transformed from private ownership of businesses to dispersed public ownership. Capital markets are driven by the capital provided to companies by investors. Investor protection is essential and should be provided through appropriate regulations, effective corporate governance, and optimal market mechanisms.

29. The Free Enterprise System and Capital Markets (Cont.) Investor confidence eroded at the turn of the 21st century due to: High-profile financial scandals Economic downturn September 11 terrorist attacks Ineffectiveness of market mechanisms Investors’ demand of protection through regulation and transparency Congress responded by passing the Sarbanes-Oxley Act of 2002, also known as SOX, to identify and manage conflicts of interest by improving corporate governance, financial reporting and audit activities.

30. Public Trust and Investor Confidence Investor confidence is the key driver of the nation’s economic growth, prosperity, and financial stability. More than 110 million Americans invest in capital markets. US markets have a good reputation and are considered the most transparent, efficient, and reliable, as they: - Facilitate efficient allocation of a scarce resource of capital - Enable public companies to raise capital for establishing/expanding their businesses - Provide a safe, lucrative marketplace for investing to fund retirement or pay for children’s education

32. The Role and Responsibility of Business in Society

33. The Role and Responsibility Corporate stakeholders are classified into several layers and are categorized into three general tiers. Eight layers of shareholders and stakeholders:

34. The Role and Responsibility

35. The Role of Financial Information in the Capital Markets The sustainability of public companies is key to keeping investor confidence high. Financial disclosures under SEC regulations are necessary to provide investors with reliable information, so they can make informed decisions. Public companies in the United States are required to file their financial reports with the SEC, including audited annual financial statements on Form 10-K, reviewed quarterly financial statements on Form 10-Q, and extraordinary transactions on a current basis on Form 8-K (e.g., departure of directors, officers, auditors), in addition to proxy financial statements submitted to investors.

36. Corporate Reporting: Financial and nonfinancial information Financial Reporting: Financial statements and other financial reports Financial Statements Reporting: Financial statements and related notes Corporate Reporting

37. A corporate reporting model that captures both financial and nonfinancial key performance indicators is needed. Nonfinancial information disseminated to the capital markets by public companies includes: • Market information, such as market growth, market share, and regulatory environment • Corporate governance information, such as the board of directors’ composition, structure, and committees • Strategic information, such as goals and objectives • Information about management, such as the track record, compensation plans, and incentive plans • Value-creating information, such as customers, employees, suppliers, innovative brands, and supply chain • Corporate responsibility information, such as environmental, ethical, and social information • Forecasts, projections, and other technical and quantitative market information

38. Information from public companies flows into the marketplace from three fundamental sources: • Regulated disclosures • Voluntary disclosures • Research analyst reports

39. Regulated disclosures include filings with the SEC of annual audited financial statements on Form 10-K, quarterly reviewed financial reports on Form 10-Q, extraordinary transactions on a current basis on Form 8-K (e.g., auditor changes, resignation or death of a director or an officer, bankruptcy), and internal control reports for large public companies (Sections 302 and 404).

40. Public companies often voluntarily release earnings guidance regarding projected performance and other financial and nonfinancial information in addition to their mandated disclosures. Earnings announcements, even though not required, provide valuable information to market participants and motivate companies to meet their earnings expectations. Voluntarily released earnings guidance is expected to result in higher valuations, lower volatility, and improved liquidity.

41. The perceived benefits of issuing earnings guidance include: • Satisfying requests from investors and analysts • Maintaining a channel of communication with investors • Intensifying management’s focus on achieving financial targets • Moderating the volatility of the company’s share price

42. The obsession with short-term results leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance.

43. Accountability: The New Business Imperative Accountability is the cornerstone of corporate governance in continuously monitoring the best practices and being accountable to shareholders. Although the primary focus and goal of accountability reporting in the foreseeable future will continue to be an economic issue to create sustainable long-term shareholder value, the issues of SEE performance of companies will gain momentum.

44. Entity Performance Performance Governance Economic Ethical Social Environmental Goals Roles and Responsibilities of CG Participants Value creation and Enhancement for all Stakeholders Ethical and Moral Values Social Issues regarding Products and Services Performance Codes of Conduct Social Responsibility Report Environmental Management and Report Reports CG Report Financial Reports Assurance Report Assurance Report Environmental Audit Report Assurance Assurance Report Audit Report

45. Layers of Financial Statement Scrutiny

46. Introduction to Corporate Governance Effective corporate governance can only be achieved when all participants: add value to the company’s sustainable long-term performance; effectively carry out their fiduciary duty and professional responsibilities; are held accountable and personally responsible for their performance; develop a practice of not only complying with applicable regulations, but also committing to doing the right thing and observing ethical principles of professional conduct in avoiding potential conflicts of interest.

47. Introduction to Corporate Governance Corporate Culture and Integrity The compliance culture can be promoted through the establishment of a centralized CCO who is primarily responsible for ensuring compliance with all applicable laws, regulations, rules, standards, codes of ethics, policies, and procedures, and oversees all compliance functions. Corporate Accountability The multiple bottom lines (MBL) objectives of economic, social, ethical, and environmental (ESEE) performance have been advocated by global business and investment communities. The perceived benefits of reporting both financial and nonfinancial key performance indicators (KPIs) are improved quality of information; enhanced communications with analysts and investors; and integration of the organization’s operating, financial, and social performance.

48. Introduction to Business Ethics Ethics: “a set of moral principles: a theory or system of moral values” Corporate governance should create an ethical business environment in which all employees are encouraged and empowered to “do the right thing”. An important aspect of the emerging trend toward increased corporate accountability and governance is reflected in the role and relevance of business ethics and codes of professional conduct.

49. Overriding Causes of the Financial Crisis • Ineffective Regulations • Gramm-Leach-Bliley (GLB)/Financial Modernization Act of 1999. • Federal Housing Enterprise Financial Safety and Soundness Act of 1992 (FHEFSSA) required the Department of Housing and Urban Development (HUD) to create Fannie Mae and Freddie Mac to purchase mortgages used to finance “affordable housing,” which triggered a government-mandated market for subprime mortgages. • Federal Housing Enterprise Regulatory Reform Act of 2005 entailed operating, administrative, and regulatory provisions for Fannie Mae and Freddie Mac, including assessment authority; authority to limit non mission-related assets; minimum and critical capital levels; risk-based capital test; capital classifications and undercapitalized enterprises; enforcement actions and penalties; golden parachutes; and reporting. VIDEO(Video)

50. Other Overriding Causes of the Financial Crisis • Greedy and incompetent executives • Subprime mortgage crisis • Falling asset pricing, including houses • Highly leveraged financials • Inactive credit markets • Credit-driven rather than equity-driven markets • http://www.youtube.com/watch?v=Q0zEXdDO5JU ,Video • Government policies promoting home ownership • Securitization of mortgage-backed assets • Inadequate risk assessment of business transactions • Lack of transparency of public financial information • Failure of accounting standards to properly measure fair value of financial instruments