Are you up to speed on Sarbanes-Oxley? That’s the law Congress put in place after Wall Street was rocked by the corporate scandals at Enron Corp. and other companies. Sarbanes-Oxley, or SOX as it’s often called, sets out reporting mandates that directly affect public companies, but did you know that the law also reaches into the advisory world? What’s more, the act actually benefits advisors on the competitive playing field–as one advisor has found.
First, Title 11 Section 1106 of the Act stiffens criminal penalties under the Securities Exchange Act of 1934, while Title 9 Section 904 increases penalties under ERISA. The act also increases penalties for violations of the Securities Exchange Act of 1933. “Anybody who’s involved in the securities business has to be aware” of those facts, says Larry Byrnes, CEO of Competence Software Inc. in Clearwater, Florida, which develops finance and investing courses that promote financial literacy.
Rick Cortese, VP and executive director of National Regulatory Services (NRS) in Lakeville, Connecticut, agrees that advisors should “not be indifferent to Sarbanes-Oxley.” Advisors should “at least have a basic understanding” of the act, he says. If an advisor is a publicly held company, then the act directly applies to them, he says, or if an advisor is a broker/dealer dual registrant, then some of the act’s analyst conflict-of-interest provisions apply. But even if neither of those descriptions applies, “as a fiduciary, an advisor needs to [understand the act] because they are dealing with companies that should be compliant with Sarbanes-Oxley,” he says. Advisors should have a grasp of whether the fund companies that they’re doing business with are compliant, and also be comfortable that the publicly held companies in which they are taking investment positions are compliant, Cortese says.
Up to Speed
If you’re not well versed on Sarbanes-Oxley, now is as good a time as any to brush up on it. Since its passage in 2002, corporate executives have characterized the act as burdensome, expensive, and basically ineffective. The two former top execs at Enron are now on trial, and the Act’s Public Company Accounting Oversight Board (PCAOB), which acts as accounting firms’ regulator, faces its own lawsuit. In February, The Free Enterprise Fund and Beckstead & Watts, a small accounting firm in Nevada, filed suit in U.S. district court in Washington challenging the legitimacy of the PCAOB. The groups say the PCAOB is unconstitutional because it wields regulatory powers and can levy fines yet goes unchecked by the government. It’s been rumored for some time that Sarbanes-Oxley is due for an overhaul, but Paul Nikolai, a CFP with Deloitte & Touche Investment Advisors in Cincinnati, doubts the Act will “change radically, if at all.” Senator Paul Sarbanes (D-Maryland), who co-authored the legislation with Representative Michael Oxley (R-Ohio), recently defended Sarbanes-Oxley, arguing that the law is working as intended.
When delving into the specifics of the Act, advisors should focus on Title 11, which addresses corporate fraud accountability and amends federal criminal law to establish a maximum 20-year prison sentence for tampering with records, and also increases penalties for violations of the ’34 Act, Cortese counsels. Advisors “need to understand there are some serious outcomes here, and if you’re dealing with publicly held companies in a consulting capacity and you’re working with the management of those companies, you want to be very comfortable that everything is moving forward as it should because you could get nailed as aiding and abetting another party that’s violating the law,” he says. If an advisor is a dual registrant and works as a research analyst, or has an investment banking function, they need to review Title 5 of the Act, which is the conflict-of-interest section, he says. If you’re doing due diligence on funds or other publicly held entities, it’s important to grasp “some of the concepts [under the Act] that deal with auditor independence, corporate responsibility and governance, and financial disclosures,” he adds. The Act includes “mandated enhanced financial disclosures, so if you’re on an investment committee and you’re an analyst doing research, you need to be on top of how financial disclosures have changed under Sarbanes-Oxley.”
Sarbanes-Oxley also stiffens penalties for violations of ERISA–that’s under Title 9, Section 904. The law now sets out a fine of $100,000 and 10 years in prison for an ERISA violation, with a maximum fine of $500,000 for corporations. A criminal penalty for someone who willfully violates ERISA would likely be a case of embezzlement, says David Pratt, who’s been an ERISA lawyer for the past 30 years and has been teaching law at the Albany Law School in the New York state capital for the last 10 years. Embezzlement is fairly rare, he says, “but it does happen.” Advisors who are fiduciaries to a retirement plan are more likely to face civil penalties under ERISA for a “fiduciary breach” that involves providing improper investment advice, he says. Under Section 502(L) of ERISA–which is enforced by the Department of Labor–an advisor “would be liable for losses to the plan, plus an additional 20% penalty,” Pratt says.