Sarbanes-Oxley and You

by Terrance Malkinson and George McClure

An invitation to become a member of an organization's board of directors is a recognition of personal and business excellence. Before accepting, however, it is important to have a full understanding of the role and its responsibilities. In the past, a board appointment was often largely ceremonial — a reward, or the result of cronyism. Today, however, a board appointment is not to be taken lightly. Directors must possess professional skepticism, critically analyze the business, and ask the right questions, insisting upon accuracy in the answer.

With the passage of the Sarbanes-Oxley Act of 2002, important new legal responsibilities are placed on directors. The Act's legal requirements should not discourage you from serving, rather they should challenge you to educate yourself and act with due diligence in the performance of your responsibilities. Many benefits, including peer respect, business and social networking, mentoring and sharing knowledge come from serving on a board.

Sarbanes-Oxley is but one of many instances of governance legislation dating back to 1890 with the Sherman Antitrust Act, used by President Roosevelt to break up huge monopolistic trusts. Congress passed Sarbanes-Oxley in 2002, in response to a series of financial reporting frauds that undermined public confidence in the capital markets. The "SOX" Act was designed to restore public confidence by increasing regulatory oversight and addressing issues that permitted the numerous financial reporting frauds. Although this Act is U.S. legislation, it has resulted in governments and organizations worldwide re-evaluating and improving governance practices.

In brief, the Act:

• Expands the regulatory role for auditors, lawyers and analysts

• Provides an overall framework for regulating financial markets while leaving the details to the Securities and Exchange Commission

• Requires accountability, certification of financial statements and documentation for internal control systems

• Requires creation, adoption and disclosure of a code of ethics for key executives

• Provides for an audit committee that ensures compliance to generally accepted accounting principles

• Provides a confidential procedure for addressing complaints related to questionable accounting or auditing practices

The Sarbanes-Oxley Act puts an onus of responsibilities on corporate officers. The potential for liability and prosecution is increased. With due diligence, mitigating your risk while serving as a director is possible. Here is some precedent for personal protection for directors:

• Business Judgment — Decisions made by directors who are fully informed and free from conflict of interest should not be second guessed by the courts. Business judgement is predicated on duty of care, duty of loyalty, and duty of good faith.

• Indemnification — Directors' and officers' liability insurance coverage helps but must be renewed regularly to ensure adequacy. The organizations' ability to indemnify their directors must also be reviewed to ensure compliance with company bylaws. Coverage may be worthless, should the organization become insolvent.

One of the main thrusts of the Sarbanes-Oxley Act was to increase the strength and visibility of the audit committee. This committee brings oversight to an organization's financial reporting, internal control and audit processes. Members of this committee must have the necessary professional analysis skills, particularly as financial systems increase in complexity, increasing the opportunity for fraud. Members must also ensure that everything is in compliance with legal and regulatory requirements, spending whatever time necessary to ask the important and difficult questions.

One very important provision is establishing procedures for receiving, retaining and acting on confidential anonymous complaints regarding questionable accounting or auditing practices.

A major consideration for potential directors is damage to their reputations from association with a company that has engaged or is engaging in unethical behavior. Before accepting a board appointment:

• Research the organization, ask tough questions

• Engage in proactive communication with managers and employees; listen to the so-called "whiners" (who are often ignored, but may provide you with important information)

• Ensure that you have all of the necessary information before making a decision. Do not assume that what someone else (particularly management) has told you is true

• Enforce zero-tolerance for errors

• Disclose any conflicts of interest, perceived or real, and remove yourself from discussion/voting where conflict of interest enters

• Rnsure that meeting minutes are accurate. Should you disagree with a decision, make sure that your dissenting position is reflected in the minutes — as a minimum, be named "against" the motion vote

In the end, Sarbanes-Oxley and related legislation are in place as part of the process of continuous improvement in governance. The place to start ensuring that the highest standard or professionalism and ethical business practice becomes standard operating procedure begins with parents. It must continue throughout the primary educational system. Colleges, universities and professional associations have special responsibility to demonstrate and educate; ensuring an understanding of honesty in business and the consequences of unethical behavior to society and careers.

References and Further Reading

R. Charan, Boards that Deliver: Advancing Corporate Governance from Compliance to Competitive Advantage, Jossey-Bass ISBN 0-7879-7139-1. 2005.

M. Green, "The New Scrutiny," Best's Review, 106(9):22-28, 2006.

S. Green, Sarbanes-Oxley and the Board of Directors: Techniques and Best Practices for Corporate Governance, John Wiley and Sons, Inc. ISBN 0-471-73608-2, 2005.

Terrance Malkinson is a proposal manager/documentation specialist; an elected Senator of the University of Calgary; a Governor of the Engineering Management Society; international correspondent for IEEE-USA Today's Engineer Online; editor-in-chief of IEEE-USA Today's Engineer Digest; and editor of the IEEE Engineering Management Society Newsletter. The author is grateful to the Haskayne School of Business Library at the University of Calgary. He can be reached at todaysengineer@ieee.org.

George McClure is chair of IEEE-USA's Communications Committee, a member of the IEEE-USA Career & Workforce Policy Committee, and technology policy editor for IEEE-USA Today's Engineer. Comments may be submitted to todaysengineer@ieee.org.