Johannesburg, 27 Aug 2003
The importance of good corporate governance has been dramatically elevated in the wake of recent corporate scandals that have shaken the world`s financial foundations.
In response to these issues, professional bodies and lawmakers across the globe have begun to develop initiatives to guide individuals and companies in the execution of their fiduciary responsibilities.
Two such initiatives -- the King Report 2002 and the Sarbanes-Oxley Act of 2002 -- are of direct and indirect relevance to SA`s approach to desirable corporate governance standards.
The former is now the bible for domestic corporations, while the latter is the rulebook equivalent for South African companies with listings in the US.
Against this background, the Institute of Directors and PricewaterhouseCoopers have conducted an in-depth comparison of the King Report 2002 and the Sarbanes-Oxley Act, in the process of which similarities and differences have been highlighted and the impacts of such discussed.
Malcolm Dunn, a member of the National Executive of PricewaterhouseCoopers Inc, characterises the King Report 2002 as expanding the scope of good governance by advocating an integrated approach in the interest of a wide range of stakeholders -- embracing the social, environmental and economic aspects of a company`s activities.
"The King Report 2002 encourages greater activism by shareholders, business and the financial press and relies heavily on disclosure as a regulatory mechanism.
"It also highlights that conforming to corporate governance standards could result in constraints on management, and that corporate boards then have to balance these constraints with performance for financial success and the sustainability of the company`s business."
The US federal government, on the other hand, has adopted "extensive reform" with a view to forestalling a potential crisis in public investor confidence.
Thus, Dunn notes, the Sarbanes-Oxley Act is a wide-ranging and far-reaching legal response to specific corporate abuses. "Its broad intent is to deal with the core issues of transparency, integrity and oversight of the financial markets."
Unlike the King Report 2002 which represents more of a set of guidelines for companies, Dunn states that the Sarbanes-Oxley Act represents what previously would have been an unimaginable incursion of the US federal government into the corporate governance area.
The provisions of the Sarbanes-Oxley Act:
* Establish an independent accounting oversight board;
* Require executive certification of financial statements;
* Expand rules governing conflicts of interest; and
* Increase civil and criminal penalties.
The comparison of the King Report 2002 and the Sarbanes-Oxley Act focuses on the following topics:
* Board of directors and audit committee;
* Financial reporting and internal control;
* Accounting and auditing; and
* Organisational ethics and remuneration.
Board of directors and audit committee
The King Report 2002 acknowledges that the effectiveness of any control system depends on the control environment, or tone at the top, set by corporate directors and offices.
The American approach draws on the concept of democratic shareholder rights. Hence, the Sarbanes-Oxley Act focuses more on the roles and responsibilities of the audit committee, as one of the "gatekeepers" to the financial reporting and disclosure function, than on the responsibilities of the board of directors.
Financial reporting and internal control
The King Report 2002 maintains that it is the directors` duty to present a balanced and understandable assessment of the company`s position in reporting to its stakeholders. The quality of information should be based on the principles of openness and substance over form. Internal control is part of the risk management process. The directors are responsible for the entire process.
The Sarbanes-Oxley Act, by law, adds impetus to the adoption of best financial reporting and internal control practices. It heightens the CEO`s and CFO`s awareness of their responsibilities by requiring them to certify the company`s reports.
Similar to the King Report 2002, the Sarbanes-Oxley Act requires management to include in annual filings an internal control report, stating that management is responsible for establishing and maintaining an adequate internal control structure and procedures for financial reporting, and containing an assessment of the effectiveness of these controls and procedures.
Significantly, however, and unlike the King Report 2002, the Sarbanes-Oxley Act will require the external auditor in 2005 to attest to, and report on, management`s assessment. This internal control attestation element could possibly be one of the most significant and expensive impacts on businesses of the Sarbanes-Oxley Act.
Accounting and auditing
The Sarbanes-Oxley Act and the King Report 2002 view external auditors as guardians of public interest, with provisions to ensure that the external auditors` independence is not impaired.
The Sarbanes-Oxley Act has mandated the formation of The Public Company Accounting Oversight Board, which has ultimate responsibility for setting auditing, quality control and independence standards and is independent from the public accounting profession. The Act makes it unlawful for a registered accounting firm to provide certain, specific non-audit services to existing audit clients.
The King Report 2002 acknowledges that corporate internal audit`s unique full-time focus on risks and controls within an organisation is vital to a sound governance process. The Sarbanes-Oxley Act does not contain any similar provisions affecting the internal audit function of a company.
Organisational ethics and remuneration
Both the King Report 2002 and the Sarbanes-Oxley Act seek to influence individual ethical behaviour through requirements surrounding a code of ethics. The King Report 2002 recommends the establishment of a remuneration committee and disclosure of remuneration paid to individual directors to increase the transparency of the governance process.
The Sarbanes-Oxley Act, on the other hand, expands existing compensation-related regulations by:
* Accelerating the reporting of stock transactions by corporate management and directors;
* Prohibiting loans to directors; and
* Requiring the CEO and CFO to forfeit any bonus or incentive-based compensation if financial statements are restated due to "misconduct".
Steven Derrick, partner Global Capital Markets Group, says the full impact of the King Report 2002 and the Sarbanes-Oxley Act on business practice is yet to be seen.
"What is of importance, though, is that while different institutional investors have their individual agendas domestically and abroad, certain key corporate governance issues are found to be of common concern.
"It is in the court of public opinion where a company`s corporate governance practices, and the business results they produce, will ultimately be judged."
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