Corp. Governance, COSO, ERM Chapter 1 Flashcards
What is the primary duty (role) of the board of directors?
To monitor management behavior.
What is the responsibility of the Nominating or Corporate Governance Committee of the board of directors?
Oversees the board Responsible for hiring new CEO
What is the responsibility of the audit committee of the board of directors?
The audit committee appoints and oversees the external auditor.
What is the duty of the compensation committee of the board of directors?
The compensation committee handles the CEO’s compensation package.
What does the NYSE and NASDAQ require of the board of directors?
They require the board to be independent.
How can an executive compensation package ensure that goals of management align with those of shareholders?
Executive compensation should create an incentive for management to govern in a shareholder-friendly way that doesn’t sacrifice the long-term success of the enterprise for short-term gain.
What is shirking?
When management doesn’t act in the best interest of shareholders. It can be alleviated by tying compensation to stock performance or company profit.
What is the main goal in an executive compensation package?
The package should ensure that the goals of management should match those of the shareholders.
Which influences help mold the direction that management takes?
They range from internal (Board of Directors- Audit Committee- Internal Control) to external (Creditors- SEC- IRS) These influences should not be tainted by undue influence from management or have financial ties to management such as compensation-related duties
What is the primary role of the board of directors?
The primary role is to safeguard the company’s asset and to ultimately maximize shareholder return.
What are some of the duties of the directors?
Election, removal and supervision of the officers (Directors generally review the conduct of the officers, and may remove and officer with or without cause); adoption, amendment, and repeal of bylaws; setting management compensation ; and initiating fundamental changes to the corporation’s structure.
Who has the sole discretion to declare dividends?
The board of directors. Distributions may be in the form of cash, property, or the corporation’s own shares. Shareholders have no power to compel a distribution.
Who are the Officers?
Are individual agents of the corporation who ordinarily manage its day-to-day operations and may bind the corporation to contracts made on its behalf. Officers may serve as directors. Officers may also be shareholders. Although not required, they may be. As part of their compensation, sr. mgmt may receive stock option to potentially purchase shares of the company’s CS.
What is “the business judgment rule”
The board must always act in the best interest of the company. However, directors are not insurers of the corporation’s success. A director will not be liable to the corporation for acts performed or decisions made in good faith, if conducted in a manner that the director believes to be in the best interest of the corp. and with the care an ordinarily prudent person in like position (called business judgment rule). Thus, directors will only be liable to the corporation for negligent acts or omissions (i.e. failure to obtain fire insurance, hiring a convict embezzler as treasurer)
What is “the right to rely”?
A director is entitled to rely on information , opinions, reports, or statements (FS), if provided by officers, employees, legal counsel, accountant.
Who would be liable for unlawful distributions?
Directors may be held liable for authorizing a distribution in violation of law, such as when : 1) Corporation would not be able to pay its debts as they become due in the regular course of business; or 2) Corporation’s total assets would be less than its total liabilities.
What is Indemnification in a Corporation?
Corporations are allowed to indemnify directors an officers for expenses of any lawsuit brought against them in their corporate capacity. (Except in a shareholder derivative suit.)
What are the limitations on director’s liability?
➢ Financial benefits received when not entitled
➢ Intentional harm inflicted on corporation or the shareholders
➢ Unlawful distributions authorized by director
➢ Intentional violation of criminal law
➢ Breaches of the duty of loyalty
Who is responsible for the selection and removal of officers?
officers are selected by the directors and may be removed by the directors with or without cause.
What is the officer authority?
Authority to enter into contracts and act on behalf of the corporation in the ordinary course of business (quorum).
➢ Actual – oral/written instruction
➢ Apparent – “tittle” CEO/CFO
What is “the corporate opportunity doctrine”?
if a director is presented with a business opportunity that is of interest to his company, the duty of loyalty prohibits the director from taking the opportunity for himself.
What is Sarbanes-Oxley Act of 2002?
The SOX Act of 2002 was enacted in response to corporate scandals that largely centered on the quality of corporate financial disclosure and highlighted the inadequate oversight of management, auditors and the Board of Directors. The Act has had a profound effect on the financial reporting requirements of public companies. There are numerous provisions for expanded disclosures. Key provisions of the act related to those disclosures are described in Title III and Title IV.
What the Title III of SOX relates to?
Corporate responsibility - it relates to the establishment of an audit committee and the representations made by key corporate officers, typically CEO and CFO. The establishment of an audit committee addresses the problems related to inadequate board oversight.
What topics pertaining to financial reporting the Title III of SOX includes?
- Public Company Audit Committee Corporate
- Responsibility for Financial Reports
- Improper Influence on Conduct of Audits
- Forfeiture of Certain Bonuses and Profits
What requirements are imposed on a public company under Sarbanes-Oxley Title III - Corporate Responsibility?
Management must submit a report on the effectiveness of Internal Control in the 10K.
Management must disclose significant Internal Control deficiencies.
CEO/CFO must certify that the financial statements comply with securities laws and fairly present the financial condition of the company.
The SOX Act defines the responsibilities of the audit committee of an issuer as including:
1) Appointment of the auditor
2) Compensation of the auditor
3) Oversight of the auditor
- Resolve disagreements between management and the auditor.
- The accounting firm reports directly to the audit committee.
The SOX Act defines the criteria for the independence of audit committee members for issuers as including the following characteristics:
- Each member of the audit committee shall be a member of the BOD of the issuer, but shall be otherwise independent.
- Audit committee members may no accept any consulting, advisory or other compensation or fees from the issuer other than pursuant to their roles on the board.
- A unit committee members may not be an affiliated person (a person who can influence financial decisions) of the issuer.
The SOX Act assigns the following c_orporate responsability for financial reports_ for issuers:
The CEO and CFO must certify the following for annual and quarterly reports:
- The officers have read the report
- The report does not include untrue statements
- The FS are fairly stated.
- The signing officers make assertions regarding their responsibilities for IC
- The signing officers have disclosed IC weakness and instances of fraud to the auditors and AC.
- The status of changes to IC subsequent to the date of their evaluation.
The SOX Act assigns the following corporate responsibilities regarding internal controls that must accompany financial reports:
CEO and CFO must certify the following for annual and quarterly reports:
➢ The officers are responsible for establishing and maintaining IC
➢ IC have been designed to ensure material info has been made available
➢ IC have been evaluated for effectiveness as of a date within 90 days prior to the report
➢ Report includes their conclusions as to the effectiveness of IC based upon their evaluation.
The CEO and CFO signing the report assert must also represent whether there have been any significant changes to IC.
The SOX Act assigns the following corporate responsibilities regarding the required disclosures to the auditors and audit committee by officers:
CEO and CFO by signing report assert that they have made the following disclosures to the audit committee:
➢ All significant deficiencies in the design or operation of IC that might adversely affect the financial statements.
➢ Any fraud, regardless of materiality that involves any management or any other employee with a significant role in IC.
The SOX act specifically prohibits i_mproper influence on the conduct f audits_ defined as follows:
No officer or director, or any person acting under the direction thereof, may take any action that would fraudulently influence, coerce, mislead, or manipulate the auditor in a manner that would make the FS materially misleading.
The SOX act imposes certain financial penalties on offers who are responsible for material misstatements resulting from their misconduct. Penalties include:
If issuer is required to prepare accounting restatement due to material noncompliance under the securities laws, the CEO and CFO may be required to reimburse the issuer for:
➢ Bonuses or incentive-based or equity-based compensation
➢ Gains on sale of securities during the 12-month period
What are the key issuers SOX addresses?
• Corporate Responsibility - Title III • Enhanced financial disclosures - Title IV • Fraud - Title VIII
Title IV of the SOX act, “Enhanced Financial Disclosures”, includes the following topics:
- Disclosures in periodic reports (material adjustments, off-BS transactions - op. leases. contingent obligations. relationships w/unconsolidated subs)
- Enhanced Conflict of Interest Provisions (personal loans - except ordinary business)
- Disclosures of Transactions involving Management and Principal Stockholders > 10% (statement filed @ registration, when achieve 10%, and when ownership is changed)
- Management Assessment of IC (assessment of IC, statement that mgmt is responsible for establishing and maintaing adequate control structure and procedures, and assessment of effectiveness, auditor must attest - audit)
- Exemption (certain investment companies)
- Code of Ethics for Sr financial officers (if no code, must state why not. Code must promote honest, ethical conduct, FACT -full fair accurate and timely disclosures, in FS. Compliance w/ laws and regs)
- Disclosure of Audit Committee Financial Expert (must disclose the existence, if none why not? - mix of experience and knowledge, understanding of GAAP)
- Enhanced Review of Periodic Disclosures By Issuers (on form 10K - protection of investors - material restatements, significant volatility in stock prices, largest market capitalization, disparities in price-to-earnings ratio, significant affect material sector of the economy)
- Real Time Issuer Disclosures
The SOX act requires certain d_isclosures in periodic reports_:
Disclosures in periodic reports – intended to ensure application of GAAP and transparence to the reader. Enhanced disclosures include:
a. All material correcting adjustments identified by the auditor should be reflected in the FS.
b. All material off-balance sheet transactions should be disclosed:
- Operating leases
- Contingent obligations – lawsuits
- Relations with unconsolidated subs – related parties
c. Conformance of pro-forma FS to the following requirements:
- No untrue statements
- No omitted material info
- Reconciled with GAAP basis FS d. Use of special purpose entities (SPE’s)
The SOX act requires certain conflict-of-interest provisions. Those provisions include:
Issuers are generally prohibited from making personal loans to directors or officers, except if the consumer credit loans are made in the ordinary course of business and no special preferential treatment is given.
The SOX act includes provisions for disclosure of transactions involving management and principal stockholders. Those provisions include:
a. Disclosure (filling a statement) for persons who generally have direct or indirect ownership of more than 10% of any class of most any equity security.
b. Statements are filed at the following items:
>> At the time of registration
>> When the person achieves 10% ownership
>> If there has been a change in ownership
The SOX act includes provisions for management assessment of IC. Those provisions include a report showing:
Management Assessment of IC – Section 404. Each annual report is required to contain a report that includes:
a. A statement that management is responsible for establishing and maintaining an adequate IC structure and procedures for reporting.
b. An assessment, as of the end of the most recent fiscal year of the effectiveness of the IC structure and procedures for financial reporting.
c. The auditor must attest to management’s assessment of IC.
The SOX act includes provision for audit committee disclosures. Those disclosures include:
At least one member of the audit committee should be a financial expert on the committee. Financial reports should disclose the existence of the financial expert or the reasons for the lack of an expert.
For purposes of service on the audit committee, what qualifies an individual for classification as a financial expert?
a. Qualification through education, past experience.
b. Knowledge of the financial expert should include:
>> Understanding of GAAP
>> Experience in the preparation of FS for comparable issuers
>> Application of GAAP
>> Experience with IC
>> Understanding of audit committee functions
The SOX act includes provision for Enhanced Review of Periodic Disclosures by Issuers. Those disclosures include:
The SEC is required to review disclosures made by issuers, including those in Form 10-K, on regular and systematic basis for the protection of investors. When scheduling review, the SEC should consider the following:
- Issuers that have issued material restatements
- Issuers that experience significant volatility in their stock prices.
- Issuers with largest market capitalization – material to market
- Emerging companies with disparities in price-to-earnings ratios
- Issuers whose operations significantly affect any material sector of the economy (large banks/insurance co).
Title VIII of the SOX act considers what topics?
Title VIII Corporate and Criminal Fraud Accountability considers the following topics:
- Criminal penalties for altering documents
- Statute of limitations for securities fraud
- Whitlesblower protection
- Criminal penalties for securities fraud
What are the criminal penalties for altering docs?
a. Individuals who alter, destroy, conceal, cover up, or make false entry in any record, document; or impede or obstruct an investigation – up to 20 years
b. Audit of issuers should retain audit and review work papers for a period of 7 years. Failure results in fine, imprisonment for no more than 10 years.
