Review the section on Sarbanes-Oxley (26-1a) and the whistle blower requirements in the Securities Exchange Act of 1934.

1. Under Sarbanes-Oxley, list the three events that an auditor would need to report to the audit committee of the client's board of directors. Why is it important for these events to be reported? What is the reporting designed to prevent?

2. List the three actions involved if an auditor suspects a client has committed an illegal act. Why are these actions considered necessary? What are the actions designed to prevent?

26-1a Sarbanes-Oxley After the stock market tumbled, Congress acted to restore investor confidence by passing the Sarbanes-Oxley Act of 2002 (SOX). The major provisions of SOX as it relates to auditors are as follows: The Public Company Accounting Oversight Board. Congress established the Public Company Accounting Oversight Board (PCAOB) to ensure that investors receive accurate and complete financial information. The board has the authority to regulate public accounting firms, establishing everything from audit rules to ethics guidelines. All accounting firms that audit public companies must register with the board, and the board must inspect them regularly. The PCAOB has the authority to revoke an accounting firm's registration or prohibit it from auditing public companies. The PCAOB has reported that it had found flaws in over onethird of the audits performed by Big Four accounting firms, a percentage that is increasing over time.3 Reports to the audit committee. Under SOX, auditors must report to the audit committee of the client's board of directors, not to senior management. The accountants must inform the audit committee of any (1) significant flaws they find in the company's internal controls, (2) alternative options that the firm considered in preparing the financial statements, and (3) accounting disagreements with management. Consulting services. SOX prohibits accounting firms that audit public companies from providing consulting services to those clients on topics such as bookkeeping, financial information systems, human resources, and legal issues (unrelated to the audit). Auditing firms cannot base their employees' compensation on sales of consulting services to clients.

Some observers argue that these conflict of interest rules are too lenient that auditors should do nothing but audit. They argue that even providing advice on taxes or internal control systems, as SOX permits, could warp an accountant's objectivity about auditing issues. In the United States, the largest accounting firms earn 39 percent of their total revenues from consulting work (usually to nonaudit clients). Also, SOX rules on these issues apply only in the United States. Globally, the Big Four earn 57 percent of their income from consulting. Conflicts of interest. An accounting firm cannot audit a company if one of the client's top officers has worked for that accounting firm within the prior year and was involved in the company's audit. In short, a client cannot hire one of its auditors to ensure a friendly attitude. Term limits on audit partners. After five years with a client, the lead audit partner must rotate off the account for at least five years. Other partners must rotate off an account every seven years for at least two years.

Whistleblowing

Auditors who suspect that a client has committed an illegal act must notify the client's board ofdirectors. If the board fails to take appropriate action, the auditors must issue an official report to the board. If the board receives such a report from its auditors, it must notify theSEC within one business day and send a copy of this notification to the auditors. If the auditors do not receive this copy, they must notify the SEC themselves.