Sarbanes-Oxley Act and Nonprofit Organizations Research Paper

Introduction

The corporate accounting scandals of Enron in 2001 and WorldCom in 2002 severely affected the financial markets and shook shareholders’ confidence in large corporations. The legislation was needed to cope with such scandals involving misdirection and inappropriate disclosure by management and executives of corporations. The Sarbanes-Oxley Act also referred to as SOX was embedded into the legal framework on July 30, 2002, by President George W. Bush. This Act influences individuals and corporations related to various trades and industries. This Act directly affects the financial reporting process and the code of ethics implemented in various organizations. The Act places special emphasis on corporations and their workers, auditors and audit firms, law firms, brokers, and analysts. This paper presents reasons for the enactment of Sarbanes-Oxley and the impact of this act on non-profit organizations.

Events Leading to Sarbanes Oxley

During the period of 2000-2002 various companies were involved in corporate governance and financial scandals. These scandals of varying magnitude extensively involved issues like financial reporting, auditing, corporate governance, internal control, and ethical values related to these issues. These companies included industry giants like Enron, WorldCom, Xerox, Halliburton, Arthur Andersen, and Tyco (Patsuris, 2002). The frequency of such financial scandals was highest in these two years as compared to other periods of the American Economy even after the implementation of various accounting standards and rules. As the financial scandals started to grow in number and the compliance to various auditing and accounting issues began to decline, the concern for new Standards or Legislation grew with them. The catalysts for the enactment of Sarbanes Oxley were the corporate scandals involving Enron, WorldCom, and Arthur Andersen – the firm responsible for the audit of both Enron and WorldCom. The collapse of Enron directly affected the shareholders and financial markets while Arthur Andersen which was one of the biggest audit firms in the world also shut down its business. The outcome of these scandals not only affected the shareholders but also the American economy as a whole and something needed to be done. In an interview, Senator Paul Sarbanes, one of the two minds behind SOX pointed out various problems prevalent in the pre-SOX era such as faulty corporate governance measures, conflict of interests, auditor independence issues, and improper disclosures (Lucas, 2004). The problems pointed out by Senator Sarbanes include faulty corporate governance measures which include internal control mechanisms and structures implemented by the management and directors of corporations. Among other problems, one was conflicts of interest and independence of auditors where these auditors also performed non-audit-related activities such as providing consultancy for the client companies. These are some of the problems and events which lead to the proposal of SOX by Senator Paul Sarbanes and Michael Oxley and the eventual enactment of SOX in 2002.

Impact of SOX on Nonprofit Organizations

The Sarbanes Oxley Act of 2002 implements various measures to deal with the problems suggested by Senator Sarbanes and includes eleven titles. Each title addresses a unique issue related to various individuals and firms involved with public companies, their management, auditors, and legal representatives. The Act has created a Public Company Accounting Oversight Board – PCAOB and deals with auditor independence, corporate responsibility, financial disclosures, conflicts of interest, and corporate and criminal accountability (U.S. Congress, 2002). Though many companies have been affected by the implementation and compliance of SOX, the focus here is on nonprofit organizations. Although the Sarbanes Oxley Act was enacted after the scandals of publicly traded companies nonprofit organizations can also benefit from the act. Overall there are not many scandals related to nonprofit organizations as compared to the corporate world but the public trust in these organizations has deteriorated in the past few years. The sections of the Act could help nonprofit organizations to gain and retain the confidence and trust of the general public. The first state legislation which enhanced the Sarbanes Oxley Act for nonprofit organizations is the Nonprofit Integrity Act of 2004 of California (Ross, 2004).

Practical Applications of Sarbanes Oxley in Nonprofit Organizations

The National Association of College and University Business Officers – NACUBO has also made some recommendations in higher education for embedding the sections of the Sarbanes Oxley Act. The report by NACUBO summarizes three main areas of SOX which are relevant to higher education and the management of colleges and universities. These three areas as pointed out by NACUBO are independent auditors, senior management, and audit committees. Regarding independent auditors, the association suggests that the auditors should remain independent and not provide any non-audit services to the clients. Sarbanes Oxley requires the management and directors of corporations to develop and maintain a code of ethics and an internal control mechanism to prevent and resolve any conflicts between personal and professional relationships. NACUBO suggests that the same mechanism for the management of colleges and universities should be adapted. The third relevant area of the Sarbanes Oxley Act for higher education as indicated in the report is the audit committee; the audit committee of the board of directors should appoint, compensate and oversee independent auditors (National Association of College and University Business Officers, 2003).

The impact of SOX on medical institutions can be illustrated by an example of the Children’s Memorial Hospital. The General Counsel of the hospital Donna Wetzler notes that the governance decisions of the hospital are now based on good governance best practices. An audit committee for the hospital is now in place independent and separate from the finance committee. She also commented that nonprofit organizations should implement internal control mechanisms and follow proper accounting procedures to yield a better financial structure and a code of ethics.

A survey conducted by The Urban Institute focused on the impact of the Sarbanes Oxley Act on nonprofit organizations. The survey showed that 20 percent of all nonprofit organizations surveyed had an independent audit committee and the percentage of independent audit committees in larger nonprofit organizations was higher. The nonprofit organizations surveyed indicated that it would be difficult to have a separate audit committee if an Act of such kind was implemented for the nonprofit organizations. The second part of the survey indicates that a majority of the organizations studied already had their statements audited by an independent external auditor. The overall results of the survey indicate that most nonprofit organizations would have a problem implementing Sarbanes Oxley due to higher costs excluding one or two sections that were already in practice or did not have a high cost (The Urban Institute Center on Nonprofits and Philanthropy, 2006).

The two most relevant sections of Sarbanes Oxley with respect to nonprofit organizations are the sections of internal control and independent audit committees. The internal control section entails that the management and directors of the company implement an internal control mechanism and maintain the standards of this mechanism with rigid procedures. The internal control mechanism should also be analyzed continuously by the auditors and legal representatives of the corporation. The other section entails that every corporation should have an independent audit committee to oversee the audit process. The cost of implementation for both of these sections in nonprofit organizations is quite high with respect to time and money (Broude & Prebil, 2005).

Conclusion

The Sarbanes-Oxley Act has affected the governance of nonprofit organizations in various ways. The nonprofit organizations can benefit from the internal control and auditor-related sections of the Sarbanes-Oxley Act to gain public trust and confidence. The implementation of the Act in nonprofit organizations could help them in becoming more transparent and accountable to various stakeholders including the general public. The implementation of the Act would also help ensure the application of a more refined, reliable, and consistent financial system. The cost aspect of this implementation though is quite high in terms of both time and money. Indeed the implementation of SOX has its benefits for nonprofit organizations but the cost factor dampens the probability of its implementation. Thus it is concluded that some sections of the Sarbanes Oxley Act can be adapted for nonprofit organizations but other sections would have a high-cost factor.

References

1. Broude, P., & Prebil, R. (2005). The Impact of Sarbanes-Oxley on Private & Nonprofit Companies. Chicago: Foley & Lardner LLP.
2. Lucas, N. (2004). An interview with United States Senator Paul S. Sarbanes. Journal of Leadership & Organizational Studies , 2.
3. National Association of College and University Business Officers. (2003). The Sarbanes-Oxley Act of 2002: Recommendations for Higher Education. Washington D.C: National Association of College and University Business Officers.
4. Patsuris, P. (2002). The Corporate Scandal Sheet. Web.
5. Ross, S. (2004). Sarbanes-Oxley: 2004.
6. The Urban Institute Center on Nonprofits and Philanthropy. (2006). Nonprofit Governance and theSarbanes-Oxley Act. Washington D.C: The Urban Institute.
7. U.S. Congress. (2002). Sarbanes Oxley Act 2002. Washington: U.S. Congress.