May 27, 2020  
 
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The Sarbanes-Oxley Act: Title II

Written by Bennet Grill for Gaebler Ventures

The Sarbanes-Oxley Act highlighted some of the faulty accounting and dishonest business practices which contributed to the recession of the early 2000s.This article focuses on Title II of the Sarbanes-Oxley Act, a section of the Act that discusses auditor independence.

The second title of the Sarbanes-Oxley Act establishes the conditions and regulations governing auditor independence, that is, the extent of services and activities an auditor may perform while remaining independent from the interests of their clients.
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Firms found to have performed fraudulent accounting activities, such as Arthur Andersen, were often engaged in inappropriate relations with their clients to an extent that it became beneficial for the accounting firm to offer an unrealistically favorable review or audit of their client company.

Auditors are supposed to remain strictly unbiased and issue reports free from the influence of the client firmó Arthur Andersen was found to have accepted large payments to essentially lie about the performance of Enron and WorldCom.

In theory, once there is a wall of separation built between the interests of the client and the interests of the accounting firm, auditors will be less susceptible to augmenting financial accounting information to their clients' favor.

The second title specifically reviews nine prohibited activities off limits to public accounting firms when they are performing auditing services. These services include:

  • bookkeeping or services related to financial statements
  • financial information systems design
  • appraisal or valuation services
  • actuarial services
  • internal audit outsourcing services
  • management functions
  • broker, dealer, or investment banking services
  • legal or expert services
  • any other service the Board determines impermissible

These nine prohibited services are established to prevent conflicts of interests so that that an accounting firm will never be in a position to audit its own work.

Prohibiting an auditor from any management functions of the client separates the interests of the client and the auditor, and preventing the auditor from providing other financial services to the firm prevents the auditors from being in a situation where altering or falsifying financial data could materially benefit the accounting. Taking into consideration the corporate scandals of the early 2000s, establishing this list of prohibited activities was a necessary step to reduce the risk of further corporate accounting fraud.

This title also mandates that all auditing and non-auditing services (excluding the nine listed as prohibited activities) must be pre-approved by an Audit Committee of the client. Included in this section is a de minimus exception which waives this pre-approval requirement provided that the total amount of non-audit services do not exceed more than five percent of the revenues paid to the auditor by the client. All such services, however, are required to be disclosed to all investors of the client.

The last major section of title two mandates that a public accounting firm may not provide audit services for a client for more than five years in a row. This provision is yet an addition safeguards against collaboration between auditors and their clients to augment or alter financial disclosures.

Title II of the Sarbanes-Oxley Act outlines the importance of the independence of auditors from the interests of their clients, a necessary condition for honest and open accounting practices.

The Sarbanes-Oxley Series -- Learn More About Sarbox

The Sarbanes-Oxley Act: An Introduction
The Sarbanes-Oxley Act: Title I
The Sarbanes-Oxley Act: Title II
The Sarbanes-Oxley Act: Title III—Audit Committees
The Sarbanes-Oxley Act: Title III—Blackout Periods
The Sarbanes-Oxley Act: Title IV
The Sarbanes-Oxley Act: Title V
The Sarbanes-Oxley Act: Title VI
The Sarbanes-Oxley Act: Title VII—Accounting Firms
The Sarbanes-Oxley Act: Title VII— Past Violators
The Sarbanes-Oxley Act: Title VIII
The Sarbanes-Oxley Act: Title IX-XI

Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.

Related Articles

Want to learn more about this topic? If so, you will enjoy these articles:

The Sarbanes-Oxley Act: Title III—Audit Committees
The Sarbanes-Oxley Act: Help for Small Businesses


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