Corporate Governance-related principles, laws and provisions

A .Sarbanes-Oxley Act (SOX Law): A "Rules-based" Corporate Governance Regulation

The Sarbanes-Oxley Act (or SOX Act) is a United States federal law that aims to protect investors
by requiring more reliable and more accurate corporate disclosures. The Act was spurred by
major accounting scandals, such as Enron and WorldCom (today called MCI Inc.), that tricked
investors and inflated stock prices. Spearheaded by Senator Paul Sarbanes and Representative
Michael Oxley, the Act was signed into law by then President George W. Bush on July 30, 2002.

As described in the introduction on corporate governance in Chapter 1, the SOX Act is primarily a
corporate governance regulation. It is a law that has detailed rules compared to other corporate
codes that are more principles-based rather than rules-based.

The following are the most important sections of the Act:

➤ Section 302

Financial reports and statements must certify that:

The documents have been reviewed by signing officers and passed internal controls within the
last 90 days. The documents are free of untrue statements or misleading omissions. The
documents truthfully represent the company's financial health and position.

The documents must be accompanied by a list of all deficiencies or changes in internal controls
and information on any fraud involving company employees.

Financial reports which include financial statements for external reporting purposes are required
to be certified by the CEO and the CFO. The certifications must explicitly state that they have
reviewed such corporate financials and that they are free of untruthful financial representations.
This is made in order to prevent corporate executives from making the excuse that they have not
reviewed the financial statements if, subsequently, they are found to contain material
misstatements or omissions that negatively affect investors' decisions.

This requirement also requires corporate executives to perform a careful review of the amounts
and disclosures reflected in the financial statements, thereby increasing the reliability of the
reports.

➤ Section 401

Financial statements are required to be accurate. Financial statements should also reflect
disclosures of any off-balance liabilities, transactions, or obligations.

Off-balance sheet is an accounting term for asset, liability, or any transaction that is not recorded
on the balance sheet simply because the asset is not legally owned or the liability is not a direct
liability of the reporting entity. Prior to the changes in the accounting standards on leases, the
most typical off-balance sheet item is an operating lease. An operating lease is not typically
reflected as a liability on the balance sheet. In this case, the reporting entity shall disclose future
lease payments on the lease contract to provide additional information to readers of the financial
statements.

➤ Section 404
Companies must publish a detailed statement in their annual reports explaining the structure of
internal controls used. The information must also be made available regarding the procedures
used for financial reporting. The statement should also assess the effectiveness of the internal
controls and reporting procedures.

Under Section 404 of SOX Act, management is required to make an assessment of the
effectiveness of the company's internal controls over the financial reporting process. The CEO
and CFO must certify the assessment of internal controls over the financial reporting process.
This was required because the governance and controls on the recording process of Enron failed
to prevent the massive accounting fraud.

In addition, the accounting firm that audited the financial statements must also assess the internal
controls of the company and issue a report thereon.

➤Section 409

4 Companies are required to urgently disclose drastic changes in their financial position or
operations, including acquisitions, divestments, and major personnel departures. The changes
are to be presented in clear, unambiguous terms.

A more detailed disclosures on significant changes in the structure of the company such as
mergers and acquisitions must be made in financial reports. This information are important to
investors in assessing the company's overall financial position. In addition, disclosures of
divestments must also be done.

Mergers and Acquisitions

Mergers mean the combining into one of two or more companies. Divestments refer to the
disposal of a business that was previously held by a company.

➤ Section 802

Section 802 outlines the following penalties:

Any company official found guilty of concealing, destroying, or altering documents, with the intent
to disrupt an investigation, could face up to 20 years in prison and applicable fines.

Any accountant who knowingly aids company officials in destroying, altering, or falsifying financial
statements could face up to 10 years in prison.

Destroying documentary evidence and obstructing investigations of a corporate fraud now carry
heavier penalty of up to 20 years in prison. In the Enron fraud case, the audit partner and staff of
premier accounting firm Arthur Andersen got indicted for obstruction of justice through destruction
of audit evidence. This resulted to the downfall of the world's formerly number one accounting
firm.

Any company that is under the scope of the SOX Act must comply with all of the legal provisions if
one can be considered a well-governed organization.
Source: Public Company Accounting Oversight Board. 2002. Sarbanes-Oxley Act. Accessed August 20, 2020.
https://pcaobus.org/About/History/Documents/PDFs/Sarbanes_Oxley_Act_of_2002.pdf
Benefits of SOX Act to Investors

After the implementation of the SOX Act, financial crimes and accounting fraud became less
frequent. Organizations were discouraged from attempting to inflate figures such as revenues
and net income. The SOX Act has become a deterrent to corporate crimes like obstructing justice,
securities fraud, mail fraud, and wire fraud. The maximum sentence term for securities fraud was
increased to 25 years, while the maximum prison time for the obstruction of justice was increased
to 20 years.

The act increased the maximum penalties for mail and wire fraud from five years of prison time to
20 years. Also, the SOX significantly increased the fines for public companies committing the
same offense. Thus, investors benefited by having access to more reliable information and were
able to have a sound basis for their investment decisions.

Costs to Businesses

While the SOX Act benefited investors, compliance costs increased for small businesses.
According to a 2006 SEC report, smaller businesses with a market capitalization of less than
$100 million faced compliance costs averaging 2.55% of revenues, whereas larger businesses
only paid an average of 0.06% of revenue. The increased cost burden was mostly carried by new
companies that had recently gone public.

Repercussions?

Due to the additional cash and time costs of complying with the SOX Act, many companies tend
to put off going public until much later. This leads to a rise in debt financing and venture capital.

B. OECD Principles of Corporate

The selected SOX requirements

Now we turn to another corporate governance framework but is considered to be principles-based

The main areas of the OECD Principles are:

I. Ensuring the basis for an effective corporate governance framework.

The corporate governance framework should promote transparent and efficient markets, be
consistent with the rule of law, and clearly articulate the division of responsibilities among different
supervisory, regulatory, and enforcement authorities.

II. The rights of shareholders and key ownership functions.

The corporate governance framework should protect and facilitate the exercise of shareholders'
rights.

III. The equitable treatment of shareholders.

IV. The role of stakeholders in corporate governance.

The corporate governance framework should recognize the rights of stakeholders established by
law or through mutual agreements and encourage active cooperation between corporations and
stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

V. Disclosure and transparency.

The corporate governance framework should ensure that timely and accurate disclosure is made
on all material matters regarding the corporation, including the financial situation, performance,
ownership, and governance of the company.

VI. The responsibilities of the board.

The corporate governance framework should ensure the strategic guidance of the company, the
effective monitoring of management by the board, and the board's accountability to the company
and the shareholders.
Source: Organisation for Economic Cooperation and Development. 2004. Principles of Corporate Governance. Accessed October 26,
2020. https://www.oecd.org/daf/ca/Corporate-Governance-Principles-ENG.pdf

Corporate Governance-related Provisions of the Revised Corporation Code

Section 22 of Republic Act 11232, otherwise known as the Revised Corporation Code of the
Philippines provides:

Section 22. The Board of Directors or Trustees of a Corporation; Qualification and Term.

- Unless otherwise provided in this Code, the board of directors or trustees shall exercise the
corporate powers, conduct all business, and control all properties of the corporation.

The board of the following corporations vested with public interest shall have independent
directors constituting at least twenty percent (20%) of such board:

a. Corporations whose securities (debt securities or equity securities) are registered with the
SEC, corporations listed with an exchange or with assets of at least Fifty Million Pesos
(P50,000,000.00) and having two hundred (200) or more holders of shares, each holding
at least one hundred (100) shares of a class of its equity shares;
b. Banks, pawnshops, and corporations engaged in money service business, pre-need, trust
and insurance companies, and other financial intermediaries; and
c. Other corporations engaged in business vested with public interest similar to the above,
as may be determined by the Commission.

For instance, if a bank has 15 members in the board, then, it should have at least three
independent directors.

As defined in the law, an "independent director" is a person who, apart from shareholdings and
fees received from the corporation, is independent of management and free from any business or
other relationship which could, or could reasonably be perceived to materially interfere with the
exercise of independent judgment in carrying out the responsibilities as a director.

Independent directors must be elected by the shareholders present or entitled to vote in absentia
during the election of directors. Independent directors shall be subject to rules and regulations
governing their qualifications, disqualifications, voting requirements, duration of term and term
limit, maximum number of board memberships and other requirements that the SEC prescribes to
strengthen their independence.

Section 24 provides that after their election, the directors of a corporation must formally organize
and elect: (a) a president, who must be a director; (b) a treasurer, who, must be a resident; (c) a
corporate secretary, who must be a citizen and resident of the Philippines; and (d) such other
officers as may be provided in the bylaws.

If the corporation is vested with public interest, the board shall also elect a compliance officer. The
same person may hold two (2) or more positions concurrently, except that no one shall act as
president and secretary or as president and treasurer at the same time.

The officers shall manage the corporation and perform such duties as may be provided in the
bylaws and/or as resolved by the board of directors. Section 26 provides for the disqualification of
corporate directors, trustees, or officers, listed as follows:

Section 26. Within five (5) years prior to the election or appointment as such, the person was:

(a) Convicted by final judgment:

(1) Of an offense punishable by imprisonment for a period exceeding six (6) years;

(2) For violating the Corporation Code; and

(3) For violating Republic Act No. 8799, otherwise known as "The Securities Regulation
Code";

(b) Found administratively liable for any offense involving fraudulent acts; and

(c) By a foreign court or equivalent foreign regulatory authority for acts, violations, or misconduct
similar to those enumerated in paragraphs (a) and (b) above.

The foregoing is without prejudice to qualifications or other disqualifications, which the SEC, the
primary regulatory agency, or the Philippine Competition Commission, may impose in its
promotion of good corporate governance or as a sanction in its administrative proceedings.
Source: Philippine Securities and Exchange Commission. 2019. Republic Act 11232. Revised Corporation Code. Accessed February
5, 2021. https://www.sec.gov.ph/wp-content/uploads/2019/11/2019Legislation_ RA-11232-REVISED-CORPORATION-CODE-
2019.pdf

Revised SEC Code of Corporate Governance for Publicly- Listed Companies: A "Comply
or Explain" Approach

SEC Memorandum Circular 19, Series of 2016 provides guidelines on the Corporate Governance
of Publicly-Listed Companies. The circular is officially titled Revised SEC Code of Corporate
Governance for Publicly-Listed Companies (Code). Publicly-listed companies, as the term
implies, are companies whose shares of stock are traded on the Philippine Stock Exchange.

The Code adopts a "comply or explain approach" rather than the rules-based mechanism of the
SOX Act. A "comply or explain" approach combines voluntary compliance with mandatory
disclosure. Proponents of the "comply or explain" approach are of the opinion that there is no "one
-size-fits-all" kind of corporate governance for all companies because they differ in size, nature of
operations, location, and operating environment among other factors. Therefore, it is virtually
impossible to require companies in different industries to follow a single and rigid set of rules.

REFERENCE:

Meneses, J. R., Villaceran, E. (2022). Governance, Business Ethics, Risk Management, and
Internal Control.Rex Book Store