The US Business Accounting System: Government Regulation

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Introduction

Since America got independence, the government has been constantly regulating business practices through accounting procedures. The importance of effective accounting regulation procedures is one of the primary reasons for the establishment of the federal government, but since then, the government has lagged behind in regulating business practices after there was immense pressure to loosen its grip on business procedures. However, with deregulation came an increase in corporate scandals as was witnessed from the Enron and Lockheed scandals.

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Over the past decade or so, the US accounting system has shown a serious need for regulation, especially in terms of the disclosure of financial information, corporate governance, financial reporting and accounting practices because the current system of operation has a lot to be desired in meeting the needs of professionals, investors and the rapidly changing technological environment. Even though the American system of financial information is one of the best in the world, there is still a strong need to improve it; recent scandals are evidence enough to this fact.

This study proposes that there is an increasing need for more government regulation to deal with the vulnerabilities and weaknesses of the US accounting system because the government needs to protect public interests and investor confidence. This overhaul of the regulatory system ought to be done through reordering perspectives and priorities within the accounting profession; in addition to regularly monitoring the way companies perform their obligations towards their stakeholders. The system envisioned should also be thoroughly vetted so that all stakeholder interests are incorporated even as the government changes its system to create more control or regulation.

The Securities Acts of 1933 and 1934

Summary of Regulation

The securities act of 1933 was enacted by congress after the stock market crash of 1929 which preceded the great depression. The securities act of 1933 and 1934 were probably among the first regulations in the American governance system to stipulate the sale of securities since it outlined that any sale or offer of securities using instrumentalities of intrastate commerce ought to be registered, unless they are exempted under the rules of the specific act (Meyer, 1994, p. 225). Investopedia (2010) defines the regulations of the act as created to “provide governance of securities transactions on the secondary market (after issue) and regulate the exchanges and broker-dealers in order to protect the investing public” (p.1). It further explains that “All companies listed on stock exchanges must follow the requirements set forth in the Securities Exchange Act of 1934. Primary requirements include registration of any securities listed on stock exchanges, disclosure, proxy solicitations and margin and audit requirements” (p. 2).

Before the enactment of these laws, the sale of securities was majorly governed by state laws, but in conventional terms, it was regarded as blue sky laws; however, when congress enacted the 1933 and 1934 acts, it left in its wake, the patchwork of state security laws (National Conference of Commissioners on Uniform State Laws, 2003, p. 53). This reform was essentially meant to support federal regulations by state laws because there was an existing debate on the authenticity of federal laws in the regulation of sale of securities (Meyer, 1994, p. 225). The 1933 and 1934 acts had two major purposes which led to their establishment. First, they were meant to provide investors with enough material evidence regarding the sale of a given security and second, they were meant to prohibit deceit and misrepresentations relating to the sale of securities to the general public (National Conference of Commissioners on Uniform State Laws, 2003, p. 53). The underlying premise in the establishment of the acts was that all companies should provide their investors with adequate information regarding the issuers of securities plus the security, to assist in achieving the objective of providing potential investors with enough material information for fair dealings in the market. When this type of disclosure was encouraged, it was assumed that chances of unfair play in stock market trade would be minimized. The disclosure of material information was to be done trough the registration of securities with the stock exchange security exchange commission because this body is the federal mandated body responsible for the oversight of security markets. However, before the establishment of the body, the oversight of security markets was done by the Federal trade commission until the security exchange trade act of 1934 was established (National Conference of Commissioners on Uniform State Laws, 2003, p. 53).

Analysis of Related Scandal

The Wall Street crash of 1929 led to the enactment of the security acts of 1933 and 1934 since there wasn’t much regulation at the time of the stock market crash which later saw the crisis develop into one of the biggest economic crises in the US and indeed one of the most extensive in the world (Peterson, 2007, p. 107). The crisis never affected the US only because almost all significant Western industrialized economies were affected just like the recent global economic slump of 2008. The crisis was preceded by a speculative perception among American investors of an economic boom which saw many investors invest in the stock market; with a significant majority taking loans to finance their investments (Peterson, 2007, p. 107). In fact, stock brokers were lending the public up to three quarters of the face value of the stock process but comprehensively, more than $ 8.5 billion was given out in loans (Peterson, 2007, p. 107). Unfortunately, this was more than the amount of currency circulating in the US at the time, and many more people were forced to borrow even more, considering share prices were slowly rising and expected to rise even further in coming months. People therefore borrowed more. These developments led to some form of economic bubble which later saw the share prices fall. It created frenzy among the investors and many started to sell off their stocks in panic, leading to the stock market crash (Fisher, 2007, p. 56).

This crisis was particularly brought about by the lack of regulation by the US government because it was surprising for the government to sit back and see a lot of money being mopped from the economy (to be invested in one market), without any form of cushioning in the event of a collapse of the market. Because of this fact, the government later developed a policy to temporarily suspend trading, if ever share prices fell sharply again (to prevent panic selling as was witnessed in the stock market crisis) (Fisher, 2007, p. 56). Considering the intrigues of the stock market, the government was majorly to blame for the crisis because they failed to protect the American investors from adverse effects of the stock market.

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The Foreign Corrupt Practices Act

Summary of Regulation

The foreign corrupt practices act was established with two major provisions; one which addresses accounting transparency (which also falls under the security exchange act of 1934), and the provision against bribery of foreign officials through the regulation of the activities of issuers, domestic concerns and any stipulated enterprises or officials (Hoffman, 2008, p. 392). The act contains provisions that prohibit the actions of the above officials from making use of intrastate commerce corruptly by preventing corrupt payments to foreign officials or parties through the contravention of operational guidelines governing the action of such officials (Hoffman, 2008, p. 392).

These regulations were enacted after the security exchange commission established (from investigations done in the mid 1970s) the fact that many US companies made illegal payments of up to $300,000,000 to foreign state officials, political cronies and political parties (Hoffman, 2008, p. 392). These payments were especially done by some US companies to gain favor from foreign parties in terms of ministerial favors to secure business contracts and such like actions. Congress therefore enacted the foreign corrupt practices act to restore faith in the American business systems through the prevention of corrupt foreign practices. The act was signed into law in 1977 by President Roosevelt but it was later amended by the International anti bribery act of 1998 which included a provision not only binding US companies but also foreign companies from making illegal payments to American businesses (Hoffman, 2008, p. 392).

Analysis of Related Scandal

The Lockheed bribery scandal is a classical example of the risks involved by deregulating foreign transactions. The Lockheed bribery scandals were instigated by officials from the Lockheed Company to sell US air jet fighters to foreign companies; an action which caused a lot of jittery throughout many European countries such as West Germany, Italy, Netherlands, and some Asian countries such as Japan (Monye, 1997, p. 205). The scandal almost saw the collapse of the corporation since it was already at the brink of collapse due to the business failure of the Tri-Star airline project (Monye, 1997, p. 205). However, the federal government bailed out the company even though it was established that members of the Lockheed Company paid foreign officials millions of dollars in bribery to secure military supply contracts (Monye, 1997, p. 205). These bribery claims were replicated in a number of countries across the globe.

In West Germany, Ernest Hauser, a former official of Lockheed, exposed the fact that the German minister for Defense, Franz Josef had received more than $10 million in bribery for the purchase of Start fighters in 1961. The accusations sent a flurry of accusations and counter accusations but since the allegations were not corroborated, the accusations were dropped; however, after the papers relating to the controversial deal went missing, the accusations were revisited again (Monye, 1997, p. 205). Reports from unidentified sources alleged that members of the German Bundestag allowed officials from Lockheed to visit its aerospace bases in the US but the entire trip was to be funded by Lockheed itself. It was later affirmed that documents relating to the controversial purchase of the star fighter jets were destroyed in 1961but later investigations done in the 70s exposed that Lockheed never paid for the trip to the Bundestag aerospace base but Bundestag did (Monye, 1997, p. 205).

In Japan Lockheed was also engaged in a number of scandalous deals with business officials in Japan, the Finance Minister, and certain high ranking members in the Japan political circle (Monye, 1997, p. 205). The deal was characterized by the willingness of the Japanese Air defense force which was willing to purchase F-11 fleet of jet fighters to replace the existing fleet of F-86 fighters, but after constant lobbying by Lockheed officials, the government was coerced to purchase the F104 fleet of airlines instead. In related events, Lockheed sought the services of a prominent Japanese underworld figure known as Yoshio Kodama to influence Japanese parastatals to purchase their fleet of airlines (Monye, 1997, p. 205). It was later confirmed through congress investigations that Lockheed officials paid up to $3million in bribery to the then Japanese Prime minister to aid the company secure the deal in good time (before Mc Donald Douglas beat them in the sale) (Monye, 1997, p. 205). In total, the officials and agencies involved in the bribery scandal included the Japanese Prime minister, ANA officials, and Kodama.

Other questionable deals of bribery were undertaken in Netherlands, Italy, and Saudi Arabia (Monye, 1997, p. 205). These questionable deals especially thrived because there wasn’t enough regulation by the American government which enabled Lockheed officials to repetitively bribe state officials in several countries; in almost two decades without detection. The Foreign corrupt practices act was therefore a good move by the government to detect such business malpractices and establish fair competition in the American business environment.

Sarbanes Oxley Act

Summary of Regulation

The Sarbanes Oxley act was otherwise known as the Public Accounting Reform and Investigator Protection Act enacted in 2002 to streamline the public accounting systems of US companies by ensuring efficiency and accountability was observed in the American business environment (Garner, 2008, p. 55). This bill was enacted after a number of scandals such as the Enron, Tyco International, Aselphia, World Com and the likes sufficed to expose the weaknesses and vulnerabilities of the US accounting systems (Garner, 2008, p. 55). These scandals greatly eroded the confidence the American public had in the US security market after a shift in the share prices of the affected companies led to a loss of investor money amounting to billions of dollars (Garner, 2008, p. 55).

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The act only applied to public companies but Garner (2008, p. 55) explains that “the act contains 11 titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law”. However, with regards to the scope of the act, Garner (2008, p. 55) further explains that:

“the act created a new, quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, charged with overseeing, regulating, inspecting and disciplining accounting firms in their roles as auditors of public companies. The act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure”.

Even though the act has been termed by some economists as one of the major economic reforms in the American business practice, after President Roosevelt made significant reforms during his tenure, there is still a lot of debate on the implicit costs, and benefits from the implementation of the act (Garner, 2008, p. 54). However, to a large extent, this act has restored public confidence, in addition to strengthening the existing accounting systems; although critics argue that the act has greatly eroded America’s competitive advantage in the world market because of an increase in controls and regulations of business practices (Garner, 2008, p. 54). Nonetheless, it is correct to say that the act has improved the confidence of fund managers, and other investors, in line with the veracities of corporate financial instruments; even though since its inception, there has been a relative drop in foreign businesses in America (Garner, 2008, p. 54).

Analysis of Related Fraud/Scandal

Enron Scandal

The Enron scandal grew from the lack of regulation in the American accounting system. The scandal happened in 2001 and led to the collapse of the once robust Enron cooperation and its antecedents including Arthur Andersen accounting firm which was apparently, one of the world’s top accounting firms (Markham, 2006, p. 95). This scandal is termed in certain quarters as one of the biggest accounting scandals in the American history of its time because it was one of the biggest examples of audit failure in American business practice (Markham, 2006, p. 95). Jeffrey Skilling is quoted in most reports as the instigator of the scandal because through his heinous activities, he was able to conceal debts running to billions of dollars through the company’s financial statements by employing staff who took advantage of existing accounting loopholes to mislead investors into investing in the company, even though it was making huge losses (Sterling, 2002, p. 5).

Andrew Foster was also another executive in the company, extensively named as having misled company executives in undertaking poor financial decisions as well as convincing Andersen Audit Company to ignore the apparent business malpractice altogether (Markham, 2006, p. 95). The scandal was characterized by a significant fall in share prices from an all time high of $90 to almost less than $1 which also saw shareholders lose investments of up to $11billion shillings (Markham, 2006, p. 95). Enron later filed for bankruptcy after which its $63 billion dollars worth of assets was liquidated (Sterling, 2002, p. 5). With these developments, many new regulations were enacted by congress to further streamline the US accounting systems as reported by Sterling (2002, p. 5) who makes reference to the “the Sarbanes-Oxley Act, which expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders”. He further affirms that “The act also increased the accountability of auditing firms to remain unbiased and independent of their clients” (p. 5). The scandal can therefore be seen as having developed from a lack of adequate regulations to oversee American business practices which led to the use of accounting loopholes by Enron officials in concealing debt. The Sarbanes Oxley Act was therefore introduced as a regulation to seal these loopholes by making accounting procedures more efficient.

Conclusion

From the corporate events described in this study, it can be evidently seen that a lack of regulation can lead to adverse economic effects, not only for the American economy, but also to other economies tied to the American economy. From the development of the foreign corrupt practices act and the securities acts of 1933 and 1934, it becomes clear that American business practice is not only tied to the American economy but also to other economies. This implies that the American government needs to increase its regulatory practices in the corporate world; most especially now when business has gone global.

The above regulations described in this study, identified as corrective measures to the shortcomings of the American business accounting systems. The system cannot be totally relied on because the business environment is constantly changing and with the increased liberal nature of the world economy, plus increasing global pressures, there is an increased need to regulate business practices; otherwise, a bigger and more devastating economic adversity may be experienced, like the recent global financial crisis.

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References

Fisher, K. L. (2007). The Wall Street Waltz: 90 Visual Perspectives: Illustrated Lessons From Financial Cycles and Trends. London: John Wiley and Sons.

Garner, D. E. (2008). Accounting and the Global Economy after Sarbanes-Oxley. New York: M.E. Sharpe.

Hoffman, S. (2008). The Law and Business of International Project Finance. Cambridge: Cambridge University Press.

Investopedia. (2010). Securities Exchange Act of 1934. Web.

Markham, J. (2006). Financial History of Modern United States Corporate Scandals. New York: M.E. Sharpe.

Meyer, C. (1994). The Securities Exchange Act Of 1934, Analyzed And Explained. New York: Wm. S. Hein Publishing.

Monye, S. (1997). The International Business Blueprint. London: Wiley-Blackwell. Print.

National Conference of Commissioners on Uniform State Laws. (2003). The New Uniform Securities Act. Aspen: Aspen Publishers Online.

Peterson, N. (2007). Wall Street Lingo: Thousands of Investment Terms Explained Simply. New York: Atlantic Publishing Company.

Sterling, T. (2002). The Enron Scandal. New York: Nova Publishers.

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