The law demands that there should be independence between the corporate audit committee and management and furthermore, any organization must have one financial expert included in the audit committee. This independence provision aims to make sure that there is interference of management in the audit activities of the committee. This requirement should be mandated for non-profit organizations to reduce fraud because the organizations have finance sector too that should be held accountable. For instance, having financial experts in the audit committee will ensure that any financial report coming from the organization is accurate since the experts can analyze and understand the financial statements.
The Sarbanes Oxley Act (SOX) provisions demand that some distance or separation should exist in the relationship between auditors and the corporation. This provision is aimed at reducing the probability of collusion between auditors and Company management to commit fraud. This provision should be extended to non-profit organizations to reduce the cases of fraud that result from the collaboration of management and auditors (Charifzadeh, 2017). The reason why fraud is likely to reduce is that auditors will be completely separate from the corporation.
The act requires that profit health organizations disclose information about the financial situation of their entity or material changes for the operation of the Company. For non-profit organizations, they are supposed to make sure that IRS Form 990 is accurate. They also must provide an accurate picture of their financials to clients, donors, media and public officials.
For-profit organizations, the Chief Executive officer, and chief financial officers must certify that information on financial statements is an actual representation of the financial operation and condition of the company. The not for profit entities should carry out a thorough examination of their financial systems, reporting and policies to ensure that they comply with the set standards (Charifzadeh, 2017).
Making SOX requirements to be mandatory for not for profit organizations, works greatly to reduce fraud and financial mismanagement. The SOX requirements are effective in reducing fraud because the non-profits will take steps to ensure that the reliability and integrity of their financial statements that are made available to donors, outsiders and government agencies are maintained (Bryce, 2017). The financial stability and integrity of not for profit healthcare organizations are the fundamental issues that Attorneys General look in any entity (Bryce, 2017). It is essential to make sure that there is transparency in financial reporting so that charitable donors who make decisions to contribute to the organizations have reliable information about the financial position of the entities. Most healthcare entities prepare their financial statements based on estimates. The SOX regulations which require that a financial expert be part of the audit committee will help fraud and wrong representation of financial figures.
Effectiveness of SOX regulations
Through SOX, many healthcare organizations have been able to analyze, strengthen and implement the internal controls to fulfill section 404 of the SOX Act. For this reason, managers running healthcare organizations have become more responsible for ensuring that internal management and financial controls are effective (Cleverley, 2017). The objective of this section of the Act is aimed at improving risk management systems, governance and quality/integrity of financial statements. Management in most organizations is taking their diligently and with integrity because they know that under the SOX regulations, they are heavily liable for any mismanagement that leads to financial loss. If the healthcare organization does not perform well financially, there is no room for cover up by giving inflated or misleading information. The increase in internal controls due strict SOX regulations has drastically reduced cases of fraud in the healthcare industry that results from errors in Medicare accounting (Cleverley, 2017). Most healthcare organizations have reported a great improvement in accounting for refundable fees, analysis of reimbursements to third-parties and accounting for nursing home patients. Such developments have come about because of the strict SOX provisions that impose severe penalties on any officer found perpetuating fraud.
Right now, many organizations are able to deal with conflict of interest problem in the most appropriate way possible. Section 409 of SOX Act which requires organizations to do the Real Time Issuer Disclosures has compelled management of many healthcare organizations to define what falls under the conflict of interest (Cleverley, 2017). Healthcare companies have adopted conflict of interest policy and disclosure statement that gives guidelines on how to deal with such issues as they arise and procedure of appointing the audit committee members (Cleverley, 2017). The efficiency in the management of conflicts of interest has drastically improved due to the SOX regulations.
However, the effectiveness of the SOX regulations is limited by numerous accounting challenges that many healthcare organizations face. For instance, healthcare entities rely on estimates for them to prepare financial statements which bring into question, the validity of such information. Sometimes, there is a disconnect between the actual reimbursement and the billed charges by the healthcare provider which makes accounting difficult (Wahlen et al. 2017). The third party and government reimbursements keep changing, and therefore retroactive adjustments have to be frequently made (Cleverley, 2017). Because of these challenges, the effectiveness of SOX regulations is limited.
The case in question is that of China Sky One Medical, Inc. (“CSKI”) and Liu being accused of financial fraud where the defendant is accused of export sales fabrication and overstatement of financial results for two years (Case no. AAER-3404). There was negligence in part of the external auditor who overstated the financial results of CSKI in 2007 and 2008 which impacted the earnings per share in the Company’s balance sheet. The export sales of $12.2 reported in CSKI Form 10-K was false, yet it constituted 25% of the reported total revenues. The Company further reported fake sales in its Forms 10-Q and 10-K of 2008 and thus affecting the reflection of the financial performance of the company.
CSKI violated 2 major Generally Accepted Accounting Principles (GAAP) in preparation of its financial statements. First, is the Revenue recognition principle which demands that revenue is only earned and recognized when the product is delivered (Wahlen et al. 2017). In this case, CSKI never delivered the products for the full amount recorded in their financial statements. The company delivered a smaller quantity of drugs but deliberately recorded a higher amount to show that it was performing better regarding revenue generation which is against GAAP. Another principle that CSKI violated is the Full disclosure principle which requires a Company to provide accurate information regarding its past financial performance (Wahlen et al. 2017).
Specific provisions of SOX that were violated
First, Liu who is the Chief Executive Officer of CSKI violated Section 304 of the SOX Act by receiving incentive compensation for good performance of the Company yet the compensation was calculated from falsified financial statements (AICPA, 2017).
Liu is also in contravention of Exchange Act Rule 13b2 by giving false financial statements to accountants, yet they are materially misleading and did not have facts. Liu either directly or indirectly falsified the records or books of accounts of CSKI.
Liu and CSKI are liable for violation of Section 1102 which states that no officer within the Company should tamper with the financial record(s) with the intention of impairing the object's integrity. The law says such a person is liable to pay a fine and get a 20 years jail term in prison.
SOX Act has enhanced Title IX for penalty enhancements to officers who are found guilty of having committed a financial fraud crime. Any CEO or CFO who willfully certifies financial statements and disclosures that do not comply with the Securities Exchange Act is to pay a fine of not more than $500,000 and/or be imprisoned up to 5 years. The penalty put forth in the SOX Act is enough to deter the commission of such frauds.
Recommendations for internal control to reduce fraud
1. The first measure is the use of an up to date technology tools such as governance, risk, and control (GRC) solutions that are in the market to aid in monitoring and streamlining the operations to ensure compliance to the standard financial accounting standards. Use of such technology solutions ensures there is dynamic, real-time reporting for management efficiency in internal system control.
2. Establishment of accountability and ownership where employees of the company or organization are personally accountable for their assigned responsibilities and areas of work. To do this, the organization should implement control self-assessments (CSA) which are techniques that allow individual employees to take part in risk evaluation, internal control assessment and discovery of potential control deficiencies. The technique will work to prevent financial fraud like the one witnessed in CSKI.
References
American Institute of Certified Public Accountants. (2017). Employee benefit plans: January 1, 2017.
Bryce, H. J. (2017). Financial and strategic management for nonprofit organizations.
Charifzadeh, M., Taschner, A., " Wiley-VCH. (2017). Management accounting and control: Tools and concepts in a central European context.
Wahlen, J. M., Jones, J. P., " Pagach, D. P. (2017). Intermediate Accounting: Reporting and analysis.
Cleverley, W. O. (2017). Essentials of health care finance. Jones " Bartlett Learning.
