D216 Business Law for Accountants - Set 5 - Part 3

Correct Answer: A Ponzi scheme

This is a Ponzi scheme, which promises high returns with little risk yet generates no real profit, instead paying earlier investors with money from later ones. It collapses once fresh investment slows to nothing. Option a is incorrect because a short-swing profit violation involves an insider trading a company's own stock within six months; it does not describe a fraud that pays old investors with new investors' money. Option b is incorrect because misappropriating trade secrets concerns stealing confidential business information, a wholly different wrong from an investment fraud that recycles later investors' contributions to pay earlier ones. Option d is incorrect because bait and switch is a deceptive advertising tactic luring shoppers with a cheap item; it has nothing to do with an investment scam funded by a stream of new investor money.

Correct Answer: The Public Company Accounting Oversight Board

The Sarbanes-Oxley Act created the Public Company Accounting Oversight Board to regulate and oversee public accounting firms. Before that law, the audit profession was largely self-regulated; afterward the board set and enforced its standards. Option a is incorrect because the securities regulator predates this law and oversees securities markets broadly; the governance statute created a distinct new board specifically to regulate the firms that audit public companies. Option b is incorrect because the trade commission polices deceptive practices and advertising and was not created by the corporate-accountability law, nor does it oversee public accounting firms' auditing standards. Option c is incorrect because the consumer credit bureau supervises consumer financial products, a different arena entirely from auditor oversight; it is not the board the corporate-governance statute established.

Correct Answer: It eliminates the ignorance defense

The Section 906 certification makes the chief executive and chief financial officer personally accountable for the financials and eliminates the ignorance defense. An officer can no longer escape responsibility by claiming not to know what the statements contained. Option b is incorrect because the certification does the opposite of allowing delegation; by signing personally, the executives put their own names behind the numbers rather than shifting responsibility onto the auditors. Option c is incorrect because certifying the financials increases personal exposure and can carry criminal penalties for a false certification, so it plainly does not exempt officers from criminal liability. Option d is incorrect because the same governance statute separately bans loans to directors and officers; the certification requirement concerns accountability for financial statements, not permission to lend company money to executives.

Correct Answer: Outside directors, at least one financial expert

Under the governance statute, all audit-committee members must be outside independent directors, and at least one must be a financial expert. Independence lets the committee scrutinize management impartially and protects the outside auditor from pressure. Option a is incorrect because officers are precisely the insiders the committee is meant to scrutinize; staffing it with a majority of officers would defeat the independence the statute requires for impartial oversight. Option b is incorrect because the chief executive and chief financial officer are management insiders barred from the committee; placing the very executives being overseen on it would eliminate the required independent scrutiny. Option d is incorrect because the statute specifies outside directors with a financial expert, not randomly selected shareholders; a random shareholder committee would lack both the required independence structure and financial expertise.

Correct Answer: The compensation committee

The compensation committee determines officer pay and designs packages that align officers' interests with shareholders' interests. Tying executive rewards to company performance is exactly the alignment technique this committee is charged with implementing. Option b is incorrect because the audit committee oversees accounting, financial reporting, and internal controls; setting and aligning executive pay is a separate governance function belonging to a different committee entirely. Option c is incorrect because an executive session is simply a private meeting of directors without officers present; it is a meeting format, not the standing committee responsible for designing officer compensation. Option d is incorrect because designing pay is assigned to a dedicated compensation committee, not to any randomly formed nominating body; a random panel is not the governance structure charged with this duty.

Correct Answer: Reassess the controls' effectiveness every year

Sections 302 and 404 require senior officers to establish and maintain effective internal controls and to reassess their effectiveness annually. The duty is to build, keep, and yearly re-test the machinery that produces reliable financial reports. Option a is incorrect because the statute governs the integrity of financial reporting, not market performance; no provision requires management to guarantee a rising stock price, which no company could honestly promise. Option b is incorrect because the governance law increases, rather than removes, auditor involvement for larger companies; eliminating the outside auditor contradicts the very oversight the internal-control sections were designed to strengthen. Option c is incorrect because the sections impose control-building and annual reassessment duties, not a blanket obligation to reimburse shareholders for every reporting error; that is not what these disclosure provisions require.

Correct Answer: Whistleblower protection against retaliation

The corporate-governance statute protects whistleblowers by prohibiting a company from firing or otherwise discriminating against an employee who reports a violation. This shields the people best positioned to spot accounting fraud from retaliation. Option b is incorrect because the law shields a reporting employee from retaliation; it does not reward whistleblowers with a guaranteed promotion, which is not among the protections the governance statute provides. Option c is incorrect because whistleblower protection guards against employer retaliation, not against prosecution; the statute does not grant blanket criminal immunity for all of the reporting employee's own conduct. Option d is incorrect because this statute's protection bars retaliatory firing rather than promising a share of recovered money; a personal cut of funds is not what its whistleblower provision offers.

Correct Answer: Loans to directors and officers are banned

Under Section 402, the corporate-governance statute flatly prohibits loans to directors and officers, a ban that is especially pointed during a public offering. Officer loans were a notorious abuse in the pre-statute accounting scandals. Option a is incorrect because the prohibition is a flat bright line, not a conditional rule; board approval cannot authorize a loan to an officer that the statute categorically forbids. Option b is incorrect because the ban applies generally and is merely emphasized during offerings; the statute does not carve out offering periods as a time when officer loans become permissible. Option d is incorrect because the prohibition covers both directors and officers; limiting it to directors alone would leave officers free to take the very loans the scandals showed were abused.

Correct Answer: Shareholders elect, board governs, officers manage

The chain runs shareholders own and elect the board, the board governs by making major decisions and supervising management, and the officers manage daily operations. Governance is distinct from the day-to-day management the officers carry out. Option b is incorrect because officers do not own the company and the board does not run daily operations; it scrambles every role, reversing ownership, governance, and management from their true positions. Option c is incorrect because directors are not owners and shareholders are not day-to-day managers; ownership rests with the shareholders while running operations belongs to the officers, exactly opposite to this ordering. Option d is incorrect because putting management in shareholders' hands and ownership in the board's misassigns two layers at once, ignoring that owners elect directors who then supervise the officers who operate the business.

Correct Answer: The audit committee

The audit committee owns accounting, financial reporting, oversight of both internal and outside auditors, and the internal controls that keep reported results accurate. It sits between management and the outside auditor as the shareholders' watchdog. Option a is incorrect because the compensation committee sets officer pay and aligns incentives with shareholders; overseeing accounting, auditors, and internal controls is a distinct function belonging to a different committee. Option c is incorrect because a nominating committee focuses on selecting board candidates, not on financial reporting or internal controls; it does not carry the accounting-oversight responsibilities described here. Option d is incorrect because an executive session is a private directors' meeting format rather than a standing committee; oversight of accounting, auditors, and internal controls rests with the dedicated audit committee.