Chinese "Sarbanes-Oxley Act" Prompts Listed Companies to Build Effective Transparent Supervision System

After year-long discussion and study, the Shanghai Stock Exchange (SSE) finally rounded off compilation of the "SSE Guidelines for Internal Control of Listed Companies" (Guidelines), which was officially issued yesterday (June 5). The Guidelines, the first standardization document directing listed companies to establish and perfect internal control mechanism in China, is regarded by the industry as the Chinese version of "Sarbanes-Oxley Act". Blueprint of the Guidelines is expected to promote listed companies to establish an effective transparent regulatory mechanism for improving the quality of listed companies in China.

Internal control mechanism attracts attention

Since 2003, the repeated exposure of out-of-line issues involving the senior management of listed companies has stirred the securities market. Despite faulty corporation governance structure and sluggish judicial instrument, more blame shall be put on lack of internal control mechanism of listed companies. This is especially the case with losing control of holding subsidiaries and investment of financial derivatives.

Sources from regulatory authorities said that fundamental cause of these issues lies in the management's indifference to and ignorance of mass doubtful points in operation. Some listed companies even didn't actively cooperate with examination on deep-seated problems after exposure. So, flaws of internal control mechanism lead to these vicious issues on the securities market. Thus, prompting listed companies for a sound internal control mechanism has become ever more pressing.

Many developed markets have also reinforced supervision over internal control risks of listed companies in recently years all over the world. After exposure of Enron and WorldCom incidents, the US Congress worked out the "Sarbanes-Oxley Act"to make strict rules on internal control and its disclosure by listed companies. Afterwards, securities markets in other countries and regions including Japan also established disclosure mechanism related to internal control. All this urged China to attach importance to internal control of listed companies.

The "China Securities Regulatory Commission's 'Notice of Opinions on Improving Listed Companies' Quality' approved and forwarded by the State Council", issued on February 2, 2005, made new requirements for internal control of listed companies. Among the new requirements, "internal control mechanism and self-evaluation report by listed companies with verification and appraisal by external audit" provides a basis for pushing forward self-evaluation report on internal control by listed companies with verification and appraisal by external audit mechanism.

The SSE Guidelines, based on opinions from all walks of life, provides directions for listed companies to establish and carry out internal control mechanism, and makes new requirements for information disclosure of internal control by listed companies.

The framework has been set for highlighting the individuality.

According to an SSE official, the Guidelines has the following characteristics in its content:

Firstly, it aims at promoting and directing listed companies to establish internal control mechanism. Since listed companies in China belong to different industries with specific characteristics in operation of their own, different internal control mechanisms are necessary. Thus, the Guidelines focused on promoting and directing listed companies to establish and carry out internal control mechanism instead of giving out a general model of internal control mechanism.

Secondly, the Guidelines, based on the "General Frame of Enterprise Risk Management" of COSO affiliated to the international authority of internal control, National Commission on Fraudulent Reporting, was customerized for risk management to listed companies in China.

Thirdly, it requires that listed companies establish internal control mechanisms by themselves according to their features. The Guidelines, which provides no model of internal control mechanism for listed companies, requires that all companies establish independent internal control mechanism with their own characteristics and experience in operation to emphasize individuality. Meanwhile, SSE encourages listed companies to appoint professional institutions for assistance in establishing the mechanism.

Fourthly, according to the Guidelines, SSE will perfect the internal control mainly through supervising information disclosure. For example, the Guidelines requires that listed companies carry out examination and supervision over internal control with designated functional department and establish corresponding working system. The functional department can report to the directorate directly, with the department chief appointed by the directorate. Another example, the Guidelines stipulates information disclosure of internal control of listed companies, which are required to disclose implementation of internal control in a quarterly report. Moreover, it shall be disclosed in the form of special announcement when high risks occur in internal control. In addition, according to regulations in the "Notice of Opinions on Improving Listed Companies' Quality", the Guidelines requires that companies give a self-evaluation report on internal control along with an annual report, with verification and appraisal by external audit.

Internal control and corporation governance supplement each other

Then, what's the difference between the internal control and corporation governance? Do they have something in common? According to analysis of experts by the industry, the corporation governance, in a broad sense, includes internal control. Generally speaking, corporation governance involves relationship between Shareholders'Meeting, the directorate and board of supervisors, while internal control mainly assorts with contract relationship in level of directorate, especially lower than the management. Once, internal control is weakened, measures of corporation governance won't be carried out. Thus, internal control and corporation governance supplement and stimulate each other. In view of structure of corporation governance, it helps establish and perfect the internal control. In turn, reasonable design and effective implementation of internal control mechanism will perfect corporation governance structure and establishment of modern enterprise mechanism.

SSE pointed out in the Guidelines that the directorate should ensure the sanity and effectiveness of internal control mechanism; the directorate and the staff should ensure truthfulness, accuracy and completeness of information disclosure related to internal control mechanism. Obviously,  "directorate with responsibility" overlaps the internal control and corporation governance.

Experts think that bringing internal control into the broad category of corporation governance, working out guidelines for internal control and promoting listed companies for a perfect internal control mechanism will complete the current regulation system of corporation governance in China. In addition, it will help improve quality of listed companies.