The Sarbanes-Oxley Act of 2002 (SOX) was established after many corporate scandals such as Enron, WorldCom, and AIG cost investors billions of dollars. Financial fallout from these scandals reduced the American public’s trust in the economy. The enactment of SOX in 2002 holds corporations to higher standards in reporting financial statements to internal and external users. Even though the standards for SOX are still evolving, the new regulatory environment generated in its wake will now protect the public and the market from fraud within corporations. This paper will discuss the main aspects of the SOX Act, its imposed requirements and its effectiveness in avoiding future fraud. Passage of the SOX Act
Regulatory compliance has always been a part of doing business. There are many regulations developed to help protect the public from fraud and most businesses must meet certain industry standards. According to Kimmel, Weygandt & Kieso (2011) “Congress passed the SOX Act to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals” (p. 8). SOX was “named after Senator Paul Sarbanes and Representative Michael Oxley, who were its main architects” (“The Sarbanes-Oxley Act Summary and Introduction,” 2006).
The SOX Act provides a solid set of internal controls and auditing standards that are aimed to discourage and punish corporate and accounting fraud, as well as corruption. SOX is designed to carry out these tasks by imposing severe penalties for civil or criminal acts, while protecting the interest of workers and shareholders. The SOX Act restores investor confidence by regulating financial auditing procedures and making them transparent to the general public and investors. In order for the Act to be successful enforcement is crucial. Only by fear of penalty or imprisonment will this act be enforceable. Regulatory Requirements of the SOX Act
The Sarbanes-Oxley Act contains 11 sections (or titles) which contain specific requirements for financial reporting. As far as compliance is concerned, Sections 101, 302, 401, and 404 (detailed below) are the main imposed requirements of SOX. Sections 802 and 906 detail the penalties and incentives to avoid future fraud. As a result of SOX, these sections, according to Kimmel et al (2011), address the following aspects of regulatory compliance: Top management must now certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe. Also, SOX increased the independence of the outside auditors who review the accuracy of corporate financial statements, and increased the oversight role of boards of directors. (p. 8) Section 101: Establishment; Administrative Provisions
“The Public Company Accounting Oversight Board (PCAOB) is directed by the Sarbanes-Oxley Act of 2002 to establish auditing and related professional practice standards for registered public accounting firms to follow in the preparation and issuance of audit reports” (Public Company Accounting Oversight Board, 2015). The group administers “the audits of brokers and dealers, including compliance reports filed pursuant to federal securities laws, to promote investor protection” (Public Company Accounting Oversight Board, 2015). Additionally, each board member shall serve a term no greater than five years, and no person may serve on the board consecutively for more than two terms (Public Company Accounting Oversight Board, 2015). Section 302: Corporate Responsibility for Financial Reports
“As a result of SOX, top management must now certify the accuracy of financial information” (Kimmel et al., p. 9). These certifications require that a corporation’s top management officers accurately disclose the company’s financial data and objectively represent its financial picture every quarter to establish accountability (“Sarbanes-Oxley Act Section 302”, 2006). Section 401: Disclosures in Periodic Reports
This title directs that companies provide and publish financial statements that are accurate and maintain generally accepted accounting principles. Companies must also provide annual or quarterly “financial statements that include material off-balance sheet liabilities, obligations or transactions” (“Sarbanes-Oxley Act Section 401”, 2006). Section 404: Management Assessment of Internal Controls
In an article published on WhatIs.com, Rouse (2008) wrote that Section 404 “mandates that all publicly-traded companies must establish internal controls and procedures for financial reporting and must document, test and maintain those controls and procedures to ensure their effectiveness” (para. 1). Section 404 also requires that a public accounting firm is held responsible for providing an audit report that evaluates and certifies the company’s internal procedures. Section 802: Criminal Penalties for Altering Documents
This title defines altering as “anyone who knowingly modifies, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object” (Sox-Online.com, 2012). Anyone convicted of Section 802 faces a sentence or imprisonment of up to 20 years (Sox-Online.com, 2012). “This section also imposes penalties of fines and/or imprisonment up to 10 years on any accountant who knowingly and willfully violates the requirements of maintenance of all audit or review papers for a period of 5 years” (“Sarbanes-Oxley Section 802”, 2006). Because of Section 802, companies are quickly working to establish strong Information Technology Departments that can house electronic financial data. Section 906 – Corporate Responsibility for Financial Reports
Within a corporation, it is often hard to place blame on an individual. This section captures corporate responsibility by mandating that each chief executive officer must submit a written statement along with each report to certify the report’s validity. Under Section 906, penalties for certifying a misleading or fraudulent financial report are $5 million in fines with an option to serve up to 20 years in prison (Spear, 2014). Pros and Cons of the SOX Act
Although the enactment of the SOX Act has received tremendous support, it is not without its fair share of detractors. Involved and cumbersome requirements cause confusion and frustration for companies attempting to comply with the Act more than a decade after its enactment. Companies and lawmakers alike have had difficulty over the years with the interpretation and compliance of the Act. Another major contention of critics is that the cost of compliance far outweighs the benefits in an international marketplace. The reporting requirements of SOX are specific to businesses in the United States; international businesses do not have the same requirements. “Regulatory compliance opposes economic cost on organizations and can affect their competitive advantage” (Srinivasan, 2014, p. 44). Increasing the cost for American businesses decreases competitive advantage in the worldwide marketplace. Despite complaints by critics, the SOX Act has many positive aspects. According to Burns (2004), a Harris poll found “59% of investors believe the Sarbanes-Oxley Act will help safeguard their stock investments, and 57% say they would be very unlikely to invest in a company that didn’t comply with the law” (p. R8).
Business relationships have also improved with increased transparency. The reduction of information irregularity is a direct benefit to the company and its investors. Periodic testing of internal controls required by SOX increases the transparency among internal and external stakeholders of the business. In addition, the increase in financial transparency has improved business relationships on many levels. With an increase in confidence and a perceived reduction of fraud, investors can make intelligent business decisions on the purchase and sale of publicly traded companies. Conclusion
In conclusion, the establishment of the SOX Act makes corporations liable for accurate and up to date reporting of financial data. To evaluate the effectiveness of SOX in preventing future frauds, one must take into consideration the many different situations in which the legislation is applicable. Enactment of the Sarbanes-Oxley Act increases corporate responsibility and sets restrictions on auditing services. The SOX Act reduces the potential for fraud; however, it does not eliminate it. From a business perspective, compliance is beneficial. The cost of implementing SOX requirements are high, but the benefit of increased investor confidence is higher. There are going to be some situations where fraud is inevitable. Fraudulent wrongdoers and companies will find loopholes and recent Court of Appeals cases are evidence of that. As with any law, this regulation will reduce the frequency but not completely prevent future criminal activity.
A Guide to the Sarbanes-Oxley Act. (2006). Sarbanes-Oxley Act Section 302. Retrieved June 6, 2015, from http://www.soxlaw.com/s302.htm A Guide to the Sarbanes-Oxley Act. (2006). Sarbanes-Oxley Act Section 401. Retrieved June 6, 2015 from http://www.soxlaw.com/s401.htm A Guide to the Sarbanes-Oxley Act. (2006). Sarbanes-Oxley Act Summary and Introduction. Retrieved June 6, 2015, from http://www.soxlaw.com/index.htm Burns, J. (2004, June 21). “Is Sarbanes-Oxley Working?” Wall Street Journal, pp. R8–R9. Hanna, J. (2014, March 10). The costs and benefits of Sarbanes-Oxley. Retrieved June 5, 2015 from Forbes.com: http://www.forbes.com/sites/hbsworkingknowledge/2014/03/10/the-costs-and-benefits-of-sarbanes-oxley/ Public Company Accounting Oversight Board. (2015). PCAOB oversees. Retrieved June 4, 2015 from http://pcaobus.org/Pages/default.aspx Rouse, M. (2008, January). Sox Section 404 (Sarbanes-Oxley Act Section 404). Retrieved June 6, 2015 from http://searchfinancialsecurity.techtarget.com/definition/SOX-Section-404 Sox-Online.com. (2012). Sarbanes-Oxley Act Section 802: Criminal penalties for altering documents. Retrieved June 5, 2015 from http://www.sox-online.com/act_section_802.html Spear, B. (2014, July 6). Section 906 of Sarbanes Oxley Act. Retrieved June 5, 2015 from http://www.ehow.com/about_6589998_section-906-sarbanes-oxley-act.html Srinivasan, M. C. (2014). Assessing the impact of Sarbanes-Oxley Act on the logistics industry: an exploratory study. Transportation Journal, Volume 53, 44 – 78.