The Sarbanes-Oxley Act, also known as SOX was introduced on 30the July 2002. Also referred to as the Public Company Accounting Reform and Investor Protection Act was introduced in response to a high number of corporate and accounting controversies preceding it. Huge corporations, such as Enron, WorldCom, Peregrine Systems and Tyco International caused numerous investors and stakeholders to lose millions of dollars. These unfortunate people had no legal regulation or law to secure their investments. Moreover, in addition to massive financial losses, these cases also resulted in a loss of public confidence in the market security of the United States.
It was proposed by the U.S. Representative Michael G. Oxley and Senator Paul Sarbanes, hence its name. Approved by the U.S. President George W. Bush, the law is rightfully regarded as a remarkable achievement over the last decades. The Act has eleven articles, and they act as the guidelines and framework for financial reporting. These articles are further divided into several titles. Some of the important titles include corporate responsibility, enhanced financial disclosures, public company accounting and auditor independence.
The lack of any adequate law regarding financial frauds and reporting led to a large number of corporate financial frauds during the period from 2000 to 2002. Some of the scams, especially the cases of Enron and WorldCom created massive publicity. These cases highlighted the ineffectiveness of the financial system and policies of the United States. These circumstances contributed to the political interest in improving the situation, as the fall elections were approaching. Therefore the White House and the Congress deemed it necessary to introduce legislation that focused on the protection of investors from financial frauds and hence, the Sarbanes-Oxley Act was introduced in 2002.
Before its introduction, the United States was mired in a vast number of cases involving the conflicts of interest of the auditors. The financial supervisors of the investors worked in the absence of governmental regulation. In addition to performing audits for their client firms, they also acted as financial consultants for them. Their contracts with the firms were highly in favor of the auditors, hence the creation of conflicts of interest.
Another major area of concern was the audit committees and the board of directors. They were responsible for the formulation of approaches of oversight for financial reporting. Most of the scandals that occurred during the period were attributed to the members of the board not adequately performing their duties. Moreover, a majority of them lacked the appropriate expertise to comprehend the complexities of the business. The audit committees relied on the managerial staff instead of deciding on financial matters independently. Another important aspect was the role of the stock market analysts, as they were the ones recommending selling or buying of the stock or bonds of companies.
The stock market decline of 2000 further worsened the problematic business atmosphere for the investors. Some mutual funds managers who favored the purchase of specific technology stocks were merely interested in selling them. Therefore, the fall of these technology stocks further outraged the investors who were already facing financial difficulties due to continuous losses.
Finally, the issue of compensation played a crucial role towards the development of the Act. The practice of incentives and bonuses and the accompanying unstable prices of the stocks led to a need to manage the earnings. Therefore, the elected government officials introduced the Sarbanes-Oxley Act to regulate the financial processes of corporations and to mitigate the widespread practices.
Significant Characteristics of the Act
The Act was much needed at the moment and regarded as playing a vital role in restoring the confidence of the public in the stock market and the economy of the United States. Moreover, it strengthened the control of the government on the accounting principles of corporations.
Specific provisions of the Act have been imperative in improving the economy of the United States. The Section 302 of the Act deals with the certification of internal control. The law has defined two types of certifications, the criminal and the civil. The primary purpose of this section is to ensure that the financial information is reported correctly. Under this Act, the officers that are signing are made to certify that they are the ones responsible for the formulation and the maintenance of the internal controls. Moreover, they are mandated to report the financial information within the specified time. These officers have to evaluate the internal controls within ninety days before submitting the reports to the commission.
Another section of the Act, the Section 404 is very significant. Known as the internal control assessment, it has been a source of controversy. According to this section, the management and the external auditor must formulate the internal control reports over the financial reporting. It is a very complicated process and implementing it proves to be very costly for the organizations. Furthermore, the process requires hectic documentation and tests of the financial manual. The section mandates the management to establish the report on internal control as a part of the yearly report of exchange act. Also, the report should include data on the effectiveness of the structure of control.
Moreover, the Sarbanes-Oxley Act also states the consequences of its violations. In fact, the portion dealing with the punishments is deemed to be very strict. According to the Act, the sentence for financial fraud or obstruction of justice can be incarceration for up to 25 years. Also, several existing punishments for federal crimes were either extended or made stricter. The previous penalty for mail and wire fraud was drastically increased from five to twenty years. The same was the case with the violations of certain securities laws, with the punishment rising from ten to twenty years. The monetary penalty was also increased from the previous amount of 2.5 million U.S. dollars to 25 million.
In conclusion, the Sarbanes-Oxley Act of 2002 was implemented in response to the dire economic and financial environment of the United States. The main reason for the Act was to maximize transparency in the processes of financial reporting and ensure that the investors and the stockholders are provided correct information. The investors have greatly benefitted from the law as they are now presented with full disclosure of financial information, and hence they can make responsible financial decisions. Moreover, the law has been instrumental in mitigating the occurrence of corporate financial frauds, as the law has made the management accountable for the maintenance of the internal controls.