Sarbanes-Oxley Act

Quick Summary of Sarbanes-Oxley Act

US legislation that tightened up corporate financial reporting, introducing a federal accounting supervision board and criminal liability for executives who are shown to have falsified accounts.

A 2002 U.S. federal law which establishes a broad array of standards for public companies, their management boards, and accounting firms.

SOX is a set of highly controversial regulations imposed by the government to help ensure that the accounting scandals and subsequent failures of Enron and Worldcom aren’t repeated.

It was passed after a series of accounting scandals at Enron, WorldCom and Tyco International diminished public trust in U.S. corporations, and is designed to increase corporate accountability. The law established the Public Company Accounting Oversight Board (PCAOB), which oversees the auditors of public companies. Sarbanes-Oxley sets forth eleven specific reporting requirements that companies and executive boards must follow, and requires the Securities and Exchange Commission (SEC) to oversee compliance.

The basic goals of the act were threefold, to increase transparency in the accounting of public companies, to ensure independence in the auditing process of public companies, and to install harsher penalties for violators.

The major changes implemented in the act include:

• The creation of the Public Company Accounting Oversight Board or PCAOB. A new government entity with whom all public companies must register. PCAOB oversees all public accounting firms to ensure accurate compliance with SOX is uniform.
• New and increased auditor restrictions on conflicts of interest as well reporting requirements
• Increased responsibility and liability for corporate leadership (CEO, CFO) for accuracy and completeness of financial statements produced by the company. The CEO must now also sign the corporate tax form.
• Requires stricter and prompter reporting of accounting changes such as off-balance sheet transactions
• Mandatory disclosure of potential conflict of interest for securities analysts covering public companies. The act also gives the SEC increased power to punish analysts and other securities professionals (such as brokers) who break the law.
• Increased the severity of specific penalties for and enumerated what constitutes a white-collar crime and corporate fraud. The act also gives the SEC greater latitude to freeze assets when corporate fraud is suspected. Whistle-blowers are also given greater protections under the act.
• Authorized research into the nature of the previous fraud occurred.

The act is named after the two congressmen who sponsored it, Paul Sarbanes (D-MD) and Michael Oxley (R-OH).

Criticism and Praise

SOX is highly controversial and its full effects are still debated.

Critics charge that SOX is far too restrictive, costing companies and consequently taxpayers billions of dollars as well reducing America’s competitiveness for attracting and creating new companies. They also claim that SOX is so restrictive that many companies now choose to go private to avoid its scrutiny and that many new up and coming companies decide against going public due to SOX’s prohibitive costs. Some critics also contend that SOX is particularly damaging to smaller and foreign companies due to the disproportionate time requirements and cost to them.

Proponents argue that SOX provides greater transparency for investors and was necessary to restore confidence in the market after the numerous accounting scandals that occurred at the turn of the century such as Enron, Worldcom, Adelphia and Tyco.

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