05 May Understanding the Sarbanes Oxley Act and Its Impact
The United States Congress enacted the Sarbanes Oxley Act in 2002 to bring major changes to financial regulation and corporate governance for businesses in the country. This act, named after Senator Paul Sarbanes and Representative Michael Oxley, was created to ensure investors were protected from corporations making use of fraudulent accounting practices. It put into place reforms to prevent this type of fraud and to improve financial disclosures. This act contains eleven sections and companies are required to comply with all sections. To ensure this legislation is enforced, a public company accounting board was also created. Every public company board, management and public accounting firm in the United States must comply with this act.
Other Names For The Sarbanes Oxley Act
- Public Company Accounting Reform and Investor Protection Act
- Corporate and Auditing Accountability and Responsibility Act
The Goals Of The Sarbanes Oxley Act
Legislation concerning corporate accounting and governance was already in place when this legislation was enacted. Congress, however, found that the existing legislation wasn’t enough to protect investors. This legislation was designed to supplement the existing legislation or amend it to ensure the security regulations were strong enough to provide this protection. The main goal of the Sarbanes Oxley Act is to reduce or eliminate corporate fraud, but there are other objectives as well.
Whistleblowers now have job protection if they report their employer for violating this law. Companies may no longer provide loans to executives, and corporate boards are now more financially independent. Furthermore, a CEO may be held accountable for any errors in an accounting audit as a result of this legislation.
Why It Was Brought Into Legislation
A number of public scandals led to the need for the Sarbanes Oxley Act. Most people were familiar with the scandals that faced Tyco International, Enron Corporation, and WorldCom, yet there were numerous others. These and other publicly traded companies provided deceptive or false financial statements which led to their stock increasing. When this deception was discovered, the companies involved, almost one thousand in total, provided accurate information, and this led to the value of the stock market declining by almost $6 trillion.
Significant Contents Of The Act
The Sarbanes Oxley Act changed the way a company’s financial statement is prepared. Public accounting firms can no longer self-regulate, and every firm must be registered if they wish to provide audit reports for any company that is publicly traded. In addition, a public accounting firm can no longer audit a publicly traded company and consult for them also. An auditor is no longer able to report to a company’s executives but must provide a report to an audit committee that is established by the Board of Directors of the firm.
This committee must include a minimum of one person who is a financial expert. Furthermore, partners of an auditing firm are no longer allowed to work with the same client for more than five years. Lastly, when a firm issues a financial statement, it must be certified by the CEO and CFO. This means these two individuals must declare they have reviewed the statement, that they believe it to be true, and that they understand they are personally responsible for any internal financial controls. Company executives are also required to repay any capital gains from stock sales and bonuses within a 12 month period if the gains are found to be the result of misconduct.
The Consequences For American Companies And How They Have Responded
American companies expressed a great deal of concern regarding the Sarbanes Oxley Act when it was first introduced. Over the years, however, the act has survived with very few changes. While investors find it easier to evaluate companies they may be interested in buying stock in, some small businesses found the regulations to be burdensome. Fortunately, the Dodd-Frank Act opted to remove the mandate that public companies must complete an independent audit of internal control practices for any company with a market cap below $75 million. Furthermore, Congress opted to modify audit standards in 2007 to make them easier to implement.
Companies that are not in compliance with the Sarbanes Oxley Act find they are heavily penalized, thus enormous amounts of money are invested to ensure they are in conformity. Some companies also question whether they must be in compliance, even when they aren’t directly covered, thus they spend money to ensure they are. They may be using these funds unwisely, yet it is hard to determine if this is the case.
As a result of these issues, some foreign companies have opted to move overseas. Others have decided to remain private so they aren’t bound by the regulations laid out in the law. Finally, some companies now choose to trade on an electronic quotation system, as companies using this system aren’t regulated by the Securities and Exchange Commission. All come with their own costs, however, thus it is hard for the majority of businesses to avoid the consequences, both intended and unintended, of the Sarbanes Oxley Act.
One thing that has been learned through the implementation of the Sarbanes Oxley Act is regulations need to be flexible. Businesses differ in a wide variety of ways, thus a one-size-fits-all approach does not work. People need to be able to determine how to truly determine the effects of any regulation, not simply the Sarbanes Oxley Act, as this helps to ensure laws and regulations in the future meet the needs of businesses and investors alike. There are a variety of ways to accomplish this, and it’s simply a matter of figuring out what works in any given situation.