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Shining the Light on the Sarbanes-Oxley Act


The Earth Moves. And Congress Jumps.

Shortly after the dawn of the new millennium, the tremors of corporate giants tumbling to the ground reverberated through the United States and around the world. Fueled by sleight-of-hand accounting practices and the greed of corporate officers, companies like Enron, Adelphia, and WorldCom played what amounted to three-card monte with corporate assets.

By the time the dust had settled, tens of thousands of employees had lost their jobs, leviathan corporations and accounting firms had declared bankruptcy, and chief executives had checked into the federal penitentiary. In an attempt to quell the skittish securities markets, the U.S. Congress brought the hammer down on corporate malfeasance in publicly traded companies by passing the Sarbanes-Oxley Act of 2002 (known as the SOX Act).

Calling the provisions of the Act “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt,” President George W. Bush signed the SOX Act into law on July 30, 2002, ushering in a new era of corporate accountability standards.

One Mission. And Eleven Sections.

The SOX Act was designed to restore public confidence in the veracity of large, publicly traded corporations’ financial dealings and reporting. The objective of the Act’s 11 titles is to ensure that auditors remain independent; corporations and auditors are accountable to the public for the numbers they publish; an independent body governs financial reporting processes; sufficient measures are in place to deter fraudulent activity; financial activities are transparent enough to allow fraud detection to occur; and if fraud is detected, someone is held responsible.

The 11 titles of the SOX Act can be summarized as follows:

Title I establishes the Public Company Accounting Oversight Board. As its name implies, the oversight of auditing firms was shifted from self-regulation to PCAOB oversight. Firms that prepare or issue audit reports for publicly traded companies must register with the PCAOB and are subject to inspection. There are currently over 1,800 auditing firms registered. The PCAOB also sets auditing standards, and investigates and disciplines firms not in compliance with the SOX Act.

Title II serves to limit potential conflicts of interests for auditing firms by, for example, prohibiting auditors from also performing much more lucrative consulting services for the companies they audit. It also includes requirements for new auditors as well as requirements that auditors be rotated.

Title III focuses on corporate responsibility for a company’s financial reports, and decrees that a company’s audit committee be independent of and oversee the work of its accounting firm. It further requires that corporate officers attest to the integrity of the company’s financial reports. The section also prohibits insider trading during pension fund blackout periods

Title IV regulates many of the shady accounting practices that led to the downfall of companies like Enron, Adelphia, and WorldCom, such as off-balance sheet transactions, pro forma figures, and personal loans to executives. Section 404 of Title IV is often cited as the most significant aspect of The SOX Act, and as the most costly provision to implement. Section 404 mandates that auditors submit an annual management report that gauges the efficacy of a company’s internal controls, as well as a second report from management and auditors that assesses internal controls over financial reporting.

Title V outlines the disclosure requirements for securities analysts, who may have conflicts of interest that preclude them from objectively making recommendations to their clients and to the public.

Title VI funds the Securities and Exchange Commission, and gives the SEC the authority to censure stock brokers and advisors or prevent them from engaging in their professions. It also authorizes the courts to restrict the ability of brokers to offer penny stocks.

Title VII orders the Government Accountability Office to study the consolidation of public accounting firms and the impact these mergers have on the ability of firms to conduct impartial audits, as well as to provide solutions to problems that may emerge in its findings. It also provides for the study of credit rating agencies and investment banks, as well as for the study of securities professionals (including accountants and investment bankers) who have violated Federal securities laws.

Title VIII addresses criminal penalties for specific acts of corporate fraud – including destruction, alteration, or falsification of corporate records, and defrauding shareholders – and reviews the Federal sentencing guidelines for obstruction of justice and extensive criminal fraud. It also includes whistleblower protections for employees of publicly traded companies.

Title IX includes enhanced sentencing guidelines for those that engage in corporate malfeasance and mandates that failure to certify corporate financial reports is a crime.

Title X dictates that the CEO of a company must sign the company’s Federal tax return.

Title XI empowers the SEC to petition a Federal court to freeze payments about to be made to corporate officers, directors, or employees who may be engaging in fraud. It also requests that the U.S. Sentencing Commission review sentencing guidelines for corporate fraud and toughen penalties.

Widespread Resonance. And Global Echoes.

The SOX Act’s compliance requirements are restricted to large, publicly traded corporations, but its benchmarks have created a gold standard that many smaller companies, nonprofit organizations, and privately held businesses strive to achieve. The Act’s unprecedented level of accountability and transparency for corporate governance, company management, and public accounting firms engender a high degree of stakeholder confidence that incentivizes compliance.

The influence of the SOX Act has travelled far beyond the borders of the United States, with other nations passing similar legislation. Among the countries and regions that have enacted stringent corporate accountability laws are Canada (Bill 198 or C-SOX), Europe (the 8th Directive or E-SOX), India (Clause 49 or I-SOX), and Singapore (Negative Assurance or S-SOX).