The Sarbanes-Oxley Act


As the investors worldwide were recuperating from busted tech-bubble of 2000, a series of corporate misgovernance, fraudulent accounting practices and auditing abnormalities surfaced from corporations like Enron and WorldCom. In response of these corporate financial scandals, US Congress passed a legislation known as "The Sarbanes-Oxley Act" or "SOX" (by July 30, 2002) which brought in new set of regulations and responsibilities for all boards of US public companies, their executive management members and associated public auditing & accounting firms, ordering Securities and Exchange Commission (SEC) to administer the entire compliance process.

Elements of The SOX Act

Various players of the SOX Act

SOX Act tried to address disturbing trends in US Public Corporations in relation to inadequate oversight of accountants, lack of auditor independence, weak corporate governance procedures, stock analysts' conflict of interests, inadequate disclosure provisions, and grossly inadequate funding of the Securities and Exchange Commission.

  1. Inadequate oversight of accountants: To minimize accounting irregularities, a Public Company Accounting Oversight Board (Sarbanes 2002) has been established and charged with authority to keep vigilance over public accounting firms providing auditing services to various public corporations. Strict guidelines has been provided for registering auditors, improving accounting standards (GAAP and especially non-GAAP), defining various compliance processes, policing and inspection for conduct and quality control.

  2. Lack of auditor independence: Prior to SOX enforcement, various auditors of public corporations became engaged in providing "other" or "non-auditing" consulting services to their respective clients creating classic contexts of "conflict of interest". In order to maintain these lucrative consulting opportunities, auditors who otherwise should have behaved like corporate financial watchdogs, failed to challenge several accounting anomalies, often in collusion with some senior management exectutives. SOX enforced auditor independence as one of its core directive to prevent future occurance of such incidents.

  3. Weak corporate governance: SOX mandated that chief executive members of public corporations (usually CEO or CFO) must take individual responsibility for integrity of the quarterly and annual financial reports. Forced relinquishment of benefits and civil penalties exist in case of non-compliance.

  4. Security analysts' conflict of interests: Other than publicly available financial statements of corporations, retail investors and high networth individuals (HNI) often depend on insightful analysis of various security analysts before making any investments on those companies. A stock analyst fraudulently inflating the investment hypothesis of a given public company in exchange of commission from management is again a classic example of "conflict of interest". SOX Act defined strict code of conduct for all security analysts.

  5. inadequate disclosure provisions: SOX Act amended existing regulations regarding financial disclosure requirements with reporting of "off-balance-sheet" transactions, stock transactions of corporate officers especially senior executives and more. Public shareholders of respective corporations really appreciated these additional disclosure requirements in relation to their investments.

  6. Inadequate funding of the Securities and Exchange Commission: To enforce all regulations concerning various parties of the largest financial market of the world, SEC lacked necesary funding in the pre-SOX era. SOX ensured that SEC has adequate budgetary approvals for these additional regulations and their administrations

Apart from these, SOX Act also described specific punishments for tampering various corporate and financial records of a company under the section of "Corporate and Criminal Fraud Accountability Act of 2002" and enhanced severity of these punishments under the section of "White Collar Crime Penalty Enhancement Act of 2002". The act also motivated employees of a public company to be responsible in their acts by providing whistleblower protection.