Sarbanes-Oxley Act of 2002

University Degree Business and Administrative studies

SARBANES-OXLEY ACT OF 2002

Accounting for Non-Financial Majors

2/16/2011

Abstract

The Sarbanes-Oxley Act introduced major changes in corporate governance and compliance. In my report I will explain the background of the Sarbanes-Oxley Act, why it was needed and who the act impacted. My report will also explain the SEC’s role in the Act and the roles companies must play. Finally I will discuss the penalties applicable to those that do not comply with the Act.

Sarbanes-Oxley Act Background Information

Around the end of 2001 and the beginning of 2002, many corporate scandals reached a level that was unprecedented. Enron and WorldCom were two of the most well known of these scandals. Considering these companies were known as some of the largest, successful companies in the United States, their downfall shocked the nation. Despite being named Fortune Magazine’s “most innovative company” for the six years prior to 2002, Enron filed chapter 11 bankruptcies in December of 2001 (Enron, 2009). Not long thereafter, WorldCom filed Chapter 11 bankruptcy in July of 2002, becoming the largest bankruptcy in United States History (Beltran, 2002).

There had been many corporate scandals prior to the Enron and WorldCom era; however none of which affected the economy with such magnitude. Tens of thousands of people found there selves unemployed and broke from the fall of Enron and WorldCom (History, 2009). Many types of governances had been put in place before the Sarbanes-Oxley Act. The National Commission of Financial Fraudulent Reporting, the Commission of Sponsoring Organizations (COSO), the American Accounting Association (AAA), the American Institute of Certified Public Accountants (AICPA), Financial Executives International (FEI), the Institute of Internal Auditors (IIA), and the National Association of Accountants were all created in an effort to encourage accurate financial reporting (History, 2009). Although all of these organizations were in place in the 1980’s, corporate scandal still prevailed; as was evident in 2001 with Enron and WorldCom.

Many companies file bankruptcy due to bad investments, mismanagement and many other ill organized functions. What made Enron and WorldCom so significant was that their financial statements showed no warning signs prior to the bankruptcy. Later evidence found that both organizations had manipulated their financial statements misleading stockholders and potential investors (Beltran, 2002). It was evident to our government and the World; more regulations were needed in order to protect shareholders, which is what led to the Sarbanes-Oxley Act of 2002.

This is a preview of the whole essay

The Sarbanes-Oxley Act of 2002, also known as SOX and sometimes referred to as the Public Company Accounting Reform and Investor Protection Act of 2002, was signed into law by President George W. Bush on July 30, 2002 (History, 2009). Creation of the Act was encouraged by President Bush based on three principals: information accuracy and accessibility, management accountability, and auditor independence (History, 2009). Sarbanes-Oxley produced the Public Company Accounting Oversight board to ensure auditing financial statements is up to private accounting firm standards (Fass, 2003). SOX will impact Chief Executives and Chief Financial Officers by holding them directly responsible for the accuracy of financial accounting (Fass, 2003). These individuals will now be able to be fined more than anyone has ever known, as well as spend a significant amount of time in jail if they are caught reporting wrongful financial statements. According to a website known as, A Guide to the Sarbanes-Oxley Act (2006), “all organizations, large and small, must comply.” Regulations of the Act will apply to all companies under the jurisdiction of U.S. Securities and Exchange Commission, also known as the SEC (A Guide, 2006). The impact will be felt by any publicly traded company, in addition to any private company that may merge or be bought by a public company. All businesses could be affected by the Sarbanes-Oxley Act.

The SEC role in the Sarbanes-Oxley Act

The U.S. Securities and Exchange Commission (SEC) has several major roles under the Sarbanes-Oxley Act. They are primarily responsible for overseeing the investigation and prosecution of financial fraud, corporate fraud and other crimes committed by corporations (A Guide, 2006). The SEC is responsible for studying the effect of rotating auditing firms, which is one of SOX regulations (Hartman, 2004). Under the Sarbanes-Oxley Act, auditing firms must be rotated (Sarbanes 2009). Therefore, an accounting firm is not able to become “partners” with the corporation in an attempt to mislead.

The SEC is also responsible for ensuring attorneys report violations of securities law or fiduciary reporting (Hartman, 2004). Therefore attorneys will be held responsible if it is proven they had knowledge of corporate fraud. Conflicts of interest are also one of the SEC responsibilities. Within SOX, a conflict of interest refers to a public accounting firm performing an audit if the chief executive officer, controller, chief financial officer, chief accounting officer, or any person serving in an equivalent position worked for the accounting firm during the 1 year period before the audit was initiated (Data file 2002). This rule is to ensure there are fewer temptations to personally profit from manipulating financial statements.

Company Roles and Responsibilities

All businesses are affected by the Sarbanes-Oxley Act of 2002. Most of the regulations are only pertaining to larger corporations or businesses with publicly traded stock. However, all business should comply due to the possibility of them becoming a publicly traded entity or being acquired by one. A company's executives are held more responsible for fraudulent reporting. The major focus of the act is to make sure that publicly traded corporations report their assets, liabilities, and equity and income accurately on financial statements (Block, 2009).

Business are held responsible for accurate reporting under Section 302; auditing, quality controls and Independence Standard and rules under section 103; and management assessment of internal controls under section 404 (Fass, 2003). Section 409, Real-time Issuer Disclosure ensures that companies report changes, that may affect stock prices, be reported within 48 hours of the incident (Fass, 2003). Since the implementation of SOX, companies have had to spend significantly more time ensuring their financial statements are accurate. All accounting statements must comply with the Generally Accepted Accounting Principles (GAAP) (Block, 2009). Beings that these rules are easily manipulated, SOX and the SEC have governed more restraints. The Act requires businesses to implement internal controls to ensure they are reporting transactions, records, and financial statements with integrity (Hartman, 2004). SOX also require CEOs and CFOs to sign off to the accuracy of all financial statements (A Guide, 2009). This holds executives personally responsible, whether willful or unwillful, if statements are inaccurate. Beings the act has so many regulations; this can be time and cost consuming for companies. Companies must also insure records are kept and not destroyed for 7 years (Guide, 2009).

Penalties

There are very stiff penalties for non-compliance with the SOX. Many companies are under the impression if there is no proof of fraudulent behavior, they will not be prosecuted. However, as a warning to those individuals, if you are caught destroying documents or intent to destroy documents, penalties are of great significance. According to NYSSCPA.org, the alteration, concealment, or destruction of any documents in intent to hinder a federal investigation can lead to 10 years imprisonment. Companies that fail to maintain audit and review work papers face fines or a prison sentence up to five years (NYSSCPA, 2009).

CEOs and CFOs are more at risk than many within the business. These executives are subject to $1 million in fines and a 10 prison term for unwillfully misleading financial statements; whereas willful misconduct could lead to $5 million in fines and a 20 year sentence in prison (NYSSCPA, 2009). Although these sentences seem harsh, they are needed to safeguard shareholders. If the penalties were not as harsh, it is likely the fortunes gained by individuals will likely lead them to commit wrongful accounting practices.

Conclusion

In conclusion, I have realized how important the Sarbanes-Oxley Act is. This act was needed to ensure ethical practices. Misleading financial statements has led to shareholders losing their entire savings, with the perpetrators only receiving a slap on the wrist or being forced to resign. Executives that earn millions of dollars should be held responsible, for those that invested everything they had will never see life the same.

The SEC’s responsibility is critical to ensure the Act’s success. Someone has to be responsible for holding company’s accountable for fraudulent practices. Business owners were likely very frustrated when the Act initially was enacted into law due to the costs associated with compliance. However, it is entirely too tempting for rich to become richer at the expense of shareholders. The act is imperative, in my opinion, to protect investors.

References

Enron Corp. Bankruptcy Information. (2009, June 10). Retrieved August 15, 2009, from http://www.ny sb.uscourts.gov/enron.html History of the Federal Reserve. (2009.). FED101.

Beltran, L. (2002, July/August 22). Nation's No. 2 long-distance company in Chapter 11 -- largest with $107 billion in assets. In WorldCom Files Largest Bankruptcy Ever. Retrieved August 15, 2009, from CNN Money Web site: http://money.cnn.com/2002/07/19/news/worldcom_bankruptcy/

History and Legislative Background of the Sarbanes-Oxley Act of 2002. (2009). Retrieved August 15,

2009, from http://media.wiley.com/product_data/excerpt/57/04719982/0471998257.pdf

Fass, A. (2003, July 22). Reforming the Boardroom. In One Year Later, The Impact of Sarbanes-Oxley.

Retrieved August 15, 2009, from Forbes Web site: http://www.forbes.com/2003/07/22/

cz_af_0722sarbanes.htmlF

A Guide To The Sarbanes-Oxley Act. (2006). Sarbanes-Oxley Act. Retrieved August 15, 2009, from

http://www.soxlaw.com/index.htm

Financial Accounting and Disclosure Information. (2009). Sarbanes-Oxley. Retrieved August 15, 2009,

from http://www.sarbanes-Oxley.com/search

Sarbanes-Oxley Act [Data file]. (2009). Retrieved August 15, 2009, from United States Government Web

site: http://www.sec.gov/about/laws/soa2002.pdf

Hartmann, J. (2004, May). The Impact of Sarbanes-Oxley. Online, 28(3), 22-29. Retrieved August 15, 2009, from Academic Search Premier database.

The Website of the New York State Society of CPAs. (2009). The Sarbanes-Oxley Act. Retrieved August

15, 2009, from http://www.nysscpa.org/oxleyact2002.htm

Sarbanes-Oxley Act of 2002

This is a preview of the whole essay

Document Details

Related Essays

Sarbanes-Oxley Paper

The future of the accounting profession and the implications the new Sarban...

Current national accounting requirements often differ with the result that...

Examine significant developments of financial market in the two periods, 19...