The Act was passed into law on July 30, 2002 by the former US president George Bush to protect investors and general public from fraudulent corporate financial practices. It spurred from the latest financial scandals of the 2000s – Enron Corporation, Tycon International and WorldCom where investors lost lots of money due to their high reliance on falsified audited financial statements.
The act now created stricter financial laws enforced by the Security and Exchange Commission (SEC) to provide investors some level of confidence while placing high responsibility on the directors, accountants & auditors for compliance, adding criminal penalties to charges if violated. This is expected to strengthen reliability of corporate financial practices.
The name Sarbanes Oxley Act was coined from the names of the US senator and representative who sponsored the bill- Paul Sarbanes and Michael Oxley.
The act consists of eleven elements covering board’s responsibilities and criminal penalties for defaults, auditor’s independence, corporate responsibility, internal control assessments, conflicts of interest and enhanced financial disclosures to regulate practices of publicly traded companies. There are three major sections I will be touching on.
Section 302- Full Disclosure
The section requires the principal officers of a traded company- CEO and CFO to certify that the company’s financial statement comply with all SEC disclosures and requirements by signing off that they reviewed the report, and it contains no material misstatement but fairly presents the company’s financial position, results of operation and cash flows. And if found to be inaccurate, they will be liable to criminal penalties including jail terms.
Section 404- Assessment of Internal Control
It is management’s responsibility to maintain its own sound internal control system for a reliable financial reporting, to assess its effectiveness and the auditor’s responsibility to attest to the soundness of management’s judgement of a sufficient financial control system. They are expected to publish an Internal Control Report documenting the adequacy of the internal control system and procedures for financial reporting.
The law had also placed some restrictions on auditing practices. It requires public corporations to rotate their auditing partners every 5 years and prohibits auditors from engaging in non-audit and consulting services for audit clients to avoid familiarities and conflicts of interest.
The major criticism of this section is the high compliance costs from smaller companies.
Section 802 – Criminal Penalties
The act places strict criminal penalties including 20 years imprisonment for any company’s official found guilty of concealing or destroying documents with an intent to disrupt a legal investigation. Up to 10 years imprisonment and fines for accountants or auditors who knowingly and willfully aids the company to falsify its financial statements.
An accountant must retain all audit workpapers for a minimum of 5 years from the end of the fiscal period in which the audit was concluded.
The Sarbanes oxley act helped investors regained confidence on the reliance of financial statements since its reforms. The strict rules and penalties also help to nurture an ethical culture of transparency and accountability amidst top executives, deterring overstatement of key figures on financial statements.
With its introduction, control environment is strengthened, more reliable documentations, increased audit committee involvement, and more standardized processes are fostered.
Till next time!