Sarbanes Oxley Act of 2002
Terri Largent
BUS591: Financial Accounting & Analysis
Dr. Donald Majors
August 24, 2015

Fraud is something that the United States and the New York Stock Exchange is all too familiar with, and with the upheaval of many big companies such as Enron, Tyco, Worldcom, Xerox, and Sunbeam, the country’s economic stability took a turn for the worst. However, the year of 2002 brought about many changes for the economic world, most notably to publicly traded companies. The Sarbanes-Oxley Act of 2002 was the beginning of a new, transparent view of the stock exchange and of corporations that publicly sold and traded stock. While we are not out of the woods yet, the world is seeing the benefits of SOX and the PCAOB (Public Company Accounting Oversight Board). There are, however, skeptics and those that do not feel that the price being paid by these companies is worth the amount of stabilization that it has brought to the corporate table. This paper will examine the key components of the Sarbanes-Oxley Act of 2002, its primary objective, the economic consequences for companies as a result of the implementation of the Act, and will also show how SOX has achieved its goals thus far. Before we can fully appreciate the idea behind the Sarbanes-Oxley Act of 2002, we must first take a look at the country’s economic fragility before this law was created. While stock markets were seemingly doing very well in the eyes of the investors, behind the scenes the corporate world of many huge corporations was crumbling. Scandals rocked the world when billions of dollars were found to be fraudulently recorded by scheming auditors and business executives alike. Once these scandals were revealed stocks plummeted and the American people lost all trust in the stock market. Because of the fall of the stock market, the United States and many other trading countries around the globe, felt the hard recession that proceeded. Investigations were underway and the world was finally able to see what was really happening, thanks to the SEC (U.S. Securities and Exchange Commission). However, much of the damage had already been done and the investing world was rethinking their futures. Many investors participated in the exchanges by way of financing through their retirement funds or their pensions. Because this money was being drained, the United States government decided to step in. One can understand how the government would be concerned with having generations of people unable to retire and being forced to rely on the government to live during their golden years. Many people have come to understand the SOX as the first regulatory governance of its kind. However, there have been many legislative enactments and laws in place for many years before SOX was created. Lekatis explains that there were many laws already in place to prevent corporations from dealing in deceit and misrepresenting their financial status to investors. Some of them include the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939, the Investment Company Act of 1940, and the Investment Advisers Act of 1940. The Securities Act of 1933 set rules and regulations requiring that companies give investors financial information regarding the securities that are being presented for sale to the public. People trusted this Act because misrepresentation and other fraudulent practices were prohibited and companies were required to register certain information for public viewing. However, these statements are not guaranteed by the SEC to be truthful and current. Because the SEC did not have the power to supervise in the way needed, the Securities Exchange Act of 1934 was created. This gave the SEC the power to oversee the self-regulatory organizations (SROs) such as the New York Stock Exchange and the NASDAQ Stock Market. With this Act the SEC was also able to inforce laws against such atrocities as insider trading. The Trust Indenture Act of 1939 was created to apply laws to bonds and notes that may not always be available for public sale. The Investment Company Act of 1940 required companies to make available to the investors certain financial information about the company and company structure and operations. The Investment Advisers Act of 1940 required all advisers of investments to register with the SEC. This was to keep tabs on the training and practices of investment advisors and ensure that they were offering sound advice with the investors’ best intentions in the forefront. With all of these Acts enlisted, one would think that the general feeling of investing would be pretty secure. This may be one reason that many people invested in the Stock Market without worry about failing companies or fraudulent financial statements. While these laws were in force, unfortunately they were not being enforced. These rules of investing were not being followed and therefore companies such as Enron and Tyco were able to lie and cheat their investors out of their money and get away with is for such a long stretch of time. Because these laws were not being dutifully enforced, the world was seeing the demise of the U.S. Stock Market.
With the world in an uproar over the lack of enforced laws and the loss of their investments, Sarbanes-Oxley created new, and expanded on old, requirements for all public company boards within the United States. Requirements were also set for public accounting firms. Only by closely monitoring the finances of publicly traded companies could the country be sure of, or even begin to feel secure in future investing endeavors. The Sarbanes-Oxley Act of 2002 consists of eleven sections that define the different responsibilities enlisted to a company’s board of directors and set requirements for the SEC (Securities and Exchange Commission) to create laws and regulations on how those companies must obey the law (Hanna, 2014). Title I of the SOX establishes a nonprofit organization known as the PCAOB (Public Company Accounting Oversight Board). This board oversees the actual auditors and auditing firms that conduct audits on publicly traded companies. This board is responsible for ensuring all auditors follow strict guidelines do not have any direct ties with any of the companies they are auditing. It is against the law for an auditing firm, or auditor, to hold stock in any of the companies being subjected to their outside auditing procedures. This helps to alleviate any worry of the auditor conducting business in a less than ethical way in hopes of buffering the financial reports and making a profit from such acts. The board is also responsible for maintaining a general standard of ethics for accounting firms and enforces discipline for violations of the Act. Title II requires that auditors be rotated at times to keep the auditing process honest (Hespenheide, 2006). Title III and IV are the meat of the Act; they are primarily concerned with the responsibility of the corporations and their financial disclosures. Responsibilities of the company for financial reports are listed and the titles also define what reports are required annually and quarterly. All certifications of personnel are required to be filed timely according to these sections of the Act. If an employee is performing a job that they are not certified and educated to handle, the company can face penalties and/or fines.
The most referenced portion of the Act is listed as Section 404, within Title IV. This section requires that all companies that are publicly traded form specific responsibilities for members of management and maintain a stringent internal control system. This information must be publicly published and readily available for investors to review (Editors, 2003). The upper management is responsible for reviewing and signing off on all financial reports before they are submitted to the SEC and can face monetary penalties and even imprisonment for falsifying or hiding information from the public and the SEC. Managers are also responsible for assessing their company’s internal auditing structure and composing a report of such information on a regularly scheduled basis. This information must also be made public.
Section 404 also required that an external auditing firm be hired by all companies to review the internal auditing practices of the company. These external auditors are monitored by PCAOB and are responsible for comparing their reports with the management’s reports on the internal auditing processes of the company. They are required to give a statement attesting to the accuracy, or inaccuracy, of the managerial findings. These findings are compared to the COSO (Committee Of Sponsoring Organizations of the Treadway Commission) Integrated Framework (Hanna, 2014).
According to Internal Control – Integrated Framework (1994), there are five main principals that must be used and evaluated when conducting a review of an internal audit system. These include control environment, risk assessment, control activities, information and communication, and monitoring activities. Control environment consists of the organization, including the board of directors, management, and individuals’ commitment to ethical behavior and accountability. Risk assessment refers to the organization as a whole and if they consider the potential risks and how they should be handled. Control activities is rated by the companies risk mitigating policies via technology and established policies. Information and communication relates to the communication between the company and those that are in charge of the audit, both internal and external. It also rates how well the objectives and functionality of those objectives work to keep everyone on the same page. Finally, monitoring activities consists of the organizations constant evaluating of their internal audit control system and how well it is working, and that the flow of command is properly working to eradicate any issues within a timely manner.
Along with the previously discussed titles within SOX, there are rules that have been set in place for auditors of publicly traded companies. These include that an auditor cannot audit their own work, cannot serve in a role of support for their own customer, and cannot serve as a member of management (Kimmel, Weygandt, Kieso, 2013). This would be a huge conflict of interest because upper management must sign off of all financial statements. It is also implied that an auditing council should not report directly to management, rather they should have a stature of management themselves and the members of management and auditing should work in a sort of checks and balances system in order to prevent pressure from either side to make fraudulent adjustments to financial records and/or statements (Miller, 2011). The auditing committee must also be able and willing to adapt to the changing climate of the company. By constantly reevaluating the committee’s effectiveness and by using a risk-based approach to all operations, the auditor and auditing committee can prove extremely beneficial to the long term success of the company. These audits create an accountability that was not previously clear in the years before the Sarbanes-Oxley Act of 2002.
Failure to comply with SOX can lead to some hefty consequences for both companies and those that run the companies. According to Cascini, DelFavero, & Mililli (2012), Section 302 of SOX sets the tone for executives that are conspiring fraudulent activities within their corporations. Because CEOs and CFOs must sign off on all of the company’s financial statements, they are responsible for verifying the accuracy of the information. Purposely misinforming or concealing information can lead to fines and also time in prison. Also, companies have to keep in contact with both their external auditing personnel and their internal team. If any deficiencies are found they must immediately be reported to both accounting firms. This information must also be made available to the investing public.
The primary objective of the SOX Act is simple; to bring the operations and financial assets and risks of publicly traded companies into transparency for both the investor and the stock trading world to see (Hespenheide, 2006). The purpose of improving the accuracy and reliability of Corporate America will only build our nation’s economy and ensure that all investors have an equal opportunity to gain capital without the fear of being left destitute due to fraudulent activities. While SOX is still a work in progress, many steps have been taken to bring the darkness to light, and our economy back to one of success and drive. The SOX Act has proven it can bring about change and achieve the goals initially set out by the authors. This can be seen when we review the amount of lawsuits that were presented before SOX and those that have been forthcoming after the initiation of SOX. According to Coates (2007), in 1998 the count of alleged fraud in significant securities class actions against U.S. public companies was 41. It raised to 42 in 1999 and stayed continuously at 42 in 2000. In 2002 after SOX was enacted, the number of class actions against U.S. public companies dropped to 16. That is an astounding drop in the number of lawsuits. As of 2004, the number dropped even further down to 1. This in itself is proof that the SOX Act had put the wheels in motion for reform. In the same article, Coates (2007), stated that reports of investing practices have risen since the enactment of SOX, and more people are investing means the trust is returning to those that may have otherwise refuted investing practices.
Fraud is nothing new to the United States and the New York Stock Exchange. We are all too familiar with the upheaval of many big companies such as Enron, Tyco, Worldcom, Xerox, and Sunbeam and have seen the country’s economic stability took a turn for the worst. However, the year of 2002 brought about many positive changes for our economic wellbeing, most notably to the publicly traded company exchanges. The Sarbanes-Oxley Act of 2002 was the beginning of a new, more transparent view of the stock exchange and of corporations that publicly sold and traded stock. While we are definitely not out of the woods yet, we are all beginning to see the benefits of SOX and the PCAOB (Public Company Accounting Oversight Board). While there are, however, skeptics and those that do not feel that the price being paid by these companies is worth the amount of stabilization that it has brought to the corporate table, it is easy to see after reviewing the key components of the Sarbanes-Oxley Act of 2002, its primary objectives, and the economic consequences for companies as a result of the implementation of the Act, that the costs of hiring outside firms to conduct audits far outweighs the cost of insecure and untrusting investors. Sox has achieved many goals thus far and it is in the foreseeable future that investing in the open trade companies on the stock market will only increase with the implementation of the stricter rules and regulations offered by the Sarbanes-Oxley Act of 2002.

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