by Tanya Smith

Created on: March 10, 2009

The Basics of Sarbanes Oxley Act

Background:

The Sarbanes-Oxley Act (SOX) was created in 2002 by two Congressional Representatives: Michael Oxley, a Republican and Paul Sarbanes, a Democrat. The application of federal securities laws such as SOX are central to Corporate Governance. SOX created the PCAOB (Public Company Accounting Oversight Board) to police the accounting activities of public companies after the collapse of Enron and WorldCom, which exposed corporate fraud and caused a collapse of investor confidence which damaged the stock market and the economy. The PCAOB prohibits auditors from engaging in certain activities that would create a conflict of interest, such as providing bookkeeping, appraisals, and investing. SOX has affected corporate governance via the PCAOB and the following provisions:

1) making corporate audit committees more transparent and ensuring independent auditing

2) requiring companies to have certified financial statements

3) imposing stronger penalties for corporate fraud or misleading statements, which deters such acts and increases accountability of company officers and directors

How did SOX help the economy after 2002?

SOX resulted in more reliable financial statements being produced by companies. Companies, investors and the public all benefit, but companies benefit the most. SOX increased investor confidence and the confidence of suppliers and creditors after the Enron scandal. These encouraged and increase in investing and lending activities with public companies, so ultimately, companies became more profitable again. Also, companies must strive toward higher standards by creating "best practices", which helps ensure higher standards amongst their own managers, officers, directors and CEOs. SOX also minimizes the manager's risk of personal liability that could result in civil or criminal legal proceedings. It ensures executives are independent from auditors and accountants. It also ensures that independent directors sit on the Board of Directors to help maintain impartiality and reduce conflict of interest that could lead to manipulation of financial statements that would benefit some directors personally, but potentially harm investors and the company itself.

Does SOX help everyone?

SOX does not benefit all companies, in term of the cost of implementation. The problem of affordability seems to be felt most by smaller companies, some of whom say that it doubles their costs of being a "public company", and that this results in reduced revenue and earnings for the company and its investors. Larger companies may feel the opposite, that SOX and similar regulations brought investors money back after the scandals of Enron and Worldcom damaged those relations.

Although the cost of additional disclosure may be difficult for smaller companies to bear, the benefits to the public, investors and the companies themselves outweigh these costs overall.

Can the lessons learned from SOX be applied to current economic problems?

Further improvements could be made to SOX that would help address and solve some of the more recent problems that we have encountered. The hedge fund problems we face, illustrated by the Bernie Madoff scandal, and our recent sub-prime accounting crisis, are excellent areas to develop further. The effect of this would be to restore investor confidence again by ensuring fraudulent accounting activities, non-transparency of financial records and predatory lending practices can not occur. Furthermore, it would help protect the future retirement investments of millions of people globally, if entities such as banks are well-regulated in America and across the world.

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