Project’s Main Objective
This project report is designed to provide an insight into Sarbanes-Oxley Act of 2002. The core purpose of the Act is to develop better means of safeguarding the interests of both local and foreign investors from malicious business practices that result in misappropriation of investor funds. The Act capitalizes on transparency and accountability of corporate financial accounts whilst diminishing fraudulent business practices in organizations. The project emphasizes the role of business executives, directors, and other top managers in ensuring that accountants and auditors evaluate and report financial accounts through honest means to foster liability and appropriation of corporation resources.
General Plan of the Project
At the outset, the project provides a contextual history of the Act in line with the aforementioned objective. Next, the project outlines the strategy of executing the Act. Thirdly, it examines the implications of implementing the Act on the functionality of businesses, institutions, and the society as a whole. Fourthly, the project provides an in-depth exploration of the workability of the legislation in relation to its accomplishments, strengths, and weaknesses in accordance with the main objective of the Act. Finally, the project aims at recommending possible resolutions that may affect the implementation of any impending protective legislation to corporations.
History of the Act
Why the Law was Necessary
The necessity of a protective legislation emerged due to the increasingly rampant cases of business insecurity in the United States. Prior to the execution of the law, businesses in the United States faced boundless accounting errors and anomalies that resulted in significant decline of revenue and loss of investment capital. The overall state of events had cost the US billions of dollars that disappeared into the pockets of fraudsters and money laundering.
The lessening value of corporate accounting due to fraudulent activities could only result in mistrust and disruption of investor confidence. Independent oversight bodies were also unable to conduct proper monitoring and analysis of corporation audits since the existing accountancy system lacked the necessary regulatory frameworks that could guarantee standard examination of corporate financial accounts. Many firms used operating lease bookkeeping techniques that failed to account for rent expenses, amortization, and incentives. The occurrence of the Enron, Tyco, and WorldCom frauds compelled the government to execute Sarbanes-Oxley Act to protect investors from accounting inaccuracies and falsified practices. The Act affects all publicly traded corporations, including wholly owned affiliates and foreign investments in the United States.
Public Policy Description
The Sarbanes-Oxley Act of 2002 demands the executive officers and directors of organizations to avail correct certifications of financial reports. The Act has provisions for severe penalties if organizations present inconsistent accounting records that imply the involvement of fraudulent practices in the financial processes (Gupta, Weirich, & Turner, 2013, p. 374). For instance, the submission of inaccurate certification attracts a fine of one-million dollars or ten years of imprisonment. Besides imprisonment, the Act specifies that businesses that fail to honor the requirements of the Act maybe subjected to certain lawsuits and undesirable publicity.
The Sarbanes-Oxley Act comprises 11 sections that contain numerous subsections to define the compliance requirements. However, Wiesen (2003) reveals that subsections 302, 404, 401, 409, 802, and 906 contain the most important information in relation to ethical accounting practices within organizations in the United States (p. 430). Nevertheless, section 404 is deemed the most significant law in the entire Act because it provides auditing regulations that pertain to corporate accountancy committees and internal audit sections of organizations.
Generally, the overall Act addresses issues that concern ethical accounting practices in organization in an attempt to diminish fraudulent audit mannerisms and/or win back investor self-assurance in the US businesses. The Act stresses that accounting firms should maintain effective management of processing, distribution, and accessibility of crucial financial information whilst establishing processes that guarantee effective communication, identification of information inadequacies, transparency, and accountability of financial records in corporations.
Market Failure or Government Failure
Since the enactment of Sarbanes-Oxley Act, controversial discussions about the forces that compelled the US congress to pass the law have continued to crop up in governmental meetings. Nevertheless, Hostak, Lys, Yang, and Carr (2013) elucidate that the implementation of the Act was a legislative response to the progressively high corporate fraudulent cases that had resulted in pilfering of billions of dollars that belonged to the US investors (p. 525).
Falsification practices that resulted in scandals such as Tyco, Enron, and WorldCom were major drives for legislative reforms in the US. Gaynor, McDaniel, and Neal (2006) unveil that Enron became insolvent in October 2001 following the preceding deceitful practices that culminated into misappropriation of funds in the American energy organization (p. 375). The energy organization had falsified financial information to please foreign investors. In the following year, Tyco lost more than 165 million dollars, a situation that recorded the scandal among the prime international corporate financial crimes.
The company’s Chief Executive Officer and the Chief Financial Officer colluded with the concerned financial bodies to obtain huge sums of unsecured loans as reserves for their business establishments in various parts of the United States. Apparently, these frauds occurred without the awareness of investors who were, at the time, investing hugely in the organizations (Lin, Kang, & Roline, 2009, p. 8). In a similar case, WorldCom executives conspired with their auditors to pilfer investor capital by falsifying the expenditures of the giant US media firm as reserve funds for prospect projects.
The increasingly high number of fraudulent cases drew the interest of legislators in the United Stated since they had raised questions of clarity and consistency of financial information of the companies as investors began to worry about their lost capital. As a result, the US congress agreed to enact the Sarbanes-Oxley Act in an attempt to alleviate inadequacies in corporate financial accounting in the US. Prior to the enactment of the Act, the congress had raised concern about the deterioration of accounting ethics in organizations across the United States. In due course, the alleviation of this corporate financial menace required the formulation of sound legislations to prevent the prevalence of fraudulent practices in corporations to win the assurance of investors (Gaynor et al., 2006, p. 877).
Furthermore, failure of the board of directors to play the crucial role of monitoring and evaluating the corporate financial systems also led to a need for legislative guidelines. The workforce deployed in the oversight bodies possessed inadequate knowledge and information about the nature of corporations. Therefore, the level of competency in corporate financial accounting played a pivotal role in the formulation and enactment of the Act. In addition, poor management practices contributed to lack of proper cohesion between employees and the top management of the corporations. As a result, disagreeing parties developed varying intentions of conducting internal audits and other financial management duties for their self-interest.
Implementation of the Policy
The process of implementing the Act follows the directives of court administrators, lawyers, and judges. At the time of enactment of the Sarbanes-Oxley Act of 2002, the United States legislation, under the Bush administration, provided the execution guidelines to ensure that leaders of corporations had the proper information about the conduct of corporate financial accounting in their firms. As aforementioned, the major challenges with the maintenance of proper corporate financial records were closely associated with the failure of corporation executives and directors (Public Law, 2002, par. 4).
Actually, corporation executives and directors bear the responsibilities of ensuring that their firms embrace proper financial accounting ethics that also comply with the United States accounting standards as advanced by the Financial Accounting Standards Board (FASB). Nonetheless, before the enactment of the Act, Orin (2008) posits that these organizational leaders served as major agents for fraud in their own organizations (p.144). In other cases, they lacked competency in handling corporate finance duties that led to intrusion of unacceptable business practices in the affected companies.
The Act clearly specifies that the corporation executives and directors should ensure proper evaluation of the corporation’s business model whilst drawing appropriate decisions that lead the organization to effective internal audit. Particularly, corporate financial accounts should have the knowledge about the information contained in subsection 404 of the Sarbanes-Oxley Act. The information can guide them conduct precise internal audit of the corporation whilst ensuring zero-tolerance to intentional or unintentional financial errors. The accomplishment of the enactment process also demanded the devotion of the efforts of the top management to shape the behavior of auditors by conducting the implementation process with the professionalism that the Act deserved.
Nonetheless, Townsend (2014) reveals that the requirement did not aim at compromising the functions of auditors as experts in corporate accountancy (p. 893). Furthermore, the value of external auditors enhanced the enactment process by offering advice and/or conducting proper evaluations prior to implementation. Business executives and directors have a core function of ensuring that the corporation’s workforce abides by the set corporate ethics as stipulated in the Sarbanes-Oxley Act.
Impact on Business and Society
The Sarbanes-Oxley Act has had numerous implications on both the business and the society. The Act demands that business should provide accurate details pertaining to the corporation’s code of ethics and the degree of adherence to these ethics by corporation executives, financial officers, and accounting officers. The requirement is mandatory for every corporation. Failure to disclose such information can tempt courts of law to demand explanations that perhaps attract some determined penalties. The Act requires corporate organizations to perform annual external audits (Valenti, 2008, p. 405). Apparently, the Act necessitates the need for additional audits per year for the purposes of achieving increased accountability and transparency within corporations. Section 404 of the Act has diversified the need to have more audits, a situation that has demanded augmented organizational strength to meet legal demands.
Furthermore, the conduction of annual audit exercises by external auditors increases the overall operational cost of a corporation since auditing demands the hiring of expertise personnel. Still, the necessities of conducting internal auditing have also amplified the operational costs. Hostak et al. (2013) affirm that the legislation has led to a technological revolution in corporate businesses and organizations as they install internal auditing software to enhance transparency and accountability of financial records (p. 522).
Moreover, the Act has presented corporations with provisions for establishing detailed strategies to enable business executives and directors monitor and/or evaluate the internal performance of the organization. Besides the abovementioned implications to business, the Act has elevated the benefits for communities as companies practice codes of ethics as per the law. The legislation has improved the value of communities as the end consumer of their products and services through practicing socially acceptable organizational processes. The establishment of stringent audit policies has enabled organizations to enrich their performance in line with the set business goals and objectives. According to the US Securities and Exchange Commission (2013) report, a good number of corporations have complied with the provisions of the Act as a first step towards protecting their businesses from fraudulent practices by malicious executives, directors, and even employees (par. 3).
Did it Work?
The Sarbanes-Oxley Act has worked for many corporations in the United States as organizations appreciate the increasing shareholder confidence in a variety of business sectors. Lin et al. (2009) advance that the implementation of the Act accounts for the increased transparency and accountability of financial data in many corporations in the United States (p. 8). Today, there is enhanced consistency of audits due to the established financial monitoring, evaluation, and reporting standards. Despite this fact, the Act has incredibly raised the operational costs of companies as audit procedures have to be repeated periodically to assess the financial timelines of corporations.
Since the enactment of the Act in 2002, the use of the policy in organizations has won the confidence of many investors. This situation has increased investment opportunities for both locals and foreigners. Hence, it has uplifted the rate of economic development across the US. The Act allows workers to obtain relevant information on important business practices that pool resources together whilst adhering to health work ethics for the common good of an organization. The application of the Act has capitalized on accountability and transparency of financial records whilst reducing fraudulent practices in corporations.
In addition, the Sarbanes-Oxley Act serves as a crucial tool for fostering social corporate ethics and social corporate responsibility (SCR) in organizations. The growth of businesses where executives, directors, and the workforce adhere to work ethics attracts the interests of investors, thereby creating further opportunities for economic growth. Fraudulent practices scare investors as they dread losing their funds in dubious corporations.
In spite of the strengths of the Sarbanes-Oxley Act of 2002, the application of the laws has had some negative implications on some businesses. For instance, organizations have experienced increased operational costs, as financial accounting demands increasingly expensive auditing processes. Largely, the adoption of the auditing techniques as stipulated in the Act has met corporations with increased costs of design and strategy of auditing processes as they strive to comply with the Act and the FASB accounting standards. Wiesen (2003) affirms that the adoption of the new strategies has also required companies to either hire or employ extra professional workforce in an attempt to meet the labor demands that are associated with the elaborate auditing procedures (p. 430).
These implications have become worse for smaller-sized corporations that have a narrow capacity to implement a wide of range auditing procedures. Owing to their smaller number of employees and limited operational funds, additional workforce to complement the demands of the Act forces the companies to restrain the existing employees with additional tasks, which degrade the value of audited information (Wiesen, 2003, p. 432).
Recommendations for Future Policymakers
The purpose of deploying policies in organizations is to assure the society fair business operations that do not provide opportunities for misappropriation of stakeholder resources. Indeed, the intention of corporate financial policies on organizations is to integrate the needs of the various stakeholders in effect of their demands and rights in the organization. Nonetheless, Sarbanes-Oxley Act of 2002 did not encompass the opinions of all stakeholders. For instance, the policymakers had the authorization to structure the document even without prior consultations with executives, directors, and managers of small enterprises to seek their capabilities to handle the provisions of the Act. Consequently, the result was a costly corporate financial legislation that failed to provide alternatives for varying sizes and natures of organizations. This oversight of stakeholder opinion has led the demand for a similar legislation to incorporate the contributions of all stakeholders.
Gaynor, L., McDaniel, L., & Neal, T. (2006). The effects of joint provision and disclosure of non-audit services on audit committee members’ decisions and investors’ preferences. The Accounting Review, 81(2), 873-896. Web.
Gupta, P., Weirich, R., & Turner, E. (2013). Sarbanes-Oxley and Public Reporting on Internal Control: Hasty Reaction or Delayed Action? Accounting Horizons, 27(2), 371-408. Web.
Hostak, P., Lys, T., Yang, Y., & Carr, E. (2013). An Examination of the Impact of the Sarbanes-Oxley Act on the Attractiveness of U.S. Capital Markets for Foreign Firms. Review of Accounting Studies, 18(2), 522-559. Web.
Lin, W., Kang, G., & Roline, A. (2009). The Effects of the Blue Ribbon Committee and the Sarbanes Oxley Act of 2002 on the characteristics of the Audit Committees and the Board of Directors. Advances in Accounting, Finance & Economics, 2(1), 1-11. Web.
Orin, M. (2008). Ethical Guidance and Constraint Under the Sarbanes-Oxley Act of 2002. Journal of Accounting, Auditing & Finance, 23(1), 141-171. Web.
Public Law. (2002). Public Law 107-204: 107th Congress. Web.
Townsend, K. (2014). The Jumpstart Our Business Startups Act takes the bite out of Sarbanes-Oxley: adding corporate governance to the discussion. Iowa Law Review, 99(2), 893. Web.
US Securities and Exchange Commission. (2013). The Laws that Govern the Securities Industry. Web.
Wiesen, J. (2003). Congress Enacts Sarbanes-Oxley Act of 2002: A Two-Ton Gorilla Awakes and Speaks. Journal of Accounting, Auditing & Finance, 18(3), 429-448. Web.
Valenti, A. (2008). The Sarbanes-Oxley Act of 2002: Has It Brought About Changes in the Boards of Large U. S. Corporations? Journal of Business Ethics, 81(2), 401-412. Web.
107th Congress, An Act
Title I—Public Company Accounting Oversight Board
- Sec. 101. Establishment; administrative provisions.
- Sec. 102. Registration with the Board.
- Sec. 103. Auditing, quality control, and independence standards and rules.
- Sec. 104. Inspections of registered public accounting firms.
- Sec. 105. Investigations and disciplinary proceedings.
- Sec. 106. Foreign public accounting firms.
- Sec. 107. Commission oversight of the Board.
- Sec. 108. Accounting standards.
- Sec. 109. Funding.
Title II—Auditor Independence
- Sec. 201. Services outside the scope of practice of auditors.
- Sec. 202. Preapproval requirements.
- Sec. 203. Audit partner rotation.
- Sec. 204. Auditor reports to audit committees.
- Sec. 205. Conforming amendments.
- Sec. 206. Conflicts of interest.
- Sec. 207. Study of mandatory rotation of registered public accounting firms.
- Sec. 208. Commission authority.
- Sec. 209. Considerations by appropriate State regulatory authorities.
Title III—Corporate Responsibility
- Sec. 301. Public company audit committees.
- Sec. 302. Corporate responsibility for financial reports.
- Sec. 303. Improper influence on conduct of audits.
- Sec. 304. Forfeiture of certain bonuses and profits.
- Sec. 305. Officer and director bars and penalties.
- Sec. 306. Insider trades during pension fund blackout periods.
- Sec. 307. Rules of professional responsibility for attorneys.
- Sec. 308. Fair funds for investors.
Title IV—Enhanced Financial Disclosures
- Sec. 401. Disclosures in periodic reports.
- Sec. 402. Enhanced conflict of interest provisions.
- Sec. 403. Disclosures of transactions involving management and principal stockholders.
- Sec. 404. Management assessment of internal controls.
- Sec. 405. Exemption.
- Sec. 406. Code of ethics for senior financial officers.
- Sec. 407. Disclosure of audit committee financial expert.
- Sec. 408. Enhanced review of periodic disclosures by issuers.
- Sec. 409. Real time issuer disclosures.
Title V—Analyst Conflicts of Interest
- Sec. 501. Treatment of securities analysts by registered securities associations and national securities exchanges.
Title VI—Commission Resources and Authority
- Sec. 601. Authorization of appropriations.
- Sec. 602. Appearance and practice before the Commission.
- Sec. 603. Federal court authority to impose penny stock bars.
- Sec. 604. Qualifications of associated persons of brokers and dealers.
Title VII—Studies and Reports
- Sec. 701. GAO study and report regarding consolidation of public accounting firms.
- Sec. 702. Commission study and report regarding credit rating agencies.
- Sec. 703. Study and report on violators and violations.
- Sec. 704. Study of enforcement actions.
- Sec. 705. Study of investment banks.
Title VIII—Corporate and Criminal Fraud Accountability
- Sec. 801. Short title.
- Sec. 802. Criminal penalties for altering documents.
- Sec. 803. Debts nondischargeable if incurred in violation of securities fraud laws.
- Sec. 804. Statute of limitations for securities fraud.
- Sec. 805. Review of Federal Sentencing Guidelines for obstruction of justice and extensive criminal fraud.
- Sec. 806. Protection for employees of publicly traded companies who provide evidence of fraud.
- Sec. 807. Criminal penalties for defrauding shareholders of publicly traded companies.
Title IX—White-Collar Crime Penalty Enhancements
- Sec. 901. Short title.
- Sec. 902. Attempts and conspiracies to commit criminal fraud offenses.
- Sec. 903. Criminal penalties for mail and wire fraud.
- Sec. 904. Criminal penalties for violations of the Employee Retirement Income Security Act of 1974.
- Sec. 905. Amendment to sentencing guidelines relating to certain white-collar offenses.
- Sec. 906. Corporate responsibility for financial reports..
Title X—Corporate Tax Returns
- Sec. 1001. Sense of the Senate regarding the signing of corporate tax returns by chief executive officers.
Title XI—Corporate Fraud and Accountability
- Sec. 1101. Short title.
- Sec. 1102. Tampering with a record or otherwise impeding an official proceeding.
- Sec. 1103. Temporary freeze authority for the Securities and Exchange Commission.
- Sec. 1104. Amendment to the Federal Sentencing Guidelines.
- Sec. 1105. Authority of the Commission to prohibit persons from serving as officers or directors.
- Sec. 1106. Increased criminal penalties under Securities Exchange Act of 1934.
- Sec. 1107. Retaliation against informants.