Purpose of SOX
The 2002 Sarbanes–Oxley Act, popularly called the Public Company Accounting Reform and Investor Protection Act and Corporate and Auditing Accountability and Responsibility Act, is a U.S. government law that outlines new and improved requirements across all U.S. corporate boards, public accounting firms, and management. It's named after Michael G. Oxley and Senator Paul Sarbanes. The act came to effect as a response to a series of dreadful accounting crisis. These incidents cost investors millions, and millions of dollars as the impacted firms' stock prices plummeted and rattled public trust in the national stock markets.
SOX is a significant collection of legislation generally used in the United States, often by the board of directors of the public sector and public accounting businesses. With the latest results arising from the accounting sector's legislative changes, the Sarbanes-Oxley Act has significantly impacted the accounting industry (Prentice, 2004). The SOX Act is aimed at protecting investors through prevention of financial malpractices and fraudulent accounting in public firms. The Act’s core purpose is to ensure transparency in the corporate sector and guarantee provision of financial information and as when required. Public companies are supposed maintain an accurate database of their financial information which is supposed to be available to regulators and investors in a real-time. This requirement helps improve corporate behavior and prevent scandals such as the fraudulent accounting in public corporate such as WorldCom and Enron. WorldCom used accounting manipulation to hide financial losses and the failure to disclose the information maintained the company’s stock market prices high. The executives in the firm used this loophole to enrich themselves by disposing their shareholding leaving other investors at a loss when the deception could not be kept in secret any longer.
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The purpose of the SOX Act is achieved by the requirement of expanded disclosures of both non-financial and financial measures adopted by each public firm. The transparency objective of the Act is accomplished by the requirement of real-time disclosure of financial data, compliance to the Generally Accepted Accounting Standards and disclosure of all material transactions not disclosed in the balance sheet.
The SOX Act Titles I-VI
Title 1: Public Company Accounting Oversight Board (PCAOB)
This is the first title of the act and it is made up of nine parts covering sections 101 to section 109. The title addresses the establishment of the Public Company Accounting Oversight Board which is a non-governmental and no-profit motive organization charged with the creation of quality control mechanisms in the audit process. The mandate of the body is to give independent supervision of statutory accounting corporations that provide auditing services (Goelzer, 2003). The board’s objective is to restore and promote maintenance of higher accounting standards in accounting with an ultimate aim of protecting stockholders and the public in general against fraud and greediness observed in the corporate scandals of the late 1990s. PCAOB has power to carry out an investigation or inspection of public accountants at the discretion of the board and for any violations found, the body can institute sanctions and ensure compliance with standards for the errant parties. It also constitutes a critical investigative committee to register auditors, establish specific enforcement audit processes and procedures, inspect and track actions and quality assurance, and ensure adherence to particular SOX mandates.
Title II: Auditor Independence
The title comprises nine parts and sets requirements for the external auditor's independence to reduce potential conflicts. It discusses new requirements for auditor approval, inspection partner rotation, and reporting requirements for auditors. The title highlights the range of services the auditor may provide and maintain independence and bias from the interests of the client. There should be clear distinction from the interests of the audit firm and the client’s interests to minimize chances of augmentation of the accounting data to favor the client. It prohibits the provision of additional services to the clients. Therefore, a firm providing tax services is not allowed to provide extra services to the same customer. To further limit the conflict of interest by the auditors, the title places a requirement of rotation of audit partners and prohibits auditors from taking roles at the client’s firms for a year after delivering services.
Title III: Corporate Responsibility
Title III has eight parts and requires senior managers to take personal responsibility for corporate financial statements' consistency and reliability. It describes the relationship between external and company audit bodies and outlines the responsibility for the accuracy and viability of company financial statements for corporate officers (Prentice, 2004). It lists clear restrictions on company officers' actions and defines specific confiscations for non-adherence benefits and civil liabilities. Section 302, for instance, mandates that the 'principal officers' of the company and authorize quarterly analysis of financial statements. Among the restrictions of the third title is to ensuring that only the accurate set of accounts are released to the public and provides a requirement for the establishment of an audit committee in public corporations. The title places the role of ensuring accuracy of the accounting information at the company’s executives, specifically the chief finance officer and the chief executive officer who are also required to verify the correctness of the financial information provided to the Securities and Exchange commission. The executives are also tasked with reporting on the efficacy of the internal controls instituted in their respective firms and provide an updated report incase of any changes. The Title sets limits on stock trades and bonuses paid to the executive members. In instances where a public company publishes restated accounts, Title III requires that the executives forfeit all the bonuses received for that period
Title IV: Enhanced Financial Disclosures
This IV title contains nine segments. It outlines improved financial transaction reporting criteria, such as transactions off the balance sheet, Pro-forma statistics, and corporate officers' stock transactions to minimize misrepresentations. It requires internal controls and mandates both statements and audits on such rules to ensure financial reports and disclosures (Eilifsen et al., 2013). It also needs prompt notification by the Commission for security exchange (SEC) its corporate reporting agents of resources adjustments in the financial situation and relevant assessments. Title IV places a requirement of a more transparent executive activities through placing a disclosure requirement on insider stock trades and prohibition of provision of personal loans to the members of the executive. All the necessary disclosures made in accordance with Title III must be made in a timely way.
Title V: Analyst Conflicts of Interest
There is only one part of Title V, which contains steps intended to restore investors' trust in stating securities analysts reports. Title V specifies the security analyst rules and requirements for known personal dispute disclosure. The aim of this title is to dictate the treatment of financial analysts and their ability to report adversely on companies. The area seeks to minimize possibilities of conflict of interest that could lead to production of biased reports by providing a limit on the extent to which investment bankers interact with analysts.
Title VI: Commission Resources and Authority
This Title has four parts and outlines strategies for restoring the investor's trust in securities audits. It also determines the power of the SEC to censor or forbid the practice of securities professionals. The title also defines the extent and jurisdiction of the SEC powers to assist in the discharge of its mandate. Among the powers is the ability to hire additional manpower to assist the SEC in its oversight role. The title also specifies the circumstances in which an individual may be prevented from operating as an advisor, broker, or dealer.
Prohibition of Internal Auditors in Consulting Audited Firm
Significant improvements in the rules for corporate governance and financial practice were made by the SOX Act, launched in 2002. This included ensuring shareholder and public security against fraudulent acts and accounting mistakes in companies and enhancing company disclosure accuracy (Prentice, 2004). The Sarbanes-Oxley Act consists of eleven titles with the essential parts of dealing with a firms' needs to satisfy the Act's mandate. Sarbanes-Oxley Act applies its rules to a company's disclosure control. Good financial statements should be provided by an internal procedure layout, in which SOX needs that signatories to an existing internal control assert these responsibilities. This ensures that all organization representatives, through the organization's periodic statements, make details about the company and compound outlet offices available to the officials. As part of the obligation, officers need to determine and present their findings in reports on their internal control effectiveness based on their assessments. SOX also requires external auditors to advise if the management is observing internal control of the corporation's financial records maintenance. Therefore, this activity contributes to the idea of a financial statement concerning an individual's report's accuracy.
The Sarbanes-Oxley Act retains the CEO and the CFO's responsibility for the details provided by their organization in the income statement. It has established new levels of accountability for companies and penalties for those standards of accountability that are not met. SOX has developed new standards for financial reporting. SOX transformed how company boards communicate with their auditors. The Enron auditors were initially involved in the scandal, which led the company to break up and become bankrupt. However, the Court Reversed that judgment several years later, but not in time to save the firm. SOX demands that all organizations send yearly reports on the institutional controls in place and the efficacy of those internal control systems. A business deemed to be in breach of the SOX guidelines is subject to very stringent penalties. Fraudulent statements endanger investor's capital.
The SOX Act modulates in periodic reports the disclosure of items. This legislation, effected by Enron bankruptcy, triggered organizations much attention by urging them to consider their off-equilibrium specifics (Eilifsen et al., 2013). Unless such things are considered, an organization or a person can engage in fraudulent actions while using the instruments. This way, the SOX Act, together with SEC analyses and statements, reinforced the focus on such devices to enhance understanding of the extent to which those instruments are used and whether the accounting principles address these instruments adequately.
The incorporation of the Sarbanes-Oxley Act has modified the internal control evaluations. It mandates the management and outside auditors to account for ICFR. The segment needs an organization's involvement; internal statements are created and retained, and internal controls are evaluated when demonstrated to the general public. Generally, SOX dictates that organizations follow an internal control system, as defined by the Tread-way Commission's Committee of Sponsoring Organizations (COSO).
A further shift faced by the accounting field is the unacceptable effect on the efficiency of audits. SOX lays down rules for the suspension, compliance, non-preemption of other provisions, and dates for audits that are considered to have been carried out improperly. The Agency is to recommend, in compliance with section 303, rules that are prescribed within six days or less 90 days just after the promulgation of the Act and 270 days after promulgation of the permanent regulation. The Agency also has divested the authority to enforce this clause and any rule provided about SOX.
In particular, the Sarbanes-Oxley Act has become very successful in enhancing the performance and consistency in corporate governance practices, protecting investors, and attempting to further this purpose by enforcing stringent rules on corporations' audits and auditors. It also avoids market manipulation and acquisitions, allows businesses to introduce strict corporate governance, and raises the penalty for white-collar crimes linked to shareholder manipulation (Koehn & Del Vecchio, 2006). The Act has undergone a drastic reform in the business sector to regain public trust in the transparency of managerial decisions and accounting standards. The Act introduced new compliance mechanisms to tackle corporate fraud, prosecute corporate wrongdoers, and discourage embezzlement with penalties. For example, for the financial year, 2019 on August 20, 2003, the Agency (SEC) has lodged 543 compliance proceedings, 147, including money laundering or infringement reporting (Sarbanes Oxley Act, 2012). Over this duration, the Agency desired to prohibit 144 government officials and managers from retaining these leadership roles with major corporations.
These punishments differ according to the bill's section, which is breached, ranging from substantial financial penalties, exclusion from the stock market, to the ultimate penalty of default. The sanctions were strict about deterring deviant behavior from the rules laid down in Sox and avoiding another major scandal such as Enron. The Oxley act, although incomplete, protected the wider public when making investments. The percentage of companies compliant with the Act was too high because of its adaptability in a fast-changing technical climate. There's still so much space for change in the review process, but the 2002 Sarbanes-Oxley Act was a successful baseline.
They keep not just businesses engaged in fraud but also the parties involved. For instance, recent moves show a commitment to the Commissions' part to prosecute managers irresponsible in their personnel supervision. They also devised methods that take leverage on the innovative provision of this Act to refund funds to stockholders who have incurred losses instead of merely raising such financial resources for the government. This is a change plan. For those who work in public corporations or advise public companies, the board's decisions cannot sound quite crucial to your daily operations challenges. The Sarbanes-Oxley Act and the SEC and the stock market regulations that it engendered have established a series of new problems for publicly traded companies. It was probably a relief not to have had to reflect on the board's statements as well. The PCAOB would have a considerable effect on auditors and clients in the public sector (Goelzer, 2003). The board outlines all the aspects in which the board's work can directly affect public corporations. Although the Board's Regulatory Power applies only to accountants, examinations and audits may also impact public corporations. To decide if the auditor has done his or her job correctly, it would usually be appropriate to review the client's audit documents and communicate these requirements to workers.
The board's work can affect the advisory services that publicly traded corporations can receive through their external auditor. In the 1990s, consultancy fees, such as systems integration, tax preparation, data management support, and various other consulting services, grew extremely important to large corporations. In certain instances, customers paid considerably more non-audit activities than audited financial statements to their auditors (Coglianese et al., 2004). Mushrooming non-audit revenue raised concerns about the auditor's autonomy and the auditor's ability to risk compromising consultancy business by sticking up to the client on audit matters. The SOX act has tried to put countermeasures to this pattern. Congress agreed on the need for auditors to do their auditing job. The SOX Act provision outlines nine types of non-audit services that accountants are forbidden to offer to their clients (Goelzer, 2003). Services not included in the list of prohibited services can still be given, but only after approval in advance by the client's advisory board and publicly reported.
With the current management crisis, the challenge of who can govern has been brought to the forefront. The government currently shares regulatory and supervisory powers with numerous non-governmental, self-regulatory entities. Self-regulation has been prevalent both in the service of the capital markets and in the legal and accounting professions' supervision. There are three things to be asked. Are these current self-regulation arrangements sufficient? Should the change in government it's regulation of self-regulatory organizations? Or does the government have a larger and more direct role to play in regulation? In addition to determining who is to regulate, recent controversies have illustrated the difficulty of deciding how to control. Most commonly, regulators are presented with a choice between ideas and rules. Will regulatory requirements express broad objectives or objectives that direct actions through adherence to fundamental principles? Or are laws to come in the form of clear regulations that inform businesses and their attorneys and auditors precisely what is permissible and inappropriate? Regulation has its benefits, and these have been commonly adopted. Still, they can always encourage corporate entities to figure out ways of complying with the law as written while subverting its purpose.
Finally, regulatory authorities face the task of determining how to apply the laws or values they have embraced. Is more vigorous compliance needed, huh? Should law enforcement authorities investigate only specific offenders, or should they also prosecute companies where corruption occurs? When do regulators impose criminal (as opposed to civil) sanctions? Moreover, considering that both federal and state governments have authority over publicly traded companies, law enforcement authorities must deal effectively with jurisdictional rivalry (Coglianese et al., 2004).
Added Cost as a Result of SOX compliance
As the oversight of public corporate continue to change over the years, the cost implications of compliance continue to rise. Ensuring compliance continue to dominate the expenditure related to SOX. An annual survey of SOX compliance conducted in 2016 revealed that a third of organizations spend at least $500000 annually on compliance ("Understanding the costs and benefits of SOX compliance", 2016) . Other firms constituting less than 50 per cent spent less than one million dollars whereas a substantial number of public firms especially in telecommunications and insurance spend at least two million dollars or more.
The most significant cost consequences of SOX for public corporations are paying the board's work. Accounting companies must pay licensing fees and annual audit fees to cover the expenses of handling their submissions to the Board of Directors (Koehn & Del Vecchio, 2006). However, Congress provided that their principal source of funding would be taxes levied on public corporations about their market capitalization. The Sarbanes-Oxley Act of 2002 also added extra costs for businesses, thus maintaining compliance with the Act. Many companies seeking to go public to attract new investors face difficulties due to SOX's complex accounting criteria and the Cost of enforcing internal controls (Deng et al., 2004). This led to a reduction in the number of Initial Public Offering (IPOs). Adoption of the SOX Act has resulted in a massive trend of acquisitions and mergers.
In short, SOX has demonstrated its value in the accounting market, which has strengthened many economic systems since its introduction. This is due to SOX assuring the issuance of accurate and reliable accounting records and discloses all the details needed, which both the general populace and stakeholders consider essential to their judgment processes. As shown in this article, SOX promotes transparency in the company's financial performance by preventing fraud and unlawful practices that asset managers are inclined to partake in. Thus, the incorporation of the Act has a beneficial impact on a stable business enterprise's ownership and operation.
References
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Deng, M., Melumad, N., & Shibano, T. (2012). Auditors' liability, investments, and capital markets: A potential unintended consequence of the Sarbanes‐Oxley Act. Journal of Accounting Research , 50 (5), 1179-1215.
https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1475-679X.2012.00458.x
Eilifsen, A., Messier, W. F., Glover, S. M., & Prawitt, D. F. (2013). Auditing and assurance services . McGraw-Hill.
https://vip.librarycloud.co.uk/pdf/downloads/Auditing%20And%20Assurance%20Services%20Aasmund%20Eilifsen%20Et%20Al.pdf
Goelzer, D. L. (2003, October 31). The Work of the PCAOB: Why Should Public Companies Care? Retrieved from Public Company Accounting Oversight Board: http://pcaobus.org/News/Speech/Pages/10312003_GoelzerPublicCompanies.aspx
Koehn, J. L., & DelVecchio, S. C. (2006). Revisiting the ripple effects of the Sarbanes-Oxley Act. The CPA Journal , 76 (5), 32.
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Prentice, R. A. (2004). Guide to the Sarbanes-Oxley Act: What Business Needs to Know Now That it is Implemented. Michigan: Cengage South-Western.
https://www.amazon.com/Guide-Sarbanes-Oxley-Act-Business-Implemented/dp/0324323654
Understanding the costs and benefits of SOX compliance . Protiviti.com. (2016).
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