Sarbanes-Oxley Act of 2002
Sarbanes-Oxley Act of 2002
Introduction
The Sarbanes-Oxley Act (SOX) of 2002 is an enactment by the United States Congress that seeks to avert fraudulent financial activities in American companies. This act has numerous components that seek to enhance financial accountability in American companies. Additionally, the SOX act provides a framework for stern penalties for individuals and companies who participate in corporate fraud.
The sponsors of this act were the then Maryland Senator, Paul Sarbanes and Ohio Representative, Michael Oxley (Porter & Norton, 2010). In the wake of heightened fraudulent activities in the United States corporate sector, there was the dire need to establish a comprehensive law that protects local and foreign investors. For instance, investors and shareholders had lost millions of dollars in the Enron corporate scandal.
Since the enactment of the SOX Act, company boards are required to maintain high standards of financial accountability as well as corporate diligence. Whereas the act has been heralded by many as an excellent platform for streamlining the American corporate sector, it has also elicited criticism from some quarters. For instance, some opponents argue that the SOX Act discourages foreign investors from venturing into the United States corporate sector.
This paper seeks to identify the most pertinent components of the SOX Act as well as its core objectives. Additionally, the paper will assess the various criticisms surrounding the SOX Act and the implications of its implementation.
Thesis: The Sarbanes-Oxley Act of 2002 is an effective framework for streamlining accountability in the United States corporate sector.
Components of the Sarbanes-Oxley Act
The SOX Act is subdivided into eleven main components and each has numerous sections. The first title seeks to streamline the audit standards in the American corporate sector. This title comprises of strict guidelines for ensuring that financial auditors are credible. The absence of such credibility was a critical contributing factor towards some of the accounting scandals that rocked the American corporate sector. However, the first title in the SOX Act seeks to deal with such challenges (Gibson, 2010). This title also has some sections aimed at streamlining corporate compliance for audit. Corporate entities must uphold the different stipulations of auditing criteria in order to attain compliance.
The second title of the SOX Act emphasizes on auditor independence. According to this component, the auditor must not have a conflict of interest in the operational framework of an organization. In essence, this stipulation seeks to streamline the standards of accuracy in all auditing procedures. An independent auditor does not have the power to manipulate the audit results. The second title of the SOX Act also prohibits auditors from doubling up as consultants. This is extremely helpful in terms of alleviating potential conflict of interest during the audit process (Leonard, 2011).
The third component of the SOX Act focuses on corporate responsibility. The top executives in an organization must be fully accountable of all financial results. Before companies release their results, it is fundamentally essential for the top executives to ascertain the relevant standards of accuracy. If corporate entities do not comply with these standards, the SOX Act provides a comprehensive framework for strict penalties. The third title of the SOX Act also comprises of numerous guidelines for enhancing the standards of accounting integrity.
The fourth component focuses on financial disclosures (Warren, 2010). Such disclosures are extremely pertinent in terms of enhancing the validity of financial reports within the American corporate sector. The financial reports of corporate organizations are subject to thorough reviews by the Securities Exchange Commission.
In contrast to other components, the fifth title of the SOX Act comprises of a single section. This section focuses on the alleviation of conflicts of interest during the compilation of corporate financial reports. Such conflicts have the inherent capacity to undermine the validity of financial reports. On the other hand, the sixth title of the SOX Act defines the role and authority of the SEC in the regulation and control of financial reporting within the American corporate sector. For instance, the SEC has the responsibility of determining and licensing individuals to act as brokerage agents or financial advisers (Fletcher, 2008).
The seventh title of the SOX Act focuses on the review of financial reports. Such reviews are pertinent towards the alleviation of potential flaws during the reporting process. For instance, the financial scandal at Enron occurred because of inconclusive reviews by the SEC. This title also seeks to curb the pursuit of selfish interests by influential directors and board members in American corporations (Gibson, 2010).
The eight component of the SOX Act focuses on the penalties for individuals who participate in corporate fraud. The act provides stern penalties for all individuals who participate in fraudulent activities. Such penalties include tremendous fines for noncompliance, lengthy jail sentences for fraud and revocation of licenses among others. Subsequent titles of this act focus on accountability and tax compliance among others.
Criticism Surrounding the SOX Act
Since its enactment, the Sarbanes-Oxley Act of 2002 has elicited widespread criticism from numerous quarters. Firstly, opponents of the act argue that it undermines the capacity to chief executive officers to focus on strategic management of organizations. This is because they shift extensive attention towards the enhancement of compliance standards with regard to financial accountability. When executives do not focus on strategic management, it becomes complex for them to establish adequate strategies for streamlining organizational performance (Porter & Norton, 2010).
Although it is appropriate for chief executives to focus on financial accountability, this should not serve as a stumbling block towards their input on strategic management. However, the strict provisions of the SOX act have made it increasingly difficult for organizational executives to implement effective strategies for innovative management. Another significant shortcoming of this act is the high cost of compliance.
Corporate entities must invest a lot of capital in order to attain compliance standards for the SOX act. For instance, the frequent audits of financial records require enormous investments from an organization (Warren, 2010). This increases the total expenditures incurred by an organization. According to opponents, this has the capacity to undermine the standards of operational efficiency in corporate establishments. Consequently, this undermines the capacity of organizations to attain the various goals in terms of profitability.
Opponents of the act are also assertive that it undermines the inherent business climate in corporate organizations. The stern regulative measures for financial reporting and accountability have led to the deterioration of the inherent business climate within the American corporate sector. For instance, some companies are forced to focus on accountability issues at the expense of marketing strategies (Holt, 2007). Consequently, this undermines the standards of competitiveness. This has negative implications upon the inherent business climate within the American corporate sector.
Another criticism of the SOX Act pertains to its disproportionate effect on small scale corporate establishments. For instance, the extensive investments for compliance have far reaching implications on small scale corporate establishments. On the other hand, large corporate establishments do not incur extensive costs because of economies of scale. It is also pertinent to highlight that the upholding independence among auditors is among the most significant challenges. According to opponents, some auditors might masquerade as independent entities whereas they have a conflict of interest in the financial performance of an organization. This undermines the SEC’s efforts to implement the different provisions of the SOX act effectively (Leonard, 2011).
The integrity of the SEC during the implementation of the SOX act has also been called into question on several occasions. For instance, the SEC might be seemingly lenient towards the dominant corporations in the American stock markets. This presents the challenge of double standards during the implementation of the act. Criticism of the act also pertains to its effect in terms of influencing foreign direct investments.
Although the act seeks to enhance protection of investors’ portfolios, it might also discourage some investors from venturing into the American corporate sector. Potential investors are always looking for destinations with minimal bureaucracies. However, the SOX act might appear like a bureaucratic tool to some investors (Porter & Norton, 2010). Consequently, this might have negative implications on the performance of the entire economy. All these perspectives highlight the different shortcomings and criticisms surrounding the SOX Act.
Economic Consequences for Companies
The SOX act has had numerous implications on companies from an economic point of view. This affects the small scale companies as well as large scale corporate establishments. One of the most outstanding consequences of the act on companies pertains to the initial costs. In order for companies to implement the different stipulations of the act, they must set aside sufficient resources. This has had negative implications on the performance of organizations especially in terms of attaining the right standards of profitability.
It is also vital to highlight that the SOX act undermines the capacity of most organizations to remain competitive within the American corporate sector (Warren, 2010). Instead of focusing on the marketing and promotional objectives, company executives spend a lot of resources trying to attain compliance. This perspective indicates the manner in which the act has undermines the capacity of corporate entities to remain competitive.
Another significant attribute pertains to the increasing gap between small scale corporate establishments and large scale entities. The large scale corporate establishments have the relevant financial muscle needed to implement the different provisions of the SOX act (Holt, 2007). On the other hand, small scale corporate establishment might struggle to raise the funds required in order to attain compliance. This creates a disproportionate scenario for small corporate establishments compared to large scale corporate entities. Since the enactment of the SOX act, numerous small scale enterprises have expressed concerns about the extensive level of disparity.
The act also comprises of stern penalties for all individuals and organizations participating in corporate fraud (Porter & Norton, 2010). When companies are hit with such penalties, it affects their capacity for competitiveness.
The Attainment of Goals
The SOX act of 2002 has been successful in terms of attainment of some of its fundamental objectives. Firstly, the act has led to a considerable enhancement of investor confidence. According to the Securities and Exchange Commission, the act represents an excellent platform for enhancing the capacity of the American economy to attract foreign direct investments. This was one of the fundamental goals during the enactment of the SOX framework. Prior to its enactment, potential investors were wary of the high susceptibility within the American corporate sector. However, the act has been instrumental towards alleviating this perception (Warren, 2010).
Another perspective that highlights the effectiveness of the act pertains to the substantial reduction in the incidence rates for corporate fraud in the country. Prior to the enactment of this framework, instances of fraud were rampant within the American corporate sector. Executives and boards could pursue selfish interests without being mindful of any penalties. Consequently, individual investors faced the risk of extensive losses. However, the SOX framework has been extremely instrumental towards alleviating these trends. This is because it enhances the standards levels of financial accountability in corporate establishments.
The SOX framework has also been extremely effective in terms of streamlining the standards of audit within the American corporate sector (Gibson, 2010). In addition to academic qualifications, financial auditors must have the relevant pedigree for being impartial and professional. Under the provisions of the SOX framework, auditors must not have any conflict of interest in the corporate establishment being evaluated.
The effectiveness of the SOX framework is also evident in terms of its impact upon the functionality of the SEC. Under the provisions of SOX, the SEC has the mandate to review the financial reporting mechanisms of public corporate establishments. Corporate entities in the United States cannot attain compliance status without satisfying the standards set by the SEC. Consequently, the SEC can impose sanctions on companies that do not attain the relevant compliance standards. Such sanctions also include suspension from the trading in the stock exchange, financial penalties and liquidation among others. Such penalties have been effective in discouraging company executives from participating in corporate fraud.
The act has also been an excellent tool for protecting local and international investors from potential losses (Holt, 2007). This is evident through the increased confidence of investors in the American economy. From another standpoint, it is vital to highlight that various countries have taken the cue from the United States and developed similar policies to the SOX act. This is a perspective that helps in justifying the effectiveness of the act. In 2009, Value Line was implicated in a fraudulent scheme by the SEC (Leonard, 2011). It would have been complex for the SEC to unravel such a fraudulent scheme had the SOX act not been enacted by Congress. All these attributes help in justifying the effectiveness of the Sarbanes-Oxley Act in terms of the realization of its initial goals.
Conclusion
The Sarbanes-Oxley Act of 2002 is an effective framework for streamlining accountability in the United States corporate sector. Although this act has had different shortcomings, it has been largely effective. This mostly applies to the maintenance of the highest standards of financial accountability. The first title in the SOX Act seeks to deal with such challenges. This title also has some sections aimed at streamlining corporate compliance for audit.
Corporate entities must uphold the different stipulations of auditing criteria in order to attain compliance. Opponents of the act are assertive that it undermines the inherent business climate in corporate organizations. The stern regulative measures for financial reporting and accountability have led to the deterioration of the inherent business climate within the American corporate sector. However, such measures are helpful in discouraging fraudulent activities.
References
Fletcher, W. H. & Plette, T. N. (2008). The Sarbanes-Oxley Act: Implementation,significance and impact. New York, NY: Nova Science Publishers
Gibson, C. H. (2010). Financial reporting and analysis: Using financial accounting.Mason, OH: South-Western
Holt, M. F. (2007). The Sarbanes-Oxley Act: Costs, benefits and business impact.Burlington, MA: CIMA Publishing
Leonard, B. (2011). Study of the Sarbanes-Oxley Act of 2002. Darby, PA: DIANE Publishing
Porter, G. A. & Norton, C. L. (2010). Financial accounting: The impact on decision makers. Mason, OH: South-Western
Warren, C. S. (2010). Survey of accounting. Mason, OH: South-Western
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