Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act is a U.S. federal law enacted in 2002 aimed at protecting investors from fraudulent financial reporting by corporations. It was created in response to major accounting scandals, such as those involving Enron and WorldCom, and introduced significant reforms to enhance transparency and accountability in corporate governance and financial practices.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act mandates stricter regulations on financial reporting and increased penalties for fraudulent activities, including significant fines and prison sentences for executives.
2. One of the key provisions is Section 404, which requires companies to establish internal controls and procedures for financial reporting to ensure accuracy.
3. The act also enhances the independence of external auditors by prohibiting auditing firms from providing certain non-audit services to their clients.
4. It requires that top executives personally certify the accuracy of financial statements, which holds them accountable for any misrepresentation.
5. The act has led to increased costs for compliance among publicly traded companies but has significantly improved investor confidence in financial markets.

Review Questions

• How did the Sarbanes-Oxley Act respond to corporate scandals, and what changes did it implement to prevent future misconduct?
  • The Sarbanes-Oxley Act was enacted in direct response to high-profile corporate scandals like Enron and WorldCom, which highlighted serious deficiencies in financial reporting and corporate governance. The act implemented stringent regulations, including the establishment of the PCAOB to oversee audits, mandates for accurate financial disclosures, and penalties for fraudulent activities. These changes were designed to restore investor confidence and ensure greater transparency in corporate finances.
• Discuss the impact of Section 404 of the Sarbanes-Oxley Act on corporate internal controls and its implications for company executives.
  • Section 404 of the Sarbanes-Oxley Act requires companies to assess and report on the effectiveness of their internal controls over financial reporting. This provision has significant implications for company executives, as they must ensure that robust systems are in place to prevent inaccuracies. By holding executives accountable for the integrity of financial reports, this section aims to reduce fraudulent practices and enhance overall corporate governance.
• Evaluate the long-term effects of the Sarbanes-Oxley Act on U.S. capital markets and investor behavior.
  • The Sarbanes-Oxley Act has had profound long-term effects on U.S. capital markets by instilling greater confidence among investors through improved transparency and accountability in corporate governance. While it has led to increased compliance costs for public companies, many investors feel more secure knowing that there are stricter regulations in place against fraud. This trust has encouraged more investment in public markets, fostering economic growth. However, some argue that the burden of compliance may deter smaller companies from going public, affecting market dynamics.

Related terms

Public Company Accounting Oversight Board (PCAOB): An organization established by the Sarbanes-Oxley Act to oversee the audits of public companies and ensure compliance with established auditing standards.

Financial Accounting Standards Board (FASB): An independent organization responsible for establishing financial accounting and reporting standards for companies and nonprofit organizations in the U.S.

Corporate Governance:

The system of rules, practices, and processes by which a company is directed and controlled, including the relationships among stakeholders.