Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 aimed at enhancing corporate governance and accountability, particularly in response to financial scandals such as Enron and WorldCom. It established stringent regulations for financial reporting, auditing, and corporate disclosures, ensuring that companies maintain accurate records and protect investors' interests.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act introduced the Public Company Accounting Oversight Board (PCAOB) to oversee the audits of public companies, enhancing the reliability of financial reporting.
2. It requires companies to establish internal controls for financial reporting and mandates that executives personally certify the accuracy of financial statements.
3. The law imposes severe penalties for fraudulent financial activity, including hefty fines and prison sentences for executives involved in misleading investors.
4. Section 404 of SOX specifically requires management to assess the effectiveness of internal controls over financial reporting annually.
5. SOX has led to increased compliance costs for companies but aims to restore public confidence in the U.S. capital markets by preventing accounting fraud.

Review Questions

• How does the Sarbanes-Oxley Act improve corporate governance in publicly traded companies?
  • The Sarbanes-Oxley Act improves corporate governance by establishing stricter regulations for financial reporting and requiring greater accountability from corporate executives. It mandates that company executives personally certify the accuracy of financial statements, thereby increasing transparency and reducing the risk of fraudulent activities. Additionally, the act requires robust internal controls to be implemented, which helps protect investors' interests and restore confidence in the financial markets.
• What role does the Public Company Accounting Oversight Board (PCAOB) play under the Sarbanes-Oxley Act, and why is it significant?
  • The Public Company Accounting Oversight Board (PCAOB) was established by the Sarbanes-Oxley Act to oversee the audits of public companies, ensuring compliance with established auditing standards. The PCAOB plays a significant role in enhancing the credibility of financial reports by providing independent oversight of audit firms and their practices. This independent regulation helps improve the reliability of corporate disclosures, ultimately benefiting investors and promoting trust in the U.S. capital markets.
• Evaluate the impact of the Sarbanes-Oxley Act on small versus large publicly traded companies regarding compliance costs and operational changes.
  • The Sarbanes-Oxley Act has had a varied impact on small versus large publicly traded companies, particularly concerning compliance costs and operational changes. Large companies often have more resources to absorb the compliance costs associated with SOX, such as implementing rigorous internal controls and undergoing frequent audits. In contrast, small companies may struggle with these expenses relative to their revenue, leading some to consider going private to escape regulatory burdens. While SOX aims to enhance accountability for all public companies, it can disproportionately affect smaller firms due to their limited resources and capacity to comply with extensive requirements.

Related terms

Corporate Governance: The system of rules, practices, and processes by which a company is directed and controlled, focusing on the relationships among stakeholders.

Financial Reporting: The process of producing statements that disclose an organization's financial status to management, investors, and the government.

Auditing: The examination of financial records and statements to ensure accuracy and compliance with established standards and regulations.