Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 aimed at improving the accuracy and reliability of corporate disclosures in the wake of major financial scandals like Enron and WorldCom. It established strict reforms to enhance corporate governance and accountability, directly responding to widespread financial fraud that eroded public trust in financial markets.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act was signed into law on July 30, 2002, by President George W. Bush as a direct response to high-profile accounting scandals.
2. SOX introduced significant changes to the regulation of financial practices and corporate governance, including stricter penalties for fraudulent financial activity.
3. One key provision of SOX is Section 404, which requires companies to establish internal controls for financial reporting and disclose their effectiveness.
4. The Act mandates that company executives personally certify the accuracy of financial statements, increasing accountability at the highest levels.
5. SOX also established the PCAOB to oversee auditing firms, aiming to ensure that audits are conducted with integrity and independence.

Review Questions

• How did the Sarbanes-Oxley Act address issues related to corporate fraud and accountability?
  • The Sarbanes-Oxley Act tackled corporate fraud by implementing strict regulations for financial reporting and corporate governance. It established requirements for internal controls on financial reporting, making executives personally accountable for the accuracy of their company's financial statements. This shift aimed to restore investor confidence by ensuring that misleading practices like those seen in scandals were less likely to occur.
• Evaluate the impact of Section 404 of the Sarbanes-Oxley Act on companies and their internal controls.
  • Section 404 has had a significant impact on companies as it requires them to document and test their internal control systems for financial reporting. This provision increased compliance costs, particularly for smaller companies, but ultimately aimed to enhance the reliability of financial information. By making companies more transparent about their internal processes, Section 404 helps protect investors and promotes greater accountability within organizations.
• Assess how the establishment of the Public Company Accounting Oversight Board (PCAOB) has influenced auditing practices post-Sarbanes-Oxley Act.
  • The creation of the PCAOB significantly influenced auditing practices by instituting standardized oversight of audit firms. This board conducts inspections and enforces compliance with established auditing standards, ensuring that audits are performed objectively and transparently. The PCAOB's role has been crucial in rebuilding trust in public company audits, addressing concerns that contributed to the financial scandals that led to SOX's enactment.

Related terms

Corporate Governance: The system by which companies are directed and controlled, focusing on the roles and responsibilities of various stakeholders.

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

Public Company Accounting Oversight Board (PCAOB): A nonprofit corporation created by SOX to oversee the audits of public companies to protect the interests of investors.