Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 aimed at protecting investors from fraudulent financial reporting by corporations. It established stricter regulations for public company boards, management, and public accounting firms, significantly enhancing internal controls and disclosure requirements.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act was passed in response to major corporate scandals such as Enron and WorldCom, which highlighted the need for improved financial disclosure and accountability.
2. Section 404 of SOX requires management to assess the effectiveness of internal control systems and for auditors to attest to these assessments.
3. The Act imposes criminal penalties for altering or destroying records with the intent to obstruct a federal investigation.
4. It requires companies to disclose if they have a code of ethics for senior financial officers and mandates greater transparency in financial reporting.
5. SOX has had a significant impact on corporate governance, increasing the responsibilities of boards of directors and audit committees.

Review Questions

• How does the Sarbanes-Oxley Act enhance internal control systems within public companies?
  • The Sarbanes-Oxley Act enhances internal control systems by mandating that management establish and maintain effective internal controls over financial reporting. Section 404 specifically requires companies to conduct annual assessments of their internal controls, which must be audited by an external auditor. This increased scrutiny helps ensure that companies are less likely to engage in fraudulent financial reporting, promoting greater reliability in financial statements.
• Discuss the role of the Public Company Accounting Oversight Board (PCAOB) as established by the Sarbanes-Oxley Act and its significance for auditor independence.
  • The Public Company Accounting Oversight Board (PCAOB) was established by the Sarbanes-Oxley Act to oversee the audits of public companies, ensuring compliance with stringent standards. The PCAOB enhances auditor independence by regulating auditing firms and requiring them to adhere to specific ethical guidelines. By increasing oversight of auditors, SOX aims to mitigate conflicts of interest and maintain the integrity of financial reporting.
• Evaluate the long-term implications of the Sarbanes-Oxley Act on corporate governance and investor trust in the U.S. financial markets.
  • The long-term implications of the Sarbanes-Oxley Act on corporate governance include a strengthened framework for accountability and transparency among public companies. By enforcing rigorous internal controls and enhancing disclosure requirements, SOX has helped restore investor trust in U.S. financial markets following significant scandals. This increased confidence may lead to more stable market conditions and encourage investment, ultimately benefiting both investors and businesses through improved governance practices.

Related terms

Internal Control: A process designed by an organization’s management and other personnel to provide reasonable assurance regarding the achievement of objectives related to operations, reporting, and compliance.

Public Company Accounting Oversight Board (PCAOB):

A nonprofit corporation established by SOX to oversee the audits of public companies, ensuring that auditors follow stringent rules and standards.

Whistleblower Protection: Legislation that protects employees who report unethical practices or violations of laws within their organizations from retaliation.