Sarbanes-Oxley Act of 2002

Definition

The Sarbanes-Oxley Act of 2002 is a U.S. federal law enacted to enhance corporate governance and financial disclosure in response to major accounting scandals. This legislation established stricter regulations for public companies and imposed significant penalties for fraudulent financial activity, aiming to restore investor confidence and ensure accurate financial reporting.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act was introduced in response to high-profile corporate scandals such as Enron and WorldCom, which eroded public trust in financial markets.
2. Key provisions of the act include the requirement for CEOs and CFOs to certify the accuracy of financial statements, enhancing accountability at the top levels of management.
3. The act established severe penalties for violations, including fines and imprisonment for executives who knowingly falsify financial records.
4. The legislation also mandated that companies conduct annual audits of their internal control systems, increasing scrutiny over financial reporting processes.
5. The Sarbanes-Oxley Act has been credited with improving the quality of financial reporting, but critics argue that it has increased compliance costs for businesses.

Review Questions

• How does the Sarbanes-Oxley Act of 2002 influence corporate governance practices in publicly traded companies?
  • The Sarbanes-Oxley Act significantly influences corporate governance by requiring greater transparency and accountability in financial reporting. Publicly traded companies must establish strong internal controls to protect against fraud and ensure accuracy in their financial statements. This creates a culture where management is held responsible for their actions, thereby improving trust among investors and stakeholders.
• Discuss the role of the Public Company Accounting Oversight Board (PCAOB) as established by the Sarbanes-Oxley Act in overseeing auditing practices.
  • The PCAOB plays a crucial role in overseeing auditing practices for public companies as mandated by the Sarbanes-Oxley Act. It sets auditing standards, inspects audit firms to ensure compliance with these standards, and enforces disciplinary actions against firms that violate regulations. This oversight aims to enhance the reliability of audits, thereby protecting investors from fraudulent financial reporting.
• 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 disproportionate impact on small publicly traded companies compared to larger ones. Smaller firms often face higher relative compliance costs due to limited resources, which can be burdensome when implementing required internal controls and audits. This has led to some small firms considering going private or delisting from stock exchanges to avoid the costs associated with compliance, thus affecting their growth prospects. In contrast, larger companies usually have more resources to absorb these costs and implement necessary operational changes more efficiently.

Related terms

Public Company Accounting Oversight Board (PCAOB): A regulatory body created by the Sarbanes-Oxley Act to oversee the audits of public companies, ensuring compliance with established auditing standards.

Internal Controls: Processes and procedures implemented by a company to ensure the integrity of financial reporting and compliance with laws and regulations.

Corporate Governance: The system by which companies are directed and controlled, encompassing the practices, policies, and rules that determine how a company operates and is held accountable.