Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 to enhance corporate governance and financial disclosure. It was created in response to high-profile financial scandals, aiming to protect investors by improving the accuracy and reliability of corporate disclosures through stringent reforms in accounting practices and internal controls.

5 Must Know Facts For Your Next Test

1. SOX requires publicly traded companies to establish and maintain adequate internal control structures and procedures for financial reporting.
2. The act mandates that executives must personally certify the accuracy of financial statements, subjecting them to penalties for false certification.
3. SOX led to the creation of the PCAOB, which regulates auditors and establishes auditing standards for public companies.
4. Section 404 of SOX specifically addresses management's responsibility for establishing internal controls and requires annual assessments of their effectiveness.
5. Failure to comply with SOX can result in severe penalties, including hefty fines and imprisonment for responsible executives.

Review Questions

• How did the Sarbanes-Oxley Act change the landscape of corporate governance in response to financial scandals?
  • The Sarbanes-Oxley Act fundamentally changed corporate governance by introducing strict regulations aimed at increasing transparency and accountability. It required publicly traded companies to implement robust internal controls over financial reporting, ensuring that financial statements are accurate and reliable. This shift aimed to restore investor confidence following major scandals like Enron and WorldCom by holding company executives accountable for the integrity of their financial disclosures.
• Discuss the implications of Section 404 of the Sarbanes-Oxley Act for management and auditors.
  • Section 404 of SOX has significant implications for both management and auditors as it requires management to assess and report on the effectiveness of their internal controls over financial reporting. Auditors must then independently verify this assessment, which means they must have a deep understanding of a company's internal control systems. This increased scrutiny aims to prevent fraud and ensure that financial reports accurately reflect a company's financial position.
• Evaluate the long-term effects of the Sarbanes-Oxley Act on corporate practices and investor trust in the U.S. economy.
  • The long-term effects of the Sarbanes-Oxley Act on corporate practices have been profound, leading to more stringent compliance measures and improved transparency in financial reporting. Companies have invested heavily in enhancing their internal controls, which has fostered a culture of accountability among executives. As a result, investor trust in U.S. markets has gradually increased, contributing to greater market stability. However, some critics argue that compliance costs can be burdensome for smaller firms, which may affect their ability to compete effectively.

Related terms

Internal Controls: Processes and procedures implemented by a company to ensure the integrity of financial and accounting information, and to prevent fraud.

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

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