Sarbanes-Oxley Act

Definition

The Sarbanes-Oxley Act is a federal law enacted in 2002 aimed at protecting investors by improving the accuracy and reliability of corporate disclosures. This legislation was introduced in response to major corporate scandals, highlighting the need for stronger regulations in financial reporting and accountability.

5 Must Know Facts For Your Next Test

1. The Sarbanes-Oxley Act was passed in the wake of high-profile scandals such as Enron and WorldCom, which shook investor confidence and highlighted severe deficiencies in corporate governance.
2. One of the key provisions of the act is Section 404, which requires companies to establish and maintain an adequate internal control structure and procedures for financial reporting.
3. The act imposes strict penalties for corporate fraud, including fines and imprisonment for executives who knowingly falsify financial reports.
4. It established the Public Company Accounting Oversight Board (PCAOB) to oversee the auditing profession and ensure compliance with the law.
5. The Sarbanes-Oxley Act has had a significant impact on the cost of compliance for public companies but has also been credited with increasing transparency and accountability in financial reporting.

Review Questions

• How did the Sarbanes-Oxley Act respond to ethical failures in corporate America, and what are its main objectives?
  • The Sarbanes-Oxley Act was a direct response to ethical failures exemplified by scandals like Enron and WorldCom. Its main objectives include enhancing corporate governance through stricter regulations on financial reporting, protecting investors by ensuring the accuracy of financial disclosures, and imposing severe penalties on executives for fraudulent activities. By addressing these ethical shortcomings, the act aimed to restore public trust in the integrity of financial markets.
• Discuss the significance of Section 404 of the Sarbanes-Oxley Act regarding internal controls and its implications for businesses.
  • Section 404 of the Sarbanes-Oxley Act requires public companies to assess and report on their internal controls over financial reporting. This section is significant because it mandates that companies not only implement effective internal controls but also provide an external audit opinion on their effectiveness. The implications for businesses include increased responsibility for management to ensure accurate reporting, as well as potentially higher costs related to compliance and auditing processes. However, it ultimately aims to enhance the reliability of financial information available to investors.
• Evaluate the long-term impact of the Sarbanes-Oxley Act on corporate behavior and investor confidence in financial markets.
  • The long-term impact of the Sarbanes-Oxley Act on corporate behavior has been profound. It has fostered a culture of accountability among executives, encouraging companies to prioritize ethical practices and transparency in their financial reporting. As a result, investor confidence has improved significantly due to increased trust in the accuracy of disclosed information. The act's emphasis on rigorous auditing standards and internal controls has contributed to a more stable financial environment, although it has also led some companies to express concerns about compliance costs hindering their operations. Overall, it has created a more responsible corporate landscape.

Related terms

Corporate Governance: The system of rules, practices, and processes by which a company is directed and controlled, ensuring accountability and transparency to stakeholders.

Internal Controls: Processes put in place by an organization to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud.

Public Company Accounting Oversight Board (PCAOB): A nonprofit corporation established by the Sarbanes-Oxley Act to oversee the audits of public companies to protect investors' interests and promote informative, accurate, and independent audit reports.