What Is the Sarbanes-Oxley Act?
The Sarbanes-Oxley Act (commonly called "SOX") reformed corporate financial reporting and the accounting profession. Congress passed SOX in 2002 after a string of corporate scandals, most prominently at Enron and WorldCom, shocked the public and rattled markets. Revelations that corporate executives filed misleading financial statements and of cozy relationships between accounting firms and the companies they audited were a common feature in these scandals. Sarbanes-Oxley sought to enhance the integrity of corporate financial reporting and better regulate the accounting profession.
Details about Sarbanes-Oxley regulations are listed below. See FindLaw's Securities Law section for more articles.
Impetus for Reform: the Enron Scandal
Publicly traded companies file periodic financial reports. These provide the public with important information on a company's assets, liabilities, revenue, cash flow, and business operations. This steady stream of data is immensely important to the market. Investors rely on it to decide whether to buy or sell stock, partners and competitors rely on it to make business decisions, and the market as whole relies on it to analyze companies and industries. All of this activity plays a role in assessing a company's value - especially its stock price. So when financial statements are wrong, misleading, or even completely fraudulent there can be widespread repercussions.
This is precisely what led to SOX. Beginning in 2001, a series of corporate scandals involving financial reporting and accounting practices erupted. Enron, then the seventh-largest company in America, became embroiled in a scandal over its accounting practices and eventually collapsed. Subsequent investigations uncovered widespread efforts to manipulate the company's stock price. Enron executives systematically misrepresented the company's assets, hid liabilities, and overstated its earnings. Numerous Enron executives were eventually convicted of financial crimes and its accounting firm, Arthur Anderson, later went out of business. The Enron scandal and a similar scandal at WorldCom prompted Congress to pass the Sarbanes-Oxley Act in 2002.
Sarbanes-Oxley Act: Key Provisions
Sarbanes-Oxley made numerous reforms to corporate financial reporting and the accounting profession. SOX requires corporate executives to certify the accuracy of their company's financial statements; maintain and assess internal controls to prevent wrong, misleading, or fraudulent financial data; and imposes criminal penalties for misleading shareholders and altering documents to impede an investigation. Sarbanes-Oxley also established an oversight board for the accounting profession, regulates the relationship between corporations and accounting firms, and shields corporate whistleblowers from retaliation.
Executives Must Certify Financial Statements
Sarbanes-Oxley requires a public company's chief executive officer and chief financial officer to certify the accuracy of its financial reports. These executives are required to certify that they've reviewed the financial reports, that the reports are accurate, and that the company has internal controls in place to ensure accurate financial disclosures and prevent fraud and misrepresentation.
Companies Maintain Internal Controls to Prevent Fraud
Sarbanes-Oxley requires companies to develop internal controls to ensure the accuracy of its financial reports. Each financial report contains an internal control report, and a company's annual year-end report assesses the effectiveness of those internal controls. A company's external auditor is required to attest to this internal control assessment as well.
The Public Company Accounting Oversight Board
Sarbanes-Oxley established the Public Company Accounting Oversight Board (PCAOB). This non-profit, private sector board regulates accountants auditing pubic companies - a significant proportion of all accountants. The PCAOB can issue rules and regulations related to accounting. Before SOX, the accounts were a self-regulated profession similar to medical professionals and lawyers.
New criminal offenses and enhanced penalties for corporate fraud and related misdeeds were enacted as well. Sarbanes-Oxley makes it a crime to defraud shareholders of publicly traded companies through the filing of misleading financial reports. Executives face fines of up to $1 million and ten years imprisonment for knowingly certifying financial reports that don't comply with the SOX's requirements. Those penalties are enhanced for executives who "willfully" certify noncompliant financial reports: they face fines of up to $5 million and up to twenty years imprisonment. Sarbanes-Oxley also criminalizes the falsification and destruction of records to impede or influence an investigation.
Sarbanes-Oxley also took steps to protect employees who report corporate fraud, also known as whistleblowers. The act prohibits retaliation against whistleblowers who lawfully report corporate misdeeds. Companies may not "discharge, demote, suspend, threaten, harass, or discriminate against" employees who provide information to investigators or testify in enforcement proceedings. SOX created a civil action for employees who are subjected to retaliation, allowing them to sue an employer for violating this provision.
If you have been the victim of securities fraud or have further questions about securities law, you may want to consult with a securities attorney.
Contact a securities lawyer to assist with any issues related to securities laws and financial instruments.