Sarbanes-Oxley Act: Detailed Overview

In 2001, United States Securities and Exchange Commission (SEC) announced that they were investigating the accounting practices of Enron based on concerns raised by shareholders and analysts in last few years (Forbes, 2013). Investigation revealed manipulation of accounting rules, masking of huge losses and liabilities as well as several charges of money laundering, bank fraud, insider trading and conspiracy by then CEO Ken Lay, former CEO Jeffrey Skilling, CFO Andrew Fastow and several other high-ranking executives (Forbes, 2013). Accounting firm Arthur Anderson was responsible for the auditing of Enron, but firm issued favorable reports by ignoring Enron’s malpractices and received monetary benefits in exchange (Collins, 2019). SEC investigation found Arthur Anderson destroying the financial documents of Enron to avoid being caught. Court stopped the accounting firm from public accounting practices lead to closure of company followed by thousands of layoffs (Collins, 2019). The catastrophe could have been avoided by following corporate ethical and responsibility policy, which require truthful financial reporting, transparency, and auditing practices. Executive management acted poorly and did not follow the high standards of corporate ethics lead to bankruptcy of Enron. Moreover, external accounting firm Arthur Anderson did not perform their job ethically and professionally, which also lead to closure of their firm.

Sarbanes-Oxley Act

The Sarbanes-Oxley act of 2002 was enacted to avoid accounting debacles like Enron and WorldCom in future (Murray, 2019). The act consisted of several mandatory strict codes of conducts encompassing financial practices, accounting controls, corporate governance as well as criminal penalties against violators. It consists of 11 titles and several subsections regarding compliance. The 11 titles of the act are (Corporate Records Management, 2019):

1. Public company accounting oversight board with provisions of accounting oversight through public audit services.

2. Auditor independence with strict conflict of interest requirements.

3. Corporate responsibility is mandated through accountability provisions for company executives over the accuracy and completeness of their financial reports.

4. Enhanced financial disclosures require reporting of off-balance sheet transactions, stock transactions of their executives etc.

5. Analyst conflict of interest title restore confidence in the reporting of securities analysts with specific code of conduct and disclosures of known conflict of interests.

6. Commission resource and authority empowers Securities and Exchange commission to bar a person from practicing as broker, adviser or dealer.

7. Studies and reports relate to research on violations against SEC mandated actions.

8. Corporate and criminal fraud accountability title outlines penalties for fraud by alteration or destruction of financial records, manipulations etc. while protecting whistle-blowers.

9. White collar crime penalty enhancement title recommends stronger sentencing and penalties related to failure in certification of financial reports as a criminal offence.

10. Corporate tax returns require signing of company’s tax returns by Chief Executive Officer.

11. Corporate fraud accountability protects financial records from tampering and empowers SEC to freeze payments temporarily.

Key Provisions of Sarbanes-Oxley Act

Section 302

Section 302 of the act specifically held the company’s executive responsible of their company’s financial records (Murray, 2019). For public interest, unexpected losses due to investment issues or scandals are mandated to be disclosed publicly in real time. In summary,

1. All financial reports must be reviewed by Chief Executive Officer and Chief Financial Officer

2. Financial reports need to be free from any misrepresentations

3. Fair presentation of information is mandated in the financial report

4. Chief Executive Officer and Chief Financial Officer are accountable for internal accounting controls.

5. Any deficiency or fraud is required to be disclosed in the financial report by Chief Executive Officer and Chief Financial Officer

6. Any changes to accounting controls are required to be disclosed by Chief Executive Officer and Chief Financial Officer (Sarbanes-Oxley 101, 2019).

Section 401

Section 401 mandate disclosure of all material, like obligations, transactions, and off-balance sheet liabilities (Sarbanes-Oxley 101, 2019).

Section 402

Act’s section 402 tackles the issues of the conflict of interest by making it illegal for an executive to receive and even solicit credit or loan directly or indirectly from the issuer (Murray, 2019).

Section 404

Section 404 mandate management responsible of internal accounting and auditing controls (Sarbanes-Oxley 101, 2019). Any issues in internal controls are required to be disclosed. External auditors must attest the accuracy of company’s assertion that internal accounting controls are effective, operational and in place.

Section 406

Code of ethics are outlined in section 406 for senior financial executive of the company by promoting honest and ethical conduct, full, fair, accurate, timely and understandable disclosure in periodic reports and full compliance with governmental rules and regulations (Murray, 2019). Any changes to code requires public disclosure.

Section 409

Section 409 require disclosure of any material changes to financial conditions or operations to public in real-time (Sarbanes-Oxley 101, 2019).

Section 802

Integrity of financial reports is governed by section 802, which prohibits alteration, destruction or falsification of records (Murray, 2019).

Section 906

Section 906 set up management accountable of financial reports by setting up penalties upwards of $5 million in fines and 20 years in prison (Sarbanes-Oxley 101, 2019).

Ethics and Policy Development based on Sarbanes-Oxley Act

Sarbanes-Oxley act laid down a strong foundation to govern a public corporation with trust, integrity, transparency, and accountability. Section 406 mandate promotion of ethical, honest and fair behavior by executive management. Following governmental rules and regulations are mandatory, with full disclosure to public in the event of violation. Similarly, section 402 held the executive management at high standards by making it illegal to receive and even solicit credit or loan directly or indirectly from the issuer (Murray, 2019). Subsequently, Section 401 mandate public disclosure of all material, like obligations, transactions, and off-balance sheet liabilities (Sarbanes-Oxley 101, 2019).

Another key section of Sarbanes-Oxley, which is 404 mandates a corporate policy with strict internal accounting and auditing controls (Murray, 2019). The controls are required to be certified by external auditors to ensure the measures are effective, operational and in place as required by law. However, the section 302 is the main area of Sarbanes-Oxley act which places the CEO and CFO accountable and responsible of accuracy in the financial reports of the company. Misrepresentations or changes are required to be disclosed immediately (Sarbanes-Oxley 101, 2019).

Summary

Venzuela (2016) studied the effectiveness of Sarbanes-Oxley act’s financial code of ethics and found that earnings restatements due to financial mismanagement have reduced significantly since the enactment of act in 2002. The act mandates certification of internal audits and setup civil and criminal penalties for security violations (Super Pages, 2019). Some of the highlights of the Sarbanes-Oxley act are:

1. All public companies, big or small are regulated for financial statements, accounting practices, and corporate responsibilities.

2. Act grants the external auditors more access to company data, with special provisions for compensation disclosure of upper management.

3. Act protects the whistleblowers from retribution by adding up to 10 years of prison time for the companies.

4. Act require correct financial statements to reflect company’s fiscal health and responsibility.

5. Company executives are required to sign off their financial statements for accountability under the act.

6. Act set up to 20 years of prison if corporate employees alter or hide or misfile documents to obstruct justice. Accountants can get up to 10 years in prison for intentionally throwing away documents before the five-year limit.

In summary, Sarbanes-Oxley act illustrates the significance of ethical corporate responsibilities, with stiff penalties for violations (Super Pages, 2019).

References

Forbes (2013). 5 most publicized ethics violations by CEOs. Retrieved from https://www.forbes.com/sites/investopedia/2013/02/05/5-most-publicized-ethics-violations-by-ceos/#5d5233224bbc

Collins, D. (2019). Arthur Anderson – American Company. Retrieved from https://www.britannica.com/topic/Arthur-Andersen

Sarbanes-Oxley 101 (2019). Sarbanes-Oxley Act – Summary of Key Provisions. Retrieved from https://www.sarbanes-oxley-101.com/sarbanes-oxley-compliance.htm

Super Pages (2019). Sarbanes Oxley Act Summary. Retrieved from https://www.superpages.com/em/sarbanes-oxley-act-summary/

Venzuela, L. (2016). Study validates effectiveness of Sarbanes Oxley 406 financial code of ethics. Retrieved from https://phys.org/news/2016-10-validates-effectiveness-sarbanes-oxley-financial.html

Corporate Records Management (2019). What to known about Sarbanes-Oxley. Retrieved from https://www.crmfiles.com/comply-with-sarbanes-oxley-dallas-fort-worth/

Murray, L. (2019). Sarbanes-Oxley Code of Conduct Requirements. Retrieved from https://smallbusiness.chron.com/sarbanes-oxley-code-conduct-requirements-4060.html