The Sarbanes-Oxley Act of 2002 was enacted into law in 2002 to respond to the various financial scandals that were taking place in the for-profit corporate sector of the United States. The act was meant to address the abuse of finances and accounting standards by companies such as Adelphia, Enron and WorldCom where the executives of these companies defrauded their shareholders, their employees and the US economy of billions of dollars. Once it was enacted, SOX was meant to introduce major changes to the corporate governance and financial management of capital in many corporations within America.
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The Sarbanes-Oxley Act or the SOX act of 2002 was developed by Senator Paul Sarbanes and House Representative Michael Oxley and it contains eleven sections which outline the responsibilities of chief executive officers as well as financial controllers in managing the finances of a company (Morgan et al, 2008).
Examination of the SOX Act of 2002
Under the Sarbanes-Oxley Act of 2002, companies that are publicly traded in the US are required to increase their internal financial and accounting controls after personal clarification with the chief executive and chief financial officers of the company. This is meant to strengthen the auditing, accounting and financial practices of the company.
The act also requires for-profit corporations in the country to increase their external controls through enhancing the duties and responsibilities of the audit committee. The act also states that chief financial controllers and auditors need to provide supporting evidence that will be used to whistleblow on the abuse of company funds (Morgan et al, 2008).
The SOX bill does not apply to privately held companies as many of the laws deal with the management of shareholder, corporate and public funds which are usually common in publicly traded companies. The new and enhanced standards within the SOX Act deal with additional responsibilities for the corporate board and chief executive officers of most organizations as well as the introduction of criminal penalties for managers caught defrauding corporations of public funds.
Other enhanced standards within the act include auditor independence, enhanced financial disclosures, conflicts of interest and corporate fraud accountability. All these aspects are included within the eleven sections of the act where they analyse the specific mandates and requirements that managers need to have when conducting financial reporting (Kuschnik, 2008).
Each of these sub sections are important and necessary in the financial management of publicly traded corporation as they ensure that there is accountability during the management of financial funds.
For example auditor independence which falls under the second title deals with limiting the conflicts of interest that arise during audit reporting while corporate fraud accountability which falls under the eleventh title of the act deals with the identification of corporate fraud and the various penalties that are served to deal with fraud.
This section also revises the sentencing guidelines that were in existence before to deal with people who defrauded companies of billions of dollars. This review was seen to be important as it would enable the Securities and Exchange Commission (SEC) to temporarily freeze any transactions or payments that were deemed to be unusual for the company (Kuschnik, 2008).
In general, the act deals with ensuring the financial reports generated by auditors and finance managers within organization to develop internal control reports that can be used to determine the accuracy of the company’s financial data. The adoption of the SOX act is meant to establish a best-practice standard when it comes to the management of corporate funds.
The act also changes how corporate management boards and executives interact with each other as well as with their corporate auditors and financial controllers. It also ensures that the top managers of a corporate organization are held accountable for the accuracy of financial statements released at the end of every company financial year (Litvak, 2007).
Benefits and Costs of the Sarbanes-Oxley Act
According to Bednanrz (2006), the costs of implementing the SOX act will exceed the benefits of the act when it is fully implemented. A survey conducted on the compliance costs of the act in various publicly traded corporations within the US revealed that the first year compliance costs would exceed $4.6 million dollars.
This figure applied to all the large multinational and domestic companies in the US. Medium sized companies and smaller companies operating within the US were likely to incur significant additional costs that were projected to amount to $2 million during the first-year compliance with the SOX guidelines.
These huge costs incurred during the first year would make it difficult to determine whether the Sarbanes-Oxley Act was actually working in managing corporate finances and auditing issues (Bernanrz, 2006).
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With regards to the benefits of the act, various financial analysts and experts noted that the borrowing costs were lower for companies that had improved their internal control measures while corporate transparency had improved within many publicly traded organizations during the first year of compliance.
Section 404 of the act ensured that companies had conservative reported earnings where financial reports and statements underwent verification to determine their accuracy before being presented to the various stakeholders of the company. Companies that had strong internal controls were able to experience an increase in their share prices and their financial statements were more reliable (Morgan et al, 2008).
Reactions of Company Executives and Changes to Accounting Practices
While many legislators have praised the Sarbanes-Oxley act to be effective in dealing with financial fraud within corporations, many business managers have expressed frustration with the act. The Federal Regulation Board has been faced with a lot of complaints about the high costs that are needed to implement the act in major public corporations within the country.
Executives from General Electric, Lockheed Martin and Emerson Electric were among those who spoke about the various challenges of complying with the SOX act two years after it was implemented (Bednanrz, 2006).
The executives agreed that while it was too soon to determine the benefits of complying with the act, there were considerable costs such as audit fees which were expected to increase by approximately 40% during the first year of compliance.
Business managers working for BP saw the duplicate testing of internal controls to dilute the business practices of the organization as they saw it to be a frustrating exercise. They instead preferred to perform a single internal control testing exercise which would enable them to identify and document any financial issues or problems (Bednanrz, 2006).
Bednanrz, A., (2006, May 11). Executives tell regulators Sarbanes-Oxley costs exceed benefits. Retrieved from: https://www.networkworld.com/article/2311689/execs-tell-regulators-sarbanes-oxley-costs-exceed-benefits.html
Kuschnik, B., (2008). The Sarbanes-Oxley Act: big brother is watching you or adequate measures of corporate governance regulation. Rutgers Business Law Journal, 64-95
Litvak, K., (2007). The effect of the Sarbanes-Oxley Act on non-US companies cross-listed in the US. Journal of Corporate Finance, 13(55), 195-228
Morgan, D.F., Green, R., Shinn, C.W., & Robinson, K.S., (2008). Foundations of public service. New York: M.E. Sharpe Incorporated