An Overview of the Sarbanes-Oxley Act of 2002 (SOX)

Essentially, "the goal of accounting is to provide useful information for decisions" (Wild, Larson & Chiapetta, 2007, p. 8). Countless individuals use accounting information every day from potential creditors to company managers to average people like you and me (Wild et al, 2007, p. 5-6). Each of these different users of accounting information make crucial decisions based upon this information, trusting that those who prepared it made it as accurate and honest as possible. Consequently, accounting must be paired with ethics or it will simply lose its usefulness and damage our overall social and economic welfare. Unfortunately, though, managers and other senior members of many of America's most trusted businesses (e.g., Enron and WorldCom) forgot this important reality and manipulated accounting information for their own selfish purposes. In the end, this has caused a general mistrust of businesses, especially large corporations, among many Americans (Wild et al, 2007, p. 6, 8).

To help restore Americans' trust in those companies that distribute their stocks to the public, "the Sarbanes Oxley Act was created to inspect and monitor companies in an attempt to protect shareholders and investors..." (AboutSarbanesOxley.com, n.d.). Congress designed the Sarbanes-Oxley Act (SOX) to make these businesses employ better supervision of their company accounting practices, as well as stricter internal controls (Wild et al, 2007, p. 11).

To understand how SOX has affected the reporting requirements of public companies today, we will need to take a closer look at the titles of SOX. Let us begin with Title I of SOX, which outlines the establishment of the Public Company Accounting Oversight Board. This board is responsible for such things as (1) determining what accounting firms can legally audit public companies, (2) establishing the set of standards these firms must maintain to legally serve in this function, and (3) penalizing any of these auditors that do not comply with the requirements of SOX or the Board (Sarbanes-Oxley.com, n.d., Section 101). As a result, SOX has changed what documentation and controls these firms are required to maintain when they audit public companies. For example, auditors must create (and keep for a minimum of 7 years) documentation that shows how they reached their conclusion on their final report. Furthermore, auditors are required to explain all of their efforts to test public companies' internal controls (Sarbanes-Oxley.com, n.d., Section 103).

Next, we will discuss Title II of SOX, which regulates the independence of auditors. Section 201 explains that auditors are no longer permitted to provide most non-auditing services (e.g., bookkeeping) once they have audited a public business (Sarbanes-Oxley.com, n.d., Section 201). Furthermore, all material information about the auditor's services and communications with the business's management must be fully disclosed to that company's audit committee (e.g., communications from the management outlining unadjusted differences) (Sarbanes-Oxley.com, n.d., Section 204). Also, an accounting firm is prohibited from conducting an audit of a public company if there is clearly a conflict of interest (Sarbanes-Oxley.com, n.d., Section 206).

Let us move on to the third title of SOX, which addresses specifically the responsibilities of the corporation. First, every corporation is required to set up audit committees, completely independent of the company. These committees have the important responsibility of overseeing all auditing procedures and communications between the public accounting firm and the corporation's management (Sarbanes-Oxley.com, n.d., Section 301). Additionally, all principle executive and financial officers must certify in every quarterly or annual financial report such things as (1) that they believe all information contained within the report is true and accurate, and (2) that they have practiced full disclosure with the auditor and audit committees, revealing any internal control problems, irregularities, or fraud (Sarbanes-Oxley.com, n.d., Section 301). Also, Title III explains that it is illegal for anyone to try to improperly influence an audit (Sarbanes-Oxley.com, n.d., Section 303). Ultimately, noncompliance with this section can lead to forfeiture of bonuses/profits or other penalties (Sarbanes-Oxley.com, n.d., Sections 303 & 306).

Title IV of SOX explains the new enhanced financial disclosures. Section 401 discusses the necessary disclosures for periodic reports, including any corrections/adjustments found by a public auditor and any relevant off-balance sheet transactions that may have a strong bearing on the business or its future (Sarbanes-Oxley.com, n.d.). Furthermore, the public company must ensure that any conflicts of interest and transactions involving the business's management or major stockholders are clearly disclosed in its regular reports (Sarbanes-Oxley.com, n.d., Sections 402 & 403). Finally, public companies are now required to disclose their code of ethics (and any changes made), in addition to periodic evaluations and reports of their internal controls (Sarbanes-Oxley.com, n.d., Sections 404 & 406).

Title V, in contrast, addresses conflicts of interest with analysts. This title calls for the establishment of proper rules to try to avoid these conflicts in the future (Sarbanes-Oxley.com, n.d.). For example, the Commission has attempted to "to establish structural and institutional safeguards within registered brokers or dealers to assure that securities analysts are separated by appropriate informational partitions within the firm" to avoid unnecessary bias (Sarbanes-Oxley.com, n.d., Section 501c).

Finally, let us take a quick look at the last six titles of SOX. Title VI outlines the Commission's resources and authority, while Title VII discusses the studies and reports that the Commission is required to oversee. Titles VIII, IX, and XI specifically describe the different penalties for violating SOX and various other important details surrounding the prosecution of such cases. Finally, Title X emphasizes that chief executive officers must sign the public company's income tax return (Sarbanes-Oxley.com, n.d.).

In conclusion, the Sarbanes-Oxley Act does not have any direct control over small businesses, since they are not public companies. However, this does not mean that SOX does not affect them at all. Instead, in the years since SOX was enacted, it has become clear that this act may be negatively affecting the growth of private companies. There has been a sharp decrease in the amount of funds companies have been able to earn their first year of going public (Pethokoukis, 2006). Some financial experts suspect that "Sarbanes-Oxley compliance costs are so high that some private companies are choosing to be bought out rather than go public and assume that financial burden" (Pethokoukis, 2006, para. 3). Consequently, private business owners must spend more time analyzing whether or not they can actually afford to go public. Finally, it is also logical to assume that since SOX requires public companies to spend more time verifying their financial records with outside accountants, public accounting firms will be much busier, making it harder for private companies to receive the accounting services they might need.

References:

AboutSarbanesOxley.com. (n.d.). Highlights of the Sarbanes Oxley Act. Retrieved May 29, 2008, from http://www.aboutsarbanesoxley.com/highlights.htm

Pethokoukis, J. (2006, April 17). Sarbanes-Oxley affects small businesses wanting to go public. U.S. News. Retrieved May 29, 2008, from http://images.usnews.com/usnews/biztech/articles/060417/17sbw.htm

Sarbanes-Oxley.com. (n.d.). Sarbanes-Oxley Act of 2002. Retrieved May 30, 2008, from http://www.sarbanes-oxley.com/section.php?level=1&pub_id=Sarbanes-Oxley

Wild, J. J., Larson, K. D., & Chiapetta, B. (2007). Fundamental accounting principles (18^th edition). Boston: McGraw-Hill/Irwin.