The Sarbanes-Oxley Act of 2002 is a law passed by the United States Congress on July 30, 2002, to protect investors against misleading financial reporting by firms. It was also known as the SOX Act of 2002, and it mandated rigorous modifications to existing securities regulations as well as harsh new penalties for violators.
The Sarbanes-Oxley Act was passed in response to financial scandals that rocked publicly traded corporations like Enron Corporation, Tyco International plc, and WorldCom in the early 2000s. This federal law was enacted in 2002 to regulate financial reporting and improve corporate governance. The high-profile thefts rocked investor trust in the reliability of company financial statements, prompting many to call for a revision of decades-old regulatory rules.
Understanding the Sarbanes-Oxley (SOX) Act
The Sarbanes-Oxley Act of 2002 altered or supplemented existing laws dealing with security regulation, such as the Securities Exchange Act of 1934 and other regulations enforced by the Securities and Exchange Commission (SEC).
The new legislation incorporated updates and additions in four significant domains:
- Corporate accountability
- Increased criminal penalties
- Accounting oversight
- New safeguards
Key Provisions of the Sarbanes-Oxley (SOX) Act
The Sarbanes-Oxley Act of 2002 is a complicated piece of legislation. Section 302, Section 404, and Section 802 are the section numbers of three of its important provisions.
Section 302 of the SOX Act of 2002 - This clause requires senior executives to personally testify in writing that the company's financial statements "fairly depict the issuer's financial status and results of operations" at the time of the financial report. Individuals who approve fraudulent financial statements can be subject to severe criminal penalties, including imprisonment.
Section 404 of the SOX Act of 2002 - This clause requires management and auditors to create internal controls and reporting procedures to ensure that those controls are adequate. Several critics of the law have claimed that the Section 404 requirements might be detrimental to publicly traded corporations since it is often costly to implement and maintain the requisite internal controls.
Other requirements under the Act include:
- Off-balance-sheet activities and interactions that potentially have an influence on financial status must be disclosed in periodic reports.
- Personal loans from corporations to CEOs are nearly usually prohibited.
- Institution of fines and prison terms for tampering with or destroying documents in the course of investigations or court proceedings;
- Security violations must be reported to the CEO by attorneys who represent public firms before the SEC.
Criticisms of the Sarbanes-Oxley Act
From the beginning, detractors of the Act included numerous CEOs who thought they were unfairly burdened by additional restrictions as a result of the dishonest and careless actions of a few individuals.
Opponents also claimed that the Act was a politically motivated response to a few high-profile corporate financial problems, and that it would stifle competition and business growth.
Business executives have expressed concern that complying with the Sarbanes-Oxley Act's rules would consume too much executive time and cost an unreasonable amount of money.
Benefits of the Sarbanes-Oxley Act
Several business executives, on the other hand, recognised the need for improvement and believed the Act may drive better financial practices that would benefit corporations and their stakeholders.
Moreover, even some who were at first dubious of the Act gradually recognised its merits as the law was fully implemented in succeeding years.
Proponents of the bill specifically stated that the Act aided corporations in improving financial management by strengthening controls, standardizing processes, enhancing paperwork, and establishing greater board monitoring.
According to studies, the Act enhanced investor trust.