The Sarbanes-Oxley Act of 2002 was passed by the United States Congress as a way to protect investors from the risks of fraudulent accounting conducted by corporations. This act put strict reforms into place to improve financial disclosures and prevent fraudulent accounting practices. There are also regulations within the act that apply to privately held companies, such as the willful destruction of evidence to interfere with Federal Investigations.
The need for this Act arose after one too many large-scale corporate accounting scandals such as Arthur Andersen and Enron. With these big names in the news for fraud, public confidence became rather shaky.
The bill was signed into law on July 30, 2002 in hopes of reestablishing some of the public’s trust in corporations. It stands as the largest-reaching US securities legislation passed in recent years.
The Senate refers to the Sarbanes-Oxley Act as the “Public Company Accounting Reform and Investor Protection Act,” and the House refers to it as Sarbanes-Oxley, Sarbox or SOX.
Regardless what you call it, the Act outlines how corporations must comply with the law. The Act is also intended to add stricter criminal penalties for certain acts of misconduct.
11 Titles Of Sarbanes-Oxley
There are many details outlined by this monumental Act, broken down into 11 different titles. Here are the fundamental points from each title that help make the overall premise more understandable for businesses and investors.
Title I: Public Company Accounting Oversight Board
The Public Company Accounting Oversight Board was instituted in order to manage the audit of all public corporations. The board creates and sets forth the standards and rules for auditing reports as well as inspects, investigates and enforces compliance with these rules. The board is also tasked with central oversight of the independent accounting firms assigned to provide auditing services.
Title II: Auditor Independence
In aims of removing conflicts of interest, there are nine sections within Title II that outline standards for external auditor independence. For instance, audit firm employees must wait one-year after leaving an accounting firm to become an executive for a former client. There are restrictions concerning new auditor approval and auditor reporting requirements. A company that provides auditing services to a client is not legally allowed to provide any other services to that same client.
Title III: Corporate Responsibility
In order to further uphold accountability, regulations impose all senior executives with the individual responsibility of the accuracy of financial reports.
Title IV: Enhanced Financial Disclosures
The Act greatly increases the number of disclosures a company must make public such as off-balance-sheet transactions, stock transactions involving corporate officers, and pro-forma figures. All of these disclosures and more must be reported in a timely fashion.
Title V: Analyst Conflicts Of Interest
The point of Title V is to improve investor confidence regarding the reporting of securities analysts. This section includes codes of conduct as well as the disclosure of any and all conflicts of interests known to the company. Everything must be reported, such as if the analyst holds any stock in the company or has received any corporate compensation, or if the company is a client.
Title VI: Commission Resources And Authority
Title VI outlines a number of practices including the SEC’s authority to remove someone from the position of a broker, advisor or dealer based upon certain conditions.
Title VII: Studies & Reports
Title VII outlines certain studies and reports the SEC and the Comptroller General must perform. These tests and reports include analyzing public accounting firms, credit rating agencies and investment banks to ensure they do not play a role in facilitating poor/illegal practices in securities markets.
Title VIII: Corporate and Criminal Fraud Accountability
Any alterations, concealment or destruction of records in hopes of influencing the outcome of a Federal investigation is punishable by fines and up to 20-years in prison. Anyone that plays a role in defrauding shareholders of publicly traded companies is subject to imprisonment and fines. Title VII also outlines special protections for whistle-blowers.
Title IX: White Collar Crime Penalty Enhancement
There are 6 sections in Title IX, all in aims of increasing criminal penalties for white-collar crimes. This Title adds failure to certify corporate financial reports as a criminal offense, and encourages stronger sentencing guidelines in hopes of making punishments outweigh the potential for quick financial gains.
Title X: Corporate Tax Returns
Section 1001 from Title X mandates the need for the Chief Executive Officer to sign company tax returns.
Title XI: Corporate Fraud Accountability
Title XI includes seven sections dedicated to defining corporate fraud. It defines any tampering of records as a criminal offense punishable under specific penalties. It also outlines sentencing guidelines and increases overall penalties. This particular Title gives the SEC the ability to freeze transactions considered “large” or “unusual.”