Overview of the Sarbanes-Oxley Act
The Sarbanes-Oxley Act is a U.S. federal law that protects the interests of investors by making certain practices compulsory in financial record keeping and reporting for companies. This law was passed in 2002 following major corporate scandals affecting investors and payment of stock value in Enron and WorldCom, amongst others. It was reported that several companies “used accounting trickery, shell corporations, and other fraudulent techniques to hide business losses from the public and keep stock prices artificially high. Executives and board members used this deception to enrich themselves, cashing out and leaving investors and, in Enron’s case, employees who had been urged put their retirement into company stock holding the bag when the deception could no longer be maintained, and the stock price collapsed.” This scandal created a national deficit in investor earnings, prompting two U.S. representatives, namely Senator Paul Sarbanes and Representative Michael Oxley, to sponsor the bill in hopes that the Act would strengthen corporate accountability and governance.
Congress’s primary aim was to impose reporting, accounting, and data retention laws to prevent company managers from interfering with audits. In addition, the Act imposed regulatory laws to improve corporate governance and behaviors, holding managers and companies accountable for the production and accuracy of data they share with investors before buying stock and through the period of owning stock in all companies. Although the Act primarily targeted reports given to auditors, it placed heavy regulations on the accuracy of the information, threats, and data that must be made available to financial auditors and investors.
Provisions and Requirements of the Sarbanes-Oxley Act
The Act rightfully has many provisions; some of the essential requirements that apply to private companies, such as small businesses and publicly traded companies, include:
- No matter how large or small, public companies need to file regular reports with the Security Exchange Commission. Additionally, all reports filed must be signed by top executives of the company as to the authenticity of the reports being filed.
- Section 404 is vital to small businesses because it includes a requirement for annual and quarterly audits, including the company’s internal assessment of financial systems. “This assessment must show that there are enough controls in place to safeguard the accuracy of the company’s financial data. This assessment is called a Section 404 audit and is done along with a financial audit. Unfortunately, this has proved the most onerous part of the Act for small companies because it means spending more money on auditors’ reports and collecting more types of financial information.”
- The Act explicitly stops all companies from procuring the destruction of any data to impede a federal investigation, external investigation, or audit. In addition, some penalties for data destruction might include up to 20 years in prison.
- Provision has been made in the Act to stop companies from retaliating against whistleblowers. For instance, a company cannot terminate an employee’s service because he acted as a whistleblower. Additionally, any retaliation might lead to up to 10 years in prison.
- Section 409 of the Act states that “any material changes in the financial conditions or operations of the company must be disclosed to the public in a timely manner.”
Additionally, the Act makes clear that all “applicable companies must establish a financial accounting framework that can generate financial reports that are readily verifiable with traceable source data. This source data must remain intact and cannot undergo undocumented revisions. In addition, any revisions to financial or accounting software must be fully documented as to what was changed, why, by whom, and when.”
Conclusion
The Sarbanes-Oxley act is a federal law that dictates how all public companies and even some private companies are required to disclose financial information. Amongst other requirements, the Act burdens all businesses, no matter the size, to disclose information, keep proper data records, annual and quarterly audits of finances internally and externally, and mandate reporting any financial changes to investors. Although penalties for noncompliance with this Act are severe and can include jail time for some offenses, small businesses must familiarize themselves with the Sarbanes-Oxley Act and ensure full compliance with its provisions.
Sources
https://www.sec.gov/info/smallbus/404guide/intro
https://sarbanes-oxley-act.com/
H.R.3763 – 107th Congress (2001-2002): Sarbanes-Oxley Act of 2002, H.R.3763, 107th Cong. (2002), https://www.congress.gov/bill/107th-congress/house-bill/3763/text.
Lisa Magloff, How Does the Sarbanes Oxley Act of 2002 Affect Small Business Owners? https://smallbusiness.chron.com/sarbanes-oxley-act-2002-affect-small-business-owners-877.html
Your blog post breaks down a very complex Act into digestible words. The way you distinguish what public companies versus small businesses need to do according to this act are very useful. Your simple and concise wording makes it easier to figure out what steps to take.
Hi Zainab!
I really enjoyed reading about the Sarbanes-Oxley Act, and how it now protects investors from the trickery and spoof accounting done by these big corporations. It was really interesting to learn how the Act protects whistleblowers by forbidding retaliation by a corporation, with a potential punishment of up to 10 years in prison. As someone who recently watched a few videos about Enron, I was somewhat familiar with some of the aspects in which Enron used to trick individuals. It was nice reading about the intricacies of these new laws that were put in place. You did a great job explaining these and how they apply to both small and large businesses.
-Alec Shields
Hi Zainab! You did a great job of summarizing and parsing a complex law. As mentioned above, I also thought it was valuable that you distinguished between what a publicly traded company and a small business need to do to comply with the law. You came across as very knowledgeable about the law and its many intricacies. My only suggestion would be to identify who your specific audience is and tailor the advice and language/tone to that audience.