TheSarbanes-Oxley Act (SOX)
TheSarbanes-Oxley Act (SOX)
TheSarbanes-Oxley Act (SOX) was signed into law in the year 2002 afterfinancial wrongdoing that was highly practiced in the US capitalmarkets. The result was the closure of the largest companies and someaudit firms. The act, therefore, was set up to ensure that there isreliability while the companies are doing the financial reporting aswell as making sure that the audit done on the US firms is of highquality.
Theeffect of SOX to the CEOs and CFOsofpublic companies
SOXaffected the CEOs and CFOs of the public companies in different waysafter it endorsed new responsibilities to them. This is because theyengineered most of the financial scandals, like Enron thus, suchresponsibilities were to make them personally liable in case ofdishonest performance. Enron is a company in the USA that collapsedbecause the leaders manipulated its financial statements for theirpersonal gains. The actions of the top management were unethical asthey were against the interest of those who had heavily invested inEnron. It was immoral for them to alter the figures willingly in thefinancial reports of the firm so that they could gain materially.
First,they should ensure that they review the financial reports with an aimof unearthing any possible errors that are committed by the auditcommittee of their companies. Such analysis will enable them torealize any mistakes at early stages and instruct the responsibleunits to make the necessary adjustments to alleviate the report(Chorafas, 2010). Secondly, they are to ensure that the reportsprepared are fairly represented and do not have any materialmisstatements that may have negative financial implications for thepeople who depend on them to make their decisions. “A crooked topmanagement is tempted to falsify this information, in order to lookbetter than it deserves, and to cover up poor or dishonestperformance” (Lecturer notes). Such a requirement will restore theconfidence of the investors who are victims of the malicious andintentional activities done by the officers of the company who shouldsafeguard them.
Fourthly,they should go through the report to find out the omissions that arematerial in nature and the false ones that can make the finalfinancial statements be misleading to the users. The untruestatements and material omissions can create an exaggeration in thefinancial statements thus, making the companies appear to befinancially healthy, whereas, in reality, numerous financialmalpractices are taking place in the public enterprises. Thus, thetwo officers should eliminate such untrue statements as soon as theyare realized (EY, 2010).
Fifthly,in the establishment and maintenance of the internal controls thatare responsible for reporting the financial declarations of thecompany alongside other disclosures, they should acknowledge thatthey are responsible. Such responsibilities will make them be in aposition to realize the discrepancies in the internal controls andcarry out the necessary corrections to minimize the errors that canoccur. “Because management is primarily responsible for the design,implementation, and maintenance of internal controls, the entity isalways exposed to the danger of management override of controls,whether the entity is publicly held, private, not-for-profit, orgovernmental” (AICPA, 2016). It will be easier, therefore, to tracethe person responsible for overriding the internal controls.
Lastly,they should state how effective the internal controls are when doingthe financial reporting and disclose what they discover to be thematerial changes. This will contribute to determining the efficiencyof the company’s controls and the reports that are prepared fromthem (EY, 2013).
Theseduties are meant to make them be fully accountable for their actionsthat are directly related to the preparation of financial statementsand thus restoring the confidence of the investors. In case theofficers give credibility to the financial statements that havematerial misstatements, SOX has outlined stiff penalties that theywill face personally. It is for the good of the two officers toensure that they observe the rules and regulations of SOX so thatthey cannot face the punishments laid out in the Act. All theiractions that are related to financial reporting should be guided bytransparency and accountability all the time.
Themain advantages and disadvantages of SOX
Thesurveys indicate that since SOX Act was enacted in 2002, there arebenefits that can be directly attached to it in the course of tryingto reduce the fraud in financial statements.
First,there is the reliability of the public companies’ financialstatements. SOX is making every necessary effort to restore thepublic confidence that was lost when the largest businesses in theUS, like Enron, collapsed due to massive financial malpractices. SOXmaintains that an adequate internal controls be maintained by thepublic firms that will lead to quality and more reliable financialinformation (Maleske, 2012).
Secondly,it has strengthened the corporate governance of the companies. Theboard of directors has an increased independence because of itsemphasis on the quality financial statements through robust andreliable internal controls. The directors and managers have anincreased turnover making them concentrate on the regulatorycompliance in all units of the company. The employees of the companybecome disciplined and work towards ensuring that their services areethical as well as ensuring that their actions are governed byhonesty. Most public companies have significantly improved incorporate governance performance in the USA since SOX was enacted(Maleske, 2012).
Thirdly,the financial statement fraud is highly reduced. The financialreports fraud that was intentionally committed by the big companieslike Enron and WorldCom made them collapse, and this necessitated SOXto come up with the methods in which such malicious acts could beminimized. Since its enactment, SOX has never failed to discover anyfinancial fraud in the reports of the public companies. Consequently,the cases of financial fraud have substantially reduced from the timethe act came into operation.
Fourthly,the provisions of SOX have attracted the attention of the private andnonprofit companies to make similar changes as the public companiesas the best practice to benefit just like their counterparts. SOX wasmeant for the public companies, but the nonprofit and private sectorsare implementing it because of the reported benefits that outweighthe attached drawbacks. Such companies have indicated that theprocedures of their corporate governance have improved alongsideother positive outcomes. There is effectiveness in operations andcontrol reported in the private companies as well as motivation tothe employees of these institutions (Chorafas, 2010).
Lastly,it has helped the public companies improve their liquidity. Mostenterprises that have implemented the provisions of SOX haveexperienced an improvement in their market liquidity. The increasedmarket liquidity is because of the disclosures that are mandatory toall the public companies in the USA.
Themain drawback with the SOX is the costs that are associated with it.The costs can either be direct or indirect.
First,in the case of direct costs that need to comply with the requirementsof SOX, the public companies are required to employ additional menhours which will be met at an additional expense. These costs will bemet by the companies thereby reducing their profits. The audit feealso increased significantly in all the public enterprises after theact was applied. Most audit companies adjusted their pricesaccordingly because of the additional duties that they were requiredto observe for them to comply with the requirements of the act(Asian-Pacific Economics Blog, 2015).
Secondly,there were also indirect costs. Most of these expenses are thenon-cash expenditures that have posed challenges in their measurementand quantification. Some of the companies found out the indirectcosts were very high to an extent that they saw it better to goprivate and evade these expenses. Some of the investors lostopportunities to invest with some of the public companies because ofthe strict requirements set by SOX for listing. The companies thatwere unable to meet the requirements are no longer registered withthe US Exchange and have considered being registered in otherexchange markets like the London Stock Exchange where the rules forlisting are not that strict. Most of the domestic companies are alsogoing private because SOX has raised capital for them when investingin the foreign markets.
Thereis also the loss of opportunity costs during the early years oftrying to comply with the requirements of SOX. Lastly, the financialdepartments of the public companies are working to meet thedocumentation reporting requirements as required by act. Theemployees have to strain and take much of their time to meet theconditions set that in most cases have demanded more staff beemployed.
Legislationof public companies
Ibelieve that legislation can to a great extent help ensure that thefinancial statements of public enterprises are accurate. This is onlypossible if such legislation is done in the strictest way possiblethat will give no room for fraud to take place. The previous lawshave failed because they gave a loophole for the top management toget involved in the financial embezzlement of some public companieswithout any punishments imposed on them. The previous laws met a verycrooked top company management that could easily falsify thefinancial reports of the companies without detection as there were nostrong internal controls that could minimize the chances of materialmisstatements in the financial statements of public enterprises.
Currently,the CEOs and CFOs of most companies are mandated by the legislationto ensure that the financial reports they deliver have integrity.“This makes the integrity of financial reporting a fiduciary dutyand an ethical issue” (Lecturer notes). Previously, it is believedthat the internal controls that would have helped minimize fraud butwere tampered with by these two officers with an aim of committingthe financial malpractices to mislead the public and those who dependon the statements to make their final decisions. Nowadays, due tolegislation like that of SOX, the CEOs and CFOs are supposed toensure that they are responsible for the establishment andmaintenance of the internal controls. This will give them no room forcommitting any fraud because they will be held liable for suchmistakes. They should, therefore, ensure that they take note of thisto evade any possible punishments that are set by the SOX. Similarly,some strict fines and penalties can be used to punish the officers incase of any financial fraud detected within their capacity. They,therefore, pay much attention to these to maintain their integrity offinancial services. Lastly, the officers should ensure that theirreputation and that of the companies under them is attractive to theinvestors who have invested in such businesses and also attract somemore. As the management executives, they are tied to the failure orsuccess of the company whereby in the case of failure they will bepunished.
AICPA.(2016). Management Override of Internal Control: The Achilles’ Heelof Fraud Prevention, Retrieved fromhttp://www.aicpa.org/ForThePublic/AuditCommitteeEffectiveness/DownloadableDocuments/achilles_heel.pdfon August 11, 2016.
Asia-PacificEconomics Blog. (2015). Sarbanes-OxleyAct Pros and Cons,Retrieved from http://apecsec.org/sarbanes-oxley-act-pros-and-cons/on August 11, 2016.
Chorafas,D.N. (2010). TheSarbanes-Oxley Act and its Aftereffects,Retrieved fromhttp://www.ittoday.info/Articles/SOX_and_Its_Aftereffects.htmon August 11, 2016.
EY.(2013). TheSarbanes-Oxley Act 10. Enhancing the Reliability of FinancialReporting and Audit Quality,Retrieved fromhttp://www.ey.com/Publication/vwLUAssets/The_Sarbanes-Oxley_Act_at_10_-_Enhancing_the_reliability_of_financial_reporting_and_audit_quality/$FILE/JJ0003.pdfon August 11, 2016.
Maleske,M. (2012). 8Ways SOX Changed Corporate Governance,Retrieved fromhttp://www.insidecounsel.com/2012/01/01/8-ways-sox-changed-corporate-governance?slreturn=1470901053&page=3on August 11, 2016.