Question

Please explain in detail

Please explain in detail he Sarbanes Oxley Act How and why does this law arise

Answer 1

Need for Sarbanes Oxley Act :

This law was enacted in 2002 and is also known as SOX. The act is named after US Senator Paul Sarbanes and US Representative Michael G Oxley.

There were many scandals (financial and accounting) affecting corporate world in the united states which cost investors / general public billions of dollars mainly due to change in the share prices of companies. Securities and Exchange Commission was not able to control the scandals in many corporations due to lac of specific laws to prosecute perpetrators of the scam who were behind these scandals. Main scandals which are main reason for enactment of this law are: Enron, Adelphia, Peregrine etc.

These corporates cooked up books of accounts to inflate the revenues and profits to jack up the share prices. Gullible investors bought the shares of these companies hoping to get good returns from the businesses these corporations supposedly owned and operated. As expected, these corporations went bankrupt shortly after the window dressing of the books and financial statements wa revealed. Billions of dollars were robbed from the innocent investors. Securities and Exchange Commission was not able to prosecute the top management and executives, board members, auditors because there were no specific laws. Only corporates/companies were responsible for that and individuals responsible for the crime could not be prosecuted in absence of specific laws.

These scandals and limitations of law enforcement agencies prompted government to bring specific regulations so that top management and board members can be held responsible for any fraud and manipulation in financial statements of companies.

After enactment of these rules(SOX), board members and top management (CEO, CFO etc.) should individually certify the accuracy of financial statements. Under these regulations, penalties for fraudulent financial activity, misstatements etc. are much severe. Also, SOX increased the oversight role of boards of directors and the independence of the outside auditors who audit and certify fairness and accuracy of corporate financial statements/results.

It was noticed in these scams that auditors’ independence was compromised and boards have failed to stop manipulation of financial statement and reports and other fraudulent activities which resulted in huge loss to the investors across US and overseas.

Brief of Act:

The act is mainly divided into eleven chapters covering establishment of public company accounting oversight board, independence of auditors, responsibility of individual executives for preparation and accuracy of financial statements, additional/detailed corporate disclosures, criminal fraud accountability etc.

The act tries to ensure accuracy and fairness of financial statements, by ensuring dependency of auditors and making individuals responsible for preparation and certification of financial statements and reports.  

The act provides for stricter fines and penalties for criminal acts.