Question

The Sarbanes Oxley Act was issued in 2002 in response to the many corporate scandals to help reduce fraud, improve the reliability of financial reporting and restore public confidence in the accounting profession. Identify a financial reporting fraud that occurred prior to 2002 and discuss how the requirements of SOX could have prevented the fraud from occurring.

Answer 1

The Sarbanes-Oxley Act is a federal law that enacted a comprehensive reform of business financial practices.

The 2002 Sarbanes-Oxley Act aims at publicly held corporations, their internal financial controls, and their financial reporting audit procedures as performed by external auditing firms.

The act was passed in response to a number of corporate accounting scandals that occurred in the 2000–2002 period.

This act, put into place in response to widespread fraud at Enron and other companies, set new standards for public accounting firms, corporate management, and corporate boards of directors.

Enron and the Need for Internal Financial Controls

A large scandal involving the public company Enron showed the American public and its representatives in Congress that new

compliance standards for public accounting and auditing were sorely needed. Enron was one of the biggest, and, it was thought, one of the most financially sound companies in the U.S.

Enron, located in Houston, Texas, was considered one of a new breed of American companies that participated in a variety of ventures related to energy. It bought and sold gas and oil futures, built oil

refineries and power plants, and became one of the world's largest pulp and paper, gas, electricity, and communications companies before it filed for bankruptcy in 2001.

Several years before Enron’s bankruptcy, the government had deregulated the oil and gas industry to allow more competition,

but deregulation also made it easier for companies to act fraudulently. Enron, among other companies, took advantage of this situation.

The various misdeeds and crimes that Enron's officers and employees committed were extensive and ongoing.

Particularly damaging misrepresentations produced inflated earnings reports for shareholders, many of whom eventually

suffered devastating losses when the company failed. Many other instances of dishonesty and fraud also occurred,

including embezzlement of corporate funds by Enron executives and illegal manipulations of the energy market.

The Sarbanes-Oxley Act

To cut down on the incidence of corporate fraud, U.S. Senator Paul Sarbanes and U.S. Representative Michael Oxley drafted legislation known as the Sarbanes-Oxley Act (SOX).

The intent of SOX was to protect investors by improving the accuracy and reliability of corporate disclosures in financial statements and other documents by:

Closing loopholes in accounting practices

Strengthening corporate governance rules

Increasing accountability and disclosure requirements of corporations, especially corporate executives, and corporations’ public accountants and auditors

Increasing requirements for corporate transparency in reporting to shareholders and descriptions of financial transactions

Strengthening whistle-blower protections and compliance monitoring

Increasing penalties for corporate and executive malfeasance

Authorizing the creation of the Public Company Accounting Oversight Board (PCAOB) to monitor corporate behavior further, especially in the area of accounting

In response to what was widely seen as collusion between Enron and public accounting firm Arthur Andersen & Co. concerning Enron's fraudulent behavior,

SOX also changed the way corporate boards deal with their financial auditors.

All companies, in accordance with SOX, must now provide a year-end report regarding the internal controls they have in place and the effectiveness of those internal controls.