Question

The Sarbanes-Oxley Act (SOX) was passed in 2002. The legislation was intended to prevent accounting fraud. What did offending companies do to cause legislators to get involved in the situation? What safeguards were put in place by SOX? In your opinion, will SOX prevent accounting fraud? Why or why not? In your opinion, should legislators put further safeguards in place? Why or why not?

Answer 1

SOX was enacted in order to prevent frauds and to restore the faith of the public in these public companies and their executives but reality seems to be different. This was required as huge companies(eg Enron)were involved in huge scandals and took advantage of the deregulation to commit frauds that led to their bankruptcy. Huge and ongoing crimes and wrong deeds were committed even by the employees of these companies. Wrong and inflated earnings report were presented for the shareholders causing them to suffer losses when the company failed. There was also huge embezzelment of the corporate funds.

Safeguards brught in by SOX are as follows:

1. Every public company is required to file their financial reports periodically signed by the principal financial officer that the report doesn’t contain any untrue statements and there are no material omissions. The signatories to the report are alsp responsible for the establishment of validated internal controls.
2. SOX requires that the management should be responsible for putting in place an effective and adequate internal control structure. The management must assess these controls and must report on the same if there are any deficiencies in the same and external auditors also need to certify that effective controls are in place.
3. Companies are required to promptly disclose any changes in the financial condition or any other changes which might affect the public or the investors on an ongoing basis.
4. Criminal penalties, imprisonment upto 20 years were put in place for those responsible for alteration of documents.
5. Criminal penalty was put in place for misleading the public by certifying a fraudulent financial report.

SOX was enacted in order to prevent frauds and to restore the faith of the public in these public companies and their executives but reality seems to be different.

SOX was not very successful in reducing accounting frauds as SOX became an extremely expensive work for the companies in terms of the paper work involved in it. This actually entails huge documentation on what a company does in the operations of the company or with regards to its financial data.

So this SOX exercise only became a way for the government to make the investors and other users of the financial statements feel better in the belief that the government had stepped in to so that the public companies would take strict action against the frauds.Sox law focused more on the detailed documentation of the procedures and little effort was made in the direction of setting up steps that the company should proactively follow to prevent and detect frauds in the companies.

Further Safeguards are not reuired asFraud is a problem that cannot be completely solved by enacting legislations . SOX itself has resulted in huge cost to the companies as a result of the detailed documentation that needs to be maintained year after year. Additional safeguards or regulations would would add more to the expenses of the company without bringing in any substantial benefits in terms of prevewntion and detection of frauds.On the contrary the companies should work towards setting up an ethical culture in their companies which along with substantive internal controls designed in a way that aims at preventing , detecting , reducing and eliminating the frauds.