What Is Sarbanes Oxley Law?

The Sarbanes-Oxley Act was passed by Congress in 2002 in an effort to prevent and punish corporate corruption and to repair investor confidence. The act imposes on all publicly traded corporate organizations the requirement of mandatory accounting oversight, detailed disclosure requirements and criminal liability for noncompliance or violations of the act.

Legislative History

Sarbanes-Oxley is named for Sen. Paul Sarbanes and Rep. Michael Oxley, the act's primary authors. The law was overwhelmingly passed by both houses of Congress in response to the widespread public and government outrage against corporate abuses. Fraudulent accounting practices and misleading financial reports issued by such corporate giants as Enron, WorldCom and Arthur Anderson caused millions of dollars in losses to investors and an irreparable damage to the public trust.

Corporate Responsibility

Sarbanes-Oxley now clearly places responsibility on corporate executives for the content of a company's financial reports issued to investors. Executives must certify that they have reviewed the reports and that the reports contain no materially false statements or omissions. Financial reports must not be misleading; they must impart a clear and accurate portrayal of the company's financial condition. Although executives need not draft the reports, they must implement and monitor internal controls that affect their preparation.

Internal Controls

A key feature of Sarbanes-Oxley is the responsibility of management to establish, maintain and assess a system of controls that discourages fraud and prevents mistakes in the reporting of a company's assets and liabilities. The act also imposes on upper management a duty to disclose any material weakness in the company's internal control system. The effect of this requirement imposes upon corporate executives responsibility over the content of the financial report as well as over those who prepare the reports.

Disclosure

The underlying intent of Sarbanes-Oxley is to deter abuses by accounting professionals. The law now requires accountants to prepare corporate financial reports in accordance with generally accepted accounting principles (GAAP), the commonly accepted standard of recording and reporting accounting data. The act also requires the disclosure of transactions that materially affect a company's finances but that might not appear on the company's balance sheet because of the way in which the transactions are structured.

Timeliness of Disclosure

Publicly held companies must now disclose to investors and other company stakeholders, in commonly understood terms, any material changes in the company's financial outlook. Disclosure must be made in a timely manner for the protection of investors and in the public interest. Sarbanes-Oxley has been interpreted to require disclosure in as little as two to four days; under the old law, these disclosures did need not be revealed until the subsequently issued quarterly report.

Criminal Penalties

Sarbanes-Oxley imposes criminal sanctions for knowing and willful violations of the act. The law specifically prohibits the certification of knowingly false documents, involvement in securities fraud, alteration of corporate documents and retaliation against whistle-blowers. The threat of costly fines and even incarceration is intended to deter corporations under investigation from engaging in document destruction and the obstruction of justice. The penalties target the corporate officers themselves, assigning individual responsibility at even the highest levels of corporate management.