What Is the Sarbanes-Oxley Legislation?

Oversight of accounting practices helps protect investors.

Sarbanes-Oxley, formally called the Public Company Accounting Reform and Investor Protection Act, is legislation that was enacted in 2002 in response to financial scandals. The legislation was designed to provide assurance to investors, and it placed many requirements on companies that sell stock shares to the public.

History

A set of guidelines known as the Generally Accepted Accounting Principles had long been respected as a method, when followed, that reflected accurate information on which investors could make financial decisions. Financial scandals, including Enron and WorldCom, demonstrated the need for enforcement. Sen. Paul Sarbanes and Rep. Michael Oxley led the government response, which produced the bill known today as Sarbanes-Oxley Act.

Key Points

Sarbanes-Oxley focuses on honesty, accountability, and competence. Chief executive officers and chief financial officers must sign financial statements indicating their direct knowledge of and verifying the accuracy of the content. Attorneys must report knowledge of any scandalous activity. Boards of directors must be composed primarily of people who are not company executives. Audit committees must include a member with financial expertise. External auditing must be provided as an independent service from other accounting activities. Companies must monitor financial procedures. A company must provide public updates regarding its financial circumstances.

Oversight

Created by the Sarbanes-Oxley legislation, the Public Company Accounting Oversight Board's purpose is to oversee auditing activities of public companies. It aims to ensure that audit reports are accurate, complete and impartial. Companies overseen by the board pay annual fees to support it. The board, in turn, is overseen by the Securities and Exchange Commission.

Penalties

Strict penalties are imposed for violations--these can include fines and imprisonment. Many violations are linked to improper and insufficient documentation and record-keeping practices. These issues led to many of the pre-Sarbanes-Oxley investor catastrophes.

Concerns

Regulations have benefits, but they also come with a cost. Companies must spend to ensure compliance. The original cost estimates to conform ranged from hundreds to millions of dollars based on company size and the reforms needed.

References

• "Excellence in Business, Third Edition"; Courtland L. Bovee, John V. Thill, and Michael H. Mescon; 2007
• The Sarbanes-Oxley Act
• The Sarbanes-Oxley Act: Section 409
• Public Company Accounting Oversight Board: About the PCAOB
• The Sarbanes-Oxley Act: Section 802

Resources

• Federal Accounting Standards Advisory Board