In 2002, Senator Paul Sarbanes and Representative Michael Oxley sponsored legislation aimed at creating greater financial accountability within corporations and restoring investor confidence in publicly traded companies. The Sarbanes-Oxley Act of 2002 was a reaction to the scandals of corporate giants such as WorldCom, Enron and Tyco. Poor accounting and auditing within these companies failed to discover huge financial abuses committed by chief officers within these companies. The eventual collapse of these companies cost both employees and investors billions of dollars.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, or SOX, achieves several different purposes. In Section 302, it ties CEOs and CFOs to the accuracy and thoroughness of auditing reports. If there are willful or knowing inaccuracies, SOX creates legal penalties for these officers. Section 402 prohibits companies from making personal loans to corporate officers and places limits on their ability to trade company stock. Section 404 mandates a set of internal auditing controls that must be checked and verified by external auditors. Section 409 requires publicly traded corporations to disclose changes in its financial status in real time. Section 902 makes it a crime for anyone to hide or destroy any auditing documents used to commit fraud or alter them so they cannot be used in court.
The single biggest complaint is that it costs too much to implement SOX, specifically Section 404. Regulators originally estimated the costs to be around $91,000, but many companies have found actual costs to run into the millions. Large companies are able to swallow the costs, but smaller companies have found it to be a hardship. For this reason, many startups have chosen to not list on publicly traded markets or decided to trade on foreign markets, such as the London Exchange, to avoid being subject to SOX compliance.
For corporate executives, SOX has changed the structure of their compensation packages. Stock options were a very common part of a company executive's overall compensation plan. When the executive needed cash, the company would loan him money against the value of the stock. The executive got to use the cash value of the stock without having to sell it. Instead of taking stock options as a large part of their compensation package, many changed to another format, including cash, which affected the bottom line of many companies.
Companies keep all their information and records, including financial records, on mainframes. Compliance with SOX is encouraging companies to save everything to avoid dumping vital auditing information. An article on CNET News asked if keeping this large volume of information actually promoted fraud by making it harder to detect financial abnormalities among the volume of unnecessary data. A whitepaper from Data Governance pointed out the difficulty placed on companies by SOX concerning updating their mainframes. Prior to SOX, updates were done manually but manual updates had the risk of errors. Since SOX created a penalty for CEO and CFOs for data errors, many companies had to either change their mainframe updating system to an automated one at a high cost or take their chances.