What Is The Sarbanes-Oxley (SOX) Act of 2002

What Is The Sarbanes-Oxley (SOX) Act of 2002

The Sarbanes-Oxley Act of 2002 was established to prevent fraud in public companies in the United States. Back in the year 2000, several controversies started surrounding public companies with their corporate officers. Investors at this time started doubting the viability of investments, which could permanently impair the economy in the long run. The nail in the coffin was the Enron fraud scandal, which led to the bankruptcy of a well-established company on Wall Street poised to last for decades longer. Its corporate officers were caught embezzling money from the investors, leading to the eventual bankruptcy of the company.

Basically, Sarbanes-Oxley was established to avoid fraud in public companies and keep the public's faith in investing. The main requirement in the act requires companies to establish an internal control system capable of maintaining the integrity of financial statements and financial reporting. The act also requires corporate officers to create a codified statement in writing stating that the company has complied with this requirement. Attesting to this without truth exposes them to criminal lawsuits by the government. This way, corporate officers who knowingly defraud the state by falsifying or manipulating reports for financial gain are criminally liable under the act. Sarbanes-Oxley is a rather lengthy code, but it has three key provisions that explain the overall requirements and the objective of the law. These are sections 302, 404, and 802.

Section 302

Section 302 states that any corporate officer who is fully aware of fraud and still attests to the integrity of the company's records and practices shall be criminally liable under the act. Section 302 codifies the punishment for corporate officers who knowingly defraud the public by wrongly attesting to financial reports which are presented to the investing public. From this section, it would be understood that the requirements under the act were to establish a functioning control system that enables a company to record financial transactions with integrity. An officer, by fully attesting to the company's compliance with this requirement, shall be liable criminally under the act, which sets out harsher punishment for fraud. This provision is the keystone for requiring corporate officers to establish a controlled environment which is free from fraudulent practices.

Section 404

Section 404 codifies the requirement of establishing an internal control on the part of the management and its auditors. This section states that a company operating publicly shall have a minimum level of controls needed to ensure proper financial reporting. This has also required public companies to have reporting methods according to standards set by relevant accounting bodies. This section was severely criticized at first because companies had to incur several expenses to maintain good control systems. Some companies had to establish entire departments just to properly account for accounts with heavy transaction loads, such as accounts payables and receivables. The government stood firm on this requirement. Eventually, companies found ways to use the internal control systems required by the act to improve their operations, by improving their internal reporting practices as well.

Section 802

Section 802 is a more specific section of the act. It deals with the three rules for recordkeeping. The first rule established here is related to falsifying and destroying reports. It codifies the criminal punishment for officers who perpetrate fraud by manipulating reports for personal gain. The second rule sets the amount of time required to retain documents and records to make sure that these are auditable for a period of time. The last rule sets out the specific records needed to be kept by a company at the minimum, to make sure that proper controls are being set.

Sarbanes-Oxley was an attempt to save the US Economy by assuring the public of the integrity of public companies. With several operations stopping all over the country, a looming economic meltdown was bound to happen. Sarbanes-Oxley has established the operating culture of perhaps most of the companies in the world today. Because of globalization, even companies outside of the US were required to follow strict operating rules to make sure that the Enron incident would not happen again. Eventually, countries with strong ties with the US started requiring their local companies to comply with almost identical requirements as the Sarbanes-Oxley Act.