SOX the Sarbanes-Oxley Act (SOX)

SOX

The Sarbanes-Oxley Act (SOX) was introduced as a response to a spate of corporate scandals that had eroded public confidence in the capital markets. The law took several steps to deal with the lapses in corporate governance. The perceived core of the governance problem was poor oversight of management from boards of directors and poor ethics on the part of management. Prior to SOX, it was relatively unlikely that an executive would face criminal proceedings for failing to adequately oversee a public company. Sarbanes-Oxley sought to instill more responsibility into the roles of executives and board members in order to reduce the incidence of fraud and illegal activity, thereby restoring public confidence in the capital markets.

Among the different parts of SOX are the following. The officers of the company must sign the annual report, and are held personally responsible for the information contained therein. The officers, therefore, are responsible for the internal controls that govern the company. SOX also mandates that information about these controls must be published in the annual report. The registered accounting firm performing the audit on the report must also sign the report and will also be held liable for the information contained therein. The financial statements must be accurate, including the inclusion of off-balance sheet liabilities, obligations or transactions (SoxLaw, 2003).

While SOX imposes these restrictions on executives and auditors, it does not fully address the governance issues that lead to the law's creation in the first place. Many of those issues were criminal, rather than ethical, in nature. Certainly instances of fraud would not be discouraged by the need of the executive to sign one his or her name to one more lie.

Combating instances of fraud and poor governance requires that firms go beyond the limited scope of the Sarbanes-Oxley Act. One critical area is with respect to board oversight. The Act mandated that the boards contain enough external members in order to function with relative independence from management. Board members must be sufficiently competent to detect fraud. This means that some board members should have functional competence in the areas in which the company operates while other board members should have significant financial expertise to detect suspicious transactions. Improving governance at the director level is critical to improving governance overall (Guerra, 2004)

Another area where improvement is needed is with respect to auditors and analysts. Public accounting firms had taken the attitude that auditing was an ancillary function to their consulting businesses, creating a conflict of interest. This conflict is to be eliminated, where firms are not to engage in consulting business with the companies that they audit. Analysts must have firewalls between them and the companies they analyze -- they or their firms must not engage in merchant banking with firms that they also analyze.