Sarbanes-Oxley Act of 2002 Administration as Also

¶ … Sarbanes-Oxley Act of 2002

administration as also a majority of other western administration witnessed the collapse of corporate giants like Enron & Worldcom in the aftermath of noticeably fraudulent executive actions of these companies. This led to shareholders losing confidence and stringent laws was felt necessary in the form of new legislation to avoid repetition of Enron and Worldcom like incidents. The then President George W. Bush entrusted Senator Paul Sarbanes and Congressman Mike Oxley to come up with stringent new laws which would arrest or at least diminish probability of corporate scandals from repeating which came to be known as the Sarbanes-Oxley Act, of 1992. (Holt, 2008)

Key components of SOX Act covered under major Sections of the Act:

Sec 406 of the Act mandates every senior Financial Executive to be signatories of a Code of Ethics. Sec 409 mandates that companies make adequate disclosure regarding material financial alterations in the company's state of affairs in a speedy and timely way. Sec 802 and 1101 forbids changing, damaging or falsification of any document with the motive of hampering the investigation of any matter within the control of any agency of U.S. administration making it important to preserve, document and archive all records. Sec 806 & 1107 are sections governing whistleblower protection. Sec 807 contains shareholder defrauding penalties that might be associated with backdating matters in case they were not done properly in the first place. Sec 906 contains the requirements of reports at regular intervals ensuring it has all the material information. (Holt, 2008)

Let us understand the primary objective of the Act. The SOX Act's primary objective is that, every public company that is listed on a U.S. Exchange or has in excess of 300 U.S. shareholders, in case of foreign company, must be SOX Act compliant. SOX Act is only compulsory in case of reporting or public corporations. Besides, the effects of SOX are having an extensive impact on private companies as well as small businesses. The primary need is because of the fact that there is an immense public consciousness of the requirement for good corporate governance on every company interactions. Banks, lending intermediaries, accountants, Govt. contract issuers and shareholders in case there are any who are desirous to be aware of knowing that the company they are doing business with are acting in an ethical manner. They also want to know if the management has full knowledge about the functioning of the company and some type of internal control mechanism is in place. (Holt, 2008)

The reporting mechanism is precise and truthful and the management owes complete responsibility of the outcomes of the activities of the company. As a part of the SOX, every person in the management must comprehend and be signatory to a Code of Conduct which is able to instigate confidence and trust both at the internal as well external level of the company. Besides, it is also pertinent to entrust somebody as an internal auditor and as a Compliance Manager who will be the watchdog of the company guaranteeing that the Policy and Procedures are adhered to and the rules and expectations of governments as also other regulators are observed. He can also be designated as the whistleblower and he should be in possession of definite instructions as well as authority to handle situations in a correct and efficient manner. (Holt, 2008)

An appropriate Internal Control System needs that a fixed set of rules or procedures are set up in concert with a system of guaranteeing that they are observed which is the work of an internal auditor. The company must have at least an independent Director on Board. In a lot of situations it was observed that in case of illegal actions, a Director be it company or independent was defended from personal liability for errors or mistakes in judgment when they wee able to prove that they had employed normally cautious business judgment. In case the company is issuing shares for the public, or planning for a Merger & Acquisition, corporate loans to insiders must be called in. (Holt, 2008)

It is often problematic to clear them from books quickly, especially in case they are of long-term nature. It is always important to employ a documentation manager. The person will ensure that every document records and transactions, financial documents, communications or any other types of documents are accurately preserved and filed and are accessible at the time of its need. This is because during times of problems, availability of concrete paper trail prevails over all. And paper currently covers electronic communications also. (Holt, 2008)

(2) Criticisms surrounding the Act

Despite the sweeping changes ushered by SOX, it has been receiving its share of criticism. There has been a feeling among the financial executive community as per a survey described in CFO magazine that the cost of compliance outweighs the benefits outlined in the SOX. The academic and business community emphasize that some of the SOX's most important provisions provide miniscule or absolutely no safeguard to investors and the associated high costs placed on companies to conform to the provisions of SOX. The Act's leading objective is increasing investor confidence, but the 'compliance by checklist' method in connection with disclosure and corporate governance might give guarantee that a company is adhering to the rules although it is contentious if the investors stand to gain from the same. (Wade, 2008)

It has been felt that the lawmakers and regulators must discard the present insider trading laws. But equally persuasive arguments are there which favor the insider trading ban. Likewise in connection with a lot of corporate governance practices, compelling arguments are there which states that a specific practice is good and equally convincing arguments exists that the identical procedure has not been able to improve the enterprise's performance or governance. These are prominently demonstrated by some of the incongruities associated with some of the SOX's important provisions. (Wade, 2008)

It is an absurdity that businesses which were most aggressive in manipulating earnings were the companies which profited the maximum from the provisions of SOX. Even though SOX appears to have reinstated some of the investor confidence, nevertheless according to some research it might not be the case. For instance, SOX Sec 301 mandates that each member of an audit committee should be independent. Experimental research nevertheless is unable to prove irrefutably that an audit committee established completely by independent directors really improves the performance of the company. It is doubtful whether an audit committee comprising of independent directors will help in reduction of accounting wrongdoings. Therefore Audit Committees set up after SOX might not get increased investor confidence. SOX's tackling of insider trading is also debatable. A lot of disagreement exists whether SOX improves company's performance, betters the quality of financial disclosure or helps in investor protection. (Wade, 2008)

There have been complaints that SOX's corporate governance provisions are unable to deal with the problems that resulted in the infamous accounting fiascos during 2001 and 2002. It has also been claimed that the Act highlights on petty issues like the person having access to office keys while sufficient importance has not been accorded to issues regarding the person having access to financial data. Several people of this genre arrive to the conclusion that SOX will not be able to protect investors from financial fraud at the corporate level in future, depending in experimental research which point out that some of the changes in corporate governance under the Act will not be able to dissuade fraudulent financial reporting. There does not seem to be any meaningful coherence between some of the Act's most important Sections and enhanced performance of the company. (Wade, 2008)

Besides, there is a lack of correlation between the provision of non-audit services and quality of audit. Likewise in respect of Sec 402(a) and Sec 302 it can also be similarly argued. Sec 402(a) forbids public companies which are not financial institutions from making loans to executives which was framed to avoid unavoidable disagreement among the interests of executives and the interests of the enterprise on behalf of whom they are working. But experimental researchers advocate that executives raise their equity investment in their enterprises after getting firm loans. These equity purchases assist in aligning the interest of the executives with those of the company and its shareholders. Thus there is a lack of unanimity regarding the effectiveness of Sec 402(a) as an instrument that safeguards investors. Moreover, under Sec 302, Chief Executives and Chief Financial Officers should confirm as regards the exactness, nevertheless experimental research results show a variance if executive certification gives investor with any material information or benefit. (Wade, 2008)

(3) Economic consequences if any for companies as a result of implementing the Act:

Regardless of the claimed advantages of SOX, it has often been noted that speedy legislation of the Act was done for gaining political mileage. As the Bush administration was drawing flak from the Democrats for soft-pedaling on corporate swindles in the Congressional Voting of Nov' 2002, the Republicans were keen to loosen the pressure by venting their determination to book cases of corporate fraud. The business community cites that there is hardly any economic consequence of compliance. Besides, the Financial Executives International undertook a survey of 224 companies regarding the direct costs involved in becoming Sec 404 of SOX compliant. The result of the survey revealed that the average first-year cost estimate of nearly $3 million for almost 26,000 hours of internal duties and 5000 hours of external work. (Zhang, 2005)

Besides additional audit fees of $823,200 is involved that translates to a rise of 53%. While additional costs are normally regarded as substantial, they are possibly inundated by the opportunity costs of resources and the likely intense effect of SOX on business practices. This apart, the Act puts Executives to more degree of litigation risk as also harsher penalties. Because of these, CEOs will take less risky actions, as a result of which they will change their business strategies and this will have a value reducing effect of their companies. The direct and indirect private costs of SOX on companies could far offset its private benefits since it is probably extremely costly to eradicate every type of corporate wrongdoings. Complete absence of fraud is utopian and can be attained through a very rigorous control mechanism which eliminates almost all prudence and flexibility in business practices. This lack of flexibility can be more damaging for the majority of companies compared to a few swindles. (Zhang, 2005)

Besides, the enactment of SOX propels a wide-ranging concern that SOX could indicate a shift towards greater federal regulation and lawmaking of corporate USA. The monetary or economic significance of the SOX Act has been accepted widely and is regarded as analogous only to that of the Securities Act of 1933 and 1934. Since SOX as well as the message sent by SOX regarding the future legislation possibly changed stock prices and their effect are unable to be separated, it cannot be inferred that SOX implementation is costly. But evidence alongwith the cross-sectional tests imply that SOX has the possibility of imposing net private costs on companies. Legislators expect SOX to improve corporate controls of companies and check misrepresentations of accounting. In case the exposed accounting scams which resulted in the rulemaking actions recommend a persistent market failure, the Acts can be able to enhance the company's value as well as efficiency. For instance, legislations which lower the transaction expenses of takeovers can enhance market efficiency for corporate controls and raise the value of the firm. (Zhang, 2005)

Nevertheless there is a lack of clarity that the remedies of administration are invariably less costly compared to the private contracting process, particularly in SOX's case. The business fraternity as also some research scholars disparages SOX on specific issues. Business Executives protest regarding the matter of additional compliance costs as also indirect opportunity costs forced by SOX. They are of the opinion that adhering to the rules distracts their attention from carrying out business and brings in scanty benefit. Besides, SOX's economic consequences are little as it discourages CEOs from value-increasing the risky investments, since SOX considerably raises the litigation threats of management. The change in management's risk-taking behavior will possibly decelerate the growth of their firms and even dissuade economic growth. (Zhang, 2005)

(4) Has SOX achieved its goals so far?

SOX in its attempt designed a unique, semi-public institution to supervise and control auditing, the Public Company Accounting Oversight Board -- PCAOB. The primary task of this new Board was implementing a second important goal i.e. To enlist auditors to enforce current laws against theft and fraud by Corporate Officers. Strengthening this core are new rules governing the auditor-firm association, rotation of auditors, auditor provision of non-audit services and finally whistle-blower provision. In regard to fulfillment of goals, at the direct level, the laws crafted novel incentives for firms to expend money on internal controls, apart from the increases in audit costs which would have happened after the corporate scandals of the early part of 2000 decade. (Coates, 2007)

In exchange of these enhanced costs, SOX guarantees a series of long-term benefits. It was envisioned that investors will experience a reduced threat of losses from fraud and theft, and take advantage from increased reliable financial reporting, higher transparency as well as accountability. It will be the public companies that will stand to gain in the form of lower cost of capital, and the economy will benefit due to enhanced resource allocation and speedy growth. Nevertheless, the overall costs of SOX are difficult to quantify and the advantages also harder, therefore any sincere evaluation of the SOX should be provisional and qualitative. Nevertheless, SOX will bring about long-term advantages. However even after passage of several years following the enactment, SOX on the whole still is a process under construction. (Coates, 2007)