SOX the Sarbanes-Oxley Act (SOX)

SOX The Sarbanes-Oxley Act (SOX) was enacted in 2002 as an investor protection act in the wake of a number of different financial scandals, each of a slightly different type. Public confidence in both financial reporting and in auditing brought about the changes, which were designed to restore public confidence in the accuracy of financial statements and by extension in the entire capital market system. There are eleven sections to SOX, so the impacts on corporate financial reporting are wide-ranging.

SOX establishes rules and regulations for financial reporting, including responsibility for financial statements, transparency in reporting and disclosures, the auditing process and other areas. The legislation is widely believed to strengthen corporate accounting controls. However, there are drawbacks to SOX, many of them related to the cost of implementing the act and the perceived lack of benefit for those costs. A core element of Sarbanes-Oxley is the concept of responsibility.

The CFO and CEO are directly responsible for the financial statements and under SOX need to sign off their personal approval of the statements. They can face legal consequences if the statements are later proven to be fraudulent or otherwise materially false. The auditors as well are held to a higher standard of responsibility than was previously the case.

This increased personal responsibility for financial statements was intended to improve the quality of those statements by providing a specific incentive to executives and auditors to ensure that the statements are accurate. While there is some debate as to whether or not this has come to pass, it is evident that the level of responsibility for financial statements has increased as a result of the passage of SOX. Embedded in the legislation is the creation of a new body charged with SOX oversight, the Public Company Accounting Oversight Board (PCAOB).

This board replaces a system of industry self-regulation and is financed by companies registered with the SEC. The PCAOB has more enforcement mechanisms within its arsenal than previous self-regulatory bodies had, in part because of its connection with the Securities and Exchange Commission. The PCAOB's function heightens the pressure on the executives and auditors to ensure that statements are prepared more effectively.

For accountants working within public traded companies, the role has become imbued with much more pressure as the result of SOX, as the stakes for many stakeholders have been effectively raised. Internal controls have essentially been heightened by SOX. Companies, fearful of the consequences of malfeasance, are now oriented towards ensuring that transactions are recorded properly and that there is oversight of the financial reporting process at all levels.

In addition to increased pressure on accounting departments, this has increased the costs associated with the preparation of financial statements and created more barriers of bureaucracy in between the recording of transactions and the publishing of the statements. The auditing process was also significantly affected by the passage of Sarbanes-Oxley. Indeed, the most significant impacts of the legislation are faced by auditors. Auditors are forbidden to have conflicts of interest, such as consulting agreements with the firms they serve as auditors. This has increased the independence of the audit function.

Auditors are now held directly responsible for the statements. This has shaped some changes in the auditing profession, in that auditing firms now no longer have other relationships with the firms they audit, and the trend in revenues for auditing firms is towards in increase in auditing revenues and a decrease in consulting revenues. SOX also addressed the issue of board oversight. With the increased attention on financial reporting, most boards now have at least one member with strong financial experience to help analyze the financial statements.

This again places increased pressure on those preparing the financial statements. All told, SOX has increased the scrutiny afforded the corporate financial reporting process. These changes, however, have increased investor confidence in financial statements, which in turn has had positive impacts on the stability of capital markets, as fewer scandals emerge. Another interesting implication of SOX has been a reduction in financial re-statements, where firms announce a set of earnings based on rough estimates, only to revise those statements at a later date.

Restatements were epidemic prior to SOX and in many cases appeared to be oriented towards misleading investors. The negative consequences for such errors that have come about as a result of SOX has encouraged.