Sarbanes-Oxley Act: Impact on Corporations and Universities

Introduction to the Sarbanes-Oxley Act

The Sarbanes-Oxley Act of 2002 was intended to help investors feel more confident in the steps they take when relying on a particular organization. There has been a mixed reception regarding how the act has impacted different corporations. While its application is important to most businesses, the cost factor overrides the advantages in some areas. This paper defines the structure of the act and examines the overall effect it has had on organizations. It demonstrates the extent to which smaller public companies are influenced by the rules stated in the act and the reaction of the Securities and Exchange Commission (SEC) to the responses received from these smaller companies. It also shows how non-profit organizations such as universities are dealing with compliance issues, along with recommendations on how to address problems that may arise.

The American Competitiveness and Corporate Accountability Act of 2002, better known as the Sarbanes-Oxley Act, was an outcome of financial scandals involving Enron, Arthur Andersen, and WorldCom. It was passed on July 30, 2002, with the aim of restoring public trust in the corporate sector of America. It was enacted as legislation to safeguard the public and shareholders from being victims of fraud and flawed accounting methods. The SEC controls the administration of this legislation, managing updates based on deadlines and setting rules according to current needs. The Sarbanes-Oxley Act can be considered a defining framework rather than a set of business practices; it specifies the type of records to be maintained and the duration for which they must be stored. The impact of this legislation extends from the financial sector of organizations to the information technology side, which handles electronic records. As per the act, organizations must store all data records — including electronic messages exchanged in business transactions — for a minimum of five years. Violations can result in fines, prison time, or both. This makes it essential for IT departments to devise efficient methods that comply with all rules stated by the legislation while keeping costs to a minimum (Sarbanes-Oxley, 2009).

Key Provisions and Structural Overview

The act requires corporations to adhere to a number of rules. Officers and executives in higher positions are responsible for preparing the company's financial report statements. Executives are not permitted to borrow money from the company they are employed by. Conducting trades within the organization is prohibited during pension-fund blackouts. Disclosure of compensation and profits received by executives is mandatory. Internal audits certified by external auditors are also required. Breaching company security codes is punishable by law and can lead to various forms of penalties. The act stipulates heavier penalties for executives who falsify information on financial reports. Firms are prohibited from providing legal expertise to companies they are currently auditing. The "SOX-404" compliance, directed at larger organizations, requires an annual audit of internal finances. The act as a whole is organized under 11 titles, with the most significant being Sections 302, 401, 404, 802, 906, and 409. The act has jurisdiction over all companies in the U.S. and abroad whose equities and debts are registered with the Securities and Exchange Commission (Exploring the Impact, 2006).

The act led to the establishment of the Public Company Accounting Oversight Board (PCAOB), which is accountable for overseeing the auditors of public companies. Unregistered firms do not have the authority to audit U.S. public-sector companies. This requirement was, however, removed for private firms after some years, eliminating the need for registration with the board. A Ponzi scheme led by Bernard Madoff in 2008 prompted regulators to remove this waiver, making it necessary for all firms to have their details recorded with the SEC so that their activities could be tracked.

Debate Over Effectiveness and Cost Burdens

The success of the Sarbanes-Oxley Act has been discussed from various standpoints over the years. Those who oppose it emphasize how its implementation is expensive and argue that it need not be applied as broadly as it is. They argue that the act has failed to maintain adequate financial records and is hampering business development in the U.S. The Madoff scandal has been cited as an illustration of its shortcomings. A different group believes the act has brought major improvements to the financial statements presented by organizations today and has boosted the confidence of shareholders. Proper compliance with all rules of the act, leaving no room for excuses, is seen as essential for this success to continue. The real impact lies somewhere between these extremes. Even though several years have passed since the act came into being, it remains a hotly debated topic among legal experts. It has come a long way in increasing the reliability of how organizations operate. The collapse of corporations such as Enron and WorldCom — which actually prompted the creation of the act — had previously been viewed as acceptable methods of corporate control. The act was established and sponsored by Senator Paul Sarbanes of Maryland and Representative Michael G. Oxley of Ohio, which explains its name. They aimed to use the act to strengthen the foundations of company management and accounting departments (Mello-e-Souza and Awasthi, 2009).

The expenses associated with Sarbanes-Oxley range from accounting fees and managing internal operations to increases in employee insurance premiums. These extra costs are often passed on to customers through price increases, which can adversely affect the profit margins of smaller companies (Champy, 2007). A major portion of their limited resources goes toward satisfying the law's requirements. As Mello-e-Souza and Awasthi (2009) note, "Financial statement analysis involves exploring a company's numbers in search of explanations for past performance as well as telltale signs about the future. Like a detective, the analyst is seeking the key to unravel a mystery or patterns to help organize a vast array of numbers." Employees dedicated specifically to compliance issues must be hired in addition to lawyers and accountants to address related problems that arise periodically. Surveys conducted by Financial Executives International have shown the amount spent on Sarbanes-Oxley compliance to exceed $4 million per year. A study conducted across different industries by Ernst & Young LLP in 2005 revealed expenses to be more than 50% above initial expectations. This has led to the emergence of several small-scale companies that specialize in helping organizations manage Sarbanes-Oxley compliance issues. The act has had a significant effect on the financial sector broadly, causing companies considering going public to reconsider their decisions and prompting those that relied on American markets for capital to look elsewhere. Public offerings are increasingly being conducted in international markets rather than in the U.S.

SOX in Non-Profit Organizations and Universities

The reach of the act extends beyond large corporations into non-profit organizations as well. Better accounting practices have been recommended for universities. The National Association of College and University Business Officers (NACUBO) produced a report titled "Consideration of Sarbanes-Oxley Guidelines and Applicability at Colleges and Universities." This report demonstrated how universities have used the act to identify areas in which they face financial threats, rather than treating it simply as a set of compulsory rules. They have chosen to apply certain best practices from within the act that would prove beneficial to their operations. If, for example, a college determines that a whistleblowing policy will deliver significant advantages without requiring excessive resources, it might follow Section 806 of the act. Requiring colleges to comply with all sections of the act would not be efficient, as it would demand considerable financial resources that many institutions cannot spare. It therefore makes more sense for them to select a set of Sarbanes-Oxley best practices to assist with their reporting structure, governance issues, and internal controls (Implications for Nonprofit, 2003).

While the act is primarily directed at public companies, it affects universities in several ways. Under the act, transactions conducted within the university and among employees would be subject to greater scrutiny. The integrity of the financial operations of these organizations, controlled by state agencies and related services, would improve. The provisions offered by the act would serve as models upon which standards for other non-profit organizations can be developed in the future. It will create a better understanding of the limitations placed on auditors and allow for deeper scrutiny of the financial and transaction statements they present. While the business governance rules do help universities avoid scandals to a good extent, a blanket application of all sections would not be practical.

Surveys have been conducted to determine the extent to which the Sarbanes-Oxley Act should be implemented in universities and colleges. One study revealed that approximately half of respondents believe incorporating certain sections of the act would be beneficial. A study by PricewaterhouseCoopers titled "Taking the Right Path" brought together presidents and officers of different universities to share their views on the feasibility of having SOX govern their governance structures, risk management, and internal controls. The results showed that institutions, regardless of whether they are public or private, generally have an auditing department with at least one representative possessing financial expertise, with defined roles used to select external auditors who present annual audit reports. Most public institutions already have officers who report on internal control operations to the auditors. However, if an internal control report were required immediately, most institutions would be unprepared. The study also revealed that representatives of public institutions are more likely to certify financial statements than those in private ones. Risk management is fairly robust, with close to 50% of public institutions using risk management techniques compared to around 30% of private ones. Incorporating a more comprehensive risk management structure would be financially challenging for most non-profit institutions (Implications for Nonprofit, 2003).

Works Cited

Champy, J. (2007, May 8). Sarbanes-Oxley advice for smaller public companies. Retrieved June 2, 2010.

Freeman, J. (2009, December 15). The supreme case against Sarbanes-Oxley. Retrieved June 3, 2010.

Mello-e-Souza, C., & Awasthi, V. (2009, April). Probing financial statements in a post-Sarbanes-Oxley world. Retrieved June 3, 2010.

Goins, S., & Giacomino, D. (2009, April 1). Applying Sarbanes-Oxley principles to colleges and universities. Retrieved June 2, 2010.

The Sarbanes-Oxley Act and implications for nonprofit organizations. (2003, March). Retrieved June 2, 2010.

Exploring the impact of Sarbanes-Oxley. (2006, November 21). Retrieved June 2, 2010.

Waldron, H. (2006, June 27). Sarbanes-Oxley — General recommendations on how to achieve SOX compliancy. Retrieved June 2, 2010.