Sarbanes-Oxley Act

The Sarbanes-Oxley Act (officially titled the Public Company Accounting Reform and Investor Protection Act of 2002), signed into law on 30 July 2002 by President Bush, is considered the most significant change to federal securities laws in the United States since the New Deal. It came in the wake of a series of corporate financial scandals, including those affecting Enron, Arthur Andersen, and WorldCom. The law is named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH). It was approved by the House by a vote of 423-3 and by the Senate 99-0.

The act was designed to review dated legislative audit requirements. The goal of the act was to protect investors by improving the accuracy and reliability of corporate disclosures. The act covers issues such as establishing a public company accounting oversight board, auditor independence, corporate responsibility and enhanced financial disclosure.

Provisions

Its major provisions include:

Certification of financial reports by CEOs and CFOs
Ban on personal loans to Executive Officers and Directors
Accelerated reporting of trades by insiders
Prohibition on insider trades during pension fund blackout periods
Public reporting of CEO and CFO compensation and profits
Additional disclosure
Auditor independence, including outright bans on certain types of work and pre-certification by the company's Audit Committee of all other non-audit work
Criminal and civil penalties for securities violations
US companies are now obliged to have an internal audit function, which will need to be certified by external auditors.
Significantly longer jail sentences and larger fines for corporate executives who knowingly and willfully misstate financial statements.
Prohibition on audit firms providing extra "value-added" services to their clients including actuarial services, legal and extra services (such as consulting) unrelated to their audit work.
A requirement that publicly traded companies furnish independent annual audit reports on the existence and condition (i.e., reliability) of internal controls as they relate to financial reporting.
Internal controls

Next to this the company's CEO and CFO should report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports as stated in section 404 of the act. The Public Company Accounting Oversight Board (PCAOB) ([1]) has issued some guidelines on how management should render their opinion.

The main point is that management should use a risk management approach such as COSO (which descibes how to assess the control environment, determine control objectives, perform risk assesments, and identify controls).

Debate

While addressing a number of domestic concerns, the Act has been criticised by foreign regulators for seeking jurisdiction over their national affairs.

Smaller companies may be affected by Sarbanes-Oxley if trading with a large company subject to it. In addition to this a large number of them are requiring their smaller suppliers to register with the ISN.

An analysis at the Cato Institute website by Richard Bassett and Mark Storrie of Risktoolz, a firm that provides corporate finance services, is critical of a law that criminalizes previously wrong but noncriminal behavior in corporate finance service providers. They conclude that Sarbanes-Oxley "will likely have the effect of harming investors by penalizing risk taking on the part of corporate management and increasing the quantity but not necessarily the quality of financial reports." [1]

There is also some concern that the "reporting up" requirements of section 307 of the Act may erode attorney-client privilege.

"There is no question that, broadly speaking, Sarbanes-Oxley was necessary," said John A. Thain, chief executive of the New York Stock Exchange, in remarks echoed by others at the roundtable. [1]