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Sarbanes–Oxley Act
➢ The Sarbanes–Oxley Act (SOX) is a major U.S. federal law passed in 2002 to improve corporate
governance, financial reporting accuracy, and internal controls in public companies. Enacted to
restore investor trust by improving the accuracy, reliability, and transparency of financial
reporting.
• Purpose of the Sarbanes-Oxley Act
The main goal of SOX is to protect investors by ensuring that companies provide accurate and reliable
financial information.
Key objectives:
• Increase transparency in financial reporting
• Strengthen internal controls
• Improve corporate governance
• Reduce fraud and accounting manipulation
• Hold top executives personally responsible for financial statements
• Why the Law Was Created
Before SOX, companies had weak regulation and oversight over financial reporting. Major problems
included:
• Executives manipulating accounting records
• Auditors having conflicts of interest
• Weak internal control systems
• Lack of accountability for executives
After the Enron collapse in 2001, investors lost trust in financial markets, so the U.S. government passed
SOX to restore confidence.
• Major Provisions of SOX
1. Section 302: Corporate Responsibility for Financial Reports
This section requires CEOs and CFOs to personally certify that financial statements are accurate.
They must confirm:
• The report does not contain false information
• Internal controls are properly maintained
• Fraud or weaknesses are disclosed
If executives lie, they can face criminal penalties.
2. Section 404: Internal Control Assessment
This is the most important and most expensive section.
It requires:
• Management to evaluate and report on internal controls
• External auditors to verify the effectiveness of those controls
Purpose:
• Ensure systems exist to prevent fraud or errors in financial reporting.
3. Section 401 – Financial Disclosure
Companies must provide clear and transparent financial disclosures, including:
• Off-balance-sheet transactions
• Financial risks
• Accounting policies
This prevents companies from hiding liabilities.
4. Section 409 – Real-Time Disclosure
Companies must disclose material financial changes quickly, so investors get timely information.
5. Section 802 – Criminal Penalties
Severe penalties are introduced for:
• Destroying financial records
• Altering documents
• Committing accounting fraud
Punishment can include large fines and up to 20 years in prison.
• Impact on Internal Control
SOX significantly strengthened internal control systems.
Companies must:
• Document financial processes
• Identify control risks
• Test internal controls regularly
• Fix weaknesses immediately
Frameworks like Committee of Sponsoring Organizations of the Treadway Commission are often used
to comply with SOX.
• Who Must Comply?
SOX mainly applies to:
• Public companies listed in U.S. stock markets
• Their subsidiaries
• Accounting firms auditing these companies
Private companies are not directly required to comply but often follow similar standards.
Advantages of Sarbanes-Oxley
1. Improves accuracy of financial reporting
2. Increases investor confidence
3. Reduces corporate fraud
4. Strengthens internal controls
5. Makes executives accountable
Disadvantages / Criticism
1. High compliance cost, especially for smaller companies
2. Requires extensive documentation and audits
3. Some firms chose to delist from U.S. stock markets to avoid SOX rules