Introduction
Sarbanes Oxley Act, commonly known as SOX, has come into being in 2002 and its compliance is mandatory for reporting of financial information by firms. The aim of this paper is to discuss Sarbanes Oxley Act of 2002, the reason of its creation and how it prevents inappropriate behaviour in financial reporting. The paper has three sections. The first section discusses what Sarbanes Oxley Act, 2002 is and the need for the creation of such an act. The second section re-establishes the role of Sarbanes Oxley Act (2002) in the prevention of fraudulent financial reporting. The third section concludes the paper.
Sarbanes Oxley Act, 2002 and its Need
The introduction of Sarbanes Oxley Act, in 2002, was in response to revelations of fraudulent financial reporting by a few large corporates like Enron, WorldCom etc. during the period. Such revelations of misrepresentation of financial statements and subsequent organisational collapses led to financial losses for investors who began to lose faith in investments. The loss of investor confidence created the need for a regulatory framework to bring about more transparency and accountability in the system, and Sarbanes Oxley Act (2002) came into being. The act helped restore investor confidence and faith in the security market, thereby encouraging investments.
The primary objective of Sarbanes-Oxley Act was to create accountability for companies' financial statements (Spear, 1999-2014). The name of the act is after Senator Paul Sarbanes and Representative Michel Oxley who were the main architects of the law (Soxlaw.com, 2006). In this act, major changes were introduced to the regulation of financial practice and corporate governance (Soxlaw.com, 2006).
Role of Sarbanes Oxley Act, 2002 in Preventing Fraudulent Financial Reporting
The Sarbanes Oxley Act ensures dissemination of accurate and fair information by organisations in their financial statements. The act prevents fraudulent reporting activities in mainly four ways.
Firstly, to ensure obedience and discourage non-compliance, the act entails criminal penalties for deviant behaviours. According to Spear (1999-2014), the act stipulates that anyone who knowingly alters, destroys, mutilates, conceals, covers up or falsifies financial records "shall be fined under this title, imprisoned not more than 20 years, or both." Such external penalties serve as a deterrent and prevent fraudulent financial reporting.
Secondly, it discourages senior management of organisations to get involved or promote any such fraudulent activity by mandating them to endorse the released financial statements. According to Spear (1999-2014), under section 302, the act requires chief financial officers to certify that the financial reports "fairly present in all material respects the financial condition" of the company. The act also proposes that top management must ensure that financial information is accurate and not misleading. According to Purcell (1999-2014), the act also imposes on upper management a duty to disclose any material weakness in the company's internal control system.
Thirdly, the act mandates companies to report additional information like off-balance sheet financial transaction, internal control structures and note on material financial changes in the organisations that brings about more transparency in financial reporting.
Fourthly, the act encourages firms to invite external auditors for reviewing financial reporting and the effectiveness of its corporate governance. Independent reviewers increases transparency in the system and minimises fraud risk.
Conclusion
Sarbanes Oxley Act was introduced to curtail fraudulent financial reporting and boost investors’ confidence in the security market. It prevents misrepresentation of facts in financial statements by imposing criminal penalties for deviants, imposing senior management certification on financial statement and mandating organisations to report all material off-balance sheet financial transactions. It also encourages firms to conduct independent audits to bring about more transparency.
References
Purcell, Carson (1999-2014). What is Sarbanes Oxley Law? Retrieved from http://www.ehow.com/about_5082561_sarbanes-oxley-law.html
Spear, Bryan (1999-2014). Sarbanes-Oxley Act. Retrieved from http://www.ehow.com/facts_6867318_sarbanes_-oxley-act.html
Soxlaw.com (2006). A Guide to the Sarbanes Oxley Act. Retrieved from http://www.soxlaw.com/
