Abstract
The Sarbanes-Oxley Act changed the ethical nature of accounting for publicly traded companies. The Act requires new forms of ethical behavior from companies, such as creating and maintaining a code of conduct that all employees, even executives, must follow. It also requires that they honestly and accurately report financial reports and maintains that the executive officers of a company have the most responsibility in reporting and certifying that the information is correct. The Act also changes the auditor-client relationship by making auditing more independent of the client, establishing an auditing committee overseen by the SEC, and ensuring transparency.
The Sarbanes-Oxley Act (SOX) was created in the wake of the financial scandals of the early 2000s, notably the Enron scandal. SOX created strict regulatory standards for all publicly traded companies, with the goal of helping investors by preventing companies from skewing their financial reports to make the company look better than it really is. SOX has been considered one of the most far reaching acts affecting how public companies operate since the 1930s (Verschoor, 2012). The act increases corporate responsibility in regards to financial reporting, and has enhanced the role of auditors investigating companies. The SOX Act directly increased confidence in financial reporting that was lost after the early scandals by providing a legal means to hold companies accountable for misreporting financial reports in an effort to make their company appear to be better investments than they really are.
The SOX Act helped redefine business and accounting ethics for publicly traded companies. The need for ethical reporting is clear, as shareholders need to be able to decide for themselves if they choose to invest in a company or not with all of the proper information provided, but several sections deal with implementing an ethical code of conduct that senior management is expected to follow. The importance of this decision lies in the revelation that Enron management had chosen to violate certain aspects of their code of conduct in order to skew reports (“Corporate ethics and Sarbanes-Oxley,” 2016). Now, companies are required to have a code of ethics in order to be listed on the NYSE or NASDAQ. Under section 402, companies are also required to submit their code of conduct for all employees, and specify why they do not have one if the company chooses not to create one. Section 406 of the act provides some basic guidelines for what companies should include. The company is also responsible for releasing statements every time the code of conduct changes to ensure shareholders are aware.
Under section 302, CFOs and CEOs are required to sign off and certify that they have reviewed the financial reports of their companies. These officers are required to attest that the information provides is accurate and that they understand their roles in ensuring accuracy and in promoting an honest corporate business culture. This section is extremely important, because it makes it clear who is primarily responsible for accurate reporting; chief company officers also are not able to pretend that they did not have the required information, which is important when determining culpability and responsibility (Murray, 2016).
Section 402 also makes it illegal for employees, no matter how high, to loan money to their executive officers. Subsidiary companies are also not allowed to extend the same type of credit in an effort to ensure the money circulating through the system can be accurately reported (Murray, 2016). Most important to the bill is the “real-time disclosure” clause in section 406, which mandates that companies disclose financial information in an effective time frame, and do not wait for opportunistic moments. Companies are required to disclose on a set schedule. It also mandates that any change in a company’s financial situation must be disclosed as soon as possible, and the report must be easy to understand for the average consumer/investor. These disclosures are necessary to investors and the public interest, and help ensure these groups have all the information necessary to make well-reasoned investments.
Section 404 of the bill requires companies to prove that they have internal control mechanisms in place to help alleviate the chance of fraudulent reporting. This section of the bill is controversial, as it significantly increased the costs for companies entering the publicly traded sphere, due to the necessity of hiring internal auditors and maintaining new departments to protect the company’s financial reporting (Verschoor, 2012). This section also helps increase the professionalism of the corporate auditing committees and allows them a legal basis for conducting ethical audits in the workplace. This section has also led to a greater transparency in the financial world, and it has directly changed the ethics of financial accounting, shifting the role of the accountant away from that of just a financial reviewer to that of an ethical reporter.
SOX also changed the way auditing works, as independent auditors are now used by the SEC to ensure that companies are not committing a felony by fraudulent reporting. Auditor are required to examine the accounting rules of companies and make sure they follow ethical standards; if they do not, the company must change them at their own expense (Resourceful, 2003). Auditors are also expected to be able to remain objective in regards to the company they are auditing; they must avoid conflicts of interest and report them when the need arises. The Act also set up an independent board called the Public Accountant Oversight Board, which monitors the SEC’s external audits (“How the Sarbanes-Oxley act of 2002 impacts the accounting profession,” 2015). The Board is comprised of CPAs, and they control the rules and codes of auditing in compliance with the generally accepted accounting principles, otherwise known as GAAP.
The Board is even allowed to investigate accounting firms in order to ensure they are following the SOX Act to the letter. The Board is also able to sanction and fine businesses that are not following the required laws. Additionally, foreign firms must submit their accounting information through the board if it details information about another company, such as if a foreign accounting firm audits a US based company.
Further changes to the relationship between auditors and their client companies occurred as a result of SOX. Auditors cannot audit companies where one of their former employees went on to gain an executive position at the client company, which would constitute a conflict of interest. Auditors also do not report to the company’s management, but directly to the Auditing Committee (“How the Sarbanes-Oxley act of 2002 impacts the accounting profession,” 2015), changing the ordinary chain of command. Auditing companies are now expressly forbidden to offer any services other than audits, furthering protecting the conflict of interests clause. Auditors also cannot provide eight types of consulting services: bookkeeping, information systems design and implementation, appraisals or valuation services, actuarial services, internal audits, management and human resources services, broker/dealer and investment banking services, and legal or expert services related to audit services (“How the Sarbanes-Oxley act of 2002 impacts the accounting profession,” 2015). Thus, auditors are expected to remain fully independent of their client companies to ensure accuracy and unbiased evaluations of the company’s accounting standards.
The SOX Act changed the world of financial accounting dramatically to protect the financial stability of employees, investors, and the world economy as a whole. It changed the ethical standpoint of companies by making them directly responsible and liable for accurately reporting their financial situation, and also changed the nature of auditors to ensure that they remain unbiased and independent of the client company. These factored together makes it extremely difficult for a company to misreport and skew their financial statements.
Works Cited:
Verschoor, C. C. (2012, September 5). Has SOX been successful? Retrieved June 15, 2016, from accountingweb, http://www.accountingweb.com/practice/practice-excellence/has-sox-been-successful
Corporate ethics and Sarbanes-Oxley. (2016). Retrieved June 15, 2016, from findlaw.com, http://corporate.findlaw.com/law-library/corporate-ethics-and-sarbanes-oxley.html
Murray, L. J. (2016). Sarbanes-Oxley code of conduct requirements. Small Business Chron. Retrieved from http://smallbusiness.chron.com/sarbanes-oxley-code-conduct-requirements-4060.html
Resourceful. (2003, September 1). How Sarbanes-Oxley will change the audit process. Retrieved June 15, 2016, from journalofaccountancy, http://www.journalofaccountancy.com/issues/2003/sep/howsarbanesoxleywillchangetheauditprocess.html
How the Sarbanes-Oxley act of 2002 impacts the accounting profession. (2015). Retrieved June 15, 2016, from McDermott Associates, LLC, http://www.dgm.com/information-center/sarbanes-oxley-information/how-the-sarbanes-oxley-act-of-2002-impacts-the-accounting-profession
