In the late 1990s and early 2000s, the financial world had taken a shift from its virtuous paradigm and was covered with a lot of scandals. Scandals had shaken the beliefs of the people in the financial market as well as in the reputed companies. The dot com bubble where the technology had a big impact on people’s investment and the high-profile companies were just ignored the regulations to protect their shareholders. These had a negative impact on people’s perception of investment as billions of them lost their hard-earned money because of these scams.
Since these massive frauds had affected billions of people Senator Paul Sarbanes, a Democrat from Maryland, and Michael Oxley from Ohio were appointed to create an act that would protect and safeguard investors from such scams in the future. In the modern world where everything is based on technology, internal audit controls cannot be very effective without addressing controls around informational scrutiny. An insecure system will be unreliable for finding the financial report as it may contain unauthorized transactions or manipulation of numbers. In 2002 Sarbanes-Oxley Act or “Public Company Accounting Reforms and Investor Protection Act” came into effect. This act applies to all US Companies and foreign companies that have been registered debt or equity in the US stock exchange. In 2002 while signing the law President George W. Bush called it “the most far reaching” business world reforms since the days of Franklin Delano Roosevelt.
The act mainly focuses on four factors such as Corporate Responsibility for Financial Reports, Management Assessment of Internal Controls, Criminal Penalties for Altering Documents, and Real Time Issuer Disclosure. It requires a registered external audit firm to attest the copies of the financial reports prepared by the firm in order to maintain the accuracy of the statements and provide assertion that the internal audit control re in place, operational, and effective as should have been upheld by the management. The Executive officer and the financial officer are required to sign the prepared statements to indicate that the statements are true and do not omit any information that may mislead the investors. The financial reports must be frequently and adequately be available to the investors with the appropriate changes required in the financial statements to safeguard their interest. And any obstruction, misinformation, omission, or addition that influences the judgment of the investors would be fined or maybe imprisoned or both.
The Act implements new standards of accounting that would ensure an improvement in the reporting standards and help the investors to make an informed decision. It changed the management’s responsibility towards financial reporting. The act imposed responsibility on the top managers as they would be required to give up bonuses as well as profits made from the sale of the company’s stock if because of their faulty financial reporting standards investors suffer. It also imposes sanctions and conviction if the act is violated and if any director or an officer would be convicted, they may be prohibited from serving the company in the same position. A 2005 survey by the Financial Executive Research Foundation found that 83% of the large company's CFO believe that the act has boosted investor confidence while 33% believe that it has decreased the chances of fraud.
Its main objective is to force companies to provide accuracy and transparency at the time of disclosure of their financial statements and to punish the guilty if not taken seriously. There is criticism that very few people have been arrested and have been punished for wrong doing. It is also a costly affair as there is a requirement to pay audit fees to external auditors who must attest to the copies of the financial statements and keep a check on the internal audit control methods and committee. According to a CPA Journal, audit and audit related fees increased 103% between 2001 and 2004 for 496 of the S&P 500. The fees increased 41% alone in 2004. (According to the journal it only examined the 496 companies). On a year-on-year basis almost every company reported an increase in its Sarbanes Oxley Compliance cost in 2012.
Critics have called it unnecessary, harmful, and inadequate because stock exchange executes most of the compliance required by the act and it increases the risk of being a director or a corporate officer and hence the companies have to pay premiums to those individuals which restrict foreign and small companies to list themselves in American Stock Exchange. It has failed to identify major problems of accounting, auditing, taxation, and corporate governance that have invited corporate unlawful activities and increased the probability of bankruptcy. Another critic suggests that this has made international business difficult as the companies outside the US have compliances to be fulfilled and additional costly compliance makes the US an unviable option for international companies to be listed on the US stock exchange. Even after the criticisms that exist this act has been recognized as one of the important reforms in the financial sector and is still followed by the US stock exchange listed companies.
Still, the 2008 crisis happened and destroyed people’s trust yet again in the financial market. It has managed to strengthen the disclosure requirements, but it couldn’t completely prevent fraud. But why did could not prevent the fraud? The act was able to warn companies about overleverage in the early stage, but companies did not pay attention to the information causing the huge financial crisis that took years to recover. Though the act was successful enough in pointing to the managers of the company to review their statements, it was not complied with which led to the crisis. But because of the criminal offense and the penalty imposed the main offenders were penalized.
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