What is the Sarbanes-Oxley Act?
The Sarbanes-Oxley Act of 2002, also known as “SOA” or “SOX” is a congressional act with established a series of laws aimed at improving corporate governance, reducing corporate fraud, and eliminating deceptive accounting practice. The main provisions of Sarbanes-Oxley can be divided into three categories:
- Accounting Oversight: One of the primary reforms of Sarbanes-Oxley was the creation of the Public Company Accounting Oversight Board.
- Corporate Governance Reforms: Sarbanes-Oxley includes a series of reforms aimed at eliminating and/or managing conflicts of interest between shareholders and the management of the corporation.
- Creation of Criminal Penalties: Sarbanes-Oxley criminalized a variety of fraudulent behaviors related to the compilation, maintenance, and reporting of corporate results.
Who Does Sarbanes-Oxley Apply To?
The requirements of Sarbanes-Oxley primarily effect large publicly traded companies. Specifically, the reforms target companies with at least 500 shareholders and more than ten million dollars in assets, or companies traded on a national exchange, such as the New York Stock Exchange (NYSE) or the NASDAQ. Companies meeting either of these criteria are often referred to as “registered companies” because they are required to register with the Securities and Exchange Commission.
Sarbanes-Oxley Reforms
Accounting Oversight
Sarbanes-Oxley established The Public Company Accounting Oversight Board (“PCAOB”), a private non-profit entity which is charged with registering accounting firms and establishing technical and ethical rules regarding audits of registered companies. Only accounting firms registered by the PCAOB can issue audit reports for registered companies. To enable enforcement, the PCAOB is also given the power to investigate and punish misconduct by registered accounting firms or accountants.
Corporate Governance Reforms
Sarbanes-Oxley mandates a series of rules regarding audits, executive compensation, and public disclosure with the intention of reducing both fraud by corporate insiders and conflicts of interest. The reforms which have the greatest impact on corporate governance are:
- Requiring the board of directors to create an audit committee comprised of independent directors and tasked with selecting, paying, and monitoring the public accounting firm auditing the company. The audit committee must also create a confidential process for the reporting and evaluation of complaints regarding the company’s internal accounting procedures.
- Requiring the CEO and CFO of reporting companies to certify each public filing. If an officer willfully certifies an untrue report, certifying officers can be punished with a fine of five million dollars or twenty years in prison. An officer who certifies a public filing not only attests to its accuracy, but also swears the officer has reviewed the report and that the report fairly represents the company’s financial position.
- Companies are prohibited from making personal loans to directors or executive officers of the company. This requirement does not apply if the company operates a consumer credit business, the loans are made in the ordinary course of business, and the loans are not made on terms more favorable than the terms the company offers to the general public.
- Requiring the company’s CEO and CFO to reimburse the company for any bonuses, incentive-based compensation, or profit from the sale of company securities received within one year after inaccurate reports were filed with the SEC.
- Prohibiting directors and executive officers from trading in company stock during company pension plan blackout periods. This prohibition is subject to several technical exceptions enumerated in 15 U.S.C. Section 7244(a)(1).
- Extending the statute of limitations for civil securities fraud suits until the later of: (1) two years after the later of discovery of the facts establishing the cause of action or (2) five years after the fraudulent activity occurs.
Creation of Criminal Penalties
Sarbanes-Oxley created criminal punishments for a variety of fraudulent activities. Chief among these are:
- Punishing the destruction, alteration, or falsification a document or record with the intent to impede a federal investigation with up to twenty years in prison.
- Requiring accountants who conduct audits of registered companies to keep all work papers for at least five years. Accountants who willfully violate this requirement can be punished with up to ten years in prison.
- Increasing the maximum penalty for securities fraud to twenty five years.
- Whistleblower protections which create a cause of action for any employee who is discharged as a result of providing information about potential securities law violations to their superiors or the federal government.
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