Criminal Liability - Sarbanes Oxley Act

Updated at June 24th, 2021

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What is the Sarbanes-Oxley Act?What are the criminal provisions under the Sarbanes-Oxley Act?Discussion Question Practice Question Academic Research

What is the Sarbanes-Oxley Act?

The Sarbanes-Oxley Act (SOX) is a set of federal laws addressing criminal and unethical conduct of public company boards and management. It also addresses the accounting and auditing practices of firms servicing these public companies.

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What are the criminal provisions under the Sarbanes-Oxley Act?

The criminal sanctions under the Sarbanes-Oxley Act (SOX) Act are as follows:

Title VIII & XI - This portion of SOX contains the "Corporate and Criminal Fraud Accountability Act of 2002". It provides criminal charges for the creation or destruction of fraudulent corporate records. It generally addresses fraud through the use of corporate records and provides established ranges of criminal penalties. It also establishes protections against retaliation for those reporting such activity.
Title IX - This portion of SOX is called the "White Collar Crime Penalty Enhancement Act of 2002. It provides criminal charges for illegal and unethical conduct by officers and managers that harms the public. It specifically requires corporate managers to certify that records are true and accurate.

SOX was passed in the wake of numerous corporate scandals that rocked the financial markets, such as World Com, TyCo, Enron & Arthur Andersen.

Discussion Question

Do you think that additional government regulation of corporate practices in the form of criminal penalties helps to curve unethical conduct? Do any positive effects outweigh the negative consequences to the business (such as increased costs, bureaucracy, etc.)?

Many would argue that government regulations hinder business and are ineffective in curbing criminal conduct by corporations. The hindrance of business regards increased costs, bureaucracy, uncertain standards, etc. Others would argue that these regulations are absolutely necessary and, without them, corporations have free range to undertake questionable activities without oversight. One thing is certain. It is extremely difficult to enforce statutes and regulations against corporations and the decision-makers (executives and board members).

Practice Question

Derek is CFO of ABC, Inc. After years of declining profits, Derek devises a method for improving the appearance of ABCs balance sheet. Derek creates a group of limited liability companies that are owned by ABC. ABC transfers corporate debt to these entities, which is reported off of the main balance sheet and in the footnotes of the financial statements. Derek knows that this form of disclosure is likely to convince investors that ABC has a strong financial position. Has Derek committed a crime?

Derek could be charged with crimes under the Sarbanes-Oxley Act since he has given false information, a false balance sheet, and records to attract investors. The Sarbanes-Oxley Act protects investors from fraudulent financial reporting by corporations. Section 302 of the Act mandates that senior corporate officers personally certify in writing that the company's financial statements comply with SEC disclosure requirements and fairly present in all material aspects the operations and financial condition of the issuer. Section 404 of the SOX Act of 2002 requires that management and auditors establish internal controls and reporting methods to ensure the adequacy of those controls. Section 802 of the Act contains the three rules that affect recordkeeping; 1. Destruction and falsification of records, 2. The retention period for storing record, 3. Specific business records that companies need to store, which includes electronic communications. Generally, the Act prohibits corporates from misrepresenting information about the corporation. https://www.investopedia.com/terms/s/sarbanesoxleyact.asp

Academic Research

Ribstein, Larry Edward, International Implications of Sarbanes-Oxley: Raising the Rent on U.S. Law. U Illinois Law & Economics Research Paper No. LE03-005. Available at SSRN: https://ssrn.com/abstract=401660 or http://dx.doi.org/10.2139/ssrn.401660
Engel, Ellen and Hayes, Rachel M. and Wang, Xue, The Sarbanes-Oxley Act and Firms' Going-Private Decisions (May 6, 2004). Available at SSRN: https://ssrn.com/abstract=546626 or http://dx.doi.org/10.2139/ssrn.546626
Singer, Zvi and You, Haifeng, The Effect of Section 404 of the Sarbanes-Oxley Act on Financial Reporting Quality (April 30, 2009). Journal of Accounting, Auditing and Finance, Vol. 26, No. 3, 2011. Available at SSRN: https://ssrn.com/abstract=1052541 or http://dx.doi.org/10.2139/ssrn.1052541
Litvak, Kate, The Long-Term Effect of Sarbanes-Oxley on Cross-Listing Premia (2008). European Financial Management Journal, Vol. 14, pp. 875-920, 2008; U of Texas Law, Law and Econ Research Paper No. 107; 2nd Annual Conference on Empirical Legal Studies. Available at SSRN: https://ssrn.com/abstract=994583
Lanois, Paul, Between a Rock and a Hard Place: The Sarbanes-Oxley Act and Its Global Impact (2007). University of Pennsylvania Journal of International Law, Vol. V, No. 4, 1-19, 2007. Available at SSRN: https://ssrn.com/abstract=2894294
Piotroski, Joseph D. and Srinivasan, Suraj, Regulation and Bonding: The Sarbanes-Oxley Act and the Flow of International Listings (January 1, 2008). Rock Center for Corporate Governance at Stanford University Working Paper No. 11. Available at SSRN: https://ssrn.com/abstract=956987
Bova, Francesco and Minutti-Meza, Miguel and Richardson, Gordon D. and Vyas, Dushyantkumar, The Sarbanes-Oxley Act and Exit Strategies of Private Firms (January 21, 2011). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1730242 or http://dx.doi.org/10.2139/ssrn.1730242

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