Sarbanes-Oxley Act (SOX) – Definition

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Sarbanes-Oxley Act (SOX) Definition

The Sarbanes-Oxley Act (SOX Act) was passed by the congress of the United States on July 30, 2002, this act is also called the Corporate Responsibility Act of 2002. This act was enacted to safeguard investors from corporate fraud which are fraudulent accounting activities by corporations. The Act strengthens financial literacy and accountability of corporate boards by initiating strict reforms to prevent financial accounting fraud.

Before the Sarbanes-Oxley Act of 2002, a lot of corporate financial frauds and accounting maladies were recorded, this led to public scandals. Popular instances of these scandals are Enron Corporation, Tyco International plc and WorldCom financial malpractices that made investors lose credibility in corporate boards.

A Little More on What is Sarbanes-Oxley Act (SOX)

A demand for an overhaul of existing regulatory standards binding corporate financial accounting led to the passage of SOX Act of 2002. The SOX Act was able to protect investors from corporate frauds through two provisions that are contains in Section 302 and 404 of the Act. In addition to the reform provisions contained in the aforementioned sections, the Sarbanes-Oxley Act enforced reform regulations in four major areas. These areas include Accounting regulation in corporate boards, corporate responsibility, accounting regulation as new protections to safeguard investors.

The provision in section 302 of the SOX Act stipulates that top officials of corporate boards are responsible for the accuracy of financial reports issued by their corporations. This requires that board management need to certify the validity and precision of their financial statements.

Section 404 on the other hand requires that board management and auditors create a control policy or technique for the adequacy of internal reporting methods, they also have to maintain this internal control technique. This requirement however demands huge fund because it is expensive to establish and monitor internal controls.

Furthermore, in order to protect investors from the possibility of fraudulent accounting activities by corporations, SOX Act formulates three record keeping rules in section 802. These rules will help maintain the adequacy and credibility of financial records. The first rule protects against false records while the second rule gives a time frame for retention of records or string of records. The third rule also gives specific instructions on the type of records that companies need to retain, this also include the storage of electronic communications. These rules however do not specify how records should be stored. SOX Act also provides audits, accuracy and control measures that will crack-down corporate fraud.

References for Sarbanes-Oxley

Academic Research on Sarbanes-Oxley Act of 2002

Economic consequences of the SarbanesOxley Act of 2002, Zhang, I. X. (2007). Journal of Accounting and Economics, 44(1-2), 74-115. Despite that the Sarbanes–Oxley Act of 2002 tackles a lot of issues in financial accounting and records of corporate boards, there are still some consequences attributed to the aact. This paper examines the economic consequences of the Act using reactions of markets to this legislation. It outlines the significant downsides of this act using statistics of markets and stock returns. This paper further examine samples of discrepancies in stock returns of US firms and the happenings that led to this variation.  The delay in complying to section 404 rule which requires the establishment of internal controls and their maintenance is also examines.

Market vs. regulatory responses to corporate fraud: A critique of the SarbanesOxley Act of 2002, Ribstein, L. E. (2002). J. Corp. L., 28, 1. Contained in this paper is a critique of the Sarbanes-Oxley Act of 2002 and markets responses to its regulations on corporate fraud. With the public scandals and frauds of Enron Corporation, Tyco International plc and WorldCom that shook investor confidence, diverse debates have arose over regulating corporate boards. The regulation of corporate governance is meant to restore the lost confidence of investors in the securities markets. However, after SOX Act was passed in response to the yearning for corporate regulation, there is a critique against this act. This critique resulted from the limited effectiveness of this act, its costs among other factors.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SarbanesOxley Act of 2002., Law, P., & Act, A. (2002). Public Law, 107, 204. This paper studies the enactment of the 2002 Sarbanes-Oxley Act by the senate and House of Representatives of the United States. It highlights the rules and enforcement procedures contained in this act. The establishment and administration of Public Company Accounting Oversight Board (PCAOB) was also examined. The passage of SOX Act introduced auditing rules, quality control and other independence standard rules binding financial accounting and record keeping by corporate boards. It also highlights corporate responsibility and how this enhanced a more proficient financial disclosures by organizations. An assessment of the establishment and maintenance of internal controls is also done.

Sarbanesoxley act of 2002, Sarbanes, P. (2002, July). In The Public Company Accounting Reform and Investor Protection Act. Washington DC: US Congress. This paper examines that roles of Sarbanes-Oxley Act of 2002 in public accounting reform and investor protection. This paper studies the SOX Act and its creation of far-reaching reforms in the American markets and business practices. It analyses all the corporate and public scandals that led to the passage of the act in 2002 as well as the impacts of these scandals which include loss of investor confidence and loss of investment capital.  It also presents an overview of historical perspective on internal control and financial reporting. It empirically studies the impacts of SOX Act in restoring public confidence in capital markets.

Market reactions to the disclosure of internal control weaknesses and to the characteristics of those weaknesses under section 302 of the Sarbanes Oxley Act of 2002, Hammersley, J. S., Myers, L. A., & Shakespeare, C. (2008). Review of Accounting Studies, 13(1), 141-165. Section 302 of the Sarbanes Oxley Act of 2002 mandated corporate managements to disclose internal control weaknesses of their businesses. This paper examines the reactions of stock price and stock returns to management’s announcement of control deficiencies. These disclosures of internal control weaknesses inform potential investors of the nature of corporate businesses. This paper extensively discusses the disclosure of these internal control weaknesses, their characteristics, severity and how they affect stock price reactions in markets. This paper however finds out that stock prices react negatively to the disclosure of internal control weaknesses.

Market reaction to events surrounding the SarbanesOxley Act of 2002 and earnings management, Li, H., Pincus, M., & Rego, S. O. (2008). The Journal of Law and Economics, 51(1), 111-134. The Sarbanes-Oxley Act of 2002 contains legislation which is meant to affect public financial accounting and also protect investors from corporate fraud in any its forms. This paper investigates market reactions to events surrounding the legislation of the Sarbanes-Oxley Act. It further considers whether stock price effects or changes are connected with how management of corporate businesses manage their earnings. This paper however finds out that legislation events surrounding SOX have positive effect on stock returns and the extent at which firms managed their earnings. This in turn lead to an improved quality of financial accounting and recording.

The SarbanesOxley Act of 2002 and capital‐market behavior: Early evidence, Jain, P. K., & Rezaee, Z. (2006). Contemporary Accounting Research, 23(3), 629-654. This paper investigates capital market behaviours and reactions to the Sarbanes-Oxley Act of 2002. The SOX Act was enacted to tackle public accounting scandals that were rampant before 2002, the enactment of this act is to create a reform in corporate accounting by putting corporate financial frauds and anomalies to an end. This study investigates the capital-market reaction to this act by outlining both positive and negative reactions of stock prices and returns. It also examines the diverse events that surrounded the passage of the SOX Act. This paper presents evidence from the study which posits that the Act has more benefits than harms.

A lobbying approach to evaluating the SarbanesOxley Act of 2002, Hochberg, Y. V., Sapienza, P., & VissingJørgensen, A. (2009). Journal of Accounting Research, 47(2), 519-583. This paper studies the lobbying behavior exhibited by investors and corporate shareholders on the implementation of the rules of the Sarbanes-Oxley Act of 2002. Investors and shareholders engage in lobbying behaviors depending on how adversely or beneficially the implementation of the SOX rules will affect them. For instance, investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation. This paper also investigates firms whose shareholders lobbied against the implementation of the laws because of its potential effects on their business. This paper also investigates disparaging factors that motivated the lobbying behaviours.

Was the SarbanesOxley Act of 2002 really this costly? A discussion of evidence from event returns and going-private decisions, Leuz, C. (2007). Journal of Accounting and Economics, 44(1), 146-165. Using evidence from event returns of stock markets and corporate businesses, this paper investigates whether the Sarbanes-Oxley Act of 2002 is really costly or not. In many papers, the cost of implementing certain rules of SOX Act are discussed, this paper however aims to find out if implementing this act is costly or not. With a study conducted on stock returns and going-private decisions, this paper analyses returns around SOX legislative events. This paper highlights several key factors that can be attributed to the cost of implementing SOX and how these factors reflect on stock returns and going-private decisions.

Enron’s legislative aftermath: Some reflections on the deterrence aspects of the SarbanesOxley Act of 2002, Perino, M. A. (2002). John’s L. Rev., 76, 671. Diverse corporate frauds and criminal financial accounting in securities markets were recorded in year 2000 and this demanded a reform in public financial accounting that will protect investors from financial malpractices. With the passage of the SOX Act, these accounting excesses and financial maladies were curbed. However, the implementation of some aspects of the act were delayed given factors that include their costs. This paper examines reflections on the deterrence of some aspects of the Sarbanes-Oxley Act of 2002. Diverse reflections on the act as well as findings are presented in this paper.

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