Sarbanes–Oxley Act
The Sarbanes–Oxley Act of 2002 is a United States federal law that mandates certain practices in financial record keeping and reporting for corporations. The act, (Pub. L. 107–204 (text) (PDF), 116 Stat. 745, enacted July 30, 2002), also known as the "Public Company Accounting Reform and Investor Protection Act" (in the Senate) and "Corporate and Auditing Accountability, Responsibility, and Transparency Act" (in the House) and more commonly called Sarbanes–Oxley, SOX or Sarbox, contains eleven sections that place requirements on all U.S. public company boards of directors and management and public accounting firms. A number of provisions of the Act also apply to privately held companies, such as the willful destruction of evidence to impede a federal investigation.
Long title
An Act To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.
Sarbanes–Oxley, Sarbox, SOX
15, 18, 28, 29
The law was enacted as a reaction to a number of major corporate and accounting scandals, including Enron and WorldCom. The sections of the bill cover responsibilities of a public corporation's board of directors, add criminal penalties for certain misconduct, and require the Securities and Exchange Commission to create regulations to define how public corporations are to comply with the law.[1]
Background[edit]
In 2002, Sarbanes–Oxley was named after bill sponsors U.S. Senator Paul Sarbanes (D-MD) and U.S. Representative Michael G. Oxley (R-OH). To be "SOX compliant," top management must individually certify the accuracy of financial information. In addition, penalties for fraudulent financial activity are much more severe. The act increased the oversight role of boards of directors and the independence of the outside auditors who review the accuracy of corporate financial statements.[2]
The bill was enacted as a reaction to a number of major corporate and accounting scandals, including those affecting Enron, Tyco International, Adelphia, Peregrine Systems, and WorldCom. These scandals cost investors billions of dollars when the share prices of affected companies collapsed, and shook public confidence in the US securities markets.[3]
The act contains eleven titles, or sections, ranging from additional corporate board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the law. Harvey Pitt, the 26th chairman of the SEC, led the SEC in the adoption of dozens of rules to implement the Sarbanes–Oxley Act. It created a new, quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, charged with overseeing, regulating, inspecting, and disciplining accounting firms in their roles as auditors of public companies. The act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure. The nonprofit arm of Financial Executives International, Financial Executives Research Foundation, completed extensive research studies to help support the foundations of the act.[4]
The act was approved in the House by a vote of 423 in favor, 3 opposed, and 8 abstaining and in the Senate with a vote of 99 in favor and 1 abstaining. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt. The era of low standards and false profits is over; no boardroom in America is above or beyond the law."[5]
In response to the perception that stricter financial governance laws are needed, SOX-type regulations were subsequently enacted in Canada (2002), Germany (2002), South Africa (2002), France (2003), Australia (2004), India (2005), Japan (2006), Italy (2006), Israel, and Turkey.[6] (See Similar laws in other countries below.)
Debates continued as of 2007 over the perceived benefits and costs of SOX. Opponents of the bill have claimed it has reduced America's international competitive edge because it has introduced an overly complex regulatory environment into US financial markets. A study commissioned by then New York City Mayor Michael Bloomberg and New York Senator Chuck Schumer cited this as one reason America's financial sector is losing market share to other financial centers worldwide.[7] Proponents of the measure said that SOX has been a "godsend" for improving the confidence of fund managers and other investors with regard to the veracity of corporate financial statements.[8]
The 10th anniversary of SOX coincided with the passing of the Jumpstart Our Business Startups (JOBS) Act, designed to give emerging companies an economic boost, and cutting back on a number of regulatory requirements.[9]
Implementation of key provisions[edit]
Sarbanes–Oxley Section 302: Disclosure controls[edit]
Under Sarbanes–Oxley, two separate sections came into effect—one civil and the other criminal. 15 U.S.C. § 7241 (Section 302) (civil provision); 18 U.S.C. § 1350 (Section 906) (criminal provision).
Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are "responsible for establishing and maintaining internal controls" and "have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared". . The officers must "have evaluated the effectiveness of the company's internal controls as of a date within 90 days prior to the report" and "have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date". Id..
The SEC interpreted the intention of Sec. 302 in Final Rule 33–8124. In it, the SEC defines the new term "disclosure controls and procedures," which are distinct from "internal controls over financial reporting".[39] Under both Section 302 and Section 404, Congress directed the SEC to promulgate regulations enforcing these provisions.[40]
External auditors are required to issue an opinion on whether effective internal control over financial reporting was maintained in all material respects by management. This is in addition to the financial statement opinion regarding the accuracy of the financial statements. The requirement to issue a third opinion regarding management's assessment was removed in 2007.
A Lord & Benoit report, titled Bridging the Sarbanes–Oxley Disclosure Control Gap, was filed with the SEC Subcommittee on internal controls which reported that those companies with ineffective internal controls, the expected rate of full and accurate disclosure under Section 302 will range between 8 and 15 percent. A full 9 out of every 10 companies with ineffective Section 404 controls self reported effective Section 302 controls in the same period end that an adverse Section 404 was reported, 90% in accurate without a Section 404 audit.
Sarbanes–Oxley Section 303: Improper influence on the conduct of audits[edit]
a. Rules To Prohibit. It shall be unlawful, in contravention of such rules or regulations as the Commission shall prescribe as necessary and appropriate in the public interest or for the protection of investors, for any officer or director of an issuer, or any other person acting under the direction thereof, to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading.
b. Enforcement. In any civil proceeding, the Commission shall have exclusive authority to enforce this section and any rule or regulation issued under this section.
c. No Preemption of Other Law. The provisions of subsection (a) shall be in addition to, and shall not supersede or preempt, any other provision of law or any rule or regulation issued thereunder.
d. Deadline for Rulemaking. The Commission shall—1. propose the rules or regulations required by this section, not later than 90 days after the date of enactment of this Act; and
2. issue final rules or regulations required by this section, not later than 270 days after that date of enactment.[41]
Sarbanes–Oxley Section 401: Disclosures in periodic reports (Off-balance sheet items)[edit]
The bankruptcy of Enron drew attention to off-balance sheet instruments that were used fraudulently. During 2010, the court examiner's review of the Lehman Brothers bankruptcy also brought these instruments back into focus, as Lehman had used an instrument called "Repo 105" to allegedly move assets and debt off-balance sheet to make its financial position look more favorable to investors. Sarbanes–Oxley required the disclosure of all material off-balance sheet items. It also required an SEC study and report to better understand the extent of usage of such instruments and whether accounting principles adequately addressed these instruments; the SEC report was issued June 15, 2005.[42][43] Interim guidance was issued in May 2006, which was later finalized.[44] Critics argued the SEC did not take adequate steps to regulate and monitor this activity.[45]
Filing procedure[edit]
A claim under the anti-retaliation provision of the Sarbanes–Oxley Act must be filed initially at the Occupational Safety and Health Administration at the U.S. Department of Labor. OSHA will perform an investigation and if they conclude that the employer violated SOX, OSHA can order preliminary reinstatement.[56] OSHA is required to dismiss the complaint if the complaint fails to make a prima facie showing that the protected activity was a "contributing factor" in the adverse employment action.[57]
Clawbacks of executive compensation for misconduct[edit]
One of the highlights of the law was a provision that allowed the SEC to force a company's CEO or CFO to disgorge any executive compensation (such as bonus pay or proceeds from stock sales) earned within a year of misconduct that results in an earnings restatement. However, according to Gretchen Morgenson of The New York Times, such clawbacks have actually been rare, due in part to the requirement that the misconduct must be either deliberate or reckless. The SEC did not attempt to claw back any executive compensation until 2007, and as of December 2013 had only brought 31 cases, 13 of which were begun after 2010. However, according to Dan Whalen of the accounting research firm Audit Analytics, the threat of clawbacks, and the time-consuming litigation associated with them, has forced companies to tighten their financial reporting standards.[69]
Praise[edit]
Former Federal Reserve Chairman Alan Greenspan praised the Sarbanes–Oxley Act in 2005: "I am surprised that the Sarbanes–Oxley Act, so rapidly developed and enacted, has functioned as well as it has ... the act importantly reinforced the principle that shareholders own our corporations and that corporate managers should be working on behalf of shareholders to allocate business resources to their optimum use."[74]
SOX has been praised by a cross-section of financial industry experts, citing improved investor confidence and more accurate, reliable financial statements. The CEO and CFO are now required to unequivocally take ownership for their financial statements under Section 302, which was not the case prior to SOX. Further, auditor conflicts of interest have been addressed, by prohibiting auditors from also having lucrative consulting agreements with the firms they audit under Section 201. SEC Chairman Christopher Cox stated in 2007: "Sarbanes–Oxley helped restore trust in U.S. markets by increasing accountability, speeding up reporting, and making audits more independent."[75]
The 2007 FEI study and research by the Institute of Internal Auditors (IIA) also indicate SOX has improved investor confidence in financial reporting, a primary objective of the legislation. The IIA study also indicated improvements in board, audit committee, and senior management engagement in financial reporting and improvements in financial controls.[76][77]
Financial restatements increased significantly in the wake of the SOX legislation, as companies "cleaned up" their books. Glass, Lewis & Co. LLC is a San Francisco-based firm that tracks the volume of do-overs by public companies. Its March 2006 report, "Getting It Wrong the First Time," shows 1,295 restatements of financial earnings in 2005 for companies listed on U.S. securities markets, almost twice the number for 2004. "That's about one restatement for every 12 public companies—up from one for every 23 in 2004," says the report.[78]
A fraud documented by the Securities and Exchange Commission (SEC) in November 2009, validated whistleblower allegations first logged in 2005.[79] may be directly credited to Sarbanes–Oxley. The fraud, which spanned nearly 20 years and involved over $24 million, was committed by Value Line (Nasdaq: VALU) against its mutual fund shareholders. The fraud was first reported to the SEC in 2004 by the then Value Line Fund (Nasdaq: VLIFX) portfolio manager and Chief Quantitative Strategist, Mr. John (Jack) R. Dempsey of Easton, Connecticut, who was required to sign a Code of Business Ethics as part of SOX.[80][81][82] Restitution totaling $34 million was placed in a fair fund and returned to the affected Value Line mutual fund investors.[83] The Commission ordered Value Line to pay a total of $43,705,765 in disgorgement, prejudgment interest and civil penalty, and ordered Buttner, CEO and Henigson, COO to pay civil penalties of $1,000,000 and $250,000, respectively. The Commission further imposed officer and director bars and broker-dealer, investment adviser, and investment company associational bars ("Associational Bars") against Buttner and Henigson. No criminal charges were filed.
The Sarbanes–Oxley Act has been praised for nurturing an ethical culture as it forces top management to be transparent and employees to be responsible for their acts whilst protecting whistleblowers.[84] Indeed, courts have held that top management may be in violation of its obligation to assess and disclose material weaknesses in its internal control over financial reporting when it ignores an employee's concerns that could impact the company's SEC filings.
Legal challenges[edit]
A lawsuit (Free Enterprise Fund v. Public Company Accounting Oversight Board) was filed in 2006 challenging the constitutionality of the PCAOB. The complaint argues that because the PCAOB has regulatory powers over the accounting industry, its officers should be appointed by the President, rather than the SEC.[85] Further, because the law lacks a "severability clause," if part of the law is judged unconstitutional, so is the remainder. If the plaintiff prevails, the U.S. Congress may have to devise a different method of officer appointment. Further, the other parts of the law may be open to revision.[86][87]
The lawsuit was dismissed from a District Court; the decision was upheld by the Court of Appeals on August 22, 2008.[88] Judge Kavanaugh, in his dissent, argued strongly against the constitutionality of the law.[89] On May 18, 2009, the United States Supreme Court agreed to hear this case.[90] On December 7, 2009, it heard the oral arguments.[91] On June 28, 2010, the United States Supreme Court unanimously turned away a broad challenge to the law, but ruled 5–4 that a section related to appointments violates the Constitution's separation of powers mandate. The act remains "fully operative as a law" pending a process correction.[92]
In its March 4, 2014 Lawson v. FMR LLC decision the United States Supreme Court rejected a narrow reading of the SOX whistleblower protection and instead held that the anti-retaliation protection that the Sarbanes–Oxley Act of 2002 provided to whistleblowers applies also to employees of a public company's private contractors and subcontractors, including the attorneys and accountants who prepare the SEC filings of public companies.[93] Subsequent interpretations of Lawson, however, suggest that the disclosures of a contractor's employee are protected only if those disclosures pertain to fraud perpetrated by a publicly traded company, as opposed to wrongdoing by a private contractor.
In its February 25, 2015 Yates v. United States decision the Supreme Court of the United States sided with Yates by reversing the previous judgement, with a plurality of the justices reading the Act to cover "only objects one can use to record or preserve information, not all objects in the physical world". Justice Samuel Alito concurred in the judgment and noted that the statute's nouns and verbs only applies to filekeeping and not fish.[94]
Sarbanes–Oxley reporting tools[edit]
Close scrutiny of corporate governance and greater responsibility placed on directors to vouch for the reports submitted to the SEC and other federal agencies, have resulted in the growth of software solutions aimed at reducing the complexity, time and expense involved in creating the reports.[95] This trend accelerated in 2008 with the passage of the Dodd–Frank Wall Street Reform and Consumer Protection Act.
2021 U.S. Capitol attack charges[edit]
Some twenty years after its implementation, a provision of the Sarbanes–Oxley Act, 18 U.S. Code § 1512, was introduced in the prosecution of many of the rioters of the January 6, 2021 U.S. Capitol attack. Some 40% were charged with corruptly impeding an official proceeding.[96][97][98]