The Sarbanes-Oxley Act: What It Is and Why It's Important
By Indeed Editorial Team
Updated March 8, 2022
Published April 26, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The Sarbanes-Oxley Act of 2002 was introduced to address key issues in financial reporting among businesses. The regulations focus on ensuring accuracy, timeliness and accountability. In this article, we discuss the Sarbanes-Oxley Act, why it's important and several main features of the legislation.
What is the Sarbanes-Oxley Act?
The Sarbanes-Oxley (SOX) Act of 2002, also known as the Corporate Responsibility Act, is legislation aimed at improving financial activities and financial reporting. The act is named after its creators, Senator Paul Sarbanes and Representative Michael Oxley. The legislation covers four main areas:
The Sarbanes-Oxley Act affects many organizations and financial professionals, including:
Certain private companies
In addition to regulations, the act created the Public Company Accounting Oversight Board to oversee the accounting industry. Most of the act's regulations apply to publicly held companies, but some provisions also apply to certain private businesses.
Why is the Sarbanes-Oxley act important?
The Sarbanes-Oxley act is important because it provides greater oversight for corporations. The act came as a result of several high-profile corporate fraud cases and was designed to deter corporations from committing similar crimes. The Act provides protections for investors from false financial reporting and for whistleblowers who report fraudulent activities.
The new guidelines institute stricter rules for corporations concerning how they track and report their finances and introduce harsher penalties for individuals and companies that don't comply. The main objectives of the rules are to:
Prevent data manipulation.
Ensure timely reporting of financial changes.
Create effective financial and data controls.
Promote transparency among corporations.
Require regular monitoring of the security and accuracy of financial safeguards used by corporations.
The SOX Act seeks to increase trust and confidence between corporations, the public and investors.
Key parts of the Sarbanes-Oxley act
Below are some of the key sections of the Sarbanes Oxley act of 2002:
Public Company Accounting Oversight Board
The Public Company Accounting Oversight Board performs the following functions:
Setting audit report standards
Requiring all auditors of public companies to register with the board
Investigating and enforcing compliance
Prohibiting certain business relationships that can present conflicts of interest
Section 302 of the SOX Act requires corporate officers to officially certify that their organization's financial statements meet SEC disclosure requirements and are accurate representations of their company's financial status. Officers who willingly certify financial statements that are inaccurate are subject to criminal consequences, including jail time.
Section 401 requires companies to disclose any financial liabilities or obligations that may affect their financial stability presently or in the future. Many of these situations are considered "off-balance sheet" because they do not traditionally appear on the company's general balance sheet. This section increases corporate transparency in all of their financial dealings.
Section 404 of the SOX Act says that managers and auditors must create internal controls and strategies to ensure those controls are effective at producing accurate financial reports. If auditors or other financial professionals find problems with the controls, they must disclose them. Companies must use external registered auditors to sign off on managers' evaluation of the accounting and reporting controls.
Companies must disclose any material changes in their financial status or operations to the public on a "rapid and current basis." These updates should be provided in simple language and may require "qualitative information and graphical representation."
Section 802 of the SOX Act includes guidelines for three areas of financial records, including:
The destruction and falsification of financial records
Maintaining and storing financial records
The specific records that businesses must store, including physical and electronic communications
The section also outlines the possible penalties for altering or falsifying records, including fines and imprisonment.
Section 906 focuses on accurate reporting of financial data, including a requirement that a company's CEO and CFO, or equivalent, sign off on the documents. The section outlines the possible criminal penalties for failing to comply with the regulation, including fines and prison time.
The SOX Act requires companies to implement a range of security measures to protect their data. These include:
Restricting access to physical and digital files so that employees only have access to the information they need to do their jobs
Backing up financial data at an external location
Securing data from internal and external threats
Managing how companies update systems, including changing software, adding users to the system and upgrading databases
Benefits of the Sarbanes-Oxley Act
Some of the benefits of the SOX Act include:
Increased investor confidence: Knowing the strict guidelines put in place for companies' financial activities, investors can have more confidence in the reports and data they receive from corporations. This can encourage more investment activity.
Increased transparency: The SOX Act increases the amount of information companies must disclose, enhancing transparency and trust between large corporations and the public.
Improved internal controls: The SOX Act focuses largely on companies implementing effective internal controls which allows the companies to determine their own strategy for ensuring data safety and accuracy. This means that companies can find the solutions that work best for their practices.
Protections for employees and contractors: The SOX Act includes protections for employees and contractors who report suspicious activity to the Securities and Exchange Commission, prohibiting companies from retaliating against these individuals.
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