Adoption of the Sarbanes-Oxley Act of 2002 as an Important Piece of Legislation

Subject: Law
Pages: 3
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Study level: College

Analysis

Sarbanes –Oxley (SOX) Act is a policy that was drafted and implemented by policymakers back in the year 2002. The need to come up with such a law was influenced by the white-collar crimes that were being experienced in big organizations such as Enron and several others.

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The employees of such organizations were squandering money which led to the crash of those organizations especially the ones that dealt with stocks. In this light, SOX is divided into various sections including 302, 401, 404, 409, and 802, each having rules and regulations that are to be met by the affected organizations (SOX Act of 2002, 2006).

After incidences like the case of Enron, many people could not trust the securities because they feared losing their hard-earned investments to people who are only concerned about benefiting themselves. According to Catharine (2008), Congress drafted the SOX act in a bid to restore the trust that had diminished. This is because when people lost their money they blamed the government since they felt that it had failed in its role of safeguarding the interests of investors.

The act was pioneered by two members of congress, that is, Paul Sarbanes and Michael G. Oxley. Before the introduction of the SOX Act organizations were experiencing huge losses because their most senior personnel were mismanaging their money and could always get away with it by presenting faulty financial statements that were customized to cover their evil deeds. This is because no designated organ could analyze the statements to establish whether they are true (Doherty, 2009).

Why the New Standards Were Established

The main reason why the act was introduced is that many organizations had collapsed owing to their employees’ engagement in white-collar crimes. The Securities and Exchange Commission (SEC) was accorded the mandate to draft new rules that were to be observed by all publicly owned organizations. The rules included the liberation of auditors, corporate governance, and local evaluation systems. SEC established a watchdog organization that was intended to monitor the activities of auditors who were working with public organizations.

The organization is called the Public Company Accounting Oversight Board (PCAOB). According to the SOX act 2002, all auditors were to be vetted regularly by this board to ensure that all their operations were transparent. This meant that independent auditors could only be granted an opportunity to render their services to public organizations if they are registered by this board.

The second title of the act dictates the freedom entitled to external auditors and also sets the limits of such auditors with public organizations. For instance, the title states that the auditors cannot go beyond their auditing tasks to offer other financial services to these organizations because that would mean they have vested interests. Besides these limitations imply that the auditor can not offer any form of advice to the organization.

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The act also states that senior financial officers should analyze their respective organization’s reports to ensure that there are no mistakes before they are vetted by external auditors. The officers can be prosecuted if they are found guilty of neglecting this role. Some ethics are to be adhered to by all accounting personnel, either external or internal to make sure their interests do not clash with those of the organization. The act clearly states the penalties that can be imposed on any official found guilty of manipulating financial statements (SOX Act 2002, 2006).

Costs and Benefits of SOX Act of 2002

Various issues influenced the enactment of the SOX Act of 2002. The first one is that external auditors were not answerable to anybody and thus they took advantage of this fact and incorporated their interests at the expense of the public organizations because they were double sure no one would hold them accountable. This means they were not performing their tasks as expected.

Secondly, the act was meant to prevent the recurrence of an issue where financial institutions were lending money to organizations without prior information of their performance and ability to repay the loans. This is because investigations of organizations such as Enron revealed that the creditors could have been cautioned from incurring losses if only they had taken their time to analyze the risks they were getting into by observing the performance of their potential debtors.

Debra (2006) states that the initial amount of applying this act was generally high but as time moved by they were getting streamlined to get adapted to the changes. This is because the organization had to budget for the hiring of external auditors and also legal advisors where there were people to be sued.

Organizations that were centrally organized did not incur many expenses compared to those that had various divisions. However, organizations that are controlled by this act are deemed to have reduced their stock prices as compared to companies that are not linked to the act. Doherty (2009) outlines that the costs of SOX are not clear because smaller companies have been excused from the law.

As more and more public organizations employed this act issues of mismanagement of funds in public organizations started to decline because the financial statements were probably valid. This is because no one could manipulate the statements without getting caught and further, the prosecution of financial offenders made people wary of engaging in dubious activities.

The SOX Act was also beneficial to organizations because those that rectified their local financial controls reported swelling on their share price. This is because there were no more dubious deals that would cause such organizations to lose money accountably. There were also instances when organizations experienced a decline in borrowing because they had enough money unlike before when they kept on borrowing and yet the money could not be accounted for because the fraudsters were very smart in covering their tracks.

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References

Catharine, S. (2008). Sarbanes-Oxley Act of 2002 Five Years On: What Have We Learned?” Journal of Business & Technology Law. 333.

Debra, L.D. (2006).The Effectiveness of the Sarbanes –Oxley Act 2002 in Preventing and Detecting Fraud in Financial Statements. Florida: Universal Publishers.

Doherty, B. (2009). Sarbanes-Oxley Revisited. CBS Business Network. Web.

Sarbanes-Oxley Act 2002. (2006). The Sarbanes-Oxley Act. Web.