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Simple English definitions for legal terms
Sarbanes-Oxley Act
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A quick definition of Sarbanes-Oxley Act:
The Sarbanes-Oxley Act (SOX) is a law passed in 2002 to make sure that companies are honest about their finances and to protect investors. It was made because some big companies, like Enron, were lying about their money and causing people to lose a lot of money. SOX makes companies have better procedures for checking their finances and makes the CEO and CFO responsible for making sure the financial reports are accurate. It also created a board to oversee public audit companies and made it illegal for company leaders to interfere with audits. SOX also requires companies to disclose certain financial information and protects whistleblowers who report wrongdoing. Some people think SOX is too expensive for small companies, but others think it helps make sure companies are honest about their money.
A more thorough explanation:
The Sarbanes-Oxley Act (SOX) is a federal law passed in 2002 to improve auditing and public disclosure in response to accounting scandals at major firms in the early-2000s. The act was named after its sponsors, Senator Paul Sarbanes and Representative Michael Oxley, and is also known as SOX.
One of the main goals of SOX was to prevent a firm's management from interfering with an independent financial audit. The act requires public companies to adopt internal procedures for ensuring the accuracy of financial statements and makes the CEO and CFO directly responsible for the accuracy, documentation, and submission of financial reports and internal control structure.
SOX also created the Public Company Accounting and Oversight Board (PCAOB) to oversee public audit companies and promulgate auditing standards to ensure quality reporting and independent auditing. The act imposes criminal liability on any officer who knowingly or willfully submits non-complying financial statements and makes it unlawful for any officer or director to exercise improper influence on audits, such as through coercion, manipulation, or fraud.
One major criticism of SOX is the cost that greater disclosure and internal control requirements pose on smaller firms seeking to raise public funds. However, studies have found net benefits to SOX in net decreases in compliance costs and increased accuracy in financial statements.
Example: Enron was one of the major firms embroiled in accounting scandals that led to the passage of SOX. The firm's stock price dropped from $90.75 at its peak in the fall of 2000 to $0.26 by the time it filed for bankruptcy in 2002. This drastic drop in stock prices occurred when a whistleblower exposed Enron's practice of hiding debts and losses using accounting techniques, such as hiding toxic debt and assets from investors and creditors in off-balance-sheet special purpose vehicles.
Example: SOX requires management to establish adequate internal control structure and procedures for financial reporting. It also requires management to submit an end-of-the-year assessment on the effectiveness of the internal control structure. This provision aims to prevent a firm's management from interfering with an independent financial audit and ensure the accuracy of financial statements.