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Home > Regulation Checklists > Sarbanes–Oxley: Its Development and Aims

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Sarbanes–Oxley: Its Development and Aims


Checklist Description

This checklist describes the Sarbanes–Oxley Act of 2002, its aims and its purpose.

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Definition

The Sarbanes–Oxley Act is a US federal law that was enacted in response to several major corporate and accounting scandals, such as those affecting Enron and WorldCom, which involved large-scale internal fraud. These scandals damaged confidence in US financial markets. A variety of complex factors created the conditions and culture in which the fraudulent activities were able to flourish undetected for a number of years, including conflicts of interest and incentive compensation practices. The analysis of their complex and contentious root causes contributed to the passage of the bill in 2002. The Act was named after Senator Paul Sarbanes and Representative Michael G. Oxley. It is also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and is often referred to as Sarbanes–Oxley, Sarbox, or SOX.

The act imposes high standards of accountability and transparency on the boards and management of all US publicly listed companies and public accounting firms. The legal framework established a new, quasi-public agency, the Public Company Accounting Oversight Board (PCAOB), which has responsibility for the overseeing, registration, regulation, inspection, and disciplining of accountancy companies that carry out audits of public companies.

Beside the PCAOB, Sarbox covers issues such as auditor independence, corporate governance, assessment of internal control, enhanced financial disclosure, analysts’ conflicts of interest, corporate tax, and corporate fraud. There are 11 legislative sections for this purpose, known as titles, which enable the imposition of additional corporate board responsibilities as well as criminal penalties. The Securities and Exchange Commission (SEC) has the power to implement rulings on requirements to comply with Sarbanes–Oxley.

There remains much disagreement over whether Sarbox has been a useful piece of legislation. Although the Act has helped to restore public confidence in the US capital markets and has strengthened corporate accounting controls, there is also evidence to suggest that it has displaced business from the United States to the United Kingdom, where regulations for the financial sector are less overbearing. In the United Kingdom, the nonstatutory Combined Code of Corporate Governance, monitored by the Financial Services Authority, is similar to Sarbox but has a lighter touch.

As the capital markets are global, Sarbox has also affected non-US companies cross-listed in the United States. Companies based in countries with poor regulation have benefited from better credit ratings by complying with Sarbox, despite the cost. Companies in countries that have a strong regulatory regime already benefit from adequate transparency, so the cost of compliance with Sarbox is less. Either way, companies that choose to be cross-listed on other exchanges, such as the London Stock Exchange, benefit from better credit ratings anyway. Studies comparing new foreign listings on both the US and UK exchanges between 1995 and 2006 showed that Sarbox had no real impact on the listing preferences of large foreign companies for the main exchanges. However, since Sarbox was enacted there is evidence that small foreign companies choosing between Nasdaq and the London Stock Exchange’s Alternative Investment Market are less likely to opt for the US listing. It is thought that this is due to the higher costs associated with compliance with Sarbox. Certainly, the Alternative Investment Market has enjoyed spectacular growth since Sarbox was enacted, and this cannot be put down to coincidence alone.

Legislation or regulation similar to Sarbanes–Oxley has been introduced in Canada, Japan, Australia, South Africa, France, Germany, and Italy, ensuring that tighter antifraud controls have been brought into play in most major markets.

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Further reading

Books:

  • Anand, Sanjay. Sarbanes–Oxley Guide for Finance and Information Technology Professionals. 2nd ed. Hoboken, NJ: Wiley, 2006.
  • Bainbridge, Stephen M. The Complete Guide to Sarbanes–Oxley: Understanding How Sarbanes–Oxley Affects Your Business. Avon, MA: Adams Media, 2007.
  • Marchetti, Anne M. Sarbanes–Oxley Ongoing Compliance Guide: Key Processes and Summary Checklists. Hoboken, NJ: Wiley, 2007.

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