The Sarbanes-Oxley Act of 2002 came in the wake of several high-profile corporate accounting scandals, including those involving Enron, WorldCom and Tyco International. Confidence in publicly traded companies collapsed when the media revealed the details of unethical insider trades, corporate hubris and corruption of outside auditors. Congress enacted the Sarbanes-Oxley Act, named after Sen. Paul Sarbanes (D-Maryland) and Rep. Michael Oxley (R-Ohio), to rein in such practices.
Greater Oversight of Accounting Practices
The act created the Public Company Accounting Oversight Board. The board regulates and inspects public accounting firms that deal with publicly traded companies. The act also requires CEOs and chief financial officers to establish internal accounting controls as a means to prevent fraud and malfeasance. These internal control summaries must be included in financial reports to increase corporate transparency. False statements on these internal control documents may subject company executives to criminal penalties.
Increased independence of auditors and analysts
Sarbanes-Oxley lessens the influence companies wield over auditors and accounting firms. In previous situations of corporate reporting fraud, investigators found inappropriately close business relationships between some companies and the firms that audited them. This gave the auditors a financial incentive to portray the company in a positive light. Sarbanes-Oxley basically allows auditing of auditors as an oversight technique.
Increased Penalties for Corporate Crime
Sarbanes-Oxley allows the Securities and Exchange Commission to penalize or bar securities professionals for inappropriate behavior, such as insider trading. The law also allows the SEC to punish executives who violate regulations. The SEC may bar executives convicted under Sarbanes-Oxley from directorships or officerships in public companies. The act increased prison sentences and fines for a number of corporate crimes. It also extended the statute of limitations for shareholders to sue for fraud or deceit perpetrated by the company.
Tighter Controls on Insider Activity
The act places greater controls on insider activities. The SEC defines an insider as an executive officer, a director or a shareholder with at least 10 percent of outstanding shares. The act requires faster reporting of insider trades to the SEC than previously required. Any insider trades must be reported within 48 business hours of the trade. The act also bars any insider trades during retirement fund blackout periods. Blackout periods occur when the fund experiences major changes. Participants are prohibited from changing their investment options during this blackout period.
