Government regulations play a major role in corporate financial reporting. In this lesson, you will learn about one of the most important regulations enacted in the last two decades - the Sarbanes-Oxley Act.
Have you ever heard of a company called Enron? Or what about an accounting firm by the name of Arthur Andersen? If so, then you know they're synonymous with corporate corruption. They are also two of the reasons that the Sarbanes-Oxley Act was put into place. The Sarbanes-Oxley Act , also known as SOX, is a federal law that protects investors from fraudulent accounting practices.
Let's take a closer look at the Enron scandal so that you'll understand better why SOX was implemented.
Enron was, by all accounts, a corporate powerhouse. In the late 1990s and the beginning of the year 2000, the company was not only a successful electricity and natural gas company, but it also blossomed out into the telecommunications field. The company made billions of dollars and employed thousands of people. Stock of Enron was a hot commodity. Everyone wanted a piece of this phenomenon.
In the year 2001, the false façade that Enron had been exhibiting began to crumble when it was discovered that the multitude of dollars reported as earned on the company's financial statement were all fake. That's where the Arthur Andersen firm came into play. They were the accounting firm that chose to act in a corrupt manner and assist Enron executives with their fraudulent reporting scheme. It was only after a young and savvy financial analyst uncovered the false reporting in the financial statements did the scam come to light.
To make a long story short, once the world learned of the scandal, the company went under and investors lost millions. The impact that investors felt was a driving influence for government leaders to implement the Sarbanes-Oxley Act, and that's exactly what they did in the year 2002.
Purpose of SOX
Now that you know why SOX was created, it's time to talk about what it does. The most important thing that this act does is to make corporate executives be accountable for what appears on the company financial statements. Before SOX, it was common for this same group of people to say they weren't aware of false reporting on the financial statements. Now, corporate executives must sign off on the financial statements when they're made available to the public. This validates that they know what's on the financial statements and that the information is true and accurate.
Another very important part of the Sarbanes-Oxley Act is that it requires all financial statements to include an audit report. An audit report is a report that's prepared by an auditor, and it validates the reliability of a company's financial statements. An auditor is a professional whose job it is to examine the financial records of a company and prepare the audit report.
A third important purpose of SOX is to make sure that publicly traded companies have internal controls in place. Publicly traded companies are companies that offer shares of stock for sale to outside investors. Internal controls are procedures that are put in place within an organization to ensure business is carried out in an orderly, effective and accurate manner.
The Sarbanes-Oxley Act, also known as SOX, is a federal law that protects investors from fraudulent accounting activities. It was enacted in 2002, following several high-profile corporate scandals that cost investors billions of dollars.
One of the scandals that best exemplifies the purpose of enacting SOX is the Enron case. This case involved a scheme of fraudulent financial reporting that was carried out by the firm Arthur Andersen, which was employed by Enron, and Enron corporate executives.
There are three main purposes for the Sarbanes-Oxley Act. First, SOX made sure that corporate executives were aware of what appeared on company financial statements. No longer can they plead ignorance if these reports are found to be falsified. A second purpose of the act is to ensure that audit reports are included in the financial statements of a company. An audit report is a report prepared by an auditor that validates the reliability of a company's financial statements. An auditor is a professional whose job it is to examine the financial records of a company and prepare the audit report. A third important purpose of SOX is to make sure that publicly traded companies have internal controls in place.
Though this act cannot ensure that all accounting firms and all companies will be truthful in their reporting practices, it does make sure that there are repercussions for fraudulent behavior.
When this lesson is done, you should be able to:
- Define the Sarbanes-Oxley Act
- Describe the three main purposes of SOX
- Identify the events of the Enron scandal that brought about the need for the act