Key Components of the Sarbanes-Oxley Act of 2002 - Case Study Example

Sarbanes-Oxley Act Of 2002 Sarbanes-Oxley Act Of 2002 Identify key components of the Sarbanes-Oxley Act of 2002 and describe its primary objective. The Sarbanes-Oxley Act that was enacted during the period of 2002 came into existence in order to counter the unethical and illegal accounting scandals such as the Enron scandal. The main purpose of the act was to ensure that in future organizations do not indulge in such activities and the interest of the investors and other stakeholders were protected and to resume the confidence of the investors in stock market trading and the confidence they had lost in publically listed companies. The Act has been laid down in eleven different sections but its most important parts are the requirement of release of organizations information, support and promote unethical and illegal behavior being reported by organizations and their members, elevate the independence of auditors from the organizations they are working in, reduction of conflict of interest that was being experienced by analysts and to ensure that scandals such as Enron scandal do not take place in future. The main aim of enacting this act was to change the way organizations were providing their financial information to stakeholders, mainly investors. The reporting methods have been altered for the organizations in order to make their business activity more transparent for the investors so they can make investment related decisions with the help of correct and fair information. The act even holds the top level management of the organizations as well as their auditors responsible for ensuring the all the information being disclosed by the company is correct and not misleading. The second important part of this Act was to alienate the auditors from the control of the organizations in order to ensure that no conflict of interest takes place between the auditors and the organizations. The Act has established that those individuals and groups that are providing auditing services to the company are not allowed to provide any other services until they attain an acceptance from the PCAOB. The act even instructs that those individuals who are part of the organization’s auditing committee are even institutes as the organization’s board of directors and these individuals should operate independent from the organization. A third important element of the Act is that it encourages the reporting of the wrongdoings of an organization. The act has made it mandatory that those individuals who work as attorney for the organization reveal any illegal and unethical acts being conducted by the organization. The Act even requires the organization’s auditing company to have a proper method through which any form of accountancy fraud taking place within the company is reported and treated. Furthermore the act has ensured that those employees who report these wrong doings are protected against any effort made by the organization to retaliate against the employee for whistleblowing. A major aim of Sarbanes-Oxley Act was to deter as well as sanction organizations for indulging in accounting frauds. Three sections of the Act including title VIII, IX as well as title XI have clearly established the penalties that are to be levied on organizations that involve in accounting fraud. The authority to oversee the operations of organizations has been vested within the authority of Securities And Exchange Commission and the commission is even responsible for ensuring that all parts of the Act are being strictly followed by organizations. Explain what the criticisms are surrounding the Act. Sarbanes-Oxley Act was has not been accepted in quite a positive manner and it has been subjected to severe criticism since the time of its enactment. One of the major criticisms that the Act was that it was believed to increase the cost of operations of businesses that had to comply with the Act. Due to this high cost of compliance the Act was criticized because it was feared that several companies would either delist themselves from the stock exchanges that were operating within the United States or the Act acted as deterrent for companies to get themselves listed. Furthermore the Act was even criticized because it demotivated the intention of several foreign firms to get them listed on the stock exchange. For example: Piotroski conducted a study in order identify the impact of Sarbanes-Oxley Act on the number of new companies listing themselves in stock exchanges located in United States. In this study the researchers identified that during the period of 2008 a small sized foreign organization had a lower probability of getting themselves listed in United States based stock exchanges as compared to UK based stock exchanges (Piotroski, 2008). Another major criticism that has been faced by the Act is that it is believed to hamper the ability of United States based businesses to compete against foreign and international businesses. The economic cost of maintaining internal controls that have been levied by the Sarbanes-Oxley Act is quite high and such costs are not levied on companies that are located in other locations. Due to this the cost of operations of United States businesses have increased and they are failing to compete in the global world. A third criticism of the Sarbanes-Oxley Act is based on the premise the private organizations should not be managed and controlled by the government. Those who criticize this Act state that the government is intruding in the business of corporations and corporations should be allowed to be governed on their own. The government has not only been criticized for getting involved in corporate governance through the measure of Sarbanes-Oxley Act, they have been criticized for increasing their own financial burden (Weiss, 2014). The Act resulted in the creation of Public Company Accounting Oversight Board and the purpose of this board was to keep an eye on the auditing practice of publically trading companies in order to ensure that the investors were safe from financial fraud. The creation of this board has increased the financial burden of the government. There are even minor criticisms of the Act including the criticism of increasing the work of the CEOs who are required to ensure that the financial reporting of their company is free from errors and does not mislead the investors. The criticism is that the CEOs have already too much work on their plates and increasing their workload may not allow them to focus on more important elements related to the organization that can help the organization grow and expand. Explain the economic consequences for companies as a result of implementing the Act. There are several economic costs that companies have to bare and might bare if they comply with the sections of Sarbanes-Oxley Act. One of the main cost that was projected to be experienced by organizations was the increase in the number of labor hours of different employees. Initially it was estimated by the Securities And Exchange Commission of United States that due to compliance with the Act, companies will have to experience an additional 500 labor hours. The initial projections were quite low and later during the period of 2003 the estimations were revised to 883 labor hours or a financial cost of $91,000 that companies may bare due to compliance with the Act. But Kling reports that the SEC has not estimated the number of labor hours properly and reports that the total number of labor hours that an organization may have to experience as a result of complying with the Act accounted for 35,000 labor hours (Kling, 2014). Other than the increase in the number of labor hours caused due to compliance with the Act, organizations even had to increase the wages they were paying to auditors and this negatively impacted their overall profitability. Various studies have been conducted on the increase in auditor’s fee that organizations had to pay if they complied with the Act. One such study was conducted by Hartman who tried to identify the increase in the fee that organizations pay to auditors during the period of 2001 and 2006. The researchers identified that companies that were a part of the S&P 500 witnessed a major increase of 251% in fee that they paid to the auditors (Hartman, 2007). The auditors were not the only ones who had to be paid extra or high, the organizations even had to pay more to the attorneys if they were complying with the Sarbanes-Oxley Act. Hartman identified that during the period of 2002 to 2003, organizations complying with the Sarbanes-Oxley Act had to pay twice the amount as attorney fee as compared to the amount they paid before the passage of the Sarbanes-Oxley Act. Other than the direct economic costs that organizations had to suffer as a result of the enactment of the Act, organizations even suffered several indirect costs such as the opportunity of losing investors and various other indirect costs. Sarbanes-Oxley Act compliance costs millions of dollars to those companies that complied and as a result of this several companies were demotivated to list themselves on the stock exchanges of the United States. Due to this several companies that either did not list themselves or got themselves delisted from the stock exchange ended up experiencing the indirect cost of losing investors who would have invested in those companies that would have listed or loss of those investors who had once invested in the business but were no longer investors or shareholder as the companies decided to delist themselves. Furthermore, due to delisting of the companies, organizations had to return the money back to the investors. Explain if the Sarbanes-Oxley Act has achieved its goals so far. Provide examples to support your reasoning. The effectiveness and the success of Sarbanes-Oxley Act are dependent on how well it has been successful in attaining its desired purposes. One of the primary purposes of the Act was to restore the confidence of the investors in the equity markets that had been lost due to the accounting frauds committed by companies such as Enron. The Act has undoubtedly been able to elevate the confidence of the investors in the United States based stock exchanges and companies. This is quite evident through the increase in the participation of the investors in the stock exchange which leads to dramatic increase in the levels of the index. For example: when the Sarbanes-Oxley Act was passed and signed into law, the index level of Dow Jones Industrial Average was nearly 7,000 points, but five years later, during the period of 2007 the index level raised to 13,500 (Oxley C2). This confidence of the investors in the stock exchanges of the United States could not have been regained without Sarbanes-Oxley Act. The Act contains several provisions that have helped in increasing the credibility of the financial reports in the eyes of the investors. This means that another major aim of the Act was to ensure that the financial reports and statements that were being provided to the investors and the general population are not misleading and provided fair information to the investors. Sarbanes Oxley Act has been quite successful in attaining this purpose but it has cost a lot to the organizations that have complied with the Act. In order to identify whether the financial statements that were published in compliance with the Act are credible enough, it is necessary to look at the figures of financial restatements. The term financial restatements refer to the creation and submission of a new financial statement based on earlier financial statements if there are any discrepancies in the previous ones. The number of financial restatements declined after the passage of the Act and this is evidence that the Act has been quite effective in attaining its purposes. For example: The Center Of Audit Quality has reported that the number of financial restatements declined by 85% during the period of 2012 as compared to the period of 2006 and that is due to the imposition of the Sarbanes Oxley Act (Thecaq.org, 2015). One of the major aims of the Act was to ensure that the frauds that are financial in nature decline. This aim was created in order to safeguard the investors from incurring huge losses and to avoid the possibility of financial frauds committed by Enron. For example: Harwood states that the numbers of lawsuits that have been filed against organizations since the implementation of the Act have declined quite significantly. The author states that during the period of 2005 to 2011 the number of lawsuits filed for the purpose of financial fraud has been at an average of 150 cases per year which is quite lower as compared to the 200 cases that were filed between the periods of 1997 to 2005 (Harwood, 2012). References Hartman, T. E., & Foley & Lardner LLP. (2007). The cost of being public in the era of Sarbanes-Oxley. Chicago, Ill.: Foley & Lardner LLP. < http://www.foley.com/files/Publication/6202688d-eebc-42bc-8169-5dfb14ef3ced/Presentation/PublicationAttachment/666c1479-ea9c-4359-bb07-5f71a18166f6/Foley2007SOXstudy.pdf> Harwood, E. (2012). The Tenth Anniversary of SOX: Its Impact and Implications For Future Securities Litigation and Regulatory Enforcement Activity. CONERSTONE RESEARCH. Retrieved 14 January 2015, from https://www.cornerstone.com/GetAttachment/bf9596bc-bd80-4b92-8780-0e6fd82190d0/The-Tenth-Anniversary-of-SOX-Its-Impact-and-Implic.pdf Kling, A. (2014). Cost of Sarbanes-Oxley | EconLog | Library of Economics and Liberty. Econlog.econlib.org. Retrieved 14 January 2015, from http://econlog.econlib.org/archives/2004/02/cost_of_sarbane.html Oxley, Michael G. "The Sarbanes-Oxley Act of 2002—restoring Investor Confidence." Current Issues in Auditing. 1.1 (2007). Print. Piotroski, J., & Srinivasan, S. (2008). Regulation and Bonding: The Sarbanes-Oxley Act and the Flow of International Listings. Journal Of Accounting Research, 46(2), 383-425. doi:10.1111/j.1475-679x.2008.00279.x Thecaq.org,. (2015). New Academic Study Shows Substantial Decline in Financial Restatements During the 2003–2012 Period. Retrieved 14 January 2015, from http://www.thecaq.org/newsroom/2014/07/24/new-academic-study-shows-substantial-decline-in-financial-restatements-during-the-2003-2012-period Weiss, J. W. (2014). Business ethics: A stakeholder and issues management approach. San Francisco: Berrett-Koehler. Read More