Review the provisions of the Sarbanes-Oxley Act of 2002 to address the accounting scandals in the late 1990s and early 2000s (Enron, WorldCom, etc.). Identify the provisions that you believe made the most significant impact. What other provisions could have been included in the Act to strengthen the responsible stewardship and integrity of the accounting profession? Conversely, what existing provisions in the Act do you believe (if any) are unnecessary or over-regulate the profession?
Summarize the events of a recent accounting scandal. Identify how the illegal or unethical act was detected and describe the punishments that resulted (fines, prison terms, etc.). Consider what could have been done to detect this act earlier or to prevent it from happening in the first place. Select a different example than those listed in previous posts.
Section 302: Corporate Responsibility for Financial Reports: This requires the CEO and CFO to personally certify the accuracy and completeness of their company's financial statements and disclosures.
Impact: This provision shifted accountability from the accounting department to the highest levels of corporate leadership. By attaching personal legal liability and criminal penalties for violations, it forces top executives to take ownership of the financial reporting process and internal controls.
Section 404: Management Assessment of Internal Controls: This is the most costly and comprehensive provision. It requires management to issue an annual Internal Control Report that affirms the management's responsibility for maintaining an adequate internal control structure over financial reporting (ICFR) and assesses the effectiveness of those controls. Furthermore, Section 404(b) requires the external auditor to issue an opinion on the effectiveness of the company's ICFR (the "integrated audit").
Impact: Section 404 made internal controls a matter of regulatory compliance, leading to massive investments in systems, processes, and personnel dedicated to financial control and documentation. It ensures that the foundation of the financial data—the controls—is sound, thus improving the reliability of the final financial statements.
Additional and Unnecessary SOX Provisions
Potential Provisions to Strengthen SOX
To further strengthen responsible stewardship and integrity, SOX could have included:
Mandatory Audit Firm Rotation: While SOX requires the rotation of the lead audit partner (Section 203), it does not mandate the rotation of the audit firm itself.
Reasoning: Requiring a company to switch audit firms every five to seven years would break the familiarity and economic dependency that builds up over decades, further increasing auditor independence and professional skepticism.
Stricter Penalties for Mid-Level Management: SOX focused heavily on the CEO and CFO.
Reasoning: Clearly defining and enforcing penalties for controllers, divisional managers, and general counsel who facilitate fraud would create a stronger ethical culture throughout the entire corporate hierarchy, not just the top.
Provisions Deemed Unnecessary or Over-Regulative
The most frequently criticized provision as over-regulating or excessively costly is:
Section 404(b): The External Auditor's Opinion on ICFR: This requirement forces the external auditor to perform a separate, complex audit of internal controls, which significantly increases audit fees, particularly for smaller public companies.
Reasoning: Critics argue that while management's assessment of controls (404a) is critical, requiring the auditor to re-test and opine on the controls provides diminishing marginal returns on assurance relative to the immense cost, especially for smaller organizations (which led to an exemption for "smaller reporting companies" in later amendments).
Sample Answer
Review and Impact of the Sarbanes-Oxley Act of 2002 (SOX)
The Sarbanes-Oxley Act of 2002 (SOX) was enacted in response to massive accounting scandals (e.g., Enron, WorldCom, Tyco) that exposed failures in corporate governance, auditing, and financial reporting integrity. Its fundamental goal was to restore public trust in the capital markets by strengthening corporate accountability and the independence of the auditing profession.
Provisions with the Most Significant Impact
While SOX introduced sweeping changes, the following three provisions have had the most profound and lasting impact on corporate financial reporting and the auditing profession:
Title I: Public Company Accounting Oversight Board (PCAOB): This provision established the PCAOB, an independent, non-profit corporation, to oversee the audits of public companies.
Impact: Before SOX, the accounting profession was largely self-regulated. The PCAOB instituted external, mandatory inspections of audit firms, ensuring higher quality standards and greater accountability in the auditing process. This fundamentally changed the relationship between auditors and the firms they audit.