Sarbanes-Oxley Act on Auditing

The Impact of the Sarbanes-Oxley Act on Auditing

The Impact of the Sarbanes-Oxley Act on Auditing

Introduction

On July 30, 2002, the United States Senate enacted Public Law 107-204 by an overwhelming majority. This Act, entitled “Sarbanes-Oxley Act of 2002” and henceforth referred to in this text as SOX was subsequently signed into law by then president George W. Bush. SOX amended existing U.S. Code, the federal law of the United States of America. SOX's primary intent, “to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes”, exemplifies effective regulation (Sarbanes-Oxley Act of 2002). As with so much U.S. law, SOX was enacted in the wake of injustice. Investors unduly suffered massive financial loss due in part to their reliance upon fraudulent financial reporting, inadequate disclosure, criminal executive behavior and an ineffective regulatory environment. Publicly traded companies such as Enron, WorldCom, Tyco, and Adelphia exploited the investing public through the manipulation and obfuscation of U.S. GAAP, feigned compliance with securities laws and regulatory authorities and a variety of unethical and criminal behavior.

These actions were not without consequence as investors lost billions of dollars and offending firms were exposed to civil and criminal liability. In the fallout of the financial scandal some firms ceased to exist, as was the case with Arthur Andersen. Others suffered financial collapse reflected by their share price, like Tyco and WorldCom. Still more turned to public relations and sought legal counsel for damage control. The damage was already done. Public perception of publicly traded companies was severely eroded, perhaps even irreparably. The public outrage was palpable and the provisions of SOX reflect this sentiment.

Underlying the operation of an efficient financial market is the assumption that investors make sound investment decisions based on the availability of timely, reliable financial information. Undoubtedly, financial information varies in quality, form and content. The transition from the high-risk garbage in garbage out investing environment prior to the Securities and Exchange Acts of 1933 and 1934 to effective regulation of a dynamic market is a process, not an event.

SOX is a vital part of the process to restore investor confidence in publicly traded U.S. exchanges. In the case of the companies named above, financial reporting and disclosure was functionally inadequate, materially misleading, fraudulent and even criminal. Sherman and Chambers (2009) attribute these failures to a lack of fundamental integrity on the part of executive management. Investors who based their financial decisions on information provided by these companies suffered massive financial losses. These investment decisions were based on the fictitious information available to them as required by law, however the losses were all too real. Investors were left wondering why there was not adequate regulation to protect them from such egregious abuse. Clearly, the mechanism in place at the time failed to perform its function. The combined efforts of the Securities and Exchange Commission (SEC) and its designate the American Institute of Certified Public Accountants (AICPA), failed to enact ...