Sarbanes-Oxley Act

Introduction

The recent corporate scandals that have occurred at Enron, World.com and Tyco, to name a few, have done more than anger investors and the public. To the relief of many, these corporate scandals have spurred the government to pass legislation that significantly impacts the manner in which organizations present their financial statements. The Sarbanes-Oxley Act passed in 2002 sought to combat fraud by "improving the reliability of financial reporting, and restoring investor confidence" (Wagner, 2006, p. 133). Given the fact that Congress has not passed substantial legislation impacting the financial reporting of the organization since the 1930s, the passage of the Act clearly has notable ramifications for change. In an effort to assess that change, this investigation considers an overview of the Act and how it will impact corporate financial reporting.

Sarbanes-Oxley--An Overview

A precursory overview of the Sarbanes-Oxley Act demonstrates that there are a host of new provisions that have been developed for corporate financial reporting and responsibility. Among the most notable parts of the Act is Section 404 which requires "various internal controls and procedures for financial reporting such as the retention of documents (including email). Corporations must document their internal management controls, and the company's independent auditor must sign off on their effectiveness" (Scott, 2004, p. 48). In addition, the Act contains a "whistleblower provision" which requires companies to have a secure an anonymous system for whistleblowers to report company fraud (Scott, 2004). Further, the Financial Accounting Standards Board (FASB), which oversees accounting procedures for all organizations, "must have a majority of members not affiliated with accounting firms and to be funded by fees from publicly traded companies" (Hartmann, 2004, p. 23).

When the basic context of the Sarbanes-Oxley Act is examined overall, it becomes evident that the US government has put into effect fairly stringent legislation governing the financial reporting and disclosure requirements of publicly traded companies. Although the Act clearly impacts the FASB and the chief executives of the organization, it does not appear to have any real impact on the GAAP (Generally Accepted Accounting Practices) utilized by most organizations. Under the GAAP, specific rules for financial reporting are put forth; organizations must follow these rules without compromise. Unfortunately, these rules make it possible for the organization to present misleading information. The Sarbanes-Oxley Act fills the gaps inherent in the GAAP by making the chief executive officers of publicly traded companies liable for any misrepresentations put forth in both quarterly and annual financial statements. Thus, while the Act does not amend the GAAP, the rules set forth in the Act are now being utilized over the standards set forth in the GAAP (McEnroe, 2005).

In order to help ensure that organizations and executives behave in a responsible manner that conforms to the regulations set forth in the Sarbanes-Oxley Act, the Public Company Accounting Oversight Board (PCAOB) was created. This organization seeks to monitor the behavior of the accounting firms which provide service to publicly traded companies. The Enron scandal brought to light not only the questionable accounting practices utilized by executives of the organization but also the review practices that were utilized by the organization's accounting firm, Arthur Andersen. In an effort to ensure that accounting firms are also following the rules, the PCAOB has been developed to effectively audit the auditors. The rules used by the PCAOB supercede those imposed by the GAAP and give auditors a substantial foundation for auditing the organization's accounting practices. Accounting practices that do not meet the strict scrutiny of the PCAOB must be abolished by the organization (Osterland, 2005).

Impact of Sarbanes-Oxley

Clearly, the decision of the federal government to support such sweeping changes in financial reporting for private organizations is reflective of a deeper need to improve investor confidence. The central question that arises in this context is: What impact, if any, will the Act have on both organizations and investor confidence? McClenahen (2003) in his examination of how the Act is viewed by executives of the organization reports that, "while 31% of the executives expect the legislation to restore public confidence in