Sarbanes-Oxley Act resulted from a series of major corporate collapses resulting from fraudulent accounting practices. Most notable were the collapse of Enron and WorldCom which were some of the largest bankruptcies in American history. The Securities and Exchange Commission (SEC) was not equipped to deal with the form of fraud that took place prior to the Sarbanes-Oxley Act due to the lack of ability to prosecute CEOS and executives personally for accounting fraud. This meant that investors were prone to fraud in which companies inflated numbers and made their value appear greater than it was in reality. The Sarbanes-Oxley Act would revitalize the SEC making it more effective at protecting investors.
The Sarbanes-Oxley Act was designed to reinforce corporate ethics and increase transparency in corporate accounting. This was accomplished by creating the Public Company Accounting Oversight Board (PCAOB). The PCAOB is a board appointed by the SEC that is composed of CPA’s and non CPAs. The members of the board are charged with creating and enhancing the Generally Accepted Accounting Principles (GAAP) for auditing and reporting in public companies (Whittington, & Pany, 2012). PCAOP protects the investor by establishing specific auditing, quality control, ethics, independence, and other standards (Whittington, & Pany, 2012). Some of the rules that are enforced include compliance inspections for registered accounting firms; conduct investigations and disciplinary proceedings involving public accounting firms as well as levy sanctions; and revoke CPA credentials (Spillane, 2004).
The PCAOB protects the investor by setting standards on accounting practices. As a result, the impact from these new standards provided the SEC with the ability to sanction companies that did not meet specific standards for financial transparency. Within the scope of SOX, public companies were now required to publish and standardize accounting controls as well as other information pertinent to financial reporting. At risk of violating SOX and being sanctioned by the SEC the following standards needed to be followed: (Kimmel, Kieso, & Weygandt, 2012).
(Kimmel, Kieso, & Weygandt, 2012)
Further provisions of SOX allowed for CEOS and executives to be held accountable for financial fraud and misreporting. “Corporate executives and boards of directors must ensure that these controls are reliable and effective. In addition, independent outside auditors must attest to the adequacy of the internal control system” (Kimmel, Kieso, & Weygandt, 2012, p. 337). These standards strengthened the enforcement of securities fraud by removing barriers. Prior to SOX CEOs could escape prosecution by claiming they were not aware of the fraud or accounting improprieties. By placing standards on accounting practices that increased transparency and made executives directly accountable it was no longer possible for leadership to claim ignorance. The implementation of SOX has set into motion a series of accounting reforms. Under SOX, the PCAOB is constantly altering and refining accounting practices both for companies and for accountants. For instance, reporting standards for accountants when performing audits is an area that is constantly changing due to different circumstances that arise in being compliant. For instance, defining bad faith estimates for revenue and losses continues to be an area of controversy and constant change in the standards (Spillane, 2004). This practice continues with SOX allowing accounting reforms to continue making a transparent and fair market.
Kimmel, P. D., Kieso, D. E., & Weygandt, J. J. (2011). Financial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons.
Spillane, D. K. (2004). PCOAB Enforcement: What to Expect. The CPA Journal.
Whittington,, R. O., & Pany, K. (2012). Whittington, R.Principles of Auditing & Other Assurance Services (Eighteenth ed.). New York, NY: McGraw-Hill.