Basics of Sarbanes-Oxley Act of

2002
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Basics of Sarbanes-Oxley Act of

2002
Historical Timeline of Laws that Precedes Sarbanes-Oxley Act of 2002
In 1911, Kansas enforced a comprehensive securities law in response to agents that sell interests that
had no financial backing. Several years down the line, the 1929 market crash acted as the turning point
for the institution of preventive measures on business proceedings.
Consequently, the Securities Act of 1993 was enacted. Through this, investors were required to
thoroughly disclose their financial information and were prohibited from engaging in shady, fraudulent,
and misleading business transactions, which involved securities.
The implementation of the Securities Exchange Act of 1934 resulted in the formation of the Securities
and Exchange Commission. According to Law Library - American Law and Legal Information, the
agency is responsible for supervising and regulating brokerage firms, transfer agents, clearing
agencies, and securities self-regulatory organizations (SROs) in the country.
A dispute between Otis & Co. and Pennsylvania Railroad Company in 1944 ensued the inference of the
basis of the Business Judgment Rule wherein executives and directors are not subject to liabilities if
they act in good faith unless proven otherwise. Thereupon, several amendments and bills were passed
and enacted that led us to Sarbanes-Oxley Act (SOX) of 2002.

Legislation of SOX
The eruption of the Enron scandal made investors become doubtful and uncertain regarding the U.S.
market. According to Forbes, there were 21 more scandals, aside from Enron from 2001 to 2002.
Investigations revealed that auditing firms provided auditing and consulting services to the same
entities, which is clearly a conflict of interest. These events are the ones that led to the legislation of
SOX.
The Sarbanes-Oxley Act is a combined proposed bill of Senator Paul Sarbanes and Congressman
Oxley. Sarbanes proposed the Public Company Accounting Reform and Investor Protection Act while
Oxley introduced the Corporate and Auditing Accountability and Responsibility Act. The intention of SOX
is to safeguard investors by improving the veracity and trustworthiness of corporate disclosures. In
addition, the law will guarantee that the board of directors of public companies is responsible for
receiving rigorous information relative to the financial status of the company and in disclosing it
scrupulously to the public.
Establishment of Public Companies Accounting Oversight Board
Under the Sarbanes-Oxley Act of 2002, an independent oversight body is responsible for inspecting and
supervising financial statement audits of public companies and in the institution of auditing guidelines in
the country. This, therefore, led to the establishment of the Public Companies Accounting Oversight
Board (PCAOB).
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Basics of Sarbanes-Oxley Act of

2002
The Securities and Exchange Commission designates five members of the committee. Their duties and
responsibilities include the institution of auditing guidelines for external audits of public companies,
overseeing accounting firms that offer auditing services and probing for possible transgressions or
infractions of SOX regulations, rules, and guidelines in professional accounting. In addition, PCAOB
release practice alerts so that auditors can address potential issues or risks.
The frequencies of PCAOBs inspection on accounting firms depend on its auditing capacity. For
instance, firms that conduct yearly audits to more than 100 public companies are subjected to annual
PCAOB inspection. In so doing, audit professionals will know the areas that need further practice
reminders or audit guidance in order to better their performance.
If and when PCAOB discovers irregularities and violations, the auditors and/or the firm will face fines,
revocation of the firms registration with PCAOB, or proscription from the association.
Corporate Responsibility
Consequent to the implementation of SOX, the companys Chief Executive Officer (CEO) and Chief
Financial Officer (CFO) are now held liable and accountable for the transparency and accuracy of their
companys financial statements. Before the financial reports are submitted to SEC, the CEO and CFO
must first attest that these reports adhere to the provisions of the Securities Exchange Act of 1934 and
are not misrepresented and misstated.
In confirming the veracity of the reports, the CEO and CFO must certify that:
They have examined the financial reports and found them accurate and properly presented.
They have assured and maintained a satisfactory internal control policy that will provide a reliable
financial report.
They have gauged the efficacy of the internal control.
They have reported, to the companys auditing body and external auditors, any fraudulent activities
involving executives or employees who play an important part in the implementation of the internal
controls.
They have reported to the companys auditing body and external auditors relevant shortcomings and
inadequacies determined during their assessment.
Furthermore, SOX directs corporations to form independent audit committees whose duties include
culling, compensating, and supervising their external auditors. Services carried out by external auditors
that are not relevant to financial audit must first be authorized by the audit committee.

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Basics of Sarbanes-Oxley Act of

2002
Corporations are compelled to report all material off-balance sheet undertakings and activities, which
may influence their present or eventual financial health. In addition, material changes in the companys
financial status and code of ethics for its top executives must also be disclosed.
Autonomy and Responsibility of Auditors
External auditors are expected to provide up-to-date information on significant accounting practices and
regulations employed by the corporate management to the audit committee. In addition, any dialogues
or talks between the management and the auditor regarding other possible schemes or protocols
should also be reported.
To avoid conflict of interest, SOX forbids external auditors from providing certain services to their
clients. These services encompass the following: bookkeeping, devising and realizing financial
information systems, actuarial services among others. The auditor must not be associated, linked, or
have ties with the client firm in any way whatsoever.
The auditor is responsible for substantiating and reporting the companys internal controls. In addition,
he/she is tasked with assessing the entitys internal control system and to validate if the system can
provide accurate and reliable financial reports.
At the end of an audit, the auditor will express an opinion established on the outcome of the auditors
assessment. This will be a part of the companys audited financial statements.

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