The Sarbanes-Oxley Act of 2002 cracks down on corporate fraud.

It created the Public Company

Accounting Oversight Board to oversee the accounting industry. It banned company loans to
executives and gave job protection to whistleblowers. The Act strengthens the independence and
financial literacy of corporate boards. It holds CEOs personally responsible for errors in accounting
audits.

The Act is named after its sponsors, Senator Paul Sarbanes, D-Md., and Congressman Michael
Oxley, R-Ohio. It's also called Sarbox or SOX. It became law on July 30, 2002. The Securities and
Exchange Commission enforces it.

Many thought that Sarbanes-Oxley was too punitive and costly to put in place. They worried it
would make the United States a less attractive place to do business. In retrospect, it's clear that
Sarbanes-Oxley was on the right track. Deregulation in the banking industry contributed to the
2008 financial crisis and the Great Recession.

Section 404 and Certification

Section 404 requires corporate executives to certify the accuracy of financial statements
personally. If the SEC finds violations, CEOs could face 20 years in jail. The SEC used Section 404
to file more than 200 civil cases. But only a few CEOs have faced criminal charges.

Section 404 made managers maintain “adequate internal control structure and procedures for
financial reporting." Companies' auditors had to “attest” to these controls and disclose “material
weaknesses."

Requirements
SOX created a new auditor watchdog, the Public Company Accounting Oversight Board. It set
standards for audit reports. It requires all auditors of public companies to register with them. The
PCAOB inspects, investigates, and enforces compliance of these firms. It prohibits accounting
firms from doing business consulting with the companies they are auditing. They can still act as tax
consultants. But the lead audit partners must rotate off the account after five years.

But SOX hasn't increased the competition in the oligarchic accounting audit industry. It's still
dominated by the so-called Big Four firms. They are Ernst & Young, PricewaterhouseCoopers,
KPMG, and Deloitte.

Internal Controls
Public corporations must hire an independent auditor to review their accounting practices. It
deferred this rule for small-cap companies, those with a market capitalization of less than $75
million. Most or 83 percent of large corporations agreed that SOX increased investor confidence. A
third said it reduced fraud.

Whistleblower
SOX protects employees that report fraud and testify in court against their employers. Companies
are not allowed to change the terms and conditions of their employment. They can't reprimand, fire,
or blacklist the employee. SOX also protects contractors. Whistleblowers can report any corporate
retaliation to the SEC.

Effect on the U.S. Economy

Private companies must also adopt SOX-type governance and internal control structures.
Otherwise, they face increased difficulties. They will have trouble raising capital. They will also face
higher insurance premiums and greater civil liability. These would create a loss of status among
potential customers, investors, and donors.
SOX increased audit costs. This was a greater burden for small companies than for large ones. It
may have convinced some businesses to use private equity funding instead of using the stock
market.

Why Congress Passed Sarbanes-Oxley

The Securities Act of 1933 regulated securities until 2002. It required companies to publish a
prospectus about any publicly-traded stocks it issued. The corporation and its investment bank
were legally responsible for telling the truth. That included audited financial statements.

Although the corporations were legally responsible, the CEOs were not. So, it was difficult to
prosecute them. The rewards of "cooking the books" far outweighed the risks to any individual.

SOX addressed the corporate scandals at Enron, WorldCom, and Arthur Anderson. It prohibited
auditors from doing consulting work for their auditing clients. That prevented the conflict of interest
which led to the Enron fraud. Congress responded to the Enron media fallout, a lagging stock
market, and looming reelections.