Question

What events prompted the enactment of the Sarbanes-Oxley Act of 2002 (ACT) by the United States Congress. What were the main provisions of the Act. To what extent do you think the ACT has been effective in curbing down the number of fraud incidents?

Answer 1

Sarbanes Oxley Act was launched in 2002 with the objective of more stringent accounting and auditing measures. It proposed to increase the role of external auditors for the review of accuracy of corporate financial statements.

This Act was a result of a large number of corporate and accountong scandals in US which left the investors wealth to zero and shook the investors' confidence in the US securities market. One such example is WorldCom, which suffered a setback in 2000 when the telecommunications was in decline. At that time, the CEO, CFO and the Director of General Accounting used fraudulent accounting practices to maintain the stock prices of the company.Window dressing of accounts was primarily done in two ways:

1. Revenue Expenses were booked as Capital Expenditure and

2. Bogus Revenues were booked

In 2002. a team of internal auditors revealed a fraud of $3.8 billion, post which the investigations revealed that the assets of the company were inflated by about $11 billion.

A few other such scams were done by Enron, Tyco International etc.

Main provisions of the Act are as follows:

1. Public Company Accounting Oversight Board for the oversight of firms providing audit services. The board defines the process and precedures for Compliance Audits.

2. To ensure independence of auditors, provisions for rotation of auditors, restriction on auditors for providing non-audit services etc.

3. Increased reporting and disclosure requiremments including off-balance sheet transactions etc

4. Ensuring that the senior executives take individual responsibility for the accuracy and completeness of financial reports

5. CEO should sign the company tax return etc.

Sarbanes-Oxley Act has designed strict rules for accounting as well as auditing practices, to ensure that the fradulent accounting practices/frauds do not happen at the first place and even if the senior management tries to do so, It is immediately captured and revealed by the auditors.

One major emphasis of Sarbanes-Oxley Act is the transparency in accounts. The Act requires complete documentation of all the accounting activities and reporting of such transactions. It also mandated the public companies to obtain and independent audit of their internal control practices.

Many people are of the opinion that the act focuses on increasing documentation only, which led to a rise in the cost for the companies, with higher pressure on small companies and it really does not do anything substantial to control frauds.

Since the Act has survived for more than 15 years, In my opinion the Act has surely been effective in curbing down the number of inicidents. Since we haven't seen such massive frauds since the time the Act has come into place.