The Sarbanes-Oxley Act of 2002 and Corporate Fraud

The Sarbanes-Oxley Act emerged in response to economic disasters that resulted from corporate scandals such as the one involving Enron. The primary objective of the act is to promote transparency and accountability. Such is to be attained through the establishment standard accounting and auditing procedures. In addition, civil and criminal penalties for violations and fraud were put in place by Securities and Exchange Commission (SEC). The impact of the law has raised numerous concerns. Despite having a positive impact on reducing corporate fraud and protecting public interest, the act has some flaws.

It is a requirement that all publicly traded companies provide for corporate disclosure (Piotroski & Srinivasan, 2008). The disclosure must undergo a review by the SEC. In addition, the company must allow for an independent audit and provide a report. It helps the public to make right decisions when handling investment issues as the latter are based on a company’s ability to grow and make returns. To ensure that all firms give relevant information, the provision of a report in accordance with the established guidelines is required. In this regard, all companies should provide statistics that are reflective of their actual performance. Enron found itself bankrupt after appearing to be one of the fastest growing companies. This is because it accounted for operating costs as capital investment (Healy & Palepu, 2003). In addition, it reported gross value as opposed to net value. With the introduction of the SOX requirements, the aspect of transparency and accountability in minimizing corporate fraud is likely to materialize since such differences that promote fraudulent behavior are disallowed. Besides, holders of managerial positions and auditors remain responsible for their accounting actions.

Another aspect that lowers corporate fraud is the policy that encourages the absence of a relationship between auditors and public company managers (Piotroski & Srinivasan, 2008). Under the Sarbanes-Oxley Act, managers cannot influence auditing outcomes as auditors provide financial statements independently. Auditor independence implies that different auditors audit public companies. The requirement that lead auditors are rotated every five years also contributes to a reduction in fraud. In reference to SOX impact on the accounting and auditing firms and the way they operate, it reduces corporate fraud cases.

SOX holds not only the auditors and accountants responsible for financial reporting but also the management of the company (Piotroski & Srinivasan, 2008). CEO’s and CFO’s must play a part in releasing annual and quarterly reports as stipulated by the SEC. They are required to approve that the provided financial reports reflect the true operations of the company. In the event that there is a violation of the accounting guidelines, the CEO and CFO are liable and might be forced to reimburse the company. For accountability purposes, external auditors are required to inform the company’s audit committee if there is reason for a management review and any concerns about possible risks. Hence, governance practices are controlled leading to the decline in the level of corporate fraud.

Piotroski and Srinivasan (2008) observed that section 404 of SOX demands that every publicly traded company must test the effectiveness of its internal control. The requirement demands that firms develop and document all financial proceedings as well as possible risks attached to them. To ensure that this is upheld, companies are under obligation to provide an internal control report to the SEC every year. Reports contain analyses on how the management maintains transparency of financial reporting (Piotroski & Srinivasan, 2008). Finally, the penalties put in place are stricter since the prison sentences and fines were increased.

Taking into account the requirements and punishments introduced, the SOX Act is likely to minimize corporate fraud. The increase in fines by the courts may not have a strong impact but the other requirements do. Fines can be paid but the fall due to the failure to adhere to the provided requirements would be devastating to any publicly traded company. Thus, the SOX is effective in evaluating and preventing future cases of corporate fraud.

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