AMBA 630 – The Economics of Management Decisions
Professor Little and Professor Riley
February 17, 2015
The Sarbanes-Oxley Act was implemented in response to a number of financial scandals that took place in the early 2000s. These scandals included Enron, Tyco & WorldCom, all of which made investors nervous. This Act was drafted by Paul Sarbanes and Michael Oxley, and signed by President Bush on July 30, 2002. This Act was established to enhance corporate responsibility, financial disclosures, and overcome corporate and accounting fraud. In addition, the “Public Company Accounting Oversight Board” (PCAOB) was established to oversee the activities of the auditing process. The Sarbanes-Oxley act is under the oversight of the U.S. Securities and Exchange Commission (SEC). The SEC appoints the PCAOB, which consists of five members to supervise the auditors of public companies. The PCAOB performs regular inspections of the audit quality control systems of registered audit firms. All firms that perform public company audits must be regulated and registered with the PCAOB.
Effects on CEO’s and CFO’s of Public Companies
Since the Sarbanes-Oxley Act was signed into law in 2002, CEOs and CFOs of publically traded companies have been under the financial microscope of Security and Exchange Commission. The SOX mandated stringent reforms to create financial transparency for investors in a response to counteract a number of accounting scandals stemming from various high profile companies that had shaken up the prudent financial landscape in the early 2000s (Investopedia, n.d.). The most notable provisions of the SOX that affects the fiduciary responsibilities of CEOs and CFOs of publically traded companies to their investors are noted in SOX Sections 302, 304 and 404.
According to the Sarbanes-Oxley Act of 2002, Section 302, senior management officers are mandated to certify the accuracy of the reported financial statements. Signing officers must review and approve all financial reports made public to investors. Likewise, reports filed under the SOX must be free of all material untrue statements and misleading statements. In addition, senior management officers are responsible for internal controls and evaluation of controls ninety days prior to submission of reports. Top management teams must disclosure any changes to the internal controls and the reasoning for the changes (2002, p. 33). This allows for full transparency to investors and benefits society by linking efficient capital markets by reducing the risks of fraudulent misconduct undermining the value or private property (UMUC AMBA 630, 2015). Consequently an example of failure to disclosure information on internal controls is highlighted by the demise of Enron, an American the energy company. The International Swaps and Derivatives Association (2002) contended that Enron failed to demonstrated effective corporate governance in which its mechanisms for internal control were superseded by top level management (p. 2).
In an attempt to prevent company executives from profiting from corporate misconduct the Sarbanes-Oxley Act enacted Section 304. According to the Sarbanes-Oxley Act of 2002 Section 304, it empowers the SEC to force CEOs and CFOs of public companies to forfeit any bonuses or additional compensations back to the company if the findings resulted in “misconduct” or restatement due to “material noncompliance” from the sale of securities within 12 months of the issuance (p. 34). SOX Section 304 has been interpreted in judicial court as only allowing the SEC to bring legal action against CEOs and CFOs of companies that they have been deemed to bear “misconduct.” A main criticism of Section 304 is it does not contain expressed or implied right to action so individuals are not allowed to litigate against