This video discusses the main effects of the Sarbanes-Oxley Act on companies, executives, and audit firms. Sarbanes-Oxley (also known as SOX) is a federal law that was passed by Congress in response to a wave of accounting frauds in 2002. SOX requires a public company’s CEO and CFO to certify that the company’s financial statements are accurate. It also increased the penalties for accounting fraud and required firms to test the effectiveness of their internal controls. The company must then issue a report on the effectiveness of its internal controls; similarly, the company’s auditor must examine the internal controls of the company and issue a report (this is known as Section 404 of Sarbanes-Oxley). SOX also prohibited audit firms from performing many types of nonaudit services for audit clients, and it created the Public Company Accounting Oversight Board (PCAOB) to regulate the audit industry. Audit firms are required to register with the PCAOB, and the PCAOB creates auditing standards and periodically samples audits to make sure they are of high quality.
The Sarbanes-Oxley Act (aka SOX) is a federal law passed by the United States Congress in 2002. Sarbanes-Oxley Act was created after a large number of companies and company executives were found to have committed accounting fraud (Enron and WorldCom were the two most prominent frauds but there were plenty of others: HealthSouth, Global Crossing, Tyco, etc.). The effect that Sarbanes-Oxley had on publicly-traded companies, their executives, and the auditing industry cannot be overstated. Sarbanes-Oxley:
1. Requires a publicly-traded company’s CEO and CFO to certify that the company’s financial statements are accurate
2. Increased the penalties for accounting fraud
3. Requires publicly-traded companies to test the effectiveness of their internal controls and then issue a report on the effectiveness of their internal controls. Also, the company’s audit firm must also examine the effectiveness of the company’s internal controls and issue a report on the effectiveness of their internal controls. This is the Section 404 requirement and it is the one that companies complain about the most (it is costly to comply with these requirements)
4. Created the Public Company Accounting Oversight Board (PCAOB) to regulate the auditing of public companies. Audit firms that have at least one publicly-traded audit client must register with the PCAOB, comply with PCAOB auditing standards, and be subject to periodic quality control audits from the PCAOB
5. Prohibits audit firms from performing many types of nonaudit services for audit clients.
Here are the key takeaways from all of this, in layman’s terms:
1. CEOs and CFOs must agree that the financial statements are not fraudulent, and if they are fraudulent the CEO and CFO will go to federal prison. Saying, “I’m not an accountant, I had no idea there was fraud!” will not get them off the hook
2. Publicly-traded companies need to establish and maintain high-level quality controls. Both their managers and the audit firm must test the controls and say whether or not they are working
3. The PCAOB is the new watchdog of the Big 4 accounting firms. The audit industry no longer gets to be “self-regulated” (yes, that’s actually what it was before)
4. Audit firms can’t provide all kinds of consulting services to audit firms, because this will prevent them from being objective on the audit
Sarbanes-Oxley did not completely put an end to corporate fraud. If the end of the world came tomorrow, we would still have cockroaches and corporate fraud. Whenever you have billions of dollars at stake there will be people trying to steal some of it. However, Sarbanes-Oxley introduced some pretty solid rules and introduced a new regulator (PCAOB). Many people lost their jobs, pensions, etc. when Enron, WorldCom, and Arthur Andersen went down so hopefully that scale of accounting fraud is behind us (fingers crossed). It is a reminder of the importance of integrity and honesty in the accounting profession. The world doesn’t need any more “creative” accountants.