When Congress passed the Sarbanes-Oxley Act of 2002, its primary focus was on combating fraud, improving financial reporting reliability, and restoring investor confidence. However, some executives have discovered unexpected benefits of the law. This article explores how Sarbanes-Oxley has prompted positive changes in corporate governance, management practices, and investor perception.
Taking Control of Controls
- Section 404 of Sarbanes-Oxley places the responsibility of maintaining a sound internal-control structure for financial reporting on management.
- Executives who approached Sarbanes-Oxley with gratitude saw an opportunity to divert resources towards improving financial management processes and capabilities.
- Initial implementation of Sarbanes-Oxley in 2004 was burdensome, leaving little time for proactive initiatives beyond literal compliance.
- As compliance reviews and assessments exposed weaknesses and gaps, executives recognized the need for internal reforms.
Factors Contributing to Positive Changes
- Factors in the business world, independent of recent abuses, made the timing of Sarbanes-Oxley enactment fortuitous.
- Frantic mergers and acquisitions, incompatible information technologies, flawed electronic security, foreign expansion, business alliances, and supply chain complexities rendered operations and reporting opaque.
- Sarbanes-Oxley prompted a stocktaking in companies, leading to the identification of weaknesses and the need for internal reforms.
Leveraging Sarbanes-Oxley for Improvement
- In year two of compliance, many organizations are still struggling to find the time and resources to simplify and standardize processes and systems.
- However, some forward-thinking executives have leveraged Sarbanes-Oxley to implement improvements in key areas.
- Companies are standardizing and consolidating financial processes, eliminating redundant information systems, automating manual processes, and integrating far-flung offices and acquisitions.
- SOX-inspired procedures are becoming a template for compliance with other statutory regimes.
Strengthening the Control Environment
- Good governance requires a strong control environment, which forms the foundation of internal control.
- Demonstrating a strong control environment can reduce the overall scope of internal-control evaluation, resulting in lower compliance costs.
- Conducting internal surveys, emphasizing fraud prevention, internal control, and regulatory compliance, and implementing ethics training can contribute to a strong control environment.
- Investor rating services assess the control environment, impacting investor sentiment and the company’s cost of capital.
Improving Documentation
- Sarbanes-Oxley’s requirements for CEOs and CFOs to personally attest to the effectiveness of internal control over financial reporting have increased the importance of documentation.
- Documentation efforts have helped companies define responsibilities, facilitate training and oversight, and improve employees’ understanding of operations.
- Updating documentation processes has revealed inadequate controls and led to the implementation of missing control activities.
Increasing Audit Committee Involvement
- Sarbanes-Oxley has increased the legal liability and workload of directors, resulting in more engaged audit committees.
- Audit committees are now required to be free of most financial and personal ties to the company, and at least one member should be a “financial expert.”
- Directors take their new responsibilities seriously, as evidenced by longer and more frequent committee meetings and more pointed questions.
Exploiting Convergence Opportunities
- Some companies combine Sarbanes-Oxley compliance with other regulatory obligations to gain efficiencies and reduce costs.
- Identifying commonalities among statutory regimes enables the use of a single set of controls for compliance.
- RSA Security, for example, found convergence opportunities in employee record keeping, resulting in streamlined controls and cost savings.
Conclusion
Sarbanes-Oxley, despite its initial burdens, has brought unexpected benefits to companies. It has prompted positive changes in governance, management practices,.
Additional Resources on Sarbanes-Oxley and Corporate Governance:
Websites and Online Resources:
- U.S. Securities and Exchange Commission (SEC) – Sarbanes-Oxley Act: The official website of the SEC provides comprehensive information on the Sarbanes-Oxley Act, including regulatory guidance, rules, and related resources. Link to the SEC website
- Financial Executives International (FEI): FEI is a leading professional association for senior financial executives. Their website offers valuable insights, articles, and resources on corporate governance, compliance, and financial management topics. Link to the FEI website
Books:
- “Sarbanes-Oxley for Dummies” by Jill Gilbert Welytok and Daniel Ichelson: This book provides a beginner-friendly introduction to the Sarbanes-Oxley Act, its implications, and its impact on corporate governance and management practices. Link to the book on Amazon
- “Sarbanes-Oxley and the Board of Directors: Techniques and Best Practices for Corporate Governance” by Michael Overly and Michael Overly: This book focuses on the role of the board of directors in Sarbanes-Oxley compliance and provides practical guidance for implementing effective corporate governance practices. Link to the book on Amazon
Academic Journals and Research Papers:
- “The Unintended Consequences of the Sarbanes-Oxley Act” by Alexander Dyck, Adair Morse, and Luigi Zingales: This academic paper explores the unintended consequences of the Sarbanes-Oxley Act and its impact on corporate behavior, market liquidity, and small businesses. Link to the research paper
- “The Impact of the Sarbanes-Oxley Act on Audit Fees” by Chan Li and Efrim Boritz: This research paper analyzes the effects of Sarbanes-Oxley on audit fees and the cost of compliance for companies, providing insights into the economic implications of the legislation. Link to the research paper
Reports and Studies:
- PricewaterhouseCoopers (PwC) – Sarbanes-Oxley: Strengthening Corporate Governance: PwC offers a comprehensive report on Sarbanes-Oxley, covering its impact on corporate governance, best practices, and compliance strategies. Link to the PwC report
- Deloitte – The Benefits of Sarbanes-Oxley: Deloitte’s report explores the unexpected benefits and positive changes brought about by Sarbanes-Oxley, including improvements in internal control, risk management, and investor confidence. Link to the Deloitte report
Professional Organizations and Associations:
- National Association of Corporate Directors (NACD): NACD provides resources, research, and insights on corporate governance best