When Enron declared bankruptcy in 2001, it was one of the world’s largest corporate scandals. That year, they had over $63 billion dollars worth of assets and soon became a symbol for executive-level corruption after declaring bankruptcy only four years later. This large scandal was then followed by the Sarbanes-Oxley Act, which sought to avoid future scandals like this from happening again.
Sarbox is a law passed by the United States Congress that aims to protect shareholders from fraud. The Sarbanes-Oxley Act of 2002, also known as SOX, strengthens corporate oversight and improves internal controls. These controls will hopefully protect investors against fraudulent financial statements provided by companies. One way SOX does this is by requiring independent third parties to verify company financials before they can be released. Such measures are welcome for many investors, though it may prove difficult for some businesses when complying with these requirements.
The Sarbanes Oxley Act was put into place in response to accounting scandals at Enron and other corporations late in 2001, where management manipulated finances as well as kept secret off-balance-sheet debt obligations while reporting profits based on unrealistic assumptions about market prices.
SOX was created to increase the transparency of how businesses are run and therefore make it easier for investors. However, this increased regulation has led many companies to outsource their jobs overseas in order to remain competitive when faced with high compliance costs. Point blank, this is a law that both helps and hinders investments. That being said, its main goal is to increase the company’s transparency through more stringent regulations on management practices. To help you and your business make an informed decision on how this will affect your business or investment strategy we’ve compiled the pros and cons of SOX which should give perspective on whether it’s worth supporting or not.
- At All Times, Crucial Information Can’t Be Withheld From Shareholders
The Enron Corporation used a shady practice called mark-to-market accounting, also known as cooking the books, by hiding their losses. For example, if they built an asset, such as a power plant and predicted that it would make a profit before even earning any revenue from it and then actually made money, which was less than what was projected on paper, Enron transferred assets off the company’s ledgers into another corporation. These numbers were not accounted for at all. In other words, rather than hurt its bottom line with financials being reported accurately, the company would lose profits wouldn’t be devastating since no one knew about them except insiders who benefited from insider trading schemes.
By requiring that all company reports be verified independently for accuracy, stockholders can rest assured knowing their investments have not been put at risk due to dishonest business activities like this one.
- The Need for Internal Controls is Vital
The Sarbanes-Oxley Act of 2002 is a federal law that requires managers to perform internal control testing on their company’s financial statements. The idea behind this legislation was for the government and investors to be more aware if there are any management overrides happening, which led to an extensive investigation into Enron Corporation in 2001.
In order to prevent the same internal controls that led to Enron’s downfall, management is required to test these controls quarterly and file a report on their effects. This prevents managers from manipulating transactions by placing checks and balances in place that can catch abnormalities before it becomes too serious of an issue for anyone involved.
- Sometimes, Smaller Companies Feel the Burden
SOX has been criticized by small public companies that are required to follow the same reporting rules as large, multinational corporations. Essentially, Section 404 states internal control procedures for all organizations but still leaves out the differentiation between company size and resources available. This leaves smaller companies with a difficult choice of either following SOX or spending their own money on additional external compliance measures they don’t have in place internally yet.
One of the reasons that small businesses succeed is because they don’t have to worry about their IT. The around the clock support and flat-rate fee structure make it a low-cost, predictable expense with great benefits as well. With a managed service provider, you or your business doesn’t have to worry about constantly upgrading your technology. They’ll take care of everything from data backup and disaster recovery to providing technical support at all hours, so no matter what time it is or where you are in the world, at a fraction of the cost.
- Audit Fees are Increased
When auditors are forced to be more accountable for their audit reports, they have less time and resources available. This means that fees go up which allows them the time required for work with SOX compliance while covering additional liability from a data breach. One thing to consider is South Dakota, which is a state that has one of the strictest laws in regards to data breaches. In this state, companies are now able-bodies liable after any incident. So when the increased audit fee of SOX compliances is increased, ask yourself if your business can afford to pay $10,000 a day due to a data breach.