The Sarbanes-Oxley Act: A Quick Guide for Small Businesses

The Sarbanes-Oxley Act was passed in 2002 to protect investors from corporate accounting fraud. The legislation was passed in response to the Enron debacle of 2001, which was the largest and most spectacular bankruptcy in American history up to that time.

Shortly after Enron's collapse, two other firms, Tyco and WorldCom, also suffered major scandals and went bankrupt. As a result of these incidents, hundreds of thousands of investors lost millions of dollars due to fraudulent accounting by the companies involved.

To rebuild investors' confidence in the market, Congress acted to make publicly-owned corporations' disclosures about their finances more accurate and reliable. Named after its congressional sponsors, Sarbanes and Oxley, the act is sometimes referred to as "SOX" or "Sarbox." (Its official name is the Public Company Accounting Reform and Investor Protection Act of 2002.) Many experts consider it the biggest overhaul of U.S. securities regulations since the New Deal.

Here are the major provisions of the act:

  • Chief executives and financial officers are held responsible for their public companies' financial reports.
  • Executive officers and directors may not solicit or accept loans from their companies.
  • Insider trades are reported more quickly.
  • Insider trades are prohibited during pension fund blackout periods.
  • Disclosure of executive compensation and profits is mandatory.
  • Internal audits as well as review and certification of audits by outside auditors are mandatory.
  • There will be criminal and civil penalties for securities violations.
  • Longer jail sentences and larger fines are now imposed on executives who intentionally misstate financial statements.
  • Audit firms may no longer provide actuarial, legal, or consulting services to firms they audit.
  • Publicly traded companies must establish internal financial controls and have those controls audited annually by an independent auditor.

This last provision, commonly referred to as "SOX 404 compliance," primarily affects large companies. The Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, amended SOX by exempting smaller publicly held companies from the requirement to have their financial controls audited (although they must still establish internal financial controls).

Unless your small business is publicly held or you are planning to take your company public very soon, Sarbanes-Oxley most likely has no repercussions for your business. However, if you're an investor, SOX might allow you to sleep a little easier about your investments.


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