Sarbanes-Oxley Act of 2002

Sarbanes-Oxley Act of 2002, U.S. federal law adopted in the wake of multiple corporate accounting scandals, including the infamous Enron scandal, in the early 2000s. The Sarbanes-Oxley (SOX) Act was designed to reduce corporate fraud by strengthening financial auditing and public disclosure requirements for publicly traded companies and increasing penalties for certain white-collar crimes.

The Enron scandal involved several acts of auditing and disclosure fraud—including concealment of debts and financial losses—by the Enron Corporation, a major public energy company. After a whistleblower exposed Enron’s misconduct, the company’s stock price dropped from about $40 in August 2001 to less than $1 per share before the company filed for bankruptcy in December of that year, creating disastrous losses for shareholders. The scandal also resulted in the dissolution of Arthur Andersen LLP, a large accounting firm that had acted as Enron’s auditor and financial consultant.

The Sarbanes-Oxley Act was sponsored by Republican Rep. Michael G. Oxley and Democratic Sen. Paul Sarbanes. On July 25, 2002, the act was passed with overwhelming bipartisan support by a vote of 423 to 3 in the House of Representatives and 99 to 0 in the Senate. The act was signed into law by Pres. George W. Bush days later, on July 30.

The SOX Act consists of 11 titles, or general provisions, dealing with accounting oversight, auditor independence, corporate responsibility and financial disclosure, and penalties for financial crimes. Title I of the act establishes the Public Company Accounting Oversight Board, an independent nonprofit corporation whose purpose is “to oversee the audit of public companies…in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.” The board’s five members are appointed by the Securities and Exchange Commission in staggered five-year terms.

To ensure auditor independence, Title II of the SOX Act prohibits audit firms from simultaneously performing certain unrelated services for their auditing clients (unless the services were preapproved), including bookkeeping, “appraisal or valuation,” actuarial work, and “management functions or human resources.” The same title requires that auditors be approved and rotated by the audit committees of public companies and that auditors issue timely reports. Title III mandates that all members of a public company’s audit committee also serve on the company’s board of directors.

Title III also imposes greater corporate responsibility as well as stricter standards for accurate financial disclosures. Under the title, the principal executive and financial officers of a public company must certify that its periodic financial disclosures are accurate and complete, and the company’s executives may not interfere with the auditing process.

Title VIII establishes criminal penalties for those who commit relevant offenses:

Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States…shall be fined under this title, imprisoned not more than 20 years, or both.

The same title also includes protections for whistleblowers.

Title IX creates enhanced penalties for white-collar crimes, including mail and wire fraud and violations of the Employee Retirement Income Security Act.

The SOX Act has received both praise and criticism since its enactment. Proponents have noted that the law has helped potential investors regain trust in public companies and has provided important protections for whistleblowers. Others say that, because compliance with the SOX Act is costly, the law has hurt smaller firms.