Running head: SARBANES-OXLEY ACT & CORPORATE GOVERNANCE

Sarbanes-Oxley Act & Corporate Governance

Course Project
Loraine J Jackson
FIN 6409 - Financial Management
Instructor: Dr. Warren Wright
March 13, 2016

SARBANES-OXLEY ACT & CORPORATE GOVERNANCE

Abstract
The Sarbanes-Oxley Act was passed in 2002 by Congress as a safety measure to better protect
investors and stakeholders from the possibility of fraudulent accounting activities by officials in
publicly traded corporations, company boards, and public accounting firms. This act spells out
new and expanded requirements for all public corporations as well as provisions that apply to
privately held companies. This Act makes clear the stringent reforms as a method to improve
financial disclosures from corporations. Additionally, this act will assist in the prevention of
accounting fraud and to as ensuring the integrity of the financial markets, as well as to allow
investors to accurately measure management performance. There is the need for improved
corporate governance by managers and top executives. The scandals over the past several years
have involved top executives, auditors, even politicians and regulators, as well as stakeholders
and employees. Statements and actions of some top officials undermined the societys trust in
the integrity of the financial markets and corporations. As a result of this Act and improved
corporate governance, there is greater responsibility by management, as well as internal controls
that are established and clearer methods of adherence to the law, making it easier to focus on
issues with compliance. Companies must continually improve its corporate governance and
transparency in all aspects of operations and financial management in order to meet social
obligations past earning profits within legal and ethical controls.

The Impact of the Sarbanes-Oxley Act and Corporate Governance

I
A

Sarbanes-Oxley Act

Sarbanes-Oxley Act Defined

Sarbanes-Oxley Act was developed by Senator Paul Sarbanes and Representative

Michael Oxley, for whom this Act is named. This legislation was enacted in 2002 and
established extensive reforms to the regulation of financial practices and corporate governance.
The Sarbanes-Oxley Act is organized by eleven titles, with the more important being the sections

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on compliance; 302, 401, 404, 409, 802 and 906 (Sarbanes-Oxley 101, 2014). This Act was
developed as a result of various financial scandals in the years such as Enron, Arthur Andersen,
WorldCom, and Tyco, for instance. It is the most comprehensive securities legislation to be
created in the United States, requiring all corporations to file reports with the Securities and
Exchange Commission (SEC) on a regular basis. Corporations and other enterprises are required
to have responsibilities for reporting and corporate obligations as well as greater accountability,
with non-compliance resulting in severe penalties.
Greater Accountability
The Sarbanes-Oxley Act also has an oversight board, which was created to supervise
audits of public corporations, thus providing greater accountability for companies. This is the
section of the Act that establishes the criteria and the regulations for audit reports. Furthermore,
all accounting firms who are responsible for auditing public corporations are required to register
with the Oversight Board (Simon, 2009). This board also also examines, scrutinizes, and put
into effect compliance from companies that are registered. There is a greater financial disclosure
requiring all transactions and that may impact financial status to be disclosed. For instance, a
personal loan to a top executive from a corporation is prohibited. Additionally, yearly reports are
required to include information stating that management is accountable for internal control
composition and processes for financial reporting. The Sarbanes-Oxley Act requires
corporations and auditors have greater responsibility in the financial reporting and the auditing
aspect of corporate business. Further, corporate responsibility for financial reports can be found
in Section 302 of the Sarbanes-Oxley Act, which states that the CEO and CFO are directly
responsible for the accuracy, documentation and submission of all financial reports (Sarbanes-

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Oxley 101, 2014). These financial reports should not contain any misrepresentations and this
information is to be presented in a fair and accurate manner, and this is discussed in section 401.
Financial Disclosure
Sections of the Sarbanes-Oxley Act also cover financial disclosure. Financial statements
are required to be precise and presented in a manner free of incorrect statements or information.
According to Sarbanes-Oxley, financial statements must also include all data, off-balance sheet
liabilities, obligations or transactions.
B

Compliance
Corporations must remain in compliance with these laws and regulations. Just as it is

necessary with any other type of regulatory requirements, compliance to SOX regulations should
be dealt with in a methodical manner through the use of study and proper analysis. Additionally,
compliance should be planned and executed as a typical project within an organization.
Furthermore, some sections of the act are more pertinent to compliance than others, and some of
the sections such as section 302 of the Sarbanes-Oxley Act, which states that the CEO and CFO
are directly responsible for the submissions of financial reports as well as the internal control
structure to the SEC. Another section is section 404, which is views as being the most
complicated, contested, and most expensive to implement of all the Sarbanes Oxley Act sections
for compliance (Sarbanes-Oxley 101, 2014). This section stated that all annual financial reports
must include an Internal Control Report, and registered external auditors must indicate to the
accurateness of company management declaration that internal accounting controls are in place,
functioning and are effective. These areas of the regulation improved reporting standards and
that require management to provide an analysis of the efficiency of internal which will assist an
organization with financial reporting and compliance.

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II

Other Areas of the Sarbanes-Oxley Act

Protecting Whistleblowers
Included in Sarbanes-Oxley, there is a section, which spells out the protection for
employees of publicly traded companies who provide evidence of fraud. This is section 806.
Sarbanes-Oxley encourages the disclosure of corporate fraud by protecting employees of
publicly traded companies or their subsidiaries who report illegal activities (Sarbanes-Oxley 101,
2014). The Department of Labor is authorized to protect individuals from retaliation and also
they can criminally charge those individuals who are to blame for the retaliation. This protection
should encourage employees and other individuals to provide information to the SEC if they feel
there was a violation relating to any type of fraudulent activity against stakeholders, investors, or
other individual.
Fraud Prevention
As a result of provisions and regulations in the Sarbanes-Oxley Act, and penalties that
could be enforced, instances of fraud are seen to be greatly reduced. In addition, instances of
fraud are significantly lessened by an organization using a compliance-based program, which
emphasizes their efforts on prevention through the threat of discovery and penalties for violations
of the law or code of conduct within an organization. According to Hess (2007), teaching
employees the regulations and guidelines they must observe in relation to an integrity-based
program, places emphasis on incorporating ethics into their decision-making and motivating
these individuals to realize the ethical ideals of the corporation. Further, organizations that
employ an integrity-based approach, emphasizes creating legitimacy with individuals in an
organization through values and self-governance that has been developed internally in a firm

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(Hess, 2007). Obedience to the law is based on a sense of moral obligation to obey laws and
regulations by an individual not based on the threat of punishment.
Internal Controls and Processes
Internal control is defined as a process that is affected by a board of directors,
management and other personnel, that is intended to provide reasonable assurance in regards to
reaching objectives such as the effectiveness and efficiency of operations, the reliability of
financial reporting and compliance with applicable laws and regulations (Draz, 2011). In order to
implement effective fraud prevention, it is critical that the attitude of a company have a tone that
is set at the top of the organization, with strong attitudes, transparency, and internal controls
being promoted throughout the environment. These internal controls should develop and
progress over time as changes in the business such as technological advances and the fraud
environment varies in response to competitiveness, industry practices, regulations and new laws,
and economic environments. In regard to Sarbanes-Oxley Section 302, this section requires
corporate officers be responsible for internal controls and having evaluated these internal
controls, keep a record of any insufficiencies in the internal controls, as well as significant
changes that could have a negative impact on the internal controls (Rosenbaum, 2010).

III

Corporate Governance

Ethics at the Core

Ethics is at the center of corporate governance, and management must exhibit
accountability for their actions on a local, national, and global scale. Business operations cannot
be ethical, but top executives and corporate policymakers can put into operation ethics within the
structure of the business strategy of an organization. Furthermore, corporate ethics and the

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desire for having a profitable business must be aligned with stakeholders. It is up to high ranking
executives to make sure that ethics and the desire for profitability are both supported. According
to Brigham,
A firms commitment to business ethics can be measured by the tendency of its
employees, from the top down, to adhere to laws, regulations, and moral standards
relating to product safety and quality, fair employment practices, fair marketing
and selling practices, the use of confidential information for personal gain,
community involvement, and illegal payments to obtain business (Brigham,
2016).
What this means is that the measure of ethics should be the basis for all activities in an
organization in regard to organization and financial processes. Additionally, if lower level
employees see top executives behaving inn an ethical manner, and this expected behavior is
implemented into policies and all areas of activity in an organization, there will be less instances
of unethical behavior and fraudulent acts committed. Managers and other influential members of
a corporation must hold themselves accountable for their conduct and the manner a company
operates that will impact stakeholders, employees, and their community.

Establishing Standards and Compliance

Corporate governance standards and compliance go hand in hand. Corporate governance
is concerned with the manner that a company is run by its managers and the level of
accountability towards shareholders and the corporation itself. According to Brigham, corporate
governance is the degree to which a company employs principles of value-based management
often depends on its corporate governance (Brigham, 2016, p. 404). It is a set of laws, rules, and

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procedures that impact operations and the decisions made by its managers for a corporation.
There are implications for company behavior in regard to the manner employees are treated, in
addition to shareholders, consumers and banks (Improving Business Behaviour: Why we need
Corporate Governance, 2016). Good corporate governance plays a critical role in reinforcing the
integrity and efficiency of financial markets. Conversely, poor corporate governance deteriorates
the potential of a company, opening the door for financial difficulties and possibly fraud from
inside on many levels. Therefore, it is crucial for standards to be set and followed by all within
the organization. If a company is governed well from the top down, typically, they will be
successful as employees will act in accordance to top executives. In addition to establishing
standards, is the compliance by employees. When employees are compliant to regulations set by
top executives, there is less chance of unethical behavior. Top executives should support the best
interests of the company and the investors alike and this involves inaugurating beneficial
relationships with other individuals in the company and especially employees in maintaining a
balance of everyone interests.
Promoting Transparency
Transparency can be fostered by top executives and corporations have a legal and ethical
obligation to conduct their business with integrity. This necessitates responsibility and the
obligation as well as resources such as policies that are fundamental in the effort to prevent and
intervene when corruption within organization in apparent. In addition, Companies can lessen
the risks brought about by a lack of transparency by being open about their corporate structure
and by making basic financial information public as warranted. This permits stakeholders to have
an unblemished perception in regard to the operations of a corporation, and makes the company

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more accountable for its activities. Public reporting is a strategic component of the measures
needed to address corruption and provide the transparency.
IV

BP Disaster

Corporate Scandal
After scandals such as Enron and Tyco prior to the creation of the Sarbanes-Oxley, there
was a disaster that impacted the United States for many years to come. The BP disaster occurred
after a gas release and succeeding explosion occurred on the Deepwater Horizon oil rig in the
Gulf of Mexico. Recognized as the worst oil spill in U.S. history, this disaster killed 11 people.
Underwater cameras revealed the BP pipe was leaking oil and gas on the ocean floor about 42
miles off the coast of Louisiana, and by the time the well was capped after 87 days of spewing
oil, an estimated 3.19 million barrels of oil had leaked into the Gulf (The Ocean Portal Team,
2015). This disaster still affects some individuals to this day as their livelihood has never been
restored.
Accountability
The Securities and Exchange Commission today charged BP with misleading investors
while its Deepwater Horizon oil rig was gushing into the Gulf of Mexico by significantly
understating the flow rate in multiple reports filed with the SEC (BP to Pay $525 Million Penalty
to Settle SEC Charges of Securities Fraud During Deepwater Horizon Oil Spill, 2012).
Executives at BP made public statements standing behind earlier claims of the flow rate estimate
being 5,000 barrels per day when in fact, their internal data indicated much higher estimates of
52,700 to 62,200 barrels of oil per day. BP never corrected or updated the misrepresentations
and omissions it made in SEC filings for investors, for which they were severely fined and
penalized. Corporations need to be held accountable in all aspects of their operations. Good
corporate citizenship and responsible crisis management means that a company can't hide critical
information simply because it fears the backlash. (BP to Pay $525 Million Penalty to Settle SEC
Charges of Securities Fraud During Deepwater Horizon Oil Spill, 2012). Furthermore, this
disaster has had lasting effects on the environment, but by concealing the severity of the spill, BP

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caused harm to their stakeholders, investors, and the public, all who are promised transparency,
truthfulness, and honesty from a corporation, especially in critical times such as this disaster.
V

Corporate Responsibility

Competitive Advantages
Corporate responsibility will result in an advantage for any organization. This is
explained in section 302 of Sarbanes-Oxley. This section emphasizes corporate responsibility for
financial reports and specifies the precise requirements for managers and high ranking executives
of an organization in the effort to comply with SOX regulations (Sarbanes-Oxley 101, 2014)..
Requirements were developed so any financial report does not contain untrue statements, omitted
facts, or statements that can be seen as misleading. When the financial statements of a company
are appropriate, accurate, and properly represented, interested investors are able to make more
intelligent investing decisions. In addition, the public, investors, and lenders are more liable to
have increased confidence in the corporation, therefore creating a competitive advantage in the
market.
Penalties and Fines
There are fines and penalties that can be assessed to an organization if in fact it has been
found that an organization who is found to have violated these laws can suffer severe penalties.
The section that addresses criminal penalties for certifying a misleading or fraudulent financial
report is section 906. Under SOX 906, penalties can be upwards of $5 million in fines and 20
years in prison. This is a direct excerpt from this particular section in regard to criminal
penalties:
Whoever - (1) certifies any statement as set forth in subsections (a) and (b) of
this section knowing that the periodic report accompanying the statement does not

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comport with all the requirements set forth in this section shall be fined not more
than $1,000,000 or imprisoned not more than 10 years, or both; or (2) willfully
certifies any statement as set forth in subsections (a) and (b) of this section
knowing that the periodic report accompanying the statement does not comport
with all the requirements set forth in this section shall be fined not more than
$5,000,000, or imprisoned not more than 20 years, or both (Sarbanes-Oxley 101,
2014).
The penalties that can be enforced on an individual or a corporation are indeed severe, and will
assist in the deterrent of criminal, fraudulent, and unethical behavior.
In conclusion, the Sarbanes-Oxley Act contains regulations that increase the level of
accountability for financial statements. In addition, this Act defines the penalty for fraud, makes
executives in a corporation responsible for financial disclosures and this financial reporting of
their corporation is truthful. Auditors are required to provide full accounts to audit committees in
regard to accounting policies and practices. The documentation required under the SarbanesOxley Act forces the necessity for executives to document the internal control environment of
their company, but to confirm that the controls are working effectively in order to ensure any
business risks are being properly minimized. Companies have a responsibility to their
shareholders and the public as well as their employees to be transparent in aspects of corporate
governance. Lastly, this Act was designed to better protect investors and shareholders as well as
to increase their confidence in public corporations by the strengthening of internal control and
corporate governance.

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References
BP to Pay $525 Million Penalty to Settle SEC Charges of Securities Fraud During Deepwater
Horizon Oil Spill. (2012, November 15). Retrieved March 13, 2016, from SEC.gov:
https://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171485962
Brigham, E. F. (2016). Intermediate financial management. Retrieved March 13, 2016, from
https://everest.vitalsource.com/#/books/9781133708803/cfi/0
Draz, D. (2011, March 28). Fraud prevention: Improving internal controls. Retrieved March 13,
2016, from CSO Online.com: http://www.csoonline.com/article/2127917/fraudprevention/fraud-prevention--improving-internal-controls.html

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Hess, D. (2007). A BUSINESS ETHICS PERSPECTIVE ON SARBANES-OXLEY AND THE

ORGANIZATIONAL SENTENCING GUIDELINES. Michigan Law Review, 105(8),
1781-1816. Retrieved March 16, 2016, from
http://web.b.ebscohost.com/ehost/detail/detail?vid=10&sid=c76ddf8d-992a
Improving Business Behaviour: Why we need Corporate Governance. (2016). Retrieved March
13, 2016, from OECD.org:
http://www.oecd.org/daf/ca/corporategovernanceprinciples/improvingbusinessbehaviour
whyweneedcorporategovernance.htm
Rosenbaum, E. (2010, June 22). BP, Big Oil: Meet Sarbanes-Oxley Section 302. Retrieved
March 13, 2016, from The Street.com: http://www.thestreet.com/story/10788628/1/bpbig-oil-meet-sarbanes-oxley-section-302.html
Sarbanes-Oxley 101. (2014). Retrieved July 23, 2014, from Sarbanes Oxley Act 101:
http://www.sarbanes-oxley-101.com/
Simon, D. R. (2009, December). Corporate Accountability: A Summary of the Sarbanes-Oxley
Act. Retrieved March 13, 2016, from Legal Zoom.com:
https://www.legalzoom.com/articles/corporate-accountability-a-summary-of-thesarbanes-oxley-act
THE GOOD, THE BAD, AND THEIR CORPORATE CODES OF ETHICS: ENRON,
SARBANES-OXLEY, AND THE PROBLEMS WITH LEGISLATING GOOD
BEHAVIOR. (2003). Harvard Law Review, 116(7), 2123. Retrieved March 13, 2016,
from http://web.b.ebscohost.com/ehost/pdfviewer/pdfviewer?sid=881608e2-0e08-42ca8472-bc44d4f1ae74%40sessionmgr198&vid=1&hid=102

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The Ocean Portal Team . (2015). Gulf Oil Spill . Retrieved March 13, 2016, from Ocean Portal:
http://ocean.si.edu/gulf-oil-spill