Effects And Controversy Of The Sarbanes Oxley Act Accounting Essay


Not only were billions of dollars lost in corporate accounting scandals involving Enron and Worldcom, thousands of jobs on top of an immeasurable amount of credibility was also lost in the process. As most everyone knows by now, or should know, 2002 became a turning point in the world of business. Publicly traded companies such as Enron and Worldcom were caught by the SEC misrepresenting financial statements, quickly leading to steep downward spiral in stock prices of publicly traded firms throughout the market. Once considered to be one of the top five accounting firms, Anderson was fined $500,000 and given five years of probation following the Enron scandal. The firm initially lost over 1,000 employees and is no longer audits corporations (CBCNews, 2002). As a result of these scandals, investors lost millions of dollars as the marketplace took a big hit that day nearly five years ago.

On June 25, 2002, it was announced that Worldcom was a part of the largest corporate fraud case in American history at the time, with numbers reaching up to $3.8 billion (Snee, 2007). Mr. Snee goes on to say that stocks sunk to new lows on news of the fraud, as investor's increasingly lost faith in companies' earnings statements. As a result of such fraudulent activities associated with Worldcom and Enron, President George Bush signed the Sarbanes-Oxley act into law on July 30, 2002 (Edison, 2006). The Sarbanes-Oxley Act is backed by the SEC to insure credibility and accountability of financial statements among publicly traded companies. Although it was certain to restore investor confidence in the marketplace, the Sarbanes-Oxley Act has become a center point of controversy in the business world today since its enactment back in 2002. In this paper, I will explore the affects of the Sarbanes-Oxley Act, identifying key advantages and disadvantages of this law.

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One primary advantage of this Act is the positive impact it had in the stock market. Everybody can essentially agree on the fact that its main purpose was to restore investor confidence in the U.S. market. In a report conducted by the University of Iowa's college of business, researchers found that overall; the market jumped eleven percent by August of that same year (Snee, 2007). Cost of compliance of this law was highly irrelevant at the time as priority was placed directly on cleaning up financial statements to provide more accurate and reliable information to the outside investor. The law stated that independent auditors were now required to prepare financial statements for publicly traded firms. Sarbanes-Oxley developed the Public Accounting Oversight Board, a private, nonprofit corporation, to ensure that financial statements were, and still are, audited according to independent standards (Miller & Jentz, 2006). Along with this, under Section 906 for Certification Requirements, the Act states that chief executive officers and chief financial officers of public companies sign off on their company's financial reports (Edison). This section essentially created an ambiance of increased responsibility among corporate executives.

A few other significant provisions of the Sarbanes-Oxley Act include loan specifications to Directors and Officers. Section 402 prohibits any company that reports to the SEC from making personal loans to directors and executive officers (Miller & Jentz, 2006). More self-explanatory provisions in the Act include protection from employer discrimination against whistleblowers, and enhanced penalties for violations against the SEC (Miller & Jentz, 2006).

While this may seem more than appropriate, businesses have put up a big front regarding the negative impact these regulations have on their company. Despite the fact that the Sarbanes-Oxley Act has increased investor confidence, several disadvantages have emerged regarding the Act that not everyone is entirely aware of.

One of the most controversial parts of the Sarbanes-Oxley since its enactment is section 404. This section has two primary requirements: (1) public companies must evaluate and disclose the effectiveness of their internal controls as they relate to financial reportings; and (2) it requires that the effectiveness of such internal controls be attested by an independent outside auditor (Edison, 2006). For the first time, companies must document its internal controls and verify they are operating effectively. This requirement has its own personal impact on oil and gas companies. PricewaterhouseCoopers notes, "Oil and gas and utility companies operate in an increasingly complex environment where internal control deficiencies can have an important impact on the accuracy of financial reporting. Reserves reporting, decommissioning, customer account collection difficulties, energy trading, taxation, and carbon allowances are just a few of the areas posing specific challenges" (Edison, 2006). With tighter restrictions, more time and money must be spent to ensure accuracy within financial statements. Companies must now dedicate more money in hiring teams of auditors to ensure compliance with Sarbanes-Oxley rather than hiring more workers.

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According to a survey conducted by Financial Executives International, publicly traded companies spent an average of $4.36 million annually to comply with the Sarbanes-Oxley Act (Edison, 2006). The decision of small businesses to go public has been highly influenced by this act. Small businesses tend not to have excess money around to hire teams of auditors to regularly check their financial statements. According to Minnesota Senator Norm Coleman, this act forces small businesses to make a decision of either hiring new workers or auditors, otherwise unnecessary if deciding to stay private. An obvious competitive disadvantage is exploited here with larger public companies with greater economies of scale to deal with increased compliance costs (Coleman, 2007). High compliance costs are forcing small businesses to remain private and not develop and expand within the domestic capital market. It is no secret that the principle objective of smaller firms is operational growth fueled by access cash and financing. Thus, alternative financing must exist for a company to avoid the tribulations of "going public"(Robert Kennedy College, 2005). As a result, fewer and fewer businesses have gone public since Sarbanes-Oxley was put into place in 2002. The costs are simply far to excessive for some firms to even consider going public. According to Andrew Edison's article on Exploring the Impact of Sarbanes-Oxley, nine of the ten largest initial public offerings last year, and 24 of the 25 largest public offerings in 2004, were conducted in overseas markets. Although the Act unquestionably restored investor confidence in the U.S. market, there is evidence here illustrating an adverse affect on the firms themselves, as they are beginning to conduct business in other markets to control compliance costs.

Not only has the act negatively affected the market via small businesses, the impact has also been felt internationally. In a report done by Robert Kennedy College in Switzerland, it states, "the negative impact on the U.S. economy has already been felt as foreign companies reconsider the listing of their stocks on American stock exchanges. Companies such as Porsche, Daimler Chrysler and Bayer, are displeased with the Act's requirement of the company's upper officers to have to sign off on reports and be held entirely liable for accuracy. Porsche's CEO Wendelin Weideking commented saying that it "makes no sense." He argues that hundreds of employees are involved in finalizing the accounts and that under German law, the management board is collectively responsible, not one individual (Robert Kennedy College). Executive officers of other companies feel they spend more time trying to avoid liability under the Act, rather than focusing on how to increase shareholder value.

Other complaints I have heard pertaining to Sarbanes-Oxley is that it is rather extensive and difficult to comprehend. For an amendment like this to be fully effective, it must be precise but simple. There is no question that Sarbanes-Oxley is here to stay. Whether or not revisions will succumb, will only be told through time. As previously illustrated, in order for small businesses to grow and prosper, there must be some modifications in the future to help control compliance costs associated with the Act.

Positive impacts of the Sarbanes-Oxley Act of 2002 appear to be one sided. It is great for the world of investors but it seems to be negatively effecting small businesses and international trading. Its true there has been a fraudulent case involving millions of dollars since 2002, but its not like it was a regular occurrence in the first place. Overall, I support the general concepts the Act requires but in order to maintain growth in small businesses in the U.S., some modifications must take place, for it is critical to the economy that small firms expand and foster value.