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Why Was the Sarbanes-Oxley Act Created?

There is always a story behind a law. There is always a reason it was passed and a purpose for it. If you have heard of the Sarbanes-Oxley Act, then you know that this piece of legislation overhauled corporate regulations back in the early 2000s. A comprehensive reform of the financial practices of businesses, the Sarbanes-Oxley Act put a number of important regulations in place with which businesses must remain in compliance to this day. Let’s take a look into the background of the Sarbanes-Oxley Act.

Why Was the Sarbanes-Oxley Act Created?

In 2002, the Sarbanes-Oxley Act, a piece of federal legislation aimed at the internal financial regulations and external auditing of financial reports of publicly held corporations was passed. After a series of serious cases involving corporate corruption between 2000 and 2002, the federal government needed to respond and form a plan of how to address the widespread corruption that apparently had become so prevalent at major corporations in the U.S.

The large-scale scandal at publicly traded Enron was eye-opening for many Americans as well as their congressional representatives. When Enron, a company that was, at the time, viewed as one of the financially sound stalwarts among major U.S. corporations, ended up filing for bankruptcy, the world was shocked at what was revealed. Enron was an oil and gas giant that had diversified dealings with both oil refineries and power plants, among other endeavors. As it turned out, Enron was taking advantage of government deregulation of the oil and gas industry.

It was revealed that Enron officers and employees misrepresented earnings reports to shareholders and other acts of fraud that led to shareholders ultimately suffering devastating financial losses when the truth of Enron’s failure surfaced. It was also revealed that Enron executives were actively embezzling corporate funds. On top of all of this, the company was illegally manipulating the energy market. Unfortunately, the crimes of Enron were occurring in other major U.S. corporations, such as Worldcom at this time.

The Sarbanes-Oxley Act followed in the wake of these corporate scandals. The confidence of investors in the financial markets had taken a serious hit and the government felt compelled to act. The Act itself had a serious impact on the way that corporations are governed and regulated in the U.S. Among other reporting and regulation requirements, the Sarbanes-Oxley Act required corporations to:

  • Strengthen audit committees
  • Perform internal control tests
  • Strengthen disclosure requirements

Under the Act, corporate directors and officers can be held personally liable for the accuracy of company financial statements. Top-level managers must actually personally certify the accuracy of financial reports. A top-tier manager who is found to have knowingly or willfully made false certifications of financial reports can face anywhere between 10 to 20 years in prison. The Act also established harsher criminal penalties for those engaging in securities fraud.

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What do laws such as the Sarbanes-Oxley Act mean for you and your company? Talk to the team at Castronovo & McKinney. Contact us today.