SARBANES-OXLEY ACT OF 2002(SOX)

Students Name __________________

Professors Name __________________
Course Title __________________
Date __________________






Introduction to SOX:
Financial Analysis involves evaluation of business, budgets, projects etc to ensure stability,
liquidity, and solvency and at last profitability of the business in presence of domestic and global
macro-economic environment to determine suitability of investment. This evaluation is not
completely objective and gets impacted by personal biases of the analysts which result into
misleading outputs for investors. Many analysts get influenced by herd mentality and try to
follow the presently accepted mood of the people.
Situation before development of SOX: In year 2000, many were betting on Information
Technology shares just to follow the wave. This resulted into well know bubble burst of IT
stocks. Similar situation was observed during 2008 when real estate was crashed along with
financial sector downturn. Analysts are also found favoring few companies to serve their hidden
motives as depicted in the movies like Wall Street, Too Big Fish etc and trying to keep some
stocks-up or some at low price-level. Sometimes, traders inflate the stock prices, book the
profits and then suddenly crash the stock. All this creates shocks in the market which sweeps
away money and confidence of more than 95% of the investors.
Sarbanes-Oxley Act (SOX) of 2002 :It was enacted following a series of failures involving
various functions designed to protect the interests of the investing public. Containing several
highly controversial provisions, SOX created a total revision of the regulatory framework for the
public accounting and auditing profession and provided guidance for strengthened corporate
governance. It was considered to be the most far-reaching legislation affecting public
corporations and their independent auditors since the 1930s

Definition of Ethics: Ethics is derived from Greek word Ethos which means character. It is a
branch of philosophy and deemed as a normative science which deals with norms of human
conduct and judgment regarding right and wrong. Business Ethics is study of proper business
policies and practices regarding potentially controversial issues, such as corporate governance,
insider trading, bribery, discrimination, corporate social responsibility and fiduciary
responsibilities. It provides basic framework/guidelines which can help people in evaluating
what would constitute an ethical behavior under various circumstances. Unethical behavior can
potentially smash-up the firms reputation.
Unethical Behavior:- "Unethical behavior has caught up public attention in recent times due to
plethora of scandals in the last few decades irrespective of the sector of operation of the business.
The tough economic times have brought many transformations in the conduct of business with
the most disturbing and erosive being the immorality in employees conducts and propensity for
corruption. Consequently, as devised by public interest theory, government/regulators have
enforced stringent regulations and inspection actions to be taken in case of misconduct, more
noticeably after unethical scandals in financial reporting by Enron, WorldCom, Tyco etc.
Development of SOX: One of the important development was the Sarbanes Oxley Act (SOX) -
enacted to bring in accountability and more transparency in financial reporting and thus to
restore investors confidence in response of the fraudulent practices observed at high profile
companies .The legislation came into force in 2002 and introduced major changes to the
regulation of financial practice and corporate governance. Named after Senator Paul Sarbanes
and Representative Michael Oxley, who were its main architects, it also set a number of
deadlines for compliance.
Objective of formation of SOX: The Sarbanes-Oxley Act (SOX) mandated strict reforms to
improve financial disclosures from corporations and prevent accounting fraud. SOX was enacted
in response to the accounting scandals in the early 2000s. Scandals such as Enron, Tyco, and
WorldCom shook investor confidence in financial statements and required an overhaul of
regulatory standards. It was an act passed by U.S. Congress in 2002 with objective to protect
investors from the possibility of fraudulent accounting activities by corporations.
The Sarbanes-Oxley Act is arranged into eleven titles. As far as compliance is concerned, the
most important sections within these are often considered to be 302, 401, 404, 409, 802 and 906.
Key Provision of SOX:-The rules and enforcement policies outlined by the SOX Act amend or
supplement existing legislation dealing with security regulations. The two key provisions of the
Sarbanes-Oxley Act are:
1. Section 302: A mandate that requires senior management to certify the accuracy of the
reported financial statement
2. Section 404: A requirement that management and auditors establish internal controls and
reporting methods on the adequacy of those controls. Section 404 had very costly implications
for publicly traded companies as it is expensive to establish and maintain the required internal
controls.
Result so far: However later with the cases like Madoff, Lehman, AIG, SOX was criticized as
ineffective and unpractical regulation. It has been intensively debated under Special Interest
theory and capture theory where suggest that the regulations are formed keeping in mind the
interest of special groups and lobbyists. The stronger the lobbyist the more influence it will have
in the final regulation. Regulator also derives the benefits through the interest groups in terms of
getting resources and votes for them.
My Viewpoint: I firmly believe that business environment has always been conducive for the
players practicing the business via ethical conducts. For a business to be sustainable, it must
serve the need of all its stakeholders in an ethical way. Many companies have lost investors
confidence for not conducting its business ethically, even if it is providing good returns. Leaders
in organizations face many challenges in promoting ethical behavior conduct throughout the
enterprise. A leader can imbibe in and display ethical qualities which he expects to be displayed
by his team, as ethical behavior in any organization begins from the top and subsequently
percolates down. Companies are taking the issue on priority and the same is proved by
companies propounding for ethical code for conduct of employees.
One of the biggest accounting scandals that caught the limelight was of Enron in the year 2002.
It which was biggest auditing failures/ frauds in the world history that time which involved the
innovative accounting that explored the loopholes in the Generally Accepted Accounting
Principles (GAAP), standards used for preparing the financial statements by companies.
Famous Case of Enron: Enron's complex and innovative presentation of its financial statements
mislead not only the shareholders but also the financial analysts. Additionally, the business
model was made so complex that the company utilized the accounting limitations as per
regulations applicable that time and thus was able to suppress the losses and manipulate the its
balance sheet misrepresenting favorable performance. They inflated their trading revenues,
suppressed Mark-to market losses and invented the concept of special purpose vehicle to
maintain a good credit rating.
Main party accused to be responsible for this scandal is the auditing form name Arthur Andersen
which was accused of practicing irresponsible standards in its audits. It had conflict of interest by
charging and earning very high consulting fees from Enron. Enron pressurized Andersen to
defer/ hide the charges from the Special purpose entities in which Enron had invested as it would
have made its credit risk known to all. In 2001, some articles appeared questioning the Enrons
stock price which was trading that time at around 50 times the earnings. This was starting point
was unearthing this entire accounting fraud and thus stock price plummeted.
In October 2001, the company decided to restate its financial statements for previous years from
1997 to 2000 to correct its accounting frauds. This has led to decline in the investor confidence
and downgrading of companys credit rating.
Corporate Governance and Business Ethics: According to me corporate governance and
business ethics are two pillars on which the sustainable success of the organization lies.
Corporate governance is a set of rules that define the relationship between stakeholders,
management, and board of directors of a company and influence how that company is operating.
It is a multifaceted subject which helps in effective decision making. Good quality services and
better delivery methods can be ensured with good corporate governance. Good governance is
based on unambiguous and lucid communication. It helps in enhancing the accountability of
organization .On the other hand poor corporate governance leads to unprofessional conduct,
fraud and wastage. For E.g.: Enron, Xerox, Tyco and many other organizations faced crisis
because of poor governance.
Display of ethical behavior in the organization begins from the top level management which set
examples for people at lower level of hierarchy. Therefore, a leader must conduct his business
and display ethical qualities which he expects to be practices by his team. Good leader endeavors
to achieve a moral excellence that includes uprightness, fairness, farsightedness, and courage.
Various mechanisms liker stringent government regulations, better systems and processes in
financial institutions, enhanced corporate governance, and increasing customer awareness are
suggested to develop moral character amongst practitioners and avoid ethical lapses. More
importantly, imbibing financial ethics in business schools can provide future financial managers
with a proper ethical education and thereby lesser chances of moral and ethical lapses as in
Enron can be expected.
Thus to conclude, a leader must preach and model the ethics as he is the face of the organization.
A culture of zero tolerance on ethical grounds, clear system of values and code of conduct,
system for reporting, investigating and punishing wrongdoers along with regular training in
ethics at all business levels can be practiced to strive for ethical business environment.
Conclusion: Sarbanes Oxley Act (SOX)was enacted in response of the fraudulent practices
observed at high profile companies like Enron and WorldCom to bring in accountability and
more transparency in financial reporting and thus to restore investors confidence. In light of
cases like Madoff, Lehman, AIG etc. SOX was criticized as ineffective regulation. But we must
understand that in the free market where not everyone wants to play fair, we cannot just stop
regulating wrongdoers for the law being not fool proof. Also, Financial Analysts need to be more
objective in their analysis and accountability should be maintained in case of any
misrepresentation by analysts.


References:-
1) Case study : Fall of Enron published by Harvard Business review
2) Bratton, William W. (May 2002). "Does Corporate Law Protect the Interests of
Shareholders and Other Stakeholders?: Enron and the Dark Side of Shareholder Value"
3) Article on Applying Virtue Ethics: The Rajat Gupta Case retrived from
http://sevenpillarsinstitute.org/morality-101/applying-virtue-ethics-the-rajat-gupta-case
4) http://www.nelsonbrain.com/content/jennings73533_0538473533_02.01_unit01.pdf :
South western legal studies in Business Academic series
5) http://www.soxlaw.com/