Sarbanes-Oxley

On July 30, 2002, President George W. Bush signed the Sarbanes-Oxley Act (SOX) into law. SOX and the [Page 1409]regulations passed by the Securities and Exchange Commission (SEC) pursuant to its mandate are the most dramatic and wide-ranging rules to apply to U.S. public companies since passage of New Deal-era financial legislation. SOX was passed in response to several corporate governance scandals involving improper financial reporting at U.S. companies such as Enron and Worldcom and remains a controversial piece of legislation.

All companies publicly raising funds in the United States must comply with SOX, whether the company is based in or does business in the United States. SOX seeks to increase the monitoring of U.S. public company managers by parties such as directors, auditors, and attorneys. SOX requires each director on the boards audit committee to be independent, which means that the director can provide no other services to the company and cannot receive fees other than for serving as a director. SOX also requires the audit committee to include a financial expert. In addition, the New York Stock Exchange (NYSE) and the NASDAQ stock market, in response to SOX and a request by the SEC to review their corporate governance requirements for listed companies, enacted rules requiring a majority of the directors on a board to be independent.

SOX also prohibits external auditors from providing any nonaudit services to issuers and prohibits lead auditor partners from providing services to the same company for more than five years. SOX established the Public Company Accounting Oversight Board (PCAOB), which is responsible for overseeing, investigating, and disciplining auditors. The PCAOB also took over the role of promulgating auditing standards for external audits of public companies from the American Institute of Certified Public Accountants.

SOX imposed new duties on company managers to improve the financial reporting process. Section 404 of SOX mandates that managers maintain, evaluate, and report on internal control over financial reporting. Internal control is a system to provide reasonable assurance to investors that a company's financial statements are reliable and comply with generally accepted accounting principles. Pursuant to Section 404, managers are responsible for completing an annual report about internal control that discloses any material weaknesses. An outside auditor must also provide an independent evaluation of management s assessment of internal control.

Under SOX, top managers have a particularly heightened responsibility regarding internal control and financial reporting. SOX requires the chief executive and chief financial officers to annually certify the truth of the company's financial and nonfinancial disclosures and publicly disclose any significant changes in internal controls. SOX also requires attorneys working for the company to report any violations of securities laws or breach of fiduciary duty up through the corporate hierarchy. In addition, SOX increased criminal liability for violations of the federal securities laws, enabled the SEC to prohibit persons from serving as directors and officers if they are found “unfit” to serve, and prohibited companies from making loans to directors or executive officers. The SEC also implemented regulations pursuant to SOX to reduce potential conflicts of interest between securities analysts, who provide third-party research about companies, and their employers, who may have investment banking or other relationships with the same companies.

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