While these provisions have benefitted investors, they have simultaneously increased the cost of compliance for small-cap companies. Research has noted that smaller companies that have chosen to go public face disproportionately high audit costs. The additional resources and financing required to ensure compliance with the Act forces such companies to delay going public, thereby causing a rise in debt financing and venture capital investments for smaller entities. During the 2008 financial crisis, Former Speaker Newt Gingrich blamed the Act for the low number of initial public offerings and appealed to Congress to repeal the Act. Some critics also claim that the Act was an extreme political reaction to a few high-profile corporate financial scandals and has hindered competition and the growth of businesses. Private companies that fail to adopt SOX-like governance and internal structures have also faced increased difficulties in raising capital, higher insurance premiums, and greater civil liabilities. Despite the ongoing criticism, the SOX Act is essentially unchanged since its inception. It remains in force as landmark legislation that restored investor confidence and brought increased transparency in financial reporting.
Relevant Provisions of the Act
One of the key provisions of the Act includes:
Section 302, which pertains to “Corporate Responsibility for Financial Reports,†provides that the senior corporate officials must certify the authenticity of financial statements in writing to ensure no misrepresentation. They are responsible for the internal accounting controls of the company. They must ensure that the necessary disclosure requirements of the SEC are followed such that any material change in their financial condition is reported to all stakeholders.
Section 404 mandates that companies must establish and publish details regarding the structure of their internal accounting procedures in their annual financial disclosure reports. Additionally, an auditing firm must also assess the effectiveness of its internal controls and financial reporting as a part of the audit process.
Section 802 lays down three main rules for record-keeping, which includes:
strict penalties for destroying, altering, or falsifying financial statements.
a well-defined retention period for storing accounting records.
the specific nature of business records to be maintained, which includes electronic communications.
Benefits of the Act
The SOX Act has played a significant role in reducing financial crime and accounting fraud since the heavy penalties deter organizations under the scrutiny of the SEC from overstating key figures such as revenues or net incomes. Investors have access to truthful and complete information about the financial condition of an entity. The Act also provides adequate protection against retaliation, dismissal, or discrimination to employees and whistleblowers that report fraud and testify in court against the organization. The Act also created an “auditor watchdog,†the Public Company Accounting Oversight Board (PCAOB), which sets standards and rules for audit reports. Auditors of public companies must register with them such that the PCAOB can inspect, investigate, and ensure compliance with the established rules. Certain rules have been designed to prevent conflict of interest. For example, accounting firms cannot perform non-audit functions (such as business consulting) for companies during the audit process. While all public companies must hire an external audit firm to review their practices, the Act makes a relaxation by deferring the rule for small-cap companies with a market capitalization of less than 75 million.
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