Scandals, Lies, and the Downfall of Empires
Enron was the first domino to fall. In the months and years to follow, companies such as WorldCom followed Enron into bankruptcy, lawsuits, and prison. Blasted in notable newspapers like The Economist, The Wall Street Journal, and The New York Times, these industry giants with unbelievable (truly) profits had been in business for decades, but 2001 and the years following were a turning point where everything they achieved crumbled around them. For investors, the estimated loss due to the accounting scandals fell at around $900 billion. Businesses today continue to be shaped by the consequences which arose from the collapse. From the rubble, the Sarbanes-Oxley Act of 2002 was created. Born from Senator Paul Sarbanes of Maryland and Representative Michael G. Oxley of Ohio, SOX sought to protect investors by bettering the accuracy of financial reporting. By creating standard financial record keeping and reporting practices, increasing the board of directors oversight and responsibility and that of any independent auditor which reviewed and reported on the company’s financial information.
Complying with the Act
SOX was created with the intended recipients being public and private companies. For private companies, SOX is considered to be best practice for corporate governance. For those seeking to go public, it’s doubly important to adhere to it since companies have to be in compliance with the Act prior to going public. Out of its 11 titles, five are to be kept in mind. Title I created the Public Company Accounting Oversight Board (“PCAOB”). The name speaks for itself. Under oversight authority of the Securities and Exchange Commission (“SEC”), the PCAOB oversees the audits of public companies and SEC registered firms. Title IV requires financial disclosures and any material changes to be filed and updated in a timely manner. It also increased the amount of items which need to be disclosed by the company. Jumping forward four titles, Title VIII deals with the destruction, alterations, concealment or falsification of records in federal investigations or in bankruptcy. And if the company’s auditor doesn’t maintain audit or review work for a five-year period. Title IX amends federal law to increase white-collar criminal penalties, ensure senior corporate individuals are required to certify the accuracy of the financial statements and establishes criminal liability for those who refuse to do so or for those who certify while knowing it doesn’t comply with the Act. The final title, Title XI, amends criminal law to adjust maximum prison sentences for tampering or seeking to interfere with an official proceeding.
SOX for Private Companies
Public companies were the main targets of the Act. Although the Act fully covers public companies, privately-held companies were and continue to be held to specific sections of the Act and of the penalty standards for non-compliance. Less sections apply to private companies, but a few of the ones that do include actions such as:
- Willful destruction or falsification of key documentation in federal investigations
- Retaliation efforts against whistleblowers
- Penalties which occur for not complying with the Act
Ardent adversaries argued many companies would be unable to handle the financial burden. Due to the large financial impact it’d place on the feet of small private businesses, it’d decrease industry competitiveness since fewer companies would seek to go public due to a regulation they viewed as being too strict. Advocators stated that the many benefits such as the increased investor confidence in the company’s financial reports, the decrease of financial fraud occurring, and the expanded internal compliance reviews and processes would outweigh the negative aspects and ramifications of SOX.
21 Years Later: Looking Back
Costs for complying with the Act had a much higher price tag than initially predicted and that includes non-cash expenses such as staff labor and operational expenses. Some public companies chose to “go dark”– meaning they transitioned back into being a private company by delisting and deregistering. In The Costs of Being Public After Sarbanes-Oxley: The Irony of “Going Private”, it stated Schedule 13E-3 filings in 2004 totaled 144 companies and of those, roughly 38% cited the cost of compliance as their reasoning. But on the opposite side, what advocates said from the beginning rings true: the benefits outweigh the costs. In one study, CEOs’/CFOs’ Swearing by the Numbers: Does It Impact Share Price of the Firm?, it showed the bid-ask price of securities decreased after certifications by CEOs and CFOs who certified the accuracy of their financial statements. Another study demonstrated a positive correlation for companies between corporate governance and increased financial performance. And a third cited that the enactment of SOX improved companies’ liquidity and the nearer they were to compliance, the more improved their liquidity measures were. Although the costs were high, over two decades later, what the Act sought to accomplish was achieved: protection of investors. That in itself trumps the negative aftermath.