Sarbanes-Oxley (Sox) – Effective or Not?

Sox - Effective or NotIn 2002 the Sarbanes-Oxley Act (SOX) was enacted following a series of failures involving various functions designed to protect the interests of the investing public. At the time, it was considered to be the most far-reaching legislation affecting public corporations and their independent auditors since the 1930s.  But the question is, has SOX been effective? We turn to Curtis C. Verschoor and an article on Accounting Web for the answer.
SOX is widely credited for strengthening at least two major areas of investor protection: 
  1. CEO and CFO responsibility and accountability for all financial disclosures and related controls
  2. increased professionalism and engagement on the part of corporate audit committees
Yet some continue to question its overall value, citing, as an example, its failure to prevent the situations that led to the financial crisis of 2008.
 
Section 404
 
One of the most controversial aspects of SOX Act is Section 404, which requires company management to provide assertions of effective internal control over financial reporting and for the company’s independent audit firm to attest to those assertions.
 
Congress has been repeatedly pressured to ease this requirement, which it did with the Jumpstart Our Business Startups Act (JOBS Act), passed by Congress and signed by President Obama April 5, 2012. The JOBS Act contained a provision that eliminated the SOX Section 404 requirements for organizations that meet the definition of an emerging growth company.
 
Aside from requiring management’s assertions and the auditor’s attestation, SOX Section 404 also requires public companies to disclose whether or not they have adopted a code of ethics applicable to their senior financial officers.  All these requirements have significantly elevated the visibility of ethics and made a strong ethical culture a best practice for organizations of all sizes and types.
 
Audit Firm Performance
 
When evaluating the overall effectiveness of SOX, a vital consideration to make is whether the performance of independent auditors has improved over the last ten years.  Whether the revised oversight structure adequately regulates public company auditors appears to be an open question even after so many years.
 
Since auditing became a distinct occupation many hundreds of years ago, auditors have functioned largely as self-regulating professionals. Prior to SOX, important decisions regulating the profession were made largely or exclusively by the auditing industry, its firms, and auditors themselves. 
 
When SOX was enacted, the practice of public accounting was divided into audits of publicly held companies and all other entities. SOX established the Public Company Accounting Oversight Board (PCAOB). The PCAOB was given the mission to set and enforce practice standards for a new class of firms “registered” to audit publicly held companies. Standards for not-for-profit and governmental entities continue to be set by the industry itself.
 
An annual speech by the PCAOB chairman has been the only public evaluation of the quality of performance of audit firms. These reports have expressed only general comments, not comprehensive statistics. 
 
The general requirement in SOX that all findings resulting from PCAOB inspections be held confidential hinders any analysis of perhaps the key measure of audit quality: audit failure. Public reports of annual inspections of specific audit firms contain no details of findings on individual clients.
  
An analysis of firm performance reported in PCAOB firm inspections appearing in Between the Numbers showed a 20 percent rate of audit failure at E&Y for 2010, more than double the rate in the 2009 inspections. 
 
SOX Enforcement
 
To be fair, a great deal of the effectiveness of SOX depends on the vigor to which it’s enforced. Questions remain as to whether the SEC’s and Department of Justices’s enforcement of SOX has been sufficient. A July 30 article in The Wall Street Journal notes that SOX’s “biggest hammer – the threat of jail time for corporate executives who knowingly certify inaccurate financial reports – is going largely unused.”
 
Although SOX has been successful in increasing corporate focus on a strong ethical culture in publicly owned companies, there’s room for improvement in audit firm performance as well as the PCAOB’s process for assessing and reporting on it.

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