MAHARASHTRA NATIONAL LAW UNIVERSITY

MUMBAI

Corporate Governance Final Draft

An overview of the Sarbanes-Oxley Act, 2002 and its impact on US
Economy.

Submitted to: Prof. Teesta Hans

Submitted by: Saket Pathak

Enrolment no.: 2019124

Section: B

Submitted on: November 5th, 2022.

B.A., LL.B. (Hons.) Seventh Semester, Fourth Year

 TABLE OF CONTENTS

CONTENTS

I. Introduction.............................................................................................................................3

II. Objectives of the project........................................................................................................4

III. About the Act – Background and Purpose...........................................................................5

IV. Major Provisions of the Act.................................................................................................8

V. Impacts of the US economy: Positive and negative..............................................................9

VI. Conclusion.........................................................................................................................12

VII. References.........................................................................................................................13

2
 I. INTRODUCTION

Investors’ trust in the financial markets was severely damaged as a result of scandals
involving companies such as Enron, Tyco International, and WorldCom. 1 The management of
the company involved in these incidents engaged in financial manipulation and concealed the
off- balance-sheet debt obligations while stating that the company was profitable. 2 It was
painfully obvious that the preexisting legal structure included gaps and loopholes. 3 In
addition, at this point in time, it had become abundantly evident that thewere
scams bulkcarried
of out as a
result of the fact that it was easy for management to circumvent the internal control system
that
was already in place.4 As a result, the Sarbanes-Oxley Act of 2002 (which will be referred to
simply as “the Act” from this point on) was approved. The fact that Senator Paul Sarbanes, a
Democrat, and Senator Michael Oxley, a Republican, worked together to create this act as
part
of a bipartisan effort underscores the significance of the act. 5 This Act was a reprieve for
professional organisations, who had for a long time pushed for the installation of stronger
restrictions in order to monitor the efficient operation of internal controls. However, the Act
is frequently criticised for being a hasty act, which is a common criticism levelled against it.6

The Act, which was passed 20 years ago this year, has had a significant influence on the
corporate governance system in the United States. This year celebrates the 20th anniversary of
its passage. This does not mean that the effect has been entirely beneficial; nonetheless, it has
had a favourable impact on a significant majority of people. 7 This project will initially make
an effort to investigate the legislative history of the Act so that it may later conduct an in-
depth research and analysis of the Act. It will analyse the most important aspects of the
Act and

1
Sarbanes-Oxley Act, LEGAL INFORMATION INSTITUTE, CORNELL LAW SCHOOL, (last visited Sept.
21, 2022), https://www.law.cornell.edu/wex/sarbanes-oxley_act
2
The Pros and Cons of the Sarbanes-Oxley Act, SOX ACT, (last visited Sept. 19, 2022),
https://www.soxlaw.com/the-pros-and-cons-of-the-sarbanes-oxley-act/
3
Supra note 1.
4
Mohamed Hegazy, Noha Abou Kamer, A critical analysis of auditors’ perception of the impact of Section 404
of the Sarbanes Oxley Act on audit quality: an Egyptian perspective, AFRO-ASIAN JOURNAL OF FINANCE
AND ACCOUNTING, (2010),
https://www.researchgate.net/publication/227440012_A_critical_analysis_of_auditors'_perception_of_the_impa
ct_of_Section_404_of_the_Sarbanes_Oxley_Act_on_audit_quality_An_Egyptian_perspective
5
Understanding And Complying With The Sarbanes-Oxley Act, SOX LAW, (last visited Sept. 20, 2022),
https://www.soxlaw.com/
6
Stephen Wagner, Lee Dittmar, The Unexpected Benefits of Sarbanes-Oxley, HARVARD BUSINESS
REVIEW, (last visited Sept. 20, 2022), https://hbr.org/2006/04/the-unexpected-benefits-of-sarbanes-oxley
7
Michael Peregrine, McDermott, Will & Emery, The Important Legacy of the Sarbanes Oxley Act, HARVARD
LAW SCHOOL FORUM ON CORPORATE GOVERNANCE, (last visited Oct. 01, 2022),
https://corpgov.law.harvard.edu/2022/08/30/the-important-legacy-of-the-sarbanes-oxley-act/
3
determine how those aspects varied from the laws that had been in effect previously. In
addition to this, a comprehensive analysis of the Act and its effects on businesses will be
carried out.

II. OBJECTIVES OF THE PROJECT

1. In order to have an understanding of the situation before the Act was drafted
2. To get an understanding of the rationale for the implementation of the Act and the
manner in which its provisions reflected these rationales
3. In order to have an understanding of the most important sections of the Act
4. To get an understanding of both the positive and negative effects that the Act has had.
5. To have an understanding of the steps taken by the government to lessen the impact of
the adverse effects.

4
 III. ABOUT THE ACT – BACKGROUND AND PURPOSE

Along with other financial catastrophes of a like sort, a shocking run of large U.S. companies
declaring bankruptcy within a fairly short period of time was the spark that ignited the
legislative effort that ultimately culminated in the enactment of the Sarbanes-Oxley Act. The
energy trading business Enron, which had been acclaimed by the financial media for its
innovative approach and workplace culture for a period of time, was implicated in the most
prominent of these tragedies. It filed for protection under Chapter 11 in December 2001,
which at the time made it the largest bankruptcy case in the history of the United States. It
was immediately overshadowed by the bankruptcy of WorldCom, which took place in July of
2002 and was a far larger company.8
During that same period, several other enterprises operating in the communications, cable
television, corporate software, and security systems industries also submitted applications for
bankruptcy protection. The cumulative effect of these failures was to cause investors to lose
billions of dollars, to eliminate thousands of jobs, to cause economic damage to the suppliers
and communities that provided services to these enterprises, and to significantly reduce public
trust in the financial markets.9
The designers of Sarbanes-Oxley made an effort to address the fundamental problems that
had
led to the unsettlingly analogous financial disasters that had taken place at Enron and the
other
companies. These included extremely aggressive revenue recognition and “mark-to-market
accounting” practises, complicated financial statements that confused stockholders and
analysts alike, intricate business models that made it difficult to perform external monitoring,
speculative special-purpose entities, and the management conflicts that these presented.10

In addition to this, the root causes included what are called alleged conflicts of interest on the
part of auditors and securities analysts, inadequate corporate disclosures, inappropriate
executive compensation incentives, governance structures that lacked the knowledge required
to effectively oversee the company and its financial practises, overly aggressive corporate
cultures that gave little weight to ethics and compliance, and the marginalisation of the
corporate legal function. 11
In the United States of America, the SOX Act implemented significant changes to the
corporate governance structure.
Both the standards for auditing and the roles of audit committees were

5
8
Id.
9
Id.
10
Id.
11
Id.

6
 12
modified as a result. One of the primary focuses of the Sarbanes-Oxley Act (SOX) was to
eliminate the possibility of management of a corporation interfering with an independent
financial audit. 13 The Act was enacted with a number of major goals in mind, one of the most
important of which was to prohibit the management of a firm from interfering in a financial

14
audit. Protecting investors of a firm from any misleading financial statements made by the
15
corporation was another goal of the Act. The Act was enacted in order to accomplish this.
This is accomplished via the Act, which mandates that independent parties conduct stringent
checks on the accuracy of a company's financial statements before such statements may be
made public. 16 By enforcing tight controls on the management, one of the other objectives of
17
the firm was to improve the level of openness that existed within the enterprises. The
Public
Company Accounting Oversight Board (PCAOB) was also formed as a result of this Act in
order to facilitate the auditing process within firms. 18 The act was drafted as a response to the
crisis involving Enron, and its primary objective was to control the kind of disclosures that
19
were utilised by the firm to cover up its losses. It resulted in an increase in the obligations
that were placed on the company's officers and directors. In addition to that, it detailed the
offences associated with securities fraud as well as the penalties for such offences.

The Sarbanes-Oxley Act applies to a variety of different types of organisations, including

publicly traded companies in the United States that are of a certain size or larger. 20 It makes no
difference where the stocks are really traded: SOX compliance is needed for all shares listed
on the NYSE, Nasdaq, and over the counter. Additionally, compliance with SOX is necessary
for any international companies that have debt or equity on file with the US Securities and
Exchange Commission (SEC).21
In order to audit companies that are required to comply with SOX, accounting firms need to
be in compliance with the standard. There are a select number of publicly traded companies
that do not have to comply with the SOX audit rules, and these companies are as follows: 1)
“non- accelerated filers”, which as of March 2020 refers to companies with annual revenues
of less

12
Sarbanes Oxley Act – Summary of Key Provisions, SARBANES OXLEY 101, (last visited Sept. 21, 2022),
https://www.sarbanes-oxley-101.com/sarbanes-oxley-compliance.htm
13
Supra note 1.
14
Supra, note 1.
15
The Pros and Cons of the Sarbanes-Oxley Act, SOX ACT, (last visited Sept. 19, 2022),
21

6
https://www.soxlaw.com/the-pros-and-cons-of-the-sarbanes-oxley-act/
16
Id.
17
Id.
18
Sarbanes-Oxley Act, 2002, Title I.
19
Supra note 1.
20
Supra note 5.

22

6
than $100 million and a public float of less than $700 million; and 2) emerging growth
enterprises for a period of five years. Both of these categories will remain in effect. 22
Privately held companies and organisations are typically exempt from the compliance
obligations imposed by SOX. This is the case despite the fact that a significant number of the
SOX criteria are "best practises" that would be advantageous to implement regardless of
whether or not the firm is legally required to do so.

28
Id.

7
28
Id.

8
 IV. MAJOR PROVISIONS OF THE ACT

Section 302:23 This clause outlines the responsibilities of both the CEO and the CFO with
regard to the preparation of financial reports. It mandates that the Chief Executive Officer
and Chief Financial Officer examine each and every financial report. They are responsible for
ensuring that there are no misunderstandings and that the data is presented in an accurate
manner. In addition to this, they are required to detail any significant alteration that has been
made to the organization’s internal controls. To put it more simply, it mandates the
implementation of internal controls by corporations in order to guarantee the reliability of
their
financial statements.

Section 401:24 This section mandates the disclosure of all of the company’s commitments,
transactions, and liabilities that are not shown on the balance sheet.

Section 402:25 A company’s off-balance liabilities, obligations, and transactions are required
to be included in the company’s financial statements, as stated in this Section of the Act.

Section 404:26 An analysis of the effectiveness of the company’s internal controls is required
to be included in the annual financial report, as stipulated by this paragraph. It is necessary to
draw attention to the deficiencies that have been found in these studies. In addition to that, the
statement has to include an analysis of how successful these internal control procedures were.

Section 802:27 In this section, the consequences for knowingly manipulating the papers
relating to any inquiry process or any audit are outlined.

Section 806:28 In this section, we discuss how to safeguard employees who blow the whistle
on fraud by providing them with legal protection.

23
Sarbanes-Oxley Act, 2002, § 302.
24
Sarbanes-Oxley Act, 2002, § 401.
25
Id.
26
Id.
28
Id.

9
27
Id.

28
Id.

1
0
 V. IMPACTS OF THE US ECONOMY: POSITIVE AND NEGATIVE

Positive impact
Disclosure of information to shareholders
Mark-to-market accounting, more commonly referred to as “cooking the books”, was utilised
by the Enron Corporation as a means of covering up its financial losses during the Enron
scandal. Enron moved assets off of the company’s ledgers and into another organisation. For
instance, if they built a power plant and calculated that it would produce a profit before it
ever generated an income, Enron moved those assets into another organisation. When a profit
was finally made, however, it was far lower than what had been anticipated on paper. There
was not the slightest attempt made to account for these numbers. 29 To put it another way, the
company would suffer a loss in earnings, but it wouldn’t be disastrous because no one knew
about it except for the insiders who benefitted through insider trading tactics. This was
preferable to the company’s bottom line being harmed by honest financial reporting.
By requiring that all company reports be independently verified for their accuracy,
shareholders may have the peace of mind that their investments have not been put in jeopardy
as a result of unethical business practises such as the one described here.
Importance of internal controls
The Act mandates that managers examine the internal controls over their organization’s
financial statements.30 This legislation’s goal was to increase investor and government
awareness of management overrides, which prompted a thorough examination into Enron
Corporation in 2001.

Management is expected to verify these controls periodically and provide a report on their
results in order to avoid the same internal controls that resulted in Enron’s demise. By putting
checks and balances in place that can detect irregularities before they become a severe
problem for anybody concerned, this stops administrators from manipulating transactions.

Imposition of penalties
The Act received a lot of praise for “taking control of the controls”, which is a control on
31
how the internal control mechanisms were operating within the organisation. This was a
major accomplishment. Auditors have been forced to work harder and improve the quality of
their

29
Supra note 6.
30
The Sarbanes-Oxley Act, 2002.
9
31
Stephen Wagner, Lee Dittmar, supra note 6.

10
work in order to avoid the additional fines that have been imposed by the Act as well as the
following risk of litigation that has resulted from this risk. In addition, there has been a
considerable drop in the number of financial crimes and accounting frauds that have been
committed in the country. Companies were strongly discouraged from making dishonest
statements on significant metrics such as their revenues and net profits. The possibility of
profiting from being sloppy in one’s presentation of financial documents has been judged to
be more alluring than the risk of having one’s actions brought to the attention of the United
States Securities and Exchange Commission (SEC).32

Negative impact
Burden on smaller companies
SOX has been under criticism from very small public companies, all of whom are required to
abide by the same reporting rules as large worldwide organisations. Section 404 does not
make any distinctions based on the size of the company or the amount of resources it has
available;33 hence, all businesses are required to implement internal control procedures.
Smaller companies now have to face the difficult choice of whether or not to comply with
SOX, which will require them to spend their own money on additional external compliance
processes that are not currently in place internally.
According to a study conducted by the SEC in 2006, the average percentage of revenues
consumed by compliance expenses for smaller companies with a market valuation of less
than
$100 million was 2.55%, whereas the percentage of revenues consumed by compliance
expenses for larger companies was only on the order of 0.06%. The majority of the financial
burden of the rising costs was shouldered by more recent enterprises that had only just gone
public. 34
One of the most significant drawbacks of the Act is that it places a significant financial
burden on businesses of a smaller size, despite the fact that it requires them to adhere to
stricter standards of transparency and internal control. Smaller businesses typically have less
resources available to them, making it more difficult for them to comply with the
requirements of the Act on an economic level. Therefore, one may claim that the effects of
this Act are disproportionately felt by less significant businesses.35

32
Sarbanes-Oxley Act, CORPORATE FINANCE INSTITUTE, (last visited Sept. 21, 2022),
https://corporatefinanceinstitute.com/resources/knowledge/other/sarbanes-oxley-act/
33
The Sarbanes-Oxley Act, 2002, § 404.
34
Supra note 32.
35
Ehud Kamar, Pinar Karaca-Mandic, Eric L. Talley, Sarbanes-Oxle Sarbanes-Oxley's Effects on Small Firms:
11
What is the Effects on Small Firms: What is the Evidence?, COLUMBIA LAW SCHOOL SCHOLARSHIP

12
Disincentivisation to businesses
In addition, it has been noticed that, after the Act was passed and put into effect, there has
been a reduction in the total number of IPOs. According to the reports, the Act evidently
poses a barrier to investment as well. Due to the increased cost and amount of work required
for compliance with the Sarbanes-Oxley Act, several companies have chosen to postpone
going public until a far later date. As a direct consequence of this, smaller companies who do
not have the financial resources necessary to comply with the legislation are more likely to
resort to debt financing and venture capital investments.36

Increasing auditing charges

In addition to this, the auditors are struggling with a lack of time and resources due to the
greater accountability that has been placed on audit reports. As a result, the costs of auditing
have shot through the roof.37
Unnecessary interference of federal government
It was too wide, it represented an unnecessary intervention by the federal government into the
financial markets, it federalized corporate governance, it would place a significant financial
burden on a great number of smaller enterprises, and it would damage the initial public
offering market.38

ARCHIVE, (last visited Sept. 20, 2022), https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?

article=2479&context=faculty_scholarship 36 Supra note 32.
37
Supra note 2.
38
Supra note 7.

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 VI. CONCLUSION

The Act has been lauded for its effectiveness in enhancing both openness and accountability
within the business environment. On the other hand, actual research has shown that the Act
has led to an increase in the amount of money that businesses must spend on accounting and
auditing. The fact that there have been fewer initial public offerings (IPOs) recently is an
additional sign that corporations are wary about operating their businesses in accordance with
this Act. The Act, on the other hand, has only been around for a very short time, and
interpretations of how it should be applied are continuously developing.
The growth rate of the American economy slowed down once the Act was finally put into
effect. It has been noticed that the Hong Kong Stock Exchange has surpassed the New York
Stock Exchange as the most important platform for trading securities in the world. 39 The
Sarbanes-Oxley Act (SOX Act) initiated the corporate accountability movement, enhanced
the reliability of financial reporting, created the Public Corporation Accounting Oversight
Board (PCAOB), and profoundly changed the relationship between the company and the
auditor.40 Because of improved regard for corporate compliance, fiduciary obligation to
shareholders, careful board scrutiny, and ethical behaviour, there have been less financial
accounting scandals throughout the course of time. This is a direct effect of these factors. As
the Sarbanes- Oxley Act approaches its 20 th anniversary, there may be opportunities for
leadership training and even for introspection on the ways in which this landmark piece of
law has impacted the economy and the way governance is carried out in the modern world.41
In year two, a number of businesses have begun to standardise and consolidate crucial
financial processes (often in shared service centres), get rid of redundant information
systems, integrate various platforms, reduce data definition inconsistencies, automate manual
tasks, reduce the number of handoffs, better integrate distant offices, better integrate
acquisitions, ramp up new employees more quickly, broaden responsibility for controls, and
get rid of pointless controls. In addition, the practises that were inspired by SOX are
beginning to be utilised as a model for complying with many other regulatory obligations.

39
Supra note 32.
40
Supra note 7.
41
Id.

14
 VII. REFERENCES

Articles/ Research papers

 Sarbanes-Oxley Act, LEGAL INFORMATION INSTITUTE, CORNELL LAW
SCHOOL, (last visited Sept. 21, 2022), https://www.law.cornell.edu/wex/sarbanes-
oxley_act
 The Pros and Cons of the Sarbanes-Oxley Act, SOX ACT, (last visited Sept. 19,
2022), https://www.soxlaw.com/the-pros-and-cons-of-the-sarbanes-oxley-act/
 Mohamed Hegazy, Noha Abou Kamer, A critical analysis of auditors’ perception of
the impact of Section 404 of the Sarbanes Oxley Act on audit quality: an Egyptian
perspective, AFRO-ASIAN JOURNAL OF FINANCE AND ACCOUNTING,
(2010),
https://www.researchgate.net/publication/227440012_A_critical_analysis_of_auditors
'_perception_of_the_impact_of_Section_404_of_the_Sarbanes_Oxley_Act_on_audit_
quality_An_Egyptian_perspective
 Understanding And Complying With The Sarbanes-Oxley Act, SOX LAW, (last
visited Sept. 20, 2022), https://www.soxlaw.com/
 Stephen Wagner, Lee Dittmar, The Unexpected Benefits of Sarbanes-Oxley,
HARVARD BUSINESS REVIEW, (last visited Sept. 20, 2022),
https://hbr.org/2006/04/the-unexpected-benefits-of-sarbanes-oxley
 Michael Peregrine, McDermott, Will & Emery, The Important Legacy of the Sarbanes
Oxley Act, HARVARD LAW SCHOOL FORUM ON CORPORATE
GOVERNANCE, (last visited Oct. 01, 2022),
https://corpgov.law.harvard.edu/2022/08/30/the-important-legacy-of-the-sarbanes-
oxley-act/
 Sarbanes Oxley Act – Summary of Key Provisions, SARBANES OXLEY 101, (last
visited Sept. 21, 2022), https://www.sarbanes-oxley-101.com/sarbanes-oxley-
compliance.htm
 The Pros and Cons of the Sarbanes-Oxley Act, SOX ACT, (last visited Sept. 19,
2022), https://www.soxlaw.com/the-pros-and-cons-of-the-sarbanes-oxley-act/
 Sarbanes-Oxley Act, CORPORATE FINANCE INSTITUTE, (last visited Sept. 21,
2022), https://corporatefinanceinstitute.com/resources/knowledge/other/sarbanes-
oxley-act/
 Ehud Kamar, Pinar Karaca-Mandic, Eric L. Talley, Sarbanes-Oxle Sarbanes-Oxley's
Effects on Small Firms: What is the Effects on Small Firms: What is the Evidence?,
15
 COLUMBIA LAW SCHOOL SCHOLARSHIP ARCHIVE, (last visited Sept. 20,
2022),
https://scholarship.law.columbia.edu/cgi/viewcontent.cgi?article=2479&context=facu
lty_scholarship

Statutes
 The Sarbanes-Oxley Act, 2002.

16