What Is Sarbanes Oxley and Corporate Governance?
Sarbanes Oxley and corporate governance is how the federal government controls different aspects of corporate business practice. 3 min read updated on February 01, 2023
Sarbanes Oxley and corporate governance is how the federal government controls different aspects of corporate business practice. The Sarbanes-Oxley Act (often shortened to SOX) was passed in 2002 as a response to the numerous corporate scandals that occurred across the United States. The goal of SOX is to protect investors through better corporate disclosure rules, provide the U.S. Securities and Exchange Commission with greater enforcement powers, and enforce more severe white-collar crime penalties.
Specific SOX Corporate Governance Guidelines
Specifically, SOX created new corporate governance guidelines that affect how companies manage themselves. These guidelines include:
- More responsibility on senior executives to improve the quality of their company's financial disclosures and reports.
- Limiting the services that auditors can offer to a publicly traded client.
- Making any audit committees more independent from the company they are working for.
SOX also created a nonprofit corporation, called the Public Company Accounting Oversight Board, to oversee and regulate all auditing practices that relate to publicly traded companies.
How the SOX Act Affects Senior Corporate Managers
Senior corporate managers had specific changes made to their roles by SOX. Under SOX, senior corporate managers are required to:
- Certify that the company's financial disclosures accurately describe their current financial condition.
- Relinquish any stock, bonus, or option that they received 12 months after giving out a misleading financial statement.
- Report financial transactions much quicker than in the past, with a deadline of the second day after the transaction.
- Disclose any off-balance sheet transactions made.
- Be more straightforward when it comes to pro forma disclosures.
- Include a statement on all annual reports that management is ultimately responsible for coming up with, as well as implement and assess adequate internal controls.
- Announce whether or not the business has created an ethics code for their senior financial officers, and if there isn't one, explain its absence.
- Prevent company loans to directors or officers of the company.
- Take action if a lawyer mentions that there has been a material violation of the law. If the corporate manager refuses to take action, the lawyer has the right to report the infraction to the board of directors or audit committee.
How the SOX Act Affects Audit Committees
Naturally, the SOX act also creates new rules for a company's audit committee. These include:
- Requiring audit committee members to have no affiliation with the company in question other than acting as an independent director.
- Giving the audit committee full responsibility for the oversight, compensation, and appointment of each auditor.
- Allowing audit committee members to question and interview company auditors without having any corporate leadership in the room.
- Making sure the audit committee creates guidelines to follow if there are complaints about the audit process.
- Adding a minimum of one financially competent person to the committee.
- Prohibiting the receipt of consulting fees from the company the committee is investigating.
How to Create Good Corporate Governance
With these changes in mind, you might be wondering how to create good corporate governance in your company. There is no perfect example to draw from, so consider seeking the assistance of a law firm or outside consultant to create a system that's perfect for your company. Some factors to consider include:
- Building a strong board of directors who come from varied backgrounds and bring a wealth of knowledge to the table.
- Forming separate committees for disclosures, compensation, and auditing.
- Aligning compensation for officers and directors with the projected financial future of the company.
- Creating and enforcing stringent codes of conduct for all staff.
- Hiring a lawyer to review all contracts before they are signed.
- Implementing new control procedures and policies that will keep your company's financial records and books accurate.
- Insuring your business with all relevant coverage, including crime/fidelity, fiduciary liability, D&O, miscellaneous professional liability, and EPL coverages.
- Introducing a system of checks and balances that will keep employees or outsiders from misusing company assets.
- Disclosing any material matters to shareholders within a pre-established timeframe.
Benefits of Good Corporate Governance
Obviously, good corporate governance policies will keep you safe from legal prosecution according to SOX. However, there are some other advantages, including:
- Making the company look less risky to investors, employees, customers, and more.
- Making it easier to attract ethically strong employees, specifically when it comes to reducing employee theft, regulatory fines, and litigation.
- Increasing firm value by boosting sales growth and earning higher overall profits.
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