SARBANES-Oxley Act Of 2002: Financial Analysis
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SARBANES-OXLEY ACT OF 2002(SOX)
Introduction to SOX:
Financial Analysis involves evaluation of business, budgets, projects etc to ensure stability, liquidity, and solvency and at last profitability of the business in presence of domestic and global macro-economic environment to determine suitability of investment. This evaluation is not completely objective and gets impacted by personal biases of the analysts which result into misleading outputs for investors. Many analysts get influenced by herd mentality and try to follow the presently accepted mood of the people.
Situation before …show more content…
development of SOX: In year 2000, many were betting on Information Technology shares just to follow the wave. This resulted into well know bubble burst of IT stocks. Similar situation was observed during 2008 when real estate was crashed along with financial sector downturn. Analysts are also found favoring few companies to serve their hidden motives as depicted in the movies like Wall Street, Too Big Fish etc and trying to keep some stocks-up or some at low price-level. Sometimes, traders inflate the stock prices, book the profits and then suddenly crash the stock. All this creates shocks in the market which sweeps away money and confidence of more than 95% of the investors.
Sarbanes-Oxley Act (SOX) of 2002 :It was enacted following a series of failures involving various functions designed to protect the interests of the investing public. Containing several highly controversial provisions, SOX created a total revision of the regulatory framework for the public accounting and auditing profession and provided guidance for strengthened corporate governance. It was considered to be the most far-reaching legislation affecting public corporations and their independent auditors since the 1930s
Definition of Ethics: Ethics is derived from Greek word “Ethos” which means character. It is a branch of philosophy and deemed as a normative science which deals with norms of human conduct and judgment regarding right and wrong. Business Ethics is study of proper business policies and practices regarding potentially controversial issues, such as corporate governance, insider trading, bribery, discrimination, corporate social responsibility and fiduciary responsibilities. It provides basic framework/guidelines which can help people in evaluating what would constitute an ethical behavior under various circumstances. Unethical behavior can potentially smash-up the firm’s reputation.
Unethical Behavior:- "Unethical behavior has caught up public attention in recent times due to plethora of scandals in the last few decades irrespective of the sector of operation of the business.
The tough economic times have brought many transformations in the conduct of business with the most disturbing and erosive being the immorality in employee’s conducts and propensity for corruption. Consequently, as devised by public interest theory, government/regulators have enforced stringent regulations and inspection actions to be taken in case of misconduct, more noticeably after unethical scandals in financial reporting by Enron, WorldCom, Tyco …show more content…
etc.
Development of SOX: One of the important development was the Sarbanes Oxley Act (SOX) - enacted to bring in accountability and more transparency in financial reporting and thus to restore investor’s confidence in response of the fraudulent practices observed at high profile companies .The legislation came into force in 2002 and introduced major changes to the regulation of financial practice and corporate governance. Named after Senator Paul Sarbanes and Representative Michael Oxley, who were its main architects, it also set a number of deadlines for compliance.
Objective of formation of SOX: The Sarbanes-Oxley Act (SOX) mandated strict reforms to improve financial disclosures from corporations and prevent accounting fraud.
SOX was enacted in response to the accounting scandals in the early 2000s. Scandals such as Enron, Tyco, and WorldCom shook investor confidence in financial statements and required an overhaul of regulatory standards. It was an act passed by U.S. Congress in 2002 with objective to protect investors from the possibility of fraudulent accounting activities by corporations.
The Sarbanes-Oxley Act is arranged into eleven titles. As far as compliance is concerned, the most important sections within these are often considered to be 302, 401, 404, 409, 802 and 906.
Key Provision of SOX:-The rules and enforcement policies outlined by the SOX Act amend or supplement existing legislation dealing with security regulations. The two key provisions of the Sarbanes-Oxley Act are:
1. Section 302: A mandate that requires senior management to certify the accuracy of the reported financial statement
2. Section 404: A requirement that management and auditors establish internal controls and reporting methods on the adequacy of those controls. Section 404 had very costly implications for publicly traded companies as it is expensive to establish and maintain the required internal
controls.
Result so far: However later with the cases like Madoff, Lehman, AIG, SOX was criticized as ineffective and unpractical regulation. It has been intensively debated under Special Interest theory and capture theory where suggest that the regulations are formed keeping in mind the interest of special groups and lobbyists. The stronger the lobbyist the more influence it will have in the final regulation. Regulator also derives the benefits through the interest groups in terms of getting resources and votes for them.
My Viewpoint: I firmly believe that business environment has always been conducive for the players practicing the business via ethical conducts. For a business to be sustainable, it must serve the need of all its stakeholders in an ethical way. Many companies have lost investors’ confidence for not conducting its business ethically, even if it is providing good returns. Leaders in organizations face many challenges in promoting ethical behavior conduct throughout the enterprise. A leader can imbibe in and display ethical qualities which he expects to be displayed by his team, as ethical behavior in any organization begins from the top and subsequently percolates down. Companies are taking the issue on priority and the same is proved by companies propounding for ethical code for conduct of employees.
One of the biggest accounting scandals that caught the limelight was of Enron in the year 2002. It which was biggest auditing failures/ frauds in the world history that time which involved the innovative accounting that explored the loopholes in the Generally Accepted Accounting Principles (GAAP), standards used for preparing the financial statements by companies.
Famous Case of Enron: Enron 's complex and innovative presentation of its financial statements mislead not only the shareholders but also the financial analysts. Additionally, the business model was made so complex that the company utilized the accounting limitations as per regulations applicable that time and thus was able to suppress the losses and manipulate the its balance sheet misrepresenting favorable performance. They inflated their trading revenues, suppressed Mark-to market losses and invented the concept of special purpose vehicle to maintain a good credit rating.
Main party accused to be responsible for this scandal is the auditing form name Arthur Andersen which was accused of practicing irresponsible standards in its audits. It had conflict of interest by charging and earning very high consulting fees from Enron. Enron pressurized Andersen to defer/ hide the charges from the Special purpose entities in which Enron had invested as it would have made its credit risk known to all. In 2001, some articles appeared questioning the Enron’s stock price which was trading that time at around 50 times the earnings. This was starting point was unearthing this entire accounting fraud and thus stock price plummeted.
In October 2001, the company decided to restate its financial statements for previous years from 1997 to 2000 to correct its accounting frauds. This has led to decline in the investor confidence and downgrading of company’s credit rating.
Corporate Governance and Business Ethics: According to me corporate governance and business ethics are two pillars on which the sustainable success of the organization lies. Corporate governance is a set of rules that define the relationship between stakeholders, management, and board of directors of a company and influence how that company is operating. It is a multifaceted subject which helps in effective decision making. Good quality services and better delivery methods can be ensured with good corporate governance. Good governance is based on unambiguous and lucid communication. It helps in enhancing the accountability of organization .On the other hand poor corporate governance leads to unprofessional conduct, fraud and wastage. For E.g.: Enron, Xerox, Tyco and many other organizations faced crisis because of poor governance.
Display of ethical behavior in the organization begins from the top level management which set examples for people at lower level of hierarchy. Therefore, a leader must conduct his business and display ethical qualities which he expects to be practices by his team. Good leader endeavors to achieve a moral excellence that includes uprightness, fairness, farsightedness, and courage. Various mechanisms liker stringent government regulations, better systems and processes in financial institutions, enhanced corporate governance, and increasing customer awareness are suggested to develop moral character amongst practitioners and avoid ethical lapses. More importantly, imbibing financial ethics in business schools can provide future financial managers with a proper ethical education and thereby lesser chances of moral and ethical lapses as in Enron can be expected.
Thus to conclude, a leader must preach and model the ethics as he is the face of the organization. A culture of zero tolerance on ethical grounds, clear system of values and code of conduct, system for reporting, investigating and punishing wrongdoers along with regular training in ethics at all business levels can be practiced to strive for ethical business environment.
Conclusion: Sarbanes Oxley Act (SOX)was enacted in response of the fraudulent practices observed at high profile companies like Enron and WorldCom to bring in accountability and more transparency in financial reporting and thus to restore investor’s confidence. In light of cases like Madoff, Lehman, AIG etc. SOX was criticized as ineffective regulation. But we must understand that in the free market where not everyone wants to play fair, we cannot just stop regulating wrongdoers for the law being not fool proof. Also, Financial Analysts need to be more objective in their analysis and accountability should be maintained in case of any misrepresentation by analysts.
References:- 1) Case study : Fall of Enron published by Harvard Business review 2) Bratton, William W. (May 2002). "Does Corporate Law Protect the Interests of Shareholders and Other Stakeholders?: Enron and the Dark Side of Shareholder Value" 3) Article on “Applying Virtue Ethics: The Rajat Gupta Case” retrived from http://sevenpillarsinstitute.org/morality-101/applying-virtue-ethics-the-rajat-gupta-case 4) http://www.nelsonbrain.com/content/jennings73533_0538473533_02.01_unit01.pdf : South western legal studies in Business –Academic series 5) http://www.soxlaw.com/
SARBANES-OXLEY ACT OF 2002(SOX)
Introduction to SOX:
Financial Analysis involves evaluation of business, budgets, projects etc to ensure stability, liquidity, and solvency and at last profitability of the business in presence of domestic and global macro-economic environment to determine suitability of investment. This evaluation is not completely objective and gets impacted by personal biases of the analysts which result into misleading outputs for investors. Many analysts get influenced by herd mentality and try to follow the presently accepted mood of the people.
Situation before …show more content…
development of SOX: In year 2000, many were betting on Information Technology shares just to follow the wave. This resulted into well know bubble burst of IT stocks. Similar situation was observed during 2008 when real estate was crashed along with financial sector downturn. Analysts are also found favoring few companies to serve their hidden motives as depicted in the movies like Wall Street, Too Big Fish etc and trying to keep some stocks-up or some at low price-level. Sometimes, traders inflate the stock prices, book the profits and then suddenly crash the stock. All this creates shocks in the market which sweeps away money and confidence of more than 95% of the investors.
Sarbanes-Oxley Act (SOX) of 2002 :It was enacted following a series of failures involving various functions designed to protect the interests of the investing public. Containing several highly controversial provisions, SOX created a total revision of the regulatory framework for the public accounting and auditing profession and provided guidance for strengthened corporate governance. It was considered to be the most far-reaching legislation affecting public corporations and their independent auditors since the 1930s
Definition of Ethics: Ethics is derived from Greek word “Ethos” which means character. It is a branch of philosophy and deemed as a normative science which deals with norms of human conduct and judgment regarding right and wrong. Business Ethics is study of proper business policies and practices regarding potentially controversial issues, such as corporate governance, insider trading, bribery, discrimination, corporate social responsibility and fiduciary responsibilities. It provides basic framework/guidelines which can help people in evaluating what would constitute an ethical behavior under various circumstances. Unethical behavior can potentially smash-up the firm’s reputation.
Unethical Behavior:- "Unethical behavior has caught up public attention in recent times due to plethora of scandals in the last few decades irrespective of the sector of operation of the business.
The tough economic times have brought many transformations in the conduct of business with the most disturbing and erosive being the immorality in employee’s conducts and propensity for corruption. Consequently, as devised by public interest theory, government/regulators have enforced stringent regulations and inspection actions to be taken in case of misconduct, more noticeably after unethical scandals in financial reporting by Enron, WorldCom, Tyco …show more content…
etc.
Development of SOX: One of the important development was the Sarbanes Oxley Act (SOX) - enacted to bring in accountability and more transparency in financial reporting and thus to restore investor’s confidence in response of the fraudulent practices observed at high profile companies .The legislation came into force in 2002 and introduced major changes to the regulation of financial practice and corporate governance. Named after Senator Paul Sarbanes and Representative Michael Oxley, who were its main architects, it also set a number of deadlines for compliance.
Objective of formation of SOX: The Sarbanes-Oxley Act (SOX) mandated strict reforms to improve financial disclosures from corporations and prevent accounting fraud.
SOX was enacted in response to the accounting scandals in the early 2000s. Scandals such as Enron, Tyco, and WorldCom shook investor confidence in financial statements and required an overhaul of regulatory standards. It was an act passed by U.S. Congress in 2002 with objective to protect investors from the possibility of fraudulent accounting activities by corporations.
The Sarbanes-Oxley Act is arranged into eleven titles. As far as compliance is concerned, the most important sections within these are often considered to be 302, 401, 404, 409, 802 and 906.
Key Provision of SOX:-The rules and enforcement policies outlined by the SOX Act amend or supplement existing legislation dealing with security regulations. The two key provisions of the Sarbanes-Oxley Act are:
1. Section 302: A mandate that requires senior management to certify the accuracy of the reported financial statement
2. Section 404: A requirement that management and auditors establish internal controls and reporting methods on the adequacy of those controls. Section 404 had very costly implications for publicly traded companies as it is expensive to establish and maintain the required internal
controls.
Result so far: However later with the cases like Madoff, Lehman, AIG, SOX was criticized as ineffective and unpractical regulation. It has been intensively debated under Special Interest theory and capture theory where suggest that the regulations are formed keeping in mind the interest of special groups and lobbyists. The stronger the lobbyist the more influence it will have in the final regulation. Regulator also derives the benefits through the interest groups in terms of getting resources and votes for them.
My Viewpoint: I firmly believe that business environment has always been conducive for the players practicing the business via ethical conducts. For a business to be sustainable, it must serve the need of all its stakeholders in an ethical way. Many companies have lost investors’ confidence for not conducting its business ethically, even if it is providing good returns. Leaders in organizations face many challenges in promoting ethical behavior conduct throughout the enterprise. A leader can imbibe in and display ethical qualities which he expects to be displayed by his team, as ethical behavior in any organization begins from the top and subsequently percolates down. Companies are taking the issue on priority and the same is proved by companies propounding for ethical code for conduct of employees.
One of the biggest accounting scandals that caught the limelight was of Enron in the year 2002. It which was biggest auditing failures/ frauds in the world history that time which involved the innovative accounting that explored the loopholes in the Generally Accepted Accounting Principles (GAAP), standards used for preparing the financial statements by companies.
Famous Case of Enron: Enron 's complex and innovative presentation of its financial statements mislead not only the shareholders but also the financial analysts. Additionally, the business model was made so complex that the company utilized the accounting limitations as per regulations applicable that time and thus was able to suppress the losses and manipulate the its balance sheet misrepresenting favorable performance. They inflated their trading revenues, suppressed Mark-to market losses and invented the concept of special purpose vehicle to maintain a good credit rating.
Main party accused to be responsible for this scandal is the auditing form name Arthur Andersen which was accused of practicing irresponsible standards in its audits. It had conflict of interest by charging and earning very high consulting fees from Enron. Enron pressurized Andersen to defer/ hide the charges from the Special purpose entities in which Enron had invested as it would have made its credit risk known to all. In 2001, some articles appeared questioning the Enron’s stock price which was trading that time at around 50 times the earnings. This was starting point was unearthing this entire accounting fraud and thus stock price plummeted.
In October 2001, the company decided to restate its financial statements for previous years from 1997 to 2000 to correct its accounting frauds. This has led to decline in the investor confidence and downgrading of company’s credit rating.
Corporate Governance and Business Ethics: According to me corporate governance and business ethics are two pillars on which the sustainable success of the organization lies. Corporate governance is a set of rules that define the relationship between stakeholders, management, and board of directors of a company and influence how that company is operating. It is a multifaceted subject which helps in effective decision making. Good quality services and better delivery methods can be ensured with good corporate governance. Good governance is based on unambiguous and lucid communication. It helps in enhancing the accountability of organization .On the other hand poor corporate governance leads to unprofessional conduct, fraud and wastage. For E.g.: Enron, Xerox, Tyco and many other organizations faced crisis because of poor governance.
Display of ethical behavior in the organization begins from the top level management which set examples for people at lower level of hierarchy. Therefore, a leader must conduct his business and display ethical qualities which he expects to be practices by his team. Good leader endeavors to achieve a moral excellence that includes uprightness, fairness, farsightedness, and courage. Various mechanisms liker stringent government regulations, better systems and processes in financial institutions, enhanced corporate governance, and increasing customer awareness are suggested to develop moral character amongst practitioners and avoid ethical lapses. More importantly, imbibing financial ethics in business schools can provide future financial managers with a proper ethical education and thereby lesser chances of moral and ethical lapses as in Enron can be expected.
Thus to conclude, a leader must preach and model the ethics as he is the face of the organization. A culture of zero tolerance on ethical grounds, clear system of values and code of conduct, system for reporting, investigating and punishing wrongdoers along with regular training in ethics at all business levels can be practiced to strive for ethical business environment.
Conclusion: Sarbanes Oxley Act (SOX)was enacted in response of the fraudulent practices observed at high profile companies like Enron and WorldCom to bring in accountability and more transparency in financial reporting and thus to restore investor’s confidence. In light of cases like Madoff, Lehman, AIG etc. SOX was criticized as ineffective regulation. But we must understand that in the free market where not everyone wants to play fair, we cannot just stop regulating wrongdoers for the law being not fool proof. Also, Financial Analysts need to be more objective in their analysis and accountability should be maintained in case of any misrepresentation by analysts.
References:- 1) Case study : Fall of Enron published by Harvard Business review 2) Bratton, William W. (May 2002). "Does Corporate Law Protect the Interests of Shareholders and Other Stakeholders?: Enron and the Dark Side of Shareholder Value" 3) Article on “Applying Virtue Ethics: The Rajat Gupta Case” retrived from http://sevenpillarsinstitute.org/morality-101/applying-virtue-ethics-the-rajat-gupta-case 4) http://www.nelsonbrain.com/content/jennings73533_0538473533_02.01_unit01.pdf : South western legal studies in Business –Academic series 5) http://www.soxlaw.com/