Education Center

Sarbanes-Oxley Act (SOX)

  1. What is the Sarbanes-Oxley Act (SOX) and why is it important?
  2. Who must comply with SOX?
  3. 11 Titles of SOX
  4. What is SOX Control?
  5. What are SOX Compliance Requirements?
  6. >What is SOX Compliance Audit?
  7. SOX Risk Assessment
  8. SOX Compliance Checklist
  9. Penalties for SOX Non-Compliance
  10. benefits-of-sox-compliance
  11. Closing Thoughts

What is the Sarbanes-Oxley Act (SOX) and why is it important?

The Sarbanes-Oxley Act (SOX) was passed by the US Congress in 2002 with the goals of protecting shareholders and the general public from accounting mistakes and business fraud as well as enhancing the accuracy of corporate financial disclosures. The act offers guidelines on obligations and specifies dates for compliance. In response to the financial crises at Enron, WorldCom, Tyco, and others, U.S. Congressmen Paul Sarbanes and Michael Oxley created the act with the aim of enhancing corporate governance and responsibility.

All publicly traded corporations are now required to adhere to SOX in terms of finances and IT. As a result of SOX, IT departments have changed how they store corporate and process electronic documents. Although the act does not dictate a set of business practices or specify how a company should preserve information, it does stipulate which records should be kept and for how long. Companies must keep all business records, including electronic documents and messages, for “not less than five years” in order to comply with SOX. Non-compliance could lead to hefty fines, imprisonment, or both.

The objective of SOX is “to protect investors by improving the accuracy and reliability of corporate disclosures.” The accuracy of financial information must therefore be formally attested by the management of public companies. Additionally, SOX expanded the role of boards of directors in providing supervision and boosted the independence of external auditors who evaluate the accuracy of corporate financial statements.

It is not only required by law but also wise business practice to comply with SOX requirements. All businesses should conduct themselves ethically and restrict access to their financial information. Furthermore, it promotes the protection of sensitive data from cybersecurity threats, insider risks, and security vulnerabilities.

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Who must comply with SOX?

All publicly traded businesses that conduct business in the U.S., including fully owned subsidiaries and publicly traded international businesses, are required to abide by SOX. Accounting firms that conduct public company audits are also subject to SOX.

SOX separates accounting firms and the auditing function. The company that audits a publicly traded company’s books is no longer permitted to conduct the company’s bookkeeping, audits, or business valuations. It is also forbidden for auditing firms to design or implement information systems, offer banking and investment advisory services, or consult on other management-related matters.

Private businesses, charitable organizations, and non-profits are normally exempt from SOX’s requirements, although they still should not purposefully delete or alter financial data. Before going public, private enterprises who are considering an Initial Public Offering (IPO) must adhere to SOX.

Whistleblower protection is also in effect, which prohibits reprisals against anyone who informs a law enforcement official of a potential federal infraction. Essentially, if an employer retaliates (i.e. terminates, demotes or discriminates) against an employee who discloses fraudulent behavior, the employer can face fines or imprisonment for up to 10 years.

Last but not least, SOX stipulates requirements for the implementation of payroll system controls. Costs associated with a company’s employees, compensation, benefits, incentives, paid time off, and training must be taken into consideration. Some employers are required to implement an ethics program with a code of ethics, a communication strategy, and employee training.

11 Titles of SOX

Title I: Public Company Accounting Oversight Board (PCAOB): All public firms are subject to audits, which are overseen by the Public Company Accounting Oversight Board. The board establishes the guidelines and standards for audit reports, as well as monitors, investigates, and enforces adherence to these guidelines. The board is also entrusted with centrally overseeing the independent accounting firms contracted to conduct audits.

Title II: Auditor Independence: There are nine sections in Title II that specify requirements for the independence of external auditors with the purpose of removing conflicts of interest. To work as an executive for a former customer, for instance, an audit firm employee must wait one year after leaving the firm. New auditor approval and reporting obligations are subject to limitations. A business that offers auditing services to a client is not permitted by law to offer that client any other services.

Title III: Corporate Responsibility: Regulations mandate that each senior executive be personally responsible for the accuracy of financial reporting in order to further enforce accountability.

Title IV: Enhanced Financial Disclosures: The Act significantly expands the number of disclosures a firm must give to the public, including pro forma numbers, stock transactions involving corporate officers, and off-balance-sheet activities. The prompt reporting of all such disclosures and other relevant information is required.

Title V: Analyst Conflicts of Interest: The goal of Title V is to boost investor trust in securities analysts’ reports. Disclosing any and all conflicts of interest that the corporation is aware of is also covered in this part, along with rules of conduct. Everything must be disclosed, including if the analyst owns any stock in the business, whether they have received any corporate payments, and whether the organization is a customer.

Title VI: Commission Resources and Authority: Several procedures are outlined in Title VI, including the power of the Security and Exchange Commission (SEC) to oust a broker, advisor, or dealer under certain circumstances.

Title VII: Studies and Reports: The SEC and the Controller General are required to conduct the studies and reports listed in Title VII. To ensure that investment banks, public accounting companies, and credit rating agencies are not complicit in unethical or unlawful actions in the securities markets, these examinations and reports include analyses of each of these institutions.

Title VIII: Corporate and Criminal Fraud Accountability: A person can be fined and sentenced to up to 20 years in prison for altering, hiding, or destroying records with the intention of influencing the outcome of a federal inquiry. Anyone who assists in deceiving shareholders of publicly traded corporations is liable for imprisonment and monetary penalties. Whistleblowers are also given additional protections under Title VIII.

Title IX: White Collar Crime Penalty Enhancement: There are six provisions of Title IX, all of which aim to stiffen the punishment for crimes committed by white-collar professionals. In an effort to make sanctions outweigh the possibility of immediate financial gain, this Title makes failing to certify company financial reporting a crime and supports stricter sentencing criteria.

Title X: Corporate Tax Returns: The Chief Executive Officer must formally sign all corporate tax returns under Title X’s Section 1001.

Title XI: Corporate Fraud Accountability: Seven sections of Title XI are devoted to explaining corporate fraud. It defines any tampering with records as a crime subject to a range of punishments. Additionally, it provides recommendations for sentencing and raises overall punishment. The SEC has the authority to freeze transactions that are deemed “large” or “unusual” under this specific Title.

What is SOX Control?

In a financial reporting process cycle, SOX control is a rule that prevents and detects errors. The controls are created to support the goals of each overarching business process. They serve the dual function of preventing and identifying errors that could undermine the process itself. The Public Company Accounting Oversight Board (PCAOB) is a non-profit organization that Congress established to guarantee the consistency of the integrity of audits conducted by accounting firms or by an external auditor.

The internal controls framework released by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) has been adopted by the majority of American public companies. Initiated jointly by five businesses in the private sector, COSO is committed to fostering thought leadership through the creation of frameworks and recommendations for internal control, enterprise risk management, and fraud deterrence. Referencing the COSO Framework, which identifies the five types of internal control, is helpful when developing a system of internal controls for processes that produce financial data. These include monitoring, information and communication, risk assessment, control activities, and the control environment.

What are the SOX Compliance Requirements?

The key requirements for SOX compliance include:

Senior management accountability: The CEO and CFO of a publicly traded company are directly accountable for the financial reports that are submitted to the Securities Exchange Commission (SEC). For violations, these senior officials risk severe criminal penalties, such as lengthy imprisonment.

Internal Control Report: Under SOX, management must be shown to be in charge of the internal control framework for financial records. In order to maintain transparency, any problems must be disclosed right away to senior management.

Data security policies: Under SOX, businesses are required to uphold a documented data security policy that sufficiently safeguards the use and archival of financial data. All staff members should be informed of and adhere to the SOX data policy.

Proof of compliance: SOX mandates that businesses maintain compliance records, make them available to auditors upon request, perform ongoing SOX testing, and track and evaluate SOX compliance objectives.

What is SOX Compliance Audit?

Companies are required under SOX to conduct annual audits and to communicate the findings with stakeholders upon request. Companies employ impartial auditors to conduct these specific audits in order to avoid any potential conflicts of interest. Keeping up with SOX compliance should be viewed as an ongoing project that involves planning for each audit.

Verifying the company’s financial statements is the main goal of the SOX compliance audit. Auditors assess if everything is in order by comparing prior financial statements to the present ones. Auditors can also conduct staff interviews to confirm that the compliance controls are adequate for upholding SOX compliance requirements.

A typical SOX audit entails:

  • A preliminary meeting between management and the auditors to decide the audit’s parameters and schedule.
  • Analyzing the company’s finances and looking for any errors in the financial statements, a difference of greater than 5% calls for further examination.
  • Interviews with staff members are conducted as part of a personnel evaluation to make sure that responsibilities align with job descriptions and that staff members are properly trained to handle financial data in a secure manner.

SOX sections 302, 404, and 409 mandate that the following variables and conditions be tracked, recorded, and audited: internal controls, network activity, database, login and user activity, and information access.

A control framework like Control Objectives for Information Technologies (COBIT) must be able to audit “internal controls and procedures” according to SOX auditing requirements. An audit trail of every access and activity to sensitive business information must be provided by log collection and monitoring systems.

The most significant component of a SOX compliance audit is a frequent review of a company’s internal controls. All IT resources, such as computers, network hardware, and other electronic devices through which financial data flows, are included in internal controls. The internal control elements which will be examined during a SOX IT audit include data backup, change management, access controls, and IT security.

SOX Risk Assessment

Internal Control over Financial Reporting (ICFR) is the primary subject of the SOX risk assessment. It evaluates financial data combined with potential dangers that might exist. The outcome establishes the scope and priorities for the SOX or ICFR effectiveness review operations for the upcoming fiscal year.

Conducting a SOX Risk Assessment is important because:

  • It assists management in deciding which operations, accounts, or systems can be exempt from SOX monitoring activities.
  • It enables you to recognize, rank and evaluate high-risk situations, thereby giving you ample time for corrective action if problems are found.

SOX Compliance Checklist

S.No Goals Steps you need to take
1 Prevent data tampering Implement login tracking and detection systems that can identify unauthorized attempts to log in to financial data systems.
2 Record timelines for critical activities Develop systems that can date any financial or other data that is subject to SOX rules. Encrypt such data to guard against tampering and keep it in a remote, secure location.
3 Develop variable controls to monitor access Implement systems that can track data access and modification from virtually any organizational source, including files, File Transfer Protocol (FTP), and databases.
4 Grant access to auditors to promote transparency Set up systems to alert concerned authorities every day that all SOX control measures are operating as intended. By employing permissions, systems should grant auditors access so they may read reports and data without altering them.
5 Report on the efficiency of the measures taken Establish systems that generate reports on data that has flowed through the system, crucial messages, and alarms, and actual and handled security events.
6 Identify security breaches Implement security technologies that can examine data, spot indications of a security breach, and produce insightful alerts, automatically updating an incident management system.
7 Inform auditors of security lapses and the failure of security measures Implement systems that record security breaches and enable security teams to document how each event was handled. Publish reports for auditors to see, including which security events happened, which ones were successfully mitigated, and which ones weren’t.

Penalties for SOX Non-Compliance

The severity of noncompliance penalties varies by section violation and is highest in cases when information has been willfully misrepresented, changed, or deleted. They range from the termination of directors and officers (D&O) liability insurance and the loss of exchange listing to multimillion-dollar fines and custodial sentences for corporate officers.

A CEO or CFO faces up to $1 million in fines and up to 10 years in prison if they intentionally certify a periodic report that does not adhere to the Act’s standards. A fine of up to $5,000,000 and up to 20 years in prison are possible for willful certification falsification.

Benefits of SOX Compliance

Once you’ve created a strong SOX compliance checklist to direct your operations toward compliance, you will find that a robust internal control environment reduces the risks of internal financial statement manipulation, thereby retaining public trust. Effective oversight enhances the overall company governance and lowers your likelihood of ever paying a fine for failing to comply with SOX.

The primary benefits of SOX compliance include:

Improved Control Structure: Documentation of controls, such as operations manuals, personnel policies, and recorded control processes, is required by Sections 302 and 404. Being SOX compliant enables you to gain control awareness and transparency into how these controls integrate with the business processes. When management and auditors concentrate on internal controls as part of a SOX evaluation, the organization realizes how crucial these control activities are to its financial success. The heightened scrutiny pertaining to SOX assessment drives participants to work even harder to guarantee that critical financial reporting-related tasks are properly carried out.

Strong Financial Reporting and Audit processes: Being compliant with SOX promotes effective and accurate financial reporting that develops a higher level of financial caretaking in your firm, much like ISO 27001 compliance. Companies, which comply with SOX, report more stable financial conditions and simpler access to capital markets. The Public Company Accounting Oversight Board (PCAOB) was created as a result of the implementation of SOX to assess personal accountability to auditors, executives, and board members and to monitor management’s accounting decisions. This made it possible for the audit to serve as a separate assurance function and guarantee that a company’s internal control, risk management, and governance systems are running effectively.

Team Collaboration: Internal stakeholders must work together more frequently and intensely to comply with SOX. An attempt to operate in isolation will impede compliance efforts, particularly in the area of IT security. The employees who own or contribute to financial and information controls, such as control owners, IT, or HR, must interact with internal auditors and those who manage SOX assessments across business lines. A corporate-wide program like SOX has a significant positive impact on the business, including enhanced cross-functional cooperation and communication.

Enhanced Cybersecurity Posture: Businesses can protect themselves from cyberattacks and the costly repercussions of a data leak by employing SOX. Data breaches are difficult to manage, and some firms never fully recover from the brand reputation damage. The likelihood of a malicious hack or insider threat can be considerably decreased by the security precautions that SOX requires.

Closing Thoughts

Compliance with SOX is not a “one-and-done” process. Instead, it’s a continuous, year-round endeavor to strengthen an organization’s financial controls and cybersecurity posture. Although SOX was created to address fraudulent financial reporting and criminal wrongdoing, being compliant also gives you the added benefit of achieving visibility and efficiency with cybersecurity and access control capabilities.

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