What is the Enron scandal?
The public energy company Enron became embroiled in a scandal that revealed weaknesses in accounting and auditing compliance standards. In the 1990s, Enron was one of the largest companies in the United States and was considered one of the most financially successful companies in the U.S. during one of the longest bull markets in the country’s history.
Based in Houston, Texas, Enron created markets for buying and selling futures in gas, oil, coal, paper, steel, and more. Through a series of complex accounting maneuvers, Enron inflated the value of its futures contracts in energy commodities, used special purpose entities to hide bad investments, and reduced profits by issuing stock to cover investment losses.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act was enacted to restore public confidence in corporations following corporate accounting scandals that made names like Enron synonymous with unethical corporate behavior.
The law was drafted by U.S. Senator Paul Sarbanes and U.S. Representative Michael Oxley, and it became known as the Sarbanes-Oxley Act (SOX). The goal of SOX was to protect investors by enhancing the accuracy and reliability of corporate disclosures in financial statements and other documents by:
- Closing loopholes in accounting practices
- Enhancing corporate governance rules
- Increasing accountability and disclosure requirements for companies, especially executives, public company accountants, and auditors
- Increasing transparency requirements in reports to shareholders and describing financial transactions
- Strengthening protections for whistleblowers and compliance monitoring
- Increasing penalties for corporate and executive fraud
- Mandating the creation of the Public Company Accounting Oversight Board (PCAOB) to oversee corporate behavior, especially regarding accounting
Sarbanes-Oxley Today
Although the Sarbanes-Oxley Act of 2002 is generally regarded as having reduced corporate fraud and increased protection for investors, it also has its critics. Proponents of the law argue that it provides key benefits:
- Improved financial reporting: A retrospective study over ten years published in 2014 indicated that the Sarbanes-Oxley Act may have improved the quality of financial reporting.
- Reduced fraud and financial scandal risks: Research in 2017 revealed that the Sarbanes-Oxley Act acts as an “early warning system” for companies that can help uncover fraud, as weak internal controls are linked to hidden fraud.
The stringent financial reporting requirements of the Sarbanes-Oxley Act can enhance internal controls and thereby help companies identify and stop fraud or similar corrupt activities before they lead to scandals like Enron, which can be financially devastating for the company and its investors.
On the other hand, some analysts criticize the legislation due to the high costs that companies must incur to comply with the rules. It has been shown that these costs disproportionately impact small companies, although studies suggest that costs may have stabilized since the law was initially introduced.
Critics argue that these costs deter the formation of new businesses, especially small companies, and that the law’s requirements make it difficult for these businesses to go public. However, research conducted in 2017 showed that this law had little effect on either.
Frequently Asked Questions (FAQs)
What are the four Sarbanes-Oxley controls?
Sarbanes-Oxley requirements include both business controls and Information Technology (IT) controls. On the business side, the Sarbanes-Oxley controls focus on the accuracy and security of data that goes into financial reporting. In terms of technology, there are general IT controls and application controls. General IT controls generally fall into four main areas: access, IT security, data backup, and change management.
What are the requirements of Sarbanes-Oxley (SOX)?
At a minimum, Sarbanes-Oxley requires that all financial reports include a report on internal controls. This demonstrates that the company’s financial data is accurate and that adequate controls are in place to protect financial data. It also requires the filing of financial disclosures at year-end. However, Sarbanes-Oxley is a complex law, with implications for nearly all systems used in large organizations.
Source:
https://www.thebalancemoney.com/sarbanes-oxley-act-and-the-enron-scandal-393497
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