The Sabernes-Oxley Act: History and Ethical Components

Subject: Finance
Pages: 5
Words: 1398
Reading time:
6 min
Study level: PhD


One of the main purposes of the law is the protection of society and the government to ensure that the peoples’ rights are properly protected. This purpose is the core reason behind the formulation of most laws, particularly about the property. For instance, institutions involved in the financial markets have access to the properties of numerous people in the form of money and investments (Green, 2004). Therefore, the government assumes the responsibility of ensuring that such institutions do not take unfair advantage of the power that society entrusts in these institutions. In the United States, the government enacted the Sabernes-Oxley Act of 2002 to govern financial institutions, protect the public from losses through fraudulent transactions, and reinstate public confidence in the financial markets, which was lost between 2000 and 2002 (Green, 2004). This paper highlights the Sabernes-Oxley Act, analyzes its history, ethical components, social responsibility implications, and the main criticism about the provisions in the legislation. It also suggests possible improvements to the legislation and the impacts that such improvements might have on financial institutions.

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Brief history

In the period between the years 2000 and 2002, the media publicized large corporate frauds and other unsound financial practices concerning public companies such as Enron and WorldCom (Lander, 2004). Enron had borrowed large sums of money from different banks and created a problem for investors in the lending banks. The firm’s ability to borrow such large sums was an indicator of the firm’s stability to some individuals. Therefore, such individuals went ahead to invest in the firm, thus incurring losses after the revelation that the firm was indeed in financial trouble due to bad investments. Enron had also paid a lot of money to Arthur Anderson, which is an auditing firm, over the years for the provision of audit services, hence creating suspicions of fraudulent dealings to the detriments of investors (Orin, 2002).

On the other hand, WorldCom employed the consultancy services of its auditors, thus creating a conflict of interest regarding the evaluation process during audits. Consultancy services generated more money than auditing services for audit firms. Therefore, there was a loss of objectivity for the audit firm in fear of losing clientele on the consultancy front (Lander, 2004). These implications led to the loss of a large degree of public confidence in the financial markets and a decline in investments and activity in the stock market. To remedy the situation and regain public confidence, the American government enacted the Sabernes-Oxley Act (SOX) to govern the operations of public corporations regarding their conduct concerning financial dealings (Lander, 2004). The Act contains a code of conduct and every public corporation must comply with the same. It aims at improving transparency on financial matters to the public and curbing fraud through the institution of higher penalties to criminal offenses regarding fraudulent dealings by different companies.

Ethical components

One of the key ethical components in SOX is the provision of restrictions that curb issues of conflict of interest for auditors. SOX provides for compulsory rotation of the lead auditor in a firm in a bid to reduce the chances of the occurrence of conflicting interests. Title II also establishes standards that give external auditors more independence in the auditing process (Lander, 2004).

Another key ethical issue that SOX seeks to remedy is the lack of corporate responsibility by public corporations (Anand, 2013). In the past, corporate executives were not responsible for misrepresentative financial reports. However, Sec.304 of SOX now provides for the individual responsibility of every corporate executive, which ensures that financial reports undergo scrutiny by the executives before they become public knowledge (Anand, 2013). This aspect is paramount in reducing instances where individual executives in public corporations risk the financial health of companies for personal gain.

The Act also provides for enhanced financial disclosure by ensuring that corporations also document transactions that do not appear in “balance sheets, pro forma figures, and stock transactions by corporate figures” (Greene, Silverman & Becker, 2003, p.73). In essence, this Act reduces the risks that moral hazard poses to investors by forcing a degree of care in investments on companies. The concept of moral hazard suggests that a person is likely to take a great risk if a different individual stands to suffer in case there are negative consequences from such risk (Jennings & Jennings, 2003). In the application of the concept, corporations are likely to take greater risks with money from investors and shareholders because any negative outcome would translate to losses only for investors and shareholders.

SOX Act has also established a code of conduct for analysts to prevent conflict of interest by requiring securities analysts to disclose any knowledge over conflict of interests (Jennings & Jennings, 2003). The Act has enhanced corporate and criminal fraud accountability by increasing the penalties applicable to such fraud.

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Although the importance of the Act in the protection of public interest is irrefutable, some critics argue that the compliance costs in Sec. 304 create problems for companies, especially in mid-capital companies. The main issue of contention is that the compliance charges increase with time even during turbulent economic periods. For instance, the compliance charges overburden mid-capital biotech companies. Some of the charges that public companies incur include “external audit fees, directors, and officers’ insurance, board compensation, and legal costs (Kessel, 2011, p.52). The costs form part of the recurring expenditure that public corporations incur. Therefore, most companies have to compensate by sourcing for additional capital. However, economic trends are unpredictable and in some situations, such as the 2006-2009 financial crises, the impact of the changes affects the ability of companies to generate additional capital (Kessel, 2011).

Small and medium-sized public corporations are especially vulnerable because compliance charges apply to all corporations regardless of the size of the company. Larger corporations bear the advantage of having stronger capital bases, and thus they are more resilient to changes in financial markets. Kessel (2011) also highlights the requirement by the stock exchange rules for biotech companies to seek prior consent from shareholders for the issue of certain amounts in equity securities. This important element furthers corporate governance and protects the interests of shareholders from fraudulent dealings and moral hazard-related situations. However, this aspect also means that the companies have to wait for lengthy periods while shareholders scrutinize the securities, which sometimes leads to the loss of numerous windows of opportunity to make important deals. This assertion in turn means a decline in the market value of the biotech companies and creates substantial difficulties for companies to generate enough capital to gain a competitive edge against big public corporations. In this sense, the Act appears to stifle the development of these companies in a bid to protect the public (Kessel, 2011). An analysis of the situation reveals discrimination by the government against the companies, in favor of investors and shareholders.

Richard Orin puts forth another criticism of the Act by highlighting the issue of rotation of the lead auditor to curb conflict of interest by the auditors, as contained in the Act (Orin, 2002). He argues that the rotation of the lead auditor of a firm instead of the entire firm still presents the conflict of interest problem for the public corporations. Most people in a firm work towards a common goal and are prone to similar dealings.

A few improvements would make the Act beneficial to the public without compromising the profitability of public corporations, especially mid-capital biotech companies. Kessel (2011) argues for the reduction or abolition of such hefty compliance charges on small and medium biotech companies to allow for the generation and development of strong capital bases for the biotech companies as one such improvement. Orin (2002) also suggests that instead of rotation of the firm leader, the Act should enforce the rotation of the entire firm, such that one firm does not perform all audits for the same companies. This assertion is objectively true and would be effective in reducing conflict of interest for individuals as well as the audit companies involved in public corporations.


The Sauternes-Oxley Act has gone a long way in ensuring the protection of public interests in financial markets. However, the Act is not without faults and it needs a few improvements. Overall, the Act is an essential piece of legislation that would do well in any economic setup in different countries across the world.

Reference List

Anand, S. (2013). Essentials of Sabernes-Oxley. New Jersey, NJ: John Wiley & Sons.

Green, S. (2004). Managers’ Guide to the Sabernes-Oxley Act: Improving Internal Controls to Prevent Fraud. New Jersey, NJ: John Wiley and Sons.

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Greene, E., Silverman, L., & Becker, D. (2003). Sabernes-Oxley Act: Analysis and Practice. New York, NY: Aspen Publishers.

Jennings, K., & Jennings, K. (2003). Moral Hazard: A novel. New York, NY: Harper Perennial.

Kessel, M. (2011). Sabernes-Oxley Overburdens Biotech Companies. Nature Biotechnology, 29(12), 34-67.

Lander, G. (2004). What is Sabernes-Oxley? New York, NY: McGraw Hill Professional.

Orin, R. (2002). Ethical Guidance and Constraint under Sabernes-Oxley Act. Journal of Accounting, Auditing & Finance, 23(1), 141-171.