The Sarbanes-Oxley Act or SOX, enacted in July 2002, was one of the many steps taken by lawmakers in the US to protect investors from future accounting scandals. These scandals not only cost the investors millions in losses, but also wiped out large business establishments. While we continue to hear about accounting frauds, the debate with respect to the effect of SOX in rebuilding the investor community continues to rage.

Effects of the act

More than a decade after the act was implemented, are businesses really better off reporting under SOX? Or has this only added to the costs that a company must bear to be listed within US markets? Do we believe that companies are focusing more on form over substance with respect to SOX, or that certifying under SOX has made companies take cognisance of not only reporting good numbers but also ensuring that the internal controls that are generating these financial statements are operating effectively?

Proponents of SOX will say that it has helped restore, in part, the investor community’s lost confidence. The Lord & Benoit report (2006), “Do the Benefits of 404 Exceed the Cost”, pointed to a study of nearly 2,500 companies, which indicated that companies with no material weaknesses in the internal controls, or companies that corrected them in a timely manner, experienced a greater increase in their share price than peers that did not correct such weaknesses. Criticism for SOX continues to be much more on the non-US companies front, where companies believe that this additional burden of reporting and cost has discouraged potential companies from listing on the US boards, and moved them to London, Singapore and other developed countries.

Leading economies, such as Japan, Germany, France, and Israel, have passed laws similar to SOX within their regulatory arena. Companies have always had to have good internal controls, and independent auditors had to evaluate these controls as part of their audit, which would influence their own nature and timing of work.

Benefits and Challenges

SOX has only brought attention to these internal controls, which have always been there but never spoken off. Companies have cleaned up their accounting in the wake of SOX. The strict penalties it imposes on the senior management and company has led others to ensure that there is accountability for financial reporting. SOX has also created more transparency with respect to auditor independence and prohibits auditors from taking up assignments with clients that are seen as conflict of independence, thereby furthering investor confidence and reliability on financial information being presented to the markets. The criticism for SOX has been that it has led to a decline in new IPOs in the US, and that the US markets’ competitive edge has been lost to other developed nations.

After 10 years, SOX is still going strong, even though there are enough academic research and opinions that say otherwise. However, one does not know what the future holds. With the recent enactment of JOB Act and the relaxation of SOX for smaller companies, the monetary burden on US companies to list in the US boards has gone down. This is a step in the right direction, but this does not take away from the fact that non-US companies looking to list on the US boards need to pull up their SOXs before making the decision.

The author is Partner, Grant Thornton India LLP

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