Sarbanes-Osxley Act (SOX)

In the mid to late '90s the stock market in the US was doing really well, but a lot of the companies, a lot of big companies that were being traded on the open market, were doing fraudulent activities. Things like reporting financial information wrong, tricking investors into investing into these companies. And so there was a series of laws that came out to help protect the investor. One of those is the Sarbanes-Oxley Act.

How the stock market works

The stock market is a place where companies are bought and sold. If I owned a business and I wanted to generate some quick cash flow for that business so I can further grow my business, what I could do is take my business and put it out on the open stock market and sell portions of it, or what we call shares. Then in return, since people are going to give me money that I can further invest into my company, what I can do is give them pieces of the profit.

Now to get people really interested in investing into my company, I can tell them what profits I'm making and what profits I'll expect in the future, to get them interested in buying portions of my company, making the company grow.

The unethical practices

There was a lot of unethical practices that were happening in the stock market. There were some investors that lost their life savings because of these unethical practices. There were big businesses that were reporting profits that were much greater than they actually had. They were cooking the books, or changing the data, to trick investors into investing into their company, and then when these companies went under, the investors that heavily invested into these companies lost their life savings.

What made this even worse is the people controlling these companies knew that the company was going under and sold off their shares, making record profits, and then they would walk away with no legal obligation. This left the investors in the company, often the employees of the company who had stock options and invested their whole life savings into that company, with nothing, while the people who perpetrated this act walked away with millions and millions of dollars.

The Sarbanes-Oxley Act

The Sarbanes-Oxley Act, or SOX Act, was put into place to protect investors and stop this from happening. This is for US traded companies only, or businesses that are traded on the open market but doing business within the United States, and the Sarbanes-Oxley Act was put into place in 2002.

So who must comply with SOX? Any publicly traded company that's doing business within the United States.

Highlights of the act

Here are some of the highlights of the SOX act:

• Number one is it creates some corporate responsibility, that as leaders within the company are responsible for making sure that the information that gets released is accurate.
• If it's not accurate and there's fraudulent activity that's happening, it creates stiff criminal penalties for the leaders within the company for carrying out that fraudulent activity.
• It also creates much more enhanced financial disclosure, so publicly traded companies now must be much more transparent in the information that they release.
• It also requires third-party auditors and audits to happen on the information to ensure accuracy. There's a lot of internal controls that happen to make sure that things are being reported correctly.
• It prohibits insider trading, so leaders within the company who are privileged to certain information can't use it to buy, sell and trade stocks until that information gets released to the general public. So they can't sell things ahead of time, knowing that the company is going under, until it's been released to the rest of the world.
• It also has some protection for whistleblowers. What that means is that if I see something that's happening wrong within the company, some criminal activity, and I report it, then I have a certain amount of protection that people can't come back and fire me or have something bad happen to me because I reported it.