TheU.S. has gone through several challenges that have motivatedlegislators to formulate acts and reform strategies, with theobjective of minimizing the recurrence of these problems. Some of thekey challenges include corporate scandals and the financial crisis.This paper will provide a description of the Sarbanes Oxley Act thatwas enacted in 2002 and Dodd-Frank Wall Street Reform and ConsumerProtection Act. The paper will also explain how they were started.
TheSarbanes Oxley Act (SOX) Enacted in 2002
TheSOX Act is a piece of legislation that was passed by the U.S.Congress and enacted in the year 2002. The congress intended toachieve four major objectives when formulating the SOX Act. First,there was a need to increase accuracy in reporting as well ascompliance with the accounting standards in the process of preparingthe financial statements (Guide Star U.S., Inc 1).Theact provided the rules as well as guidelines that should be followedwhen disclosing all items that are supposed to be included in thefinancial reports. For example, section 402 made it mandatory forcompanies to comply with the disclosure requirements set by the auditcommittee.
Secondly,the Congress intended to protect members of the public andshareholders of all listed corporations from executives as well asaccountants who manipulate the books of account in order to benefitthemselves (Guide Star U.S., Inc 1).TheSOX Act helped the Congress achieve this objective by sealing thegaps that existed in the laws and standards that regulated theprocess of financial reporting. By forcing the companies to complywith the financial reporting rules and disclose all information thataffect the financial status of the firm in a significant way, SOX Actensured that the amount invested by the shareholders is notmisappropriated by the people who are given the fiduciary duty to acton their behalf.
Thethird objective was the improvement in corporate governance (GuideStar U.S., Inc 1).Developersof the act understood the role of effective reporting in helpinginvestors develop trust in the local companies and the nationaleconomy. Prior to the formulation of the SOX Act, executives couldmake an excuse when their companies misrepresented differenttransactions by stating that they were not aware of the existence ofgaps in their internal controls. However, Section 404 gave themanagement of the companies the responsibility of developing andtesting different internal controls in order to ascertain theireffectiveness in reducing the risk of fraud (Guide Star U.S., Inc 1).This section goes a long way in strengthening corporate governancesince it puts the management under pressure in order to ensure thatthey do not leave any room for fraud.
Fourth,developers of the SOX Act foresaw the challenges that could be causedby the increase in the application of technology in financialreporting activities. To this end, they developed the act in order toensure that compliance, accuracy, and accountability could not becompromised by innovation. For an instant, the integration of Section802 into the act was intended to help the government ensure that thecompanies maintained the necessary electronic records in the properway and over a reasonable period (Guide Star U.S., Inc 1).Thesection deals with several aspects of electronic records, includingalteration, destruction, storage, falsification, and penalties.
Howthe SOX Act was started
TheU.S. legislators were motivated by an exponential increase in thenumber of frauds affecting major corporations. The development of SOXAct was a reaction to frauds that threatened the going concern andthe employment of hundreds of thousands of employees, in case theaffected companies collapse. By early 2000s, several high-profilescandals had been unmasked. These scandals affected popularcompanies, including Enron, Tyco, and WorldCom (Guide Star U.S., Inc1). Preliminary investigations indicated that these scandals werespearheaded by the executives of the respective companies, since theyunderstood weaknesses that existed in the reporting standards. Thelegislators discovered the need to develop an act that could enhancecorporate governance and the level of accountability on the part ofthe executives and other stakeholders.
Reactionfrom the stakeholders
Manypeople (including investors) felt that the SOX Act was an effectivetool that could protect their interests and wealth. The effectivenessof the acts has been proven by the decline in the number of largecompanies that suffer from mega scandals since its enactment.However, the business people felt that the high cost of implementingvarious provisions of the act could make it counterproductive (Ryu6). Some of the key aspects that increased the cost of complianceinclude the need to hire experts and the requirement to subcontractinternal control operations to an independent entity (Guide StarU.S., Inc 1).Althoughthe SOX Act increased the cost of doing business, it has played acritical role in protecting the high profile companies from beingexploited by executives.
Dodd-FrankWall Street Reform and Consumer Protection Act
Theshort form of these reforms is the Dodd-Frank Act that was passed andenacted in the year 2010. The act was formulated by the U.S.Congress, with the objective of enhancing consumer protection fromthe irresponsible financial practices. Developers of the act intendedto achieve this objective by placing the role of regulating theentire financial industry in the hands of the government (U.S.Congress 21). The act would ensure that consumers are well protectedby reducing the risk of the occurrence of the financial crisis. Thegovernment would assume the responsibility of ensuring thataccountability and transparency are observed by all players in theU.S. business environment.
Anotherobjective of establishing the Dodd-Frank Act was to enhance financialstability in the U.S., thus reducing the uncertainties that affectedcitizens and investors. The act empowered the government to take upthis role through the newly created body referred to as the FinancialStability Oversight Council (FSOC) (U.S. Congress 24). FSOC requiresthe banks to develop orderly shutdown plans in order to prevent thegovernment from spending public funds to bailout corporations thatare brought down by irresponsible executives.
Theact was also intended to protect consumers from the impacts of riskybusiness practices. The occurrence of the financial crisis in late2000s was attributed to subprime lending where banks gave loans tocustomers with poor credit profile and limited sources of finance(U.S. Congress 31). Frank reacted to this behavior by introducing theConsumer Financial protection Bureau, CFPB. This government agency issupposed to collaborate with the regulators of large financialinstitutions in order to prevent them from risky lending thateventually hurt consumer directly or indirectly. In addition, CFPB,which was established by Dodd-Frank Act, increased the ability of thegovernment to respond to complaints raised by consumers before theylead to serious crisis. For example, CFPB supply consumers with trueinformation about credit scores and mortgages. This service reducedthe information asymmetry that was used by banks to exploit consumersprior to the development of the Dodd-Frank Act.
Moreover,the act enhanced the level of accountability and transparency byestablishing rules that will regulate the compensation of executives.Frank was motivated by an observation that most of the executives(including the CEOs of large corporations) enriched themselvesthrough excess compensation packages that were acquired throughquestionable means. Dodd-Frank Act addressed this challenge byrequiring listed corporations to submit the vote of shareholdersapproving the compensation of executives (U.S. Congress 38).Companies are also required to disclose whether the shareholders haveallowed members of the board to buy any financial instrument. Therole of this requirement is to ensure that individuals who are giventhe fiduciary duty to protect the wealth of the shareholders do notuse it to enrich themselves.
TheDodd-Frank Act was also developed with the objective of protectinginvestors. Although there is a general perception that the act wasdeveloped to protect consumers, most of the titles secure theinterests of investors directly or indirectly. For example, the wholeof Title IX takes care of the interests of investors. Subtitles B andC increased the rules that facilitate strict regulation of thebusiness operations, which ensures that investors’ money is wellprotected by the government. Other subtitles (such as E and G)protect the wealth of the shareholders indirectly by facilitating thegrowth of the corporate governance and accountability (U.S. Congress122).
Additionally,the act provided reliable platforms through which the middle classand low-income earners could have an access to the mainstreamfinancial sector. Although the act intended to prevent the largebanks from lending to risky customers (including the low-incomeearners who could not be able to repay the loan), Frank appreciatedthe fact that all citizens have an equal right to enjoy financialservices. Therefore, the Act included Title XII that mandates thegovernment to provide incentives (such as accounts insured by thefederal government and micro-loans) to customers who would otherwisebe classified as risky borrowers (U.S. Congress 31). This sensibletitle suggests that the primary objective of the act was to reducethe weak areas that increased the vulnerability of the entirefinancial sector and not to punish customers, banks, and investors.
Howthe Dodd-Frank Act and related reforms started
BarneyFrank, who introduced the bill leading the development of the act,was motivated by the impacts of regression that took place in late2000s. The legislator attributed the regression to the tendency ofgovernment to base the U.S. economy on large banks. Reliance on thesebanks implies that their collapse could affect all sectors of thenational economy adversely, thus frustrating consumers (U.S. Congress20). In addition, Frank was convinced that low government regulationcontributed to the occurrence of the financial crisis that hit theU.S. in the year 2008. The government as well as the members of thepublic was caught unaware since the authorities had emphasized on theconcept of deregulation where companies operating in a given industryregulate themselves in order to minimize interference from thegovernment.
Byintroducing the act, Frank minimized the tendency of the Federalgovernment to depend on the large banks to run the national economy.This change was accomplished by introducing stringent regulationsthrough which the government will oversight and control theoperations of all companies, including those that are considered tobe too big to collapse (Lux 1).
Reactionfrom the affected stakeholders
Theact was developed with a good intention, but several stakeholdersfelt that it could affect them in a negative way. For example, ownersof SMEs felt that accessing loans would be difficult since the actwill classify them as risky customers (Hamster 1). Studies have alsoshown that the lending market and the banking assets dropped by 20 %and 40 %, respectively, after the enactment of the legislation, wherethe small institutions were affected disproportionately (Lux 1). Somestakeholders use this data to argue that the act did to not containthe behavior of the large banks, but it damaged the operations of thesmaller financial institutions.
Thedecision to formulate the SOX and the Dodd-Frank Acts was informed bythe increase in the number of scandals that affected high-profilecorporations and the 2008 financial crisis, respectively. These actsand reforms can be classified as reactionary measures that were takento prevent the recurrence of the problems that had already takenplace. However, they managed to reduce weaknesses that existed in thefinancial reporting and corporate governance. They enhancedaccountability on the part of corporate executives, thus ensuringthat the wealth of the shareholders and interests of consumers aresafeguarded. Although the acts and reforms have been criticized,their positive impacts can be felt by players in the U.S. market.
GuideStar U.S., Inc. The Sarbanes-Oxley Act and Implications for NonprofitOrganizations. GuideStar U.S., Inc.2016. Web. 30 October 2016. Hamster,C. Say goodbye to traditional free checking. TheAssociated Press.2016. Web. 30 October 2016.
Lux,M. and Greene, R. M-RCBG associate working paper no. 37. The stateand fate community banking. HarvardKennedy School.2015. Web. 30 October 2016.
Ryu,G. “The effect of the Sarbanes-Oxley Act on auditor’sperformance”. Journalof Finance and Accountability1 (2012): 1-7.
TheU.S. Congress.TheDodd-Frank Wall Street Reform and Consumer Protection Act.Washington, DC: The U.S. Congress. Print.