# Sarbanes-Oxley Act: What It Does to Protect Investors

> **Definition**
>
> The 2002 Sarbanes-Oxley Act sought to protect investors from costly financial scandals by strengthening corporate financial reporting and auditing standards.

## What Is the Sarbanes-Oxley Act of 2002?

The Sarbanes-Oxley Act of 2002 is a law that the U.S. Congress passed on July 30 of that year to help protect investors from fraudulent financial reporting by corporations.

Also known as the SOX Act of 2002, it mandated strict reforms to existing securities regulations and imposed tough new penalties on lawbreakers.

The act came in response to financial scandals in the early 2000s involving publicly traded companies such as Enron Corporation, Tyco International plc, and WorldCom.

The high-profile frauds that cost billions in losses shook investor confidence in the trustworthiness of corporate financial statements and led many to demand an overhaul of decades-old regulatory standards.

The act took its name from its two sponsors—Sen. Paul S. Sarbanes (D-Md.) and Rep. Michael G. Oxley (R-Ohio).

### Key Takeaways

*   The Sarbanes-Oxley Act of 2002 was a response to highly publicized corporate financial scandals earlier that decade that cost investors billions of dollars.
*   The act created strict new rules for accountants, auditors, and corporate officers and imposed more stringent recordkeeping requirements.
*   The act also added new criminal penalties for violating securities laws.

![Sarbanes-Oxley (SOX) Act](https://www.investopedia.com/thmb/XfFcbsigs3E2-w-VbkxiEqSjUGI=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Sarbanes-Oxley-V3-38f2829eee11440289b7ffeed192f342.jpg)

*The act aimed to restore investor confidence by promoting transparency and accountability within publicly traded companies. — Investopedia / Matthew Collins*

## Understanding the Sarbanes-Oxley Act

The rules and enforcement policies outlined in the Sarbanes-Oxley Act of 2002 amended or supplemented existing laws dealing with security regulation, including the Securities Exchange Act of 1934 and other laws enforced by the [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp).

The new law set out reforms and additions in four principal areas:

1.  Corporate responsibility
2.  Increased criminal punishment
3.  Accounting regulation
4.  New protections

> **Important**
>
> Because of the Sarbanes-Oxley Act, corporate officers who knowingly certify false financial statements can go to prison.

## Major Provisions of the Sarbanes-Oxley Act

The Sarbanes-Oxley Act is a complex and lengthy piece of legislation. Three of its key provisions are Section 302, Section 404, and Section 802.

**Section 302** mandates that senior corporate officers personally certify in writing that the company's [financial statements](https://www.investopedia.com/terms/f/financial-statements.asp) comply with SEC disclosure requirements and "fairly present in all material respects the financial condition and results of operations of the issuer" at the time of the financial report.

Officers who sign off on financial statements that they know to be inaccurate are subject to criminal penalties, including prison terms.

**Section 404** requires that management and auditors establish [internal controls](https://www.investopedia.com/terms/i/internalcontrols.asp) and reporting methods to ensure the adequacy of those controls.

Some critics of the law have complained that the requirements in Section 404 can have a negative impact on publicly traded companies because it's often expensive to establish and maintain the necessary internal controls.

**Section 802** contains the three rules that affect recordkeeping. The first deals with the destruction and falsification of records. The second strictly defines the retention period for storing records. The third rule outlines the specific business records that companies need to store, which include electronic communications.

Besides the financial side of a business, such as audits, accuracy, and controls, the SOX Act also outlines requirements for information technology (IT) departments regarding electronic records.

The act does not specify a set of business practices in this regard but instead defines which company records need to be kept on file and for how long.

The standards outlined in the SOX Act do not specify how a business should store its records, just that it's the company's IT department's responsibility to store them.

> **Article Sources**
>
> 1.  107th Congress, 2nd Session. "[H.R.3763 - Sarbanes-Oxley Act of 2002](https://www.congress.gov/bill/107th-congress/house-bill/3763/text)."
>     
> 2.  St. John's University School of Law. "[Enron's Legislative Aftermath: Some Reflections on the Deterrence Aspects of the Sarbanes-Oxley Act of 2002](https://scholarship.law.stjohns.edu/cgi/viewcontent.cgi?article=1078&context=faculty_publications)," Page 671.
>     
> 3.  United States Congress. "[Senator Paul S. Sarbanes](https://www.congress.gov/member/paul-sarbanes/S000064?searchResultViewType=expanded)."
>     
> 4.  United States Congress. "[Representative Michael G. Oxley](https://www.congress.gov/member/michael-oxley/O000163?q=%7B%22congress%22%3A107%7D)."
>     
> 5.  Securities and Exchange Commission. "[The Laws That Govern the Securities Industry](https://www.sec.gov/answers/about-lawsshtml.html)."