Sarbanes-Oxley Act Signed July 30, 2002: The Post-Enron Reform

The Sarbanes-Oxley Act became law on July 30, 2002, when President George W. Bush signed a corporate reform bill that Congress had passed almost unanimously five days earlier. Written in response to the collapse of Enron and the accounting fraud at WorldCom, the law made chief executives personally responsible for their companies’ financial statements and put the accounting industry under a federal overseer for the first time. Bush called it “the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”

The Scandals Behind Sarbanes-Oxley

The law grew out of a year of corporate failures. The Enron bankruptcy on December 2, 2001, showed how a large company could use complex partnerships and aggressive accounting to hide its true condition. Its auditor, Arthur Andersen, was convicted of obstruction of justice on June 15, 2002.

WorldCom turned a crisis into a stampede. In June 2002 the telecommunications company disclosed that it had improperly accounted for about $3.8 billion in expenses, a problem uncovered by its internal audit team led by Cynthia Cooper. On July 21, WorldCom filed for Chapter 11 protection with about $107 billion in assets, replacing Enron as the largest bankruptcy in US history.

How the Bill Passed

Two lawmakers gave the law its name. Senator Paul Sarbanes, a Maryland Democrat, sponsored the Senate bill, called the Public Company Accounting Reform and Investor Protection Act. Representative Michael Oxley, an Ohio Republican, sponsored the House version, the Corporate and Auditing Accountability, Responsibility, and Transparency Act, which passed 334-90 on April 24, 2002.

After WorldCom, the differences narrowed fast:

Date	Step
April 24, 2002	House passes its version, 334-90
June 2002	WorldCom discloses its accounting problems
July 21, 2002	WorldCom files for bankruptcy
July 25, 2002	Final bill passes the House 423-3 and the Senate 99-0
July 30, 2002	President Bush signs it at a 10:15 a.m. ceremony in the East Room

The days-between-dates calculator shows how compressed the end game was: nine days separated WorldCom’s bankruptcy filing from the signing ceremony.

What the Sarbanes-Oxley Act Requires

The law runs to eleven titles. A handful of sections account for most of its effect on companies.

A regulator for auditors

The act created the Public Company Accounting Oversight Board, a private-sector nonprofit corporation overseen by the Securities and Exchange Commission, to register, inspect and discipline firms that audit public companies. Before 2002 the audit profession regulated itself; Sarbanes-Oxley made outside, independent oversight of public company auditors mandatory for the first time. The SEC appoints the board’s members and approves its budget and rules. The board does not write accounting standards for companies; its job is the quality of the audits.

Limits on auditor conflicts

Audit firms were barred from selling most consulting and other non-audit services to the companies they audit, and the law set new independence rules for the board audit committees that oversee the outside auditor.

Personal certification by executives

Under Section 302, the chief executive and chief financial officer must certify that each periodic report is accurate and that the company’s disclosure controls work. Section 906 added criminal penalties for knowingly false certifications.

Internal controls

Section 404 requires management to assess the company’s internal control over financial reporting, and for larger companies an outside auditor must attest to that assessment.

Records and whistleblowers

Section 802 made it a crime to destroy or alter records to obstruct a federal investigation. Section 806 protected employees of public companies who report fraud from retaliation and gave them the right to sue.

At the signing, Bush summed up the penalty changes in plain terms: “No more easy money for corporate criminals, just hard time.” He noted that the maximum prison term for common types of fraud rose from 5 to 20 years. In a written statement the same day, he described the law’s purpose as protecting investors by improving the accuracy and reliability of corporate disclosures.

The Cost Debate and Later Changes

Section 404 quickly became the most debated part of the law. A survey by Financial Executives International found that 168 companies spent an average of about $1.7 million on Section 404 compliance in 2007. Critics, including Representative Ron Paul, argued that costs like these hurt the competitiveness of American companies; supporters credited the law with restoring investor confidence.

Congress and regulators adjusted the rules over time. In 2010, the SEC permanently exempted smaller public companies, known as non-accelerated filers, from the outside auditor’s Section 404(b) attestation. That same year, in Free Enterprise Fund v. PCAOB, the Supreme Court ruled 5-4 that the protections shielding board members from removal violated the separation of powers, but it left the board and the rest of the law in place.

The Whistleblowers of 2002

The scandals that produced the law were exposed partly by insiders, and the year ended with them in the spotlight. Time magazine named three whistleblowers its Persons of the Year for 2002: Cynthia Cooper of WorldCom, Sherron Watkins of Enron and FBI agent Coleen Rowley. For the year’s other events, see the full 2002 calendar, and for the collapse that started it all, the 2001 calendar.