In the early 2000s, corporate titans Enron, WorldCom, and Tyco became household names — thanks to huge accounting scandals at each one, ruining inventors and employees alike and souring public trust in Corporate America.
In response to those scandals (and others), in 2002 the U.S. Congress enacted the Sarbanes-Oxley Act (SOX). The law introduced new requirements to prevent accounting fraud at publicly traded companies, complete with stiff criminal penalties for executives who participate in such frauds.
The heart of Sarbanes-Oxley is a mandate for robust financial controls, to prevent fraud and to safeguard corporate financial records. “SOX reporting” is a company’s effort to meet those requirements
In this article we’ll discuss the benefits of SOX compliance, the specific requirements for becoming SOX compliant, and the SOX compliance checklist.
Who Needs SOX Compliance?
The Sarbanes-Oxley Act applies to companies publicly traded in the United States. The goal of SOX is to protect investors and maintain the integrity of financial reporting.
While private companies and non-profits aren’t legally required to adhere to SOX, some voluntarily choose to implement its principles to enhance their financial controls and corporate governance.
There are three entities that play an important role in SOX compliance:
- COSO. The Committee of Sponsoring Organizations provides guidelines and frameworks to help organizations establish effective internal control systems, which are essential for ensuring the reliability of financial reporting. The COSO framework for effective internal control, last updated in 2013, is now the benchmark almost all companies use for SOX reporting.
- PCAOB. The Public Company Accounting Oversight Board sets auditing and quality control standards for audit firms, which examine the financial statements of publicly traded companies and provide assurance about a company’s SOX reporting.
- COBIT. Control Objectives for Information and Related Technologies is a framework developed by ISACA (Information Systems Audit and Control Association) that focuses on IT governance and aligning IT processes with business objectives. Like the COSO framework, it has become crucial to guide companies’ SOX reporting.
Benefits of SOX Compliance
There are several benefits of SOX compliance.
Reduced Loss Due to Fraud and Theft
SOX requires companies to establish and maintain strong internal controls and reporting mechanisms. This leads to better financial transparency, reducing the likelihood of financial misstatements or fraud.
Greater Transparency and Accountability
Top executives, including chief executive officer and the chief financial officer, can be held personally liable for financial misconduct and misstatements. So having SOX compliance in place increases accountability and encourages responsible financial management.
Better Risk Management
SOX compliance requires companies to assess and mitigate risks related to their financial reporting processes. This can lead to better risk management throughout the organization.
What Are the Requirements for SOX Compliance?
SOX compliance requirements include:
- Internal controls. SOX mandates that companies establish and maintain effective internal controls over financial reporting processes. This means implementing procedures and checks to assure the accuracy of financial data and safeguarding against errors or fraud (Section 404 of SOX).
- Financial reporting oversight. Financial officers or individuals with comparable roles are required to confirm in every annual or quarterly report that the report is free of any false or incomplete representation of significant information (SOX Section 302).
- CEO and CFO certifications. SOX mandates that a company’s CEO and CFO personally certify the accuracy of financial statements and disclosures. They can be held accountable for the company’s financial reporting and internal controls. Penalties can include bans from serving at public companies or, in extreme cases, prison time.
- Whistleblower protection. SOX protects employees who report corporate misconduct or violations of securities laws from retaliation by their employers (SOX Section 806). This provision encourages employees to provide information about unethical or illegal activities.
- Conflict of interest. SOX requires companies to disclose and manage potential conflicts of interest among their officers and directors, assuring that personal interests do not compromise the company’s interests (Section 406).
- Disclosure of off-balance-sheet transactions. Companies must disclose all significant off-balance-sheet transactions that could affect their financial position or operations. This disclosure prevents entities from hiding debt or financial obligations in off-balance-sheet arrangements (Section 13(j)).
Preparing for a SOX Compliance Audit
All companies subject to SOX must declare each year in their annual report whether they maintain an effective system of internal control (ICFR), or if not, what material weaknesses exist. Moreover, large companies must also undergo an annual audit by their audit firm for an independent assessment of ICFR.
To prepare for a SOX audit (either one performed by the external auditors, or one performed by internal auditors to help with management’s own declaration about ICFR), companies should follow these basic steps.
- Develop an internal control framework. The first step is to create and implement an internal control structure that identifies key financial and operational risks within your organization. The COSO and COBIT frameworks are good blueprints to use.
- Conduct a risk assessment. The next step is to identify and assess the risks associated with your financial reporting processes to find areas that need additional scrutiny.
- Document applicable procedures. Document all relevant policies, procedures, and processes related to financial reporting, assuring that they are clear.
- Provide SOX training and education. Be sure to educate your staff on the specific controls and compliance requirements outlined in SOX so they understand their roles in maintaining compliance.
- Clarify organizational responsibilities. This step is often overlooked, but define and map out the responsibilities of various individuals and departments involved in financial reporting to enforce greater accountability.
- Create a SOX control report. Compile a SOX control report that summarizes the state of your internal controls, risk assessments, policies, and procedures.
SOX 404 Requirements
The requirements of Section 404 of SOX are as follows.
- Management must annually evaluate its controls governing financial reporting. (This is Section 404(a) of SOX, and applies to all companies.)
- That evaluation must test the adequacy of both the controls’ design and their operational effectiveness.
- External auditors are required to deliver three opinions as part of a single integrated audit for the company. (This is Section 404(b), which applies only to large filers. Smaller filers are exempt.)
- An opinion regarding management’s assessment
- An independent opinion regarding the effectiveness of the internal control structure for financial reporting
- The traditional opinion around the financial statements
Your SOX Compliance Checklist
Here is an eight-step checklist for SOX compliance:
- Assign a leader. Start with appointing a SOX compliance officer or team involving IT departments responsible for overseeing compliance efforts. Then, develop and communicate a clear governance structure for SOX compliance within the organization.
- Define control objectives. Identify and document the key control objectives relevant to financial reporting, including areas that could affect the accuracy of financial data. Assure controls are aligned with the objectives of preventing data tampering and maintaining financial integrity.
- Implement internal controls. Establish and document internal controls to mitigate risks associated with financial reporting. Also, assure that control activities are in place to prevent unauthorized data access and tampering.
- Document activity timelines. Maintain detailed records of financial activities, transactions, and data changes, and implement a timeline for addressing internal audit findings and remediation efforts.
- Test your defense mechanisms. Regularly assess and test the effectiveness of your organization’s cybersecurity defenses, including firewalls, intrusion detection systems, and access controls. Monitor and update these systems as needed to prevent security breaches, data loss, and tampering.
- Gather security system data. Set up mechanisms to collect, retain, and analyze security system data, including log files and network activity. Keep logs and data accessible for review by auditors when necessary.
- Disclose security incidents to auditors. Create a procedure for promptly reporting any data security incidents or data breaches to internal and external auditors. Also, include in your disclosure process how you plan to remediate and prevent future incidents.
- Document all those procedures: We recommend creating detailed documentation of SOX compliance policies and procedures and making them readily available to employees and auditors. Also draft a comprehensive audit trail policy that outlines the tracking and recording of all activities related to financial data and controls.
ZenComply Helps Businesses with SOX Compliance and Data Protection
ZenGRC is a compliance platform that supports companies grappling with SOX compliance challenges. One of its strengths lies in its role as a centralized source of truth. ZenGRC is a hub that keeps all relevant compliance documentation organized and easily accessible.
By automating repetitive elements of the compliance process, ZenGRC reduces the potential for errors and allows your team to allocate their time to more value-added tasks. Schedule a demo to learn how ZenGRC can enhance your organization’s SOX compliance process.