The Sarbanes-Oxley Act

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In 2002, President Bush signed the Sarbanes-Oxley Act into law to "re-establish investor confidence in the integrity of corporate disclosures and financial reporting" [ref].The act was brought on by the large number of corporate financial fraud cases (such as those of Enron, WorldCom, Tyco, Adelphia, AOL, and others) and by the end of the "boom" years for the stock market. The Act requires all public companies to submit both quarterly and annual assessments of the effectiveness of their internal financial auditing controls to the Securities and Exchange Commission.

Each company's external auditors must also audit and report on the internal control reports of management and any other areas that may affect internal controls. The company's principal executive officer and principal financial officer must personally certify that the financial reports are true and that everything has been disclosed. Many of the Act's provisions apply to all companies, United States and foreign. However, some provisions apply only to companies that have equity securities listed on an exchange or NASDAQ.

The details of the Sarbanes-Oxley Act address many of the tactics companies have used to "cook the books" over the years. In the next few sections, we'll go over some of the more popular methods of improving a company's bottom line -- if only on paper.

Who keeps them all straight?
The Securities and Exchange Commission (SEC):
The U.S. Securities and Exchange Commission (SEC) protects investors by maintaining the integrity of the securities markets, based on the idea that all investors should have access to certain basic facts about an investment. The SEC requires public companies to disclose meaningful financial information (and other types of information) to the public so all investors can determine whether or not a company's securities are a good investment.

The SEC also oversees stock exchanges, broker-dealers, investment advisors, mutual funds, and public utility holding companies. Each year the SEC files between 400-500 civil enforcement actions against individuals and companies that break securities laws.

Financial Accounting Standards Board (FASB):
The Financial Accounting Standards Board establishes standards for financial accounting and reporting. Those standards dictate how financial reports must be prepared.

Generally Accepted Accounting Principles (GAAP):
GAAP is the accepted method for accountancy (the practice of accounting). It works with the authority of the FASB and establishes a common set of procedures for compiling financial statements.