The Sarbanes-Oxley Act
The Sarbanes-Oxley Act (the “Act”) was enacted on July 30, 2002, in response to several significant corporate and accounting scandals, including Enron. The Act set new or enhanced standards for all U.S. public company boards, management, and accounting firms. Its “long title” is “[a]n Act to protect the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.” Besides requiring top management to individually certify the accuracy of financial information, the Act protects employees of publicly traded companies from retaliation for providing information related to possible acts of fraud against shareholders.
Example of Lawsuit Involving the Sarbanes-Oxley Act
Last week, the United States Court of Appeals for the Ninth Circuit, which has appellate jurisdiction over the district courts in California and eight other states, heard oral argument in a Sarbanes-Oxley case that first came before it in 2009. In that case, two in-house patent attorneys sued their former employer, International Gaming Technology, under the whistleblower protections of the Act, alleging that the company fired them for raising suspicions about shareholder fraud. When the case first came before the Ninth Circuit in 2009, it made headlines because it was the first time any court had addressed the substantive elements of a whistleblower claim under the Act. At that time, the Ninth Circuit paved the way for the case to proceed to trial by ruling that plaintiffs/employees do not have to prove that actual shareholder fraud has occurred to maintain a claim under the Act; plaintiffs/employees need only establish that they had an actual and objectively reasonable belief that shareholder fraud occurred. After that ruling, the case proceeded to trial, where the plaintiffs were awarded $4 million.
The defendant is now back before the Ninth Circuit, contending that the judgment should be reversed because its attorney in the original case never objected when the trial judge erroneously awarded $900,000 too much in prejudgment interest. The appeals court seems reluctant to reverse the award given the lack of case law interpreting the Act. So, given that the Sarbanes-Oxley Act is back in the news, what should startups know about it?
What Startups Should Know About the Sarbanes-Oxley Act
There has been much debate over the Act since its enactment. Critics contend that the Act has reduced America’s competitiveness against foreign financial service providers. They also contend that the Act has failed to deliver its promise of increased competition within the accounting sector; the Big-Four accounting firms continue to dominate the industry. Supporters argue that the Act has greatly improved confidence of fund managers and other investors in the truthfulness and reliability of corporate financial statements, which in turn has been beneficial to the economy.
With regard to startups and small companies, in particular, when the Act was first enacted, experts argued that it restricted innovation and suffocated the growth of startups and small companies because the cost of complying with the Act was too great. What happened was a decrease in the number of startups being funded or startups being funded with very small investments with the hope of being bought quickly by a larger company. As the startup integrated into the parent company, its efforts at innovation were stalled or completely killed. In response to these concerns, the government, on April 5, 2012, enacted the Jumpstart Our Business Startups Act or JOBS Act. The purpose of the JOBS Act is to encourage funding of small businesses and startups by easing certain securities regulations. For example, the JOBS Act extends from two to five years, the time that certain small companies and startups have to begin complying with the requirements of the Sarbanes-Oxley Act, i.e., certifying the accuracy of financial information. It also provides an exemption from the requirement to register certain public offerings with the Securities and Exchange Commission. This exemption is intended to allow a form of crowdfunding, which can be very beneficial to startups.
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