Comprehensive guide to SOX compliance requirements

Protecting against corporate fraud is a top priority for federal and global regulators. Companies active in the USA must comply with the Sarbanes-Oxley Act (better known as SOX). SOX compliance combines technical controls, administrative policies, external auditing, and corporate governance. And every company needs a SOX compliance strategy.

This article introduces SOX compliance requirements. Learn about the Act's core components and definitions. Implement necessary internal controls, explore testing methods, and apply our list of best practices to simplify the SOX compliance challenge.

Key takeaways

• SOX is a federal regulation that protects the integrity of financial reporting data and cuts the risk of corporate fraud. Companies that issue securities in the USA must comply with SOX. SOX also makes strict demands on external auditors that validate the financial status of corporations.
• Companies subject to SOX must audit their financial reporting systems every year. CFOs and CEOs must certify the accuracy of financial statements, and companies require independent audit committees. Firms must implement internal controls to protect financial data against misuse, theft, or deletion. And they must disclose any information relating to their financial situation.
• Internal controls include access management, segmentation, threat detection, change management, and data backups. Controls play a crucial role in SOX compliance. Testing controls regularly is essential to ensure their effectiveness in protecting financial data.
• Common SOX challenges include risk assessment, building controls, and managing costs. Companies can meet their SOX compliance goals by leveraging technology and using applicable control frameworks. Firms should maintain skilled compliance teams and ensure buy-in from executive-level stakeholders.

Introduction to SOX compliance requirements

The Sarbanes-Oxley Act (SOX) was passed in 2002 and regulates how companies handle and disclose financial data. SOX is the front line in the battle against corporate fraud, demanding strict adherence to rules about financial reporting accuracy, user access, and conflicts of interest.

SOX came about in response to high-profile corporate scandals in the late 1990s. The collapse of Enron showed that corrupt relationships between auditors and executives could bring down global corporations. Inaccurate financial reporting created doubts among investors, raising questions about the financial health of failed companies that appeared to be thriving.

Over 20 years later, SOX is more relevant than ever. Preventing accounting fraud and ensuring accurate reporting remain priorities. However, auditors, corporations, and regulators must also contend with cybersecurity threats that put financial information at risk.

Modern SOX compliance requires a combination of good governance and robust information technology general controls (ITGCS). Companies must ensure that every financial statement is accurate. They must lock down data to prevent tampering or deletion. Segregating duties is also critical. This task includes creating independent internal audit committees and using independent auditors.

SOX compliance requirements

SOX compliance requires a systematic approach. It's helpful to take a broad perspective before starting. In simple terms, SOX compliance requires companies to execute four critical tasks:

• Providing the SEC with accurate and independently audited financial statements. Independent audits must take place annually. (Section 302).
• Implementing and testing an internal control framework to ensure data integrity, protect assets, and prevent unauthorized access (Section 404).
• Disclosing material changes in the financial status of the company to key stakeholders (including customers, the wider public, and regulators) (Section 409)
• Writing an annual statement on internal controls. Obtaining sign-off from the Chief Executive Officer and Chief Financial Officer, and submitting the annual statement to an independent third-party audit (Section 906).
  
  

These four tasks make up the bulk of the SOX compliance challenge. Most of them are administrative tasks, requiring policies and commitment from corporate leaders. However, implementing internal controls is also a technical challenge. Creating a controlled environment requires expertise and planning. It also requires sufficient resources to protect relevant assets.

Internal controls requirements

Internal controls are technologies and policies that regulate how an organization generates, maintains, and stores financial data.

Section 404 of SOX requires companies to maintain internal controls for devices, applications, accessories, and individuals that can access financial data. Companies must also test controls and verify their effectiveness via third-party experts.

Control systems vary depending on the type of financial data and operational needs. However, critical SOX controls fit into the following categories:

• Access management systems to prevent access by unauthorized users
• Segmentation systems to segregate financial data from other corporate assets
• Threat detection and response technology to protect against malware and data breaches
• Secure change management and financial app development processes
• Data backups to enable secure data restoration
  
  

Implementing these controls is the responsibility of IT teams and compliance professionals. Each of the control areas above falls under SOX audits. Independent assessors will seek evidence that companies include all five pillars in their security systems.

For example, auditors test access controls to ensure they block users without a legitimate need to access sensitive data. They test threat detection systems and response policies to ensure companies can identify threats effectively.

When auditors detect failings, they will notify the SEC. Financial penalties or stock market delisting can result. Prioritizing data security in SOX compliance strategies is crucial.

There is no specific SOX controls framework, but tools are available to make SOX compliance easier. Organizations can use control frameworks such as the NIST Cybersecurity Framework or ISO 27001. Both frameworks provide relevant advice about how to build compliant data security systems.

Key takeaway: Companies must show that their internal controls protect sensitive financial information wherever it resides. Creating appropriate control systems can be technologically challenging. It also requires in-depth risk assessment skills to inventory and secure relevant data assets.

Key SOX sections

The Sarbanes-Oxley Act includes 11 sections or "titles." Some sections only relate to auditors or apply to specific corporate entities. However, several sections of the legislation affect companies that trade in the United States. Businesses should integrate all of these sections into their SOX compliance strategy.

SOX Section 302

This section deals with financial reporting. Companies must file an annual financial statement with the Securities and Exchange Commission. The CFO and CEO must approve all statements. Executives attest that the company has implemented necessary controls and that the content of financial reports is as accurate as possible.

SOX Section 404

Section 404 is about establishing an internal control framework. SOX requires company managers and independent auditors to report on the effectiveness of an organization's controls. Auditors must also verify that managers understand the control system and have provided an accurate attestation.

SOX Section 802

Section 802 is about record keeping and data monitoring. SOX requires companies to protect records against unauthorized deletion or falsification. The penalties under this section are severe, with maximum prison terms of 20 years.

Data retention also falls under this section. Companies must store financial data for five years. Retention rules apply to all documents related to financial reporting. Rules cover emails from relevant staff members and research or planning documents used when creating financial statements.

SOX equivalents in other countries

SOX compliance does not just apply to companies active in the United States. Market-based economies face the same problems of ensuring accountability and transparency in financial reporting. Most countries or authorities have passed similar laws to achieve these ends.

However, politics and economic regulation vary between jurisdictions. Global businesses must understand the variations between different SOX-style regulations. Some differences are negligible, but some variations significantly affect compliance strategies.

Canada (C-SOX)

Canada passed the Keeping the Promise for a Strong Economy Act in 2002. Immediately known by the nickname C-SOX, this act mirrored virtually every clause in Sarbanes-Oxley to simplify cross-border operations.

The most significant divergence involves the role of independent auditors. Under SOX, companies must enlist auditors annually to confirm their compliance status. C-SOX does not require external confirmation. Regulators are satisfied if CFOs and CEOs internally certify that internal controls are compliant.

The European Union

Since 2008, the EU has passed a series of directives to improve corporate governance. Due to some key similarities with SOX, the directives rapidly gained the name "EuroSOX".

EuroSOX directives closely resemble SOX in many areas. For example, EU law blocks auditors from offering non-audit services to clients. It also establishes a framework to regulate auditors. However, EuroSOX does not directly relate to non-audit companies. EU member states continue to regulate securities-issuing companies at the national level.

For instance, Berlin passed the German Corporate Governance Code in 2002. The Netherlands passed its own Corporate Governance Code in 2004. Paris passed the Financial Security Law of France in 2003, while Italy passed its Investor Protection Act in 2006.

These acts or codes regulate how companies use and report financial data. However, the German and Dutch codes are much less prescriptive. They define codes of conduct and best practices but are not legally enforceable laws.

French and Italian regulations closely resemble SOX. They establish financial reporting requirements, demand independent oversight, and protect whistle-blowers. Like SOX, they entail regulatory penalties for non-compliance.

Japan (J-SOX)

Japan's Financial Instruments and Exchange Act of 2006 is a close cousin of SOX and makes similar demands of corporations. As in the USA, Japanese companies must create independent audit committees and establish internal controls on financial reporting. Disclosure requirements resemble those in the USA, and regulators penalize non-compliant businesses.

The United Kingdom

The UK followed Congress by passing the Companies Act in 2006. This Act created new regulatory bodies to oversee corporate reporting, including the Financial Reporting Council. Rules on controls, reporting requirements, and independent auditors all closely mimic those in the USA.

However, the UK is also modernizing its SOX-style legislation. The "Restoring Trust in Audit and Corporate Governance Report" emerged in 2021 following a series of accounting scandals. Future legislation will most likely tighten audit standards and provide additional powers to financial regulators.