What is a SOX Control?

SOX is short for the Sarbanes-Oxley Act, a U.S. federal law that requires public companies to establish and evaluate a set of internal controls over financial reporting, to assure that investors can rely upon the company’s financial statements. Senior executives at the company must create, and attest to the effectiveness of, these internal controls, while auditors provide an independent assessment of the controls’ effectiveness.

SOX is a complicated law consisting of 11 sections, each outlining specific SOX requirements related to aspects such as auditor independence, oversight, and corporate responsibility. In particular, Section 404 of SOX governs internal controls over financial reporting (ICFR) and an auditor’s duty to assess those controls.

SOX Controls

SOX controls are meant to be safeguards within a company’s financial reporting processes, designed to help each process achieve its objectives and be free of fraud or other manipulation.

The purpose of SOX control is to prevent or detect errors that would cause deficiencies in the financial process. The sheer number of controls in a company’s SOX program doesn’t determine whether ICFR is effective. Rather, the focus should be on implementing the right controls for risk mitigation. Some common controls include access controls, segregation of duties, change management, business processes, data backup, and corporate governance practices.

To assure integrity of audits completed by an external auditor, Congress created an agency called the Public Company Accounting Oversight Board (PCAOB) to oversee the audit industry. The PCAOB sets auditing standards that audit firms must follow, including standards for auditing ICFR.

SOX IT controls and cybersecurity

SOX requirements encompass both business process controls and IT controls.

• Business controls relate to data accuracy, reconciliations, and financial data processing.
• IT controls consist of IT general controls (ITGCs) and application controls, to assure accurate and error-free systems. While all critical IT systems are important, only those directly involved in financial reporting fall under the scope of SOX compliance.

Although SOX doesn’t explicitly consider cybersecurity, maintaining a strong internal controls program often involves robust security controls. Examples of SOX controls that affect cybersecurity include controls over administrative access, incident response plans, software and patch management.

Key SOX controls

Key controls are crucial for risk mitigation and should be closely monitored and tested. Compensating controls can provide additional assurance when key controls falter.

SOX controls testing

SOX control testing assesses whether controls are functioning as intended, and is meant to identify any gaps in the internal control process. Management, internal audit, and external auditors might all perform SOX controls testing.

SOX reporting

SOX reporting includes both internal and external components. Internally, management provides testing status, issues found, and remediation plans. External auditors express their opinion on management’s internal controls over financial reporting in the financial statements.

Moreover, senior executives must personally attest to the effectiveness of ICFR in the company’s public financial statements, with the risk of prosecution if those attestations are misleading.

What Is the Purpose of SOX?

The purpose of the Sarbanes-Oxley Act is to protect investors by enhancing the accuracy and reliability of corporate disclosures. SOX emerged in response to notorious corporate accounting scandals – such as Enron, Tyco, and WorldCom – where fraudulent practices and deceptive accounting maneuvers harmed investors and eroded public trust.

By imposing stringent regulations, SOX holds boards and officers of publicly traded companies accountable for the financial statements investors rely upon, and establishes criminal penalties for non-compliance. It’s laser-focused on promoting transparency and ethical behavior, compelling companies to maintain precise financial records and ensure timely access to this information for investors and regulators.

SOX assures accuracy and secure management of vast amounts of corporate data for IT departments. Data integrity and protection become extremely crucial, requiring companies to take robust measures for safeguarding against internal and external threats.

What Does SOX Say About Internal Controls?

Section 404 of SOX states the management should establish internal controls to assure the accuracy of the organization’s financial reporting. These controls, referred to as SOX 404 controls, play a crucial role in preventing and pinpointing errors within a company’s financial reporting process.

Examples of a company’s internal controls include:

• Sign-offs on financial disclosures being submitted to the Securities and Exchange Commission (SEC) by an executive officer, such as a CEO or CFO.
• Approval requirements for access to the payroll processing system.
• Multiple sign-offs required when checks are being generated to prevent embezzlement.
• Segregation of duties within the financial reporting process activities.

When creating a system of internal control over financial reporting, it’s helpful to refer to the COSO Framework for effective internal control, last updated in 2013. That framework identifies five components of effective internal control:

• Control environment
• Risk assessment
• Control activities
• Information and communication
• Monitoring

Within those five components, the COSO framework then identifies 17 more specific principles of internal control; and each principle is in turn supported by even more specific “points of focus” to guide companies on what their system of internal control should achieve.

The importance of internal controls

The primary role of SOX internal controls is to protect the integrity of financial reporting processes. By implementing these controls, you can identify and address potential issues and assure smoother operations. You can outline measures to prevent or detect reporting errors, which enhances transparency and accountability for stakeholders.

Moreover, internal controls also go beyond financial reporting. They can affect your organization’s operations, such as compliance, risk management, and operational efficiency. This can help you meet regulatory requirements, streamline operations, and better manage risks.

Why SOX Compliance Matters for Companies

SOX compliance requires public companies to document, test, maintain and review controls over financial reporting. It’s the law, and failure to comply with SOX can result in steep penalties and possible prison time.

But aside from being mandatory, SOX compliance has several benefits to organizations such as:

• Risk triage. SOX compliance helps companies analyze their assets and understand the risks associated with financial reporting. By focusing on in-scope areas, organizations can target their controls more effectively, enhancing risk management and control effectiveness.
• Control structure strengthening. SOX compliance requires documentation of controls, leading to improved control awareness and transparency. This process highlights control gaps, faulty assumptions, and inefficiencies, enabling organizations to strengthen their control activities and identify areas for improvement.
• Better audits. SOX compliance should be supported by senior management, internal audit groups, and financial reporting teams. This collaboration enhances internal audit outcomes and streamlines the external audit process, leading to more effective and efficient operations and reduced audit costs.
• Efficient financial reporting. SOX compliance fosters transparency and reliable financial reporting by setting minimum standards and mapping the internal control environment. This results in more efficient and accurate financial reporting, reducing the need for error correction and saving time.
• Peak operational performance. Early engagement with SOX compliance drives process efficiencies and risk assessment, positioning organizations for future growth. Companies maximize operational and auditing efficiency by adopting a practical approach and integrating IT and business processes while minimizing compliance costs.
• Effective team collaboration. SOX compliance promotes collaboration among internal stakeholders, particularly in areas such as IT security. By working together and addressing emerging risks, organizations can enhance their risk management capabilities and strengthen information security measures.

Learn about these SOX compliance benefits in more detail here.

Maintain Compliance With RiskOptics

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