Security & Compliance

  • 5 min read

Penalties For SOX Violation

Minu Joseph

14th March, 2024

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If organizations fail to meet the regulatory requirements set forth by SOX, they are obligated to pay hefty penalties. In this article, we'll discuss SOX violations, penalties for non-compliance, and how to create a SOX compliant environment. 

The Sarbanes-Oxley Act is a regulatory framework enforced to safeguard investors from financial accounting fraud. 

Which organizations are bound to comply with this regulatory standard? 

• SOX primarily applies to publicly traded U.S. companies or publicly traded companies from other countries engaging in U.S. business. These entities must establish and maintain internal controls, which are subject to audits.

• Certain SOX guidelines also apply to private companies and nonprofits. These entities must adhere to provisions preventing the intentional destruction or falsification of financial documents. Moreover, they must comply with federal investigations related to financial reporting.

• Audit firms play a crucial role in upholding compliance with the Public Company Accounting Oversight Board (PCAOB) to maintain a favorable standing. This includes educating relevant practitioners and ensuring they stay informed about accounting ethics, standards, and the implications of Sarbanes-Oxley Act (SOX) requirements for their practices. 

Why does SOX compliance matter?

• Adherence to SOX compliance is not just a regulatory burden. It offers several advantages. Investors tend to have increased confidence in the financial disclosures of SOX-compliant companies, making them more inclined to invest. Additionally, SOX acts as a deterrent to corporate fraud by holding leaders personally accountable for financial statements.

• Furthermore, SOX compliance also helps to enhance organizations' overall cybersecurity. The security measures used to stop financial tampering also work well against cyberattacks and security breaches.
  
  But what if organizations fail to adhere to SOX compliance? What consequences will they face? Before we go through the consequences of non-compliance, let's first understand what SOX violation is.

What Is SOX Violation?

Sarbanes-Oxley (SOX) violation refers to instances where organizations fail to adhere to the legal requirements established by SOX. 

SOX violations can occur when organizations fail to meet the key provisions, which include:

• The obligation for senior management to provide written certification. This certification demonstrates that financial annual reports adhere to SEC disclosure requirements. Further, it shows that the organization has an effective internal control structure and also adheres to the regulations for record-keeping and retention. 
  
  While many SOX provisions specifically address financial departments, accountants, and external auditors, there are also requirements for IT departments. 

• Organizations need to conduct regular SOX compliance audits and ensure comprehensive compliance across all teams to prevent the imposition of SOX penalties.   
  
  In simple words, SOX violations occur when organizations submit inaccurate financial reporting—intentionally or unintentionally. Unintentional, inaccurate financial reports are mostly the result of organizations not having proper internal controls for safeguarding data stored in finance apps.
  
  However, such violations may result in legal consequences, and accountable individuals or entities may have to face them. For example, they have to pay hefty penalties or serve imprisonment, or in the worst case, they may have to face both consequences. 
  
  To provide a clearer understanding of the consequences of the violation, let's look at a financial scandal—a case of SOX non-compliance caught by the SEC (Securities and Exchange Commission).

Sarbanes-Oxley Violation: A Recent Example

In 2021, the SEC charged the Kraft Heinz Company and two former executives for participating in accounting misconduct.

Kraft Heinz's two former executive officers, Eduardo Pelleissone and Klaus Hofmann engaged in misconduct related to the scheme. 

Kraft was involved in various types of accounting misconduct, including wrongly recognizing discounts and maintaining misleading contracts to reduce costs. This made the company's financial performance look better than it actually was. 

After an SEC investigation, Kraft restated its financials in June 2019, correcting $208 million in improperly recognized cost savings.

As a result, Kraft had to pay a $62 million penalty. Pelleissone agreed to stop any future violations, repay $14,211.31 with interest, and pay a $300,000 penalty. Hofmann, without admitting guilt, agreed to a judgment preventing future violations, a $100,000 penalty, and a five-year ban from being an officer or director in a public company. 

Penalties For Non-Compliance With SOX 

To adhere to Sarbanes-Oxley Act (SOX), the CEO and CFO are required to provide a written statement. This statement certifies that the report meets SEC disclosure requirements and accurately represents the organization's "financial condition." Failure to fulfill these obligations can result in various SOX violation penalties for executives.

1. Penalties for Knowingly Submitting Non-Compliant Reports

If an executive knowingly submits a written statement with a report that fails to meet SOX Act requirements, where "knowingly" implies awareness of the report's deficiencies rather than an accidental error, the executive may face criminal penalties. This could include fines of up to $1 million or imprisonment for up to ten years.

2. Penalties for Willfully Certifying Non-Compliant Reports

SOX imposes more severe penalties on executives who willfully certify a financial report that either doesn't meet SEC disclosure requirements or is otherwise unsatisfactory under SOX. "Willfully" refers to the intent to mislead or deceive. In such cases, the executive may be fined up to $5 million or face imprisonment for up to 20 years.

3. Penalties for Non-Compliant Organizations

SOX violation fines extend beyond individual executives to impact organizations that fail to achieve compliance in their reports. Non-compliant companies could face delisting from public stock exchanges, causing significant repercussions for investors and shareholders.

Apart from that, it is also stated that under SOX section 909, if an individual submits inaccurate or misleading reports, they are violating SOX compliance. They will be obligated to pay a fine and serve 20 years of imprisonment. 

SOX Protections For Whistleblowers

Sarbanes-Oxley (SOX) penalties for financial misconduct can be severe, but they are not imposed on anyone who is just merely aware of misreporting. 

Under whistleblower protection for employees of publicly traded companies SOX act, whistleblowers (employees) who take steps to report instances of financial fraud within their organizations are protected from any retaliatory actions. This step was taken to encourage employees to speak up against the fraudulent practices. 

Furthermore, this act ensures that companies do not penalize employees who raise concerns. It explicitly states that employers cannot engage in actions such as discharging, demoting, suspending, threatening, harassing, or discriminating against employees who cooperate with investigators or testify against the company. In case of retaliation by organizations, employees have the right to file a lawsuit, providing an additional layer of protection under the SOX Act.

Fostering A SOX Compliance Centric Environment

Compliance isn't just about ticking boxes or focusing on certain teams mentioned in the SOX Act. It goes beyond finance and IT departments; it's something that everyone in the company should be involved in. Ensuring everyone follows the rules is crucial to avoid penalties and risks to the company's reputation.

To do this, companies need to update how they handle compliance. That means getting rid of old, manual processes and bringing everything together in one place. It's not just a one-time thing; it's an ongoing effort that requires everyone in the company to be on board. This is just the starting point for creating a culture where following rules is a natural part of how everyone does their job. 

Furthermore, to ensure the effective implementation of SOX compliance, you can opt for an effective access review solution like Zluri. 

Zluri's access review automates the entire internal audit process. With this advanced platform, your team (internal reviewers/IT managers) can conduct regular audits/periodic reviews and evaluate the state of internal controls enforcement and generate curated reports based on those insights. 

These insights further help your team ensure the right individuals have authorized access to sensitive data and nothing beyond that. Also, these reports act as an evidence that there was a proper implementation of internal controls and sensitive data (financial data) are secured. 

This way, with user access review, your organizations can seamlessly adhere to SOX compliance requirements, mitigating the risks associated with non-compliance.

About the author

Minu Joseph

Minu is a product marketer with dynamic digital marketing support and a background in journalism. She has a comprehensive understanding of B2B marketing strategy and content writing.