Adelphia founder John Rigas got 15 years (a life sentence for the 80-year-old executive), and former WorldCom CEO Bernard Ebbers got 25--two victories in the government's post-Enron wave of corporate fraud prosecutions. Meanwhile, the Enron case itself has crawled along, with few significant victories and a handful of defeats for federal prosecutors. The trials of former Enron chairman Kenneth Lay, president Jeffrey Skilling, and chief accounting officer Richard Causey are set to begin in January.
New laws were not necessary to prosecute those executives. Still, Congress responded to the scandals that destroyed or hobbled their companies by passing the Sarbanes-Oxley Act. Signed into law by President George W. Bush on July 30, 2002, Sarbanes-Oxley was supposed to crack down on accounting irregularities, punish those responsible for hiding them from the public, and curtail potential conflicts of interest in corporations' relationships with their auditors. HealthSouth CEO Richard Scrushy was the law's first big collar. He recently walked away from his trial a free, if disgraced, corporate bigwig, after 21 days of jury deliberation. Many credit Scrushy's refusal to testify in his own trial as a plus for him--he left the jury to judge the probity of a bunch of other HealthSouth execs, self-confessed fraudsters who had previously pled guilty and testified against Scrushy.
Sarbanes-Oxley, a.k.a. SarbOx, is a complicated law that has the business world abuzz with annoyance and anxiety. Among other things, it requires that CEOs and chief financial officers certify, under penalty of 20 years in prison and $5 million in fines, that their internal financial controls are in order and that they lead to accurate reports. It says executives must provide "reasonable assurance" that everything is kosher, a provision that is likely to invite litigation as well as prosecution. The law created the Public Company Accounting Oversight Board, adding yet another level of oversight to a profession already monitored by the Securities and Exchange Commission, the Fair Accounting Standards Board, and the Justice Department. The board is ostensibly private, but has the power to force accounting firms to pay both fees for its operations, and fines for disobeying its edicts. SarbOx also requires that auditors (though not necessarily auditing firms) switch out every five years, and it prohibits auditors from jumping ship to executive positions at companies they have just audited.
Critics in academia and business journalism--and many from the corporate world itself, most of whom are reluctant to talk on the record and thereby show "bad faith" regarding the law--have many complaints about SarbOx, from its picayune requirements to its overall cost. While all such guesstimates should be taken with a grain of salt, one financial consulting firm, the Johnsson Group, has put the 2004 costs of SarbOx compliance at $15 billion. The critics also argue that the law's benefits are apt to be small.
America did indeed suffer a wave of corporate scandals that ended in the loss of hundreds of billions of dollars in market value. And the scandals did involve accounting fraud, part of a desperate attempt to cover up the companies' grim realities. But the underlying problem was not crooked accounting; it was bad business practices. A reform aimed mostly at accounting is not likely to solve the problem of stocks that lose value because the people running the company have bad strategies and make stupid decisions and are losing money. In fact, better accounting will speed up the collapse in market value.
Nor is it clear that CEO-certified financial information, SarbOx's main gift to the average investor, will make a noticeable difference. A study by the University of Indiana finance professor Utpal Bhattacharya and some of his colleagues, reported by them in the Fall 2003 issue of Regulation magazine, found that public certification of financial statements by CEOs had no apparent effect on stock prices. That doesn't mean the market doesn't care about accurate financial information; it merely means the market has ways of figuring these things out without legally mandated certification.
SarbOx probably won't cripple the American economy, any more than the Clean Air Act or the Americans with Disabilities Act did. But it's bound to create bad incentives and unintended consequences. Far from increasing the efficiency of capital markets, it will discourage some businesses from going public, since most of its provisions do not apply to privately held companies; will encourage some now-public companies to go private; and will keep some foreign companies out of the U.S. stock market.
According to a survey of companies with under $1 billion in annual revenue done by national law firm Foley and Lardner, SarbOx has more than tripled the average annual regulatory costs of being a public company in the U.S., from around $1 million pre-SarbOx to $3.4 million in 2004. The law also may tend to chill mergers, since purchasing companies will now be legally responsible for the financial records and statements of their targets, documents they had no role in creating.
The costs of SarbOx compliance, while not driving anyone out of business, will siphon revenues toward legal and accounting work. That drain may, in the words of Forbes' Rich Karlgaard, "succeed in stopping the next Enron, but...crib-kill the next Cisco, Microsoft and Starbucks" by leaving them less capital with which to expand.
To get a better sense of how Sarbanes-Oxley is affecting American businesses, Reason Senior Editor Brian Doherty asked four people familiar with the law's consequences to explain what the new rules mean in practice.
Bob Merritt has 23 years of experience as a chief financial officer for restaurant chains, including Outback Steakhouse. He finally left the business in April 2005, partly out of frustration with the way Sarbanes-Oxley and its enforcement changed the nature of his work.
Karen De Coster is a certified public accountant who has done accounting work for a variety of public and private companies for seven years, and is now working in corporate finance for a Fortune 500 company in the auto industry. Although her politics tend toward radical libertarianism, she sees some benefit to "some of what is being done in the name of SarbOx compliance," along with a lot of burdensome requirements that make little sense.
As a Sarbanes-Oxley compliance consultant, Stephen Stanton is a man whose self-interest should encourage him to praise the law. But he sees little good coming from it, aside from added income for consultants and auditors.
Charles Wilson is chairman of the board of Trio-Tech International, a California-based semiconductor testing company with about 500 employees and a market capitalization of $12 million. Wilson, whose company went public in 1981, says Sarbanes-Oxley makes him wish he could reverse that decision.
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