Sarbanes-Oxley Revisited

In January 2006, reason interviewed four businesspeople and financial professionals to assess the costs and benefits of the 2002 Sarbanes-Oxley Act—the last big federal response to fears of chaos, greed, and fraud in financial markets. Sarbanes-Oxley was intended, we wrote, 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."

Recent academic studies of Sarbanes-Oxley have deepened our understanding of the law's effects. The corporate law specialist Kate Litvak, writing in the Journal of Corporate Finance, found that foreign companies whose U.S. listings subject them to Sarbanes-Oxley regulations show stock price drops compared to foreign companies that are not subject to the law. Litvak's results indicate that the market thinks Sarbanes-Oxley is more harm than help. In a 2007 survey of professional fraud examiners, three-quarters said institutional fraud was more prevalent than before the law was passed.

The eventual total costs of SarbOx to the U.S. economy are not yet apparent, since the Securities and Exchange Commission (SEC) has continued to exempt nearly 5,000 smaller companies, with market capitalizations of less than $75 million, from SarbOx's orders to audit their financial control systems. That exemption is currently set to end in December 2009. The total compliance costs for the U.S. economy as a whole are then likely to soar.

In the light of the current financial crisis, and of recent grand and overbroad power and money grabs by the likes of the Treasury Department and the SEC, CPA Karen DeCoster sounded prescient when she noted that "the bigger cost [of SarbOx going forward] is in terms of the centralization of a regulatory system that can effectively stifle the free market via the imposition of arbitrary decree." SarbOx could be seen as clearing the brush for a U.S. economy where every move and decision is under watchful (and controlling) federal eyes.

Compliance consultant Stephen Stanton was on the money when he told reason: "Most business failures have nothing to do with accounting, stated financials, or fraud. Most business failures have to do with having wrong strategy, inefficient operations, poor marketing." In the face of market chaos far worse than the upheaval that inspired Sarbanes-Oxley, we can see that the real problems have to do with fundamentals of market valuation and bad decision making for which regulatory requirements like Sarbanes-Oxley's have little relevance.

Related: In the same issue, reason investigated how the government used Sarbanes-Oxley rules to strong-arm the media in the Valerie Plame case.