Sarbanes Oxley

Is Sarbanes Oxley too much of a good thing? The over reaction to corporate corruption, meaning Enron, has produced a rather onerous piece of legislation. It has made accounting the career of the future, as opposed to engineers, scientists, mathematicians, and yes even teachers. It was not enough to only punish the guilty parties, but the whole U.S. corporate world is paying dearly. It is paying in unproductive ways – loss of time, resources and money that can be better used to compete in the world markets.

By Robert E. Freer, Jr., President of The Free Enterprise Foundation

When legislators passed the well-intentioned but overly broad Sarbanes-Oxley Act into law, they failed to anticipate both the impact it would have on the day-to-day practices of accounting firms and the competitive disadvantages it would force upon American businesses overall. Since its passage, the measure, a reaction to the accounting scandals of Enron, WorldCom and other large corporations, has strained valuable resources of American businesses and resulted in a corporate culture of red tape and suspicion that has put U.S. businesses at a disadvantage. It has adversely impacted America’s competitive position by substantially increasing non productive overhead and discouraged foreign firms and fast growing firms in the United States from listing on U.S. exchanges.

As they contend with budget issues, smaller public companies are particularly struggling to comply. Midsize firms which are currently spending the smallest percentage of their budgets on compliance have seen their costs go through the roof, but are the most likely to invest in financial reporting software and may be able to best control their costs. Regardless the size of the firm, the cost of compliance has squeezed profit margins for all, discouraging initial public offerings and forcing smaller companies to de-list, thereby decreasing the competition on which the U.S. economy was founded and that today spurs improvements in products and services for consumers.

Certainly none of this was intended by Congress. Unfortunately it is a legislative fact that Congress cannot do anything with finesse. That is certainly the case here. The statute as passed has many features that should be helpful in providing fair reporting of financial results. The creation of a federally mandated Public Company Accounting Oversight Board in Title I should do much to clean up the cozy relationship that has existed between some auditors and some registrants. Going forward, the financial community and the public will be benefited by a high level of confidence that reported financial results reflect the application of an understood standard consistently applied. This will greatly help the public and all segments of commerce.

If Congress had stopped with Title I and Title II on auditor independence and oversight, it probably would have been enough to create the level of discipline and accountability within the financial reporting system to correct the abuses. Regrettably in title III and IV, however, in tackling “Corporate Responsibility” and especially “Enhanced Financial Disclosure” the statute has added to these provisions by creating a board within the board with enhanced provisions for the audit committee and married the enhanced audit provisions with corresponding enhanced disclosure requirements and Board member responsibility for accuracy in reporting. This legislative stew has in my estimation crippled the prudent man rule that previously protected faithful actions of board members. It has also created real difficulty in timing the announcement of corporate actions, raised director exposure to litigation even for their best attempts to get it right, and disadvantages American corporations by raising compliance costs into the stratosphere. One friend of mine who has served on the audit committee of a medium sized steel company reports that her company recently paid out almost $26 million in measured compliance costs, and I recently heard an officer of Pfizer assess their annualized costs at $125 million. On any scale that is out of hand.

Some of the specific problems companies are encountering in their efforts to comply with the measure’s stipulations are that the law is vague about what internal controls are sufficient to comply. Executives also cite IT snafus and security issues as headaches in their efforts to comply. CIOs have cited problems with data structures, difficulties ensuring adequate security and business continuity as other obstacles to compliance. Some foreign companies that list in U.S. stock exchanges have withdrawn from U.S. listings, citing a provision requiring lawyers to withdraw from conflicts with parts of the law that are in opposition to their own country’s laws. This kills the competition and contributions of foreign companies to the U.S. economy. Several industry insiders have said the rules are not necessary for responsible firms, and that the funds necessary for compliance with Sarbanes-Oxley could more wisely be spent on shareholder value and building confidence among shareholders.

The Sarbanes-Oxley Act, although well-intentioned, seems to have been geared more toward public opinion than public company accountability. Lawmakers were under pressure to take action in the wake of million-dollar accounting scandals that shook the confidence of the American public. Legislators took it upon themselves to take punitive measures against an entire industry, and in their haste to please the public, drafted and passed legislation that now victimizes that same public with its cost for compliance.

A seriously thought-out amendment rolling back titles III and IV would be helpful to restoring some balance to its effect. Much of the enhanced reporting would still occur but the heavy emphasis on Board potential culpability for even an innocent error would be left for civil liability tribunals not the criminal courts. For that corporate manager truly culpable, previously existing remedies are already available and effective.

Copyright © 2007 by Robert E. Freer, Jr. All rights reserved

About the author: Robert E. Freer, Jr. is President of The Free Enterprise Foundation. He is a Visiting Professor, at The Citadel and elected in 2005 to be their first John S. Grinalds Leader in Residence. A regular contributor to the Mercury, He can be reached by E-mail at The Citadel . Copies of his earlier columns can be found The Free Enterprise Foundation.

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