All too often, as with the hurried passage of the Sarbanes-Oxley Act of 2002 (SOA), it seems more important for government officials to be seen to address some problem of popular concern than to be held responsible over time for resolving the problem. As if to demonstrate this point, Senator Paul Sarbanes (D-MD) and Representative Michael Oxley (R-OH) have announced their resignation from Congress at the end of this term.
In the concluding chapter of After Enron: Lessons for Public Policy, I wrote (in 2004) that
“The SOA was the most important political response to the collapse of Enron and several other large corporations. My own evaluation of this act is much like that of (a colleague), who described the SOA as “unnecessary, harmful, and inadequate.”
Unnecessary – because the stock exchanges had already implemented most of the SOA changes in the rules of corporate governance in their new listing standards; the Securities and Exchange Commission (SEC) had full authority to approve and enforce accounting standards, the requirement that CEOs certify the financial statements of their firms, and the rules for corporate disclosure; and the Department of Justice had ample authority to prosecute executives for securities fraud. The expensive new Public Company Accounting Oversight Board (PCAOB) is especially unnecessary. Its role is to regulate the few remaining independent public auditors, but it has no regulatory authority beyond that already granted to the SEC. Moreover, the audit firms still have a potential conflict of interest, because they are selected by and paid by the public corporations that they audit … The PCAOB may also be unconstitutional, because it is a private monopoly that has been granted both regulatory and taxing authority.
Harmful – because the SOA substantially increases the risks of serving as a corporate officer or director, the premiums for directors and officers liability insurance, and the incentives, primarily for foreign and small firms, not to list their stock on an American exchange. The ban on loans to corporate officers eliminates one of the most efficient instruments of executive compensation. And the SOA may also reduce the incentive of corporate executives and directors to seek legal advice.
Inadequate – because the SOA failed to identify and correct the major problems of accounting, auditing, taxation, and corporate governance that have invited corporate malfeasance and increased the probability of bankruptcy.
What to do?
At a minimum, Congress should clarify that the criminal penalties in the SOA require proof of malign intent and personal responsibility for some illegal act …
Any potential SOA cleanup legislation should address the potential problems of delisting by foreign and small firms from the American stock exchanges, maybe by exempting such firms from the regulatory requirements …
A wise Congress would also eliminate the expensive new and wholly unnecessary PCAOB, preferably before it establishes new precedents and creates some new special interest …
A Congress that is both wise and brave would repeal the SOA – lock, stock, and barrel. The SOA adds no necessary authority to those previously granted, creates the potential for substantial harm, and does not address the major policies that lead to problems in the U.S. corporate economy.”
What are the most important lessons from the experience under the SOA? First, the costs of implementing Section 404 of the Act have been unusually high, especially for smaller corporations. Second, there are large incentives to avoid being subject to the Act; a significant number of smaller firms have delisted (withdrawn their stock from an exchange), and almost all initial public offerings are now on a European stock exchange rather than on an American exchange. Finally, and most important: the SOA promised “to restore investor confidence” in the financial accounts of corporations listed on the U.S. exchanges, an effect that should have increased the amount that investors would pay for a stock per dollar of reported earnings. In fact, the price-earnings ratio of the S&P 500-stock index has declined continuously beginning with the second quarter of 2002 when Congress drafted and approved this legislation. The Sarbanes-Oxley Act has not restored investor confidence, and this Act should be repealed.