The Enron and WorldCom debacles
opened everyone’s eyes to the fact
that greed and mismanagement can lead to negative consequences in large
companies. The result was the Sarbanes-Oxley Act (SOX) of 2002.
However, SOX has mostly had a negative
effect on corporations, according to James
Strain, shareholder/director, chair of the
Business Law Practice Group of Sommer
Barnard PC.
Smart Business spoke with Strain about
how much SOX has cost publicly held corporations and whether reexamining it
would be worthwhile.
Has the act accomplished the legislative justifications for its passage?
The stated legislative justifications for the
passage of SOX were to address systemic
and structural weaknesses affecting the
capital markets, ultimately for the purpose
of protecting investors by improving the
reliability and accuracy of corporate disclosures made pursuant to the securities
laws. It’s fair to say that SOX has increased
corporate awareness of public disclosure
responsibility, and has largely decoupled
the rendering of auditing and other services offered by accounting firms. Whether it
has had any hand in restoring investor confidence, however, is far more problematic.
Was SOX necessary to accomplish the
asserted justifications?
As passed, SOX contained some good
features and many bad features. It’s often
thought of as a statute fraught with unintended consequences. The Securities and
Exchange Commission (SEC) had enough
authority before SOX to have caught and
punished those who engaged in securities
fraud. The rules imposed on lawyers (‘up
the ladder’ reporting of securities fraud,
withdrawal from an engagement, etc.) had
been required by the SEC since 1980.
The incentives changed with the passage
of SOX. There was a perception that lower-level employees of publicly held corporations could ‘blow the whistle’ on securities
fraud with impunity and that CEOs could go to jail for signing off on bad financial
statements. Independence of board members on audit and other committees and
independence of auditing firms became a
mandate, because of both SOX and the
self-regulatory organizations, such as the
New York Stock Exchange and NASDAQ,
imposing their wills. What changed for
lawyers was sweeping state law breaches
of fiduciary duty in with securities fraud.
As important as SOX was in these
changes, the rise of percentage of investments made by institutional investors and
the fact that they’ve ceded many duties to
organizations such as Institutional Shareholder Services has had an equally important, if not greater, effect on corporate governance and responsibility. This trend is
unrelated to the passage of SOX.
What has compliance with SOX cost publicly
held corporations?
In 2004, Foley & Lardner found that, for
publicly held companies with revenues
under $1 billion, the average continuing
annual costs of being public more than
doubled from $1.3 to $2.9 million. Of the
115 companies responding to the survey, 21 percent were considering going private,
6 percent were considering selling and 7
percent were considering merging, all
because of the cost of SOX compliance.
In a Ph.D. dissertation by Ivy Xiying Zhang
(Economic Consequences of the Sarbanes-Oxley Act of 2002), the author concludes ‘the
loss in market value around the most significant SOX rulemaking events amounts to $1.4
trillion, which likely reflects direct compliance costs, indirect costs and expected costs
of future anti-business legislation.’
Have the costs of compliance hurt the country in unintended ways?
It seems clear to me that the country has
been hurt by SOX. The loss of market value
of securities aside, many believe that capital market innovation, long a strength of
the American economy, is being driven to
foreign countries since the costs of compliance are sufficiently less and their markets
are sufficiently global.
Also, the mandated independence has
created more of a combative relationship
between executives of publicly held companies and their directors. Directors are
more worried about personal liability and
asserting their independence than they are
about making sure the corporation is headed in the right direction. CEOs are spending more time kowtowing to their boards’
desires than strategically planning for the
long-term. This trend will undoubtedly hurt
the competitiveness of U.S. companies and
their ability to prosper.
Has SOX been worth its cost to the country or
should it be revisited?
It may be too soon to say there’s an irreversible move away from U. S. capital markets towards global markets elsewhere,
but that trend should be a concern. It
seems to me that a more thoughtful
approach to SOX and an examination of
the consequences to date would be good
for the country and for the economy.
JAMES STRAIN is shareholder/director, chair of the Business
Law Practice Group of Sommer Barnard PC. Reach him at (317)
713-3460.