Improvements in Integrity, Financial Accountability, Ethical Conduct and Corporate Responsibilities under the Sarbanes-Oxley Act of 2002
We passed Sarbanes-Oxley in the wake of the Enron scandal to try to root out financial and accounting irregularities. How could similar irregularities occur at Lehman Brothers? History has a way of constantly repeating itself. -- Joseph Grant 2010
The high-profile corporate shenanigans by Enron and Lehman Brothers have made it clear that tough legislation was needed to compel Americans businesses to clean up their financial acts. Indeed, in response to Enron's late 2001 bankruptcy, Congress enacted the Sarbanes-Oxley Act of 2002 but the Lehman Brothers' bankruptcy in late 2008 made it clear that there was still a problem in some sectors of American business. This paper provides a review of the relevant literature to determine how the integrity of corporate finance, ethics, and other responsibilities have improved, what the corporate finance industry culture has learned from the Enron and Lehman frauds, and how these events in turn made the U.S. And global economy better under the Sarbanes-Oxley Act of 2002. A summary of the research and important findings concerning these issues are provided in the conclusion.
Review and Analysis
A debate concerning the appropriate approach to regulating the American corporation emerged during the closing decades of the 20th century, with one school of thought holding that the governance of the large corporation was and should be primarily determined by government regulation (Ribstein 2). According to Ribstein, "This approach seemed justified by the lack of an effective means by which the shareholders could exert control over their ownership interests or the firm's governance terms" (2). The need for government oversight and scrutiny of corporate activities to ensure legality and trustworthiness is important for investor confidence, proponents argue, and without this oversight and scrutiny, managers are able to wield inordinate amounts of power to exploit their companies to their own benefit irrespective of the effects on overall corporate profitability (Ribstein 2). While not admitting its correctness, Ribstein does point out that, "The proregulatory position has proven quite nimble, shifting from standard economic arguments favoring regulation to arguments that law is necessary to back the creation and maintenance of norms of trust and fairness" (2). Conversely, other economists maintain that the American corporation was most appropriately regarded as being the fundamental product of private contractual relationships, and should therefore be entitled to the same presumption of efficiency as contracts in general (Ribstein 3). It was this view, Carter argues, that helped fuel the financial scandals in the first place. According to Carter, "Some of the main causes for the financial crisis [included] repeal of Glass-Steagall, failure to regulate such things as credit default swaps, and the overriding view that markets regulated themselves" (492).
Following the bankruptcy filing of Enron in late 2001, a number of other accounting scandals rocked the American securities markets, including Global Crossing, WorldCom, Adelphia, and several others (Perino 671). In this regard, Ribstein reports that the "spectacular crashes and frauds of Enron, WorldCom, and other companies, including Sunbeam, Waste Management, Adelphia, Xerox, and Global Crossing" became the focus of the debate concerning the appropriate role of government in regulating American companies. What is particularly disturbing is just how pervasive and insidious these practices were among American corporations at the time, and Enron was just among the first and best known. For instance, according to Ribstein, "The most public phase of the scandals began with Enron, which was at one time the seventh largest firm based on market capitalization, but in the fall of 2001 was suddenly shown to be a facade created by financial manipulation" (2).
Given the high-profile nature of these events, it is reasonable to suggest that American businesses got the message and took careful stock of their accounting practices. In reality, it appears that many did, only to ensure that they did not get caught like their counterparts at Enron. Indeed, Ribstein emphasizes that, "The frauds occurred despite several levels of monitoring by, among others, directors, prominent accounting and law firms, institutional shareholders, debt rating agencies, and securities analysts" (3). Part of the problem was the ability of many of the companies to depict a falsified sense of well-being even as the financial walls were crumbling around them. In this regard, Ribstein adds that, "Supposedly efficient securities markets adhered to overly optimistic assumptions about firms' business plans in the face of mounting evidence to the contrary" (3).
In the wake of these high-profile scandals, criminal investigations by the Securities and Exchange Commission (SEC) resulted in the U.S. Congress passing with near unanimity the Sarbanes-Oxley Act of 2002 (Pub. L. No. 107-204, 116 Stat. 7451) and President Bush signing the Act into law (Perino 671). At the time of signing, President Bush called the Sarbanes-Oxley Act (hereinafter alternatively "the Act" or "SOX") as one of the "the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt" (quoted in Perino at 672). The fundamental purpose of the Sarbanes-Oxley Act was "to correct corporate misconduct and force accountability higher up in the organization" (Bierstaker, Marshall and Greenwald 35). There were other reforms that followed the Sarbanes-Oxley Act of 2002 as well, including Securities & Exchange Commission Rules 38a-1 and 206(4)-7 of the Investment Company and Investment Advisers Acts of 1940, respectively; National Association of Securities Dealers (NASD) Rule No. 3013; and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Bierstaker et al. 36).
Certainly, no one expected positive results from the Act and the other reforms overnight, but the events that followed made it clear that cleaning up America's business community was going to take some time. For example, Skeel reports that no sooner had lawmakers put the finishing touches on the Sarbanes-Oxley Act of 2002 and enacted other reforms, a new series of financial crises emerged following the distressed sale of the largest subprime lender, Countrywide Financial, and domino-effect collapses of Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Merrill Lynch, and AIG (147).
Filed on September 15, 2008, the Lehman Brother's bankruptcy was the largest Chapter 11 bankruptcy filing in American history and it is reasonable to suggest that the collapse of the Lehman Brothers contributed to the economic downturns that followed (Grant 2). Moreover, Skeel emphasizes that, "The earlier corporate scandals were widely viewed as a failure of corporate governance and were centered largely in the United States. The 2008 crisis, however, was far more global in its scope and was closely tied to governance and regulation in the financial services industry" (147). In fact, the Lehman Brothers crisis cost more than 20,000 employees their jobs and the fallout was far-reaching and severe (Skeel 147).
The U.S. Bankruptcy Court judge assigned to the Lehman Brothers case, Anton Valukas, identified a number of failures in Lehman's corporate governance, auditing and financial controls. In this regard, Valukas emphasized that Lehman Brothers "repeatedly exceeded its own internal risk limits and controls" and engaged in a flawed and sometimes crooked decision-making process that doomed the company and its shareholders (quoted in Grant at 3). For instance, commenting on Lehman's executives, Valukas observed that corporate conduct "ranged from serious but non-culpable errors of business judgment to actionable balance sheet manipulation" (quoted in Grant at 3). In addition, the judge cited the active role played by Lehman Brothers in trying to cover up their scheme as long as possible by duping investors concerning the company's real financial situation (Grant 3).
In reality, though, these foregoing high-profile cases may be the result of improved regulatory oversight pursuant to the various reforms enacted following SOX, and the message has been communicated that strict adherence to the guidelines are not just expected, they will be rigorously enforced and violations prosecuted. These reforms have also helped change the industry culture to one that…