Sarbanes-Oxley Act: Overview and impact

Sarbanes-Oxley Act

While most Americans know the names Enron and Worldcom, fewer know the term Sarbanes-Oxley Act; however, despite the alarming impact of the two business disasters, the potential impact of Sarbanes-Oxley stands to exceed the impact of those two bankruptcies many times over. While Enron and Worldcom each held a claim to 'biggest' or 'most' in some aspect of global business and also in various aspects of global business disaster, when it was over, it was over.

That is not so with the Sarbanes-Oxley Act, or any law passed by the U.S. government, in fact. Laws tend to remain on the books once they get there, with their requirements bedeviling generations of Americans. In some respects, the Sarbanes-Oxley Act has a great deal in common with the U.S.A. PATRIOT Act; both were passed extremely quickly in reaction to events that frightened the American public. It is easy to wonder if, on calm reflection, American voters would have been so eager for their politicians to pass one or both of these acts. A statement by Baltimore editor and pundit H.L. Mencken, made long before the word terrorist was a common as bread, explains the problem: "The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary." While few people would argue with the World Trade Center disaster -- it was hardly a hobgoblin -- some might wonder if, in fact there is the continuing level of threat that would support passage of so draconian an act as the U.S.A. PATRIOT Act, with its incursions against the Bill of Rights. In the business and financial fields, it is likely quite a number of people would have withdrawn support for passage of the Sarbanes-Oxley Act if they had realized the negative effect it is likely to have on U.S. business. Indeed, Mencken's statement might well apply to the Sarbanes-Oxley Act better than it applies to the U.S.A. PATRIOT Act.

The Sarbanes-Oxley Act does little to prevent the sort of abuses and excesses seen in the Enron and Worldcom situations, but it goes a long way toward criminalizing U.S. business in general, and slowing down the economy as well; it can do little to reverse the trend toward unethical business practices it is meant to address because sufficient laws were already on the books -- if they had been enforced -- to prevent such occurrences.

Explanation of the statement components

The Sarbanes-Oxley Act is a wide-ranging piece of legislation meant to hold business to higher standards of, particularly, accounting conduct. Criminalization is the trend toward assuming anything a business does is illegal -- or at least unethical -- unless proven otherwise. In short, it turns the American system of jurisprudence -- innocent until proven guilty -- on its head. The Sarbanes-Oxley Act assumes all businesses are interested in dirty dealing a priori. In almost every field of business, there are already disclosure requirements; the problem is not with the law, it is in the fact that unethical businesses attempt to circumvent the laws and often succeed -- arguably with the help of those charged with oversight in many cases.

Evaluation of the thesis statement and argument

The Sarbanes-Oxley Act "passed overwhelmingly in the summer of 2002 in the weeks after the $104 billion bankruptcy of Worldcom followed by six months the $63 billion bankruptcy of Enron" (Insight on the News, 2004). Amazingly, President George W. Bush and Rep. Michael J. Oxley (R-Ohio) and also chairman of the House Financial Services Committee, adopted almost wholesale the oversight proposal of Sen. Paul Sarbanes (D-Md.) who was then chairman of the Banking, Housing and Urban Affairs Committee in a Democrat-controlled Senate (Insight on the News, 2004).

The Sarbanes-Oxley Act of 2002 "directed the Securities and Exchange Commission to issue rules calculated to end glaring conflicts of interest and attorney concealments that were the alpha and omega of prolonged corporate deceit" (Where were the lawyers? 2003). In fact, not only lawyers but also accountants were involved in, especially, the Enron case. In fact, the Securities and Exchange Commission (SEC) had beaten Congress to the punch when it proposed a rule a year earlier that would have required attorneys retained by companies that issue securities to flag suspect corporate transactions of the sort the Enron built its fantasy empire upon (Where were the lawyers? 2003).

It was not popular with the lawyers because it required them to withdraw from representation and notify the SEC of the reason for the withdrawal. The attorney would also have to "disavow to the commission any opinion or document that the attorney facilitated that he reasonably believes is false or misleading" (Where were the lawyers? 2003).

In fact, the position of all lawyers as officers of the court already required them to refrain from engaging in unethical business conduct and to report such conduct no matter who was misbehaving if they were aware of it. "Lawyers, moreover, unlike bankers, are professional apostles of law saddled with a moral duty to expose corporate wrongdoing at the expense of hapless investors" (Where were the lawyers? 2003). Bankers must report suspicious activities to the government, ostensibly to foil drug money laundering and organized crime.

The SEC gave up on the rule when lawyers whined that it would make corporations cease to hire attorneys if it thought they were going to be unpaid undercover agents for the government. However, Sarbanes-Oxley included that requirement. The Washington Times noted: "Just as banking customers did not dry up with the know-your-customer and suspicious-activities reporting rules, corporate clients would not flee from attorneys holding corresponding reporting obligations" (Where were the lawyers? 2003).

In this case, if the Sarbanes-Oxley Act did not directly assume that the companies were doing illegal or unethical business, clearly the attorneys thought so. The attorneys did not care about stopping that activity; they cared only about losing clients.

The lawyers' reaction helped the government paint corporations as criminal entities. Together, the lawyers and the government proceeded along exactly those lines mentioned by H.L. Mencken. The statistics make it clear that someone was concocting hobgoblins; "Out of the thousands of publicly listed companies, the malefactors comprised a few ten-thousandths of 1%" according to another Washington Times story (Criminalizing business 2002). The conclusion the Washington Times drew as that "Such an insignificant percentage is not a sign of a breakdown in business ethics and accounting morals" (Criminalizing business 2002) They also pointed out that when someone is murdered, the laws pertaining to murder are used to catch, convict and punish the murderer; "We don't pass legislation holding people responsible for not doing enough to prevent murder" (Criminalizing business 2002), which is what the Sarbanes-Oxley Act does. In fact, many contend that it was hysteria and not sound judgment that resulted in the Sarbanes-Oxley Act, a law that criminalizes accounting mistakes. In addition, it also criminalizes the leaders of business by requiring the chief executive officer (CEO) and chief financial officer (CFO) to attest to the company's financial statements -- that there are no material mistakes "the correction of which would result in a restatement of earnings -- at personal risk of enormous fines and prison time (Criminalizing business, 2002).

The result of this is accounting roulette; how can a CEO be completely sure of figures from a foreign subsidiary? Still, lawyers and accountants are advising clients to implement more systems and internal controls to at least provide some proof of due diligence and to provide a 'paper trail' if irregularities are found (Criminalizing business 2002). It smacks of Don Corleone keeping his consigliore around to advise him concerning how closely he could skirt the law, and to be there to affirm that Don Corleone had done nothing wrong if he got caught 'cooking the books,' organized crime-style. In fact, it is likely Don Corleone had more control of his empire than most CEOs have of theirs. The CEO is criminalized for NOT acting like the had of an organized crime family.

The Sarbanes-Oxley Act might also be called the "Useless Department Full Employment Act" because being absolutely sure of complying with it will require companies to create entire departments that do nothing but implement and monitor protective procedures. "Unwieldy federal regulations for corporations like the Sarbanes-Oxley Act simply add another layer of complexity to federal regulations with great cost to corporations and investors alike" (Jurado 2003).

While some may argue that they are protecting the public from Enron-style excesses, others will argue that those departments are simply the equivalent of the organized crime's contract killers whose job it is to keep the feds and other mobsters away from the boss.

As a side issue, complying with Sarbanes-Oxley requirements will take brain- and person-power away from the mission of the business, ultimately weakening many of them.

However, there is an unseen benefit for the companies that really are doing something wrong. Parts of the act require accounting firms to rotate outside auditors more rapidly. The means accountants who know a company well and can sense something amiss even before finding it will be replaced with auditors unfamiliar with the ebb and flow of the company (Criminalizing business 2002). That is tailor made for companies that really do have something to hide, but all companies are likely to act furtively anyway.

The article concludes, "The most egregious fault of Sarbanes-Oxley is the act's supposition that executives and accountants are crooks requiring government repression at all costs .... To be incorporated in the U.S. is proving to be a fatal business disadvantage" (Criminalizing business 2002; Bad stock market medicine 2002).

That may be the most egregious fault, but there are other unfortunate results as well, including the construction of a brand-new moral hazard. The moral hazard consists in the Act's function of causing citizens to rely more and more on government bureaucracies to enforce laws that should work themselves out in the marketplace, even if it means investors have to sometimes absorb downturns (Bad stock market medicine 2002). Moreover, it plays directly to Mencken's statement.

It also assumes that any company that wants to assist its employees by making loans to them is attempting to engage in Worldcom-style abuses. And it has made marketing optimism a criminal act as well, or at least, New York Attorney General Eliot Spitzer has, by filing lawsuits against Wall Street firms for publishing optimistic stock research; it remains to wonder who would buy any stock if all the research about it was couched in terms of doom and gloom. This sort of Sarbanes-Oxley look-alike behavior is likely to both further 'criminalize' business and put a significant damper on it (Bad stock market medicine 2002).

In September 2003, Spitzer extended his investigation to mutual funds, a segment of the financial landscape almost untouched before by Sarbanes-Oxley fallout. That month, Spitzer

"revealed that a number of mutual funds were ignoring, or worse, facilitating, illegal or questionable trading by certain individuals and investment institutions, including hedge funds.

As investigations do, it has broadened beyond the original hedge funds to find "other varieties of questionable behavior" (Kubarych 2004) in other segments as well. So, in addition to the 'criminal' stigma and the cost of protecting one's self from Sarbanes-Oxley, small business is also likely to experience unwanted alterations in the way hedge funds, which serve small business primarily, are run (Kubarych 2004).

Earlier, the point was made that there were already sufficient laws on the books to take care of the problems of Enron or Worldcom or successors to their unethical practices. Even before passage of the Sarbanes-Oxley Act, "The president and the director of the Office of Management and Budget would both be in prison right now if government were subject to the same accounting rules and punishments as private business" (A hegemon no more 2003).

Another observer notes that government had also better hope that the Sarbanes-Oxley Act never applies to government, because it would certainly criminalize the executive branch. The Sarbanes-Oxley Act requires decisions to be made on figures that "fairly present" financial realities to prevent the sort of pie-in-the-sky businesses Enron executives created. "If the corporate world had been conducting the wars against terror and Saddam Hussein under Sarbanes-Oxley, it would be in trouble. No one knows whether the $87 billion appropriation to cover the costs of the war and reconstruction 'fairly present' the financial realities" (Sarbanes-Oxley, etc. 2003). Indeed, using Iraq's weapons of mass destruction as a reason for the war expenditures would subject the leader of the company to penalties if, in fact, it could be shown that the leader had no reason to believe there were weapons of mass destruction ... if, in short, it was an Enron-style fantasy from the start (Sarbanes-Oxley, etc. 2003).

In addition to all this, there are even bad laws on the books. An antiquated 1924 New York state law, the Martin Act, allows defendants to be "found guilty without intending to commit fraud, though intent is ordinarily a vital element of culpability under our system of justice" (Bad stock market medicine 2002). In addition, as mentioned earlier, when laws get on the books, they are seldom repealed.

Who is the jailer?

In criminalizing corporate American, the Sarbanes-Oxley Act has also created a sort of federal penitentiary for securities procedures. It not only prohibits certain conduct, but also prescriptively mandates "the duties of certain employees and board members (designs) the structure of boards of directors, and (dictates) one-size-fits-all processes for testing internal controls for nearly all public companies" (Insight on the News 2004).

There is every reason to believe, from what is noted here, that the Sarbanes-Oxley Act is a flawed piece of legislation ... unless, of course, the intent was to criminalize U.S. corporations and add so much regulation to corporate conduct law that small businesses will have a hard time dealing with even more paperwork; arguably, small businesses will simply cease operations.

There is, however, more ammunition targeting the concept that the Sarbanes-Oxley Act criminalizes U.S. business. First, it was a very complicated and lengthy bill. That meant it would be surprising if more than a few senators had done more than just glance at it. "One thing you can count on is that any piece of legislation that passes unanimously or overwhelmingly will always be bad legislation, because nobody will have taken the time to read it," noted Fred Smith, president of the Competitive Enterprise Institute, a free-market Washington think tank" (Quoted by Insight on the News 2004).

There is still worse news on the horizon; the Senate (especially with the 2004 election increases in Republican rolls), will speed up the flow of legislation initiated by the White House and will step aside as long as the president isn't too obvious when he cuts deals for friends (Bennett and Gourevitch 2002), the same sorts of people as Enron's Ken Lay who caused the excesses that brought about the knee-jerk legislation that promises to be more destructive of American business than the bona fide criminals were. The effect of the excessive 'corrective legislation' of Sarbanes-Oxley in the aftermath of Enron/Worldcom was to transfer guilt from the wrongdoers to anyone else, in this case all remaining U.S. corporations.