Sarbanes-Oxley on trial

Marketplace Staff Apr 25, 2006

MARK AUSTIN THOMAS: Jeff Skilling and Ken Lay are providing lots of courtroom drama in the Enron trial in Houston. They’re trying to convince a jury that they’re innocent of any crimes in the downfall of the giant energy firm. Writer and commentator Matthew Bishop says it’s a bit strange since a law, which was inspired by the Enron scandal, is under scrutiny.

MATTHEW BISHOP: Ironically, although it’s making fewer headlines, the law passed by Congress to prevent more scandals of the sort that bankrupted Enron is now on trial, too.

For the past four years bosses of public companies have complained loudly about the alleged iniquities of the Sarbanes-Oxley Act.

Prominent former supporters of Sarbanes-Oxley such as saintly ex-Federal Reserve chairman Alan Greenspan and Bob Greifeld, the boss of the Nasdaq stock market, have joined them.

These men blame Sarbanes-Oxley for the fact that so many companies nowadays choose to list their shares in London, not America.

Critics of Sarbanes-Oxley point out, rightly, that the Act was rushed into law by a Congress with its eye on midterm elections and terrified that Enron and that other headline grabber, WorldCom, would rub off on them.

The main target of the critics is the law’s infamous section 404. It regulates the internal controls — systems that a company must have in place to ensure that its financial accounts aren’t misleading or fraudulent.

Section 404 is horribly vague about which internal systems an outside auditor must vet. So the big accounting firms have erred on the side of caution, auditing as many controls as possible.

Happily for them, doing that pays. Plenty of people blame the big accounting firms for failing to properly audit Enron, WorldCom, et al.

Now, the accountants are the big financial winners from Sarbanes-Oxley.

The cost of complying with Section 404 has been huge: over $7 million in the first year for the average big company.

The smallest group of public companies have forked out well over $1 million on average. These costs are down sharply in year two, but they’re still far more than anyone expected. The SEC initially forecast that the average cost of compliance per company would be a mere $91,000.

The SEC’s own advisory committee on smaller public companies recommended that smaller firms be exempted from Section 404. And so they should.

True, that would mean that only one company in five would have to comply with Section 404. But those big companies account for 94% of the total value of the shares listed on America’s stock markets.

Wasn’t the whole point of Sarbanes-Oxley to prevent disasters at big firms, not to impose unbearable cost burdens on lots of small, dynamic companies? After all, it’s the smaller companies that are the driving force of America’s economic growth.

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Matthew Bishop is American Business Editor for The Economist and comes to us by special arrangement with that magazine.

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