Tell the Truth About Sarbanes-Oxley

Today, Congress will be wrestling with a trillion dollar issue—literally.  The stakes for the U.S. economy are that high, and getting higher, so we should all pay attention.

Christopher Cox, chairman of the Securities and Exchange Commission, will appear at a hearing of the House Financial Services Committee on “Sarbanes-Oxley at Four:  Protecting Investors and Strengthening the Markets.”  Rep. Mike Oxley (R.-Ohio), co-author of the legislation, will chair the hearing. Mark Olson, chairman of the Public Company Accounting Oversight Board, which implements the Sarbanes-Oxley Act (“Sarbox”), will also testify.

In its four years, “Sarbox” has damaged the American economy as badly as a group of unsupervised four year-olds would damage a playroom. U.S. companies have spent tens of billions of dollars in compliance costs (about $35 billion), far more than the SEC’s 2003 estimate of $1.2 billion, with small companies hit especially hard.  

Companies, both American and foreign, have decided that the costs and uncertain enforcement of SOX are too high a price to pay for the benefit of access to American capital markets.  In 2005, 23 of 24 firms that raised over $1 billion in capital didn’t register their securities offerings in U.S. markets, according to the New York Stock Exchange.  The London Stock Exchange listed 129 companies last year—while only six chose New York and 14 the NASDAQ.  And yet our economy is booming in comparison to Europe and Japan.  Something is wrong, and that something is Sarbanes-Oxley.

A number of companies, even large companies such as HCA and Aramark, have decided that the best thing they can do is to go private and leave the public markets altogether.  Even Ford Motor Company has said it is thinking about the idea. When it costs an average of $1.8 million in additional costs just to be a public company, according to a survey by the law firm of Foley & Lardner, “small cap” companies with revenues under $100 million have to wonder whether the costs make sense. Of course, these “going private” transactions not only raise the cost of capital but reduce the number of securities in which ordinary Americans can invest their hard-earned money.  

On September 12, a group of organizations in the biotechnology, electronics, health, and medical device industries issued a call to reform Sarbanes-Oxley.  These are the kinds of companies that drive innovation and economic growth.  But small companies with revenues under $100 million spent an average of 2.55% of revenue on compliance with the Act in 2004.  

These companies should be spending this money on R&D and product development, not auditors and lawyers.  

Everyone favors tough prosecution of corporate criminals who steal shareholders’ money and cheat the investing public.  But the criminal provisions in Sarbanes-Oxley expand the ability of the government to wield a terrifying regulatory tool and put a further chill on entrepreneurship.  Under Sarbanes-Oxley, it is now possible for CEOs and CFOs to be sent to jail for the misdeeds of others.  These executives are required to certify corporate reports without traditional good-faith protections, and can be found criminally liable for honest mistakes.  Uncertainty on the limits the government will put on criminal prosecution under Sarbanes-Oxley has a chilling effect on the risk-taking that drives economic growth and innovation.

We already have the tools to fight corporate crime. The recent Enron trials were based on statutes that had nothing to do with Sarbanes-Oxley.  They show that the legal system can be effective at punishing corporate crime and corrupt executives.  Indeed, there have been more than 700 corporate crime convictions and over $250 million in restitution since 2002, all prosecuted under pre-Sarbanes-Oxley laws.

Until the law is reformed, companies will continue to move offshore, switch to foreign exchanges, and go private to avoid burdensome compliance.  All of these are perfectly legal strategies, of course, but they hurt the very same investors that Sarbanes-Oxley intended to protect.  These enormous costs cannot be what Congress intended when it enacted Sarbanes-Oxley.  They must be reduced or eliminated for America to continue to grow and prosper.

Instead, why not make Sarbanes-Oxley compliance optional for public companies?  If investors, including major investors such as large pension funds and asset funds, truly believe the provisions of the law are valuable in deterring corporate fraud and protecting shareholders, then companies would likely provide this information to get the benefits of access to U.S. capital markets.  And small companies would be able to decide whether their money is better spent on auditing costs or research.  But at least it would be the company’s choice, and they could still access U.S. capital markets, the greatest pool of money in the world.

It will also be interesting to hear today from PCAOB Chairman Mark Olson.  My organization, the Free Enterprise Fund, has filed suit challenging the constitutionality of the PCAOB.  Its members are not appointed by the President, as the Constitution requires, but rather by the Securities and Exchange Commission.  The SEC claims it has “broad and pervasive oversight” of the PCAOB, but in fact the organization runs independently, setting its own salaries and interpreting the Sarbanes-Oxley Act in a very broad way that goes beyond the letter of the law and does even more damage to the economy.  And ordinary Americans will be interested to learn why Mr. Olson, a public employee, is paid $615,000 a year–over half as much again as the President. (His fellow commissioners scrape along on only $500,000.)

It may not be the easiest or most polite thing in the world to go before Chairman Oxley in his final weeks of very distinguished service in Congress and criticize the bill he authored.  But for the SEC to fulfill its statutory mandate to protect investors, Chairman Cox should tell the truth about the impact that Sarbanes-Oxley has had on the American economy and urge its repeal or reform.  In fact, pushing for significant reform of the law that bears his name would be the best legacy that Chairman Oxley himself could leave.