Five years ago, in response to scandals such as the Enron matter, Congress passed the Sarbanes-Oxley Act (SOX). Today, at a luncheon sponsored by the National Review Institute, Larry Kudlow led a panel discussion about SOX.
Most panelists believe, as I do, that SOX was a massive over-reaction to the scandals of the day, and is badly in need of reform. The pre-existing law was sufficient to convict the culprits in those matters and to produce lengthy jail sentences (e.g. 25 years for Bernie Ebbers). There’s scant evidence that this sort of punishment would have been insufficient to deter future wrongdoing of this nature, and no evidence that SOX in its present blunderbuss incarnation is required.
Most panelists consider Section 404 of SOX to be its most objectionable provision. In essence, it mandates double accounting under which a company’s auditors must perform an independent audit, on top of the audit performed by the outside accountants. While this section provides full employment for accountants, it’s unlikely to contribute significantly to the confidence investors can have in the accounting process. Indeed, in the Enron scandal accountants played a significant role in perpetrating the fraud.
If companies had limitless resources and faced no competition, then any small increment of extra protection for investors could be justified. Obviously, though, this is not the situation we face. The expenses associated with SOX compliance are substantial and for smaller companies can be almost prohibitive. That’s why Senator James DeMint, who participated in the panel, proposed legislation allowing smaller companies to opt out of the independent internal audit should they so choose. In effect, this would allow investors, through the market, to determine the value of the second audit. Unfortunately, DeMint only obtained 35 votes for his amendment, which he says the White House opposed. In fact, there is little momentum for any SOX reform now, even though its co-author Congressman Oxley has spoken of the need for such reform, as have presidential candidates from both parties.
Senator DeMint, Hank Greenberg (Chairman and CEO of C.V. Starr & Co.), and Jason Trennert (managing partner of Strategas Research) placed SOX in the context of our global competitiveness. Here, the IPO market is indicative. Not long ago, about 90 percent of major IPOs were handled in this country and about 10 percent elsewhere. Now the numbers are reversed. In 2006, 350 companies raised $86 billion in European initial offerings. In the U.S., 235 companies raised $48 billion. Hong Kong too has been gaining ground as Chinese companies have largely stopped coming here for financing. Last year, New York did not participate in any of the 10 ten largest offerings. And, as Alex Pollack of AEI observed, less easy to quantify but certainly real is the harm to U.S. competitiveness that occurs when CEOs obsess over the tiny details of SOX compliance (lest they face jail time because a subordinate gets a detail wrong) instead of concentrating on innovation.
Newt Gingrich likes to talk about how liberals are trying to kill the goose that lays the golden egg. Unless SOX is reformed, it will continue to be a case in point.
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