Compliance: Is Sarbanes-Oxley Working? - ' What Does '
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Working" Mean for SOX?">
What Does "Working" Mean for SOX?
The Sarbanes-Oxley Act was passed as a response to the financial scandals of the tech-bubble era—the Enrons and WorldComs and Adelphias and Tycos that shook investor confidence and besmirched the reputation of businesses everywhere. In response, Congress decided that the markets need firmer guarantees of corporate compliance with securities law.
If you need any reminders of how grim the situation seemed at the time, consider that the bill sponsored by Sarbanes and Representative Michael Oxley (R–Ohio), passed 423-3 in the House and 99-0 in the Senate. Speaking to a Consumer Federation of America conference in March, Sarbanes said, "Critics who now attempt to minimize the seriousness of the situation should not go unchallenged."
The law demanded several things of public companies, including personal statements by senior executives that their financial statements had been audited and were correct, and statements by internal and external auditors to the same effect. The biggest impact for most companies came from Section 404 of the bill, which details the roles of management and both inside and outside auditors in maintaining a company's internal controls.
Obviously, the markets have rallied (the Dow Jones Industrial Average is up more than 50 percent since its 2002 lows), which, by definition, means that investor confidence is higher. But it doesn't necessarily mean that investors are more confident because of stricter accounting regulations. The overall economy has recovered from recession, the bubble is a distant memory, inflation has been low, and money has been cheap.
The same sort of uncertainty about the value of SOX applies to the lack of big accounting meltdowns. The wave of huge scandals has abated since SOX became law, but it's hard to pin down the role of SOX in preventing the kind of high-dollar chicanery that went on in the recent past. Coincidence is not causality, you can't prove a negative, and so on.
Maybe the scandals stopped for other reasons, and maybe they'll show up again when the economy turns south. As the Wall Street Journal editorial page—no fan of SOX—pointed out in May, all of those famous turn-of-the-millennium miscreants were prosecuted under pre-SOX laws (and that includes Enron Corp.'s Kenneth Lay and Jeffrey Skilling, who went down hard in a Texas courtroom last month). Meanwhile, the showpiece SOX-driven case to date, the trial of HealthSouth Corp. CEO Richard Scrushy, failed to return a conviction.
Robert Prentice, a professor at the University of Texas McCombs School of Business, compares SOX to the expensive and highly annoying Homeland Security regime instituted after Sept. 11, which has seen no further hijackings but has had an unknowable effect on that outcome. "You know how much a metal detector in an airport costs, and how much you pay the people," he says. "But you don't know how much these precautions save. In the same way, we'll never know if SOX prevented a big fraud from happening. And if there is a major case, we won't know if SOX prevented others from occurring at the same time."
Prentice gives Sarbanes-Oxley a cautious thumbs-up, based on things like evidence of decreased earnings management by companies since the law passed, increased investor confidence thanks to CEO certification of results, and improved liquidity. "We're starting to see some interesting stuff in the literature," he says. "These are the things that Congress wanted to do." Prentice also cites improved accuracy of stock analyst recommendations, and says, "SOX is Congress telling auditors and directors and analysts, for Christ's sake, do your job, take it seriously. That alone is worth something. Do the benefits outweigh the costs? Well, I can say there are a lot of benefits, even if you cannot at this time make a grand conclusion."
Story Guide:
Learning to Live With SOX
What Does "Working" Mean for SOX?
SOX by the Numbers
Burnt Offerings: SOX and the IPO Market
The Real Problem with SOX
Sidebar:Larry Ribstein on the Holes in SOX
Next page: SOX by the Numbers
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