Just Because It’s Legal Doesn’t Make It Right

If you needed proof that the regulations
put in place under the Sarbanes-Oxley Act
are no guarantee against financial chicanery
and the madness of crowds, the wreckage of
the U.S. housing industry and the resulting
distress in credit markets around the world
should provide a reality check.

SOX targeted fraud and shady bookkeeping,
but it didn’t change human nature. Its
formal name is the Public Company Accounting
Reform and Investor Protection Act. But
you can’t protect investors from themselves,
or from the vagaries of the free market. As
long as there is big money involved, people
are going to find ways to game systems, and
then they’ll keep doing it until the systems
break down.

Although it was intended as a corrective
to the excesses of the last boom/bubble/
bust cycle, SOX would not have prevented the
happy talk and willful credulity that fueled
the dot-com era. And it wasn’t set up to regulate
the promiscuous policies of the Federal
Reserve, the deliberate opacity of hedge funds
and banking houses, or the speculative fever
of home buyers this time around. The practices
of financial firms as they bought and
sold financial instruments based on bundled
mortgages and carried them on their books
at prices no market would support calls to
mind a maxim often credited to the journalist
Michael Kinsley: “The scandal isn’t what’s
illegal; the scandal is what’s legal.”

There is talk of the Securities and
Exchange Commission applying the same
disclosure rules that apply to companies
to the credit rating agencies, which slumbered
as the crisis approached. Yet, it’s hard
to see how a big, SOX-like law could help
distressed home buyers, or laid-off bankers,
or Wall Street honchos who may have
to pass on that new Lamborghini for a quarter
-or two. That’s not to minimize the countrywide
damage, which is far from over. The
monthly tally of resets for adjustable-rate
mortgages won’t peak until March, when
they will nearly double the record set this
fall, and will stay high through next summer.
As many as two million people could
lose their homes, according to projections,
and the damage to the wider economy is
yet to be determined.

None of which means that SOX is a failure.
Arguments for or against that position
should be based on the law’s intent and content
and what it has done to date, both good
and bad, for companies and investors. But
neither does it mean that the answer to the
ongoing unpleasantness is more regulation,
although that route is already under consideration
in Congress.

Eventually this crisis will pass. And soon
enough, another crisis will take its place. The
truth will remain that regulations, and the
technological processes that increasingly
undergird compliance with them, cannot
solve all problems.

What’s more, regulation comes at a cost,
and that technology assets used to enforce
them might be more productively deployed
in pursuing projects aimed at growth and
innovation. This doesn’t dictate that new
laws aren’t worth considering. But it does
suggest that putting too much faith in regulation
and its technological support systems
is no substitute for sound management and
prudent investing.