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Some Background Information:
Our economy (and those in most other countries) is in a bad shape. This is due to a variety of factors - the subprime loan disaster was just one of it. During the last months an incredible amount of wealth was destroyed on the stock market. Misjudgment and personal greed of many actors on Wall Street have worsened the situation over several years. The following article (written in May 2007) discusses the pro and contra arguments of a legislative act that was supposed to encourage governance and personal responsibility in the world of business. 'Sarbanes-Oxley' couldn't prevent what is happening now - including the Madoff case - but it is surely more relevant than ever.

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Stephan Kroker-Bode

Sarbanes Oxley - Good or bad for Corporate Governance? (May 2007)

  • CON: Sarbanes-Oxley is NOT the Answer
  • PRO: Sarbanes-Oxley is ONE Answer
  • References

  • Introduction

    The WorldCom Disaster in 2001 was a "crime so large it changed the law" - as titled in a New York Times article from July 2005 by Floyd Norris [15]. In fact it was the last step of many which would push lawmakers into ratifying a controversial act named after the Democrat Senator Paul Sarbanes and the Republican Representative Michael Oxley.

    Bernard J. Ebbers, former chief executive of WorldCom, had built with resolve and salesmanship (but little training in finance or engineering) one of the world's largest telecommunication companies, at its peak worth $160 billion. He was now accused of masterminding a record $11 billion accounting fraud that toppled the company he created. It was the largest bankruptcy ever, measured by WorldCom's $107 billion in assets at the time of its filing for bankruptcy protection in July 2002.

    Many blamed WorldCom's collapse especially because of the scale and audacity of the accounting fraud that five of Mr. Ebbers' former subordinates had admitted - and the size of WorldCom's bankruptcy.
    It shocked Wall Street. But those hardest hit didn't sit in boardrooms. Thousands of former WorldCom employees lost both their jobs and their insurance and pensions. WorldCom had employed 80,000 people; the company continued its business under the former name MCI in 2004 with half as many.
    The fraud had crippled thousands financially and was the last act in a series of corporate scandals which destroyed the faith of investors in corporate America.

    Ebbers himself was left with millions of dollars in debt (he owed the company more than 400 million; most of it was released later on). He was treated as an outcast in Mississippi - and was finally sentenced to 25 years in prison in July 2005 (when he was almost 64 years old). According to federal guidelines Ebbers must serve at least 86% of his sentence - that makes him 85 upon his release. This unusually long prison term eclipsed even the 15-year sentence given to John Rigas (founder of Adelphia Communications) who was 80 in 2005 and in bad health.

    WorldCom's downfall led Congress to answer critic's calls for action by reviving stalled legislation that became the Sarbanes-Oxley Act of 2002. Scott C Cleveland, telecommunications analyst at the Precursor Group: "Every publicly traded company can thank Bernie Ebbers for Sarbanes-Oxley and the handcuffs they operate under today. It's everyone else's punishment for his misdeeds."[3] And David Skeel - University of Pennsylvania law professor, adds: "After WorldCom, President Bush made a speech saying it was just a few bad apples. But that didn't go over well in the financial community any longer. They wanted firmer action. Finally, he supported the Sarbanes-Oxley bill." [1]

    Since then, The Sarbanes-Oxley act (or SOX for short) had found many supporters - but even more are fiercely lobbying against it. The opponents blame especially Section 404 of the Sarbanes-Oxley Act as being poison for economic growth. The Section 404 provision requires that companies have their outside auditors review their internal controls - the processes the companies use to record financial transactions and report their results. Companies have to report in greater detail not just the numbers, but also the methods for compiling and checking them.

    In the following article both sides of the discussion are presented - starting with arguments against Sarbanes-Oxley. Being a supporter of the act myself I nevertheless tried to cover opposing positions as unbiased as possible. My key advocate of the statement, that SOX was totally "unnecessary, harmful and inadequate" will be Alan Reynolds from the conservative Washington based Cato Institute. I will let him summarize the points at the end of this section.

    CON: Sarbanes-Oxley is NOT the Answer

    1.) SOX is inadequate - it goes not far enough.

    This would be the basic issue of critique from the political 'left' - quite the opposite of what is stated usually as the deficits of the act. The argument goes that SOX only calls for new disclosure requirements and more independent auditors - but ignores a lot of ongoing problems in America's financial sector. The true measure of a 'lame' regulatory environment has been the lack of action, either by the accounting standards organization or the government, to restrain the stock options so generously given to top executives. [1] Completely ignored - and not covered at all through the act - is the unjustified compensation for CEOs - which only ignites their greed and pushes towards artificially inflating stock values for getting even more money.

    In 1991, the average chief executive of a large company earned 140 times the pay of an average worker; by 2003, it was 500 times [1]. According to Lucian Bebchuk (professor of law, economics and finance at Harvard Law School) and Yaniv Grinstein (Cornell Business School) a proper calculation of the total compensation of the top five executives off all companies, including salaries, stock options and pensions, came to a stunning $260 billion over the last 10 years. This would be justified if there was clear evidence that the development reflects market performance or corporate earnings. But the two researchers found that since the early 1990's pay has risen about twice as fast as the market value of stocks and much faster than corporate income. In his new book "Pay Without Performance", Professor Bebchuk proposes reforms to link compensation and performance more closely. He wants stock options listed on financial statements to make compensation transparent. Director's compensation should be tied to stock prices. Shareholders should have far more power to vote for new directors - and thereby make directors more accountable. [1]

    The debate about 'unfair' wealth distribution is interesting - but can't be covered here. It is not really adequate to use SOX in this context - the act had a completely different target and was not passed to control CEO or CFO salaries to prevent fraud. Despite the fact that fraud led in several cases to an 'inproportional' high income, the general restriction of high earnings was definitely not the purpose of Sarbanes-Oxley.

    2.) SOX was not necessary - there already existed laws and institutions to prosecute fraud.

    Before SOX was established the F.E.D. already had enough legislation power to fight corporate crimes. Other laws where in place and already effective. Let's take as an example the 'Whistle-Blower Protection'. Sarbanes-Oxley is another whistle-blower protection law covering fraud against publicly traded companies and is intended for those that destroy records, commit securities fraud or fail to report fraud to investors. This law protects whistle-blowers from being fired - but it is the False Claims Act which has triple damages and gives whistle-blowers a reward. [2]
    Whistle-Blowers are the root of federal fraud cases against many well-known companies; beneficiaries of a law passed nearly two decades ago, that encourages whistleblowers to come forward by promising them up to a quarter of the money recovered by the government. Since its inception, The False Claims Act has generated $12 billion (as off 2004) for the federal treasury and more than $1 billion for hundreds of whistleblowers.

    The Sarbanes-Oxley Act significantly increased the potential punishment for corporate fraud. But SOX might be nothing more than a way to increase prison time -it is not an easier way to lock up executives. After discovering a strong evidence of underlying fraud prosecutors need to prove that the executive knew about it in order to convict. Jonathan Glater explains: "The certification provision, Section 906 of the law calls for a prison term of up to 10 years and a fine of up to $1 million for any executive who certifies a regulatory filing and who knows that the filing does not 'fairly present, in all material respects, the financial condition and results' of the company. Any executive who willfully - that is worse than knowingly - certifies such false filings faces up to 20 years in prison and a $5 million fine. Section 302 of the law opens up such executives to civil liability. These are harsh terms, but the crucial element is knowledge, and proving that an executive knew of a fraud is what is often most challenging." One of the biggest problems is the fact that there is still plenty of uncertainty about what constitutes a violation of Section 906 (as, for example, the question, if reckless disregard can be considered as an equivalent for knowing). [14]

    Paradoxically, Sarbanes-Oxley's strict rules on oversight by boards of directors would have been insufficient to prevent the downfall of Enron. By the act's standards, Enron had a 'perfect' board. The chairman of the audit committee was a former accounting professor and dean of the Stanford Business School. The S.E.C. had been aware of Enron's accounting techniques since 19992 and had never thought to question them. Sarbanes-Oxley was also not necessary in prosecuting the senior managers of Enron, WorldCom and other corporations - all have been convicted of accounting fraud under laws predating the act. [37]

    3.) SOX was rushed into existence - and that's never a good way to start something.

    Sarbanes-Oxley Audits are too costly and inefficient - the costs of carrying it out have outweighed the benefits. Both audit quality and efficiency had suffered from the rushed nature of some of the audits.
    Driven by daily news of new disastrous corporate scandals, law makers felt pushed by the public opinion to finally 'do something'. The Sarbanes-Oxley act was adopted by a vote of 97 to 0 not after a thoughtful implementation procedure but because of public pressure. That's why Sarbanes-Oxley became "the most aggressive federal anticorruption law Congress dad adopted in decades." [7] To please the public's anger and to get some short-sighted political gains a 'check the boxes' approach was encouraged that requires excessive work to measure the effectiveness of financial controls that are not really important. Some companies pointed to the fact that auditors identified tens of thousands of separate controls that had to be tested and evaluated. [19] To prevent deficits in auditing, an overcomplicated new procedure was implemented which was shooting far beyond any rational logic.

    William Niskanen writes in his New York Times article 'Enron's Last Victim: American Markets': "The act, which was passed hastily in the wake of the Enron scandal, was surely well intentioned. But it has proven counterproductive in the extreme, and Congress would be best honoring the departing lawmakers by repealing it." [37]

    4.) Auditors became overwhelmed with too much work.

    After the implementation of SOX the 'Big 4' had to chancel many 'smaller clients' They were already down from the 'Big 8' of the 1980s and had just lost one big name, deeply involved in the Enron breakdown. They simply couldn't handle the enormous new auditing tasks. As a consequence resignations from publicly traded companies reached record levels for the second year in a row in 2004. The 'Big Four' resigned from 210 public companies - up from 152 in 2003 and 78 in 2002. [6]

    Lynnley Browning writes in a New York Times article from 2005: "Only recently, the Big Four seemed willing to work with just about any corporate client - big or small, poky or fast-growing, publicly traded or private. But as more accounting scandals unfold, auditors are increasingly choosy about the companies they keep. No auditor wants to go the way of Arthur Andersen, which collapsed after it was convicted of obstruction of justice over its work for Enron." [6]

    A Big Four audit of a company is still a symbol of prestige and power - especially on Wall Street. Loosing that relationship can look bad to investors - a loss of contract can raise serious questions among a company's investment bankers, lenders and creditors. But fear blocks risk readiness which blocks innovation - a cause for a major psychological change at Wall Street. Listing on a major exchange has always been a corporate rite of passage, a big step on the path from a start-up to a 'titan'. The companies have to issue quarterly and annual reports and balance Wall Street's hunger for short-term results with long-term investment. But the ability to raise equity capital together with the prestige of being listed on a major stock market always seemed worth the trouble.
    Now even companies with good intentions may fear not only that their annual audit costs will soar but also that closer scrutiny will turn up some unforeseen weakness in their internal controls. This can potentially create a downward spiral of insecurity.

    5.) It is all about the Costs.

    Regulators had hoped that the costs of Section 404 would decline rapidly after the first year - but until 2006 it didn't happen.

    Costs are the biggest issue in the discussion about Sarbanes Oxley. One can find lots of different numbers, obviously based on a trillion of different studies. And these studies (unfortunately a bad tradition in the industry) use all different points of reference, cluster their variables differently and prevent therefore a successful comparison of their findings. Here are some results nevertheless:

  • Financial Executives International, a network and advocacy organization, said in March 2005, that a survey of 217 publicly traded companies showed they had spent $4.36 million, on average, to comply with Section 404. [12]
  • A different study of 90 clients of the Big Four accounting firms found that an average of $7.8 million was spent on compliance. [12]
  • According to a survey of the Boston consulting firm AMR Research, corporate executives estimated that companies would spent a total of $6 billion on compliance with the rules in 2006, down only slightly from $6.1 billion in 2005. Foley & Lardner, a national law firm in Chicago estimated in 2005 that the 'average cost' of being a public company had increased 233 percent for firms with less than $1 billion in revenue.
  • Big corporations are complaining about Sarbanes-Oxley - but there is little question that the financial burden of compliance falls more heavily on smaller companies. A study by NASDAQ (released in April 2005) revealed that companies with revenues less than $100 million spent 11 times more (as a percentage of revenue) compared to companies with revenues of $2 billion or more. A study by Financial Executives International said costs averaged $824,000 for companies with annual revenues under $100 million, compared with $1,572,933 for companies above this range [13]
  • AMR Research of Boston published in 2005 executive estimates that costs for 2006 would total $6 billion on compliance - only slightly down from $6.1 billion in 2005. [19]
  • Foley $ Larner, a national law firm in Chicago, said in December 2005 that since the passage of Sarbanes-Oxley, the "average cost" of being a public company had increased 233 percent for firms with less than 1 billion in revenue. [20]

  • 6.) Meeting the demands of Section 404 took time away for more productive activities.

    CEOs have other important things to do. Focusing on frauds diverts directors from activities like choosing and monitoring management, devising compensation systems and offering strategic advice - all things that are important to shareholders and investors welfare. Concentrating less on fraud control and more on overseeing management may not only enhance corporate performance but can sometimes also reduce fraud. [12] [24]

    Republican Tom Feeney (a Florida representative) described the situation during a speech for the conservative Heritage Foundation with these words: "The fact of the matter is that we've got some of our best and brightest people spending all their time working with accountants and lawyers trying to figure out how to stay out of jail and comply with Section 404, and we have no definition of when you're complying or not. And they are not spending time building better-designed widgets, or marketing widgets, or producing goods and services that will increase the value of the American economy." [Feeney 2007]

    7.) More and more small companies go private.

    Small companies are the innovators, the ones that can act quickly and create jobs. According to SOX, companies have to report in greater detail not just the numbers, but also their methods for compiling and checking them. This has served as a catalyst to make smaller companies rethink their idea of going public.

    One example: The Fidelity Federal Bancorp never really considered delisting its stock until Congress passed the Sarbanes-Oxley law with its many new reporting rules in 2002. In November 2004 the bank finally announced that it was 'going dark' - delisting its stock from the NASDAQ market. That saves $300,000 a year - a substantial sum for a bank with just $200 millions in assets. Donald Neel, chief executive of Fidelity says: "Sarbanes-Oxley was designed to provide additional corporate transparency and safeguards for the investing public. Instead, it is prompting companies like ours to become less transparent." [12]

    The number of delisters was rising significantly after the implementation of SOX. According to Alexander Triantis, associate professor at the Robert H. Smith School of Business at the University of Maryland, about 200 companies petitioned to delist their stocks in 2003 - and an estimated similar number did so in 2004. In 2002, just 67 companies went dark [5]. Another study at the same university from November 2004 found that of the 380 companies which had deregistered their securities with the S.E.C. from 1989 to 3003, about 200 had done that in 2003 alone. A study done at Emory University School of Law in Atlanta found fewer overall deregistrations - but nevertheless stated a threefold increase from 2000 to 2004. [13]

    For many companies - especially the smaller ones - SOX is "one hurdle too many on the road to bigness", as Alan Wovsaniker, analyst at corporate law firm Lowenstein Sandler says. [5]

    8.) The United States are loosing ground against other stock exchange areas.

    A large number of runaway lawsuits have scared foreign companies away from American stock exchange [32]. But as American companies struggle to comply with the rules imposed by the Sarbanes-Oxley Act, European companies face a far gentler set of 'rules' (in fact companies are governed by corporate codes, the compliance is voluntary). SOX s raised the costs for doing business in America for all companies, thus causing foreign companies to withdraw from American markets. This has demolished U.S. economic growth. [11]

    In the meantime the situation is changing in Europe too - but not the 'better' (from a corporate viewpoint). "One is potentially looking at huge, huge lawsuits." says Richard Burns, senior partner in a big British law firm [11]. Floyd Norris finishes his article with this summary: "The scandals that began to explode in 2001 generated a much harsher regulatory environment in the United States than they did in Europe. That has helped the London Stock Exchange compete with American markets for Asian stock listings, with the argument that regulatory costs and risks are lower here. But as Europe tries to come to grips with the same issues, it may be that the differences will narrow - and not in ways that corporations will like." [11]

    If there would be only one text to read about the negative consequences of Sarbanes-Oxley, Alan Reynolds, Senior Fellow of the Cato Institute would be the author of choice (one could pick his article "Sarbanes-Oxley in Retrospect" [R-1] or "The Sarbanes-Oxley Tax" [R-2]). He believes that the act was "unnecessary, harmful and inadequate" [R-1]. It was unnecessary because the S.E.C. had already authority to oversee, investigate and enforce honest accounting and auditing. It was inadequately worsening a dubious certification ritual the S.E.C. had already put in place. "Prison sentences of up to 20 years were enacted for executives who 'willfully' certify incorrectly that corporate reports have 'fairly' presented financial conditions and results. This put CEOs in the position of nervous auditors - a job few CEOs are qualified to do - rather than general managers who delegate such specialized chores to experts." [R-2]

    And the law was harmful for a lot of reasons: Sarbanes-Oxley enabled a new institution, the Public Company Accounting Oversight Board which is financed essentially by a tax on stockholders. This institution is not only a waist of money but potentially unconstitutional (unfortunately Reynolds fails to explain this point). SOX makes it harder to attract and retain qualified CEOs, CFOs and directors. Because of Sarbanes-Oxley they have become more risk-averse while new rules and regulations apply "Washington's 'zero-defect culture' - its tendency to criminalize failure - to corporate America" [R-1]. The act makes it much less attractive to be a publicly traded U.S. firm - and distracts foreign companies to be enlisted in the United States. Compensation of outside directors has increased to compensate for larger responsibilities and higher risks. Sarbanes-Oxley reduces the availability of liability insurance for directors and greatly increases the cost of such insurances. [R-1] And the financial burden for companies - especially smaller ones - was and still is unacceptable.

    On the day of the Senate vote for Sarbanes-Oxley, the Dow Jones industrial average was down as much as 440 points. Ivy Zhang, assistance professor of accounting at the University of Minnesota, summarizes "Sarbanes-Oxley had a trillion-dollar negative impact on the U.S. economy." For many critics, the act was the most boneheaded piece of business-oriented legislation since the Smoot-Hawley Tariff Act of 1930.

    After analyzing Sarbanes-Oxley from the viewpoint of its critics - her are the arguments of its supporters:

    PRO: Sarbanes-Oxley is ONE Answer

    1.) "The Free Market system relies primarily on trust and full and accurate disclosures. When trust is lost, the markets falter." (Rep. Oxley) [Capital Hearing]

    The law helped to re-establish this trust! Senator Shelby - the Alabama Republican now head of the Senate Banking Committee - was praising the act for its positive impact on 'corporate culture': "It's not perfect, but it is a good piece of legislation. It has restored integrity to corporate America and the accounting process. We've had a return of investor trust."

    But aren't the convictions of Bernard Ebbers (WorldCom), John Rigas (Adelphia) or Phillip Bennett (Refco) enough to restore this trust? No! The very fact that corporate chieftains are falling left and right indicates that more needs to be done. The cases are symptoms of endemic business corruption - and its no time for any backtracking. It seems that Corporate America still don't get it: They single-out low-and middle-level executives for relatively minor incidences - but should better spend time going after the top-tier people for overstating earnings and sliding expenses around [10].

    The argument that there are 'only a few bad apples and we don't see a systemic problem' is simply wrong - a lot of fraud problems are systemic. When it went public, Refco (one of the world's largest futures and commodities brokerage firms) was forced by Sarbanes-Oxley to report significant deficiencies in its internal controls, including an inadequate finance staff and playing shell games, using several companies to hide roughly $430 million in bad debt. Investors did not care in the beginning - but where among the victims when the stock value plummeted. Only because of the stricter Sarbanes-Oxley rules this fraud was detected - and finally punished.

    2.) The act was helpful to improve 'the tone at the top' of public companies.

    Tougher CEO and CFO certification requirements and the implementation of personal responsibility for the correctness of financial reports is another important element in regaining trust and confidence in corporate America. A new corporate culture was fostered through prohibitions on loans to company insiders, mandated accelerated electronic filing of disclosures of insider transactions and disclosure about whether company have codes of ethics for CEOs, CFOs and other senior financial personnel.

    3.) We need higher standards for Corporate Governance.

    Independent auditors are a key element. This will end accounting industry self-regulation. Accountants have to do their primary job better - to audit - and spent less (or better no time) to be a consultant for exactly the same company they have to check. Obviously there is a need to find a good balance in the definition of 'Independence'. An auditor with no independence at all would produce a bad audit - but so would one who is so 'independent' that he or she did not understand the company and its industry.

    As Senator Sarbanes explained in a Business School class in 2005 - the fundamental purpose of the law was "to get the auditors to start being auditors again". Formally a self-regulated profession, accountants now have to deal with a regulator: The Public Company Accounting Oversight Board - which audits their audits - and isn't shy about telling them when they are wrong. And - guess what: accountants are not among the modern-day critics of Sarbanes-Oxley. It seems there is an almost deep sense of relief that SOX has allowed them to return to what they were trained to do.
    For the accounting profession, Sarbanes-Oxley has done something only the best laws do: it has genuinely changed behavior to the better! And it has done this with actually benefitting the profession financially (at least as a net result).

    The law also made boards more aware of the fact that they have a real responsibility which society expects them to fulfill. When investment bankers cook up some clever way around the accounting rules, the board has to act (This doesn't make whistle-blowers obsolete - in fact they are still needed and now better protected through SOX). There is also the ongoing need for wresting board chairmanships away from chief executives [28]. We see progress. According to the executive recruiting firm Russel Reynolds Associates, 29 percent of the companies in the S&P have separated the jobs, up from 21 percent five years ago. Many shareholders say that such splits are overdue. Too many corporate disasters can be traced to concentrating power at the top.

    Finally: We can't allow the continuous decupling of private and corporate interest. CEOs have to be forced to take more personal responsibility - which not only includes their checkbook but their personal freedom as well.

    Tough potential prison sentences are one way to achieve this. Section 906 of the Sarbanes-Oxley act calls for a prison term of up to 10 years and a fine of up to $1 million for any executive who certifies a regulatory filing and who knows that the filling does not "fairly present, in all material respects, the financial condition and results" of the company. Any executive who 'willfully' (that is worse than 'knowingly') certifies such false filings faces up to 20 years in prison and a $5 million fine. It is pure right-wing propaganda if authors like Alan Reynolds from the Cato Institute question terms like 'fairly', 'knowingly' or 'willfully' - they are used in courts again and again and are precisely specified in law.
    And indeed: there are plenty of other criminal charges available in addition to Section 906 (securities fraud and conspiracy), but the ongoing trials of financial cheating, actually the various cases about illegal restating of stock-option dates [see 35], show that the law is still - even after SOX - not deterrent enough.

    4.) CEOs and Board Directors have to do their homework.

    Critics claim that meeting demands of Section 404 took valuable time from executives which could be used for more productive activities. They say that CEOs have to think about improvements of the overall position of a company - and not do bookkeeping. That is basically correct - but one of the most strategically important elements of being a god leader is not only to position its company well on the economic battlefield but to have a perfect internal control also. CEOs have to do their homework too.

    Additionally SOX has increased significantly internal efficiency: John Mahoney, chief financial officer at Staples, said that his company (with a market cap in excess of $16 billion) has spent $7 to $10 million instituting Sarbanes Oxley. But for him it's clearly worth it: "It offered us an opportunity to lock at our processes, and in many cases to improve them. We found that our people really benefited from understanding the processes. It has made Staples a better company."

    I would conclude that SOX can be seen in line with other effective corporate procedures like 'Just-In-Time' Production and ABC (Activity-Based-Costing). It has spurred - and still encourages - an ongoing challenge for more efficiency and helps to improve the company's position in a competitive playfield.

    5.) Years after Enron, public companies are still having trouble to get their numbers right.

    253 companies restated annual audited financial reports in 2004 - a 23% increase from 206 in 2003, the highest number of restatements since 2000 [4]. Near a third of the restatements involved improper reporting of revenue or faulty accounting for stock options or other equity instruments. Of the 250 companies that filed internal control report with the Securities and Exchange Commission by the end of March 2005, about 8% (or 200 companies) found material weaknesses [12].

    Here is a recent example with a well-known company: The S.E.C. levied in 2006 a $50 million penalty against the computer security company MacAfee Inc. because of the company's overstatement of revenue and earnings which had inflated the share price and had allowed it to acquire companies with its inflated stock. There is still a lot to uncover - and SOX is one important and helpful tool in this process.

    The much maligned corporate governance law has also closed a major loophole by requiring companies to report stock option grants within two day. Currently there are more than 150 investigations ongoing where executives (including Steven Jobs from Apple) used tricky ways to make 'some more money' in backdating stock options.

    6.) Before the act millions of dollars for bonuses were paid for actually lousy performance based on 'cooked' numbers - there was never a chance for stockholders to get at least some money back - this has changed.

    Here is one example out of many: William Wise, former chief executive of El Paso Corporation (an Energy Company in Houston) reported a profit of $93 million in 2001. He was rewarded with a $3.4 million bonus, 768,250 stock options, $1.7 million of restricted stock and $3.7 million in 'other compensations'. And that was on top of his regular salary of $1.3 million [9].

    Two years later (in 2003 - SOX was not yet fully in place) El Paso Corporation had this to say about the performance leading to Mr. Wise's big payday: Oops! We found cooked books - there was actually a loss of $447 million in 2001. So did Mr. Wise give at least some of the money back? No way! And he was not even forced to do so. The common policy was that if you have an evil CEO you just want to get him out the door instantly. Your biggest concern was to have this problem of the newspaper front page as soon as possible. It is needless to say that such behavior encouraged fraud and the personal greed of high ranking executives.

    The Sarbanes-Oxley Act requires top executives to pay back bonuses if the numbers on which they are based were incorrect. Until 2005 regulators did not enforce the provision. But that changed in 2006 (find more about that in Morgensons' article "Making Managers Pay, Literally" [46]).

    7.) The London Stock Exchange is flourishing - but not primarily because of Sarbanes-Oxley.

    Additionally the situation is changing in Europe too - corporate governance is improving there as well. The law has changed the face of international securities markets also and greatly increased the regulation of auditors around the world. It has spurred other countries to set up similar regulatory bodies for more corporate governance - and that is an effort that is still ongoing.
    It is surely correct that other stock markets around the world are challenging New York (which is still the number one). This has many reasons - SOX is best of all only one of them. Maybe it's location, maybe the fact that underwriting fees in London are just 3% to 4% of a transaction compared with an average of 7% in the United States.

    8.) Are additional corporate costs destroying our competitiveness - is the American economy doomed?

    I can't go into details here but it's a simple fact that the U.S. GDP has risen significantly over the last decades. The United States still are (and will be for a longer time) the strongest economy in the world. Profits of U.S. companies are higher than ever before (together with a stagnation of average wages). The only real macroeconomic problem is the huge Federal Budget Deficit (not necessarily the other "twin" - the Trade Deficit: that is a sign for a high rate of foreign investment). Unfortunately the huge increase in national debt (as off April 2007 more than $8.8 trillion - with a present value of future commitments of $47 trillion [16]) and President Bush's fudging of the budget with hidden withdraws from Social Security shows exactly the same lack of ethical behavior similar to the corporate 'Enrons' 5 years ago.

    [If you are interested in reading more about these macroeconomic issues, please check out the academic paper: "Some Lessons to learn about Trade" (April 2007) - the specific chapter is called The 'Twin Deficits' - only one is really dangerous.]

    In short: The market bottomed in the fall of 2002 because of the reasons SOX was implemented and not as a result of it - and it had a sustained rise since. The biggest challenge right now is holding the President and his cabinet (but Congress as well) to similarly high standards of performance. We should be more concerned about the honesty and integrity of the government and its governance process.

    9.) The Costs! The Costs! Oh mighty god - the Costs!

    It's correct - several studies in 2004 and 2005 alone found that there are additional costs involved to get compliance especially with Section 404 of SOX (e.g. the one from Financial Executives International which showed in March 2005 - based on a survey of 217 publicly traded companies - that there was an average spending of $4.36 million.). A different survey of 90 clients of the 'Big 4' accounting firms (Deloite Touche Tohmatsu, Ernst&Young, KPMG and PricewaterhouseCoopers) found that these big companies spent an average of $7.8 million on compliance.
    But let's put this into a perspective! That was about 0.10 percent of their revenue - and significantly less than the $9.8 million paid on average to CEOs at 179 companies surveyed during the same time [12].

    Accounting firms in this study noted that companies became more familiar with Section 404 - and the amount they spend to comply with it was supposed to drop in 2005 by as much as 46 percent.
    In 2006 another study (CRA International) found that costs of auditing internal controls at corporations fell sharply in the second year that the new rules were in force. An 'average' large company (with annual revenue of more than $700 million) paid $4.77 million in 2005 - that was down 44 percent from first-year costs of $8.51 million. For smaller companies the average cost was down 31 percent. As a percentage of revenue, the total cost fell to 0.24% from the 'gigantic' 0.38% for smaller companies - and to 0.05% from 0.11% for larger ones [29, see also 33].

    Most importantly - and that is an economic no-brainer: The costs for someone are the revenue for another.
    Or, as said in a good NY Times article of December 2005: "Some entrepreneurs smelled the sweet scent of opportunity in somebody else's problem." In 2005 alone, public companies spent an estimated $3.5 billion on technology and consulting services to meet their Sarbanes-Oxley obligations (according to AMR Research). Did we outsource all these activities to foreign companies? Nonsense! Sarbanes-Oxley had pushed a variety of new companies into existence and fostered especially the IT-Industry, dealing with SOX information technology requirements like password protection and security settings. It encouraged companies to improve their internal communication and security systems - and has helped others to create a lot of new jobs [21, see also 25].

    10.) The most important cost argument: There is little question that the financial burden of compliance falls more heavily on smaller companies.

    Indeed one has to agree: A study by NASDAQ released in April 2005 found - as a percentage of revenue - that companies that have revenues less than $100 million spent 11 times more than companies with revenues of $2 billion and more. Another study released in March 2005 by Financial Executives International in Washington said that costs averaged roughly $800,000 for companies with annual revenues under $100 million, compared with one and a half million dollars for companies with sales of $100 to $500 million.
    The bottom line: The relative cost burdens for smaller companies are higher!

    But: In 2005 the S.E.C. established an advisory committee for smaller companies. 'Smaller' companies (revenue below $75 million) did not have to comply with the rules until 2007. So-called 'Microcap' companies (with a market value under $125 million) got a 1-year extension in 2004 and 2005 - until finally in 2006 the overall rules where changed completely [27]. These companies amount to less than 5 percent of the market in terms of capitalization, but account for about two-thirds of the number of public companies.

    The new rule, implemented earlier this year, encourages auditors to use their judgment in deciding which internal controls should be reviewed, focusing on controls where the risk of significant misstatement is the highest. It is supposed to provide the auditor with flexibility to avoid unnecessary testing - and thereby reduces cost. It is too early to say if this new 'Sarbanes-Oxley-Lite' version is the right way to move some cost burden from smaller companies' shoulders or if it is just another step to weaken an important law of corporate governance. Both Sarbanes and Oxley won't be able to complain in the house anymore, they both retired in late 2006. In the 90s - today's so-called 'new' strategy of 'risk-based' auditing became an "excuse to simply do less work" says Charles Niemeier, a member of the Oversight Board.

    11.) 'Big Business' is continuously lobbying against the act to weaken it - it had to be tough in the beginning just to survive at least for a while

    It's a sad fact: As soon as corporate scandals are out of the public's mind (and that usually happens fast in the United States), government's positions against fraud are weakening. Without an ongoing pressure of the law, nothing gets done. In the New York Times, March 15, 2005 you can find: "During the recent debate on tightening the bankruptcy code, the lawmakers rejected a proposal to prohibit corrupt companies from issuing huge payouts to senior executives shortly before entering bankruptcy. They blocked consideration of measure that would have curtailed the ability of companies like Enron and WorldCom to shop for the most favorable bankruptcy courts; such actions have had the effect of disenfranchising employees and retired workers from the process. They defeated a proposal to protect those employees and retired workers when their companies go bankrupt. They refused to close the 'millionaire's loophole' that permits wealthy individuals to shelter their assets from lenders by creating special asset-protection trusts. And they rejected a proposal to put a nationwide limit on the homestead exemption, a provision that has enabled corporate executives to buy expensive homes in states like Florida or Texas to shelter their assets from creditors."

    There is a new strategy of executives today which I would call "Praise the dog - but break its teeth": Hail the overall concept - but try to water it down through lobbying as good as possible. There is even a lawsuit by the 'Free Enterprise Fund' to make the Public Company Accounting Oversight Board (which was created as a result of Sarbanes-Oxley) "unconstitutional". The pendulum is swinging back, to less federal oversight and more self-regulation. There will be always unscrupulous companies trying to open loopholes in the law. The shadow of Enron and WorldCom is fading. But there might be another disaster looming around the corner.

    The final verdict: Sarbanes- Oxley never was the 'perfect law' - but there is seldom one. It only can be an additional step towards a better Corporate Governance. To get this important task continuously improved is essential for all stakeholders a society has. It includes stockholders and potential investors, CEOs and Board members. But it also includes everybody else with an open mind and a watchful eye.


    I used as my main source several articles from The New York Times (online versions found at based on a research with the keyword 'Sarbanes-Oxley'. They are ranked related to the publishing date (beginning with October 2004), not in alphabetical order.

  • [NYT-1] Madrick, Jeff: "Where economics stand, or don't stand, on the issue of corporate scandals", October 28, 2004
  • [NYT-2] No author mentioned: "For Some Whistle-Blowers, Big Risk Pays Off", November 29, 2004
  • [NYT-3] Ken, Belson: "WorldCom's Audacious Failure and Its Toll on an Industry", January 18, 2005
  • [NYT-4] Glater, Jonathan: "Restatements Are at a High, And Lawsuits Are Rising", January 20, 2005
  • [NYT-5] Deutsch, Claudia: "The Higher Price of Staying Public", January 23, 2005
  • [NYT-6] Browning, Lynnley: "Sorry, the Auditor Said, But We Want a Divorce", February 6, 2005
  • [NYT-7] Labaton, Stephen: "A New Mood in Congress to Forgo Corporate Scrutiny", March 10, 2005
  • [NYT-8] Kirkpatrick, David: "Senator Sarbanes, Maryland Democrat, Will Retire in 06", March 12, 2005
  • [NYT-9] Glater, Jonathan: "Sorry, I'm Keeping the Bonus Anyway", March 13, 2005
  • [NYT-10] No author mentioned: "Viva Los Regulators", April 3, 2005
  • [NYT-11] Norris, Floyd: "Corporate Rules in Europe Have Been Flexible, but Change Is Coming", April 8, 2005
  • [NYT-12] Glater, Jonathan: "Here It Comes: The Sarbanes-Oxley Backlash", April 17, 2005
  • [NYT-13] Rosen, Ellen: "Not Giants Seek Relief From Cost of New Audit Rules", June 16, 2005
  • [NYT-14] Glater, Jonathan: "New Rules Make It Easier to Charge Executives, but Not to Send Them to Prison", July 2, 2005
  • [NYT-15] Norris, Floyd: "A Crime So Large It Changed The Law", July 14, 2005
  • [NYT-16] Holstein, William: "A Change for Business, If Not for Washington", July 17, 2005
  • [NYT-17] Norris, Floyd: "How to Get Rich by Losing Millions", October 14, 2005
  • [NYT-18] Norris, Floyd: "Guidelines Aim to Ease Accounting Costs for Small Companies", October 27, 2005
  • [NYT-19] Norris, Floyd: "Top Regulator Says Sarbanes-Oxley Act Audits Are Too Costly and Inefficient", December 1, 2005
  • [NYT-20] Nocera, Joseph: "For All Its Cost, Sarbanes Law Is Working", December 3, 2005
  • [NYT-21] Tahmincioglu, Eve: "Profiting From Cures for the Sarbanes-Oxley Blues", December 29, 2005
  • [NYT-22] No author mentioned: "Honing the Proper Punishment", January 9, 2006
  • [NYT-23] Norris, Floyd: "Accounting Board Needs Whistle-Blower", January 20, 2006
  • [NYT-24] Hu, Henry: "Enron Happens", January 30, 2006
  • [NYT-25] Joachim, David: "A New Law and Lots of Headaches", February 21, 2006
  • [NYT-26] Norris, Floyd: "Auditor's Links Did Not Stop This Fraud", February 24, 2006
  • [NYT-27] Norris, Floyd: "Why Not Let Companies Ignore a Law?", March 10, 2006
  • [NYT-28] Deutsch, Claudia: "Fewer Corporate Chiefs Are Also Serving as Chairmen", March 17, 2006
  • [NYT-29] Norris, Floyd: "Audit Law's Cost Decline, Survey Shows", April 19, 2006
  • [NYT-30] Norris, Floyd: "Trusting Bosses Not to Cheat", June 23, 2006
  • [NYT-31] No author mentioned: "Making Your Own Luck", June 25, 2006
  • [NYT-32] No author mentioned: "The Corporate End Run", November 12, 2006
  • [NYT-33] Labaton, Stephen: "S.E.C. to Ease Auditing Standards for Small Publicly Held Companies", December 11, 2006
  • [NYT-34] Labaton, Stephen: "A Push to Fix the Fix on Wall Street", December 17, 2006
  • [NYT-35] Dash, Eric: "Study Finds Outside Directors Also Got Backdated Options", December 18, 2006
  • [NYT-36] Norris, Floyd: "Board Proposes Lighter Auditing of Internal Controls", December 20, 2006
  • [NYT-37] Niskanen, William: "Enron's Last Victim: American Markets", January 3, 2007
  • [NYT-38] Nocera, Joe: "Tipping Over A Defense of Enron", January 6, 2007
  • [NYT-39] Stein, Ben: "So Many Millions, So Little Body Armor", January 7, 2007
  • [NYT-40] Anderson, Jenny: "U.S. Financial Sector Is Losing Its Edge, Report Says", January 22, 2007
  • [NYT-41] No author mentioned: "A Healthy, Well-Regulated Wall Street", January 24, 2007
  • [NYT-42] Anderson, Jenny: "About Those Fears of Wall Street's Decline", January 26, 2007
  • [NYT-43] Olsen, Patricia: "A Fund Giant Not Fretting About No. 1", January 27, 2007
  • [NYT-44] Shevory, Kristina: "When Budgets Loom, It's Time to Rent a C.F.O.", February 15, 2007
  • [NYT-45] Dash, Eric: "Bank of America Tagline Has Run Its Course", February 20, 2007
  • [NYT-47] Morgenson, Gretchen: "Making Managers Pay, Literally", March 25, 2007
  • [NYT-48] No author mentioned: "Statements and Restatements", March 20, 2007
  • [NYT-49] Holstein, William: "The Industry's Critics Turn to Washington", April 8, 2007

  • Additionally, the following publications were used (primarily for facts and opinions apposing SOX):

  • Capital Hill Hearing (no author): "Conference Report on Corporate Responsibility Legislation" - Federal News Service, July 24, 2002; in: Street, Marc: "Taking Sides", 2005; p. 256ff.
  • Kaplan, Steven / Bengt, Holmstrom: "The State of U.S. Corporate Governance 2004", January 2004; Joint Center Report
  • Feeney, Tom / John, David / Pollock,Alex: "Reforming Sarbanes-Oxley: How to Restore American Leadership in World Capital Markets", in: Heritage Lectures No 995, June 27, 2006
  • Feulner, Edwin: "Over-Regulation: Where Scandal Really Adds Up", July 27, 2005; in: The Heritage Foundation
  • Niskanen, William: "Congress Should Repeal the Sarbanes-Oxley Act", August 16, 2006; online at
  • Reynolds, Alan: "Sarbanes-Oxley in Retrospect", December 2003; in: Street, Marc: "Taking Sides", 2005; p. 264ff.
  • Reynolds, Alan: "The Sarbanes-Oxley Tax", March 14, 2005; online at

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