Will Democrats Lift Sarb-Ox's Heavy Burden?

Will Democrats Lift Sarb-Ox's Heavy Burden?

Berlau op ed in Investor's Business Daily
March 14, 2007

Imagine you had a time machine and could go on a stock-buying spree 25 years ago. Yet you didn't bring that much cash on board.<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />


You could do pretty well investing in the growing firms of Wal-Mart Stores or Apple. But you'd make a killing on this retailer that had just recently gone public with only four stores to its name. Buying 100 shares of Home Depot in 1982 would yield you $1.6 million by 2002.


But time travelers coming back to 2007, even with a fistful of stock market data, probably won't be so lucky. Neither will today's savvy investors who study past trends in publications such as Investor's Business Daily. This is because a law sold as protecting investors from fraud is actually hurting investors' ability to grow wealthy with legitimate firms.


As a U.S. Chamber of Commerce task force this week unveils recommendations for lightening the burdens of the Sarbanes-Oxley Act of 2002, expect the media to paint the issue as business vs. shareholders.


The truth, however, is that average investors have been some of this law's biggest victims.


Rushed through Congress after the Enron and WorldCom scandals, Sarb-Ox ended up imposing many mandates that greatly encumber honest entrepreneurs. Home Depot co-founder Bernie Marcus recently told IBD that his company could not have gone public as a four-store firm "in today's legal and regulatory climate."


This means that Home Depot's early investors would also have lost out if Sarb-Ox had been in place.


Sharp Eyes Needed

Today, it is much harder to get in on the firms that could be the next Home Depot, unless you are a super-wealthy investor that can participate in private equity deals. According to BusinessWeek, the median market cap of a company going public was $52 million in the mid-1990s. Today, it's $227 million. This means that average investors are increasingly shut out of a company's emerging growth stages, where they would, yes, take the most risks, but also could reap the biggest returns.


The most costly provision, Section 404, forces auditors and executives to sign off not only on the accuracy of financial statements, but also on a company's internal controls.


The unaccountable Public Company Accounting Oversight Board created by the law has defined "internal controls" very broadly, to include a firm's software and other items that have little relevance to financial statements. Some say the law should be called the Accountants Full Employment Act.


But Section 404 isn't the only costly provision. Rules for the strict "independence" of directors on audit committees are preventing large shareholders such as venture capitalists from serving on these committees, even if they are not part of a company's management. But these folks are often the ones with both the incentives and expertise to keep a sharp eye on management for all shareholders.


The strict ban on auditors performing consulting services for the firms they audit should also be tossed. This has resulted in companies having to hire several different firms to perform similar functions regarding taxes and bookkeeping.


Staying On Top

This ban was put in place to avoid auditor conflict of interest, but it is an impractical standard to try to avoid potential conflicts at any cost. Surgeons, for instance, have conflicts of interest if they also refer patients for surgery. But until they prove otherwise, we trust these doctors because they are in the best position to know the surgery that is needed and perform the needed operation. Public companies should be given the same benefit of the doubt.


To ensure that America remains the premiere economy for investors and entrepreneurs, Sarb-Ox must not just be fine-tuned by regulatory agencies, but thoroughly overhauled in Congress. One important sea change shows that, at least rhetorically, the tide has now turned. This change concerns the Democratic Party.


Sarb-Ox was largely crafted in 2002 by Maryland Sen. Paul Sarbanes, chairman of the Senate Banking Committee during the Democrats' brief control of the Senate after the switch of Vermont Sen. Jim Jeffords. But before their victories in 2006, some savvy Democrats such as New York Sen. Chuck Schumer and Speaker Nancy Pelosi started talking about Sarb-Ox's burdens. Pelosi told CNBC in October that the law had "unintended consequences," adding, "I don't think you need the whole package."


Sticking with their words by cutting away the most burdensome pieces of the Sarb-Ox package would go a long way in persuading investors that Democrats can support some reasonable regulatory reform.