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Prospects for substantial relief from or repeal of one of the most burdensome corporate regulations in recent memory have suddenly grown in Congress and in a constitutional challenge before the U.S. Supreme Court.
The regulation is known as the Sarbanes-Oxley Act of 2002, or SarbOx.
Rushed through Congress and signed by President Bush in the wake of the Enron and WorldCom scandals in 2002, the law has quadrupled the costs of the audit process for public companies and achieved little in preventing fraud.
Rep. John Adler (D-NJ) recently sponsored a successful amendment to the financial regulation bill being pushed by the Obama administration that would exempt smaller public companies—those with market valuations of $75 million and below—from the particularly onerous “internal control” audits mandated by Section 404 (b) of SarbOx. Despite the opposition of powerful House Financial Services Committee Chairman Barney Frank (D-MA), 101 Democrats joined all but one Republican in voting to retain the relief from SarbOx in the final financial bill that passed the House in December.
And on December 7 the U.S. Supreme Court heard a case on Sarbanes-Oxley that could lead to a gutting of a substantial part of the law and a major positive impact on the U.S. capital markets. Prominent attorneys including Pepperdine Law School Dean Ken Starr argue the structure of Sarbanes-Oxley’s Public Company Accounting Oversight Board lacks constitutional accountability because it bypasses Presidential appointment, Senate confirmation, and the Executive Branch’s power to remove.
$1.4 Trillion Cost, Shrinking Investment
University of Minnesota economist Ivy Zhang calculated SarbOx has cost the economy $1.4 trillion in direct and indirect costs. And new research from economist Kenneth Lehn of the University of Pittsburgh shows such costs reduce firms’ research and development spending and business investment, two important precursors for job growth.
Because of the high-paying work it creates for auditors in helping firms comply with the law, SarbOx has been called “a boon for bean counters” (in Business Week) and “the Accountants Full Employment Act.” Many economists, policymakers, and members of Congress of both parties are questioning whether what is good for the Big Four accounting firms is good for America.
In addition, SarbOx has achieved little in preventing fraud. In 2007 the Institute of Internal Auditors praised Countrywide Financial Corp. for its Sarbanes-Oxley controls. Two years and many scandals later, Countrywide’s former executives were charged with securities fraud.
‘Never Intended Such a Burden’
Rep. Adler said in a statement to a December Competitive Enterprise Institute conference on “Sarbanes-Oxley, The Supreme Court, and America’s Economic Future”: “404 (b) of the Sarbanes-Oxley Act was never intended to be such a burden on small and medium-sized businesses struggling to grow and create jobs.… If small companies are dissuaded from going public and are restrained in their paths to growth, we may never know whether they could have been the next successful American business.”
Attorneys with the Competitive Enterprise Institute are serving as co-counsel to the Supreme Court case.
SarbOx compliance processes can significantly delay going public even for a company as large as Google Inc. Tech journalist John Battelle reports in his book The Search that because Google “made its money literally pennies at a time, from millions upon millions of microtransactions,” it “had to significantly restructure its advertising reporting system from the ground up” to meet SarbOx internal control reporting requirements.
While SarbOx imposes this type of burden on a company like Google, which had a market valuation of more than $1 billion before it went public, the burden for smaller companies trying to raise capital can be much greater. This helps explain why in the post-SarbOx years initial public offerings slowed dramatically in the United States, with fewer IPOs in the boom year of 2006 than in 1991, when the economy was in recession.
A repealing or scaling back of Sarbanes-Oxley could boost prosperity as entrepreneurial energies are unleashed and more investment is allowed to flow to promising new companies.