Sarbanes-Oxley — Loved By Countrywide and Mozilo, Albatross to Legit Investors and Entrepreneurs, Challenged in Court — response to Jane Bryant Quinn-

For more than two years, the Competitive Enterprise Institute has been involved in a constitutional challenge to the Public Company Accounting Oversight Board, the giant agency set up by the Sarbanes-Oxley Act of 2002 to create auditing rules under the law. CEI attorneys Sam Kazman and Hans Bader are of counsel to the plaintiffs in Free Enterprise Fund (FEF) v. PCAOB, and they have worked with the lead attorneys at the Jones Day law firm on the case. Representing both the FEF and Beckstead & Watts, a small Nevada accounting firm burdened by the PCAOB’s mandates, we have argued that the agency violates the Constitution’s Appointments Clause because it wields enormous power (and the individuals on its its five-member board actually get paid more than the president), yet its leaders are not subject to the Presidential appointment and Senate confirmation that the Constitution requires for “principal officers” of the United States. (Hans Bader and I wrote about the constituional, as well as public policy, defects of the PCAOB in this policy study for CEI.)

When we narrowly lost the first round at a DC federal trial court last year, many assumed the case was over. But after we argued this April at a three-judge panel in the D.C Circuit Court of Appeals — before Judges Brown, Rogers, and Kavanaugh — the financial press and others have begun to take notice. Articles in Dow Jones and Bloomberg News pointed out the sharp questioning of the PCAOB by the appeals court panel. And recently, financial columnist Jane Bryant Quinn, a die-hard Sarbox supporter, wrote an angry column bemoaning the fact that “a federal court might throw the Sarbanes-Oxley Act into limbo” and specifically slamming CEI for our work in challenging the law. But she also notes that we may be far more successful than anyone had anticipated, opining that “because the law lacks a “severability” clause[,] if one of its provisions is found to be unconstitutional, the whole law goes down.”

I’m not going to make a prediction as to what the court will decide or, if it does decide our way, how much of the law will be struck down. But what I can predict is that if the court does rule our way, both entrepreneurs and investors will benefit in getting relief from this crushing albatross that has become a boondoggle for the big accounting firms, a costly barrier to entry for small business financing and growth, and which has failed in its promise to give shareholders more useful and understanable information about the companies they own. Pasted below is my response to Quinn just published in Bloomberg News, the wire service that syndicates her column. (The letter is on the Bloomberg newswire, but I couldn’t find it yet on the web site. It will be posted on CEI’s web site,, very soon). I explain why the problems in valuing subprime securities do not demonstrate the need for keeping Sarbox, as Quinn asserts, but illustrate the law’s failure at achieving its stated aim while forcing public companies to spend billions on trivial matters.

As I state in the letter below and elaboratate on in an article I wrote that was part of my debate on financial risk, Countrywide Financial had actually been praised as a paragon of good Sarbox compliance before everything hit the fan for that firm. CEO Angelo Mozilo had been bragging about all the “internal controls” the company had to compy with Sarbox. As I say in that article, “the company certainly did have many bells and whistles” and may have been in compliance with Sarbox, but in the meantime it was ignoring other business risks that I would venture to guess its shareholders today would rank as more important.

Here is the full letter responding to Quinn’s column:

Sarbanes-Oxley Challenge Is Rooted in Law’s Flaws: John Berlau
2008-08-14 21:04:51.700 GMT

To the Editor:
Re Jane Bryant Quinn’s column, “Accounting Cleanup Board Is Facing a Gutting” (July 16):
In her attack on our constitutional challenge to the Sarbanes-Oxley Act and the Public Company Accounting Oversight Board (PCAOB) that this law created, Quinn disregards her own good advice to investors.
When it comes to investment products, Quinn has rightly warned against taking sales pitches at face value and urged careful scrutiny of risk and return. Yet she has failed to perform this due diligence in evaluating Sarbox and the PCAOB, instead writing a rosy, unsubstantiated review of what the law has supposedly accomplished while ignoring its huge costs to both entrepreneurs and investors.
Quinn writes that even exempting smaller public companies from Sarbox’s onerous accounting mandates would be “a thumb in investors’ eyes.” Yet she comes up short in providing evidence of any tangible benefits investors have received from this law.
Quinn points to the jump in companies’ earnings restatements the law has induced as proof that it has given investors “sharper financial information.” But a report just released by the Security and Exchange Commission’s Advisory Committee on Improvements to Financial Reporting shatters the notion that this increase in paperwork has served investors well.
The committee concluded that many restatements produced in the current regulatory atmosphere “may not be important to investors,” and that the restatement process “creates significant uncertainty regarding the size and nature of the effects on the company of the error” at hand.
This coincides with earlier reports that Sarbox’s internal control mandates, as interpreted by the PCAOB, were leading auditors to look at minutiae such as possession of office keys, the number of letters in employees passwords, and other controls that have little to do with the accuracy of financial statements.
What Quinn describes as “the financial crisis linked to subprime loans (that) left the valuation of trillions of dollars of securities in doubt” isn’t, as she asserts, a reason for maintaining Sarbox. Rather, it is evidence of the law’s failure.
While the law has forced big and small public companies to spend billions of dollars on trivial matters, its ostensible goal of more accurate valuations of complex financial entities was overlooked.
Ironically, as late as last year, now-troubled mortgage lender Countrywide Financial Corp. was praised by the Institute of Internal Auditors’ Research Foundation as a case study of excellent Sarbox compliance. This it may have been, but that’s of little solace to shareholders today stung by the firm’s neglect of other important risks.
In the meantime, legitimate entrepreneurial firms have found the costs have quadrupled for being a public company, according to the Sarbanes-Oxley Compliance Journal. Home Depot Inc. co- founder Bernie Marcus has said that his company couldn’t have gone public when it did if Sarbox had been in place. This hurts investors as well, because they are effectively locked out of the potential return of growing businesses that are delaying going public.
The PCAOB’s unconstitutional structure, in which it lacks accountability to both Congress and the president, has contributed to these costly and counterproductive mandates.
Should our lawsuit prevail, it will not be a stick “shoved into the spokes” of better accounting, as Quinn puts it. It will instead be a much-needed change in direction for both investors and entrepreneurs.

John Berlau
Director, Center for Entrepreneurship
Competitive Enterprise Institute
Washington Aug. 14, 2008

To read the column on Bloomberg’s newswire, click on {NXTW NSN K4386P1A1I4H }.