Puts and Calls: Sarbanes-Oxley ‘reform’ harming economy

The Sarbanes-Oxley corporate governance act is one of the biggest expansions of government regulation in 70 years—and businesses say it’s more costly and complicated than ever imagined. Defenders counter that the 2002 law is still needed to protect the public from corporate abuses.<?xml:namespace prefix = o ns = “urn:schemas-microsoft-com:office:office” />

Yet recent news has made it harder to argue that Sarbanes-Oxley, hastily passed in response to corporate scandals at Enron and WorldCom, has benefited the “little guy.”

The mandates of Sarbanes-Oxley cost substantial time and money, and companies frequently have to divert employees from the company’s core business. And a growing number “are looking to <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />India’s information-technology outsourcing firms” to farm out the work to, according to the Wall Street Journal.

But actually, this shifting of work to India is the least of Sarbanes-Oxley’s damage to the U.S. economy and that of Pittsburgh. Since the law’s passage, Sarbanes-Oxley has meant hidden costs for workers, consumers and businesses. It has inhibited job growth, while providing little in useful benefits for shareholders.

Although Sarbanes-Oxley was sold as a cure for Enron-like corporate misbehavior, the law mostly fails to target the real wrongdoers and instead punishes all public companies as a class. Its costliest part, called Section 404, mandates that auditors not just sign off on a company’s numbers, but also its “internal controls.”

The problem is that an “internal control” can be whatever a company’s accounting firm determines it to be, such as business software and other items that are only tangentially related to financial statements. The Economist magazine reported that one auditor even insisted on signing off on every purchase a company made that was $100 or more. Documenting such minutiae is costly, wasteful and obscures meaningful data for shareholders.

Nevertheless, companies will pay $35 billion a year to comply with Sarbanes-Oxley’s “internal control” mandates, according to the American Electronics Association. The average public company will also devote 30,700 manhours a year, according to Financial Executives International. This is time and money that could be devoted to creating new products, new businesses and new jobs. And ironically, it’s the Big 4 accounting firms—the ones the statute’s supporters said the law would go after — that are getting even richer from Sarbanes-Oxley’s mandates.

Yet it is innocent small public companies that are really paying an unfair price for Enron’s sins. Take, for example, Max & Erma’s Restaurants Inc. The growing chain, which recently opened its 100th restaurant, made $1.1 million in profits last year and there has never been a hint of scandal associated with the business. The firm has used these profits to create new jobs and now employs 6,000 in the United States and 725 in the Pittsburgh area alone.

But that growth will be cut short by Sarbanes-Oxley. The law will cost the company $500,000 to $600,000 a year, according to Bill Niegsch, Max &Erma’s chief financial officer. This is about half of the company’s profits, money that otherwise would be put into growing the business. “That is the opportunity cost of opening one restaurant per year and giving 75 Americans in Pittsburgh a job,” Mr. Niegsch said.

Because of these costs, Max & Erma’s plans to voluntarily delist from the stock market. This is a step that was once unheard of for a profitable company, but that more and more firms are taking because of Sarbanes-Oxley’s enormous burdens. But even this step is not cost-free. It will restrict the restaurant chain’s capital resources and affect job growth for two to three years, Mr. Niegsch says.

Multiply Max & Erma’s by the number of entrepreneurial firms in America, and it’s easy to see why the economy still doesn’t seem to be operating at full tilt.

Ironically, the outsourcing now resulting from the law might end up being a good thing if it forces lawmakers to realize that their reforms are wreaking havoc on the American economy, rather than saving it from corruption. How many jobs will have to be lost to India—how many more Max &Erma’s will have to delist—before Congress rethinks its careless “reform?”