Sarbanes-Oxley: Albatross to Growth

Many economists, policy makers, and members of Congress of both parties are questioning whether what is good for the Big Four accounting firms is an unfettered good for America. University of Minnesota economist Ivy Zhang calculated that it has cost the economy $1.4 trillion in direct and indirect costs.

Further, new research from economist Kenneth Lehn of the University of Pittsburgh shows that such costs reduce firms’ research and development spending and business investment, two important precursors for job growth.

The good news – news that portends better prospects for growth in the next ten years – is that in December 2009, prospects for substantial Sarbox relief or repeal suddenly grew both in Congress and in a constitutional challenge before the Supreme Court, in which attorneys from the Competitive Enterprise Institute (full disclosure: my organization), have been serving as co-counsel. To highlight these important issues vital for jobs, economic growth and U.S. competitiveness, CEII, with the invaluable assistance of the Hudson Institute — New York, hosted an event on Capitol Hill entitled “Sarbanes-Oxley, The Supreme Court, and America’s Economic Future.” $75 million and below – from the particularly onerous “internal control” audits mandated by Section 404 (b).

Adler wrote to conference organizers: “My best wishes for a successful conference that highlights this important issue affecting America’s creative entrepreneurs. Section 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. In an economy where we need to create jobs, it is my goal to fix problems interfering with our small businesses ability to grow and create jobs.” Among the points raised by the conference participants were that the law’s mandates 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.” If 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, imagine the burden for smaller companies trying to raise capital. This helps explain why in the post-Sarbox years, initial public offerings slowed dramatically in the U.S., with there being less IPOs in the boom year of 2006 than in 1991, when the country was mired in a recession.

In lamenting the lack of economic growth in the decade that just passed, New York Times columnist Paul Krugman had pointed the finger at a typical culprit: the supposed deregulation that occurred in the Bush administration. “As for the Republicans, now that their policies of tax cuts and deregulation have led us into an economic quagmire, their prescription for recovery is – tax cuts and deregulation.” Krugman called the 2000s “the decade in which we achieved nothing and learned nothing.”

Yet a glance at what really happened in the first decade of the new millennium shows that Krugman and others of his ilk are the ones who have really learned nothing. They continue to insist that the financial crisis was caused by deregulation even though so much government intervention in housing — from the subsidies to Fannie Mae and Freddie Mac to the reckless lending encouraged by Community Reinvestment Act – contributed to the mortgage meltdown. And, as Rep. Ron Paul recently pointed out, “As for a lack of regulation, the last decade saw the enactment of the Sarbanes-Oxley Act, the largest piece of financial regulatory legislation” in decades.

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 tangible results in preventing fraud. Because of all 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.”

Sarbox is a significant cost factor holding back job growth and a stronger recovery. If it is repealed or scaled back, the second decade of the new millennium could see real prosperity as American entrepreneurial energies are once again unleashed through the next Microsoft and Googles going public.

On top of this, Sarbanes-Oxley has achieved very little in preventing fraud. In 2007 Countrywide Financial Corp. was praised for its Sarbanes-Oxley controls by the Institute of Internal Auditors. Two years and many scandals later, its former executives have been charged with securities fraud. And certainly, overall transparency doesn’t increase when companies go private or delay going public, as many have chosen to do because of the law’s costs.

Despite the opposition of powerful House Financial Services Committee Chairman Barney Frank – and a sneaky attempt by him and other Democratic leader to introduce a new amendment to remove the Adler-Garrett Sarbox relief on the House floor – 101 Democrats joined all but one Republican to retain the relief from the law in the final financial bill that passed the House on Dec. 11.

In the meantime, on Dec. 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. Bader, CEI attorney Sam Kazman, other prominent attorneys on the case such as Michael Carvin and Pepperdine Law School Dean Ken Starr and nine separate amici briefs from groups such as the Cato Institute and Washington Legal Foundation argue that the structure of the PCAOB – which has set burdensome accounting rules that have cost the economy billions – lacks constitutional accountability because its structure bypasses Presidential appointment, Senate confirmation, and the Executive Branch’s power to remove. You can see tall the briefs at

The conference, held on Dec. 1 in the new Capitol Visitors Center, was well-attended by staffers of both Republican and Democratic members of Congress. A highlight of the event was a letter to the conference from Rep. John Adler, freshman Democrat of New Jersey, who had sponsored the amendment to the financial regulation bill that would exempt smaller public companies – those with market valuations of internal control” audits mandated by Section 404 (b).

Speakers at the conference included Adler’s co-sponsor of the amendment, Republican Rep. Scott Garrett, cosponsor of the amendment with Adler, and financial consultant and commentator Mallory Factor, and author and former regulatory official Stephen A. Boyko, and CEI counsel for special projects Hans Bader, who is co-counsel to the plaintiffs in the Supreme Court challenge. The author served as the conference’s moderator.