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Finally! Something Good from Sarbanes-Oxley

There was a spectacle this week on Capital Hill, a trio of poor, downtrodden CEOs—just regular Joes, if you will—coming to plead their case for bailout funds before Senator Chris Dodd and the Senate Banking Committee he chairs. With their companies hemorrhaging cash at a rate of billions per month, Rick Wagoner of GM, Alan Mulally of Ford, and Robert Nardelli of Chrysler ominously warned the committee members that they were likely to go out of business if the taxpayers don't give them $25 billion. “We want to continue the vital role we've played for Americans for the past 100 years, but we can't do it alone," said Wagoner.

It was all very touching, all quite moving, or it would have been if the CEOs had not just flown in on the luxury corporate jets maintained and paid for by their cash-poor companies. According to Ford's Mulally, he has reduced his workforce by 51,000 people and closed 17 plants. Notice the conspicuous absence of Ford's fleet of eight corporate jets from that list of spending cuts. GM and Ford both hold that having their CEOs fly on private jets is a corporate decision and that it is non-negotiable, even as the companies say they are running out of cash. Wagoner's trip to Washington cost GM about $20,000. Mulally's jet flies him to and from his home in Seattle each weekend. The planes are also active flying other executives and VIPs around the country. Do the math and you can see how quickly this adds up.

And they wonder why so many people want to let them go bankrupt.

Enter Sarbanes-Oxley

In case you are wondering, Sarbanes-Oxley—also known by its official name, the Public Company Accounting Reform and Investor Protection Act of 2002—was a knee-jerk reaction to the corporate scandals that rocked the corporate world after the end of the Clinton Administration. Misdeeds at companies like Enron and Worldcom, Tyco International, Adelphia, Peregrine Systems and Arthur Anderson made people think that the sky was falling and that something must be done. The something they hit upon was Sarbanes-Oxley, hailed as the most dramatic change to corporate oversight since the invention of the Board of Directors. Here is what it does:

  • Title I: Public Company Accounting Oversight Board - Establishes the Public Company Accounting Oversight Board (Board) to: (1) oversee the audit of public companies that are subject to the securities laws; (2) establish audit report standards and rules; and (3) inspect, investigate, and enforce compliance on the part of registered public accounting firms, their associated persons, and certified public accountants.

  • Title II: Auditor Independence - Amends the Securities Exchange Act of 1934 to prohibit an auditor from performing specified non-audit services contemporaneously with an audit (auditor independence). Requires preapproval by the audit committee of the issuer for those non-audit services that are not expressly forbidden by this Act.

  • Title III: Corporate Responsibility - Confers responsibility upon audit committees of public companies for the appointment, compensation, and oversight of any registered public accounting firm employed to perform audit services. Requires an audit committee member to be a member of the board of directors of the issuer, and to be otherwise independent.

  • Title IV: Enhanced Financial Disclosures - Requires financial reports filed with the SEC to reflect all material correcting adjustments that have been identified by a registered public accounting firm in accordance with SEC rules and generally accepted accounting principles (GAAP).

  • Instructs the SEC to require by rule: (1) disclosure of all material off-balance sheet transactions and relationships that may have a material effect upon the financial status of an issue and (2) the presentation of pro forma financial information in a manner that is not misleading and that is reconcilable with the financial condition of the issuer under GAAP.

  • Title V: Analyst Conflicts of Interest - Requires the SEC to adopt rules governing securities analysts' potential conflicts of interest, including: (1) restricting the prepublication clearance or approval of research reports by persons either engaged in investment banking activities, or not directly responsible for investment research; (2) limiting the supervision and compensatory evaluation of securities analysts to officials who are not engaged in investment banking activities; (3) prohibiting a broker or dealer involved with investment banking activities from retaliating against a securities analyst as a result of an unfavorable research report that may adversely affect the investment banking relationship of the broker or dealer with the subject of the research report; and (4) establishing safeguards to assure that securities analysts are separated within the investment firm from the review, pressure, or oversight of those whose involvement in investment banking activities might potentially bias their judgment or supervision.

    Directs the SEC to adopt rules requiring securities analysts and broker/dealers to disclose specified conflicts of interest.

  • Title VI: Commission Resources and Authority - Authorizes appropriations for FY 2003 to the SEC for: (1) additional staff compensation; (2) enhanced oversight of auditors and audit services; and (3) additional professional staff for fraud prevention, risk management, market regulation, and investment management.

  • Title VII: Studies and Reports - Mandates a GAO report to Congress on: (1) the factors leading to the consolidation of public accounting firms and the subsequent reduction in the number of firms providing audit services to businesses subject to the securities laws; and (2) the impact of such consolidation upon the capital formation and securities markets.

  • Title VIII: Corporate and Criminal Fraud Accountability - Corporate and Criminal Fraud Accountability Act of 2002 - Amends Federal criminal law to impose criminal penalties for: (1) knowingly destroying, altering, concealing, or falsifying records with intent to obstruct or influence either a Federal investigation or a matter in bankruptcy; and (2) auditor failure to maintain for a five-year period all audit or review work papers pertaining to an issuer of securities.

  • Title IX: White-Collar Crime Penalty Enhancements - White-Collar Crime Penalty Enhancement Act of 2002 - Amends Federal criminal law to: (1) establish criminal penalties for attempt and conspiracy to commit criminal fraud offenses; and (2) increase criminal penalties for mail and wire fraud.

  • Title X: Corporate Tax Returns - Expresses the sense of the Senate that the Federal income tax return of a corporation should be signed by its chief executive officer.

  • Title XI: Corporate Fraud Accountability - Corporate Fraud Accountability Act of 2002 - Amends Federal criminal law to establish a maximum 20-year prison term for tampering with a record or otherwise impeding an official proceeding.

Some praise the law for making corporate culture more accountable and transparent, while others complain that the law is damaging to American business. According to former House Speaker Newt Gingrich, for example, Sarbanes-Oxley went too far in regulating corporate governance, resulting in at least three unintended consequences.

  • It was insufficient at preventing insolvencies and accounting shortfalls in companies such as Bear Sterns, Lehman Bros., American International Group (AIG) and Merrill Lynch.

    Estimates from leading figures in the venture-capital community indicate the average company will now take 12 years before it can successfully issue an initial public offering (up from five years pre-Sarbanes-Oxley) because they do not have enough capital to cover the estimated $4.36 million hidden tax in yearly compliance costs, according to an estimate by the Financial Executives International. (The initial estimate from the Securities and Exchange Commission was approximately $91,000 per company on average.) Sarbanes-Oxley turned out in practice to cost small companies 50 times more than the SEC estimated. Oxley said the law gave the accounting industry "almost carte blanche to do almost everything they wanted to do, which turned out to be far more expensive than anticipated. ... They just went crazy."

    In addition, by creating criminal liabilities for board members, Sarbanes-Oxley has made it harder to find experienced members to join corporate boards.

  • It initiated a movement among smaller public companies to return to private status or merge. In 2006, the law firm Foley & Lardner LLP conducted a survey of 114 public companies on the effects of Sarbanes-Oxley. Twenty-one percent of companies were considering going private, 10 percent were considering selling the company, and 8 percent were considering merging with another company. These respondents mostly were companies with less than $1 billion in annual revenue.

  • It is resulting in a trend where companies choose to go public on foreign, not American, stock exchanges. In 2005, a report by the London Stock Exchange cited that about 38 percent of the international companies surveyed said they had considered issuing securities in the United States. Of those, 90 percent said the onerous demands of the new Sarbanes-Oxley corporate governance law had made London listing more attractive.

There is little question that Sarbanes-Oxley has had a dampening effect on the US Economy, but whatever damage it has done has been overshadowed by far larger problems typified by the arrogance of the CEOs begging before Congress right now. There is also little question that if the Big Three do get their wish and Congress reaches into your wallet to bail them out, that each every provision of Sarbanes-Oxley should be brought to bear on the automakers. These companies should be forced to reveal everything about their finances in return for the money they claim to need to avoid disaster. This transparency should be used to force the kinds of changes in the companies that would change them from money pits to profitable businesses and the criminal provisions should be used to make those changes stick. With this Congress and the new administration coming in, that is probably the best we can hope for.

The Bottom Line

These companies do not deserve a bailout, they deserve bankruptcy and all the judicial oversight that goes with it. Their problems were self-inflicted and their CEOs, fully aware of the public backlash against the excesses of AIG, don't seem to care about the impression they make or the cost of their little luxuries, relying instead on chicken-little sky-is-falling arguments to squeeze the taxpayers for more money.

I think Mitt Romney summed the situation up best in his op-ed piece when he wrote: "Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course—the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check."

Detroit does need a turnaround, no question of it, but will Congress have the courage and the moral and intellectual honesty to make that happen?

I am not going to hold my breath.

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