SOX

A price worth paying?

May 21st 2005
From The Economist print edition

America's response to Enron and other scandals was the Sarbanes-Oxley law. It is costing plenty—but is it working?

THE Sarbanes-Oxley statute, which the United States enacted in an atmosphere of extraordinary agitation in 2002, is one of the most influential—and controversial—pieces of corporate legislation ever to have hit a statute book. Its original aim, on the face of it, was modest: to improve the accountability of managers to shareholders, and hence to calm the raging crisis of confidence in American capitalism aroused by the scandals at Enron, WorldCom and other companies. The law's methods, however, were anything but modest, and its implications, for good or ill, are going to be far-reaching.

Since the new accounting rules and regulatory infrastructure that goes with them are still bedding in, it is too soon for a definitive judgment. (That time may never come, in fact: academics are still arguing about the pros and cons of the Glass-Steagall act of 1933, a similarly momentous initiative.) It is early days for academic appraisals, but the ones that have been ventured so far tend to the view that costs will exceed benefits. Meanwhile, many of America's businessmen are deeply unhappy, and with reason: the initial costs of the new law have been bigger than expected. And it can be argued that, when it comes to repairing American corporate governance, the law anyway addresses symptoms more than causes.

With time, no doubt, the law's balance of costs and benefits will improve significantly: some of the costs have been once-and-for-all. Right now, though, the balance looks pretty unfavourable.

Alan Greenspan, chairman of the Federal Reserve, spoke up in defence of the statute this week. It was faint praise. He said he was surprised that a law which had been passed so rapidly had worked as well as it has—less of an endorsement than it first seemed, since laws dealing with issues as complex as these and passed as “rapidly” as was Sarbanes-Oxley can normally be expected to fail abjectly.

Mr Greenspan also noted that the law will be fine-tuned as experience accumulates. Quite so. Next day, the Securities and Exchange Commission (SEC), along with the Public Company Accounting Oversight Board (PCAOB, created by the law), told accountants that they were being too inflexible, “overly cautious” and “mechanical” in interpreting the statute. They called for the exercise of greater discretion—something which, three years ago, the architects of the statute had seemed to frown on. Whether good or bad, therefore, SOX, as it has become known, is by no means as yet a settled regime, but a work in progress.

Its initial provisions are wide-ranging. As well as establishing the accounting-oversight board, the statute prohibits audit firms from doing a variety of non-audit work for their clients (in order to address some obvious conflicts of interest). It requires companies to establish independent audit committees. It forbids company loans to company executives. It calls on top executives to certify company accounts. And it extends protection for whistleblowers: no company may “discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee” because of any lawful provision of information about suspected fraud. (Tip-offs from insiders are by far the most common method of detecting fraud.)

The law's most complained-of provision, however, is its section 404. This makes managers responsible for maintaining an “adequate internal control structure and procedures for financial reporting”; and demands that companies' auditors “attest” to the management's assessment of these controls and disclose any “material weaknesses”. Draconian new criminal penalties await transgressors.