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Source link: http://archive.mises.org/7222/sarbanes-oxley-costs-costs-costs/

Sarbanes-Oxley: Costs, Costs, Costs

September 26, 2007 by

David Weild, former vice chairman and executive vice president of The NASDAQ Stock Market, speaks out on SOX. He makes some sober remarks, but at the same time he walks on coals, unwilling to admit that Sarbanes-Oxley (SOX) was wrong, evil, and ill-intentioned from the start. He states that in his discussions with Silicon Valley CFOs and venture capitalists, “People are simply fed up with being held hostage by the accounting profession and the big accounting firms are clearly hurting the process of going public.”

Weild believes that SOX is undermining US business competitiveness because the feedback he received from financial people working in the trenches have complained that SOX:

1) has enabled public accounting firms to produce a lower level of service at far greater costs
2) has public accounting firms burdening companies with bureaucratic nightmares, delays, restatements, and financial reporting disagreements

Weild weakly suggests that “I can’t believe that this is where Congress and the SEC intend us to be,” though that is essentially a statement that absolves the wrongdoers of any purposeful wrongdoing. He goes on to imply that the problems burdening smaller companies that wish to go public were unintended consequences of trying to contain the bigger horses within the gate. That’s a cop-out, at best.He concludes:

I do think that Chairman Cox has done an exceptional job and I recognize fully that the above-referenced problem was not of his making. For all the good that Sarbanes-Oxley did, it was clearly drafted and passed in haste in response to the political and media climate at the time. Not unexpectedly, there have been “unforeseen consequences” and while I understand that the SEC has focused some attention on lessening the burden of Sarbanes-Oxley compliance on small capitalization stocks, I think it is time to focus attention and to hold hearings on how the current practice of accounting has harmed the IPO market in the United States.

As a Wall Street insider, it is no wonder that Weild treads lightly. Sarbanes-Oxley has not been good. It has indeed made companies probe, test, and improve the operating effectiveness of their internal controls. But at what cost? Besides the direct monetary costs there is the qualitative costs as a result of another gigantic regulatory system being foisted upon private businesses involuntarily.

But don’t blame public accounting firms for being too bureaucratic. Fact is, auditing is somewhat a fundamentally futile science. It is difficult and highly subjective. Auditors, especially in a SOX auditing role, deal with:

1) Highly prescriptive rules and judgmental aspects thereof
2) Conflicting oversight bodies (The Public Company Accounting Oversight Board tells auditors to do one thing, and the SEC tells firms to do another thing. At the end of the SOX audit, the two sets of “rules” must be reconciled and everyone needs to be happy.)
3) Huge companies with multiple divisions and multiple lines of businesses whose financial processes must be understood, documented, tested, and then an opinion is rendered as to the operating effectiveness of the company’s internal controls

I can tell you that the public accounting firm partner at the top of the food chain on an audit – especially an audit involving a very large corporation – is aged beyond his years and does not get a whole lot of sleep at night. Imagine being the guy that has to sign the letter rendering the opinions regarding management’s assessment of internal controls and the operating effectiveness of the company’s internal controls. (Though, to be fair, recent updates to SOX 404 eliminates the need for the auditor to render an opinion on management’s assessment of the operating effectiveness of its controls. This will negate some work, and additionally, will eliminate some costs.)

For SOX, the blame should be placed upon Mr. Sarbanes and Mr. Oxley, along with the assorted lobbyists, regulators, and political hacks that contributed to this nightmare. A lot of folks – including Mr. Oxley – launched stellar careers on the basis of their SOX notoriety. Mr. Oxley now earns up to $30k per speaking appearance. Sure the accounting firms and accountants – for the most part – love the regulatory state and are basking in the extraordinary fees that SOX brings forth, but generally, the guys doing the grunt work and signing away their professional reputation are putting much at stake in order to earn their paychecks.

{ 10 comments }

G September 26, 2007 at 11:43 pm

I recognize that there may be legitimate reasons for regulation, when that regulation is the best way to protect consumer choice from misleading information. In some cases this may work better than relying on tort to catch fraudulent behavior, simply due to the costs involved. Regulation might be a more sensible compromise in some cases.

But the problem with regulating the stock market, is that there is no such thing. The “stock market” is a market of markets. AMEX, NASDAQ and NYSE all compete for traders and firms. They should be the ones crafting accounting regulation on the firms which trade in them, not the government. Not only do the people who run the markets know a hell of a lot more about their industry, but its in their self-interest to craft rules (or lack thereof) which make both firms and traders happy.

Without the market process to guide them, the government is utterly incapable of doing this themselves.

flix September 27, 2007 at 5:57 am

“Without the market process to guide them, the government is utterly incapable of doing this themselves.”

That sounds familiar…Economic calculation and socialism.

John Reed September 27, 2007 at 7:05 am

“In some cases this may work better than relying on tort to catch fraudulent behavior, simply due to the costs involved. Regulation might be a more sensible compromise in some cases.”

Stephan Kinsella’s questioning of the costs of the patent system reminds us to ask what the costs of the regulatory system are. The burden of proving the efficacy of regulation vs. tort law should fall on those advocating regulation.

While I have no personal knowledge of regulatory costs (or tort law costs) it is hard to imagine many things worse than the current bloated regulatory system in this country.

John Reed

Anthony September 27, 2007 at 7:36 am

G: “I recognize that there may be legitimate reasons for regulation, when that regulation is the best way to protect consumer choice from misleading information. In some cases this may work better than relying on tort to catch fraudulent behavior, simply due to the costs involved. Regulation might be a more sensible compromise in some cases.”

In the current corporatist environment, I agree. It is difficult for consumers and competition to insure that businesses provide them the best goods possible when the State is so heavily involved in the market. Be that as it may, most regulation tends to work to the advantage of corrupt corporations, and as such I am dubious of it. I’d much prefer a free market, where competition and voluntary associations (e.g. consumer research institutes) “regulate” businesses.

TokyoTom September 27, 2007 at 8:22 am

Karen, great post.

Sarbanes-Oxley is a very nearly unmitigated disaster. It increases the costs of public firms, reduces risk-taking, increases barriers to entry, deflects foreign firms from seeking to raise capital in the US, increases the power of the SEC and its ability to provide favors to insiders, and further undermines our federal system by effectively nationalizing a fair amount of state corporate law, as least as it applies to public companies. Even the accounting firms are now subject to intrusive regulation, and further responsibilities have been imposed on the legal profession – even while both professions benefir from increased work.

In this case, the fault lies entirely with the Congress, and especially Republican leaders who were in a haste not to be burned too badly by Enron and other scandal, and to show their desire to “protect” the markets and investors.

But as G points out, the stock markets are themselves regulators, and on top of that, large firms are kept in check by other market forces – rating agencies, insurers, investors and of course competition.

Let us hope we see some common sense, and deregulation.

Competition between markets is a big issue here, as Japanese markets continue to lose business to markets that are more open and flexible, and less costly. Interestingly, though, SOX has had some appeal here, as the cross-shareholding structure has broken down post-bubble and the traditionally “wise” and powerful Japanese financial regulators look for other ways to take the place of extremely weak Japanese investors.

TokyoTom September 27, 2007 at 9:24 am

Oh, I forgot to mention a silver lining – it seems that SOX is playing a factor in driving companies private, and away from federal securities regulation. This is probably a good thing, even as it deprives Americans of investment options.

Person September 27, 2007 at 12:41 pm

TokyoTom: Good points, but what does any of that have to do with global warming?

Kevan Huston September 27, 2007 at 2:58 pm

Yeah, but it only deprives Americans of investment options thanks to the QIB limitations on private placement investments — again thanks to the SEC, whose putative objective is to “protect” the American investor. From a corporate treasury/economic standpoint, whether a firm is public or private isn’t that important. Without articial barriers to capital transfer and allocation (like the 1933 and ’34 Acts), being a private rather than a publicly “listed” company would be immaterial.

TokyoTom September 28, 2007 at 2:48 am

Person:

If I seem unidimensional, it’s only because there is one set of issues I care about more than others.

Andwhat are YOU doing here, anyway? This is not an IP thread.

Regards,

TT

Person October 1, 2007 at 10:14 am

Touche, TT, Touche. :-)

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