The American Spectator

To address reform of the Sarbanes-Oxley Act of 2002 (Sarb-Ox), recall that it was passed in the political furor following the Enron and WorldCom scandals to try to prevent future accounting frauds. Let’s start with its most obvious, largely unintended, consequences. Sarb-Ox, with its notorious Section 404 requiring internal control certifications in particular, has created a tremendously expensive amount of paperwork and bureaucracy. In the Sarb-Ox economy it seems that everybody audits everybody else.

Not only is this exceptionally costly, but it is far more costly — about 50 times more — than the SEC estimated it would be. Virtually every audit committee around the country has helplessly watched its audit fees escalate dramatically. The explicit costs alone are extremely high and disproportionately high for smaller companies.

The implicit costs of diversion of employee and management effort are also high. The opportunity costs are high. The total costs far outweigh the benefits that are likely to arise from them, especially for smaller companies.

Part of the reason for this disproportional impact on smaller companies is that the implementation of Section 404 in particular has taken a brute force approach, like the airline security line, where respectable citizens have to take their coat, belt, and shoes off. Similarly, accountants are going through companies with no sense of proportion or materiality.

In sum, Sarb-Ox represents an Orwellian principle that imposes huge costs on the shareholders, who have no choice as to whether they wish to bear these costs or not, in the name of protecting these very same shareholders. The fundamental approach is that everybody must pay because of the malefactors in few egregious cases.

p> A Bonanza for Accounting Firms br> Sarb-Ox has had marvelous economic consequences for the large public accounting firms. For them it’s been a bonanza. One journalist called it the greatest wealth transfer of modern times, from shareholders of corporations to accounting firms. /p>

At the same time, Sarb-Ox creates an enormous conflict of interest for these firms. The more massive the Sarb-Ox routines, the more detailed their reviews, the more memos, procedures, and risk control descriptions that are generated, the more often they are reviewed, the more meetings, and the more time it takes, the more profitable the accounting firms become. No wonder these firms take out advertisements praising Sarb-Ox.

In response to this, the “Pollock Proposal” is to expand Sarb-Ox to cover the accounting firms themselves. If they are going to impose costs and procedures on everybody else, they should have to go through the same routines as a prerequisite to practicing on other people. I expect their views and reviews would become more reasonable.

p> A Sampler of Quotations br> Here, from various study papers and filings, are some instructive quotations on the burdens Sarb-Ox creates: /p>