Enemy of My Enemy

This post is not about foreign policy, for a change. It's about domestic policy, and how it seems to create strange bedfellows lately.

To start:

• Two Cheers for Nancy Pelosi: Democrats think outside the Sarbox.
• Sarbanes-Oxley: A Price Worth Paying?

The Sarbanes-Oxley Act of 2002 (known affectionately as "Sarbanes-Oxley," "Sarbox," or merely "SOX") is quickly becoming the prototypical example of well-intentioned legislation whose effects as a cure are worse than the disease for which it was fashioned.

From the OpinionJournal article:

Recent estimates from the American Electronic Association, for example, show that U.S. companies are spending $35 billion annually simply to comply with the law as opposed to original federal estimates of $1.2 billion. A University of Nebraska study found that audit fees for Fortune 1,000 companies, on average, increased a staggering 103% from 2003 to 2004. The costs of being a U.S. public company are now more than triple what they were before the law passed, according to a study conducted by the Milwaukee-based law firm of Foley & Lardner. Some smaller firms report that they are spending 300% more on Sarbox compliance than on health care for their employees.

And:

Beyond the direct cost of compliance to individual companies, a recent University of Rochester study concluded that the total effect of the law has reduced the stock value of American companies by $1.4 trillion. That is $1.4 trillion that could be invested in infrastructure improvements, jobs, innovative technologies or research and development. As Sun Microsystems CEO Scott McNealy says, Sarbanes-Oxley throws "buckets of sand into the gears of the market economy."

"Sand in the gears" is a phrase I first heard my father apply to anti-business (or merely confiscatory-via-tax) policy a few years ago; the thrust of our discussion at the time was both awestruck and cynical: "Isn't it amazing that the U.S. economy is so immense, so powerful, that we can pour incredible quantities of regulatory sand into its mechanism and it not only continues to work, but to work well enough to shame the other economies of the world?" The metaphor does raise a few questions, though: just how much sand can the mechanism take before it fails, and good grief, imagine what it could do without all that sand!

The company where I work has recently completed its Sarbanes-Oxley compliance audit, and passed. It took an incredible amount of work, and diverted truly flabbergasting resources away from our core business: i.e., selling things. Yet we still turned a decent profit this quarter; earnings were down slightly from forecasts, but still, as I said, decent. More vindication of the strength of the mechanism, I suppose, but was this trip necessary?

Here's my whole problem with the very idea of legislation like Sarbanes-Oxley: it presumes guilt until convinced of innocence. It points a legal shotgun at the forehead of every publicly-traded company in the U.S. (and their compliance-auditing firms) and says, "Prove to us that you're not a bloodsucking, fraudulent bastard!" Of course, this is designed to protect investors from falling prey to the real bloodsucking, fraudulent bastards out there in the world.

The problem is that there are already laws on the books to prosecute the living Hell out of people who defraud both small and large investors, not to mention the securities market and the government. Those laws even seem to have worked: where are Enron * and WorldCom ** today (or for that matter Arthur Andersen *** consulting)? Two effectively had the death penalty exacted on them, and WorldCom re-renamed itself to MCI, and is a shadow of its former self.

All in a world before the blunt instrument of "justice" that is Sarbanes-Oxley.

There are those who believe that such safety measures are necessary for the protection of the investor, and since everybody has a 401(k) or similar stake in the market of late, even the "little guys" are investors now, so the Enron and WorldCom scandals robbed lots of little people of considerable sums of their money. Even so, I'd argue that risk is simply part of investment. There's very little reward in this life that doesn't have risk involved, and the stock market, offering some of the most impressive monetary rewards, also comes with some of the highest levels of monetary risk.

When I buy stock in a company, I'm professing my faith in that company. This means that I take on a whole slew of risks: its business model might be flawed; it might get outcompeted by other companies in the same business; and, at its helm, there might be a slack-off, an idiot, or even a crook. Risk is part of the package, and trying to mitigate that risk limits the possible reward: in forcing all public companies to comply with its purposely vague requirements, Sarbanes-Oxley consumes those companies' resources and diverts those resources from serving the companies' goal of actually making money. That figure in the second quote is haunting: $1.4 trillion dollars that might have been plowed back into the economy (and generated tax revenue, for the socialists in the crowd), instead poured down the comparative drain of Sarbanes-Oxley compliance auditing.

I've looked around as much as I can this afternoon, and the estimates I can find of the total damages caused by the Enron and WorldCom scandals amount to around $10 billion. (If anybody knows better numbers, please let me know.) Based on these napkinback numbers, we get an amount of 140 times the original cost of the problem to "prevent it happening again," which is sadly Quixotic: all Sarbanes-Oxley does is penalize the rule-followers. Diehard rule-breakers will find ways around the auditing process, and in the meantime we've thrown a massive quantity of sand into the machine, hurting the law-abiders, to little positive effect.

My hope is that articles like the above (and why are Democrats leading the charge to neuter Sarbanes-Oxley?!?) are harbingers of a change in opinion now that the real costs of the legislation are becoming apparent. I'd love to see Sarbanes-Oxley struck down or made ineffective (or less onerous) soon; the fewer fetters we have on the American prosperity engine, the better.

-Rich

PS. Speaking of risk and reward, I am in love. The inimitable 'A' will need to watch herself if she doesn't want to become the future Mrs. Rich. :-D

* From the Enron website: "Enron is in the midst of restructuring various businesses for distribution as ongoing companies to its creditors and liquidating its remaining operations."

** From the MCI site: "MCI, formerly known as WorldCom, has paid a penalty consisting of $500 million of cash and 10 million shares of new common stock of MCI, Inc. in connection with the settlement of charges brought against WorldCom by the U.S. Securities and Exchange Commission."

*** From the Wikipedia entry on Andersen: "On June 15, 2002, Andersen was convicted of obstruction of justice for shredding documents related to its audit of Enron. Since the U.S. Securities and Exchange Commission does not allow convicted felons to audit public companies, the firm agreed to surrender its licenses and its right to practice before the SEC on August 31."