How SOX Saved America
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Opinion: There they go again.
The corporate apologists demanding the repeal or evisceration of the Sarbanes-Oxley Act of 2002 have become a chorus. Just last month, Securities and Exchange Commission chairman Christopher Cox repeated his intention of reforming (or defanging) SOX.
And then it will only be a matter of time before crooked books get to rob investors again.
In case anyone needs reminding, SOX was not passed in a vacuum. It came in the wake of not one corporate accounting scandal, but a string of them.
The rogues' gallery of infamous companies didn't end with Enron -- whose accounting misdeeds wiped out the company and helped erode a stock market nation's confidence in the markets.
Think back to the post-bubble days from mid-2001 through 2003. Barely a day went by without some company "discovering" flawed financial statements. Investors began to flee like pigeons before a snow blower.
From 2002 to 2003, the Dow Jones index began to fall steadily from well over 10,000 points to below 8,000.
Yes, there was the "correction" in markets following the dot-com investing mania, a recession and then the events of 9/11, all of which contributed to the decline. But that precipitous drop also spoke volumes about investor confidence in the integrity of the markets.
According to the National Bureau of Economic Research, the recession actually ended in November 2001. Yet, stocks didn't even begin to recover until 2004, when the initial SOX requirements -- that CEOs and CFOs take personal responsibility for the accuracy of their financial records -- first took effect.
If the last 75 years of American-style capitalism have taught us anything, it's that a little bit of regulation goes a long way to ensuring prosperity for all. Since the Securities Exchange Act was first enacted in 1934, in the aftermath of the stock market crash of 1929, the U.S. economy has become the envy of the world.
And yet, the Exchange Act inspired the same kind of free-market hooey from the geniuses who brought us the Great Depression. Richard Whitney, then president of the New York Stock Exchange, predicted ominously in his testimony to Congress that stock trading would be "entirely destroyed" if that bill were made law.
Of course that didn't happen. Quite the opposite occurred. More people, especially retail investors, began investing in stocks, increasing liquidity and the availability of capital.
Now fast forward to the Sarbanes-Oxley Act. To be fair, compliance has been very costly. By the end of next year, U.S. businesses will have spent more than $32 billion on compliance, according to a recent report by AMR Research.
That's a lot. But it's money well spent.
Why? Like the Exchange Act, the SOX regulations help reassure investors of the accuracy of corporate P&Ls -- and enable them to make informed investing decisions by laying out some very basic rules about the transparency of financial statements.
Most important among them is that CEOs and financial officers personally attest that their financial statements are accurate, and that they can say it with a good degree of certainty. Information technology can help publicly traded companies achieve those goals.
SOX also requires listed companies to have at least one person on their boards who can read a balance sheet; and it obliges companies to help enable anonymous reporting for shady business practices -- so employees can blow the whistle without fear of losing their jobs.
These practices make so much sense, you would think they wouldn't require legislation. But as long as there are executives who put lining their own pockets ahead of safeguarding the interests of their shareholders, we'll need regulations that keep those behaviors in check.
Plus, SOX has been better for business than anyone would have guessed. Take a report prepared by McKinsey on behalf of New York City (ironically, for the purpose of highlighting the negative impact of SOX on the financial industry). It said U.S. equities markets actually grew at twice the clip of major European markets, 5.2 percent compound annual growth rate (CAGR) compared to Europe's 2.5 percent between 2001 and 2005.
Could it be because investors would rather put their money in a market that respects the rule of law -- and transparency in accounting rules?
That still doesn't mean complying with SOX is cheap or easy. And yes, there are some minor inconveniences, such as making people use stronger passwords. And having to tell the markets the truth.
That's where information technology comes in. Companies are finding that compliance becomes cheaper and more efficient when it's driven by IT. And safe systems require secure sign-on. Again according to AMR, U.S. companies have spent over $8 billion on SOX-related technology over the past five years, investing in things like secure electronic document storage and the ability to quickly search e-mail and other documents.
But the most surprising thing about this report is that, however grudgingly, companies are reporting benefits -- yes, measurable business gains -- thanks to SOX.
Those include improved business processes, better visibility of their operations and improved support for their globalization efforts.
But as far as we as citizens are concerned, the most important effect of SOX is on investor confidence. Because we can't afford to allow publicly traded companies to be run under the cloak of obscurity and evasiveness. The very foundation of our society's prosperity rests on the confidence we have in our markets. To roll back SOX would be to nail that confidence on the cross of ill-gotten, short-term gains.
Michael Hickins is a senior editor for internetnews.com.