The Regulatory Disaster That Isnt
If an article could scream, Stephen Moore's 2,800-word piece in a recent American Spectator would have quickly lost its voice. Moore called the Sarbanes-Oxley Act of 2002—take a deep breath—"imbecilic," "intolerable," "hazardous," "onerous," "chilling," a "fearsome weapon," "a perversion," "a new cancer," and "a wealth destruction machine" that "reduces corporate profitability and thus shrinks shareholder wealth," compromises freedom, frightens "top quality" executives from accepting multimillion-dollar annual corporate jobs, empowers unethical prosecutors as well as communist sympathizers, and "criminalizes economic behavior."
Enacted in the wake of a corporate crime spree popularized by the natty thieves at Enron, the federal Sarbanes-Oxley Act helped close loopholes that allowed white-collar crooks to steal billions of dollars and threaten the credibility—nay, the very survival—of the free enterprise system. The reforms demand truthful corporate accounting and disclosure at publicly traded companies. Before Sarbanes, executives could easily claim ignorance of their own fraudulent books; now they must attest that financial records used to encourage investment in their companies aren't cooked or grossly erroneous. Just as important, the law requires audit firms to disclose their interests in the companies they audit.
I enjoy reading the American Spectator largely because of its often humorous writers. But Moore is not joking. He believes his Sarbanes scenario won't be the result of accident or ineptitude. He sees a conspiracy of dunces (from George W. Bush, who signed it, to the Republicans who controlled the House and Senate when Sarbanes was written, debated and passed into law) and wicked politicians ("the anti-capitalistic left" who control nothing). In his mind, the latter group somehow duped the majority by concealing a motive so evil it sounds like Ayn Rand raising J. Edgar Hoover from the grave: "Striking down the productive class in America."
If Moore—who also writes for the Wall Street Journal—is right, our next national crisis won't be dramatized by airborne 18-wheelers or yachts perched on the rooftops of three-story buildings. He imagines (presumably sober) a Nightmare on Wall Street dominated by the distinctive sound of a "vast proliferation" of prosecutors "around the nation slapping handcuffs on America's wealth producers." The national pastime won't be baseball but, he says, "the relentless demonization of the business community."
Be alarmed, but don't panic. Moore believes we can avert this tragedy. The way to thwart "the lusting for the blood of corporate villains" is for a "conservative Republican leader" to emerge and "fix our public policies in this realm," he says. In other words, slay Sarbanes.
But who can corporate executives trust to sabotage the reforms? Who is slick enough to convince the nation that the reforms are sadistic? If Moore is right, who is in the best position to save capitalism?
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At his U.S. Senate confirmation hearing to head the Securities and Exchange Commission (SEC) in late July, Christopher Cox—a longtime friend of Moore's—couldn't stop smiling. The Newport Beach Republican congressman had craved numerous presidential nominations over the years. He'd wanted to become CIA director, federal judge or a high-profile ambassador. He even tried to capture the vice presidential slot in Bob Dole's 1996 campaign for the White House. He unsuccessfully campaigned for speaker of the House of Representatives two times. On at least three occasions, he plotted, but chickened out of, campaigns for the Senate.
So if Cox could win confirmation to the SEC, he'd realize a dream. He told senators that under his direction the agency, which enforces Sarbanes-Oxley, would be "aggressive," "vigilant" and "vigorous." He suggested critics of his nomination were loony for arguing that he'd defang the agency. "Continuity" and "consistency" in the agency's enforcement are critical to the stability of the nation's financial markets, he testified.
Corporate lobbyists who had cheered his nomination remained mum. They knew Cox's protests during the hearings were a necessary counterweight to his legislative record. During nearly 18 years in the House, he'd authored dozens of loopholes for businessmen who would eventually attract the attention of federal prosecutors. For example, in the 1990s Cox tried to kill a law against secret financial pacts between companies and their supposedly independent auditors. He also championed court rules that made it easier for the likes of Charles Keating (who cost taxpayers more than $1 billion) to escape justice. Before Congress, Cox served as legal counsel to one of the biggest swindlers in Southern California history.
Cox didn't laugh when he was sworn into office on Aug. 3. In fact, he maintained the pro-law-enforcement persona for 10 days. He ended the ruse in an Aug. 14 Orange County Register story, "Cox May Relieve Sarbanes-Oxley Pain."
"Smaller firms shouldn't be disadvantaged by higher relative compliance costs," he told the paper. "And, of course, the investor's needs for information aren't necessarily the same for small firms."
It was classic Cox. First, he makes a claim—that compliance costs are unaffordable to small companies—without providing any evidence. Second, he asserts—again, without evidence—that investors want less credible financial reporting from smaller publicly traded firms.
Proof? Cox doesn't offer any, and the Register, his conservative hometown daily, didn't bother to ask. Instead, the paper quoted exclusively from corporate lobbyists and local businessmen, who—like Moore in his American Spectatorpiece—claim Sarbanes reforms are killing the free enterprise system. Venture capitalist Mark Nielsen of Aliso Viejo alleged that compliance costs "can eat up 50 to 100 percent" of a company's net income. David T. Hirschmann of the U.S. Chamber of Commerce asserted that the reforms are so draconian businesses can no longer afford health care, new equipment or marketing campaigns.
It sounds terrible, but are the new accounting and disclosure laws truly crushing business?
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Even before Cox's ascension to the SEC, corporate lobbyists had quietly launched a national media campaign against Sarbanes reforms. Like the Register's piece, many articles relied on fuzzy anecdotal evidence. Several articles relied on a college professor's assertion that the two-year-old reforms had already "wiped out" $1 trillion in corporate profits. Oddly, few—if any—reporters checked the most obvious source for evidence of Sarbanes damage: corporate financial disclosure made to the SEC.
Before we began reviewing the reports of more than two dozen prominent Orange County-based corporations, we thought we'd find horror stories about the devastation Sarbanes has caused: massive layoffs, axed employee health care and benefits, sweeping salary reductions, eliminated management bonuses, emergency sales of corporate jets, dire cries of imminent bankruptcies, and skyrocketing increases in general and administrative costs for Sarbanes compliance.
But the overwhelming majority of companies we inspected showed—drum roll, please—zero signs that the reforms threaten their businesses. In fact, these corporations reported that many other issues have had a more significant impact on their bottom lines: competition, expansion, insurance, executive pay, legal woes and bonehead management decisions.
• Quest Software of Irvine reported that administrative costs were "unchanged" in the first six months of 2005 compared to last year.
• Filenet Corporation of Costa Mesa reported a 6.4 percent decline in administrative costs in the first six months of the year and said it doesn't foresee any significant increase in those costs.
• Anaheim-based Pacific Sunwear of California claimed a 0.2 percent increase in the first quarter but said the jump was "primarily due to higher corporate payroll."
• QLogic of Aliso Viejo reported record revenue levels and a 5 percent decrease in administrative costs in its most recent disclosure.
• Irvine's Dyntek, Inc., claimed that during the past nine months there had been an increase in administrative expenses, but that was "primarily due to increased selling costs." The company did not complain about Sarbanes in the report.
• Cardiac Science of Irvine showed a 2.5 percent decrease in administrative costs for the quarter ending June 30.
• I-Flow Corporation of Lake Forest reported a $2.1 million or 28 percent increase through the first six months compared to last year, but attributed the leap to compensation costs.
• Anaheim-based Bridgeford Foods Corporation reported a third-quarter decline in administrative expenses of 7.7 percent.
• For the 36 weeks ending in March, Diedrich Coffee of Irvine reported an 11.1 percent increase in administrative costs but blamed franchise development, field supervision, construction, recruiting and management information systems.
• Cherokee International reported a decrease of 1.6 percent in administrative costs for the first six months compared to 2004, but said even that little amount was offset by increased income.
• For the first six months, and in the face of tremendous legal trouble related to finances, Apria Healthcare in Lake Forest said its administrative costs were up just 1.9 percent.
• Newport Beach's Conexant Systems said its administrative expenses for the nine months ending June 30 "stayed relatively flat."
You get the picture.
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But the reports also show something critical that Cox, Moore and the Register won't tell you. If the goal of Sarbanes is to increase investor confidence in the market, it's succeeding. The reforms are forcing corporations that had been giving investors erroneous financial details—sometimes for years, sometimes with no correlation to reality—to expose themselves and clean up their acts.
For example, Biolase Technology reported that it spent $1.3 million on Sarbanes-related fees during the last six months of 2004. But the San Clemente-based firm, which has about $61 million in annual revenue, admits that the company's audit staff wasn't sufficiently experienced, failed to maintain effective controls over its accounting, didn't accurately disclose corporate moves, and couldn't measure its own inventory, expenses or liabilities. In all, Biolase conceded "11 material weaknesses" in its accounting and was forced to re-file accurate reports going back to 2003.
Thanks also to Sarbanes, United Pan Am Financial Corporation of Newport Beach reported in July that its financial reports had been inaccurate. "While we believe that our disclosure controls and procedures have improved due to [Sarbanes], our management, including the chief executive officer and chief financial officer, have concluded that the design and operation of our disclosure controls and procedures were not effective at June 30, 2005." The company says it will re-file accurate disclosure reports back to 2003.
Corinthian Colleges, Inc., of Santa Ana reported higher administrative fees, in part because of Sarbanes. But the company acknowledged that compliance with the reform law revealed "incorrect" information in financial statements for four years, from 2001 to 2004. The company said it will re-file the disclosure reports showing multimillion-dollar changes. It's in litigation over the inaccuracies and has attracted the attention of the California attorney general.
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But these are facts, and facts aren't likely to play a factor in the campaign to kill Sarbanes. Three days after the Register's new story on Cox's move to "relieve" companies of the "burdens" of the reform law, the conservative Washington Times applauded. It is "increasingly clear . . . from startling evidence," the Times editorialized, that Cox must "bring reason back" by aiding "aggrieved executives." Cox, the paper said, is the man to do the job. "We look forward to the SEC's moves under his stewardship to correct the problem."
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