The Perverse Consequences Of Sarbanes-Oxley

from the in-the-dark dept

The long-sluggish IPO market staged a rebound in 2006, leading some to conclude that all of the whining about Sarbanes-Oxley and the cost of being a public company was just that, whining. But there’s still plenty of evidence suggesting that Sarbanes-Oxley is a real burden on public companies. In addition to the direct costs of compliance, you can see it in the explosion in private equity and management buyouts, as the smart money realizes that there are advantages to being private. Bloomberg points to another perverse effect of the legislation: companies are realizing that they’re best off if they can keep things completely in the dark, as opposed to making them open. The example it cites is the corporate bond market, where there’s a flourishing practice of selling unregistered bonds to institutions. Typically, if a company had a bond offering, it would have to register that with the SEC, a process that’s become quite burdensome. But, if the bonds are just traded among institutions, with no plans to make them available to the public, then the company doesn’t have to file anything. This practice has grown by 50% in the last two years, far outstripping the rest of the market. Of course, unregistered bonds carry a higher degree of risk, but because there’s a high demand for bonds these days, it’s a risk that buyers are willing to take. This is obviously the opposite of what Sarbanes-Oxley intended, but it’s the natural result of a law that imposes higher costs on companies that report publicly.

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Comments on “The Perverse Consequences Of Sarbanes-Oxley”

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MyNameIsMatt (user link) says:

I'm but where's the harm?

Again, I wait to see what techdirt can comment on that is a direct problem with SOX. All I see is one article about the bad unregisterted bond market. Yeah, there are risks with buying unregistered bonds that don’t disclose as much information as full disclosed bonds would. Duh. Does that mean that full disclosure of financial statements and the full backing by the board and executive is then bad? No, and I’d actually say that it’s good unless you can actually point to the part of SOX that is actually a burden.

Then in the other article you have VCs complaining about the extra costs of SOX in taking a company public. In the first you have executives complaining, and in the second you have VCs complaining, but you don’t have investors complaining in either. Why? Because SOX helps investors, not VCs or executives. Is that bad? No, unless you’d like to actually point out a problem with greater financial disclosure, greater financial honesty from corporations.

The market isn’t there to support anyone that wants to be public. It’s there to offer funding options and open up ownership of a company to the public. If it’s too much of a burden being financially honest for a company, then don’t expect to let investors put their money into your company.

And the IPO market has almost nothing to do with SOX because they’re starting from zero. The real costs with SOX is from established companies that don’t have good report procedures in place and have to change everything. If a company is going public, especially one supported by a VC, then they’re likely new, and should already know the SOX requirements, hence no extra costs. The IPO market has been in a slump because of corporate fraud from the likes of Enron and the tech burst which ran up the IPO market, so of course VCs are looking for excuses.

Andy says:

Re: I'm but where's the harm?

IPO’s are all new companies??? Wha??? Google, eBay, Vonage, etc, etc. I’m trying to recall the last company that IPO’d it’s first day in business. I’m sure there are examples, but statistically most IPO’s are companies that have been operating and working toward a public offering. My .02 FWIW.

C.G. (user link) says:

SOX does hurt the investor and doesn't prevent fra

SOX does hurt the investor.

One, by adding extra expenses to the company; dividends are affected and so is the stock price. Yes, this affects all public companies and one can assume that all are burdened with similar expenses and thus keeping the field level. But the fact that dividends and capital investments can suffer from these extra regulatory based expenses means SOX inhibits growth across the board.

Second, SOX makes US companies less competitive relative to the rest of the world. Compare % growth of listings on the foreign exchanges to the US growth and you will see a difference – also look at the number of new business registered here vs other financial environments like the UK. SOX creates red tape that other countries don’t have to go through… the slowness to react to changing business threats – global threats – means the US can’t be treated equally in the economy.

Third, SOX can inhibit decision making. I know from first hand experience here where, in the past, I’ve seen company directors not make decisions that can positively affect their business, their customers, and their employees for fear that it puts them at risk for some kind of legal action. As far fetched as it seems, no one is willing to go on the record for approving a decision because it could come back to haunt them.

Fourth, SOX doesn’t prevent fraud or irresponsible spending. It still happens. Just because the law is what it is doesn’t prevent a company from spending money irresponsibly. If the board of directors all pay for a private jet, who’s to stop them? Think about how Ford was sending their CEO home on one of those… think about Goldman Sachs and the huge bonuses paid out to their CEO and head traders. Think about the NYSE and it’s former CEO. The board might be fully aware of these “perks” but it doesn’t stop them from happening.

Fifth, “Private Equity” is bigger now than it ever has. Companies are going private – saying PE partnerships are taking over. That’s just another way to say we think we can do more for the company faster than we could with the company being public. The share system might still exist afterwards but simply privately owned as an LP or some other entity. There is no coincidence that PE is so large – VC’s know that the idea isn’t to go public anymore – it knows that the money has shifted from the IPO world to the PE world and its there to attract it. Even the retail investor can get in on PE relationships now and its no wonder with SOX.

In the end, the whole country loses with SOX except for the lawyers, auditors, and implementation consultants. They are the real harm you are looking for.

Fat Cigar says:

SOX is ruining my fun

Why should I have to be legally responsible for my management decisions. I didn’t rise to this level to be answering to a bunch of loud mouth investors. WTH do thy think they are? I am very busy jetting around the world and dreaming up lies to make myself richer. Being responsible is just to hard nowadays. I think I’ll demote myself to Mailroom Boy and give up my salary, options and golden parachute now that it is hard. After all this, I now realize that they aren’t just paying me for my looks and efficient use of buzzwords. I guess I don’t like this new paradigm.

Steve says:

SOX is a necessary inconvenience

As a business analyst, I get to see how companies actually work, but from an outsider’s perspective. External competition and internal politics lead all companies to either short-circuit needed controls or to simply live without them. This happens at all levels, and it can be disastrous when the CFO joins in, as we have all seen. Sadly, only external forces, such as SOX, can provide the impetus to cause publicly traded companies to stay above board, and not just the Enron’s of the world.

Given the nature of the stock market, allowing companies to conceal their true situations cannot be tolerated. SOX does add operating costs, but those costs are necessary for the stability of the public markets, and they are spread evenly across the board for all publicly held companies.

As far as keeping companies private, that is certainly an option, but I doubt that it will become a significant trend. If it does, then that is simply an adjustment that will be driven by the emerging market forces of the 21st century.

As far as foreign competition, I know Japan has passed legislation, which has been dubbed JSOX, for exactly the same reasons SOX was adopted. Established economies with publicly traded companies simply have to have these sorts of controls to maintain order.

Companies that do not have these external controls may have lower operating costs, but they will have a more difficult time raising capital on the public market because the investment community will be rightfully suspicious of them. In addition, companies that have no controls tend to implode, which is the real impetus behind SOX and JSOX in the first place.

Last, I can’t prove this, but I suspect that the additional costs of SOX will be offset in the long term by improved operating efficiencies. Unmonitored processes generally end up being easier for those directly involved, but they create inefficiencies for the company as a whole. Process auditing will go hand-in-hand with process improvement programs, and managers will no longer be able to conceal or rationalize their inefficient processes. SOX may actually be a blessing in disguise.

MyNameIsMatt (user link) says:

SOX stuff

Andy, you’re right, IPOs don’t happen day one, they happen to companies that have been around for usually five years already, sometimes longer, but they’re still considered new companies that are not yet matured on a large scale at least.

CG, I don’t buy the extra costs argument having been in and am in technology as an implementor of better reporting/monitoring/tracking/auditing of financials. It’s almost unbelievable that companies have been allowed to not do some of this very basic stuff like know who gave who a raise and bonus. Nothing I’ve dealt with in SOX regulations have added any significant layer of cost and once they’re in place it’s all smooth and easy. Usually with a better process in place.

Growth % is a dubious number to compare and actually has a negative correlation with real returns, which is what you want. China has great growth, but after diluted share price and such where’s the return? Gone down the drain. Established economies are where the return is such as in the US or the UK, and it’s been like this long before SOX was around.

I don’t buy your argument that SOX has kept anyone from making GOOD decisions. Such as? Why would SOX effect decision making? All it does is increase the transparency of financials. It doesn’t stop someone from changing a business model or producing a new product or service that customers want. If you’re worried about the cost of recording and reporting the funding involved in opening new business, then there is probably something wrong with the funding method that would keep a person from wanting to honestly and clearly report it.

“If the board of directors all pay for a private jet, who’s to stop them?” The investors should by selling the company and demanding a better CEO and CEO/board compensation package. SOX doesn’t guarantee good decision making. It just requires the open and honest reporting of financial information, such as if the board all buy private jets, and making SOX it into anything else is either dishonest or ignorant. Yes, it won’t necessarily stop fraud either, it wasn’t meant to whole sale, but it will make fraud that much tougher when you have to report things like offshore majority holding such as Enron constructed to hide debt and instead write it off as unrelated corporate loans or whatever else.

If companies prefer to stay private power to them. Going public adds tons of headaches for executive like actually being accountable to the people that actually own the company aka investors, which is why a certain level of financial openness is required.

Foreign companies will want to continue listing in American markets because they’re the most established and well run markets around. There’s nothing else like raising funds on a US stock market, and the added cost to the company of possibly implementing new and better financial reporting is well worth the cost for honest companies. If anything, this strengthens the American market and makes them more advantageous because that’s where investors will want to put their money. Why risk your money in a market and with companies that won’t fully disclosure their financial situation and are allowed to get away with fraud once they’re caught, or let go with less penalty? More investors surely want an honest market over a dishonest one, and that’s what SOX helps provide, although, nothing is a silver bullet and there are not 100% guarantees.

No Pain No Gain says:

No Pain no gain

Well if nobody complained about SOX then it wouldn’t be working! SOX was introduced because you had major corporate fraud and Joe sixpack was losing their pensions and savings.

If any company complains about SOX, find out exactly which part they are complaining about and then investigate them for that.

Complaining about CEO & CFO signing off the accounts? Then the accounts are false and the CEO CFO know it.

Complaining about the cost of documenting how they checked the accounts? Then the checks haven’t been done, the numbers are unreliable and the CEO and CFO know it.

Complaining about disclosure of cost of share option grant? Then CEO & CFO treating shareholders as revenue stream.

Complaining that it makes USA companies less competitive? Being #1 in the corporate fraud arena is a *bad* thing.

Heather says:

Re: Re:

Here’s some food for thought – Enron would have passed SOX – there would have been no change to the “structured” finance arrangements. The only thing it would have done is preempt the executives defense of not “understanding” what they were signing off on when they signed the financial statements.

I work for a major corp and SOX is a HUGE expense. Our division accounts for less than 20% of the overall corporate revenue and yet we have a full time team of 5 just for SOX. Plus it’s the only team that travels, everyone else uses video conferencing. Every project, every process has someone assigned just to ensure SOX compliance.

a says:

SOX doesn’t prevent fraud, but it does punish those that commit fraud. Thats the point of it.

Why do you think the punishment of failure to provide proper oversight is about the same as commiting fraud? Its because the govt. knows that senior executives will do things that can’t be proven. Everyone in the world knows that the executives were doing things that were against the law, but execs were smart enough to do things in a way that made sure that it couldn’t be proven. The govt. said fine, sign on the dotted line, the buck stops with you.

Compliance officers and compliance departments were created to insulate senior executives. They play a balancing act (because their job in fact is to ensure that a company makes less money) between not ending up in jail and not getting canned. They look at their position, their career and determine how much money they have and can they retire before being sent to jail. Thats why they get paid the big bucks. They are the airbags of the company. They protect the senior executives.

Do away with SOX? Why in the world would anyone want to do that? (unless of course, you are a senior executive)

Joe Smith says:

Human nature

Doubtful that SOX will fix problems like Enron. Some of the people at Enron knew they were committing frauds – the rest thought someone else had made sure the deal was ok. One more law saying it is a fraud is not going to change things much. The people at Enron had already been told that it was wrong to steal – they either didn’t know what “steal” meant in this context or didn’t care.

Heather B says:

The government is only protecting itself and your

The government cares about SOX because IT usually ends up bailing out companies when significant fraudulent events occur. IF our government would mind its own business and let the markets run freely, investors would quickly identify those companies that are run poorly, and would move their funds elsewhere.

The majority of investment dollars are still institutional. As such, the people managing the investment decisions are generally well educated.

Take away the safety net…go through a few painful situations (while people learn who not to trust)…and all will be good 🙂


PS I think the ideas behind SOX are good. I just think many of the requirements should be part of GAAP or GAAS, and applicable across the board. Then companies would just build it into standard operating procedure. The goverment’s failure to be specific (esp. with regard to IT) has resulted in large payloads for the consultants and serious costs to the companies.

Anonymous Coward says:

MyNameIsMatt and many other posters have it right.

I can’t understand why ordinary people buy in to the self serving, red herring spouting whining of corporations.

The executives in those companies don’t give a rats butt about anyone except themselves. They certainly don’t care about their stockholders or their employees – even the ones who really care about the HUGE costs.

Get real. Corporate America earned SOX fair and square, just as they did the anti-trust, food safety, labor laws and many others. These laws were passed because they were NEEDED.

Our government’s job is to protect its citizens.

Anonymous Coward says:

“IF our government would mind its own business and let the markets run freely, investors would quickly identify those companies that are run poorly, and would move their funds elsewhere.

The majority of investment dollars are still institutional. As such, the people managing the investment decisions are generally well educated.”

So how was Enron’s stock pumped up to such high prices?


Heather B says:

The government's job...

To the anonymous coward…

Please take a few minutes to read the United States Constitution. I have a copy if you’d like to borrow it…

While you’re at it, you might read up on economics as well…

Will SOX prevent corporate corporate fraud? Absolutely not. It will make it more difficult, but all it takes is a little collusion among certain job roles. The character of our corporate leadership and the compensation systems driving them matter exponentially more than legislation. Good luck legislating character requirements…

Every time you ask the government to *protect* you, you are asking them to take your money and your freedom away. Do me a favor – read “V For Vendetta” (also a great movie) by Alan Moore and David Lloyd or 1984 by George Orwell. That way you can see what your life will be like in 15-20 years…

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